Alan Dignam, John Lowry Company Law Butterworths core text series Core Texts Series


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Company Law:
Alan Dignam and John Lowry
Constitutional and Administrative Law:
Neil Parpworth
Criminal Law:
Nicola Padeld
Employment Law:
Robert Upex, Richard Benny and Stephen Hardy
European Union Law:
Margot Horspool and Matthew Humphreys
Evidence:
Roderick Munday
Family Law:
Mary Welstead and Susan Edwards
Intellectual Property Law:
Jennifer Davis
Land Law:
Kevin Gray and Susan Francis Gray
Medical Law:
Jonathan Herring
The Law of Contract:
7/20/2012 5:08:04 PM
For
Alastair, Alex and Yasmin
Liz, Grainne, Iris and Laurence
7/20/2012 5:08:10 PM
Company Law
Seventh Edition
School of Law, Queen Mary, University of London
JOHN LOWRY
Faculty of Laws, University College London
and Honorary Fellow, Monash University
NICOLA PADFIELD
Fitzwilliam College, Cambridge
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Company law is a di
cult subject. We know this because each year our student
feedback tells us so. 
ere are two reasons for this. First, company law has become
a quasi-core subject with students choosing it because they regard it, not unnatu-
rally, as an essential requirement for pursuing a career as a commercial lawyer.
e fact that many students may not have the skills best suited to studying com-
pany law never seems to put students o
and is o
en at the root of a poor to
mediocre performance in the exams. So what are the essential skills needed? A
good knowledge of contract, a proper understanding of equity, good statutory and
common law interpretation skills and a certain 
exibility of mind needed to deal
with the legal creation of corporate personality. With this base of skills a student
will be equipped to deal with the hazardous waters of company law. If you think
you dont have these essential skills then put this book down and rethink your
options. Choose subjects based around the skills you have already identi
ed as
your strongest. It is best to do this now rather than su
er through an unhappy year
of company law.
e second reason that students 
nd company law di
cult is that it is not until the
end of the course that they see how the various parts of company law 
t together.
is is because company law is much like a jigsaw puzzle made up of smaller pieces
that 
t together to form a larger picture. Unfortunately, unlike a jigsaw puzzle you
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Preface
the fundamental principles which underlie company law and those areas of the
law which are necessarily encountered when a company is 
rst brought into exist-
ence. Part II focuses on what goes on behind the corporate veil; it considers con-
stitutional matters, classes of shares and shareholders rights and remedies. Part
III examines issues of authority that arise when business is conducted through
a company. It deals with how power is allocated to transact with outsiders, the
companys principal organ of management and the duties of directors. Emphasis
is also given to corporate governance and how the corporation can be best accom-
modated within the various corporate theories that have been developed over the
last two hundred years or so. At the end of each chapter there is a list of Further
Reading which we have selected as particularly useful for 
eshing out the topic
just covered. Additionally we have provided an extended list of reading for each
chapter in the Select Bibliography at the end of the book. If we have discussed
an article or book in a chapter the full reference to it will be found in either the
Further Reading or the Select Bibliography.
Students of the subject will soon learn that company law has been in a state of
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Preface
Primary authorship of each chapter is as follows: Alan Dignam contributed
Chapters 1, 2, 3, 5, 8, 12, 15 and 16; John Lowry contributed Chapters 4, 6, 7, 9, 10,
11, 13, 14 and 17.
We have tried to state the law as at 30 April 2012.
Alan Dignam
and
John Lowry
London
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New cases on veil li
ing, including
Chandler v Cape Plc
(2011), and
Linsen
International Ltd v Humpuss Sea Transport Pte Ltd
Discussion and analysis of UK and EU corporate governance reports.
Coverage of the Supreme Courts decision in
Commissioners for HM Revenue and
Customs v Holland
- de facto directors.
Coverage of recent case law on Part 11 CA 2006 - the derivative claim.
Coverage of
R (on the application of People & Planet) v HM Treasury
on s 172 CA
2006 (duty to promote the success of the company).
Coverage of
Sinclair Investments (UK) Ltd v Versailles Tra
ding Finance Ltd
rem-
edies for breach of 
duciary duties
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ere are a number of features throughout the textbook designed to
help you in your studies.
highlight
what will be addressed in each
chapter, so you are aware of
the key learning outcomes for
each topic.
At the end of each chapter
is a list of recommended
ese
suggestions include books
and journal articles, and will
help to supplement your
knowledge, and develop your
understanding of key topics.
Each chapter concludes with a
selection of
self-test questions
ese allow you to check your
understanding of the topics
covered, and help you engage
fully with the material in
preparation for further study,
writing essays, and answering
exam questions.
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Special thanks to the Financial Reporting Council for allowing us to reproduce
extracts from the UK Corporate Governance Code and the Stewardship Code
(see p.309 and p.443).
Financial Reporting Council (FRC). Adapted and reproduced with the kind
permission of the Financial Reporting Council. All rights reserved. For further
information, please visit www.frc.org.uk or call +44 (0)20 7492 2300.
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Table of Legislation xviii
Table of Cases xxix
PART I
Introduction to company law 3
Forms of business organisation
e sole trader
e partnership
e company
SELF-TEST QUESTIONS
Corporate personality and limited liability 15
Introduction
15
Corporate personality
15
Salomon
and the logic of limited liability
18
Some other good examples of the consequence
of separate personality
23
Members, shareholders and the ownership of the corporation
25
SELF-TEST QUESTIONS
Lifting the veil 31
Introduction
31
Statutory examples
32
Veil li
ing by the courts
34
Classical veil li
ing, 18971966
35
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Contents
e interventionist years, 19661989
35
Back to basics, 1989present
37
Tortious liability
43
Parent company personal injury tortious liability
44
Commercial tort
46
e costs/bene
ts of limited liability
48
SELF-TEST QUESTIONS
Promoters and pre-incorporation contracts 53
Introduction
53
De
ning the term promoter
53
Promoters as 
duciaries
55
Pre-incorporation contracts
58
Section 51 CA 2006: pre-incorporation contracts,
deeds and obligations
60
Freedom of establishment
62
SELF-TEST QUESTIONS
Raising capital: equity and its consequences 65
Introduction
65
Public and private companies
66
Methods of raising money from the public
69
e Financial Services Authority and the London Stock Exchange
70
e regulation of listed companies
72
e regulation of takeovers
75
Insider dealing
80
e regulation of other public o
ers
84
Sanctions
85
e regulatory regime
86
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xiii
SELF-TEST QUESTIONS
Raising capital: debentures:
xed and
oating charges 89
Introduction
89
Types of loan capital
90
Secured borrowing: company charges
92
Book debts
98
Crystallisation
102
Priority of charges
104
Registration of charges
105
Reform
108
SELF-TEST QUESTIONS
PART II
Behind the Corporate Veil
Share capital 119
Introduction
119
Receiving proper value on issue of shares
122
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Contents
e contract of membership
159
A contract between the company and the members
160
A contract between the members?
161
Who can sue?
163
Outsider rights
165
Reform
166
Shareholder agreements and statutory e
ects
167
SELF-TEST QUESTIONS
Classes of shares and variation of class rights 172
Introduction
172
e legal nature of a share
173
Class rights
174
Preference shares
176
Variation of class rights
178
EU initiatives
183
SELF-TEST QUESTIONS
Derivative claims 186
Introduction
186
e rule in
Foss v Harbottle:
the proper claimant principle
188
e types of shareholder actions
190
Exceptions to the rule in
Foss v Harbottle
195
e statutory procedure: Companies Act 2006, Part 11
201
Section 996(2)(c) Companies Act 2006
211
Bars to a derivative action
212
Liability insurance and qualifying third party indemnity provisions
212
Conclusion
213
SELF-TEST QUESTIONS
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xv
Statutory shareholder remedies 216
Introduction
216
Unfairly prejudicial conduct: CA 2006, Part 30 (ss 994996)
225
Other speci
c statutory minority rights
259
e Law Commissions proposals for reforming
the unfair prejudice provision
261
SELF-TEST QUESTIONS
PART III
Issues of Corporate Authority
The constitution of the company: dealing with outsiders 269
Introduction
269
e ultra vires doctrine
270
e reform of ultra vires
275
Agency
277
Statutory authority
280
SELF-TEST QUESTIONS
Corporate management 288
Introduction
288
e emergence of the professional managerial organ
289
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Contents
Directors duties 331
Introduction
331
e 
duciary position of directors
333
To whom do directors owe their duties?
335
e general duties of directors: CA 2006, Part 10
339
383
Accessory liability
387
Consent, approval or authorisation by members
389
Substantial property transactions
391
Loans, quasi-loans and credit transactions
392
Rati
cation of acts giving rise to liability
393
Relief from liability
394
SELF-TEST QUESTIONS
Corporate governance 1: corporate governance and corporate theory 400
Introduction
400
A brief history of corporate governance
400
Corporate theory
403
Global corporate governance
415
SELF-TEST QUESTIONS
Corporate governance 2: the UK corporate governance debate 421
Introduction
421
e background to the UK debate
421
A word on UK corporate theory
423
e corporate governance debate: the industry response
425
e corporate governance debate: the Government response
430
Corporate governance failure and the 
nancial crisis
440
e Walker Report 2009
441
Ongoing Reform
442
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xvii
SELF-TEST QUESTIONS
Corporate rescue and liquidations 448
Introduction: Corporate rescue
448
Liquidations
452
Voluntary winding-up
453
Compulsory winding-up
456
e consequences of a winding-up petition on
dispositions of company property
461
Winding-up in the public interest
465
e duties and functions of the liquidator
466
Avoidance of transactions entered into prior to the liquidation
472
e personal liability of directors under the Insolvency Act 1986
477
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Arbitration Act 1996
Companies Act 1862 . . . 7.6
Companies Act 1929 . . . 5.22
Companies Act 1948 . . . 3.5, 3.6, 11.3,
Companies Act 1980 . . . 11.1, 14.95
Companies Act 1981 . . . 10.16
Companies Act 1985 . . . 1.10, 5.19, 6.47,
Pt XVII . . . 11.21
ss 162A162G . . . 7.35
s 459 (now s 994 CA 2006) . . . 1.25,
s 461 (now s 996 CA 2006) . . . 10.42,
Companies Act 1989 . . . 6.45, 8.10, 11.22,
Table of Legislation
Paragraph numbers in
bold
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Table of Legislation
Companies Act 2006 . . . 1.14, 1.21, 1.22,
Chp 5 . . . 4.5
s 33 . . . 1.13, 8.1, 8.24, 8.28, 8.29, 8.32,
8.33, 8.37, 9.5, 10.1, 10.3, 10.19,
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Table of Legislation
14.36, 14.40,
16.27
s 172(1)(b) . . . 14.35
16.27
s 172(3) . . . 14.36, 14.38, 14.40, 14.41,
16.27
s 173 . . . 14.7, 14.8, 14.44, 14.79, 14.83
s 174 . . . 10.32, 14.7, 14.8, 14.33, 14.49,
14.50, 14.51, 14.79, 14.83
s 174(1) . . . 14.45
14.45
, 14.51
s 175 . . . 10.38, 14.7, 14.8, 14.13, 14.53,
14.69, 14.79, 14.82, 14.83, 14.92
s 175(1) . . . 14.53, 14.54, 14.77
s 175(4)(a) . . . 14.55, 14.72
s 175(4)(b) . . . 14.54, 14.83
s 175(7) . . . 14.73, 14.74
s 176 . . . 14.7, 14.8, 14.13, 14.69, 14.79,
14.83, 14.92
s 176(1)(3) . . . 14.82
s 177 . . . 13.23, 14.7, 14.8, 14.53, 14.78,
14.79, 14.83, 14.92
s 177(1) . . . 14.77
s 178(1) . . . 14.83
s 179 . . . 14.13
s 180(4) . . . 14.82, 14.92
s 182 . . . 14.53, 14.78, 14.79
s 188(5)(a) . . . 13.32
s 189 . . . 13.28, 13.31, 13.46
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Table of Legislation
. . . 7.1
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Table of Legislation
. . . 7.1
. . . 7.1
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Table of Legislation
Companies (Audit, Investigations
and Community Enterprise) Act
Companies Clauses Consolidation Act
Company Directors Disquali
cation Act
(CDDA) 1986 . . . 13.17, 13.18, 13.21,
ss 9A9B . . . 13.79
Sch 1 . . . 13.62
Consumer Credit Act 1974
Contracts (Rights of 
ird Parties) Act
Copyright Designs and Patents Act
Corporate Manslaughter and Corporate
Homicide Act 2007 . . . 12.40
Courts and Legal Services Act 1990
Criminal Justice Act 1993
Criminal Justice and Police Act
Employment Rights Act 1986 . . . 3.4
Enterprise Act 2002 . . . 6.7, 17.2, 17.9,
European Communities Act 1972
Financial Services Act 1986 . . . 5.11, 5.12
Financial Services Act 2010 . . . 5.11, 5.48
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Table of Legislation
Sch 1
Insolvency Act 1985 . . . 13.51, 13.57
Insolvency Act 1986 . . . 3.4, 7.41, 14.40,
s 74(2)(f) . . . 17.50
s 122(1)(f) . . . 17.8
s 176ZA . . . 17.47
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Table of Legislation
Sch 1 . . . 17.5
Sch 4 . . . 17.42
para 4 . . . 10.43
Sch 6 . . . 17.48, 17.49
Sch B1
para 3(1) . . . 17.3
para 10 . . . 17.4
para 14 . . . 17.4
para 22 . . . 17.4
para 4658 . . . 17.5
Insolvency Act 2000 . . . 13.69, 13.78,
Joint Stock Companies Act 1844 . . . 2.6,
Joint Stock Companies Act 1856 . . . 2.10,
Land Charges Act 1972 . . . 6.32
Limitation Act 1980 . . . 3.38
Limited Liability Act 1855 . . . 2.10
Limited Liability Partnerships Act
Limited Partnership Act 1907 . . . 1.5
Merchant Shipping Act 1894 . . . 12.36
Partnership Act 1890 . . . 1.4, 1.5
Registered Homes Act 1984 . . . 7.53
e
Act 1968
Trade Descriptions Act 1968 . . . 12.38
Workers Compensation Act 1922 . . . 2.29
Statutory Instruments
Chancery Practice Direction
Civil Procedure (Amendment) Rules 2007,
SI 2007/2204
Sch 1 . . . 10.39
Civil Procedure Rules 1998, SI
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Table of Legislation
rs 19.9A19.9F . . . 10.33, 10.39
Practice Direction 19C . . . 10.33
Pt 49B Practice Direction . . . 11.76
para 9(1) . . .
Companies (Acquisition of Own Shares)
(Treasury Shares) Regulations 2003, SI
Companies Act 1985 (Operating and
Financial Review and Directors
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Table of Legislation
Sch
paras 14 . . . 5.13
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Table of Legislation
Directive 2004/25/EC Takeovers
Directive . . . 5.313
Directive 2004/38/EC . . . 4.22
Directive 2004/109/EC Transparency
Directive . . . 5.19, 5.21
Directive 2006/68/EC (amending Dir
Directive 2007/36/EC Shareholders Rights
Directive . . . 5.19, 9.29
Directive 2010/73/EU Prospectus
Directive . . . 5.41
h (Dra
) Directive on Company Law
[1972] OJ C131/49 . . . 13.3, 16.20
Fourteenth (Dra
) Company Law
harmonization Directive . . . 4.23
Regulation 1346/2000 Insolvency
Proceedings Regulation . . . 17.9
National Legislation
New Zealand
Companies Act . . . 2.27
United States of America
Sarbanes-Oxley Act 2002 . . . 16.345
Securities Exchange Act 1934
Uniform Commercial Code
art 9 . . . 6.44, 6.46
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Table of Cases
4Eng Ltd v Harper (2008) Times, 23
June . . . 17.58
A and BC Chewing Gum Ltd, Re, Topps
Chewing Gum Inc v Coakley [1975] 1
A-G for Hong Kong v Reid (1992), NZCA;
on appeal [1994] 1 AC 324, PC . . . 14.83,
A-G v Belfast Corpn (1855) 4 IR Ch
A-G v Great Eastern Railway (1880) 5 App
Cas 473, HL . . . 12.9
A I Levy (Holdings) Ltd, Re [1964] Ch
Abbington Hotel Ltd, Re [2011] EWHC
Aberdeen Railway Co v Blaikie Bros (1853)
Adams v Cape Industries plc [1990] 1 Ch
Advance Bank of Australia Ltd v FAI
Insurances Australia Ltd (1987) 5 ACLC
AG (Manchester) Ltd (in liq); O
cial
Receiver v Watson (2008) [2008] 1
BCLC 321 . . . 13.62, 13.66
Agip (Africa) Ltd v Jackson [1991] Ch
Agnew v IRC [2001] 2 BCLC 188,
Airbase (UK) Ltd [2008] EWHC 124
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Table of Cases
Automatic Bottle Makers Ltd, Re [1926] Ch
Automatic Self-Cleansing Filter Syndicate
Co Ltd v Cunninghame [1906] 2 Ch 34,
Aveling Barford Ltd v Perion Ltd [1989]
BCLC 626 . . . 7.17, 7.18, 7.19
Bairstow v Queens Moat Houses plc [2001]
EWCA Civ 712 . . . 7.13, 7.14, 14.7,
Baker v Potter [2005] BCC 855 . . . 11.60
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Table of Cases
Benjamin Cope & Sons Ltd, Re [1914] 1 Ch
Bentley Stevens v Jones [1974] 1 WLR
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Table of Cases
Brunninghausen v Glavanics (1999) 46
Bryanston Finance Ltd v De Vries (No 2)
Bugle Press, Re Houses and Estates
Ltd (1961), a d [1961] Ch 270,
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Table of Cases
CL Nye Ltd, Re (1971), revsd [1971] Ch
Clark v Cutland [2004] 1 WLR 783,
Clemens v Clemens Bros Ltd [1976] 2 All
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Table of Cases
Coutts & Co v Stock [2000] 1 WLR
Cox v Cox [2006] EWHC 1077
Crabtree v Ng [2012] EWCA Civ 333 . . .
Craven Textile Engineers Ltd v Batley
Football Club Ltd (2000) unreported, 7
July, CA . . . 14.79
Craven-Ellis v Canons Ltd [1936] 2 KB
Cream Holdings Ltd v Davenport [2011]
EWCA Civ 1287 . . . 8.16
Creasey v Breachwood Motors Ltd [1993]
BCLC 480 . . . 3.268, 3.29, 3.30
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Table of Cases
(Livingstone, third parties) [2003] 2 AC
Duckwari plc (No 2), Re [1998] 2 BCLC
Duckwari plc (No 3), Re [1999] 1 BCLC
Duomatic, Re [1969] 2 Ch 365,
Dyment v Boyden (Liquidator of Pathways
Residential and Training Centres Ltd)
7.53, 7.54Eastford Ltd v Gillespie [2010] CSOH
Ebrahimi v Westbourne Galleries Ltd
[1973] AC 360, HL . . . 1.21, 11.3, 11.9,
Edwards v Halliwell [1950] 2 All ER 1064,
EIC Services Ltd v Phipps [2004] 2 BCLC
El Ajou v Dollar Land Holdings plc [1994]
Elder v Elder & Watson Ltd [1952] SC
Eley v Positive Government Security
Life Assurance Co (1876) 1 Ex D 88,
Elgindata Ltd, Re [1991] BCLC 959, revsd
sub nom Elgindata Ltd (No 2), Re [1993]
Ellis v Property Leeds (UK) Ltd [2002] 2
BCLC 175, CA . . . 10.11
English and Scottish Mercantile Investment
Co v Brunton [1892] 2 QB 1; a d [1892]
2 QB 700, CA . . . 6.33
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Table of Cases
Foster Bryant Surveying Ltd v Bryant
[2007] EWCA Civ 200 . . . 14.71, 14.72
4Eng Ltd v Harper (2008) Times, 23
June . . . 17.58
Framlington Group plc v Anderson [1995]
1 BCLC 495, ChD . . . 14.65, 14.69
Franbar Holdings v Patel [2008] EWHC
Freeman & Lockyer v Buckhurst Park
Properties Ltd [1964] 2 QB 480,
Frenchs Wine Bar Ltd, Re [1987] 3 BCC
FSS Travel and Leisure Systems Ltd v
Johnson [1998] IRLR 382 . . . 14.70
Fulham Football Club (1987) Ltd
v Richards [2011] EWCA Civ
Fulham Football Club Ltd v Cabra Estates
plc [1994] 1 BCLC 363, CA . . . 14.43
Furs Ltd v Tomkies (1936) 54 CLR
G & T Earle Ltd v Hemsworth RDC
(1928), a d (1928) 44 TLR 605,
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Table of Cases
Great Wheal Polgooth Co, Re (1883) 53 LJ
Greenhalgh v Arderne Cinemas Ltd [1951]
Gregson v HAE Trustees Ltd [2008]
EWHC 1006 (Ch) . . . 14.51
Gri
ths v Yorkshire Bank plc [1994] 1
Grimes v Harrison (1859) 53 ER
Gross v Rackind [2004] 4 All ER 735,
Grupo Torras SA v Al-Sabah [2001] Lloyds
Guidezone Ltd, Re [2000] 2 BCLC
Guinness v Land Corpn of Ireland (1882) 2
Guinness plc v Saunders [1990] 2 AC 663,
Gwembe Valley Development Co Ltd v
Koshy [1999] 2 BCLC 613 . . . 14.74,
Halle v Trax BW Ltd [2000] BCC
Halt Garages (1964) Ltd, Re [1982] 3 All
Harborne Road Nominees Ltd v Karvaski
[2011] EWHC 2214 (Ch) . . . 11.73
7/20/2012 5:08:23 PM
Table of Cases
Hunter Kane Ltd v Watkins [2003] EWHC
Hutton v West Cork Railway Co (1883) 39
Hydrodam (Corby) Ltd, Re [1994] 2 BCLC
Hydroserve Ltd, Re [2007] All ER (D) 184
(Jun) . . . 17.49
IC Johnson & Co Ltd, Re [1902] 2 Ch 101,
Iesini v Westrip Holdings Ltd [2009]
EWHC 2526 (Ch) . . . 10.33, 10.38
Illingworth v Houldsworth see Yorkshire
Woolcombers Association, Re
Houldsworth v Yorkshire Woolcombers
Association Ltd
In a Flap Envelope Co Ltd, Re [2003] BCC
In Plus Group Ltd v Pyke [2002] EWCA
Civ 370 . . . 14.65, 14.74
Industrial Development Consultants
(IDC) Ltd v Cooley [1972] 1 WLR
Inn Spirit Ltd v Burns [2002] 2 BCLC 780,
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Table of Cases
Kaye v Croydon Tramways Co (1898) 1 Ch
Kayley Vending Ltd, Re [2009] EWHC 904
Kaytech International plc, Re [1999]
2 BCLC 351; [1999] BCC 390,
Keech v Sandford (1726) 25 ER 223 . . . 14.7
Keenan Bros Ltd, Re [1986] BCLC
Kelner v Baxter (1866) LR 2 CP 174 . . . 4.7,
Kensington International Ltd v Congo
[2007] EWCA Civ 1128 . . . 3.30
Kiani v Cooper [2010] BCC 463 . . . 10.38,
Kinsela v Russell Kinsela Pty Ltd [1986] 4
Kleanthous v Paphitus [2011] EWHC 2287
Knight v Frost [1999] 1 BCLC 364 . . . 14.29
Knightsbridge Estates Trust Ltd v Byrne
[1940] AC 613, HL . . . 6.3
Knopp v 
ane Investments [2003] 1
BCLC 380 . . . 12.26, 14.102
Knowles v Scott [1891] 1 Ch 717 . . . 17.40
Koninklijke Philips Electronics NV v
Princo Digital Disc GmbH (2003)
unreported, 9 September, ChD . . . 3.45
Kregor v Hollins [1913] 109 LT 225,
Kuwait Asia Bank EC v National Mutual
Life Nominees Ltd [1991] 1 AC 187
Lady Forrest (Murchison) Gold Mine Ltd,
Lagunas Nitrate Co v Lagunas Syndicate
Landhurst Leasing plc, Re [1999] 1 BCLC
Lands Allotment Co, Re [1984] 1 CH 616,
Langley Ward Ltd v Trevor [2011] All ER
(D) 78 (Jul) . . . 10.33
LC Services Ltd v Brown [2003] EWHC
Leaf v International Galleries [1950] 2 KB
Lee v Chou Wen Hsien [1985] BCLC 45,
Lee v Lees Air Farming [1961] AC
Lee v Sheard [1956] 1 QB 192, CA . . . 10.8
Lee Panavision Ltd v Lee Lighting Ltd
[1992] BCLC 22, CA . . . 14.80
Leeds and Hanley 
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Table of Cases
Littlewoods Mail Order Stores Ltd v IRC
Lloyd v Casey [2001] 1 BCLC 454 . . . 11.23
Lo-Line Electric Motors Ltd, Re [1988] Ch
Loch v John Blackwood Ltd [1924] AC 783,
London and Mashonaland Co Ltd v New
Mashonaland Exploration Co Ltd (1891)
London and Paris Banking Corpn, Re
London School of Electronics Ltd, Re [1986]
Long v Lloyd [1958] 1 WLR 753,
Looe Fish Ltd, Re [1993] BCLC
Loquitur Ltd, Re; IRC v Richmond [2003]
EWHC 999 . . . 7.14, 7.108, 14.107,
Loteka Pty Ltd, Re (1989) 7 ACLC 1998
(Aus) . . . 17.33
Lowesto
Tra
c Services Ltd, Re [1986]
BCLC 81 . . . 17.25
Lubbe v Cape Industries plc [2000] 1 WLR
Lummus Agricultural Services Ltd, Re
[2001] 1 BCLC 81 . . . 17.25
Macaura v Northern Assurance Co Ltd
[1925] AC 619 . . . 2.301, 2.32, 9.1
McCarthy Surfacing Ltd, Re [2008] EWHC
MacDougall v Gardiner (1875) 1 Ch D 13,
on appeal (1875) 32 LT 653, CA . . . 8.30,
McNicholas Construction Co Ltd v
Customs and Excise Commissioners,
New Law Digest, 16 June 2000,
QBD . . . 12.39
MacPherson v European Strategic Bureau
Ltd (2000) 
e Times, 5 September,
revsd [2002] BCC 39, CA . . . 7.57, 14.80
Macro (Ipswich) Ltd, Re [1994] 2 BCLC
Madden v Dimond; Rudolf v Macey [1905]
12 BCR 80, BCCA . . . 14.25
Maidstone Building Provisions Ltd, Re
Mal Bowers Macquarie Electrical
Centre Pty Ltd, Re [1974] 1 NSWLR
Manurewa Transport Ltd, Re [1971] NZLR
Mashonaland Exploration Co Ltd v New
Mashonaland Exploration Co Ltd [1892]
Maxwell Communications Corpn plc (No
2), Re [1994] 1 BCLC 1 . . . 17.44
MC Bacon Ltd (No 2), Re [1991] Ch
MCA Records Inc v Charly Records Ltd
(No 5) [2002] EMLR 1, CA . . . 3.45
MCI WorldCom International Inc v
Primus Telecommunications Inc [2004]
EWCA Civ 957 . . . 12.25
MDA Investment Management Ltd, Re
[2005] BCC 783 . . . 14.107, 17.74
Mea Corporation Ltd, Re [2007] 1 BCLC
618; [2007] BCC 288 . . . 13.20
Measures Bros Ltd v Measures [1910] 2 Ch
Mechanisations (Eaglescli
e) Ltd, Re
Menier v Hoopers Telegraph Works
(1874) LR 9 Ch App 350, CA . . . 8.44,
Meridian Global Funds Management Asia
Ltd v Securities Commission [1995] 2
AC 500 . . . 12.39
Migration Services International Ltd, Re
[2000] 1 BCLC 666 . . . 13.61
Millam v 
e Print Factory (London) 1991
Ltd (2008) BCC 169 . . . 3.24, 3.34
Millennium Advanced Technology, Re
[2004] EWHC 711 . . . 17.38
Mills v Mills [1938] 60 CLR 150, HC
Aust . . . 14.25
Mission Capital plc v Sinclair [2008]
EWHC 1339 (Ch) . . . 10.37, 10.46
Mond v Hammond Suddards [2000] Ch
Morgan Grenfell v Welwyn Hat
eld
District Council (1993) unreported 3
June, QBD . . . 5.12
7/20/2012 5:08:23 PM
Table of Cases
Morphitis v Bernasconi [2003] EWHC Civ
Morris v Bank of India [2005] 2 BCLC
Morris v Kanssen [1946] AC 459,
Moseley v Ko
yfontein Mines Ltd [1904] 2
Mozley v Alston (1847) 41 ER 833 . . . 8.30,
MT Realisations Ltd v Digital Equipment
Co Ltd [2003] EWCA Civ 494,
Mullarkey v Broad [2008] 1 BCLC
Multinational Gas and Petrochemical
Co Ltd v Multinational Gas and
Petrochemical Services Ltd [1983] Ch
Mumbray v Lapper [2005] EWHC
Murad v Al-Saraj [2005] EWCA Civ
Murray v Bush (1873) 29 LT 217 . . . 13.17
Mutual Life Insurance Co of New York v
Rank Organisation Ltd [1985] BCLC
Natal Land Co & Colonization Ltd v
Pauline Colliery and Development
Syndicate Ltd [1904] AC 120
National Dock Labour Board v Pinn
and Wheeler Ltd (1989) BCLC 647,
National Provincial Bank v Charnley
National Telephone Co, Re [1914] 1 Ch
National Westminster Bank plc v Spectrum
Plus Ltd [2005] UKHL 41 . . . 6.15, 6.16,
Neptune (Vehicle Washing Equipment)
Ltd v Fitzgerald (No 2) [1995] BCC
New Bullas Trading Ltd, Re [1994] 1 BCLC
Newborne v Sensolid (Great Britain) Ltd
[1954] 1 QB 45, CA . . . 4.17
Newstead v Frost [1980] 1 WLR 135,
Nicholas v Soundcra
Electronics Ltd
[1993] BCLC 360, CA . . . 11.25, 11.26,
Noel v Poland [2001] 2 BCLC
Norman v 
eodore Goddard [1991]
BCLC 1028 . . . 14.50
North Holdings Ltd v Southern Tropics Ltd
[1999] 2 BCLC 625, CA . . . 11.68
North West Holdings plc, Re [2001] BCLC
North-West Transportation Co Ltd
v Beatty (1887) 12 App Cas 589,
Northern Engineering Industries plc, Re
[1994] 2 BCLC 709, CA . . . 9.23
Northumberland Avenue Hotel Co Ltd,
Re, Sullys Case (1886) 33 Ch D 16,
Norvabron Pty Ltd (No 2), Re (1986) 11
ACLR 33, FC (Qld) . . . 11.23, 11.26
Nuneaton Borough Association Football
Club Ltd, Re [1989] BCLC 454,
Nurcombe v Nurcombe [1985] 1 WLR
NW Robbie & Co Ltd v Witney Warehouse
Co Ltd (1963), revsd [1963] 1 WLR
Oak Investment Partners XII, LLP v
Boughtwood [2009] EWHC 176
Oakdale (Richmond) Ltd v National
Westminster Bank plc (1996), a d
[1997] BCLC 63, CA . . . 6.18
Oasis Merchandising Services Ltd, Re
[1997] 1 BCLC 689, HL . . . 17.59
ODonnell v Shanahan [2009] EWCA Civ
cial Receiver v Brady [1999] BCC
cial Receiver v Cooper [1999] BCC
7/20/2012 5:08:24 PM
Table of Cases
cial Receiver v Doshi [2001] 2 BCLC
cial Receiver v Hannan [1997] 2 BCLC
cial Receiver v Tailby (1886), on appeal
(1886) KB 34, CA, revsd sub nom Tailby
cial Receiver (1888) 13 App Cas
Old Silkstone Collieries Ltd, Re [1954] Ch
Oldham v Kyrris [2003] EWHC Civ 1506,
ONeill v Phillips [1999] 1 WLR 1092,
Ooregum Gold Mining Co of India v
Roper [1892] AC 125, HL . . . 7.6
Ord v Belhaven Pubs Ltd [1998] 2 BCLC
7/20/2012 5:08:24 PM
Table of Cases
Phoneer Ltd, Re [2002] 2 BCLC
Phonogram Ltd v Lane [1982] QB 938,
Piercy v S Mills & Co Ltd [1920] 1 Ch
Platt v Platt [1999] 2 BCLC 745 . . . 14.11
Polly Peck International plc (No 2), Re
[1994] 1 BCLC 574 . . . 13.61
Portbase Clothing Ltd, Re [1993] Ch
Portfolios of Distinction Ltd v Laird [2004]
Posgate v Denby (Agencies) Ltd, Re [1987]
BCLC 8 . . . 11.39, 11.49
Powdrill v Watson [1995] 2 AC
Precision Dippings Ltd v Precision
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Table of Cases
Rawnsley v Weatherall Green & Smith
[2009] EWHC 2482 (Ch) . . . 10.10
Ray
eld v Hands [1960] Ch 1,
Regal (Hastings) Ltd v Gulliver [1942] 1
Regentcrest plc v Cohen [2001] 2 BCLC
Regional Airports Ltd, Re [1999] 2 BCLC
Reiner v Gershinson [2004] 2 BCLC 376,
7/20/2012 5:08:24 PM
Table of Cases
7/20/2012 5:08:25 PM
Table of Cases
Smith v Henniker-Major & Co [2003] Ch
Smiths of Smith
eld Ltd, Re [2003] BCC
Snelling House Ltd (in liquidation), Re;
Alford v Barton [2012] EWHC 440
Sobam BV, Re [1996] 1 BCLC
Soden v British and Commonwealth
Holdings plc [1998] AC 298,
Sonatacus Ltd, Re; CI Ltd v Liquidators
of Sonatacus Ltd [2007] EWCA Civ
Southern Counties Fresh Foods Ltd, Re
[2008] EWHC 2810 (Ch); [2009] EWHC
Southern Counties Fresh Foods Ltd, Re
[2011] All ER (D) 66 (Jun) . . . 11.75
Southern Foundries (1926) Ltd v Shirlaw
[1940] AC 701, HL . . . 13.46
Spectrum (2005); National Westminster
Bank plc v Spectrum Plus Ltd [2005]
Stainer v Lee [2010] EWHC 1539 (Ch);
[2011] 1 BCLC 537 . . . 10.38, 10.39
Standard Chartered Bank v Pakistan
National Shipping Corpn (Nos 2 and 4)
[2000] 1 Lloyds Rep 218 . . . 3.43
Stanley v TMK Finance Ltd [2010] EWHC
Statek Corp v Alford [2008] EWHC 32
Stead, Hazel & Co v Cooper [1933] 1 KB
Stealth Construction Ltd, Re [2011] All ER
(D) 239 (May) . . . 17.60
Stein v Blake (No 2) [1998] BCC 316,
Stimpson v Southern Landlords
Association [2009] EWHC 1556
Stone & Rolls Ltd v Moore Stephens [2009]
Strahan v Wilcock [2006] EWCA Civ
Sun Trust Co v Bgin [1937] SCR 305,
SCC . . . 14.29
Sunrise Radio Ltd, Re [2010] 1 BCLC
Supporting Link Ltd, Re [2004] 1 WLR
Sussex Brick Co Ltd, Re [1961] Ch 289
(Note) . . . 5.24
Swan v Sandhu [2005] EWHC 2743
T & D Industries plc, Re [2000] 1 WLR
Tailby v O
cial Receiver (1888) 13 App
Cas 523 . . . 6.25
Tain Construction Ltd, Re [2003] All ER
(D) 91 (Jun) . . . 17.37
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Table of Cases
TLL Realisations Ltd, Re [2000] 2 BCLC
Toshoku Finance (UK) plc, Khan v
Inland Revenue [2002] 1 WLR 671,
Tottenham Hotspur plc, Re [1994] 1 BCLC
Towcester Racecourse Co Ltd v Racecourse
Association Ltd [2003] 1 BCLC
Towers v Premier Waste Management Ltd
[2011] EWCA Civ 923 . . . 14.7, 14.13,
Transbus International Ltd, Re [2004]
EWHC 932 . . . 17.5
Transworld Trading Ltd, Re [1999] BPIR
Trevor v Whitworth (1887) 12 App Cas
Trustor AB v Smallbone (No 2) [2001] 2
BCLC 436 . . . 3.313
Twinsectra Ltd v Yardley [2002] 2 AC 164,
Twycross v Grant (1877) 2 CPD 469,
Uberseering BV v Nordic Construction Co
Baumanagement GmbH (2002) (Case
UK Safety Group Ltd v Heane [1998] 2
BCLC 208 . . . 13.30
UK-Euro Group plc (2006),
unreported . . . 17.38
Ultraframe (UK) Ltd v Fielding [2005]
EWHC 1638 . . . 13.23
Unidare plc v Cohen [2005] EWHC
Uniso
Group Ltd (No 2), Re [1994] BCC
Uniso
Group Ltd (No 3), Re [1994] 1
BCLC 609 . . . 11.27
7/20/2012 5:08:26 PM
Table of Cases
Whalley (Liquidator of MDA Investment
Management Ltd) v Doney [2004]
EWHC 42; [2005] BCC 783,
White v Bristol Aeroplane Co Ltd [1953]
Whitehouse v Carlton Hotel Pty (1987) 162
CLR 285, HC Aust . . . 14.16
Whyte, Petitioner 1984 SLT 330 . . . 11.65
Will v United Lankat Plantations Co Ltd
[1914] AC 11, HL . . . 9.8
William C Leitch Brothers Ltd, Re [1932] 2
Williams v Natural Life Health Foods Ltd
[1998] 1 BCLC 689, HL . . . 3.42, 3.44,
Wills v Corfe Joinery Ltd [1997] BCC
Wills v Wood [1984] 128 SJ 222,
Wilson v Kelland [1910] 2 Ch 306 . . . 6.41
Windows West Ltd, Re [2002] . . . 13.57
Winkworth v Edward Baron Development
Co Ltd [1987] BCLC 193, HL . . . 14.37
Winter
ood Securities Limited & Ors v
FSA [2010] EWCA Civ 423 . . . 83
Wood v Odessa Waterworks Co (1889) 42
Woodro
es (Musical Instruments) Ltd, Re
Woolfson v Strathclyde Regional Council
[1978] SLT 159, HL . . . 3.14, 3.20
7/20/2012 5:08:26 PM
PART I
Fundamental Principles
7/20/2012 5:10:08 PM
SUMMARY
Forms of business organisation
The sole trader
The partnership
The company
Forms of business organisation
1.1
It may be helpful at this early stage to explore an overview of company law by
examining the companys place within the various forms of business organisa-
tion. In order for us to get some comparative perspective on the relative merits
of each type of organisation we need 
rst to set some criteria to judge them by.
In essence business organisations are about the e
ective combination of three
things. First, you need capital (money) so a key question in evaluating a form of
business organisation is, does it facilitate investment in the business? Second,
no business venture is guaranteed to succeed and so the second key question
is whether the form of business organisation mitigates or minimises the risk
involved in the venture. 
e third question to ask relates to the fact that wherever
you have money, risk and people combined there is potential for disagreement, so
does the form of business organisation provide a clear organisational structure?
The sole trader
1.2
e sole trader is the amoeba of the business organisation world. As the name
implies it is a one-person operation where someone just operates on their own.
ere are no legal 
ling requirements, they just go into business on their own.
Sole traders usually provide the capital with personal savings or a bank loan.
Introduction to company law
7/20/2012 5:10:12 PM
Introduction to company law
ey contract in their own name and have personal liability for all the debts of
the business. Legally there is no distinction between the sole traders personal
and business assets and so if the business goes badly the creditors can go a
er his
or her home, car or other assets in satisfaction of the business debt. As the busi-
ness is just one individual there is little risk of disagreement (unless the person is
schizophrenic) and so there is no need for a formal organisational structure. 
e
sole trader therefore is adequate for a single person with capital but is unsuitable
for larger scale investment. 
e risk to the sole trader of doing business is large
but there is no need for a formal organisational structure.
The partnership
1.3
Our hypothetical sole traders business has been doing very well and there are
a number of investors who are willing to provide further capital to expand the
business. At this point the trader feels the need for a more complex form of busi-
ness organisation to facilitate the expansion of the business. Here the trader
might consider a partnership. 
e Partnership Act 1890, s 1 de
nes a partner-
ship as the relationship which subsists between persons carrying on a business
in common with a view of pro
t. As you can see, this is a very broad de
nition.
erefore a partnership can come about by oral agreement, it can be inferred by
conduct or it can be a formal written agreement specifying the terms and condi-
tions of the partnership. 
ere is no formal process of becoming partnersif you
behave as partners the law will deem you are partners, even if you have no idea
what a partnership is. 
e minimum membership required for a partnership is
(obviously) two and the maximum is, since 2002, unlimited (prior to that it was
20 unless you were a professional 
rm (solicitors, accountants etc.) who could
exceed the maximum number). 
e assets of the 
rm are also owned directly by
the partners. 
is as we will see below is very di
erent from a company where the
shareholders do not own the companys assets.
1.4
A partnership which does not expressly exclude the Partnership Act 1890 will be
governed by it. 
is can sometimes be a problem for those who are unaware that
they are partners, as under the Act each partner is entitled to: participate in man-
agement, an equal share of pro
t, an indemnity in respect of liabilities assumed
in the course of the partnership business and not to be expelled by the other
partners. A partnership will also end on the death of a partner. Because of the
nature of partnerships it is normal for those who are aware they are entering such
an association to modify the Partnership Act and dra
a complex partnership
agreement. Law 
rms in particular have very complex partnership agreements
7/20/2012 5:10:12 PM
The company
governing their operation. 
is means that the management structure, pro
t
sharing and the life of the partnership can be made to 
t any situation.
1.5
What cannot be achieved through a partnership agreement is limited liability,
because under the Partnership Act each partner is jointly and severally liable for
the debts and obligations of the partnership incurred while he or she is a part-
ner. So if a partner runs away with the clients funds each individual partner is
legally responsible for the whole debt, not just a proportion of it. 
ere are two
types of partnership that allow limitation of liability. 
e 
rst type was created
by the Limited Partnership Act 1907 and allows certain partners to have full
limited liability. 
ese partners gave rise to the term sleeping partners as they
take no active part in the running of the partnership. 
ese types of partnerships
have become increasingly common in recent years due to their popularity with
the hedge fund industry. 
e second type was created by the Limited Liability
Partnerships Act 2000 and allows for partners in these entities to achieve limited
liability up to a point. It allows liability to be limited for general trading debts but
individual partners are not able to limit their personal liability for a negligent act
they themselves have committed. 
is type of partnership (LLP) was designed
to allow large professional partnerships (law and accountancy 
rms) to achieve
some measure of protection for partners who were not involved in a negligent
act.
1.6
A general partnership does therefore facilitate investment as it allows partners
to pool their funds. 
e risk however is large (although reduced in an LLP) but
is at least shared by all the partners. 
e organisational structure is very 
exible
as the partnership agreement can facilitate almost any situation. Indeed, while
we will see that the registered company dominates the business landscape, the
government is keen to reform partnership law to make it more attractive to small
businesses (see http://www.bis.gov.uk/policies/business-law/company-and-part-
nership-law for the latest government plans).
The company
1.7
Another alternative for our entrepreneur is to form a registered company. As our
entrepreneur is pursuing a commercial venture he/she would be forming a com-
pany limited by shares (that is a company where the liability of the shareholders
for the debts of the company is limited to the amount unpaid on their shares (see
Chapter 2)). 
ere are other types of company (the company limited by guaran-
tee and the community interest company for example) which are designed for
7/20/2012 5:10:12 PM
Introduction to company law
charitable or public interest ventures. A company limited by shares is the normal
type of commercial company formed to pursue a business venture.
1.8
Setting up a company is governed by the Companies Act 2006 (CA 2006), ss 715
and is a relatively simple process. Our entrepreneur is required to provide the
Registrar of Companies with the constitution of the company (this contains the
internal rules of the company called the articles of association and any objects
clause limiting the power the company may have, see below), a memorandum of
association stating that the subscribers intend to form a company and become
members and an application for registration containing the company name, its
share capital, the address of its registered o
ce, whether its a private or public
company, that the liability of its members is limited, a statement of the companys
directors names and addresses and a statement of compliance with the CA 2006.
e purpose of registering these documents is to provide certain key information
that could be accessed by the general public or government agencies if necessary.
is is still the case but in recent years fears that this public information could be
abused have led to restrictions on its public availability. For example since April
2002 directors could apply to have their names and addresses removed from the
memorandum under provisions introduced by the Criminal Justice and Police
Act 2001 if they could show they were at risk of potential or actual violence or
intimidation. Media reports have claimed that tens of thousands of directors
have done so in order to protect themselves. 
e CA 2006, s 165 amends this by
allowing all directors to choose to have a service address (which may be the com-
panys registered o
ce) on the public record rather than a residential one.
1.9
Prior to 1992 at least two people had to subscribe to become shareholders in a
private company (see below on public and private companies). As a result of the
Twel
h EC Company Law Directive (89/667) implemented in 1992 private com-
panies could be formed with a single member but public companies still needed
at least two members. 
e CA 2006, s 7 now provides for single-person private
and public companies. 
us our entrepreneur, if he or she wished, could skip the
stint as a sole trader and go straight to forming a company.
The memorandum and constitution
1.10
Under the previous companies acts the memorandum formed part of the com-
panys constitution. Now however, s 8 of the CA 2006 has reduced the memo-
randum of association to a more limited function. 
e memorandum is now a
simple document providing certain basic information and key declarations to
the public which state that subscribers wish to form the company and agree to
become members taking at least one share each. 
e subscribers to the memo-
randum are those who agree to take some shares or share in the company thus
7/20/2012 5:10:13 PM
The company
becoming its 
rst members. If the application to the Registrar is successful the
subscribers become the 
rst members of the company and the proposed direc-
tors become its 
rst directors. Under the previous Companies Act 1985, the total
amount of share capital that could be issued to investors had to be stated in the
memorandum. In the CA 2006, s 10 the provisions have been streamlined and
now only require a statement of the total number and nominal value of shares
to be taken on formation by the subscribers to the memorandum of association.
Additionally any rights associated (see Chapter 9 on class rights) with those
shares must be stated along with the paid up and unpaid amount on each share
(if any). 
e value given to each share is known as its par or nominal value. 
is
is both a matter of convenience to facilitate the issue to the shareholders and a
method of protecting the value of shares already issued as there are restrictions
on issuing shares below their nominal value (indeed it is a criminal o
ence, see
CA 2006, s 542 and Chapter 7). Additionally, the Insolvency Act 1986, s 74 deems
the nominal value or any amount paid above the nominal value to be the limit of
the shareholders liability in an insolvency. If the shares are paid for immediately
they are described as fully paid but shares may also be issued partly paid or even
unpaid. In the case of partly paid and unpaid shares the shareholder can be called
upon to pay for them at a later date. Shares may be also be paid for in goods and
services and not necessarily in cash.
1.11
Taking a simple example lets say the share capital of our entrepreneurs newly
formed company is 10,001 subdivided into shares of 1
each. Our entrepreneur
subscribed for 5,001 shares on registration and thus is now a member of the com-
pany holding 5,001 shares in the company at a nominal value of 1 each. In pur-
chasing the shares she paid for half with cash and the rest are unpaid with an
agreement that they are to be paid for in 3 years time. Other investors in the com-
pany subscribed for a total of 5,000 shares and now are members of the company
holding shares of that amount. It is important to note that in our entrepreneurs
company she has majority voting rights by virtue of her 5,001 shares. 
is gives
our entrepreneur the ability by simple majority to elect or remove someone from
the board (see below).
1.12
e companys constitution or articles of association are a set of rules governing
the running of the company. 
ey form the core of the organisational structure of
the companythe board of directors (the management committee or organ) and
the general meeting (the shareholders committee or organ)and generally allo-
cate the powers of each organ. 
ose forming the company can provide their own
set of articles but a model set of articles (historically these articles have been called
Table A but are referred to as the model articles in the CA 2006) is provided by
the CA 2006, s 20 as a default for those setting up a company. In reality, however,
the model articles have been generally adopted with some slight amendments.
7/20/2012 5:10:13 PM
Introduction to company law
e CA 2006, s 21 provides that the articles may be altered if three-quarters of the
members (a special resolution) vote to amend the articles. Additionally the CA
2006, s 168 gives members the right by simple majority (more than 50 per cent of
the shareholders who vote, vote for the resolution) to remove a director for any
reason whatsoever. 
us the articles and the Companies Act place the sharehold-
ers at the centre of the corporate power structure.
1.13
e articles, according to s 33 of the CA 2006, bind the members of the company,
creating a statutory contract between the members themselves and between each
member and the company (see Chapter 8). If all the documentation is in order
then the Registrar will issue a certi
cate of incorporation and the company will
then come into existence.
Public and private companies
1.14
e Companies Act 2006 recognises a distinction between two di
erent types
of company: private companies where the investment is largely provided by the
founding members either through their personal savings or from bank loans,
and public companies where the intention is to raise large amounts of money
from the general public. While this is the key di
erence there are others.
1.15
Private companies, obviously, are private. 
e vast majority of companies in the
UK are private companies. 
e law assumes a closer relationship between the
members in a private company than in a public company and so private com-
panies commonly restrict the membership of their company (to those approved
of by the directors) in the articles of association. In essence if a member wishes
to leave the company by selling their shares or a member has died, the directors
have a say in who replaces them, if anyone. 
ere may also be a pre-emption
clause in the articles which means that if a member wishes to sell their shares
they must 
rst o
er the shares to the other members. Private companies have
also historically been able to adopt an elective regime (CA 1985, s 379A) which
recognised that o
en in private companies the directors and the members of
the company are one and the same and so requirements for meetings, timing of
meetings and laying of accounts can be suspended to streamline the operation of
the private company (additionally in the old Table A articles, article 53 allowed a
more informal decision-making process). 
e CA 2006s main impact has been
in reforming company law to suit small private companies and so many of the
problematic requirements for private companies to hold meetings etc has been
done away with in the 2006 Act (the AGM requirements for example do not apply
to private companies, see CA 2006, Part 13, Chapter 14 and CA 2006, s 288 pro-
vides for an expanded written resolution regime for private companies). Private
companies cannot invite the general public to buy shares (CA 2006, s 755), but
7/20/2012 5:10:14 PM
The company
they also, unlike public companies, have no minimum capital requirements. 
e
members only need to come up with a nominal amount. 1 or even 1p would
su
ce and even then the member could purchase the shares unpaid (plus the
registration fee for the Companies Registrar) in order to form the company. 
e
members of a private company have limited liability and so the word limited or
Ltd must appear a
er the companys name. Members thereby are liable only for
the amount unpaid on their shares and not for the debts of the company.
1.16
Public companies have the aim of securing investment from the general public
and can advertise the fact they are o
ering shares to the public. In doing so the
company must issue a prospectus (see Chapter 5) giving a detailed and accurate
description of the companys plans. Because the general public are involved and
need to be protected the initial capital requirements for a public company are
more onerous than for a private one. 
ere is a minimum capital requirement
(the authorised minimum) of 50,000 (CA 2006, s 763). While there is no formal
limitation on public companies having restrictions on transfer of shares similar
to those that apply to private companies, any such restriction would be highly
unusual, given that one of the reasons for forming a public company is to raise
money from the general public and such a restriction would discourage them. In
any case if the public company is listed on the stock exchange any restrictions
on transfer will be prohibited. Note here that public companies are not neces-
sarily listed on the stock exchange. A listing is essentially a private contractual
arrangement between a public company and the stock exchange (in the UK the
London Stock Exchange (LSE) is itself a listed public company) to gain access to a
very sophisticated market for its shares. Some public companies do however exist
outside the stock exchange listing systemSir Alan Sugars Amstrad plc being a
high pro
le example. 
e application for registration for a public company must
state that it is public and, as with private companies the liability of the members
is limited thus the words public limited company (PLC or plc) must come at the
end of its name (CA 2006, s 58(1)) both as a statement that the members liability
is limited and to tell those dealing with it that it is authorised to secure invest-
ment from the general public.
So why would our entrepreneur form a company?
1.17
Using our criteria of facilitating investment, minimising risk and providing an
organisational structure the registered company seems to perform well. It is spe-
ci
cally designed as a capital-raising vehicle. 
e subdivision of shares allows
for a very large number of investors to become members of the company. 
ose
members have limited liability which minimises their risk. 
is in theory makes
raising capital easier as individuals may feel more secure in their investment.
7/20/2012 5:10:14 PM
Introduction to company law
Limited liability is also said to increase the entrepreneurial spirit of the directors,
encouraging them to take risks in the knowledge the shareholders will not lose
their houses or cars if the business venture fails. A company is also impervious
to death, and shares are also in theory transferable and so particularly in public
companies easily convertible into cash. 
e company is designed to potentially
have a large number of participants and so has a formal constitution outlining
its basic organisational and power structure. Technically, the people who control
the company are the shareholders. 
ey buy shares in the company which entitle
them to certain control rights exercised through the shareholder organ, the gen-
eral meeting. However, the running of the company cannot be e
ected by a large
number of members as such control would be cumbersome and so they elect peo-
ple to do it, the directors. 
e directors operate through the second organ of the
company, the board of directors. 
e shareholders appoint or remove directors
by simple majority vote (more than 50 per cent of the votes actually voted) at the
7/20/2012 5:10:14 PM
The company
primarily to elect the directors to the board. 
e directors will be a mix of pro-
fessional managers (executive directors) and non-executive (independent outsid-
ers) (see Chapters 13 and 16). 
e executive directors will normally have a small
shareholding but not usually a signi
cant one. 
e shareholders are also pro-
vided with an annual report from the directors outlining the performance of the
company over the past year and the prospects for the future (this is rather like a
report card on their performance). At the heart of the report are the accounts cer-
ed by the auditor (an independent accountant who checks over the accounts
prepared by the directors, see Chapter 16). Between the AGMs the directors run
the company unencumbered by the shareholders. In a large company the board
of directors will be more like a policy body which sets the direction the company
goes in but the actual implementation of that direction will be carried out by
the companys employees. In carrying out their function the directors stand in a
duciary relationship with the company. 
ey therefore owe a duty to act bona
de in the interests of the company (this generally meaning the shareholders
interests) and not for any other purpose (such as self-enrichment, see further,
Chapter 14). 
e employees who are authorised to carry out the companys busi-
ness are the companys agents and therefore the company will be bound by their
actions (see Chapter 12).
1.21
e same company law model applies to a small company but with signi
cant
erences in e
ect. 
e shareholders and directors will o
en completely over-
lap. 
e same people will also be the only employees of the company. To take
the example of a two-person company, the two shareholders will also be the two
directors and the two employees. 
ere is no separation of ownership from con-
trol, the shareholders are the managers, and therefore most of the historical stat-
utory assumptions about the companys organisational structure will not hold.
Given that one can also form one person companies the statutory assumption
had begun to take on farcical proportions. However the elective regime, as we
explained above, had historically attempted to address this problem by allowing
a quasipartnership or close company (a company with few participants who
know each other well) like this to do away with some of the more onerous aspects
of the statutory model and the CA 2006 has signi
cantly improved the di
cul-
ties close companies faced in using the company. 
e courts have also tried where
possible to recognise and make allowances for these quasi-partnership type
companies (see
Ebrahimi v Westbourne Galleries Ltd
(1973); see further, Chapter
11).
1.22
e di
erences in the types of business that use the statutory model featured
heavily in the CLRSGs
Final Report
(2001), Chs 2 and 4. 
e CLRSG recom-
mended that the statutory requirements for decision making, accounts and
audit, constitutional structure and dispute resolution be simpli
ed. 
ey also
7/20/2012 5:10:15 PM
Introduction to company law
recommended that legislation on private companies should be made easier to
understand. In particular there should be a clear statement of the duties of direc-
tors. 
e White Paper (
Modernising Company Law
(2002)) that followed the
Final
Report,
the Consultative Document, March 2005 (
Company Law Reform
(2005))
and the CA 2006 all carried through this focus on the quasi-partnership com-
pany with a think small 
rst emphasis. However, its still not clear if this focus
has been entirely successful.
1.23
Private companies present another problem. In a nutshell private companies,
because there is o
en a close relationship between the participants, have more
potential for those participants to have disagreements. In these cases company
law and the constitution of the company can be problematic for a minority share-
holder who has fallen out with the majority. Company law presumes that the
company operates through its constitutional organs. In order for the company
to operate, either the board of directors makes a decision or if it cannot then the
general meeting can do so. It can, however, happen that a majority of sharehold-
ers holding 51 per cent (simple majority voting power) of the shares in the com-
pany could act to the detriment of the other 49 per cent. A 51 per cent majority
would allow those members to elect only those who support their policies to the
board. 
us the 49 per cent shareholder would be unrepresented on the board
and powerless in the general meeting.
1.24
To take an example, X Ltd has three shareholders, Ron, Cathy and Freeda. 
e
share capital of X is 30 shares of 1 each. Ron, Cathy and Freeda hold 10 shares
each. All three are directors and employees of X Ltd. 
ings go well for a few
years but increasingly Ron and Cathy feel that Freeda is no longer contributing
much to the company. 
ey decide not to re-elect Freeda to the board of directors
and having removed her from the board they transfer all the assets of X Ltd to Y
Ltd (a company in which only Ron and Cathy have a shareholding) for a fraction
of its real value.
1.25
In this situation Freeda has no constitutional power to block this asset-stripping
exercise. She has no voice on the board (even if she did she could be outvoted by
the others) and is powerless in the general meeting. Even though there appears
to be also a breach of 
duciary duty, as Ron and Cathy are using their directo-
rial powers to bene
t themselves and not the company, only the board or the
general meeting can instigate an action to remedy the situation (see Chapter 14).
Ron and Cathy are unlikely to support an action against themselves. 
us the
constitution of the company can be used to facilitate what is known as a fraud
on the minority. 
ese situations are also made more acute in private companies
where the oppressed minority shareholder cannot sell their shares without board
approval and is thus trapped. Although the courts quickly came up with a limited
7/20/2012 5:10:15 PM
Further reading
exception to enforcing the constitutional structure (
Foss v Harbottle
(1843), see
Chapter 10) there has always been a continuing tension between enforcing the
constitutional structure (allowing directors to run the company unimpaired by
factions among the shareholders) and protecting minority shareholders against
genuinely fraudulent transactions. Eventually a statutory remedy was introduced
(CA 2006, s 994) to make it easier for shareholders to bring an action. Additionally
the CLRSG and the Government have been keen to encourage companies to use
forms of Alternative Dispute Resolution for minority shareholder problems (see
Chapter 11).
1.26
us, while the company is designed as an investment vehicle, with limited
liability for its shareholders and a clear organisational structure, it is designed
for ventures where there is an e
ective separation of ownership from control
and thus has been largely unsuitable for the majority of its users who are small
businesses. Even given the reforms in the CA 2006 which focus more on small
business needs, in many ways the partnership would be more suitable for our
entrepreneur and less onerous for small businesses generally, especially given
that limited liability is rarely a reality for these types of business. 
e removal
in 2002 of the 20-partner limit will help as it enhances the capital-raising ability
of the general partnership. However, the continued use of the corporate form by
small companies seems secure given the prestige attached to the tag Ltd.
FURTHER READING
This Chapter links with the materials in Chapters 1, 2 and 7 of
Hicks and Goos Cases
and Materials on Company Law
(2011, Oxford University Press, xl +649p).
Company Law Reform
(2005) Cm 6456 (Consultative Document, March 2005), ch 5.
http://www.bis.gov.uk/policies/business-law/company-and-partnership-law/
company-law/publications-archive
Freedman Small Businesses and the Corporate Form: Burden or Privilege? [1994]
MLR
555.
Freedman and Godwin, Incorporating the Micro Business: Perceptions and
Misperceptions in Hughes and Storey (eds)
Finance and the Small Firm
(London,
Routledge, 1994).
Henning The Company Law Reform Bill, small businesses and private companies.
Company Lawyer
[2006] 27(4), 9798.
Modern Company Law for a Competitive Economy: Final Report
(2001), Chs 2 and 4.
http://www.bis.gov.uk/policies/business-law/company-and-partnership-law/
company-law/publications-archive
7/20/2012 5:10:15 PM
Introduction to company law
Modernising Company Law
(2002) Cm 5553 Part II. http://www.bis.gov.uk/policies/
business-law/company-and-partnership-law/company-law/publications-archive
SELF-TEST QUESTIONS
Compare and contrast the various forms of business organisation discussed in this
chapter.
7/20/2012 5:10:16 PM
SUMMARY
Introduction
Corporate personality
Salomon
and the logic of limited liability
Some other good examples of the consequence of separate personality
Members, shareholders and the ownership of the corporation
Introduction
2.1
In this chapter we explore the concept of separate corporate personality and the
related issue of limited liability. 
ese concepts are at the core of company law.
A good understanding of them is essential to understanding what company law
is about. Unfortunately, the metaphysical nature of corporate personality in par-
ticular o
en caused di
culties for students. Our advice here is to read the 
rst
section on corporate personality. If you feel you have grasped the concept then
move on to the rest of the chapter and the rest of the book. If you have read the
corporate personality section and dont understand it, relax, breathe deeply, take
some time to think about it but when you feel ableread the section again. Dont
worry if you have lots of questions about corporate personalitymany of the
questions will be answered in the following section on limited liabilityall you
need at this stage is an understanding that the company really exists as a legal
personality.
Corporate personality
2.2
Human beings are generally legal personsthat is, they are subject to the legal
system in which they 
nd themselves. While that legal system imposes obligations
Corporate personality and
limited liability
7/20/2012 5:12:59 PM
Corporate personality and limited liability
on the legal person it also confers rights. When dealing with humans who are
legal persons we have little di
culty with the concept, generally viewing them as
one and the same. 
is is however incorrect and is o
en at the root of students
misunderstanding of corporate personality. Children for example, while they are
human beings, are commonly excluded from having full legal personality until
they cease being children. It is important for now if you are to understand legal
personality to keep the human and the legal person separate. In essence human-
ity is a state of nature and legal personality is an arti
cial construct which may or
may not be conferred (see, this is where the 
exibility of mind comes in).
So, if humanity is not necessary for legal personality it follows that it is possible
for legal personality to be conferred on non-humans. Some societies for example
attribute legal personality to religious icons. 
e icon itself is therefore treated as
having rights and obligations within the legal system. A logical extension of this
separation of humanity from legal personality is that groups of humans who are
engaged in a common activity could attempt to simplify their joint activity by
gaining legal personality for the venture. 
is is the origin of the corporation.
2.4
e most successful groups to attain legal personality were religious orders. 
eir
motive was relatively simple. If a religious order could obtain legal personality
the complications that regularly arose when an Abbot died, over the passing of
the orders land to the new Abbot, would fall away. 
e conferring of legal per-
sonality would mean that the religious order as a legal personality would hold
the land in its own name and as it was not human and therefore not subject
to weaknesses of the 
esh, such as death, the death of an individual head of the
order had no e
ect on the life or land of the legal personality of the order. As
the main bene
ciary of these land disputes with religious orders was the Crown
(through death taxes levied on what the Crown deemed to be the Abbots lands),
the conferring of legal personality was necessarily tied directly to a concession
from the Crown, in the form of a charter or grant, incorporating (from the Latin
corpus meaning body, so literally meaning to create a body) the order.
Over time the process of corporatisation through charters extended to local
authorities and crucially commercial organisations such as Guilds of Merchants.
e changing nature of the power relationship between Parliament and the
Crown was also re
ected in the way a charter was obtained. As Parliament
became more powerful the grants had to be 
rst con
rmed by Parliament and
eventually a charter could only be granted by an Act of Parliament. By the start
of the 18th century there was an active market in the trading of shares in these
companies. However a period of irrational speculation in these markets led to a
stock market crash known as the South Sea Bubble (a
er the South Sea Company
formed in 1711 and which became most associated with the speculative behav-
iour). Clumsy attempts by the Government to intervene to check the speculative
7/20/2012 5:13:00 PM
Corporate personality
mood caused panic and led to the crash in which many investors were ruined.
e Bubble had an enormous e
ect on the granting of charters over the follow-
ing century because o
cials were very wary of granting them and when they did
they o
en placed restrictive conditions in the grant.
2.6
is forced businesses to take things into their own hands and so the use of the
trust as an instrument to confer many of the privileges of incorporation became
commonplace. Over time these unincorporated deed of settlement compa-
nies became instruments through which fraud was easily committed and the
Government was forced to intervene. A
er a number of ine
ectual attempts
at statutory intervention Parliament passed a series of statutes that to this day
still form the framework of company law in the UK. 
e Joint Stock Companies
Act 1844 provided for incorporation by simple registration, provided safeguards
against fraud by insisting on full publicity and provided a Registrar of Companies
to hold the public documents provided by the companies.
2.7
One problem remainedthe Act of 1844, while it conferred corporate status,
still held members liable for the companys debts. (You will encounter the terms
member and shareholder throughout this and other texts as well as the case law
and the Companies Acts. It is important to note that shareholders are also mem-
bers and members are shareholders of the company. 
e use of the word mem-
ber emphasises that not only do members provide capital to the company, they
also have rights and obligations to the company and to each other over the life of
the company, just as members of a swimming club or football club have rights
and obligations to the club and its other members, see further below, para
2.33
).
is remained a problem as charter companies and deed of settlement companies
had achieved limitations on members liability. In the case of charter companies
this was through the Act that granted them and in the case of deed of settlement
companies it was through its legal complexity.
e logical follow-on from the creation of a separate legal personality is that it is
just that, a separate legal personality capable potentially of suing and being sued
in its own name, of holding property in its own name, and logically, therefore, of
making pro
ts and losses that are its own and not those of its members (share-
holders). 
is issue which should be framed as the no liability issue was framed
rather in terms of limited liability (shareholders liability would be limited to
the unpaid amount of their shares) because that was the mechanism already used
for charter companies under previous Acts of Parliament.
2.9
Note here that we need to be careful with these concepts, separate legal person-
ality and limited liability are not the same thinglimited liability is the logical
consequence of the existence of a separate personality. However, just as humans
can have restrictions imposed on their legal personality (for example, children,
7/20/2012 5:13:00 PM
Corporate personality and limited liability
the mentally ill or foreign nationals) a company can have legal personality with-
out limited liability if the statute confers it in that way (this is still possible today
by forming a registered unlimited company (CA 2006, s 3(4)).
2.10
It was not until the Limited Liability Act 1855 (the provisions of which were almost
immediately subsumed into the Joint Stock Companies Act 1856) that limited
liability was provided, as well as a simpli
cation of the registration requirements
for incorporation. 
us whenever anyone deals with a limited company in the
UK they are met with the warning; Ltd in the case of a private company or PLC
for a public company attached to the companys name to signify that the mem-
bers of this company have limited liability. In other words they are not liable for
the debts of the companyso be careful.
2.11
Note here that the Ltd or PLC refers only to the members liability and not that
of the company. 
e company itself is liable for its debts but once its assets are
exhausted the creditors cannot go a
er the members assets. Remember that the
legal personality of the members and the company are separate. 
e corporate
assets belong to the company and the members assets are their own.
2.12
Until the Joint Stock Companies Act 1856 the corporation had been the privi-
lege of large-scale business ventures and those with in
uence in Parliament or at
the Royal Court. From this point onward the company somewhat unexpectedly
became a viable form of business organisation for all types and size of business
venture. As a result company law emerged as a distinct and important area of law
because despite humanity not being an essential requirement for legal personal-
ity most law is designed for application to humans. Companies are not human,
they need to act through humans and so accommodations had to be made to
agency principles, 
duciary and statutory obligations and rights. Occasionally
where no accommodation could be made, speci
c statutory intervention aimed
at regulating the corporation was necessary. 
us, for the past 160 years or so as
the company has grown in economic importance, so too has the body of law we
call company law.
and the logic of limited liability
2.13
e ease with which business ventures could get access to corporate status cre-
ated an unexpected problem. Small businesses began to avail themselves of the
corporate form. 
ese small businesses were far from the large-scale ventures
envisaged by the framers of the 19th-century companies legislation and so a
question as to their legitimacy remained. It was only a matter of time before the
courts would be called to decide on their legitimacy.
7/20/2012 5:13:00 PM
Salomon v Salomon & Co
(1897)
2.14
Mr Salomon carried on a business as a leather merchant. In 1892 he formed the
company Salomon & Co Ltd, Mr Salomon, his wife and 
ve of his children hold-
ing one share each in the company. 
e members of the family did not intend
taking an active role in the business but rather only held the shares because
the Companies Acts required at that time that there be seven shareholders.
Mr Salomon was also the managing director. If we freeze things at this point it
is important to note that Mr Salomon had two businesses. One is the original
sole trading shoe business. 
e other is the newly registered company which has
seven shareholders and Mr Salomon as managing director. What Mr Salomon
did next is crucial to our understanding of the implications of corporate person-
ality and limited liability. 
e newly incorporated company purchased the sole
trading leather business.
2.15
Note that the reality of this transaction was that Mr Salomon the sole trader nego-
tiated a purchase price with Mr Salomon the managing director of Salomon and
Co Ltd. As a result the price Mr Salomon the managing director paid for the shoe
business was a little on the high side. 
e business was valued by Mr Salomon
at
39,000; this was not an attempt at a real valuation but what Mr Salomon
seemed to think it was worth. 
is was however a fantastical amount for a shoe
and boot business in the east end of Londonthe equivalent in today prices of
2,913,996.61 using the retail price index to calculate back to 1892. A
er all,
who was Mr Salomon, managing director, to argue? However, the real genius
of Mr Salomon was in the way he structured the transaction. 
e price was paid
in 10,000 worth of debentures giving a charge over all the companys assets,
20,000 in 1 shares and
9,000 cash. Mr Salomon also at this point paid o
all
the creditors of the sole trading business in full. Mr Salomon thus was the vast
majority shareholder with 20,001 shares and his family holding the six remaining
shares. Additionally, because of the debenture, he was a secured creditor which is
also very important.
2.16
A debenture is simply a document creating or evidencing a debt (see further,
Chapter 6). In company law however the agreements tend to be fairly complex. If
a company needs a loan but a bank or other lender has some concern about the
companys ability to repay they can create a debenture which secures the debt in
two possible ways. First, a  xed charge could be created conferring an interest in
or over an asset of the company. If the company breaches the terms of the deben-
ture then the lender can take the asset and sell it to pay o
the debt owed. A nor-
mal house mortgage is an example of a common  xed charge. 
e bank agrees
to lend a prospective buyer the money to buy a house only if the buyer agrees to
pay the money back over a certain period of time plus a certain interest rate. 
e
buyer also agrees to restrictions on their power to sell the house and that if they
7/20/2012 5:13:01 PM
Corporate personality and limited liability
fail to pay the money back as agreed the bank can take the house and sell it to pay
the debt. Similarly, if a company has  xed assets like property or machinery
then it can do the same. In general the debenture holder has contractual rights
against the company but if the transaction is secured it also creates rights in the
corporate property. Note this is something that shareholders do not have (see
para
2.30
onwards below).
2.17
Certain companies however may not have  xed assets (or they may already have
 xed charges in place but need to borrow more) but because of the nature of
their business they have valuable moveable assets. Any retail business will have
moveable assets (its stock, for example) that are valuable. 
is brings us to our
second type of secured lendingthe 
oating charge. Over time lenders met the
needs of these businesses with valuable stock by accepting a charge over a class of
assets. So a retail outlet could get a loan from a bank secured by a charge over all
its stock. 
is type of charge is necessarily more 
exible as the company needs to
be able to sell the stock and replace it as needs be. 
is is a
er all the core of its
business. 
us there can be nothing in the debenture restricting sale of the assets.
is is why it is described as secured over a class of assets; it cant be secured
over a speci
c asset as they are constantly changing. If the company does breach
the debenture agreement the charge is said to crystallise and it  xes upon the
speci
c assets in the stockroom. At this point the company cannot sell any of the
assets. A 
oating charge is a less secure type of lending because the lender has no
way of knowing whether the assets le
in the stockroom when the charge crys-
tallises will cover the debt owed. 
e lender will compensate for this additional
risk by charging a higher rate of interest (see further Chapter 6).
2.18
Returning now to Mr Salomon. While on the ground almost nothing about the
shoe trading business had changed except the sign outside containing the word
Ltd, legally everything had changed. Before the change in legal status the cus-
tomers and suppliers contracted with Mr Salomon the sole trader, who was liable
for all the debts of the company. A
er incorporation and the sale of the business
to Salomon and Co Ltd the customers and suppliers contracted with the com-
pany through its managing director, Mr Salomon (same face, di
erent personal-
ity). Mr Salomons personal liability for the debts of the business had changed
completely from unlimited liability as a sole trader to limited liability as a share-
holder in the company. Not only was Mr Salomon not liable for the debts of the
company but as managing director of the company he had also granted himself a
secured charge over all the companys assets. 
us, if the company failed not only
would Mr Salomon have no liability for the debts of the company but whatever
assets were le
would be claimed by him in satisfaction of his debt.
2.19
You may sense already, given that more than 100 years later he is featuring in
a company law text, that things did not go to plan for Mr Salomon. Almost
7/20/2012 5:13:01 PM
immediately a
er the change in the legal status of the business the company had
trading di
culties and Mr Salomon had to sell his debenture to raise money
for the business. 
is just delayed the inevitable and a
er only a year trading as
Salomon and Co Ltd the debenture holder enforced the security over the assets
of the company and the company was placed into insolvent liquidation. However
there were not enough assets le
to pay o
the debenture holder and so the
debenture holder, Mr Broderip, sought to challenge the validity of the transac-
tion to convert the legal status of the business into a company and sought to make
Mr Salomon personally liable for the debts of the company.
2.20
Mr Broderip alleged that the company was but a sham and a mere alias or
agent for Mr Salomon. 
e Court of Appeal upheld this claim and in doing
so they looked at the motives of the promoters (Mr Salomon) and the mem-
bers (Mr Salomon and his family) of the company. 
e focus of the Court of
Appeals concern was that the six family members never intended to take a part
in the business and only held the shares to ful l a technicality required by the
Companies Acts. Kay LJ considered that:
[t]he statutes were intended to allow seven or more persons,
bona
de
associ-
ated for the purpose of trade, to limit their liability under certain conditions and
to become a corporation. But they were not intended to legalise a pretended as-
sociation for the purpose of enabling an individual to carry on his own business
with limited liability in the name of a joint stock company.
2.21
Mr Salomon was thus liable to indemnify the company against its trading debts.
Mr Salomon appealed to the House of Lords and at this point the liquidator of
Salomon and Co Ltd (an o
cial appointed by the court to carry out the statutory
liquidation process, in e
ect to see what assets are le
and divide it up among the
creditors. 
is may also involve taking or defending legal actionssee Chapter
17) took over the litigation from Mr Broderip on behalf of the general body of
creditors. 
e House of Lords unanimously reversed that decision. It held that
the company was validly formed according to the Joint Stock Companies Act
1844, which only required that there be seven members, holding one share each.
ere was nothing in the Act about bona 
des. 
e motives of the shareholders
were irrelevant unless there was fraud involved. 
e business thus belonged to
the company and not to Salomon. Salomon was an agent of the company, not
the company his agent. In giving his reasons for overturning the decision of the
Court of Appeal, Lord Macnaghten stated:
[t]he company is at law a different person altogether from the subscribers . . . ;
and, though it may be that after incorporation the business is precisely the same
as it was before, and the same persons are managers, and the same hands
receive the pro
ts, the company is not in law the agent of the subscribers or
7/20/2012 5:13:01 PM
Corporate personality and limited liability
trustee for them. Nor are the subscribers, as members liable, in any shape or
form, except to the extent and in the manner provided by the Act.
2.22
e importance of the case lies in the consequences which 
ow from the deci-
sion. First, the fact that some of the shareholders are only holding shares as a
technicality is irrelevant, the machinery of the Companies Acts may be used by
an individual to carry on what is in economic reality his business. 
is also had
the less obvious e
ect of facilitating investment in large companies where share-
holders could purchase shares for speculative purposes safe in the knowledge that
participation in the company was not a prerequisite for limited liability. Second, a
company formed in compliance with the regulations of the Companies Acts is a
separate person and not per se the agent or trustee of its controller. 
ird, the use
of debentures instead of shares can further protect investors.
2.23
It is worthwhile reading both the Court of Appeal and the House of Lords deci-
sions. 
e contrast in their positions is stark. 
e Court of Appeal took a more
moralistic approach to the case before it and was clearly disturbed at the individ-
ual avoidance of responsibility for ones debts. 
is is odd given that there was no
doubt that large businesses could have limited liability or even seven persons who
formed to
bona 
de
associate and run a business. 
ey seem however uncom-
fortable with this position in the context of an e
ective one-person company.
While they do not use the word fraud, they use the words defeated, pretended,
mischief, perverting and cheating to describe Mr Salomons activities. 
ey
place the emphasis on what they see as the combined bad faith of the nomi-
nee members and the overvaluation and are of the view that if Parliament had
intended one-person nominee companies it would have said so and not speci
ed
seven members. 
e House of Lords on the other hand restricted itself to asking if
the Act was complied with. 
e Act required seven membersthe company had
seven memberstherefore the company was validly formed and the protections
of the Companies Acts would apply. 
ey also seemed to have a more favourable
view of Mr Salomon. It is also worth noting that neither the Court of Appeal nor
the House of Lords could refer to the Parliamentary reports (Hansard) to see
what Parliament intended, as the courts were forbidden from doing this until
Pepper
v Hart
(1993). Had they been able to do so they would have found that in
fact the seven member requirement had been chosen to avoid its use by very small
businesses. In other words the Court of Appeal was right in its assumption.
2.24
Clearly Mr Salomon had been clever in understanding the implication of the
registration requirements of the Companies Acts but it is the nominal family
shareholding and the transaction to sell the sole trading concern that cause
the disquiet. 
is concern has little to do with the formation procedures of the
Companies Acts but rather the fact that Mr Salomon owned and controlled both
businesses. It is his exercise of control combined with his claim to limited liability
7/20/2012 5:13:01 PM
Some other good examples of the consequence of separate personality
that is at the heart of the case. If it were a large company in which he was a small
shareholder there would be no problem. It is his ownership and control of the
business that causes the challenge to the validity of the formation of the company
and the Court of Appeal to 
nd Mr Salomon liable.
2.25
In a way, although the two decisions are starkly di
erent the outcomes may be
attributable both to what part of Mr Salomons behaviour is emphasised and the
courts view of its role. On the one hand, the overvaluation of the business seems
outrageous, but on the other Mr Salomon used the cash part of the transaction
to pay o
the sole trading concerns existing creditors. 
us the creditors at the
time of the liquidation had only ever dealt with the business as a company and
were not in any way victims of some unseen switch. Mr Salomon had also sold
his debenture in order to keep the business going. In the end the House of Lords
tended to view the overvaluation in a less harsh light than the Court of Appeal,
Lord Macnaghten describing it as a sum which represented the sanguine expec-
tations of a fond owner rather than anything that can be called a businesslike or
reasonable estimate of value. Had Mr Salomon not paid o
his creditors and put
his own money into the company in a futile attempt to keep it going, the House of
Lords view of Mr Salomons behaviour might have been very di
erent, as would
the subsequent history of company law. Additionally the Court of Appeal and
the House of Lords seem to be engaged in very di
erent analytical pursuits. 
e
Court of Appeal is partly attempting to work out what Parliament intended with
its seven member requirement while the House of Lords takes the view that it is
simply to obey the will of Parliament, i.e. seven means seven.
2.26
From this point on the separateness of the corporate personality from its mem-
bers became 
rmly embedded as a principle of English company law. In particu-
lar it had time to become embedded because until the House of Lords changed
the rules under which it operated in 1966 it was not possible for the House of
Lords to overrule itself. 
erefore any attempts to strike at the principle were
tangential and exceptional. A
er that time however, as we shall see in Chapter 3,
the guarantee of separateness became less assured.
Some other good examples of the
consequence of separate personality
Lee v Lees Air Farming (1961)
2.27
Mr Lee incorporated a company, Lees Air Farming Limited, in August 1954. 
e
nominal capital of the company was 3,000 divided into three thousand shares
of 1 each. Mr Lee held 2,999 shares, the 
nal share being held by a solicitor
7/20/2012 5:13:01 PM
Corporate personality and limited liability
for Mr Lee because the New Zealand Companies Act required two shareholders.
Mr Lee was also the sole governing director for life. 
us, as with Mr Salomon,
he was in essence a sole trader who now operated through a corporation. Mr Lee
was also speci
cally appointed as an employee in the companys articles of asso-
ciation which stated:
33. The company shall employ the said Geoffrey Woodhouse Lee as the chief
pilot of the company at a salary of 1,500 per annum from the date of incor-
poration of the company and in respect of such employment the rules of law
applicable to the relationship of master and servant shall apply as between the
company and the said Geoffrey Woodhouse Lee.
2.28
Mr Lee therefore wore three hats as far as the company was concerned. He was
the vast majority shareholder, he was the sole governing director for life and he
was an employee of the company. In March 1956, while Mr Lee was working,
the company plane he was 
ying, stalled and crashed. Mr Lee was killed in the
crash leaving a widow and four infant children who were totally dependent on
him.
2.29
e company as part of its statutory obligations had been paying an insurance
policy to cover claims brought under the Workers Compensation Act 1922. 
e
widow claimed she was entitled to compensation under the Act as the widow of a
worker. 
e issue went 
rst to the New Zealand Court of Appeal who found that
he was not a worker within the meaning of the Act and so no compensation was
payable. 
e case was appealed to the Privy Council in London. 
ey emphasised
that the company and Mr Lee were distinct legal entities and therefore capable
of entering into legal relations with one another. As such they had entered into a
contractual relationship for him to be employed as the chief pilot of the company.
ey found that he could in his role of governing director give himself orders
as chief pilot. It was therefore a master and servant relationship and so he 
t-
ted the de
nition of worker under the Act. 
e widow was therefore entitled to
compensation.
Macaura v Northern Assurance Co
(1925)
2.30
Mr Macaura was the owner of the Killymoon estate in County Tyrone. In
December 1919 he agreed to sell to the Irish Canadian Saw Mills Ltd all the tim-
ber, both felled and standing, on the estate in return for the entire issued share
capital of the company, to be held by himself and his nominees. He also granted
the company a licence to enter the estate, fell the remaining trees and use the
sawmill. By August 1921, the company had cut down the remaining trees and
passed the timber through the mill.
7/20/2012 5:13:02 PM
Members, shareholders and the ownership of the corporation
2.31
e timber, which represented almost the entire assets of the company, was then
stored on the estate. On 6 February 1922 a policy insuring the timber was taken
out in the name of Mr Macaura. On 22 February a 
re destroyed the timber on
the estate. Mr Macaura then sought to claim under the policy he had taken out.
e insurance company contended that he had no insurable interest in the tim-
ber as the timber belonged to the company and not Mr Macaura. 
e case passed
through the Northern Ireland court system, during which time allegations of
fraud were made against Mr Macaura but never proven. Eventually in 1925 the
issue arrived before the House of Lords who, agreeing with the insurance com-
pany, found that the timber belonged to the company and that Mr Macaura even
though he owned all the shares in the company had no insurable interest in the
property of the company. Lord Wrenbury, agreeing with the insurance compa-
nys contention, stated that a member:
even if he holds all the shares is not the corporation and . . . neither he nor any
creditor of the company has any property legal or equitable in the assets of the
corporation.
Just as corporate personality facilitates limited liability by having the debts belong
7/20/2012 5:13:02 PM
Corporate personality and limited liability
share of the companys property. It may be better for your own understanding at
this point therefore to use the term member rather than shareholder because it
conveys a better sense of their rights and obligations.
2.34
Let us take the example of a swimming club of which you are a member. You have
certain rights to participate in the club. An obvious right would be the use of the
swimming pool but you may also have voting rights to elect members of the com-
mittee to run the club. If another member breaks the rules of the club you can
complain to the management committee who will enforce the rules and may even
punish the other member. You do not, however, as a member of the swimming
club own a part of the clubs property. You may swim in lane number 4 twice a
day every day but in no way do you own all or part of lane number 4. 
is is the
case even if you work out that your expensive membership fee is exactly equiva-
lent to the value of one lane in the swimming pool.
2.35
e same is roughly true where you are a member of a company. As a member
you have shares in the company which entitle you to participate in the company
as a member. As such you have such entitlements as are conferred on members
by the Companies Acts and the articles of association. Broadly these are rights to
information, attendance at meetings, voting and dividends if there are any.
Dispersed shareholdings
2.36
A further complication for our understanding of membership of a company
occurs where the shares become easily transferable. If there is a ready market for
shares (for example where a company is listed on the stock exchange) then a value
can easily be attributed to the rights attached to a share in a company. When this is
done there is a connection (it is not a legal one) between the assets of the company
and a share in the company. 
e following example will hopefully illustrate this.
2.37
M plc is a listed company, that is, its shares are traded on the stock exchange (see
Chapter 5). It has 10 million shares in circulation with a nominal value of 1 each.
e shares trade today on the stock exchange at 2 each. How can there be such
a di
erence between the nominal value of the shares and the market value? Note
that the nominal or par value of the shares refers only to the value attributed to
them to achieve a convenient subdivision of the share capital. 
at price repre-
sents only the minimum price they can be issued for and may or may not be the
price they actually were issued for (see Chapter 7 and Chapter 8). For the follow-
ing example however let us assume that the nominal value and the issue price are
the same. As we will see there is no necessary connection between the assets of
the company and the value of the shares but for our purposes here let us say that
on the day the company issued the shares the assets of the company were equal
7/20/2012 5:13:02 PM
Members, shareholders and the ownership of the corporation
to 10 million. 
at is, the only asset of the company was the capital contributed
by the shareholders. 
e following is a short hypothetical trading history of the
company.
Year one
1 May: M plc issues 10 million shares at a nominal value of 1 each and the direc-
tors issue a statement that the capital is to be used to fund an organic farming ven-
ture. 
7/20/2012 5:13:03 PM
Corporate personality and limited liability
10 September: A rumour goes around that Z Ltd has spotted that the economic
7/20/2012 5:13:03 PM
Members, shareholders and the ownership of the corporation
increased by 20 per cent (OK maybe you enjoy it 10 per cent more because you just
made 20,000 in two years). 
e point is that the rights attached to the property
have not increased at all even though the market value of those rights has.
Close companies
2.42
Small one or two-person companies can also cause confusion here. As with
Mr Macaura, if there is only one shareholder then he owns all the control rights
in the company and therefore entirely controls the assets of the company. If he
entirely controls the assets of the company does he not own the company and its
assets? Arent the shareholders generally considered the owners of the company?
2.43
Here we have to rely on your understanding of corporate personality. 
e sepa-
rate personality that is the company is controlled by its constitutional organs,
the board or general meeting and not by individual board or individual gen-
eral meeting members. While the board has the day-to-day control function, the
organ that elects the board is the general meeting. 
e general meeting however
acts collectively, so even though there is only one shareholder he or she makes
decisions to elect the board through the general meeting. 
us Mr X the sole
shareholder in X Ltd exercises his votes at a general meeting of the company in
favour of his chosen directors. It is not however Mr X who appoints the directors,
it is deemed that they were appointed by the general meeting.
2.44
roughout company law you will 
nd an emphasis on the exercise of collec-
tive shareholders rights and a reluctance (it does sometimes recognise that the
shareholder collective needs tempering) to acknowledge anything other than the
shareholder collective. For example the board owe a duty to promote the success
of the company (CA 2006, s 172), meaning broadly the members in general meet-
ing. 
ey do not owe the duty to the majority shareholder but rather to the share-
holders as a whole (see Chapter 14). 
is focus on the company acting through its
constitutional organs can, as we explained in Chapter 1, have detrimental e
ects
for minority shareholders. Another example you may remember from your study
of Tort is the decision in
Caparo v Dickman
(1990) that individual shareholders
who rely on the audited accounts to buy more shares in the company cannot
recover for loss based on this reliance if the accounts turn out to be incorrect
(these are the audited accounts that are sent to every shareholder). Only the com-
pany can get damages from the auditor for such a negligent act. In traditional
company law theory the focus of the companys activities is the shareholders as a
collective (see Chapter 15 for an overview of corporate theory).
2.45
While there are advantages to the primacy of the shareholder collective such as
encouraging risk capital, clarity of focus and authority, increasingly other groups
7/20/2012 5:13:03 PM
Corporate personality and limited liability
have begun to make strong claims to inclusion. Dissenting minority shareholders
en have legitimate claims to ease oppression. Additionally employees, credi-
tors and the environment can be drastically a
ected by decisions of the company.
ese claims to inclusion in the focus of company law have over the past decade
become part of what is know as the stakeholder debate (see Grantham (1998) on
the tensions between the traditional doctrinal position and stakeholder theory).
While we deal with this development in detail in Chapters 15 and 16, for now
you should be aware that stakeholder theory has increasingly gained legitimacy
in company law reform circles, culminating in some stakeholder lite provi-
sions being included in the CLRSGs
Final Report
(see Annex C: Statement of
Directors Duties) and the Company Law Reform Bill, Part 10, Chapter 2. 
ese
changes to the formulation of directors duties have now been introduced into
the Companies Act 2006 by way of s 172. 
is section maintains the focus of
directors duties 
rmly on the shareholders but allows enlightened boards of
directors to consider other stakeholder concerns if they wish. 
e importance of
this new provision lies more in legitimising stakeholder theory generally in the
business world than in any concrete e
ects the provision will have on displacing
shareholders as the main focus of corporate activity (see further Chapter 16).
FURTHER READING
This Chapter links with the materials in Chapter 3 of
Hicks and Goos Cases and
Materials on Company Law
(2011, Oxford University Press, xl +649p).
Freedman and Finch, Limited Liability Partnerships: Have Accountants Sewn up the
Deep Pockets Debate? [1997]
JBL
387.
Grantham, The Doctrinal Basis of the Rights of Company Shareholders [1998]
CLJ
554.
Ireland et al, The Conceptual Foundations of Modern Company Law [1987]
JLS
149.
Pettit Limited LiabilityA principle for the 21st century [1995]
CLP
124.
SELF-TEST QUESTIONS
Explain how the separate personality of the company facilitates limited liability.
Was justice done in the
Macaura
Do shareholders own the company?
7/20/2012 5:13:03 PM
SUMMARY
Introduction
Statutory examples
Veil lifting by the courts
Classical veil lifting, 18971966
The interventionist years, 19661989
Back to basics, 1989present
Tortious liability
Parent company personal injury tortious liability
Commercial tort
The costs/bene
ts of limited liability
Introduction
3.1
You may not unnaturally wonder at this point what the phrase li
ing the veil
is about. It refers to the situations where the judiciary or the legislature have
decided that the separation of the personality of the company and the members
is not to be maintained. 
e veil of incorporation is thus said to be li
ed. 
e
judiciary in particular seem to love using unhelpful metaphors to describe this
process. In the course of reading cases in this area you will 
nd the process vari-
ously described as li
ing, peeping, penetrating, piercing or parting the veil
of incorporation. In a nutshell, having spent the whole of the last chapter empha-
sising the separateness of corporate personality, we now turn to those situations
where for various reasons that separateness is not maintained.
3.2
While some of the examples of veil li
ing involve straightforward shareholder
limitation of liability issues many of the examples involve corporate group struc-
tures. As businesses became more adept at using the corporate form, group struc-
tures began to emerge. For example Z Ltd (the parent or holding company) owns
Lifting the veil
7/20/2012 5:15:11 PM
Lifting the veil
all the issued share capital in three other companiesA Ltd, B Ltd and C Ltd.
ese companies are known as wholly owned subsidiaries (see CA 2006, s 1159(2)).
Z Ltd controls all three subsidiaries. In economic reality there is just one business
but it is organised through four separate legal personalities. In e
ect this structure
allows the legal personality of the parent company to avail itself of the advantages
of limited liability. 
us if the parent conducts its more risky or liability-prone
activities through A Ltd and things go wrong the assets of Z Ltd, because it is a
shareholder of A Ltd with limited liability, in theory cannot be touched. In certain
situations the legislature and the courts will not allow this to happen.
Statutory examples
3.3
e taxation authorities in the UK have been acutely aware of the potential for
group structures to avoid taxation by moving assets and liabilities around the
group. 
us, there are numerous examples of taxation legislation directed at
ignoring the separate entities in the group. 
e Companies Act also recognises
that group structures need to be treated di
erently for disclosure and 
nancial
reporting purposes in order to get a proper overview of the group  nancial posi-
tion. 
e CA 2006, s 399 therefore provides that parent companies have a duty to
produce group accounts. Section 409 also requires the parent to provide details
of the subsidiaries names, country of activity and the shares it holds in the
subsidiary.
3.4
e Employment Rights Act 1996 also protects employees statutory rights when
transferred from one company to another within a group, treating it as a con-
tinuous period of employment. Additionally, many of the situations where li
ing the veil is at issue involve corporate insolvency, the Insolvency Act 1986 has
some key veil li
ing provisions. While we deal with these provisions in detail in
Chapter 17, we brie
y consider them here.
3.5
e Companies Acts have long recognised that the corporate form could be
used for fraudulent purposes. Indeed, one of the reactions of Parliament to the
Salomon
decision was to introduce an o
ence of fraudulent trading. 
is o
ence
was continued in the 1948 Companies Act which contained both civil and crimi-
nal sanctions for fraudulent trading. While the CA 2006 still contains a criminal
ence in s 993 for fraudulent trading, the civil provisions are now contained in
ss 213215 of the Insolvency Act 1986. It is these civil sanctions that operate to li
the corporate veil. Section 213 states:
(1)
If in the course of the winding up of a company it appears that any
business of the company has been carried on with intent to defraud
7/20/2012 5:15:13 PM
Statutory examples
creditors of the company or creditors of any other person, or for any
fraudulent purpose, the following has effect.
(2)
The court, on the application of the liquidator may declare that any
persons who were knowingly parties to the carrying on of the business in
the manner abovementioned are to be liable to make such contributions
(if any) to the companys assets as the court thinks proper.
is section and its predecessor in the 1948 Act consistently proved di
cult to
operate in practice. 
e main di
culty was that there was the possibility of a
criminal charge also arising. 
e courts therefore set the standard for intent fairly
high. As the court explained in
Re Patrick and Lyon Ltd
(1933), this involved
proving actual dishonesty, involving, according to current notions of fair trad-
ing among commercial men, real moral blame. Reaching this standard was dif-
cult and eventually a new provision was introduced in s 214 of the Insolvency
Act 1986 to deal with what is known as wrongful trading.
3.7
Section 214 was introduced to deal with situations where negligence rather than
fraud is combined with a misuse of corporate personality and limited liability. In
other words there was no need to prove dishonesty. 
is is known as wrongful
trading. Section 214 states:
(1)
. . . if in the course of the winding up of a company it appears that
subsection (2) of this section applies in relation to a person who is or
has been a director of the company, the court, on the application of
the liquidator, may declare that that person is to be liable to make such
contribution (if any) to the companys assets as the court thinks proper.
(2) This subsection applies in relation to a person if
(a) the company has gone into insolvent liquidation,
(b)
at some time before the commencement of the winding up of the
company, that person knew or ought to have concluded that there
was no reasonable prospect that the company would avoid going
into insolvent liquidation, and
(c) that person was a director of the company at that time.
3.8
e idea behind the operation of the section is that at some time towards the
end of the companys trading history there will be a point of no return. 
at is,
things are so bad the company can no longer trade out of the situation. A rea-
sonable director would stop trading at this point. If a director continues to trade
er this point he will risk having to contribute to the debts of the company. 
e
case of
Re Produce Marketing Consortium Ltd (No 2)
(1989) is a good example
of the way the section operates. Over a period of seven years the company had
slowly dri
ed into insolvency. 
ere was no suggestion of wrongdoing on the
7/20/2012 5:15:13 PM
Lifting the veil
part of the two directors involved; it was just that they did not put the company
into liquidation in time and thus they had to contribute
75,000 to the debts of
the company.
While s 213 covers anyone involved in the carrying on of the business, thus
qualifying the limitation of liability of members, s 214 is aimed speci
cally at
directors. In small companies directors are o
en also the members of the com-
pany and so their limitation of liability is indirectly a
ected. Parent companies
may also have their limited liability a
ected if they have acted as a shadow
director. A shadow director is anyone other than a professional adviser in
accordance with whose directions or instructions the directors of the company
are accustomed to act (CA 2006, s 251, see Chapter 13). A parent company
might be in this position if it was exerting direct control over the board of its
subsidiaries.
Veil lifting by the courts
3.10
Since the
Salomon
decision the courts have o
en been called upon to apply
the principle of separate legal personality in what might be called di
cult
situations. In some cases they have upheld the principle and in others they
did not. Over this time various attempts have been made at providing expla-
nations for when the courts will li
the veil of incorporation; none however
are really satisfactory. Some texts attempt to explain veil li
ing by categories:
where the company is an agent of another, where there is fraud, or tax issues,
or employment issues or a group of companies exists the courts will li
the
veil. While it is possible to  nd examples of veil li
ing in all these categories
it is also possible to  nd examples of the courts upholding the separateness of
companies in these categories. Others have attempted to categorise veil li
ing
by analysing the ways the judiciary have li
ed the veil. 
us Ottolenghi (1990)
ers categorisations such as: peeping, where the veil is li
ed to get member
information; penetrating, where the veil is disregarded and liability is attrib-
uted to the members; extending, where a group of companies is treated as one
legal entity and; ignoring, where the company is not recognised at all. While
these categorisations are interesting and useful for understanding how veil
ing has sometimes operated in the past they in no way o
er a guide to how
the courts will behave in a given situation in the future. 
e most accurate
statement about this that can be made is that sometimes the courts li
the veil
and sometimes they refuse to. It may be frustrating and unsatisfactory but
that is the reality. Having said that, there have been periods where the courts
were more inclined to uphold the veil of incorporation than not. By way of
7/20/2012 5:15:14 PM
The interventionist years, 19661989
our own explanation we o
er the following timeline which is intended as a
general guide.
Classical veil lifting, 18971966
3.11
During this period the House of Lords decision in
Salomon
dominated. As we
explained in Chapter 2, the House of Lords could not overrule itself during this
period and this operated as a signi
cant restraint on veil li
ing. However, veil
ing did occur in exceptional circumstances during this period. 
e court for
example in
Daimler Co Ltd v Continental Tyre and Rubber Co
Great Britain
Ltd
(1916) li
ed the veil to determine whether the company was an enemy during
the First World War. As the shareholders were German, the court determined
that the company was indeed an enemy.
3.12
In
Gilford Motor Co Ltd v Horne
(1933) a former employee who was bound by a
covenant not to solicit customers from his former employers set up a company
to do so. 
e court found that the company was but a front for Mr Horne and
issued an injunction. In
Jones v Lipman
(1962) Mr Lipman had entered into a
contract with Mr Jones for the sale of land. Mr Lipman then changed his mind
and did not want to complete the sale. He formed a company in order to avoid
the transaction and conveyed the land to it instead. He then claimed he no longer
owned the land and could not comply with the contract. 
e judge again found
the company was but a faade and granted an order for speci
c performance. In
Re Bugle Press
(1961) majority shareholders in a company set up a second com-
pany in order to force a compulsory purchase of a minority shareholders shares.
e second company then made an o
er for the shares in the 
rst company and
the majority shareholders accepted. As this meant that over 90 per cent of the
shareholders had accepted, it therefore triggered a compulsory purchase of the
minority shareholders shares under the Companies Acts (see Chapter 5). 
e
minority shareholder objected and the court prevented the transaction again as
the second company was but a mere faade for the majority shareholders.
The interventionist years, 19661989
3.13
By the 1960s the courts were increasingly demonstrating a tendency to free them-
selves from old precedence they saw as increasingly unjust. In 1966 this tendency
led the House of Lords to change the rules under which it had operated and allow
it to change its mind and overrule itself. By 1969 Lord Denning seemed to be on
7/20/2012 5:15:14 PM
Lifting the veil
a crusade to encourage veil li
ing. In
Littlewoods Mail Order Stores v IRC
(1969)
he stated:
[t]he doctrine laid down in Salomons case has to be watched very carefully. It
has often been supposed to cast a veil over the personality of a limited com-
pany through which the courts cannot see. But that is not true. The courts can,
and often do, pull off the mask. They look to see what really lies behind. The
legislature has shown the way with group accounts and the rest. And the courts
should follow suit.
3.14
In
DHN Food Distributors Ltd v Tower Hamlets
(1976) Denning argued that
a group of companies was in reality a single economic entity and should be
treated as one. Two years later the House of Lords in
Woolfson v Strathclyde
Regional Council
(1978) speci
cally disapproved of Dennings views on group
structures in 
nding that the veil of incorporation would be upheld unless it
was a faade. However, Dennings views on the li
ing of the corporate veil still
had considerable e
ect. In
Re a Company
(1985) the Court of Appeal stated:
[i]n our view the cases before and after
Wallersteiner v Moir
[1974] 1 WLR 991
[another Lord Denning case] show that the court will use its power to pierce the
corporate veil if it is necessary to achieve justice irrespective of the legal ef
cacy
of the corporate structure under consideration.
is represented probably the high point of the interventionist period where the
courts seemed to treat the separate personality of the company as an initial negoti-
ating position which could be overturned in the interests of justice.
3.15
ere was however a growing disquiet about the uncertainty this brought
to the concept of corporate personality and limited liability. As Lowry (1993)
concluded:
[t]he problem that can naturally arise from this approach is the uncertainty
which it casts over the safety of incorporation. The use of the policy to erode
established legal principle is not necessarily to be welcomed.
Similarly Gallagher and Ziegler (1990) in an examination of when the courts will
the veil of incorporation at common law concluded that the li
ing of the veil
can have negative impacts on other aspects of the law such as directors duty to the
company as a whole, individual taxation principles and the rule in
Foss v Harbottle
(1843). However, by the late 1980s the Court of Appeal in
National Dock Labour
Board v Pinn and Wheeler Ltd
(1989) had moved 
rmly against a more inter-
ventionist approach at least where group structures were concerned. 
is was a
foretaste of what was to come in the following decade.
7/20/2012 5:15:14 PM
Back to basics, 1989present
Back to basics, 1989present
3.16
In
Adams v Cape Industries Plc
(1990) the Court of Appeal took the oppor-
tunity to examine at great length the way the courts have lifted the veil of
incorporation in the past and narrowed significantly the way in which the
courts could do so in the future. The facts of the case were extremely com-
plex and what follows is but a very simple version. The case concerned the
enforcement of a foreign judgment in England. The key issue for the Court
was whether Cape Industries could be regarded as falling under the jurisdic-
tion of a US court and therefore be subject to its judgment. This could only
occur if Cape was present within the US jurisdiction or had submitted to such
jurisdiction.
3.17
Until 1979, Cape, an English company, mined and marketed asbestos. Its world-
wide marketing subsidiary was another English company, named Capasco. It
also had a US marketing subsidiary incorporated in Illinois, named NAAC.
In 1974, some 462 people sued Cape, Capasco, NAAC and others in Texas, for
personal injuries arising from the installation of asbestos in a factory. Cape
protested at the time that the Texas court had no jurisdiction over it but in
the end it settled the action. In 1978, NAAC was closed down by Cape and
other subsidiaries were formed with the express purpose of reorganising the
business in the USA to minimise Capes presence there for taxation and other
liability issues.
3.18
Between 1978 and 1979, a further 206 similar actions were commenced and
default judgments were entered against Cape and Capasco (who again denied
they were subject to the jurisdiction of the court but this time did not settle).
In 1979 Cape sold its asbestos mining and marketing business and therefore
had no assets in the USA. 
e claimants thus sought to enforce the judgments
in England where Cape had most of its assets. At issue in the case was whether
Cape was present in the US jurisdiction by virtue of its US subsidiaries. 
e only
way that could be the case in the courts view was if it li
ed the veil of incorpora-
tion, either treating the Cape group as one single entity, or 
nding the subsidiar-
ies were a mere faade or that the subsidiaries were agents for Cape. 
e court
exhaustively examined each possibility.
3.19
e court 
rst examined the major single economic unit cases where group
structures were treated as being a single entity. It found that the cases all involved
the interpretation of a statute or a document. 
ey reached this conclusion
even though the Denning judgment (which the Court of Appeal examined) in
DHN Food Distributors Ltd v Tower Hamlets
(1976) is clearly not based upon
7/20/2012 5:15:14 PM
Lifting the veil
interpreting a statute or document. 
e court therefore rejected the argument
that the Cape group should be treated as one, stating:
save in cases which turn on the wording of particular statutes or contracts, the
court is not free to disregard the principle of
Salomon v A Salomon & Co Ltd
[1897] AC 22 merely because it considers that justice so requires. Our law, for
better or worse, recognises the creation of subsidiary companies, which though
in one sense the creatures of their parent companies, will nevertheless under the
general law fall to be treated as separate legal entities with all the rights and
liabilities which would normally attach to separate legal entities.
3.20
e court then turned to what they termed the corporate veil point. 
is cat-
egory of veil li
ing is exempli
ed by the case of
Jones v Lipman
(1962, above)
and was, in the courts view, a well-recognised veil li
ing category. 
e Court of
Appeal quoted with approval the words of Lord Keith in
Woolfson v Strathclyde
Regional Council
(1978) where he described this exception as the principle that
it is appropriate to pierce the corporate veil only where special circumstances
exist indicating that it is a mere faade concealing the true facts. In these spe-
cial circumstances the motives of those behind the alleged faade could be very
important. 
e court looked at the motives of Cape in structuring its US business
through its various subsidiaries. It found that although Capes motive was to try
to minimise its presence in the USA for tax and other liabilities there was nothing
wrong with this. 
e court concluded:
[w]hether or not such a course deserves moral approval, there was nothing ille-
gal as such in Cape arranging its affairs (whether by the use of subsidiaries or
otherwise) so as to attract the minimum publicity to its involvement in the sale
of Cape asbestos in the United States of America . . . we do not accept as a matter
of law that the court is entitled to lift the corporate veil as against a defendant
company which is the member of a corporate group merely because the cor-
porate structure has been used so as to ensure that the legal liability (if any) in
respect of particular future activities of the group (and correspondingly the risk
of enforcement of that liability) will fall on another member of the group rather
than the defendant company. Whether or not this is desirable, the right to use a
corporate structure in this manner is inherent in our corporate law.
3.21
e court then considered the agency argument. 
is was a straightforward
application of agency principle. If it could be established that the subsidiary was
Capes agent and acting within its actual or apparent authority then the actions
of the subsidiary would bind the parent. However, if there is no express agency
agreement between the subsidiary and the parent, establishing such an agency
from their conduct is very hard to achieve. 
e court found that the subsidiaries
7/20/2012 5:15:15 PM
Back to basics, 1989present
were independent businesses free from the day-to-day control of the parent with
no general power to bind the parent. 
us as none of the three veil-li
ing catego-
ries applied Cape was not present in the USA through its subsidiaries.
3.22
e judgment of the Court of Appeal in
Adams
leaves only three circumstances
in which the veil of incorporation can be li
ed. 
e 
rst is if the court is inter-
preting a statute or document. 
is exception to maintaining corporate person-
ality is quali
ed by the fact that there has 
rst to be some lack of clarity about
a statute or document which would allow the court to treat a group as a single
entity. Some judges will be more enthusiastic about 
nding such lack of clar-
ity than others. Although the Court is somewhat vague in
Adams
on what they
mean by this exception, the Court of Appeal in
Samengo-Turner v J&H Marsh
& McLennan (Services) Ltd
(2008) treated a group of companies as a single legal
entity on the basis of their single economic interest in interpreting the applica-
tion of an EU Regulation. Similarly in
7/20/2012 5:15:15 PM
Lifting the veil
the same as it would be for two human beingshave they entered into an express
agency agreement or could an agency be implied from their conduct? Parent
companies and their subsidiaries are unlikely to have express agency agreements.
ey are even less likely to have express agreements if avoidance of liability was
the reason for setting the subsidiary up in the 
rst place, as it was in
Adams
Proving an implied agency will also be very di
cult as
Adams
sets the bar very
high. An implied agency would need evidence that day-to-day control was being
exercised over the subsidiary by the parent. Again, this is unlikely to be the case
where liability limitation was one of the motives for forming the subsidiary. (For
an interesting example of where a high level of control did attribute liability to a
parent company see
Millam v 
e Print Factory (London) 1991 Ltd
(2008).)
3.25
As you can see from the above,
Adams
signi
cantly narrowed the ability of the
courts to li
the veil of incorporation. Gone are the wild and crazy days when the
Court of Appeal would li
the veil to achieve justice irrespective of the legal e
cacy of the corporate structure as it did in
Re a Company
(1985). 
e rest of the
1990s was largely dominated by the restrictive approach of
Adams
(for example
see
Yukong Lines Ltd of Korea v Rensburg Investments Corpn of Liberia
(1998))
apart from one interesting aberration which we now turn to examine.
Creasey v Breachwood Motors Ltd (1993)
3.26
e case concerned two companies Breachwood Welwyn Ltd and Breachwood
Motors Ltd. 
e two companies had directors and shareholders in common.
Mr Creasy had been dismissed from his post of general manager by Breachwood
Welwyn Ltd and had issued a writ against Welwyn alleging wrongful dismissal.
Shortly a
er this happened Welwyn ceased trading and its assets were trans-
ferred to Breachwood Motors Ltd. Breachwood Motors Ltd then took over and
carried on the business of Breachwood Welwyn Ltd. In doing this they paid o
Breachwood Welwyn Ltds creditors but did not maintain or return assets to
Breachwood Welwyn Ltd to enable it to meet its judgment debt to Mr Creasy.
e wrongful dismissal action was not defended by Breachwood Welwyn Ltd
and judgment was entered in default in favour of Mr Creasy and an order for
53,835 made against Breachwood Welwyn Ltd. A year later the company was
struck o
the companies register and dissolved. Mr Creasy successfully applied
to have Breachwood Motors Ltd substituted as the defendant in order to enforce
the judgment. Breachwood Motors Ltd appealed.
3.27
e judge in the case, Mr Richard Southwell QC, ignored the restrictive approach
in
Adams
in 
nding that the central issue was that, with the bene
t of solici-
tors advice, the directors of Breachwood Motors Ltd (who were also directors
of Welwyn) had deliberately ignored the separate legal personalities of the two
7/20/2012 5:15:16 PM
Back to basics, 1989present
companies. 
ey had transferred Breachwood Welwyn Ltds assets and busi-
ness to Breachwood Motors Ltd without regard to their duties as directors and
shareholders. 
e court was justi
ed therefore in li
ing the corporate veil and
treating Breachwood Motors Ltd as liable for Breachwood Welwyn Ltds liability
to Mr Creasy.
3.28
e case has caused considerable comment because of its maverick status and the
confused nature of the rationale. 
e judge seems to suggest that when determin-
ing the faade exception it is not only the motives of those behind the alleged
faade that may be relevant but also whether they have breached their duties as
directors. Indeed, from the judgment it seems that the motives of the directors
were irrelevant and that just the fact of a breach of duty was su
cient to justify
ing the veil. However, the Court of Appeal soon took the opportunity to over-
rule it.
Ord v Belhaven Pubs Ltd (1998)
3.29
Ord and Belhaven Pubs Ltd were engaged in a legal action about a lease. During
the course of the action the group structure of which Belhaven Pubs Ltd was a
part was reorganised because of a 
nancial crisis within the group. As a result of
the reorganisation Belhaven Pubs Ltd had no assets or liabilities and would there-
fore have nothing with which to pay any judgment against it. As the litigation
regarding the lease was still continuing Ord applied to have the parent company
of Belhaven Pubs Ltd substituted. 
e High Court judge who 
rst heard the case
allowed the substitution. 
e Court of Appeal however took the view that the
reorganisation of the group was legitimate and not merely a faade to conceal the
true facts. 
e assets were transferred at full value and the motive appeared to be
the groups 
nancial crisis rather than any ulterior motive. 
e court also took
the opportunity to speci
cally overrule the judgment in
Creasey v Breachwood
Motors Ltd
(1993).
3.30
Both the
Creasey
and
Ord
cases are illustrations of a classic veil-li
ing issue,
that of whether the reorganisation of the company was a legitimate business
transaction or the motive was to avoid liability. If the motive was to avoid liabil-
ity then according to the faade exception there was the possibility of li
ing
the veil. If the court takes the view that the veil should be li
ed (and this is
by no means certain as
Adams
takes a very strict view of the types of motives
needed) then liability can 
ow to the parent company. Indeed, in
Kensington
International Ltd v Congo
(2006) the court did hold that a dishonest trans-
action involving transfers between related companies was designed to avoid
existing liabilities and was therefore a sham. 
e court then went on to li
the
veil of incorporation.
7/20/2012 5:15:16 PM
Lifting the veil
Trustor AB v Smallbone (No 2) (2001)
3.31
During Smallbones period as Trustors managing director various sums of
money had been transferred in breach of 
duciary duty from Trustor to another
company owned and controlled by Smallbone. Trustor applied to the court to
pierce the corporate veil so as to treat receipt by the second company as receipt by
Smallbone on the grounds that: the company had been a sham created to facili-
tate the transfer of the money in breach of duty; the company had been involved
in the improper acts; and the interests of justice demanded such a result.
3.32
e court in an interesting judgment recognised the tension between some of the
earlier cases and the
Adams
judgment but concluded that
Adams
was the greater
authority. In deciding to li
the veil on the basis of the faade exception the Vice-
Chancellor concluded:
[c]ompanies are often involved in improprieties. Indeed there was some sugges-
tion to that effect in
Salomon v Salomon & Co Ltd
[1897] AC 22. But it would
make undue inroads into the principle of
Salomon v Salomon & Co Ltd
if an
impropriety not linked to the use of the company structure to avoid or conceal
liability for that impropriety was enough. In my judgment the court is entitled
to pierce the corporate veil and recognise the receipt of the company as that of
the individual(s) in control of it if the company was used as a device or facade
to conceal the true facts thereby avoiding or concealing any liability of those
individual(s).
Here the Vice-Chancellor was faed with a clear case of an improper motive but
in deciding to li
7/20/2012 5:15:16 PM
Tortious liability
give rise to a li
ing of the corporate veil. Interestingly, the court in Raja explicitly
moves away from what it calls a narrow reading of
Adams
to adopt an expan-
sive approach which partly encompasses Pngs point in 
nding that the dishonest
construction of a group of companies might give rise to a the court li
ing the veil
of incorporation even in relation to liabilities not envisioned by the creator of the
sham companies.
3.34
In a number of cases in recent years the courts have begun to tentatively suggest
that a more realistic view of group liability, akin to Lord Dennings original
concept of single economic entity, may be appropriate rather than the Court of
Appeals view in
Adams.
In
Beckett Investment Management Group Ltd v Hall
(2007), for example, Maurice Kay LJ rejected what he called a purist interpreta-
tion of corporate personality and went on to support Lord Dennings view of a
single economic entity. As we will observe below developments in the area of
group tortuous liability are also moving in a Denning-esque direction with the
decision in
Chandler v Cape Plc
(2011) to attribute tortious liability to a parent
company. As usual in this area things are rarely straightforward and so while
the
7/20/2012 5:15:17 PM
Lifting the veil
3.36
is particular problem was recognised by the CLRSG in its preliminary delib-
erations (
Modern Company Law for a Competitive Economy: Completing the
Structure,
ch 10). In that chapter the CLRSG took a very cautious and conserva-
tive view of the problem and concluded that because of the
Adams
case the
UK judiciary would be unwilling to li
the veil for involuntary creditors. 
ey
concluded no reforms were needed. 
e matter of parent liability for personal
injury torts of its subsidiaries was then dropped and does not appear anywhere
in the CLRSGs
Final Report.
Given that over the course of the CLRSG review
of UK company law a number of very high-pro
le (see below) examples of this
problem passed through the UK courts, the omission is all the more bemusing.
As Muchlinski (2002) concluded a
er reviewing the work of the CLRSG, the
Steering Group does not appear to have been strongly in
uenced by concerns
such as those of involuntary creditors who have su
ered personal injuries at the
hands of the overseas subsidiaries of United Kingdom-based Multi-National
Enterprises [a corporate group with subsidiaries abroad]. Rather, it was oriented
towards the traditional, shareholder-based, model of company law and towards a
cost-e
ective, pro-business approach to regulation.
Parent company personal injury tortious liability
3.37
In
Connelly v RTZ Corporation Plc
(1998) Mr Connelly had been a uranium
miner working in Namibia for a subsidiary of RTZ. He subsequently developed
cancer and attempted to sue the parent company in London alleging that RTZ
had played a part in the health and safety procedures employed by the subsidiary
and that RTZ owed a duty of care to him. RTZ applied to have the action struck
out in London arguing that Connelly should sue the subsidiary in Namibia.
e issue went to the House of Lords who found that the matter could not be
heard in Namibia because of the complexity of the case and the cost. London
was therefore the appropriate forum. 
e decision was not unanimous; Lord
Ho
mann dissented on the basis of the implications for the
Salomon
principle,
concluding:
[t]he defendant is a multinational company, present almost everywhere and
certainly present and ready to be sued in Namibia. I would therefore regard the
presence of the defendants in the jurisdiction as a neutral factor. If the presence
of the defendants, as parent company and local subsidiary of a multinational,
can enable them to be sued here, any multinational with its parent company
in England will be liable to be sued here in respect of its activities anywhere in
the world.
7/20/2012 5:15:17 PM
Parent company personal injury tortious liability
3.38
e case went back to the High Court and the tortious issue was tried. RTZ
argued that the subsidiary was Connellys employer. 
erefore any duty of care
was owed by the Namibian subsidiary. RTZ also argued that the claim was time
barred under the Limitation Act 1980. 
e court refused to strike out the action
on the duty of care point 
nding that it was arguable that the parent company
had responsibility for health and safety at the mine and this would have been
such as to create a duty of care to Mr Connelly. However, the claim was time
barred under the Limitation Act. Mr Connelly could have brought the case in
1989 but chose not to.
3.39
e case opened up the possibility that actions could be brought against a par-
ent company based in London for the actions of its subsidiary based abroad and
that, at least in theory, and depending on the amount of control exerted over
the subsidiary, a parent company could owe a duty of care to the workers of the
subsidiary.
3.40
e case of
Lubbe v Cape Industries Plc
(2000) continued the pattern of li
ing
the veil where tortious liability for personal injuries is at issue. 
e case con-
cerned litigation brought by over 3,000 employees and nearby residents of Cape
Industrys wholly owned asbestos-mining subsidiary in South Africa claiming
damages from the parent company in London for death and personal injury
caused by exposure to asbestos at or near the mining operation in South Africa.
e issues were the same as in the
Connelly
case. 
e House of Lords found that
South Africa was the more appropriate place to sue but that the lack of legal rep-
resentation and the expert evidence required to substantiate the claims in South
Africa would amount to a denial of justice. 
e action could therefore proceed
against the parent in London. 
e case went back to the High Court for trial and
in January 2002 Cape settled the action for 21
million.
3.41
In
Chandler v Cape Plc
(2011) the claimant was the employee of a wholly owned
subsidiary of Cape who su
ered asbestos related injuries in the course of his
employment. 
e subsidiary no longer existed nor was any insurance in place to
cover injuries such as the claimants. 
e claimant therefore sought to attribute
tortious liability to the parent company because of its control over the subsidi-
arys health and safety policy. 
e central question was therefore: was the fact of
the parent companys control over health and safety policy, despite the subsidiary
being largely independent of the parent, su
cient to confer liability for a breach
of duty of care? In reaching his decision Wyn Williams J found that the assump-
tion of responsibility by the parent company over health and safety policy at the
subsidiary created a special relationship between the employee and the parent
company which gave rise to a duty of care. On the facts of the case this duty had
been breached by the parent company and damages were payable.
7/20/2012 5:15:18 PM
Lifting the veil
Commercial tort
3.42
e di
erence in the treatment of tortious actions for personal injury and other
more commercial torts such as negligent misstatement that involve, at least
tangentially, veil li
ing is striking. In
Williams v Natural Life Health Foods Ltd
(1998) the House of Lords emphasised the
Salomon
principle in the context of
a negligent misstatement claim. 
e managing director of Natural Life Health
Foods Ltd (NLHF) was also its majority shareholder. 
e companys business
was selling franchises to run retail health food shops. One such franchise had
been sold to the claimant on the basis of a brochure which including detailed
nancial projections. 
e managing director had provided much of the informa-
tion for the brochure. 
e claimant had not dealt with the managing director but
only with an employee of NLHF. 
e claimant entered into a franchise agree-
ment with NLHF but the franchised shop ceased trading a
er losing a substantial
amount of money. He subsequently brought an action against NLHF for losses
su
ered as a result of its negligent information contained in the brochure. NLHF
subsequently ceased to trade and was dissolved. 
e claimant then continued the
action against the managing director and majority shareholder alone, alleging he
had assumed a personal responsibility towards the claimant.
3.43
e reality of this claim was to try to nullify the protection o
ered by limited
liability and as Lowry and Edmunds (1998) have pointed out the House of Lords
was particularly aware of this in reaching its decision. 
e House of Lords con-
sidered that a director or employee of a company could only be personally liable
for negligent misstatement if there was reasonable reliance by the claimant on
an assumption of personal responsibility by the director so as to create a special
relationship (as was present in the
Chandler
case above) between them. 
ere was
no evidence in the present case that there had been any personal dealings which
could have conveyed to the claimant that the managing director was prepared
to assume personal liability for the franchise agreement. However, if the tort is
deceit rather than negligence the courts will allow personal liability to 
ow to a
director or employee (see
Daido Asia Japan Co Ltd v Rothen
(2001) and
Standard
Chartered Bank v Pakistan National Shipping Corpn (Nos 2 and 4) (2002) and
Barclay Pharmaceuticals Ltd v Waypharm LP
(2012).
An o
cer of the company
may also be personally liable for costs if they pursued an action unreasonably or
for an ulterior motive (see
Gemma Ltd v Gimson
(2005)).
3.44
e
Williams
case has subsequently been in
uential where commercial torts are at
issue. For example the High Court in
Noel v Poland (2001)
dismissed a negligent
misstatement/deceit action against the chairman and a director of a liquidated
insurance company for inducing Noel to become a Lloyds name (a contractual
7/20/2012 5:15:18 PM
Commercial tort
arrangement where an individual agrees (for a fee) to cover certain insurance
losses made by the Lloyds insurance market). 
e court found that the chairman
and director were acting on behalf of the company and that there had not been any
assumption of personal responsibility.
3.45
e di
cult issue of directors tortious liability, however, has proved an endur-
ing one. In
MCA Records Inc v Charly Records Ltd (No 5)
(2003) a director had
authorised a number of infringing acts under the Copyright Designs and Patent
Act 1988. 
e Court of Appeal in a very detailed consideration of the issue of
directors liability in tort, including the
Williams
case, took a more relaxed
approach to the possibility of liability. 
e Court concluded:
if all that a director is doing is carrying out the duties entrusted to him as such
by the company under its constitution, the circumstances in which it would
be right to hold him liable as a joint tortfeasor with the company would be
rare indeed . . . [however] there is no reason why a person who happens to be
a director or controlling shareholder of a company should not be liable with
the company as a joint tortfeasor if he is not exercising control through the
constitutional organs of the company and the circumstances are such that he
would be so liable if he were not a director or controlling shareholder. In other
words, if, in relation to the wrongful acts which are the subject of complaint,
the liability of the individual as a joint tortfeasor with the company arises from
his participation or involvement in ways which go beyond the exercise of con-
stitutional control, then there is no reason why the individual should escape
liability because he could have procured those same acts through the exercise
of constitutional control.
On the facts of this case the Court found that the director was liable as a joint
tortfeasor. (See also
Koninklijke Philips Electronics NV v Princo Digital Disc GmbH
(2004) where a company director was also held personally liable.)
3.46
e di
erence in treatment of personal injury torts and more commercial torts
such as negligent misstatement is somewhat consistent with the voluntary/invol-
untary nature of their transactions with the company. We say somewhat consist-
ent, as there is an obvious inconsistency. 
e contrast between the outcomes in
the cases of
Adams v Cape Industries Plc
(1990) and
Lubbe v Cape Industries Plc
(2000) or more signi
cantly
Chandler v Cape Plc
(2011) is striking. Both these
cases concern the same underlying claim for personal injury for asbestos con-
tamination from the same company. In
Adams
the claimants were successful
in the US courts and sought to enforce the action against the parent in London.
e Court of Appeal did not li
the veil in that case. In
Lubbe
the same claim for
personal injury was made against the same company but because there was an
7/20/2012 5:15:19 PM
Lifting the veil
underdeveloped court system where the subsidiary was operating the House of
Lords li
ed the veil and allowed the parent to be sued in the UK for the action of
the subsidiary. 
e basis of the decision was that not to do so would amount to a
denial of justice. In
Chandler
the facts are very similar to
Adams
save for the basis
of the action and the courts interpretation of control.
3.47
It is di
cult to see how the decision in the
Adams
case, where the subsidiary was
operating in a jurisdiction with a developed court system and where the claim-
ants successfully used that system but needed to enforce it against the parent in
London, achieved any measure of justice. 
us a personal injury caused by a UK
subsidiary operating in the USA or any developed country will not give rise to
any liability on the part of the parent but a personal injury caused by the sub-
sidiary of a UK company in an underdeveloped jurisdiction will. 
e
Chandler
decision should now starkly illustrate the inconsistency of the range of
Cape
deci-
sions based around similar injuries. 
e fact that the CLRSG declined to consider
any reform of this area is even stranger given this inconsistency. 
e CLRSGs
predictions that the UK judiciary would not li
the veil for involuntary creditors
proved mistaken. 
e CLRSG sadly adopted a much more conservative approach
to the issue than the judiciary did, which is a terrible thing to conclude about a
law reform body.
The costs/bene
ts of limited liability
3.48
Limited liability has certain advantages. It obviously encourages investment as
the members risk is minimised. It also encourages risk taking on the part of
management who can take risks sure in the knowledge that the members will not
lose everything. Limited liability is also said to facilitate a public share market.
If liability were unlimited then the value of shares would depend on the wealth
of the individual holder. Shares would be worth less to a wealthy shareholder as
that shareholder would be more likely to be sued in a liquidation than a poor one.
is would hinder the development of a liquid share market as the value of the
shares could not be assessed until a buyer was found and his personal assets also
assessed.
3.49
For example, if we look in the
Financial Times
at the quoted share price of a
company, that price is based, as we discussed in Chapter 2, on the markets per-
ception of all the publicly available information that a
ects that limited liability
company. It is the price at which anyone can buy the shares. If we moved to a
situation where liability was unlimited then the price of a share would not be
a standard price: it would vary depending on the wealth of the buyer. In other
7/20/2012 5:15:20 PM
The costs/bene ts of limited liability
words, only the combination of the public information on the company plus the
private information on the potential shareholders wealth could determine the
price of the share. 
is would not help the development of a liquid market in a
companys shares.
3.50
Another advantage of limited liability was identi
ed by Hansmann and
Kraakman (2000) who noted that not only does limited liability protect the
shareholders from the companys creditors but it can also serve to put the busi-
ness assets of an individual out of reach of that individuals personal creditors.
For example in family law the partitioning e
ect can remove the assets from a
marriage (see
Hashem v Shayif & Anor
(2008)). 
us, by forming a company
and placing his business assets in the company in return for shares in the com-
pany the individual no longer has any legal interest in the assets. 
is serves to
partition the personal assets of the shareholder from his business assets. If the
shareholder is insolvent the personal creditors can take the shares but cannot get
at the assets of the company.
3.51
Oddly, given that limited liability seems to move the risk of doing business away
from the shareholders and on to the creditors, large powerful creditors have
also bene
ted from limited liability. As a result of the movement of risk to the
creditors, creditors have been forced to monitor and protect against risk more
ectively. Secured lending in the form of  xed and 
oating charges, risk premi-
ums in terms of interest charged and board representation have all improved the
creditors monitoring mechanisms.
3.52
ese are all undoubted advantages but limited liability does have disadvantages.
Risk is moved to the creditors, not all of whom can mitigate their risk. Small
trade creditors and involuntary creditors cannot secure their transaction, charge
a risk premium or engage in board-level monitoring. As a result in an insolvent
liquidation they have little protection. Indeed, the actions of powerful secured
creditors are o
en detrimental to the most vulnerable creditors as they o
en have
priority in a liquidation. 
is is still the case with employees as even though they
have been given priority above 
oating charges (see Insolvency Act 1986, s 175
and s 386 and Chapter 17)  xed charges, (over the most valuable assets) still have
priority. Involuntary creditors have little or no protection if limited liability is
upheld.
3.53
Perhaps the most disturbing use of limited liability occurs within group struc-
tures. In group structures limited liabilitys facilitation of asset partitioning
allows a very e
ective double limitation of liability for parent companies and
their members. Investors in a parent company can achieve limitation of liabil-
ity not only for themselves but also for the parent company by structuring its
7/20/2012 5:15:20 PM
Lifting the veil
business through a number of subsidiaries. For example Fred, Nancy, Dougal
and Mat are the shareholders in M Ltd, the parent company of wholly owned
subsidiaries N Ltd, Y Ltd and X Ltd. M Ltd has divided its business into three
between the subsidiaries. Y Ltd independently buys wine for storage and invest-
ment, N Ltd stores the wine Y Ltd buys and X Ltd markets the sale of the wine
once it has been stored for a few years. All the pro
ts of the subsidiaries 
ow
back to M Ltd. Y Ltd entered into a number of complex agreements to buy
French wine at a guaranteed price. 
e French wine harvest was a disaster and
the harvest in the rest of the world was excellent. As a result of the poor quality
of French wine and a glut of excellent wine from everywhere else Y Ltd ended
up with liability running into millions of pounds. It could not meet its obli-
gations to its creditors and was eventually placed into insolvent liquidation.
Some months later M Ltd forms another wholly owned subsidiary J Ltd to carry
out the wine-buying function. 
e question remains as to whether the parent
company could be liable for the debts of the failed subsidiary. 
e answer is
probably not.
3.54
It is important to note here that we are not discussing Fred, Nancy, Dougal and
Mat being personally liable for the debts of Y Ltd or M Ltd. 
e group application
of the
Salomon
doctrine means we are just discussing whether the assets of the
parent company can be attacked by the claimants in virtue of it being the sole
shareholder in Y Ltd. 
e personal assets of Fred, Nancy, Dougal and Mat are safe
no matter what. 
e question is whether the parent company gets limited liability
as well. 
us just as Hansmann and Kraakman (2000) suggest that asset parti-
tioning allows individuals to put their assets beyond their personal creditors, its
most important and far-reaching consequence is that it allows a company also to
put its assets beyond the reach of its creditors. 
e word Ltd or Plc a
er a parent
company name now e
ectively means the company itself has achieved limited
liability.
3.55
Despite the fact that this represents an enormous extension of the
Salomon
principle to cover corporate members, the judiciary have treated it as a straight-
forward application of the
Salomon
doctrine without questioning whether this
is appropriate. 
us the starting point in group structure veil-li
ing cases has
always been that
Salomon
applies unless there are other reasons for li
ing
the veil, rather than recognising that allowing asset partitioning to operate
for parent companies is a radical and far-reaching extension of the
Salomon
principle and taking the starting point in group veil-li
ing cases as asking (as
the courts do for example in Germany) whether
Salomon
is an appropriate
principle to apply to group structures at all. However, sometimes the separate-
ness of a subsidiary can be disadvantageous to a parent company. For example
7/20/2012 5:15:21 PM
Further reading
in
Barings Plc (in liquidation) v Coopers & Lybrand (No 4)
(2002) a loss su
ered
by a parent company as a result of a loss at its subsidiary was not actionable
by the parentthe subsidiary was the only proper claimant. (See also
Shaker v
Al-Bedrawi
(2003).)
FURTHER READING
This Chapter links with the materials in Chapters 3 and 14 of
Hicks and Goos Cases
and Materials on Company Law
(2011, Oxford University Press, xl +649p).
Davies (2008)
Gower and Davies Principles of Modern Company Law,
8th edn (London:
Sweet & Maxwell), Chs 8 and 9.
Gallagher and Ziegler Lifting the Corporate Veil in the Pursuit of Justice [1990]
JBL
292.*
Hansmann and Kraakman The Essential Role of Organisational Law [2000]
Yale LJ
387.
Lowry and Edmunds Holding the Tension between Salomon and the Personal Liability
of Directors [1998]
Can Bar Rev
467.
Lowry Lifting the Corporate Veil [1993]
JBL
41.
Mitchell, Lifting the Corporate Veil in the English Courts: An Empirical Study [1999] 3
Company Financial and Insolvency Law Review
15.
Moore
A Temple Built on Faulty Foundations
[2006]
JBL
180.
Muchlinski Holding Multinationals to Account: recent developments in English litiga-
tion and the Company Law Review [2002]
Co Law
168.
Ottolenghi From Peeping Behind the Corporate Veil to Ignoring it Completely [1990]
MLR
338.*
Png Lifting The Veil of Incorporation:
Creasey v Breachwood Motors:
A Right Decision
with the Wrong Reasons [1999]
Co Law
122.
Ramsay and Noakes Piercing the Corporate Veil in Australia (2002). Available at SSRN:
http://ssrn.com/abstract=299488.
Rixon Lifting the Veil between Holding and Subsidiary Companies [1986]
LQR
415.
Thompson Piercing the Corporate Veil: An Empirical Study [1991] 76
Cornell Law
Review
1036.
*Note that the articles above that are marked with an asterisk were written prior to the
Court to Appeal decision in
Adams v Cape Industries Plc
(1990).
7/20/2012 5:15:21 PM
Lifting the veil
SELF-TEST QUESTIONS
7/20/2012 5:15:22 PM
SUMMARY
Introduction
De
ning the term promoter
Promoters as
duciaries
Pre-incorporation contracts
Section 51 CA 2006: pre-incorporation contracts, deeds and obligations
Freedom of establishment
Introduction
4.1
As we have observed in the previous two chapters the motives of those registering
a company and conducting a business through it may have an e
ect on whether
the judiciary upholds the separateness of the corporate entity. In this chapter
we discuss another area where the motives of those behind the formation of a
company (promoters) are also relevant to the way the law treats certain activi-
ties carried out in the companys name. Sometimes the promoter may be using
the company to perpetrate a fraud. In other cases the promoter may have entered
into contracts for the company before it is formally registered. In such situations,
because the company does not exist at the time of the contract, the issue that
arises is whether the promoter is personally liable on it. With the rise of the reg-
istered company in the mid-to-late 19th century the courts had to 
nd solutions
to deal with the promotion problem.
De
ning the term promoter
4.2
A promoter is the person responsible for forming a company. Whether or not
a person is a promoter is a question of fact to be determined according to the
Promoters and
pre-incorporation contracts
7/19/2012 2:14:12 PM
Promoters and pre-incorporation contracts
role he played in the creation of the company. Typically, the promotion proc-
ess involves e
ecting the registration of the company with Companies House,
negotiating pre-incorporation contracts on behalf of the putative company, and
nding the initial directors and shareholders. In the case of public companies
the promoter will also be responsible for registering and issuing any prospec-
tus. Although the companys constitution is generally dra
ed by a professional
adviser such as a lawyer or an accountant, such a person will not be deemed to be
a promoter merely on that account (
Great
Whea
gooth
(1883)).
e term promoter is not de
ned in the Companies Act 2006 and the judges
have shown little inclination towards formulating an all-embracing de
nition
(indeed, the 2006 Act has little to say about promoters generally beyond requir-
ing the independent valuation of all non-cash assets sold to a public company
within two years of its incorporation or re-registration by a person who was a
subscriber to its memorandum at the time the company was registered, or was a
member at the time it was re-registered as a public company: see ss 598-604 and
ss 1077-1078(3)). Notwithstanding this judicial timidity, there are some helpful
descriptors in the case law. For example, in
Twycross
Grant
(1877), Cockburn CJ
stated that a promoter is one who undertakes to form a company with reference
to a given project, and to set it going, and who takes the necessary steps to accom-
plish that purpose. In
Wha
Bridge
Printing
Green
(1879) Bowen J
explained that: [T]he term promoter is a term not of law, but of business, usefully
summing up in a single word a number of business operations familiar to the
commercial world by which a company is generally brought into existence.
e reluctance on the part of the legislature and the judges to de
ne the term
comprehensively is the result of a spate of 19th-century cases involving fraudu-
lent schemes that were perpetrated against investors. Typically this was done by
a person selling to the 
edgling company his own property at a grossly in
ated
price (in return either for cash or for fully paid shares) which bore little relation
to the propertys true value. 
e response of the judges, therefore, was to leave the
meaning of the term promoter 
uid so as to include as many such fraudsters as
possible. 
ey also developed a range of speci
c 
duciary duties aimed at setting
exemplary standards of behaviour for promoters.
As far as public companies are concerned much of the case law surrounding
promoters is of little more than historical interest. It is unusual, given modern
commercial practice, for a new company to make an immediate public issue of
securities. Further, strict controls are now imposed on the marketing of securi-
ties by the Financial Services and Markets Act 2000, Part 6 and by the Listing
Rules issued by the Financial Services Authority (FSA) (see also the Companies
Act 2006, Part 43; Chapter 5, below. In 2013 the FSA is to be replaced by two
7/19/2012 2:14:14 PM
Promoters as duciaries
new regulatory bodies. 
e 
rst, is the Prudential Regulation Authority (the
PRA), which will be a subsidiary of the Bank of England. 
e second, is the
Financial Conduct Authority (the FCA), which will be responsible for the regu-
lation of conduct both in retail and wholesale 
nancial markets together with
the infrastructure that supports those markets. Private companies are also pro-
moted of course.
4.6
However, in general most private companies metamorphose from some pre-
existing business relationship such as a joint venture or a partnership and so
relatively few such promotions involve persons with dishonest motives trying to
obtain 
nance from outsiders. For private companies, therefore, the promotion
is more likely to be e
ected by the partners or proprietor of the pre-incorporated
business enterprise (as was the case with Mr Salomon, see
(1897), Chapter 2, above). Such promoters usually become the 
rst directors
and shareholders. Indeed, many if not most public companies start out as private
companies which, when in need of additional capital, convert by o
ering securi-
ties to the public at large (termed 
otation; see Chapter 5, below).
Promoters as
duciaries
4.7
It has long been settled that a promoter is not the agent of the company he is
promoting (
ner
Baxter
(1866)). Prior to incorporation, the company has no
legal existence and so to hold otherwise would result in the legal 
ction of an
agent acting for a non-existent principal. It has also been held that a promoter is
not a trustee of the company he is seeking to bring into existence (
Leeds
Han
eatres
Varieties
Ltd
(1902)). Nevertheless, a promoter, being a person
who undertakes to act for or on behalf of another in some particular matter or
matters, is viewed as a 
duciary (Finn (1977)), and is therefore subject to the
rigour of a number of 
duciary duties. De
ning the term 
duciary is more dif-
cult than attempting to explain the o
-side rule in soccer to someone who has
no interest in the sport. It is perhaps best explained by reference to the particular
obligations a 
duciary owes to his principal. In essence, as we will see in Chapter
14, 
duciary obligations are duties owed to a third party to act with loyalty in
dealings which a
ect that person (Penner (2012)). As Penner points out, the duty
to act with loyalty means more than just acting honestly and fairly but rather the
duciary must act solely in the interests of his principal: the 
duciary must act
to secure his principals best interests, and must not allow his own self-interests,
or the interests of others, to govern his behaviour in any way that would con
ict
with the principals best interests. Fiduciary law is thus the origin in modern
society of the legal notion of con
ict of interest.
7/19/2012 2:14:14 PM
Promoters and pre-incorporation contracts
e particular position of promoters as opposed to other types of 
duciaries such
as trustees and directors was explained by Lord Cairns LC in
anger
New
Sombrero
Phosphate
(1878):
They stand, in my opinion, undoubtedly in a
duciary position. They have in
their hands the creation and moulding of the company; they have the power
of de
ning how, and when, and in what shape, and under what supervision, it
shall start into existence and begin to act as a trading corporation.
duciary duties of promoters
4.9
e 
duciary duties applicable to promoters principally arise from the nature of
the transactions entered into by them in the course of bringing a company into
existence. 
e core duty of a promoter is not to make a secret pro
t from his
position. 
e scope for abuse is self-evident where a promoter sells property to
the company in which he has a personal interest and so the law therefore requires
promoters to make full disclosure of any pro
t derived therefrom (
Lady
Forrest
(Murchison
Mine
Ltd
(1901)). Failure to disclose all material facts
surrounding such a contract to an independent board renders the contract void-
able at the companys option. In
anger
New
Sombrero
Phosphate
a syn-
dicate purchased a mine containing phosphates for
55,000. 
e syndicate then
formed a company and through a nominee sold the mine to it for
100,000 with-
out disclosing their interests in the contract. 
e phosphate operations proved to
be a failure and the shareholders removed the original directors. 
e new board
successfully brought an action to have the sale rescinded. Lord Penzance was
unequivocal in his condemnation of the promoters conduct:
I invite your Lordships to draw two conclusions:
rst, that the company never
had an opportunity of exercising, through independent directors, a fair and
independent judgment upon the subject of this purchase; and, secondly, that
this result was
brought about by the conduct
and contrivance of the vendors
themselves . . . Placed in [a] position of unfair advantage over the company which
they were about to create, they were, as it seems to me, bound according to the
principles constantly acted upon in the Courts of Equity, if they wished to make
a valid contract of sale to the company, to nominate independent directors and
fully disclose the material facts. The obligation rests upon them to shew they
have not made use of the position which they occupied to bene
t themselves;
but I
nd no proof in the case that they have discharged that obligation.
4.10
Subsequently, in
Ltd
(1897) the House of Lords
accepted that in the absence of an independent board of directors the disclo-
sure duty will be discharged if full disclosure of all material facts is made to
7/19/2012 2:14:14 PM
Promoters as duciaries
the original shareholders. However, in
uckstein
Barnes
(1900) the House of
Lords stressed that such disclosure will not be su
cient if the original share-
holders are not truly independent and the scheme as a whole is designed to
defraud the investing public.
Remedies
4.11
ere are a range of remedies available to the company against a promoter who is
in breach of his 
duciary duties. For example, it may bring a restitutionary claim
for the bene
t the promoter received either in equity on the basis of a constructive
trust or by way of a claim for money had and received (Sealy and Worthington,
Cases
Materia
Company
Law
(2010); but note now the e
ect of the
decision in
Investments
(UK
Ltd
Versai
Trading
Finance
Ltd
(2011)
on proprietary claims for breach of 
duciary duties, see Chapter14, below). 
e
company may also have a claim for equitable compensation for breach of 
duci-
ary duty. In
Target
Ltd
Redferns
(1996), Lord Browne-Wilkinson noted
that if a trustee commits a breach of trust, the bene
ciarys remedy against him
is a personal one:
a trustee in breach of trust must restore or pay to the trust estate either the as-
sets which have been lost to the estate by reason of the breach or compensation
for such loss. Courts of Equity did not award damages but, acting in personam,
ordered the defaulting trustee to restore the trust estate . . . If speci
c restitution
of the trust property is not possible, then the liability of the trustee is to pay
suf
cient compensation to the trust estate to put it back to what it would have
been had the breach not been committed.
(See also,
anger
New
Sombrero
Phosphate
(above), per Lord Blackburn).
4.12
Where a promoter fails to make the requisite disclosure of his interest in a con-
tract with the company, its principal remedies are rescission and an accounting
of secret pro
ts. 
e e
ect of his breach of duty is to render the contract voidable
at the companys option (
anger
New
Sombrero
Phosphate
(1878, above)).
e company therefore has the option either to rescind the contract or to a
rm
it. 
ere are, however, certain limitations on the right to rescind. If the company
by its actions, a
er it becomes aware of the promoters breach of duty, shows an
intention to a
rm the contract, rescission will not be available (
Cape
Breton
(1885)). Similarly, the companys delay in rescinding the contract may also bar
its right to the remedy (
Long
oyd
(1958);
Leaf
Internationa
eries
(1950)).
e contract being voidable, i.e. valid until rescinded, means that if a third party
bona 
de without notice and for value acquires rights in the contracts subject
matter, those rights are valid as against the company, provided it has not rescinded
7/19/2012 2:14:14 PM
Promoters and pre-incorporation contracts
the contract before that time (
Leeds
Han
eatres
Varieties
Ltd
(1902,
above)). Finally, for rescission to be available there must be
restitutio
integrum.
at is, it must be possible to restore, at least substantially, the parties to their
original position unless, due to the fault of the promoter, this possibility has been
lost (
Lagunas
Nitrate
Lagunas
Syndicate
(1899)). In
anger
Lord Blackburn
observed that it has always been the practice of the Court of Equity to grant relief
by way of rescission whenever by the exercise of its powers it can do justice by
directing accounts, awarding equitable compensation and making allowances,
even though it cannot restore the parties exactly to the position they were in
before the contract. Even if the company elects not to rescind the contract, it may
still recover any secret pro
ts from the promoter (
uckstein
Barnes
(above)).
4.13
Where a promoter has been o
ered but not yet received a bribe or some other
bene
t, the company may itself enforce his claim for payment against the promi-
sor, on the ground that the promoter holds the claim as trustee for it (
Wha
Bridge
Printing
Green
(1879, above)). Finally, it should also be noted
that the company may have an action against the promoter in the tort of deceit.
Pre-incorporation contracts
4.14
In addition to dealing with the fraudulent activities of promoters, certain other
problems confronted the courts relating to the practicalities of promoting the
company, particularly with respect to contracts entered into prior to registra-
tion. A company comes into existence only when the certi
cate of incorporation
is issued by the Registrar of Companies. Until incorporation a company cannot
be bound by contracts entered into in its name or on its behalf: it simply does
not exist. However, as part of the process of creating a company its promoters
will generally contract with third parties for such things as a lease of premises,
equipment and connection to utilities so that once incorporation is completed
the company can begin trading without delay. 
e issue which arises in relation
to such pre-incorporation contracts is whether the promoter can avoid being held
personally liable notwithstanding that the company did not exist at the time such
contracts were concluded on its behalf. 
e response of the common law was to
apply principles of contract and agency to the issue, but partial reform was imple-
mented by s 9(2) of the European Communities Act 1972, now re-enacted in s 51
of the Companies Act 2006.
The common law position
4.15
You may recall from the law of contract that it is a fundamental requirement of
the principles of o
er and acceptance that a party must be in existence in order
7/19/2012 2:14:15 PM
Pre-incorporation contracts
for an agreement to crystallise: If somebody does not exist they cannot con-
tract (
Rover
Internationa
Ltd
Cannon
Ltd
(No
3)
(1987), Harman J).
Further, since at the time of a pre-incorporation contract the company does not
exist, upon its subsequent creation it is necessarily a stranger to it and the doc-
trine of privity will operate to prevent rights and liabilities being conferred or
imposed on the company (
ner
Baxter
(1866)). 
e Contracts (Rights of 
ird
Parties) Act 1999, which allows enforcement of contracts by third parties if the
contract expressly so provides or a term of the contract confers a bene
t on the
third party, does not apply to pre-incorporation contracts. 
e Act is based on
the recommendations of the Law Commission in its report,
Privity
Contract:
Contracts
for
the
Bene
ird
Parties
(Law Commission Report No 242, Cm
3329 (London, HMSO (1996)). Addressing the issue of pre-incorporation con-
tracts, the Law Commission drew the distinction between a contract on behalf
of a third party and a contract for the bene
t of a third party. 
e Commission
stated that the former category involves the third party company becoming a
party to the contract, and subject to all its rights and obligations, a
er its incor-
poration. It is the latter situation which the Law Commission intended the Act to
cover: in that case the third party is not, and will not become, a party to the con-
tract but will simply acquire a right to sue to enforce provisions of the contract
(para
8.11
4.16
As far as the law of agency is concerned, a person cannot be an agent of a nonex-
istent principal and so a company cannot acquire rights or obligations under a
pre-incorporation contract. 
ese principles came together to form the underly-
ing premise of the decision in
ner
Baxter
(1866). 
e promoters of a hotel
company entered into a contract on its behalf for the purchase of wine which
the company, when incorporated, rati
ed. 
e wine was consumed but before
payment was made the company went into liquidation. 
e promoters, as agents,
were sued on the contract. 
ey argued that liability under the contract had
passed, by rati
cation, to the company. Erle CJ, rejecting this argument and hold-
ing the promoters personally liable, said that:
I agree that if [the hotel] had been an existing company at this time, the persons
who signed the agreement would have signed as agents of the company. But,
as there was no company in existence at the time, the agreement would be
wholly inoperative unless it were held to be binding on the defendants person-
ally . . . and a stranger cannot by subsequent rati
cation relieve [them] from that
responsibility. When the company came afterwards into existence it was a to-
tally new creature, having rights and obligations from that time, but no rights or
obligations by reason of anything which might have been done before . . . There
must be two parties to a contract; and the rights and obligations which it creates
cannot be transferred by one of them to a third person who was not in a condi-
tion to be bound by it at the time it was made.
7/19/2012 2:14:15 PM
Promoters and pre-incorporation contracts
4.17
A promoter will avoid personal liability if the company, a
er incorporation,
and the other party substitute the original pre-incorporation contract with a
new contract on similar terms (
Nata
Land
onization
Ltd
Pau
iery
Deve
opment
Syndicate
Ltd
(1904, PC). Novation, as this is called,
may also be inferred by the conduct of the parties such as where the terms of
the original agreement are changed (
Patent
Ivory
Manufacturing
Howard
Patent
Ivory
Manufacturing
(1888)). But novation will not be e
ective if
the company adopts the contract due to the mistaken belief that it is bound
by it (
Northumber
Avenue
Hote
Ltd
(1886)). A promoter will not be
personally liable on a contract where he signs the agreement merely to con
rm
the signature of the company because in so doing he has not held himself out as
either agent or principal. 
e signature, and indeed the contractual document,
will be a complete nullity because the company was not in existence (
Newborne
Senso
(Great
Britain
Ltd
(1954)). However, the promoter may be liable to
the other party for breach of warranty of authority on the principle of
Wright
(1857), in that he misrepresented his authority by purporting to repre-
sent a director of a non-existent company which, lacking legal existence, had no
validly appointed o
cers.
4.18
e common law position has now been a
ected as a result of the UKs imple-
mentation of Article 7 of the First Company Law Directive (68/151, OJ 1968 (I))
by CA 2006, s 51 (formerly s 36C CA 1985). 
e provision seeks to protect the
other party by making promoters personally liable when the company, a
er
incorporation, fails to enter into a new contract on similar terms (i.e. novation,
the CA 2006 retains this rule). It is noteworthy, however, that the Companies Act
2006 did not introduce a straightforward rati
cation procedure for pre-incorpo-
ration contracts notwithstanding that it was a principal policy objective of the
Company Law Review to modernise and simplify UK company law.
Section 51 CA 2006: pre-incorporation
contracts, deeds and obligations
4.19
Section 51 of the 2006 Act provides that a contract which purports to be made
by or on behalf of a company at a time when the company has not been formed
has e
ect, subject to any agreement to the contrary, as one made with the per-
son purporting to act for the company or as agent for it, and he is personally
liable on the contract accordingly. In short, promoters contracting on behalf
of a putative company will be held personally liable. 
e meaning and scope of
this provision was subjected to considerable scrutiny by the Court of Appeal in
7/19/2012 2:14:15 PM
Section 51 CA 2006: pre-incorporation contracts, deeds and obligations
Phonogram
Ltd
Lane
(1982). Lord Denning MR, with whom Shaw LJ agreed,
took the phrase subject to any agreement to the contrary to mean that in order
for a promoter to avoid personal liability the contract must expressly provide for
his exclusion. 
e Court also held that it is not necessary for the putative com-
pany to be in the process of creation at the time the contract was entered into.
Subsequent case law has held that s 51 does not apply to a contract involving a
misnamed existing company (
Oshkosh
Gosh
Inc
Dan
Marbe
Inc
Ltd
(1988));
or to a contract involving a company no longer in existence (
Cotronic
(UK
Ltd
Dezonie
(1991)). However, in
Kassabaum
Inc
(2000)
the judge accepted that for the purposes of s 36C persons purporting to act on
behalf of an unformed company could be liable for its quasi-contractual obliga-
tions. Further, in
Braymist
Ltd
Wise
Finance
Ltd
(2002), a 
rm of solicitors
contracted as agents on behalf of a company yet to be incorporated, in which
the putative company agreed to sell land to property developers. Subsequently,
the developers changed their minds and the solicitors sought to enforce the
contract. 
e issue before the Court of Appeal was whether a person acting
as agent of an unformed company could
enforce
a pre-incorporation contract
under s 51. 
e Court, a
rming the decision of Etherton J, held that although
the terms of the 
rst Directive referred only to liability and not to enforce-
ment, it did not follow that s 51 was similarly limited in scope so as to prevent
enforcement of contracts made by persons on behalf of unformed companies.
e majority found that the words in the section and he is personally liable on
the contract accordingly did not operate to negative this view, but rather the
phrase merely served to emphasise the abolition of the common law distinction
between agents who incurred personal liability on pre-incorporation contracts
and those who did not.
4.20
e provision is thus double-edged so that a party who is personally liable for the
contract is also able to enforce it. Latham LJ stated:
I would accordingly hold that the solicitors are entitled to rely upon section
36C [now s 51] in order to enforce the contract in the present case. In my
judgment, this produces a just result in that there is no good reason why the
defendant should be entitled to resile from their obligations under the contract
as a result of a pure technicality when in truth they wish to do so because it
proved a bad bargain.
4.21
In summary, the objective of s 51 is to protect third parties who contracted
in the belief that they were dealing with registered companies by making
pre-incorporation contracts legally enforceable as personal contracts with
promoters unless the personal liability of the latter has been unequivocally
excluded.
7/19/2012 2:14:15 PM
Promoters and pre-incorporation contracts
Freedom of establishment
4.22
Companies are no longer static entities whose operations are con
ned to the
jurisdiction in which they incorporated. Mobility is becoming increasingly com-
mon as a means of avoiding regulation and this has come to the fore in relation
Case C-210/06 (2009)). For an
example in the context of administration, see the reasoning of Judge Raynor QC
in
European
Directories
6)
(2010), where the centre of main interests
(COMI) of a Dutch registered company was held to be London.
4.23
It remains to be seen whether the pan-European business entity, the European
Company (SE) which became available in October 2004, will address the con-
cerns of those Member States wishing to regulate undercapitalised companies
operating within their jurisdictions. 
e now defunct dra
14th EC company law
harmonisation Directive had sought to facilitate corporate migration so that a
company would be able to move its registered o
7/19/2012 2:14:15 PM
Self-test questions
in December 2007. However, given the considerable body of ECJ jurisprudence
on the issue of corporate mobility (see above), such legislation would have been
super
uous.
FURTHER READING
This Chapter links with the materials in Chapter 2 of
Hicks and Goos Cases and
Materials on Company Law
(2011, Oxford University Press, xl +649p).
Andenas Free Movement of Companies [2003]
LQR
221.
Finn (1977)
Fiduciary Obligations
(Sydney: Law Book Co).
Green Security of Transaction after Phonogram [1984]
MLR
671.
Grif
ths Agents Without Principals: Pre-incorporation Contracts and Section 36C of
the Companies Act 1985 [1993]
241.
Gross Pre-incorporation Contracts [1971]
LQR
367.
Lowry Eliminating Obstacles to Freedom of Establishment: The Competitive Edge of
UK Company Law [2004]
CLJ
331.
McCrea Disclosure of
Promoters Secret Pro
ts [1968]
UBCLR
183.
Micheler The Impact of the
Centros
Case on Europes Company Laws [2000]
Comp
Law 179.
Penner (2012)
The Law of Trusts
, Chapter 2 (Oxford: OUP).
Puri The Promise of Certainty in the Law of Pre-Incorporation Contracts [2001]
The
Canadian Bar Review
1051.
Savirimuthu Pre-incorporation Contracts and the Problem of Corporate
Fundamentalism: are promoters proverbially profuse? [2003]
Comp Law
196.
Special Issue of the
Bond Law Review
(2003) vol 15.
Twigg-Flesner Full Circle: Purported Agents Right of Enforcement under section 36C
of the Companies Act 1985 [2001]
Co Law
274.
SELF-TEST QUESTIONS
7/19/2012 2:14:15 PM
Promoters and pre-incorporation contracts
company. Alex sells the business premises to the company for
several vans for
12,000 each. He sells them to the company for
12,000 but keeps
one for his own company which also operates in the same line of business.
Charlie orders computer equipment costing
7/19/2012 2:14:15 PM
SUMMARY
Introduction
Public and private companies
Methods of raising money from the public
The Financial Services Authority and the London Stock Exchange
The regulation of listed companies
The regulation of takeovers
Insider dealing
The regulation of other public offers
Sanctions
The regulatory regime
Introduction
5.1
Companies raise money in a number of ways. 
ey may have it provided by
the founders savings in which case things are relatively straightforward. More
usually a company will obtain its capital through a loan from a bank or other
institution or from the general public. We will deal with raising capital through
a loan in Chapter 6. 
e focus of this chapter is on raising equity from the
general public and its consequences for the operation of the company. What
follows in this chapter is a general broad sweep over a very complex area. While
professionals dealing in the equity markets, or advising those who deal in those
markets, might need to be familiar with the detail of raising equity, thankfully
the student of company law need only have a general knowledge of the area to
esh out the context in which larger companies in the UK operate. In covering
this topic we start with the basics of raising equity and then move on to the
consequences of operating in a public market, covering areas such as takeovers
and insider dealing.
Raising capital: equity and
its consequences
7/20/2012 5:16:13 PM
Raising capital: equity and its consequences
Public and private companies
5.2
As we have observed in Chapter 1, the CA 2006 provides for companies to be
either private or public. Essentially the distinction in terms of capital raising
between the two types of companies is that the law presumes that in pri-
vate companies the investment is largely provided by the founding members
either through their personal savings or from bank loans and that in public
companies the intention is to raise large amounts of money from the general
public. Private companies can take a number of forms under the CA 2006.
They can be limited or unlimited. If they are limited they can be limited
either by shares or by guarantee. Crucially, private companies are prohibited
from raising capital from the general public (CA 2006, s 755). Additionally
the Listing Rules of the London Stock Exchange (LSE) require that a company
be a public company. Public companies have no such prohibition and may
freely raise capital from the general public. Sometimes where extremely large
amounts of capital are needed a public company will choose to raise capital
through listing on the stock exchange. This, as we will see, engages a further
layer of regulation.
5.3
While the majority of this chapter deals exclusively with the capital-raising
activities of public companies this does not mean that all private companies are
small concerns. Some private companies are very large, o
en obtaining their
capital through lending (see Chapter 6) or private investment 
rms (e.g. ven-
ture capital  rms such as 3i or more recently hedge funds such as Blackstone)
rather than from the general public. Sir Richard Bransons Virgin Ltd is an
example of a large private company. Virgin was formerly a listed company that
de-listed because of the enhanced scrutiny a public listing brings to a business
from both regulators and institutional investors (these are the largest inves-
tors in listed companies, and are made up of insurance companies, pension
funds and investment funds, see further Chapters 15 and 16). Very large private
companies are, however, unusual as most business ventures in need of capital
ful l it through the formation of a public company in order to access the public
funding market. We will concentrate here on the public company as a capital-
raising vehicle.
5.4
Public companies are subject to a more onerous regulatory regime than private
companies because of their dealings with the general public. In contrast to pri-
vate companies, a public company can only be formed as a company limited by
shares (CA 2006, s 4(2)). 
erefore the application for registration of a public
company must state it is public and as with private companies the liability of the
members is limited, thus the words public limited company (PLC or plc) must
7/20/2012 5:16:14 PM
Public and private companies
come at the end of its name (CA 2006, s 58(1)). While private companies can have
a purely nominal share capital, public companies have much larger requirements
imposed. Section 763 of the CA 2006 provides that the authorised minimum
share capital for public companies is 50,000.
5.5
Public companies are designed to secure investment from the general public and
can advertise the fact that they are o
ering shares to the public. In doing so the
company must issue a prospectus giving a detailed and accurate description of
the companys plans (see below). Because the general public are involved and
need to be protected, the initial capital requirements for a public company are
more onerous than for a private one. As we discussed above there is a minimum
capital requirement of
50,000 (CA 2006, s 763). However, the capital require-
ment may be partly paid so the company does not actually have to have
50,000,
it just needs one-quarter of that and an ability to call on the members for the
remaining amount (CA 2006, s 586). While there is no formal limitation on pub-
lic companies having restrictions on transfer of shares similar to those that apply
to private companies, any restriction would be highly unusual, given that the
aim is to raise money from the general public as it would discourage them. In any
case, if the public company is listed on the LSE such restrictions on transfer will
be prohibited.
The differing regulation of private and public companies
As we have noted above, because the general public is a
ected by the
capital-raising activities of these companies the state has taken a greater inter-
est in investor protection where public companies are concerned. For example
the CLRSG in its consultation document
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Raising capital: equity and its consequences
The distinction between public and listed companies
5.7
As we will see in Chapter 15, one of the key developments in company law was
the e
ective separation of ownership from control once the registered company
began to tap the stock exchange for funds in the late 19th and early 20th cen-
turies. 
e operation of these very large public companies became so complex
that shareholders could no longer run the company and so appointed managers.
ese managers did not control the company by virtue of their shareholdings, as
they usually only held a tiny fraction of its shares, but wielded enormous power
through their technical skills and the power delegated to them by shareholders.
ey could therefore act in their own self-interest if they were not monitored.
Unfortunately, one of the features of this new managerial company that raised
money in the public markets was a very large and dispersed shareholding (i.e.
millions of shareholders all holding a tiny fraction of the total shares in the com-
pany). 
us because shareholders held only a minute stake in the company they
were uninterested in monitoring management. 
is dispersed and huge share-
holder population also caused a problem for regulators as very few of these small
shareholders had the expertise to investigate fully the activities of public compa-
nies before they invested in them. 
erefore they were prone to being defrauded.
While we discuss the consequences of the separation of ownership from control
at length in Chapters 15 and 16, the problem for regulators of dispersed owner-
ship is relevant here. At 
rst the quality control function for investors was carried
out by the stockbrokers who did have the expertise to assess companies. However,
the role of the LSE itself in regulating the equity markets has been crucial as it
adopted a disclosure regime with the view to encouraging companies to provide
investors with the information they needed to make informed investment deci-
sions. Slowly, however the state became involved in shareholder protection and,
as we will see, in providing sanctions for abuse.
5.8
It is important to note that public companies are not necessarily listed on the
stock exchange. A listing on the stock exchange is essentially a private contractual
arrangement between a public company and the LSE (itself a listed public com-
pany) to gain access to a very sophisticated market for its shares. 
e public com-
pany, once it gains access to the stock market, is then generally known as a listed
company but sometimes a quoted company and its shares as listed or quoted
shares or securities. 
e LSE o
ers the facility of a secondary market, that is, a
place where shares can be traded a
er they have been issued to shareholders. It
also functions as a capital market for companies to sell new shares to the general
public who can then trade them on the stock exchange. Some public companies
do however exist outside the stock exchange listing system. For example, Amstrad
plc, Sir Alan Sugars company (you know, the mean bloke from 
e Apprentice)
is a very large public company operating without a listing on the LSE. Amstrad
7/20/2012 5:16:15 PM
was formerly a listed company but de-listed for the same accountability reasons
as Virgin Ltd. However, if a company wishes to raise large amounts of money its
orts will be immeasurably aided by a stock exchange listing. 
is is because
investors will have greater con
dence in the business if it is within the regulatory
ambit of the LSE and investors will be able to sell their shares easily through the
LSE secondary market. While there is only one stock exchange the LSE operates
two separate equity markets. 
7/20/2012 5:16:15 PM
Raising capital: equity and its consequences
pre-emption are conferred on shareholders in s 561 CA 2006 but there are excep-
tions and some listed companies may not have pre-emption rights (this is how-
ever likely to make such a company unpopular with investors). Once a company
is listed further capital raising is more straightforward without the complication
of the initial listing process.
The Financial Services Authority and
the London Stock Exchange
5.11
e Financial Services Authority (FSA), currently (see below para.
5.14
on the
reforms in progress) the main UK 
nancial services regulator, and the LSE have
an important co-operative relationship. Until May 2000 the LSE carried out the
role of the UKs competent authority for listing with responsibility for admit-
ting securities to listing, making the Listing Rules and policing compliance
with them. Following enactment of the Financial Services and Markets Act
2000 (herea
er, the FSMA), which replaced the Financial Services Act 1986,
this function is now carried out by the FSA (FSMA s 72), which is currently
the UK Listing Authority. Section 2(2) of the FSMA charges the FSA with four
regulatory objectives:
7/20/2012 5:16:15 PM
The Financial Services Authority and the London Stock Exchange
5.12
e UK Listing Authority (a department of the FSA) has primary responsibil-
ity for granting listed status to companies. To gain a listing a company must
comply with the Listing Rules which are made in accordance with Part VI of the
FSMA which is in turn based on a number of EU Directives (see the Consolidated
Admissions and Reporting Directive (2001/34/EC)). 
e status of the LSE as a
Recognised Investment Exchange (RIE) under the Financial Services Act 1986
was continued in the FSMA. It is thus exempt from the general prohibition
against carrying on a regulated activity in the UK without authorisation or hav-
ing obtained exemption (s 19 of the FSMA). An activity is regulated if it is of a
speci
ed kind which is carried on by way of business or relates to an investment
of a speci
ed kind or is a speci
ed activity carried on in relation to property of
any kind (s 22; see the FSMA (Regulated Activities) Order 2001 (SI 2001/544)).
e phrase by way of business was also contained in the 1986 Act and was con-
strued by Hobhouse J as meaning a business transaction as opposed to some-
thing personal or casual:
Morgan Grenfell v Welwyn Hat
eld District Council
(1995) and
Helden v Strathmore Limited
(2011).
5.13
e LSE is therefore the principal RIE for trading securities of UK and foreign
companies, government stocks and options to trade company securities. To
become an RIE an exchange must satisfy the FSA that it has su
cient 
nancial
resources, that it is a 
t and proper body, that it can operate an orderly market and
can secure appropriate protection for investors (FSMA s 285-290, and SI 2000/995
Sch, paras 14). 
e LSEs statutory obligation to operate an orderly market also
obliges it to monitor listed companies on an ongoing basis. As a result, when a
company has obtained a listing by complying with the Listing Rules it can only
maintain listed status if it complies with the continuing obligation speci
ed in
the Listing Rules and monitored by the LSE. Of course the fact the LSE is itself a
listed company subject to the Listing Rules means it is in e
ect regulating itself.
is odd situation has been compounded by the consistent attempts by US and
Continental European exchanges to take over the LSE by buying its shares. If for
example the New York Stock Exchange was successful in taking over the LSE (it
has been trying for some time to buy the LSE) in e
ect UK listed companies will
be regulated from the USA.
5.14
Financial regulation in the UK is in a state of 
ux as a result of the continuing reg-
ulatory reforms deemed necessary to deal with the impact of the 
nancial crisis
that unfolded from 2007 onwards. As a result of a signi
cant failure of the UKs
nancial regulatory system major reforms are underway. In 2013 the Financial
Services Authority (FSA), currently the main UK 
nancial services regulator,
will have parts of its current role split between two new regulatory bodies. 
e
Prudential Regulatory Authority (PRA) and the Financial Conduct Authority
(FCA). 
e PRA will primarily have responsibility for banking and insurance
7/20/2012 5:16:16 PM
Raising capital: equity and its consequences
and the FCA will have responsibility for retail and wholesale 
nancial markets.
As such, the FCA will become the UK Listing Authority and work closely with
the LSE to ensure the proper functioning of the listed market. Reform has also
occurred at the EU level because of regulatory failures within EU institutions,
with the creation of the European Securities and Markets Authority (ESMA).
ESMA is an independent EU Authority tasked with protecting the stability of
the European Unions 
nancial system by ensuring the integrity, transparency,
ciency and orderly functioning of securities markets, as well as enhancing
investor protection. To achieve its task it is provided with a range of powers, from
issuing guidance to compulsion of individuals and national level supervisory
authorities. As such, for the 
rst time the FSA, and in turn the PRA, will have a
single EU regulatory authority to work with. (See http://www.esma.europa.eu/
system/
les/2011_009.pdf)
The regulation of listed companies
Obligations at the time of listing
5.15
e FSA and the LSE co-operate to ensure that companies comply with the
listing requirements and the continuing obligations imposed on listed compa-
nies. 
e main substantive rules regulating admission to listing relate to the
availability of past accounts, compliance with a minimum market capitalisa-
tion and a minimum proportion of the shares in public hands (25 per cent for
7/20/2012 5:16:16 PM
The regulation of listed companies
to investors or their professional advisers as a result of requirements imposed
on the issuer of the securities by an RIE, by Listing Rules or under any other
enactment.
5.16
Exactly what document has to be issued by the company depends on the proce-
dure being adopted. If an application for listing is being made in respect of shares
to be o
ered to the public in the UK for the 
rst time, a prospectus (the docu-
ment issued to the public inviting them to invest in the shares) must be submit-
ted to, and approved by, the FSA (s 84 of the FSMA and the Listing Rules). In the
less common situation where the company is merely applying for admission to
listing of a class of shares which has already been issued, then listing particulars
also have to be submitted to and approved by the FSA (s 79 of the FSMA and the
Listing Rules). 
e content of each document is essentially the same. For a good
overview of the listing process and the issues involved see http://www.london-
stockexchange.com/companies-and-advisors/listing/markets/guide-to-capital-
7/20/2012 5:16:16 PM
Raising capital: equity and its consequences
information to holders and potential holders of its listed equity shares in such a
way as to avoid the creation or continuance of a false market in such listed equity
shares. 
is is an important principle upon which the LSE operates as it places
the onus on listed companies to push information out to shareholders as quickly
as possible to avoid a false market. 
ere are however obvious tensions between
maintaining commercial con
dentiality and speedy disclosure. For example if a
company was planning a takeover this would necessarily need to remain con
dential until the last minute despite the possibility of a false market being cre-
ated. In such a case the company could apply to the FSA for an exemption or if
the time span was short a company not wishing to disclose the exact nature of
price-sensitive information might request temporary suspension of listing until
the information can be published.
5.19
On 20 January 2007 a version of the Transparency Directive (2004/109/EC) was
implemented for UK listed companies. 
e aim of the directive is to increase
transparency of information on the issuers of securities listed on a regulated mar-
ket in the EU. In doing so Part 43 of the CA 2006 amends Part 6 of the FSMA in a
number of ways to implement the requirements of the directive. 
us it requires
companies to produce periodic 
nancial reports and speci
es the minimum con-
tent of those reports. It requires major shareholders to disclose their holdings at
certain thresholds. Indeed, one of the controversies in negotiating the Directive
was that the UK threshold for compulsory disclosure under the Companies Act
1985 was triggered at 3 per cent rather than the 5 per cent proposal in the dra
Directive. In the 
nal Directive the disclosure percentage was set at 5 per cent, 10
per cent, 15 per cent, 20 per cent, 25 per cent, 30 per cent, 50 per cent and 75 per
cent but the threshold for disclosure with regard to UK issuers of securities was
retained at 3 per cent. 
us in the UK where a shareholder achieves a 3 per cent
shareholding a disclosure must be made to the company who will then make a
public disclosure to the market. Additional disclosures must be made for every
1 per cent increase or decrease in that shareholding and in a takeover situation
a similar disclosure regime applies (http://www.thetakeoverpanel.org.uk/disclo-
sure). On the implementation of the Directive, responsibility for the sharehold-
ing disclosures was moved from the DTI (now BIS) to the FSA. 
e Directive
also requires that companies disclose information to investors in a fast, non-dis-
criminatory and pan-European basis. Additionally the Transparency regime also
provides for criminal and civil penalties for non-compliance. (See also Chapter
9 on the Shareholders Rights Directive.) Again the Financial crisis has impacted
in this area and at the EU level. Concern that the disclosure requirements of the
Transparency Directive may have encouraged short term behaviour by compa-
nies has led the Commission to propose removing the obligation for quarterly
nancial reports. (See http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=
COM:2011:0683:FIN:EN:PDF)
7/20/2012 5:16:16 PM
The regulation of takeovers
The regulation of takeovers
5.20
Once a company is listed on a stock exchange its shares may be freely traded. 
is
creates the possibility that another individual or more likely another company
can gain control of a listed company by buying up the shares in the company.
In traditional (neo-classicalsee Chapter 15 for a fuller explanation) econom-
ics this is termed the market for corporate control and is an important restraint
on management acting in their own self-interest (directors duties also act as a
restraint, see Chapter 14). In theory, at least, an underperforming management
in a listed company will cause shareholders to sell their shares. At some point
those shares will be so low that another company will try to take over the under-
performing company and either run it more e
ciently or sell o
its assets for a
pro
t. Management therefore have an incentive to perform because if they do
not they risk losing their jobs if the company is taken over. However, it is worth
noting that the CLRSG doubted this was an e
ective control on management
Developing the Framework,
para 3.164). Of course, there is the risk that manage-
ment may just under perform and try to frustrate such a bid. As such, the regula-
tion of takeovers is a matter of some concern for shareholders and, in turn, the
7/20/2012 5:16:17 PM
Raising capital: equity and its consequences
the section allows a company to follow a chain of disclosure information by
requiring information from nominees about the person they are acting for. 
e
company can additionally construct a chain of ownership by requiring in subsec-
tion (6) information from past owners as to the person they sold the shares to.
e company can also require information on any share acquisition agreements,
or any agreement or arrangement as to how the rights attaching to those shares
should be exercised (s 825). 
is is obviously helpful for the target company to
monitor any potential bidders.
5.22
Originally the common law protected the rights of shareholders to retain their
shares in a takeover situation because a compulsory purchase would o
end natu-
ral justice (see
Brown v British Abrasive Wheel
(1919)). Problems with smaller
shareholders however soon arose which caused statutory intervention in the area.
e Greene Committee (
Company Law Amendment Committee Report 1925 to
192
(Cmd 2657)) recommended allowing compulsory purchase of minority
shareholders where a takeover had occurred. 
ey explained their reasoning as
follows:
[t]he acquiring company generally desires to obtain the whole of the share capi-
tal of the company which is being taken over and in some cases will not enter-
tain the business except on that basis. It has been represented to us that holders
of a small number of shares of the company which is being taken over (either
from a desire to exact better terms than their fellow shareholders are content to
accept or from lack of real interest in the matter) frequently fail to come into an
arrangement which commends itself to the vast majority of their fellow share-
holders with the result that the transaction fails to materialise.
e Companies Act 1929 implemented the recommendations of the Greene
Committee allowing compulsory purchase and those provisions are now contained
5.23
e UK statutory scheme was in e
ect introduced to resolve a con
ict of interest
between the owners or contingent owners of a newly acquired majority share-
holding in a company and the minority shareholders in the same company. 
e
ultimate aim of the legislation was to make it easier to take companies over. 
e
legislation provides a contingent right of the majority shareholder to compulso-
rily purchase the shares of the minority shareholders. Arguably of course it can
also discourage takeovers in a general sense as a bidder needs to have enough
funding to buy all the shares rather than just the funds for a majority stake.
5.24
A potential takeover bidder therefore may proceed with a bid broadly in the
knowledge that if they gain a 90 per cent controlling stake in the target company
they can force the minority to sell their shares at the same price. A minority
7/20/2012 5:16:17 PM
The regulation of takeovers
shareholder may also force the bidder to buy their shares if the bidder does not
try to compulsory purchase their shares (CA 2006, s 983). Section 986 also allows
a minority shareholder to apply to court to object to a compulsory purchase. 
is,
however, is an extremely di
cult action to succeed in, given that 90 per cent
of the shareholders will have considered the price fair enough to accept (see
Sussex Brick Co Ltd
(1961)).
5.25
It is worth noting here that there are other provisions for companies in crisis
(insolvency and reconstruction) which can lead to a virtual takeover, notably CA
2006, ss 895901 and ss 110111 of the Insolvency Act 1986. Section 425 allows
creditors and shareholders to e
ect a takeover as part of a statutory scheme of
arrangements for a company in crisis and ss 110111 allows for the transfer of the
business of a company in voluntary liquidation to another company in return for
shares in the non-liquidated company.
5.26
However, apart from the above statutory provisions dealing with matters before
and a
er the takeover the main regulation of the conduct of the takeover in the
UK has until 2007 been non-statutory in form. Over time a body was set up by
the 
nancial services industry, encouraged by the Bank of England, to produce
rules and act as a regulator of takeovers in the UK. 
is body is called the Panel
on Takeovers and Mergers (the Panel). 
e Panel administers the rules on takeo-
vers called the City Code on Takeovers and Mergers (the Code). 
e Panel and
the Code aims to achieve equality of treatment and opportunity for all share-
holders in a takeover bid. 
e Panel and the Code have been in existence since
1968 when the Governor of the Bank of England and the Chairman of the LSE
set up the Panel in reaction to a number of controversial takeovers in which it
was felt unfair tactics had been used to the detriment of shareholders. 
e Panel
is generally agreed to have been a great success and has become a well-respected
part of the UKs 
nancial services architecture. Since 1968 the Panel has handled
more than 10,000 cases.
5.27
Members of the Panel are o
en drawn from the 
nancial services sector. 
ere
can be up to 34 members of the Panel. 
is can be comprised of up to 20 inde-
pendent members appointed by the Panel itself with the rest appointed directly
by organisations representing City of London 
nancial institutions. Currently
there are 25 members, 14 of whom were appointed by the Panel and the other
11 appointed by organisations such as the Institute of Chartered Accountants
in England and Wales and the British Bankers Association. 
e Panels remit
covers public companies resident in the UK whether they are listed or not. It
may also deal with private companies whose shareholdings are widely dispersed.
e focus of the Panels role in any given takeover is to ensure the fair conduct
of the takeover bid for the shareholders. It does not have any role in evaluating
7/20/2012 5:16:18 PM
Raising capital: equity and its consequences
the 
nancial or commercial merit of the bid, rather it leaves that decision to the
companies involved. Any questions on the competitive impact of a takeover or
merger will not be dealt with by the Panel but rather by the UK and EU competi-
tion authorities.
5.28
In order to ful
l its role the Panel has produced a code of conduct known as the
City Code on Takeovers and Mergers. 
e Code is an evolving document which
the Panel stresses is 
exible as long as companies keep to the spirit of the Code.
e Code therefore emphasises a number of general principles of which the fol-
lowing are the most important:
equality of treatment and opportunity for all shareholders in takeover
bids;
adequate information, time and advice to enable shareholders to assess the
merits of the o
er;
where it advises the holders of securities, the board of the o
eree com-
pany must give its views on the e
ects of implementation of the bid on
employment, conditions of employment and the locations of the companys
places of business;
no action which might frustrate an o
7/20/2012 5:16:18 PM
The regulation of takeovers
(see
R v Panel on Takeovers and Mergers, ex p Data
n
(1987)). However, histori-
cally the courts would only hear the review a
er the takeover is complete, thus
eliminating using the courts in a tactical sense during the progress of a takeover
bid (see below on the reform of the Panel).
5.30
Despite the courts historic recognition of the Panels public role it was not a stat-
utory body nor did it exercise any statutory powers until 2007. However, such was
the respect for the Panel within the 
nancial services sector that its rulings were
generally complied with. 
e self-regulating status of the Panel has now ended as
the result of some signi
cant European reforms in the area of takeovers.
The Takeovers Directive (Directive 2004/25/EC of the
European Parliament and of the Council of 21 April 2004
on Takeover Bids)
5.31
In 1989 the European Commission put forward a dra
directive on European
takeovers with the aim of harmonising takeover provisions within the EU. 
e
measure was actively encouraged by the UK as there was a long-felt resentment
that there was a free market for takeovers in the UK but that defensive measures
were permitted in most other EU states. 
us a German company could easily
take over a UK listed company but a UK company could not take over a large
German company. 
e dra

irteenth Directive was largely based on the City
Codes provisions and generally prevented the use of takeover defences and so
found favour with the UK Government. However, it did not 
nd favour in many
other EU states, indeed France and Germany were particularly opposed. 
us
for more than a decade little movement occurred at all. By 1999 there seemed to
be a more favourable environment for the Directive and it began to be promoted
by Austria as well as the UK and Ireland. Eventually, in 2001 political agreement
was reached on a text of the dra
Directive by the Council of Ministers but it
was rejected by the European Parliament. In April 2004 a much compromised
Directive was eventually agreed.
5.32
While the Government emphasised that the 
nal form of legislation implement-
ing the Directive retains the independence of the Panel, the Directive required
the establishment of a statutory body which would oversee statutory takeover
provisions. 
e CA 2006 Part 28 in e
ect converted the self-regulating Panel (CA
2006, s 942) into just such a statutory body to oversee takeovers in the United
Kingdom on 6 April 2007. 
is represents a signi
cant departure from its his-
toric and formerly sacred self-regulatory status. 
e Panel was far from happy
with this outcome primarily because it considered that the creation of a statu-
tory body overseeing takeover legislation would lead to increased litigation and
exibility which will defeat the usefulness of the Panel. Only time will tell if
7/20/2012 5:16:18 PM
Raising capital: equity and its consequences
this is the case but in its 
rst three years as a statutory body its functioning has
not yet been impaired.
5.33
Under the former self-regulatory system the Panel had no formal powers to sanc-
tion but was particularly good at alerting shareholders and regulators to bid
irregularities. 
e e
ect of this in
uence was that professional bodies operat-
ing in the Financial Services sector would at the request of the Panel sanction
a person or company falling within their jurisdiction. Similarly the FSA might
suspend or remove a companies listing as a result of the Panels 
ndings and
impose formal sanctions on individuals involved in the bid irregularities. Under
the Takeover Directive reforms the Panel now has its own range of sanctions
contained in CA 2006, ss 952956. 
us the panel now has formal powers to
issue statements of censure, issue directions, refer conduct to other regulatory
bodies, order compensation to be paid for breach of the code and refer a matter
for enforcement by the court.
Insider dealing
5.34
Once shares become easily bought and sold on a stock exchange the potential
for those inside or connected to the company to abuse their knowledge of the
companys future plans or announcements arises. Let us take the example of
company X planning to take over company Y. 
ere will be a period when com-
pany X will be planning its takeover but has taken no action which would alert
the market. During this period employees of company X will have very valu-
able information that the share market does not have. In general an attempted
takeover once it is apparent or formally announced will boost the share price
of the target company. 
us in this crucial planning phase the employees of X
could buy shares in company Y in the knowledge that the attempted takeover
announcement will boost company Ys share price and they can then sell those
shares and make a quick pro
t.
5.35
Every country in the world with a major stock exchange has made this practice
illegal because of its potential to destroy public con
dence in the stock exchange.
However, there are those who believe that insider dealing should not be outlawed
as it acts as part of the neo-classical market equilibrium mechanism in setting
share prices (see McVea (1995) and Chapter 15 on neo-classical theory). In other
words the buying of shares in company Y by executives of company X will alert
the market to the potential takeover and remove a false market in those shares.
In general, the view that such behaviour is morally reprehensible prevails and the
law attempts to deal with this through criminal and civil sanctions (see Campbell
7/20/2012 5:16:18 PM
Insider dealing
(1996) on why insider dealing is outlawed). As we discussed above with regard
to the continuing obligations of listed companies, the LSE also tries to ensure
that opportunities for insider dealing are minimised by ensuring that companies
disclose any signi
cant information that might a
ect share price as quickly as
possible.
Criminal sanctions
5.36
Section 397 FSMA contains a general catch-all criminal provision on false and
misleading information which would cover insider dealing type activity (see
Serious Fraud O
ce v Pearson
(2011)). However, Part V of the Criminal Justice
Act 1993 contains the main criminal provisions speci
cally on insider dealing.
Section 52(1) states:
[a]n individual who has information as an insider is guilty of insider dealing
if, in the circumstances mentioned in subsection (3) [that is, it is a regulated
market and the insider deals himself as a professional or through a professional
intermediary,] he deals in securities that are price-affected securities in relation
to the information.
e insider will also be guilty of an o
7/20/2012 5:16:19 PM
Raising capital: equity and its consequences
Communication/PR/2010/052.shtml). In March 2010, for example, the FSA coor-
dinated raids involving 143 police o
cers and FSA investigators on the homes
of senior employees of 
nancial services companies. Six arrests were made in
what was described as the biggest ever crackdown on insider dealing (see http://
www.guardian.co.uk/business/2010/mar/23/six-arrested-over-insider-dealing).
However, despite the increase in activity conviction rates remain low with only
ve successful convictions in 2010/11 and jail sentences ranging from 12 months
to three years and four months. (See http://www.fsa.gov.uk/pubs/annual/ar10_11/
enforcement_report.pdf).
The civil sanction regime
5.38
As a result of the historic di
culty in prosecuting individuals under the criminal
regime the Government introduced a civil o
ence of market abuse contained in
s 118 of the FSMA:
Market abuse
(1)
For the purposes of this Act, market abuse is behaviour (whether by one
person alone or by two or more persons jointly or in concert) which
(a) occurs in relation to
(i)
qualifying investments admitted to trading on a prescribed market,
(ii)
qualifying investments in respect of which a request for admis-
sion to trading on such a market has been made, or
(iii)
in the case of subsection (2) or (3) behaviour, investments which
are related investments in relation to such qualifying invest-
ments, and
(b)
falls within any one or more of the types of behaviour set out in sub-
sections (2) to (8).
(2)
The
rst type of behaviour is where an insider deals, or attempts to deal,
in a qualifying investment or related investment on the basis of inside
information relating to the investment in question.
(3)
The second is where an insider discloses inside information to another
person otherwise than in the proper course of the exercise of his
employment, profession or duties.
(4)
The third is where the behaviour (not falling within subsection (2) or (3))
(a)
is based on information which is not generally available to those using
the market but which, if available to a regular user of the market,
would be, or would be likely to be, regarded by him as relevant when
deciding the terms on which transactions in qualifying investments
should be effected, and
7/20/2012 5:16:19 PM
Insider dealing
(b)
is likely to be regarded by a regular user of the market as a failure on
the part of the person concerned to observe the standard of behav-
iour reasonably expected of a person in his position in relation to the
market.
(5)
The fourth is where the behaviour consists of effecting transactions or
orders to trade (otherwise than for legitimate reasons and in conformity
with accepted market practices on the relevant market) which
(a)
give, or are likely to give, a false or misleading impression as to the
supply of, or demand for, or as to the price of, one or more qualifying
investments, or
(b)
secure the price of one or more such investments at an abnormal or
arti
cial level.
(6)
The
fth is where the behaviour consists of effecting transactions or orders
to trade which employ
ctitious devices or any other form of deception
or contrivance.
The sixth is where the behaviour consists of the dissemination of
information by any means which gives, or is likely to give, a false or
misleading impression as to a qualifying investment by a person who
knew or could reasonably be expected to have known that the information
was false or misleading.
(8)
The seventh is where the behaviour (not falling within subsection (5),
(6) or (7))
(a)
is likely to give a regular user of the market a false or misleading
impression as to the supply of, demand for or price or value of,
qualifying investments, or
(b)
would be, or would be likely to be, regarded by a regular user of the
market as behaviour that would distort, or would be likely to distort,
the market in such an investment,
and the behaviour is likely to be regarded by a regular user of the market as a
failure on the part of the person concerned to observe the standard of behaviour
reasonably expected of a person in his position in relation to the market.
7/20/2012 5:16:19 PM
Raising capital: equity and its consequences
5.39
e regular user criterion provides an industry standard against which the indi-
viduals behaviour will be judged. 
e FSA maintains a Code of Market Conduct
which provides guidance as to the sort of conduct which will amount to market
abuse. It can be regularly updated to take account of evolving market practices
(FSMA, s 119). Section 120 also provides for the Code to include safe harbour
provisions specifying circumstances where passing price-sensitive information is
allowable. 
at is, the FSA can set out speci
c behaviour which will not amount
to market abuse. 
e FSA has done so generally where individuals have obliga-
tions to disclose or withhold information as part of the regulatory regime. For
example, it has created safe harbours in the Code for compliance with some list-
ing and takeover rules.
5.40
In order to investigate a suspected market abuse the FSA has wide investigative
powers under the FSMA. It also has a number of possible sanctions such as public
censure, 
nes, injunctions, restitution orders and to vary or cancel an investment
authorisation. Despite this, activities that fall within the purview of market abuse
are still generally regarded as widespread although as we noted above since the
advent of the 
nancial crisis in Autumn 2008 the FSA has been very active in the
area. Over the period 2010/11 the FSA 15 enforced penalties for market abuse
worth 8,342,804.
The regulation of other public offers
5.41
Naturally, concerns about investor protection mean that the o
ering of shares
by non-listed public companies also has to be regulated. Until 2005 such o
ers
were governed separately from o
ers by listed companies, by the Public O
ers
of Securities Regulations 1995 (SI 1995/1537; herea
er referred to as the POSR),
which implemented the 
rst EU Prospectus Directive (89/298/EEC). Since 2005
and the implementation of further Prospectus Directives (Directive 2003/71/EC
and Directive 2010/73/EU) in the Prospectus Regulations 2005, a single regime is
now in place in Part VI of the FSMA regulating the prospectus requirements of
listed and non-listed o
erings.
5.42
In certain cases however a full prospectus may not be needed. Section 101(1) and
(2) of the FSMA state that the Part VI rules may authorise the FSA to dispense
with or modify the duty to prepare a prospectus for shares to be listed or listing
particulars. In such cases information equivalent to a prospectus or listing par-
ticulars will have been published in the preceding 12 months. Provided the duty
of disclosure contained in s 80 has been discharged (see above), the issuer need
only publish an abbreviated prospectus which identi
es the changes that have
occurred since the last prospectus was published.
7/20/2012 5:16:19 PM
Sanctions
5.43
If the o
er for sale is not a public o
er (because of the exemptions), it will still
usually be regulated by the rules on investment advertisements contained in s 21
of the FSMA. Subject to certain exceptions, this prevents issuing an advertise-
ment inviting people to engage in investment activity (broadly an agreement to
buy or sell shares or securities or exercise rights in relation to shares or securities
already held, without the approval of a person authorised under the Act (s 21(8);
SI 2001/1335, art 4 and Sch 1).
Sanctions
5.44
e 
nal role identi
ed for the state is to ensure that if there is not complete or
accurate disclosure by a company, investors have a satisfactory remedy where
they have su
ered loss and that o
ences where they have occurred do not go
unpunished. Just as there are a variety of ways in which public o
ers of shares are
regulated, so there are a variety of remedies and sanctions.
5.45
Failure to comply with provisions of the FSMA has the most serious consequences
as breach is o
en a criminal o
ence. 
is is the case in relation to s 21 (above).
Breach thereof will also a
ect the enforceability of any agreement entered into
er the issue of the advertisement by the party in breach and will entitle the
other party to recover any money or other property paid or transferred by him
under the agreement; and . . . compensation for any loss sustained by him as a
result of having parted with it (s 26).
5.46
Non-compliance with the Part VI Rules will o
en be dealt with by the UK Listing
Authority imposing the sanctions open to it. 
ese include censure, 
nes and
compensation (although the Act speci
cally retains any liability at common law
or under any other legislation, (s 90(6)) depending on the nature of the breach.
5.47
Irregularities in relation to public documents might also cause a breach of the
provisions of other statutes (for instance, s 19 of the 
e
Act 1968). As noted
above, other civil remedies are also available if there has been a misrepresenta-
tion but they will not o
en provide a better remedy than those in the FSMA,
although the measure of damages may be more bene
cial to the misrepresentee
if there has been fraud (see
Smith New Court Securities Ltd v Scrimgeour Vickers
(Asset Management) Ltd
(1996)).
5.48
Finally, as we discussed above with regard to insider dealing, the FSMA con-
fers power on the FSA to prosecute persons making misleading statements, cases
of insider dealing, market manipulation, terrorist 
nancing and breaches of the
Money Laundering Regulations (ss 401, 402 and 397(2) and (3)). Additionally
7/20/2012 5:16:20 PM
Raising capital: equity and its consequences
the Financial Services Act 2010 has given the FSA enhanced powers to 
ne and
suspend individuals and 
rms, issue warnings, void remuneration packages
and impose consumer redress schemes. 
ese provisions are aimed both at spe-
ci
c behaviour and at behaviour that might damage con
dence in the public
7/20/2012 5:16:20 PM
The regulatory regime
Structure,
ch 12). However, it is envisaged that this would not have a direct e
ect
on the mode of regulating listed companies. In the view of the CLRSG:
[t]o operate successfully the bodies responsible for company law would need to
work effectively alongside other parts of the wider regulatory framework and, in
particular, the FSA, both as securities market regulator and as Listing Authority,
and the Takeovers Panel.
We recognise the importance of close co-operation between the bodies pro-
posed for company law, and those responsible for these related areas. But we
do not see any strong arguments for recommending that any of these func-
tions should be combined with those of the company law regulatory bodies. Nor
do we see any need for any more extensive redrawing of the regulatory map
(paras
12.112113
e White Paper and the Consultative Document of March 2005 broadly
endorsed this approach (see ch 5 of the White Paper and para 6.2 of the
Consultative Document) and the CA 2006 made little change to the overall regu-
latory structure.
5.53
e 
nancial crisis that unfolded in Autumn 2008 however brought signi
cant criticism of the shared regulatory arrangements in the UK, as failures at
the FSA, the Bank of England and the Treasury played a role in the crisis. As
UK government 
nancial commitment to the banking sector as a result of the
nancial crisis reached over 60% of GDP in late 2009, the biggest bailout of any
Western nation, Mervyn King, the Governor of the Bank of England remarked:
To paraphrase a great wartime leader, never in the
eld of
nancial endeavour
has so much money been owed by so few to so many. And, one might add, so
far with little real reform.
Eventually, as we noted earlier in this chapter, extensive EU and UK institutional
reform has occurred with the domestic break up of the FSA and creation of the 
e
Prudential Regulatory Authority (PRA), Financial Conduct Authority (FCA) and
the Financial Policy Committee (FPC) tasked with large-scale industry oversight.
7/20/2012 5:16:20 PM
Raising capital: equity and its consequences
regulators to work, co-ordination of the layers of supervisors will be crucial but dif-
cult across 27 member states with very di
erent traditions of oversight.
FURTHER READING
This Chapter links with the materials in Chapters 4, 17 and 18 of
Hicks and Goos Cases
and Materials on Company Law
, (2011, Oxford University Press, xl +649p).
Bagge, Evans, Wade and Lewis Market Abuse: proposals for the new regime [2000]
X1(9)
PLC
35.
Company Law Reform
(2005) Cm 6456 (Consultative Document, March 2005), para 3.6
and para 6.2: http://www.bis.gov.uk/policies/business-law/company-and-
partnership-law/company-law/publications-archive
Clarke European Union Articles 9 and 11 of the Takeover Directive (2004/25) and the
Market for Corporate Control [2006]
JBL
355.
Davies
Gower and Davies Principles of Modern Company Law
, 8th edn (London, Sweet
& Maxwell, 2008), chs 2426 and 2830.
Dignam Lamenting Reform? The Changing Nature of Common Law Corporate
Governance Regulation [2007]
Company and Securities Law Journal
E. Ferran, The Break-Up of the Financial Services Authority University of Cambridge
Faculty of Law Research Paper Series No. 10/04 (11 October 2010) at: http://ssrn.
com/abstract=1690523
Financial Services in the UK; A New Framework for Investor Protection (Cmnd 9430)
(London, HMSO, 1983).
Lord Alexander of Weedon QC Takeovers: The Regulatory Scene [1990]
JBL
Marsh Disciplinary Proceedings Against Authorised Firms and Approved Persons
Under The Financial Services and Markets Act 2000 in John de Lacy (ed)
The
Reform of United Kingdom Company Law
(London, Cavendish, 2002).
Morse The City Code on Takeovers and MergersSelf Regulation or Self Protection?
[1991]
JBL
509.
SELF-TEST QUESTIONS
7/20/2012 5:16:20 PM
SUMMARY
Introduction
Types of loan capital
Secured borrowing: company charges
Book debts
Crystallisation
Priority of charges
Registration of charges
Reform
Introduction
6.1
It is beyond the scope of this book to provide a detailed exposition of the range of
loan capital provided by 
nancial institutions. 
is chapter therefore focuses on
corporate borrowing where this is done by debentures or debenture stock. It also
examines the types of charge that companies can issue to creditors, i.e. 
oating
and  xed charges. 
e priority of secured creditors is considered, together with
an examination of the registration requirements for charges. 
e related matter
of the rules and procedures governing competing corporate creditors in insol-
vency proceedings is dealt with in Chapter 17.
6.2
7/19/2012 2:16:31 PM
Raising capital: debentures: xed and oating charges
of key respects to investment in shares. Both are securities but the nature of the
risk and the returns on the investment will be di
erent. However, it should be
noted that the key distinction between shareholders and investment creditors
is that the former has rights
the company whereas the latter acquires rights
against
the company (for example, as a general rule creditors do not have a right
to vote at general meetings: the extent to which they can exercise control over the
company depends upon the terms of the debt contract). As we discussed brie
y in
Chapter 2, if creditors secure their lending they will also have rights in the com-
panys property. In the event of insolvency the claims of a loan creditor must be
paid before the shareholders. From the perspective of the debtor company, loan
capital, as opposed to share capital, is a more 
exible means of raising 
nance.
Loan capital can be issued at a discount (
Mose
yfontein
Mines
Ltd
(1904)),
interest can be paid out of capital and, importantly, is not subject to the capital
maintenance regime (see Chapter 7).
Types of loan capital
Debentures
6.3
e indebtedness of a company to a creditor is generally acknowledged by way
of a debenture. A good example from the case law is
(1897) where, upon incorporation, Mr Salomon changed from being a sole trader
to a debenture holder and shareholder. While we provided a brief description of
a debenture in Chapter 2, it is not possible to provide a comprehensive de
nition
of the term: the word originates from Latin meaning money owed to me. 
e
Companies Act is of little help in de
ning the term beyond stating that deben-
ture includes debenture stock, bonds and any other securities of a company,
whether constituting a charge on the assets of the company or not (s 738). 
is
de
nition is also adopted for the purposes of s 29(2) of the Insolvency Act 1986.
An obvious example of a debenture which falls within the statutory de
nition is
a mortgage of freehold land by a company, it being a security of a company and
a charge on its assets (see
Knightsbridge
Estates
Trust
Ltd
Byrne
(1940), Lord
Romer). 
e judges have long attempted to formulate de
nitions of the term.
For example, in
Abercorris
(1887), Chitty J stated that
a debenture means a document which either creates a debt or acknowledges it,
and any document which ful
ls either of these conditions is a debenture. 
e
problem with this de
nition is that it is drawn too wide. For example, it encom-
passes documents such as a bank statement where the account in question stands
in credit (because it is an acknowledgement that the bank e
ectively owes its
7/19/2012 2:16:33 PM
Types of loan capital
client the amount of the credit balance). Nevertheless, Chitty Js de
nition has
been endorsed in a number of cases: see, for example,
Lemon
Austin
Friars
Investment
Trust
Ltd
(1926). More practical guidance was provided by Lindley J
in
British
India
Steam
Navigation
IRC
(1881):
Now, what the correct meaning of debenture is I do not know. I do not
nd
anywhere any precise de
nition of it. We know that there are various kinds of
instruments commonly called debentures. Yo
u may have mortgage debentures,
which are charges of some kind on property. You may have debentures which
are bonds; and, if this instrument were under seal, it would be a debenture of
that kind. You may have a debenture which is nothing more than an acknowl-
edgement of indebtedness. And you may have [as on the facts] . . . a statement by
two directors that the company will pay a certain sum of money on a given day,
and will also pay interest half-yearly at certain times and at a certain place,
upon production of certain coupons by the holder of the instrument. I think any
of these things which I have referred to may be debentures within the Act.
Notwithstanding the breadth of these de
nitions, the commercial world gener-
ally adopts a fairly restrictive view of the term, viewing debentures as referring to
secured loans.
Debentures can be categorised as either irredeemable or redeemable. Irredeemable
debentures are permitted by the Companies Act notwithstanding equitys pro-
hibition of clogs or fetters on the equity of redemption. Section 739 provides
that a condition contained in debentures, or in a deed for securing debentures,
is not invalid by reason only that the debentures are thereby made irredeemable
or redeemable only on the happening of a contingency (however remote), or on
the expiration of a period (however long), any rule of equity notwithstanding (see
Knightsbridge
Estates
Trust
Ltd
Byrne
(1940), above). Redeemable debentures
are generally expressed to be payable either on demand or on a 
xed date. Once
redeemed a debenture can be reissued by the company unless there is an express or
implied prohibition contained in the articles (s 194).
Debenture stock
Debenture stock is money borrowed from a number of di
erent lenders all on the
same terms. In e
ect the lenders become a class of creditors and their rights are
usually set out in a trust deed whereby trustees are appointed (usually a 
nancial
institution) to represent the interests of the creditors, as a class, with the com-
pany. 
e modern practice is that all the loans are aggregated and advanced to
the company by the trustees. 
e contractual relationship here is between the
trustees and the company. Individual creditors (or investors) then subscribe for
7/19/2012 2:16:33 PM
Raising capital: debentures: xed and oating charges
debenture stock in the fund (see Sealy and Worthington (2008), p 458). Where
the trustees do not take a charge (i.e. do not secure their lending, see para
below) on the companys property the debenture stock is generally termed unse-
cured loan stock. Whereas a single debenture cannot be transferred other than
as a single unit, debenture stock is transferable in whole or in some fractional part
much like a shareholding, although the trust deed may set a minimum amount.
Further, debenture stock, as with debentures, may be issued in bearer form as
negotiable instruments so that title will pass by mere delivery (
Bechuana
Exp
oration
London
Trading
(1898)).
e trust deed will list the obligations of the company to the trustees, the central
undertaking being to pay to the debenture holders the principal sum with inter-
est. It will specify the security for the loan (if any) namely, a  xed or 
oating
charge or both, together with a legal mortgage by demise of speci
ed real prop-
erty belonging to the company. 
e deed will list the events which will trigger the
enforceability of the security, for example the company defaulting in payment
to the debenture holders. It will also contain provisions relating to meetings of
debenture holders, the transfer of debenture stock and the power of trustees to
appoint a receiver in the event of a security becoming enforceable.
Secured borrowing: company charges
6.6
Corporate borrowing is frequently secured, that is to say the debtor company is
required to provide some form of security to the lender for the sum borrowed. In the
event of the company being in breach of the loan contract, the lender can then take
steps to enforce his security interest. For example, a loan can be secured over the
companys land and in the event of the company defaulting on its repayments the
creditor can enforce its security interest immediately. 
us, the principal purpose
of security is to enable the lender to recover from the company in the event of its
default which, in practice, o
en occurs as a result of impending insolvency. Goode
(2008) has described the nature of a security interest as an agreement between the
creditor and debtor by which a speci
ed asset or class of assets is appropriated to
the satisfaction of the loan. Title does not pass but rather an encumbrance on the
property is created. In
Nationa
Provincia
Charn
(1924) Atkin LJ noted
that the principal feature of a charge was that the creditor acquired a
present
right
to have the charged property made available as security:
I think there can be no doubt that where in a transaction for value both parties
evince an intention that property, existing or future, shall be made available as
security for the payment of a debt, and that the creditor shall have a present
right to have it made available, there is a charge, even though the present legal
7/19/2012 2:16:33 PM
Secured borrowing: company charges
right which is contemplated can only be enforced at some future date, and
though the creditor gets no legal right of property, either absolute or special,
or any legal right to possession, but only gets a right to have the security made
available by an order of the Court.
6.7
e concern of lenders when requiring security is to ensure priority in the repay-
ment of their loans notwithstanding the claims of the general body of creditors
who are therefore frequently le
in the vulnerable position of picking over the
few crumbs (if any) remaining of the corporate cake a
er satisfaction of secured
and preferential creditors (although the Enterprise Act 2002 has restricted the
range of debts qualifying for preferential status, see Chapter 17). In the context of
company borrowing, the most common form of charges encountered as security
interests is the  xed charge and the 
oating charge.
Fixed and
oating charges
6.8
Charges may be either  xed (or speci
c), the e
ect of which is that the chargees
rights (i.e. the lenders) attach immediately to the property in question, or 
oat-
ing whereby the chargees rights attach to a shi
ing fund of assets (
Cimex
Tissues
Ltd
(1994);
Gray
Group
Ltd
(2010)), such as receivables, stock in
trade etc. A  xed charge is akin to a mortgage and therefore restricts the debtor
companys power to deal with the charged asset without 
rst obtaining the credi-
tors permission.
6.9
e peculiar feature of a 
oating charge which distinguishes it from a  xed
charge is that the company can continue to deal with the assets in the ordinary
course of business without the need to obtain the consent of the creditor. 
is
is the very essence of the 
oating charge and it is, therefore, a commercially
convenient way of raising secured borrowing. Re
ning the point further, Millett
LJ in
7/19/2012 2:16:33 PM
Raising capital: debentures: xed and oating charges
into being by a contract supported by consideration; and once a 
oating charge
crystallises into a  xed charge, it is obvious that the chargee enjoys the same
interest. However, there is a dispute as to whether or not the holder of a 
oating
charge has an equitable proprietary interest prior to its crystallisation. On this
question various views seeking to explain the theoretical basis of the 
oating
charge have been propounded. For example, it has been argued that the 
oating
charge confers an equitable interest in favour of the chargee from the time of its
creation (albeit something less than the interest of a  xed chargee), coupled with
in favour of the company to deal with the assets in the ordinary course
of business (see, for example, Ferran (1988) and (2008)). 
e fact that the holder
of a 
oating charge acquires an immediate equity was recognised by the Court
of Appeal in
Evans
Riva
Granite
uarries
Ltd
(1910). Buckley LJ stressed that
oating charge is not a future security but rather it is a present security which
presently a
ects all the assets of the company expressed to be included in it. 
e
judge went on to note that:
it is not a speci
c security; the holder cannot af
rm that the assets are speci
cally mortgaged to him. The assets are mortgaged in such a way that the mort-
gagor can deal with them without the concurrence of the mortgagee. A
oating
security is not a speci
c mortgage of the assets, plus a licence to the mortgagor
to dispose of them in the course of his business, but is a
oating mortgage ap-
plying to every item comprised in the security, but not speci
cally affecting any
item until some event occurs or some act on the part of the mortgagee is done
which causes it to crystallise into a
xed security.
Summarising Buckley LJs formulation, Slade J in
Bond
Worth
Ltd
that a 
oating charge:
remains unattached to any particular property and leaves the company with
a licence to deal with, and even sell, the assets falling within its ambit in the
ordinary course of business, as if the charge had not been given, until . . . it is said
to crystallise . . .
6.11
Goode, agreeing with this view, 
nds that it is now settled that the 
oating charge
creates an immediate interest
rem
(Goode (2008)). Further, the Privy Council
has accepted that a 
oating charge confers a proprietary interest on its holder (
dcorp
Exchange
Ltd
(1994); see also
Cretanor
Maritime
Ltd
Irish
Marine
Management
Ltd
(1978)). An alternative view is that a 
oating charge only has
contractual e
ect and therefore the holder acquires no equitable proprietary
interest until crystallisation (see Gough (1996)). 
is view is basically founded
upon the fact that when a 
oating charge is created no appropriation of prop-
erty is made. However, Sealy and Worthington (2010) note, that a charge is a
security interest created in or over an asset or assets by the chargor in favour of
7/19/2012 2:16:33 PM
Secured borrowing: company charges
the chargee by which it is agreed that the property shall be appropriated to the
discharge of a debt or other obligation and that there is no transfer of title. 
e
chargees rights are proprietary, but created by contract . . .. It should be borne in
mind that a company is only permitted to deal with property which is subject to
oating charge in the ordinary course of business. A transaction which falls
outside of this results in the third party taking subject to the equitable inter-
est created by the charge notwithstanding that crystallisation has not occurred
ius
Harper
Ltd
Hagedorn
Sons
Ltd
(1989)).
6.12
e outcome of the argument assumes critical importance in the context of com-
pany liquidations because s 127 of the Insolvency Act 1986 provides that any
disposition of the companys property made a
er the commencement of the
winding-up is, unless the court otherwise orders, void. It follows from the major-
ity views noted above that the disposition of property takes place when the charge
is created and therefore its crystallisation does not constitute a disposition for the
purposes of s 127 (see further
French
Wine
Ltd
(1987)).
6.13
As indicated above, property which is typically made subject to a 
oating charge
is, by its nature, constantly changing and includes stock in trade, plant, book
debts and even the whole assets and undertaking for the time being of the com-
pany. Book debts, sometimes referred to as receivables, are sums owed to a com-
pany in respect of goods or services supplied by it. With respect to stock in trade,
when an item is sold the charge ceases to attach to it but when something is
subsequently added to the companys stock the charge will automatically extend
over the new item. In this sense the idea of a charge that 
oats over changing
property (attaching, de-attaching when sold and re-attaching when something
new is added) can be more readily understood.
6.14
Characterising the nature of charges has continued to occupy the judges. As has
been pointed out by Lord Millett (see below), the determination of whether a
charge is  xed or 
oating is not merely a question of construction of the docu-
ment creating it. 
e parties may have expressed that the charge in question is
one or the other but this is not conclusive of the issue, the courts being more con-
cerned with the substance of the matter rather than the description adopted by
the parties (
Roya
Trust
Nationa
Westminster
(1996)). In
Agnew
IRC
(Re
Brumark
(2001),
Lord Millett stressed that:
In deciding whether a charge is a
xed or a
oating charge, the Court is en-
gaged in a two-stage process. At the
rst stage it must construe the instrument
of charge and seek to gather the intentions of the parties from the language
they have used. But the object at this stage of the process is not to discover
whether the parties intended to create a
xed or a
oating charge. It is to ascer-
tain the nature of the rights and obligations which the parties intended to grant
7/19/2012 2:16:33 PM
Raising capital: debentures: xed and oating charges
each other in respect of the charged assets. Once these have been ascertained,
the Court can then embark on the second stage of the process, which is one of
categorisation. This is a matter of law. It does not depend on the intention of the
parties. If their intention, properly gathered from the language of the instru-
ment, is to grant the company rights in respect of the charged assets which are
inconsistent with the nature of a
xed charge, then the charge cannot be a
xed
charge however they may have chosen to describe it.
e distinction between 
xed and 
oating charges assumes immense signi
cance
during receivership and on liquidation of the company because of the relative rank-
7/19/2012 2:16:33 PM
Secured borrowing: company charges
nonetheless to make its assets available as security to the chargee in priority
to other creditors should it cease to trade. The hallmark of the
oating charge
was the agreement that the chargor should be free to dispose of his assets in
the normal course of business unless and until the chargee intervened. Up to
that moment the charge
oated.
6.16
us, like Lord Millett, Lord Phillips MR also places particular emphasis on
what Romer LJ noted as the third characteristic (see also Lord Scotts speech in
Spectrum
(2005)). 
e point is illustrated by
Arthur
Litt
Ltd
Finance
LLC
(2002). 
e company, Arthur D Little Ltd, guaranteed the liabilities of its
two parent companies to Ableco by creating a charge, described as a 
rst  xed
charge, over its shareholding in a subsidiary company, CCL. 
e chargor com-
pany retained both its voting and dividend rights with respect to the shares. 
e
companys administrator argued that it was a 
oating charge. It was held, apply-
ing Lord Milletts reasoning in
Agnew
that whether or not the charge was  xed
or 
oating is a question of law and the particular charge in issue was  xed. It did
not 
oat over a body of 
uctuating assets and, notwithstanding the companys
voting and dividend rights, it could not deal with the asset in the ordinary course
of business: the company could not dispose of, or otherwise deal with, the shares.
e asset was therefore under the control of the chargee. On the other hand, in
ueens
Moat
Houses
Capita
IRG
Trustees
Ltd
(2005) it was held that the
existence of a right unilaterally to require a chargee to release property from a
charge did not render what is otherwise a  xed charge a 
oating charge. In so
nding, Lightman J explained that:
There is a critical difference between the right of a corporate chargor to deal with
and dispose of property free from charge without reference to the chargee and
the right of a corporate chargor to require the chargee to release the charged
property from the charge. The right of a corporate chargor in the course of its
business to deal with or dispose of charged property without reference to the
chargee (save in exceptional circumstances) is inconsistent with the existence of
xed charge . . . . But there is no inconsistency between the existence of a
xed
charge and a contractual right on the part of the chargor to require the chargee
to release property from the charge.
e decision in
Cimex
Tissues
Ltd
(above), similarly illustrates how 
ne the dis-
tinction between a 
xed and a 
oating charge is. Here the charge over plant and
machinery was held to be a 
xed charge notwithstanding that it was contemplated
that certain items of the charged machinery might be replaced from time to time
due to wear and tear (see also,
antic
Computer
Systems
(1992), Nichols
LJ). As Sealy and Worthington (2010) conclude, the notion of freedom to deal with
7/19/2012 2:16:33 PM
Raising capital: debentures: xed and oating charges
Book debts
6.17
e di
culties encountered in distinguishing a  xed charge from a 
oating
charge have come to the fore in relation to charges granted by a company over
its book debts. Companies frequently have debts which are paid on a regular
basis for goods or services provided but there may be a delay between the time
the obligation to pay arises (for example, when an invoice is issued) and the time
payment is actually made. In this situation it is possible for a company to use the
money owed to it immediately rather than wait for payment. 
is can be achieved
by obtaining a loan that is secured over its outstanding debts. 
e term book
debts has been de
ned by Lord Esher MR as debts arising in a business in which
it is the proper and usual course to keep books, and which ought to be entered in
such books (
Receiver
Tai
(1886)).
6.18
e issue of whether or not a  xed charge could be created over a companys
book debts arose in
Gorman
Ltd
Barc
ays
Ltd
(1979). 
e com-
pany granted a debenture in favour of Barclays Bank which was expressed to be a
rst  xed charge over all present and future book debts. 
e debenture required
the company to pay the proceeds of its book debts into an account held with
Barclays Bank and it prohibited the company from charging or assigning its book
debts without the banks consent. In 
nding that a  xed charge had been created,
Slade J held that the restrictions placed on the companys power to deal with the
proceeds of the debts, including the banks right to stop the company making
withdrawals even when the account was temporarily in credit, gave the bank a
degree of control which was inconsistent with a 
oating charge (see also
Oakda
(Richmond
Ltd
Nationa
Westminster
(1996)). A stricter approach was
taken in
Keenan
Bros
Ltd
(1986). 
e company was required to pay the pro-
ceeds of book debts into a special account over which the bank had an absolute
discretion to permit the company to transfer moneys to its working account. 
e
Supreme Court of Ireland held that the banks control over the special account
was such as to deprive the company of the free use of the proceeds. A  xed charge
had, therefore, been created.
6.19
On this basis it could be concluded that the court will categorise a charge as 
oat-
ing if the company can continue to use the proceeds of the book debts without
the consent of the chargee (see, for example,
Bright
Ltd
(1987)). However,
the simplicity of this test as a determinant breaks down in the light of
New
Trading
Ltd
(1994) (now overruled by the House of Lords, see below) in
which the Court of Appeal recognised that a charge may be divisiblea com-
bined charge. Here a  xed charge was created over uncollected book debts, but as
soon as the proceeds were collected and credited to the speci
ed bank account, a
7/19/2012 2:16:33 PM
Book debts
oating charge took e
ect over them. Nourse LJ, delivering the judgment of the
Court, observed that the parties had unequivocally expressed their intention to
create two distinct charges and that: [U]nless there is some authority or principle
of law which prevented them from agreeing what they have agreed, their agree-
ment must prevail. He concluded:
An equitable assignment, whether it takes effect as an out-and-out assignment
or, as here, by way of charge, is a creature of exceptional versatility, malleable to
the intention of its creators, adaptable to the subject-matter assigned. Provided
it is in writing, made for value and the intention is clear, it requires no formalities
of expression; it may take effect over property real or personal, and over estates
or interests legal or equitable, vested or contingent or, as in the case of future
book debts, mere expectancies.
6.20
e decision in
is confusing and attracted much criticism, both judi-
cial and academic. For example, in
Roya
Trust
Nationa
Westminster
(1996) Millett LJ commented that: I do not see how it can be possible to
separate a debt or other receivable from the proceeds of its realisation. He also
observed that:
A contractual right in the chargor to collect the proceeds and pay them into
its own bank account for use in the ordinary course of business is a badge of a
oating charge and is inconsistent with the existence of a
xed charge.
(See also
Bright
Ltd
(above), Ho
mann J; and
ASRS
Estab
ishment
Ltd
(2000), Robert Ealker and Otton LJJ. For academic comment see Goode (1994);
Worthington (1997) and Gregory and Walton (1999).)
6.21
Not surprisingly, the decision in
was criticised by Lord Millett in
Agnew
(above). 
e debenture in question was modelled on the instrument in
as.
e Privy Council, severely curtailing the circumstances in which a charge over
uncollected book debts could be categorised as a  xed rather than a 
oating
charge, declared the
approach to be fundamentally mistaken. 
e fact
underlying the opinion of the Privy Council was that the debtor company was
free to remove the charged assets from the scope of the chargees security. In
other words, the chargor was free to deal with the assets in the ordinary course of
business. Lord Millett stated:
If the chargor is free to deal with the charged assets and so withdraw them from
the ambit of the charge without the consent of the chargee, then the charge is
oating charge. But the test can equally well be expressed from the chargees
point of view. If the charged assets are not under its control so that it can prevent
their dissipation without its consent, then the charge cannot be a
xed charge.
7/19/2012 2:16:33 PM
Raising capital: debentures: xed and oating charges
6.22
Technically, of course,
was not overruled by the Privy Councils decision.
Indeed, the Court of Appeal in
Nationa
Westminster
Spectrum
Ltd
(above) felt compelled to follow it. Here, the chargor, Spectrum, granted a
 xed (speci
c) charge to the bank over its book debts to secure an overdra
of
250,000. 
e debenture stated that the security was a speci
c charge over all
present and future book debts and other debts. It also prohibited Spectrum from
charging or assigning debts and the company was required to pay the proceeds of
collection into an account held with the bank. 
e debenture did not specify any
restrictions on the companys operation of the account.
6.23
Spectrums account was always overdrawn and the proceeds from its book debts
were paid into the account which Spectrum drew on as and when necessary.
When Spectrum went into liquidation the bank sought a declaration that the
debenture created a  xed charge over the companys book debts and their pro-
ceeds. 
e Crown, however, argued that the debenture merely created a 
oating
charge so that its claims in respect of tax owed by the company took priority over
the bank. 
e trial judge held, applying
Agnew
and declining to follow
that given the charge permitted Spectrum to use the proceeds of the debts in the
normal course of business it must be construed as a 
oating charge. In so holding
the Vice-Chancellor also declined to follow
Gorman.
6.24
e bank successfully appealed to the Court of Appeal. Lord Phillips MR, deliv-
ering the leading judgment (Jonathan Parker and Jacob LJJ concurred), took the
view that where a chargor is prohibited from disposing of its receivables before
they are collected and is required to pay the proceeds into an account with the
chargee bank, the charge is to be construed as  xed. He explained that it was
not, as a matter of precedent, open to the Court of Appeal to hold that
was wrongly decided even though the Privy Council had, in
Agnew
expressed
the view that the decision was mistaken. Further,
Gorman
was correctly
decided given that the debenture in that case clearly restricted the companys
ability to draw on the bank account into which the proceeds of its book debts
were paid. 
e Court of Appeal noted that the form of debenture used in
Gorman
had been followed for some 25 years and thus it was inclined to hold
that it had, by customary usage, acquired meaning. Lord Phillips observed that
in
Gorman:
Slade J could properly have held the charge on book debts created by the deben-
ture to be a
xed charge simply because of the requirements (i) that the book
debts should not be disposed of prior to collection and (ii) that, on collection,
the proceeds should be paid to the Bank itself. It follows that he was certainly
entitled to hold that the debenture, imposing as he found restrictions on the use
of the proceeds of book debts, created a
xed charge over book debts.
7/19/2012 2:16:33 PM
Book debts
6.25
A seven-member House of Lords, as expected, overturned the decision of the
Court of Appeal and overruled
Gorman
and
as.
Following the line
of reasoning adopted by the Privy Council in
Agnew
it held that although it is
possible to create a  xed charge over book debts and their proceeds (
Tai
Receiver
(1888)), the charge in the present case was a 
oating charge. Lord
Scott delivered the leading speech. He stressed that the ability of the chargor to
continue to deal with the charged assets characterised it as 
oating. For a  xed
charge to be created over book debts, the proceeds must, therefore, be paid into a
blocked account (see
Keenan
(above)). Lord Scott reasoned that:
The banks debenture placed no restrictions on the use that Spectrum could
make of the balance on the account available to be drawn by Spectrum. Slade J
Siebe Gorman
] thought that it might make a difference whether the account
were in credit or in debit. I must respectfully disagree. The critical question, in
my opinion, is whether the chargor can draw on the account. If the chargors
bank account were in debit and the chargor had no right to draw on it, the
account would have become, and would remain until the drawing rights were
restored, a blocked account. The situation would be as it was in
Re Keeton Bros
[above]. But so long as the chargor can draw on the account, and whether
the account is in credit or debit, the money paid in is not being appropriated
to the repayment of the debt owing to the debenture holder but is being made
available for drawings on the account by the chargor.
Although the House of Lords has jurisdiction in an exceptional case to hold that
its decision should not operate retrospectively or should otherwise be limited, it
nevertheless held that in the present case there was no good reason for postponing
the e
ect of overruling
Siebe
Gorman.
e reasoning of Lord Scott was recently applied in
Harmony
Care
Homes
Ltd
7/19/2012 2:16:33 PM
Raising capital: debentures: xed and oating charges
holders representatives. 
e court held that the security granted to the debenture
holder was a 
xed charge as it had su
cient control over the book debts collected
by the debtor. Citing the
Agnew
and
Spectrum
decisions, the court found that the
case turned on ascertaining the nature and the rights and obligations which the
parties intended to grant each other in respect of the book debt proceeds and the
companys ability to deal with them at the time when the debenture was granted.
On the facts, it was held that the debtor could not make and did not make any
use of the monies paid into the account without [the debenture holders] written
instructions to the bank. Accordingly, it was found that all book debts collected in
by the debtor from the grant of the debenture were subject to the debenture holders
control and that, unlike the position in
Spectrum
7/19/2012 2:16:33 PM
Crystallisation
Ltd
(1963)). A 
oating charge will also crystallise when a debenture holder or the
trustees take possession or appoint a receiver to realise the security as a result
of the occurrence of an event speci
ed in the debenture, for example, default in
the repayment of principal or payment of interest (
Panama
New
Austra
Roya
Mai
(1870)). It is now settled that cessation of business
as a going concern will also cause a 
oating charge to crystallise
(Re
Woodro
(Musica
Instruments
Ltd
(1986)). However, merely instituting an action for the
appointment of a receiver, or the fact of default in payment by the company, or
making a demand for payment, are not crystallising events unless speci
ed as
such in the charge (
Evans
Riva
Granite
uarries
Ltd
(1910)).
6.29
Given the contractual basis of the relationship between the chargor and the char-
gee, the parties are free to agree between themselves what acts or events should
give rise to crystallisation upon service of notice on the company. It therefore
follows that the above stated implied events can be excluded or limited by
them or, indeed, additional events may be speci
ed (
Bright
Ltd
(1987),
Ho
mann J).
Provisions for automatic crystallisation
6.30
Automatic crystallisation occurs where the active intervention of the chargee,
which would normally take the form of serving notice or appointing a receiver,
is not required. Consequently, the debenture may provide that on the occurrence
of a speci
ed event, such as the creation of a second mortgage, the 
oating charge
automatically converts into a  xed charge. Considerable debate has taken place
in the past over the desirability of permitting the parties to agree to automatic
crystallisation given that such clauses are not required to be registered (see below
on registration). 
is puts other company creditors in a particularly vulnerable
position when seeking to prove their claims in liquidation proceedings (see, for
example, the
Report
the
Review
Committee
Inso
vency
Law
Practice
(the
Cork Committee) (Cmnd 8558), June 1982). Nevertheless, following New Zealand
authority (
Manurewa
Transport
Ltd
(1971)), Ho
mann J in
Bright
Ltd
(1987) recognised the validity of automatic crystallisation clauses as a necessary
incident of the freedom of parties to contract. He said that the policy objections
to such clauses were matters to be addressed by Parliament:
I do not think that it is open to the courts to restrict the contractual free-
dom of parties to a
oating charge . . . The public interest requires a balanc-
ing of the advantages to the economy of facilitating the borrowing of money
against the possibility of injustice to unsecured creditors. [The] arguments for
and against the
oating charge are matters for Parliament rather than the
courts . . . (See also
Grif
ths v Yorkshire Bank plc
(1994).)
7/19/2012 2:16:33 PM
Raising capital: debentures: xed and oating charges
6.31
e Cork Committee concluded that there was no place for automatic crystal-
lisation clauses in modern insolvency law and it recommended that the events
giving rise to crystallisation should be de
ned exclusively by statute (
Report
the
Review
Committee
Inso
vency
Law
Practice
(Cork Committee Report,
Cmnd 8558)). 
is particular recommendation has not been taken up. However,
s 251 of the Insolvency Act 1986 de
nes 
oating charge as meaning a charge
which,
created
was a 
oating charge (emphasis added). 
is certainly under-
mines automatic crystallisation and if the facts of
Bright
(the liquidation in
this case commenced before the 1986 Act came into force) were to come before
the courts again the decision might be di
erent because the statutory de
nition
appears to frustrate automatic crystallisation.
Priority of charges
6.32
e governing principle is that security interests rank according to the order of
their creation:
prior
est
tempore
potior
est
jure.
is is subject to a number of
exceptions. A legal mortgage will take priority over a prior equitable security if it
is purchased without notice of the prior equitable interest and for value (
eman
London
County
Westminster
Ltd
(1916)). Registration of the charge
under the Land Charges Act 1972 constitutes actual notice and registration at
Companies House (see below) constitutes constructive notice.
6.33
We have seen that the peculiar feature of the 
oating charge is that the company
can continue to deal with the assets in the ordinary course of business. 
us, a
company can create a  xed charge, legal or equitable, which will rank in prior-
ity over an earlier 
oating charge (
Caste
ll
Brown
Ltd
(1898)). To protect
themselves against this risk it is now common for 
oating chargees to insert a
so-called negative pledge clause in the charge. Such a restriction is not incom-
patible with the nature of a 
oating charge (
Bright
(above)). 
e e
ect of a
negative pledge clause is to prohibit the company creating a subsequent mortgage
or charge ranking equally with (
pari
passu
or in priority to the earlier 
oating
charge. 
e subsequent chargee will not lose his priority unless he had notice of
the clause; notice of the earlier 
oating charge (by its registration, see below) does
not impute notice of any restriction it may containthe maxim where the equi-
ties are equal the law prevails applies (
ish
Scottish
Mercanti
Investment
Brunton
(1892)).
6.34
As between competing 
oating charges, the general rule is that the 
rst in time
prevails. However, a 
rst 
oating charge will be postponed to a second 
oating
charge created over a part of the assets, for example book debts, provided the 
rst
7/19/2012 2:16:34 PM
Registration of charges
charge does not restrict the power of the company to create a subsequent 
oat-
ing charge which ranks prior to or
pari
passu
with the 
rst (
Automatic
Bott
Makers
Ltd
(1926)). It is, in any case, open to the parties to a 
rst 
oating charge
to agree that the company can create subsequent 
oating charges which take pri-
ority
(Re
Benjamin
Cope
Sons
Ltd
(1914)). Curiously, in
Gri
ths
orkshire
(above), it was held that where a subsequent 
oating charge crystallises
into a  xed charge, it will take priority over an earlier 
oating charge even a
er
that has itself crystallised. 
is clearly infringes the rule that equitable interests
take priority in the order of their creation (see
Househo
Products
Ltd
Federa
Business
Deve
opment
(1981)).
Registration of charges
6.35
Creditors considering lending money to a company will want to determine the
extent to which the prospective debtor has incurred secured debt. Merely looking
to corporate assets will not give an accurate impression because, as we have seen
in relation to 
oating charges, the debtor can secure a loan on a non-possessory
basis thereby facilitating the continued use of the asset. 
ere is, therefore, a
scheme of registration that requires companies to make publicly available certain
details concerning charges on its assets. 
e current registration requirements
are laid down in Part 25 of the 2006 Act. In essence, the prescribed particulars
of certain categories of charges created by a company, together with the instru-
ment creating the charge, must be delivered to or received by the Registrar of
Companies within 21 days of its creation (s 860 and s 870). 
e Registrar enters
the particulars on the register and returns the instrument. Failure to deliver the
particulars to the Registrar within 21 days renders the charge void as against a
liquidator or administrator and any creditor of the company (s 874). It is note-
worthy that it is the security which is void under the section, not the loan, and
so in the event of insolvency it will rank as an unsecured debt. In this regard, s
874(3) goes on to provide that when a charge becomes void under the section,
the money secured by it immediately becomes payable. Although it is expressly
provided that it is the companys duty to send the necessary particulars to the
Registrar under s 860, registration may be e
ected on the application of any per-
son interested in it (s 860(2)). If a company fails to comply with this duty, then,
unless the registration has been e
ected on the application of some other person,
the company and every o
cer of it who is in default is liable to a 
ne and, for
continued contravention, to a daily default 
ne (s 860(4) to (6) and s 863(5)).
6.36
Where a company acquires property which is subject to a charge which would
be registrable under s 860 if it had been created by the company, it must be
7/19/2012 2:16:34 PM
Raising capital: debentures: xed and oating charges
registered within 21 days a
er the date on which the acquisition is completed (s
862)). Failure to comply with this requirement renders the company and every
cer in default liable to a 
ne. 
e charge itself is not invalidated.
6.37
Once the charge is duly registered it is valid as from its creation. 
is results
in a 21-day time lag which has been termed the 21-day invisibility problem by
the CLRSG (
Registration
Company
Charges
Consultation Document, October
2000 (URN 00/1213), para 3.79). An intending creditor searching the register
cannot assume that all charges have been duly recorded because there may be a
charge for which the 21-day period has not expired.
Particulars of charge
6.38
e Companies (Particulars of Company Charges) Regulations 2008 (SI
2008/2996) lays down the information which is to be given to the Registrar of
Companies when a charge is registered. Reg 2 of the Regulations provides that
the following particulars of charge must be delivered to the Registrar:
the date of the creation of the charge;
(i)
a description of the instrument (if any) creating or evidencing the
(ii)
charge;
the amount secured by the charge;
(iii)
the name and address of the person entitled to the charge;
(iv)
short particulars of the property charge.
(v)
Where a company acquires property which is subject to a charge (see
, above),
the particulars listed in (i)(v) must be delivered to the Registrar together with the
date on which the acquisition took place.
In addition to registration with the Registrar, s 876 requires every limited company
to maintain at its registered o
ce a register stating prescribed particulars of all
xed and 
oating charges on the companys undertaking or any of its property.
Failure to maintain such a register renders an o
cer of the company who know-
ingly and wilfully authorises or permits the omission of a required entry liable to a
ne. 
e validity of the charge is not a
ected.
6.39
e purpose of the registration requirements is to enable creditors to assess the
credit-worthiness of a company. It is the means by which unsecured creditors are
able to ascertain what assets are free and available to meet liabilities in the event
of insolvency. Secured creditors can also check whether the asset in question is
already charged, although with respect to both unsecured and secured creditors
7/19/2012 2:16:34 PM
Registration of charges
the 21-day invisibility problem means that the information is not necessarily
watertight. 
e information is also material to those considering investing in a
company. 
e categories of charge that require registration are listed in s 860(7)
and include, inter alia, a charge for the purpose of securing any issue of deben-
tures; a charge on, or on any interest in, land but not including a charge for any
rent or other periodical sum issuing out of the land; a charge on book debts of the
company; a 
oating charge on the companys undertaking or property.
Effects of registration
6.40
Section 869(5) provides that the Registrar shall give a certi
cate of registration,
stating the amount secured by the charge. 
e certi
cate is conclusive evidence
that the requirements of the Act as to registration have been complied with (s
869(6)(b)). 
e charge cannot therefore be set aside even if the particulars are
defective in that, for example, they omit to state accurately the amount secured
Mechanisations
(Eag
esc
Ltd
(1966)); or the date the charge was created
Eric
mes
(Property
Ltd
(1965);
Nye
Ltd
(1971)). Registration is a
perfection requirement, it is not determinative of priority. Provided registration
has been e
ected within the 21-day period as required under s 860, priority is to
be determined by the order of creation of competing charges and not by the order
of their registration.
6.41
ose who search the register will obviously have actual notice of the particulars
of the charge and those who ought reasonably to have searched will be deemed to
have constructive notice of its particulars. Section 869(4) sets out the prescribed
particulars to be entered in the register. 
ese include the date the charge was
created, the amount secured by it, short particulars of the property charged and
the persons entitled to the charge. Constructive notice does not, however, extend
to the terms of the charge such as a negative pledge clause in a 
oating charge
(1910); and
Ear
Ltd
Hemsworth
RDC
(1928)).
Late registration and recti
cation
Section 873 permits recti
cation of the register of charges in circumstances
where the court is satis
ed that the failure to register within the prescribed time
period or that the omission or misstatement of any particular was accidental,
or due to inadvertence or to some other su
cient cause, or is not of a nature to
prejudice the position of creditors or shareholders of the company, or that on
other grounds it is just and equitable to grant relief. In practice, leave to register
out of time is invariably granted by the court subject to the rights of intervening
secured creditors and provided the company is not in liquidation and winding-up
7/19/2012 2:16:34 PM
Raising capital: debentures: xed and oating charges
is not imminent (
Ashpurton
Estates
Ltd
(1983)). Since registration is a perfec-
tion issue, a creditor who obtains recti
cation under s 873 would obtain priority
over subsequent charges e
ected prior to the late registration. To avoid the preju-
dice which this anomaly can cause, it is usual for the court order to contain the
proviso that the late registration is to be without prejudice to the rights of parties
acquired prior to the time when the charge is actually registered (
Johnson
Ltd
(1902);
Barc
ays
Stuart
Landon
Ltd
(2001); and
Con
Ltd
Timespan
Images
Ltd
(2005)).
Avoidance of
oating charges
6.43
Section 245 of the Insolvency Act 1986 invalidates a 
oating charge created within
12 months (termed the relevant time) prior to the onset of insolvency unless it
was created in consideration for money paid, or goods or services supplied, at
the same time as or subsequent to the creation of the charge. 
e term money
paid has been held to include cheques which have been met by a bank on behalf
of the company (
eovi
ove
Ltd
(1965)). 
e relevant time is extended to
two years where the charge is created in favour of a connected person. However,
s 245(4) provides that a 
oating charge created in favour of a non-connected
person within the relevant time (i.e. 12 months) will not be invalidated if the
company was able to pay its debts at the time the charge was created and did not
become unable to do so as a result of creating the charge. It should be noted that
this provision does not extend to charges created in favour of connected persons.
e term connected person is de
ned by s 249 as a director or shadow director
of the company
an associate of a director or shadow director of the company
and an associate of the company. 
e object of s 245 is to prevent an unsecured
creditor obtaining a 
oating charge to secure his existing loan at the expense of
other unsecured creditors.
Unidare
(2005), the Companies Court
held that a shareholder who holds the shares as a bare trustee under which he is
required to vote in accordance with the directions of the bene
cial owner does
not in any real sense have voting power and he is not, therefore, a connected
person for the purposes of s 245.
Reform
6.44
e question of reform of security interests has attracted considerable scrutiny
over the last twenty years or so. In March 1986 the DTI commissioned Professor
Diamond to undertake a study of security interests in property other than land.
e Diamond Report, which was published in 1989 (
Review
Security
Interests
7/19/2012 2:16:34 PM
Reform
Property
(HMSO, 1989)), set out a scheme for a comprehensive register of secu-
rity interests drawing upon Article 9 of the United States Uniform Commercial
Code. It also recommended changes to the existing system of company charges
registration. Part IV of the Companies Act 1989 contained provisions broadly
based on the Diamond Report recommendations for restructuring the registra-
tion system and reducing the scope of the conclusive certi
cate issued by the
Registrar. In 1991 the Government announced that Part IV of the 1989 Act would
not be implemented. One of the principal reasons for its non-implementation
was the proposal to replace the Registrars conclusive certi
cate with a certi
cate
which was conclusive only as to the date on which the particulars were lodged
with the Registrar. 
e sanction of invalidity was to be operative in respect of any
breach of the registration requirements. 
is proposal was severely criticised by
users and it was envisaged that problems would arise with respect to the interac-
tion between Part IV of the Act and the land registration system. 
e conclu-
sive certi
cate under s 869(6)(b) of the Companies Act 2006 assures the Land
Registry that a charge is not void. Had Part IV of the 1989 Act been implemented,
the certi
cate would have given no guarantee that the particulars were accurate,
and therefore the charge might be wholly or partially void on the basis that the
requirements as to the particulars to be 
led had not been satis
ed. 
e Land
Registry was concerned that the rights created under the land registration system
could be rendered invalid because of some failure to satisfy the Companies Act
requirements.
6.45
Following the decision not to implement the relevant provisions in the 1989 Act
the DTI issued another consultation document in November 1994 (
Company
Law
Review:
Proposa
for
Reform
Part
the
Companies
Act
URN 94/635).
Among its various proposals for reform, the consensus of opinion favoured
retention of the main procedural provisions, including the Registrars conclusive
certi
cate, along with the incorporation of certain of the 1989 Act improvements
including the updating of the list of registrable charges and new provisions for
overseas companies. 
is proposal was labelled Option B. A more wide-ranging
proposal, Option C, involved the replacement of the present transaction 
ling
system (registration only a
er a charge has been created) with a notice 
ling
system (with registration before or a
er creation of the charge).
As part of the fundamental review of company law, a further consultation doc-
ument on registration of company charges was issued in October 2000 by the
CLRSG see para
6.35
above). Signi
cantly, the Steering Group returned to Option
C of the 1994 consultation exercise whereby registration would no longer be a
mere perfection requirement but would become a priority point. Under this pro-
posal, which is based upon Article 9 of the United States Uniform Commercial
Code, all that is 
led is a notice (
nancing statement) giving particulars of the
7/19/2012 2:16:34 PM
Raising capital: debentures: xed and oating charges
property over which the 
ler has taken or intends to take security, and certain
other details, including the name and address of the creditor from whom a per-
son searching the register can obtain further information (the Consultation
Document, para 2.6). 
e 21-day registration rule would be abandoned as would
the requirement that the charge instrument be presented with the application
for registration. Detailed rules are set out which would form the basis for a sys-
tem under which the priority of registered charges would be determined by their
dates of registration at Companies House. 
e period between creation and reg-
istration would cease to be relevant as there would be no period of invisibility;
and so registration ceases to be a perfection requirement but becomes a priority
point (the Consultation Document, para 2.8, Rule 2).
6.47
Other proposals considered by the CLRSG included implementation of a number
of key 1989 Act provisions. For example, it noted that under the 1985 Act, regis-
tration ensures that a charge is not invalidated against the liquidator and secured
creditors. Section 95 of the 1989 Act would, in e
ect, have extended this so that,
in addition to the liquidator, an unregistered charge would also have been invali-
dated against any person who for value acquires an interest in or right over prop-
erty subject to the charge. It noted that under the 1989 Act, but not the 1985 Act,
want of registration invalidates the charge in the event of the company selling or
disposing of an interest (including a security interest) in the charged property.
Further, s 99 of the 1989 Act would also have provided that a charge would not
be void against a person acquiring an interest in or right over property where the
acquisition is expressly subject to the charge. 
e CLRSG endorsed those provi-
sions (para 3.7).
e Steering Group also returned to the issue of the conclusive certi
cate. 
e
Consultation Document questions whether the Registrar should be placed in
the position of verifying the content of information registered. 
e Diamond
Report had commented that the burden of compliance with the registration
requirements should fall upon the presenters of the documentation because
they were better placed to determine whether what they deliver satis
es the
legislative requirements and any liability for inaccuracy in the record should
lie with them. Accordingly, the Registrars certi
cate should be conclusive only
as far as it is practicable for it to be so. To achieve this objective several options
were explored, the most radical of which was to dispense with the requirement
that the document creating the charge should be delivered to the Registrar. In
its place, the requirement was to be that the company only submits particu-
lars of the charge, and these would include the date of its creation. Companies
House would simply verify that the required particulars had been  led on time.
e presenters would be fully responsible for the information appearing on the
public record.
7/19/2012 2:16:34 PM
Reform
6.49
Finally, other signi
cant proposals included those for widening the range of the
categories of charges to be registered. It is argued that the concept of book debts
could be broadened by dropping the reference to book and retaining the con-
cept of debt thereby encompassing a wider category of money obligation. All
charges on insurance policies would be made registrable irrespective of whether
or not other contingent debts should be registrable. Further, in order to enhance
the value of 
oating charges it was proposed that the parties should be permitted
to register negative pledge clauses if they so wish. 
is would provide for con-
structive notice of the pledge either from the date the charge was created or from
the date of its registration.
6.50
e consultation period for the Steering Groups proposals closed on 5 January
2001. In its
Fina
Report
the Steering Group stated that insu
cient time had
been given to consult on its proposals and it therefore invited the DTI to consult
with the Lord Chancellors Department with the object of referring the matter
to the Law Commission (see also the White Paper, paras 6.186.19). 
e
Fina
Report
recommended that: (a) the current scheme for the registration of com-
pany charges under Part XII of the Companies Act 1985 should be replaced by
a system of notice 
ling; (b) the new system should encompass functionally
equivalent legal devices (commonly termed quasi-security devices) such as hire-
purchase and sales on retention of title terms; and (c) consideration should be
given to whether or not any new system should be extended to charges created by
individuals and unincorporated businesses (which was, of course, outside of its
terms of reference).
6.51
On 2 July 2002 the Law Commission published a consultation paper, Registration
of Security Interests: Company Charges and Property other than Land (No 164).
e LCCP states that a registration scheme should perform two functions: (1) to
provide information to persons who are contemplating extending secured lend-
ing, credit rating agencies and potential investors about the extent to which assets
that may appear to be owned by the company are in fact subject to security inter-
ests in favour of other parties; and (2) to determine the priority of securities (para
12). 
e LCCP, endorsing the views of the Steering Group, therefore provisionally
proposed the introduction of an electronic notice-
ling system based on the US
model (see para
above; similar schemes also operate in Canada and New
Zealand) to replace the current registration scheme for company charges. Further,
the new scheme would extend to a seller who takes purchase-money security
over the particular asset purchased with the 
nance provided. Such a seller would
have priority over all other creditors. Failing to register a 
nancing statement
will result in loss of priority over a charge that is subsequently registered. It is also
proposed that a security that has not been registered will be invalid against a liq-
uidator and an administrator and that notice 
ling should be extended to cover
7/19/2012 2:16:34 PM
Raising capital: debentures: xed and oating charges
certain quasi-security interests, i.e. transactions that secure payment or perform-
ance of an obligation. Hire-purchase agreements, conditional sales and retention
of title clauses would thereby become registrable (LCCP, paras 12.8012.81). 
e
Law Commission proposals would make registration more straightforward and
the priority rules would be more coherent, albeit with some loss of information.
6.52
In August 2004 the Law Commission followed up its earlier work with the publi-
cation of a consultative report (CR),
Company
Security
Interests.
e Commission
continues to recommend notice 
ling on the basis that its proposals provide sig-
ni
cant improvements and cost-savings in secured 
nance for companies. 
e
use of technology can make the registration of company charges much easier,
cheaper and quicker (Law Commission, Press Release, 16 August 2004). To
replace the paper-based registration scheme which has been in existence for
over 100 years, it is stressed that notice 
ling could be carried out by a secured
party online. 
e CR sets out a range of advantages that notice 
ling has. 
ese
include its speed and e
ciency, the fact that advance 
ling is permissible so that
a lenders priority could be protected while negotiations continue (the proposed
system is based on the principle that the 
rst to 
le has priority), and that the
oating charge would, in practice, disappear and be superseded by a single type
of security interest having all of the advantages of a 
oating charge but fewer
disadvantages to the lender.
6.53
Notice 
ling has not, however, escaped criticism. It has been pointed out that the
proposed scheme could lead to misleading information being on 
le. For exam-
ple, a lender searching the register has no way of determining whether a particu-
lar registration relates to an actual transaction or to a proposed transaction that
may have been aborted because negotiations broke down. Further, fewer details
are available than is the case under transaction 
ling (Calnan, 2004). 
e Law
Commission counters this argument with the observation that the current sys-
tem requires only two additional items; the amount secured by the charge and
the date it was created (para 2.47). It is stated that the statement of the amount
secured is of little use since, unless the charge is for a  xed amount, it is most
unlikely to be accurate by the time anyone searches the register. With respect
to the date of creation, the CR notes that providing such a date is not possible
in a system that has the advantage of allowing 
ling before the charge has been
agreed or has attached (para 2.47).
In August 2005 the Law Commission published its 
nal report,
Company
Security
Interests
(Report
No.
6,
200
Its principal proposals include:
A new system of electronic notice
ling for registering charges.
i.
Removal of the 21-day time limitthus removing the invisibility period
ii.
(see iv, below).
7/19/2012 2:16:34 PM
Reform
Extending the list of registrable charges so that all charges are registrable
iii.
unless speci
cally exempted. The principal exemptions will be for some
charges over registered land and over
nancial collateral.
Clearer priority rules. Priority between competing charges will be by date
iv.
ling unless otherwise agreed between the parties involved (this will also
remove the current 21-day period of invisibility). The distinction between
xed and
oating charges will be preserved. For
oating charges it will
no longer be necessary to rely on a negative pledge clause to prevent
subsequent charges gaining priority. It will also be unnecessary to rely on
automatic crystallisation clauses.
If a charge over registered land is registered in the Land Registry, it will not
v.
need to be registered in the Company Security Register. Instead, the Land
Registry will automatically forward to Companies House its information
about companies charges.
Sales of receivables will be brought within the scheme (e.g. factoring and
discounting agreementscurrently a fact
or will only obtain priority if it
gives notice to each account debtor).
The rules on charges over investment securities and other forms of
nancial collateral are to be clari
e report also contains dra
Company Security Regulations 2006 prepared by the
Law Commission for adoption by the DTI, (now BIS), under powers conferred by
the Companies Act 2006.
6.55
In July 2005 the DTI initiated its own consultation exercise aimed at seek-
ing views on the economic impact of the Law Commissions proposals in
relation to company charges. This was followed by a Ministerial statement
in November 2005 to the effect that there was no clear consensus of sup-
port in favour of the Law Commissions proposals and as a consequence
the Companies Bill (as it then was) would not include a specific power to
implement the recommended changes. However, it was stated that the Bill
would include a new general power to introduce company law reform orders
and this would provide the mechanism for introducing changes in relation
to company charges (
Hansard
, HL, col. WS27 (November 3, 2006)). In fact
this power was dropped from the Bill during its passage through Parliament.
Instead, a new power was enacted by virtue of s 894 permitting the Secretary
of State to amend Part 25 of the Act by regulations. Lord Sainsbury, com-
menting on Part 25 on behalf of the government, admitted that: while there
has been an element of restructuring, no substantive changes have been made
other than to ensure compatibility with the Bill . . . The approach to restate-
ment of the existing provisions [in CA 1985] means that the new provisions
7/19/2012 2:16:34 PM
Raising capital: debentures: xed and oating charges
retain the imperfections of the existing system (
Hansard
, HL Vol. 686,
col. 480 (November 2, 2006)).
6.56
Yet another consultation exercise on the registration of company charges
was launched by BIS on 12 March 2010 (
Registration
Charges
Created
Companies
Limited
Liabi
ity
Partnerships:
Proposa
amend
the
cur
rent
scheme
specia
ist
registers
(URN 10/697)). 
e consulta-
tion sought views on proposed changes to the scheme for registration of
company charges set out in Part 25 of the Companies Act 2006 (which, as
commented above, basically replicates Part XII of the CA 1985) based on the
2001 recommendations of the CLR and the subsequent proposals put forward
by the Law Commission. 
e issues included what charges should be regis-
tered, time limits, consequences of registration and of the failure to register a
charge, procedures, electronic registration, and the availability of information
about company charges (a summary of the responses to the consultation were
published by BIS in October 2010 (http://www.bis.gov.uk/assets/biscore/busi
ness-law/docs/s/10-1230-summary-responsesconsultation-registration-of-
charges)). Next, following the publication on 22 December 2010 of the results
of an evaluation of the Companies Act 2006, the Government outlined its
future priorities with respect to company law including proposals to modern-
ise and simplify the current system for the registration of company charges.
It decided, following a consultation process that the requirement to register
will be expanded to apply to all charges granted by a company registered in
the UK over any of its property (wherever situated and regardless of the law
under which the charge was created) unless there is an express exclusion. 
e
new scheme will also apply to unregistered companies and limited liability
partnerships but will not apply to overseas companies. With respect to the
procedure for registration, the Government decided that it will be possible to
register charges electronically, and an appropriately redacted extract from the
charge instrument will be placed on the public record. Regrettably though,
the 21 day invisible period would continue to exist as it con rmed that regis-
trable charges registered outside the 21 day time limit will continue to be void
against a liquidator, an administrator, and any creditor as under the current
regime, but the criminal sanction for failure to register will be abolished.
Following a consultation exercise on the registration of 
oating charges in May 2011,
7/19/2012 2:16:34 PM
Further reading
nalise its proposals and issue dra
regulations in 2012. 
e amendments to Part
25 would then come into force on 1 October 2012. 
e requirement for registered
overseas companies to 
le with Companies House charges on property located in
the UK (see 
e Overseas Companies (Execution of Documents and Registration
of Charges) Regulations 2009) was repealed on 1 October 2011.
In January 2012 BIS announced that it was continuing its work on reforming how
7/19/2012 2:16:34 PM
Raising capital: debentures: xed and oating charges
McCormack The Floating Charge and th
e Law Commission Consultation Paper on
Registration of Security Interests [2003]
Insolvency Lawyer 2.
McCormack The Priority of Secured Credit: An Anglo-American Perspective [2003]
JBL
389.
McCormack The Law Commissions Consultative Report on Company Security
Interests: An Irreverent Riposte [2005]
MLR
286.
Pennington The Genesis of the Floating Charge [1960]
MLR
630.
Worthington Fixed Charges Over Book Debts and Other Receivables [1997]
LQR
562
Worthington An Unsatisfactory Area of the LawFixed and Floating Charges Yet
Again [2004]
International Corporate Rescue
175.
SELF-TEST QUESTIONS
How might a
xed charge be created over a companys book debts?
Apple Bank Ltd lends
oating charge to
the purchase price. This charge was duly registered. Discuss.
[W]hat you do require to make a speci
c security is that the security whenever it
has come into existence, and been identi
ed and appropriated as a security, shall
never thereafter at the will of the mortgagor cease to be a security (per Vaughan
Williams LJ in
Re Yorkshire Woolcombers Association
7/19/2012 2:16:34 PM
PART II
Behind the Corporate Veil
7/20/2012 5:17:33 PM
SUMMARY
Introduction
Receiving proper value on issue of shares
Returning funds to shareholders: dividends
Returning funds to shareholders: reduction of share capital
Returning funds to shareholders: redemption or purchase by a company of its
own shares
Financial assistance for the acquisition of shares in a public company
The prohibition and the exceptions
Introduction
7.1
In this chapter we consider the means by which company law seeks to ensure
that a companys share capital is maintained in the companys possession and
therefore gives an accurate picture of the companys 
nances. A principal anxi-
ety of the law is that shareholders should actually pay the price of their shares in
money or moneys worth and that this sum is not directly or indirectly returned
to them except in accordance with the provisions of the Companies Act (see,
for example, the Companies Act 2006, ss 641
, ss 684
and ss 829
, discussed
below). 
e policy here is directed towards protecting creditors who, because of
the
Salomon
doctrine and the principle of limited liability, cannot look directly
7/20/2012 5:17:36 PM
Share capital
to say that an unsecured creditor is guaranteed
payment by virtue of a companys
capital. Indeed, many large successful companies have rather low issued capital
funds but signi
cant assets perhaps in the way of properties: for example, a hotel
chain may have an issued share capital of only 100 but own substantial proper-
ties in prime locations throughout the UK that are worth millions of pounds. As
with share capital, corporate assets may also be lost or depleted through poor
management decisions and no principle of company law in a free enterprise econ-
omy can protect investors or creditors against such assets being squandered by
under-performing management. As is pointed out by the CLRSG in
e Strategic
Framework,
consultation document (London, DTI, 1999) (para 5.42):
The principle of capital maintenance is at least as old as the limited liability
company. The law gave the shareholder the privilege of limiting his liability,
so that once he had paid, or promised to pay on call [in the case of partly paid
shares], an amount equal to the nominal value of the shares he took up he
had no further responsibility for the debts of the company. In order to protect
members and creditors, however, a body of rules was erected; such rules were
designed to prevent the capital so provided from being extracted or otherwise
eroded, save as a result of trading or other business events.
7.2
As commented above, in considering the principles governing share capital it
should be borne in mind that the law was, and it may reasonably be concluded
still is, notoriously complex. Indeed, the regime governing distributions and cap-
ital maintenance attracted considerable scrutiny by the CLRSG and the ensuing
White Papers of 2002 (Cm 5553) and 2005 (Cm 6456). In this respect, the 2005
White Paper states that while it is obviously important to protect the interests
of a companys creditors, the current provisions give rise to some of the most
complex and technically challenging provisions of the 1985 Act94 sections of
detailed rules in total (
Company Law Reform,
para 4.8); see also,
Company Law.
Flexibility and Accessibility: A Consultative Document
(London, DTI, 2004)). 
e
result is that the 2006 Act seeks to deregulate the old law by removing the need
for private companies to comply with measures that are unnecessarily burden-
some. However, as far as public companies are concerned, much of the law is
restated. As such it continues to pose a trap for the unwary and a fertile source of
fee income for corporate law practitioners.
7.3
As seen in Chapters 1 and 5, a shareholder subscribes for shares by paying or
agreeing to pay the price for the shares to be issued to him. Generally the
price paid is made up of two elements. First, there is the par or nominal value
of the shares (see s 542 CA 2006, which provides that shares in a limited com-
pany must each have a  xed nominal value): for example a companys share
capital may be 100 made up of one hundred 1
shares, here 1
is the nominal
7/20/2012 5:17:36 PM
Introduction
value. Second, a premium for the shares may be attached to the price: thus
each 1 share may be sold for 1.25 or more. In practice, a companys existing
shareholders would have cause for complaint if a new issue of shares were to be
made at par because that would have the e
ect of reducing the value of their
holdings, which may have increased above their par value by the time of the
new issue. Where shares are sold at a premium, the amount of the premium is
kept separate in the companys accounts by entering it under the heading share
premium account (s 610 CA 2006). However, the Companies Act treats such
sums as paid-up capital which cannot be returned to members unless by way
of a formal reduction of capital (see below). As we have seen in relation to the
notion of limited liability (Chapter 2), the share capital contributed by a share-
holder represents the extent of his liability should the company become insol-
vent. 
e holder of fully paid shares has no further liability to contribute to the
companys capital, while the liability of a holder of partly paid shares (a rare
species nowadays) is limited to the amount which remains unpaid, i.e. the dif-
ference between the sum actually paid and the nominal value of the shares plus
any agreed premium (s 74(2)(d) of the Insolvency Act 1986). As we will see in
Chapter 17, when a company goes into liquidation, its shareholders will not col-
lect any return of their capital while creditors remain unpaid. Of course, while
the company is a going concern and enjoying pro
tability its shareholders can
share in those pro
ts (via dividends); but if losses are incurred, no return can
be given on their investment until the company has su
cient funds to meet its
indebtedness at least equal to the share capital.
7.4
It is important to bear in mind that the regime governing maintenance of share
capital is a mixture of substantive legal principles and accounting rules. A com-
panys share capital is not ring-fenced in some separate bank account to be used
only in the event of liquidation to pay creditors. Rather, it is a book-keeping entry
and before any returns can be paid to shareholders the accounts must show that
the value of a companys assets exceeds its share capital. In essence, therefore,
share capital operates as a yardstick of pro
tability.
7.5
ere are various ways in which shareholders might legally receive funds (dis-
tributions) from the company. Many shareholders invest not just in the hope of
seeing the value of their shares increase as the company prospers so that they
make a pro
t on resale, but also in the expectation of receiving an income by way
of a dividenda share of the companys pro
ts in proportion to the number of
shares held. 
e right to receive a dividend may di
er according to the class of
shares held (see Chapter 9). However, the law also regulates other types of distri-
butions, whether in cash or in kind, and we now turn to consider the rules that
are directed towards maintaining a companys share capital. It should be noted
that the regime di
erentiates between private and public companies.
7/20/2012 5:17:37 PM
Share capital
Receiving proper value on issue of shares
No discount
7.6
One incident of the doctrine of capital maintenance is that shares may not be
issued at a discount to their nominal value. 
is was clearly laid down in
Ooregum
Gold Mining Co of India v Roper
(1892) in which the company wished to issue
shares with a nominal value of 1
on the basis that they be credited with 75p,
meaning each holder had a liability to pay only 25p, because the market value of
the shares was then less than their nominal value. In rejecting the power of the
company to do this, Lord Halsbury LC stated:
the Act of 1862 . . . makes [it] one of the conditions of the limitation of liabil-
ity that the memorandum shall contain the
amount of the capital with which
the company proposes to be registered, divided into shares of a certain
xed
amount. It seems to me that the system thus created by which the shareholders
liability is to be limited by the amount unpaid upon his shares, renders it impos-
sible for the company to depart from that requirement, and by any expedient
to arrange with their shareholders that they shall not be liable for the amount
unpaid on their shares.
7.7
is rule is now contained in CA 2006, s 552; and if shares are issued at a
discount the allottee is liable to pay the di
erence with interest. As an anti-
avoidance measure, payments of commissions and brokerage are also prohibited
except in very limited circumstances (see s 553 which permits the payment of
commissions (and discounts) up to 10 per cent of the price at which the shares
are issued). 
e prohibition does not mean that the share has actually to be paid
for in full when it is issued, since payment may be deferred: as we have seen,
there can be paid-up and un-paid-up capital. In the latter case, the shareholder
remains liable to contribute. What it does mean is that the company may not
charge less than the nominal value of the share. 
us, an outsider can be sure
that the company has received (or at least has enforceable claims for) its issued
share capital.
7.8
ere is a further issue that needs explaining. It is possible for a company to issue
shares fully paid up so that the recipient has no obligation to make any payment
at all: it might do so, for instance, if it wanted to award shares as a bonus to its
employees. In order to do this, the company itself must pay up the share by nomi-
nally transferring funds from its pro
t account to its share capital account. By
thus increasing the nominal value of its share capital, it protects creditors in the
same way as if the shares had been issued fully paid to an outsider.
7/20/2012 5:17:37 PM
Receiving proper value on issue of shares
Payment in kind
7.9
If the consideration for the shares is in kind (i.e. in goods, property or services
rather than in cash) there is clearly the opportunity to avoid the no discount
rule and a danger that the shares may be undervalued. 
is is what the liquida-
tor in
Re Wragg Ltd
(1897) alleged. In that case Messrs Wragg and Martin sold
their omnibus and livery-stable business to the company they had incorporated
for
46,300, paid for by the company by the issue of debentures and fully paid
shares. 
e liquidator alleged that the value of the business had been overstated
by
18,000 and he claimed to be able to treat shares representing this amount
as unpaid. However the court held that the good faith judgment of the direc-
tors that the bene
t received in return for the shares was worth their nominal
value was not open to challenge. Lindley LJ remarked that: Provided a limited
company does so honestly and not colourably, and provided that it has not been
so imposed upon as to be entitled to be relieved from its bargain, it appears to be
settled . . . that agreements by limited companies to pay for property or services in
paid-up shares are valid and binding on the companies and their creditors (see
also,
Salomon v A Salomon & Co Ltd
(1897), discussed in Chapter 2).
7.10
Lindley LJs formulation continues to apply to private companies. However, for
public companies there are various statutory provisions governing this scenario
(see the CA 2006, ss 584587 and ss 593609). For example, s 585(1) prohibits a
public company from accepting an undertaking to do work or perform services
in payment of its shares. However, a private company may accept such an under-
taking (thus in
eatrical Trust Ltd, Chapmans Case
(1895), payment took
the form of an agreement to become manager for 
ve years). Of particular sig-
ni
cance is CA 2006, s 593 which requires an independent valuation of non-cash
consideration; the rules are even stricter in relation to subscribers to the memo-
randum (see ss 584, and ss 598599). Failure to comply with the statutory proce-
dure can have signi
cant consequences for the allottee and subsequent holders
of the shares (see ss 588, 593(3) and 605 CA 2006). 
e allottee is required to pay
to the company the nominal value of the shares together with any premium, and
interest, irrespective of any bene
t that the company may have received. In e
ect,
therefore, the allottee is liable to pay for the shares twice. A subsequent holder of
the shares is jointly and severally liable with the allottee to pay the same amount,
unless he is (or derived title through) a
de
purchaser for value without
actual notice. Given the severity of these provisions, the court does, however,
have the power to grant relief from liability, in whole or in part (ss 589 and 606).
For example, in
Re Bradford Investments plc (No 2)
(1991) the members of a part-
nership converted a dormant private company into a public company. Without
having 
rst obtained a valuation of the partnership business in accordance with s
103, they sold it to the public company in return for 1,059,000 fully paid 1
shares.
7/20/2012 5:17:37 PM
Share capital
Subsequently, the company, being under new management, claimed
1,059,000
from the former partners as the issue price of the shares. 
ey applied to the
court under s 113 CA 1985 (now CA 2006, s 606) to be relieved from liability to
pay this sum. It was held, denying them relief, that the provision puts the onus
of proving that value was given on the applicants and they had failed to satisfy
the court that the partnership business had any net value at the time it was sold
to the company. It should also be noted that criminal penalties are imposed on
the company and its o
cers for contravening the statutory rules (s 590 CA 2006).
Further, any such transaction, whilst enforceable by the company against the
allottee, is void as against the company (s 591 CA 2006).
Relevance of nominal value
7.11
We have seen that a company may issue shares at above the nominal value (the
erence being called a share premium). 
e combination of this possibility and
that of paying for shares in non-cash consideration means that in many cases
the price received by the company is not the nominal value. In any event, it will
be sheer coincidence if the nominal and market value of a share are the same at
any time a
er issue. 
e question has therefore been rightly asked whether there
is in fact any point in ascribing a nominal value to shares, particularly when the
yardstick used for the capital maintenance rules corresponds to the total consid-
eration payable on shares issued and not just the nominal price received. In
e
Strategic Framework
consultation document the CLRSG states that the require-
ment that shares should have a nominal value has become an anachronism and
that it would favour the end of the practice (while recognising that because of EU
rules (the Second Company Law Directive (77/91/EC)) this would be di
cult for
public companies). If the requirement were to be removed, it would allow shares to
be issued for whatever price the company chose. 
e actual value received would
then be the capital which has to be maintained under the doctrine. Indeed, the
creation of no par value shares is permitted in many jurisdictions.
7.12
at said, because public companies are required to have a nominal value for
their shares the CLRSGs consultation process revealed a strong resistance
to forcing private companies to have shares with no nominal value; and since
it was thought an optional regime would require a commitment of e
ort and
resources out of all proportion to the likely bene
t (see para 7.3 of
7/20/2012 5:17:38 PM
Receiving proper value on issue of shares
is to be removed on the basis that it is invariably set at a level higher than the
company will need and so it serves no useful practice. 
is is implemented by the
2006 Act, although a statement of capital must be registered on formation (see s
10; however, any provision in a companys memorandum of association specify-
ing the companys authorised share capital that was in force immediately before
1 October 2009 is deemed to be a provision in the companys articles. Such a
provision continues to operate as a limit on the maximum amount of shares that
may be allotted and is alterable by ordinary resolution: see the Companies Act
2006 (Commencement No 8, Transitional Provisions and Savings) Order 2008,
SI 2008/2860)). In November 2009 BIS launched a consultation exercise aimed
at considering three principal questions: what elements of 
nancial information
should be included in the statement of capital, the ease with which companies can
provide information and the value of such information to third parties searching
the capital of a company). In May 2011 BIS announced that:
e Government has considered the scope to simplify the 
nancial information
requirements in Companies Act statements of capital which were the subject of
the consultation. We have also considered concerns, raised by stakeholders but
7/20/2012 5:17:38 PM
Share capital
to amend the requirements by statutory instrument. But for a number of others
there is no such power. A
er carefully weighing the arguments, we have concluded
that the changes to statements of capital should be introduced simultaneously to
minimise further confusion for companies. 
e Government will therefore bring
7/20/2012 5:17:39 PM
unlawful and ultra vires and a director who knew (or ought to have known) that
the payment amounted to a breach is liable to repay the dividends
(Bairstow v
ueens Moat Houses plc
(2001)). In
Re Exchange Banking Co, Flitcro
s Case
(1882) the liquidator of the bank issued a summons against 
ve of its former
directors who had between 1873 and 1878 been concerned in paying half-yearly
dividends at a time when they knew that some items in the accounts were bad
debts and irrecoverable and that the company had no distributable pro
ts. 
e
directors were held jointly and severally liable for the amount of the dividends.
Sir George Jessel MR concluded:
It follows then that if directors who are
quasi
trustees for the company improp-
erly pay away the assets to the shareholders, they are liable to replace them. It
is no answer to say that the shareholders could not compel them to do so. I am
of opinion that the company could in its corporate capacity compel them to do
so, even if there were no winding-up.
7.14
In
Bairstow v
ueens Moat Houses plc
(above)
the directors, acting on the com-
panys 1991 accounts that incorrectly showed in
ated pro
ts, unlawfully paid
dividends that exceeded the available distributable reserves. 
e Court of Appeal
held that the directors liability was not limited to the di
erence between the
unlawful dividends and the dividends that could have been lawfully paid, since
although they were not strictly speaking trustees, they were in an analogous
position because of the 
duciary duties which they owed to the company and
they had trustee-like responsibilities arising out of their power and duty to man-
age the companys business in the interests of all its members. 
ey were thus
liable for deliberately and, in relation to the 1991 accounts, dishonestly paying
unlawful dividends out of the companys funds which were in their control. 
e
defendants were therefore ordered to pay the company over 78 million (see also
Commissioners of Inland Revenue v Richmond
(2003)).
7.15
Sections s 847(1) and (2) CA 2006 provide that where a distribution is made in
contravention of the Act and, at the time of the distribution, the member knows
or has reasonable grounds for believing that it is so made, he is liable to repay
it to the company. If only part of a distribution is in contravention of the Act,
the members liability extends only to that part. Similarly, under s 847 a mem-
ber who, with knowledge of the facts, receives an improper dividend payment,
may be held liable to repay it as a constructive trustee
(Precision Dippings Ltd
v Precision Dippings Marketing Ltd
(1986); although this may no longer be the
case following the decision of the House of Lords in
Westdeutsche Landesbank
Girozentrale v Islington LBC
(1996)). In
Its a Wrap (UK) Ltd v Gula
(2006) the
liquidator sought repayment of dividends paid to the defendants who were the
sole shareholders and directors of the company. During a two-year period in
7/20/2012 5:17:39 PM
Share capital
which there were no pro
ts available for distribution, the companys accounts
showed that dividends had nevertheless been paid to the defendants. When the
company went into insolvent liquidation, the liquidator claimed that the divi-
dends had been paid in contravention of s 263(1) (s 830(1) CA 2006) and were
therefore recoverable under s 277 (now s 847 CA 2006). 
e defendants argued
that the sums in question were paid to them as remuneration and only appeared
in the accounts as dividends because they had been advised that this was tax
cient. 
e trial court dismissed the liquidators claim on the basis that it was
clear that the defendants had sought to gain a proper tax advantage and had not
deliberately set out to contravene the Act. 
e judge found that the phrase is so
made contained in s 277(1) CA 1985 required that the defendants knew or had
reasonable grounds to believe not just the facts giving rise to the contravention
but also the legal result of the contravention. Perhaps not surprisingly, the Court
of Appeal reversed the judges decision and held that the defendants ignorance
of the law was no defence. Arden LJ stated that s 277 had to be interpreted in
a manner consistent with Art. 16 of the Second Company Law Harmonisation
Directive which it is designed to implement. On this particular issue she con-
cluded that:
Section 277 [now s 847] must be interpreted as meaning that the shareholder
cannot claim that he is not liable to return a distribution because he did not
know of the restrictions in the Act on the making of distributions. He will be
liable if he knew or ought reasonably to have known of the facts which mean
that the distribution contravened the requirements of the Act.
Disguised distributions
7.16
In some rather less obvious cases than those relating to the payment of cash divi-
dends the courts have also been willing to 
nd that there has been a disguised
return of capital to shareholders, so that the capital maintenance principle has
been breached. For example, in
Re Halt Garage (19
4) Ltd
(1982) the court held
that although there is no rule that directors remuneration can only be paid out of
distributable pro
ts, when the directors are also shareholders it may be possible
to categorise remuneration as a disguised gi
out of capital. 
e issue in this
case was relatively straightforward because the director receiving the remunera-
tion (the wife of the majority shareholder) had not actually provided any services
for several years due to ill health and the company had gone into insolvent liqui-
dation. Oliver J held that only
10 out of the
30 per week that had been paid to
her while she was ill was genuine remuneration. She had to repay the balance.
7.17
However this is not the only type of situation where a court has been prepared to
re-categorise a transaction as a return of capital. In
Aveling Barford Ltd v Perion
7/20/2012 5:17:40 PM
Ltd
(1989) AB Ltd and P Ltd were both owned and controlled by Lee. AB Ltd,
while not insolvent, did not have any distributable reserves but it owned a sports
ground for which planning permission for residential redevelopment had been
granted. In October 1986 its directors resolved to sell the sports ground, valued
at
650,000, to P Ltd for only
350,000. In February 1987 the property was sold
to P Ltd for this price. In August of that year P Ltd resold it for
1.52 million.
AB Ltd went into liquidation and the liquidator successfully sued to have P Ltd
declared a constructive trustee of the proceeds of sale on the basis, inter alia, that
the transaction was an unauthorised return of capital by AB Ltd to Lee, its sole
shareholder, via P Ltd.
7.18
e decision in
Aveling Barford
is signi
cant because it had an unwelcome impact
on the way companies in a group who want to transfer assets to each other have to
structure the arrangement (i.e.
intra-group transfers). It attracted the particular
scrutiny of the CLRSG. 
e problem is explained in the June 2000 document,
Capital Maintenance: Other Issues:
The case did not decide anything about the situation where a company has
positive distributable reserves. But there is a body of opinion, prompted by the
decision, that an intra-group sale of an asset may constitute a distribution for
the purposes of section 263 [see now s 830 CA 2006] if the asset concerned is
sold for an amount equal to its book value, where this is less than its market
value, even where the company has distributable reserves.
The result of Aveling Barford and the debate it has engendered have cast doubt
on the validity of intra-group asset transfers conducted by reference to book
value rather than by reference to market value. It is understood that such trans-
actions are often carried out by reference to book value rather than market
value for a variety of business, administrative or tax reasons. Because of this
doubt such transactions are therefore often carried out in a more complicated
way . . . or do not proceed at all.
7.19
Sections 845 to 846 CA 2006 are designed to address the uncertainties that arose
in the wake of
Aveling Barford
Intra-group transfers are permitted provided the
company has su
cient distributable pro
ts to justify a distribution. 
is calcu-
lated on the basis of the book value (the value as it appears in the companys
accounts) of the asset in question. 
us, the book value rather than the mar-
ket value is used to assess the amount of the distribution. Put simply, the e
ect
of these provisions is that where a company with su
cient distributable pro
ts
transfers an asset at its book value, the amount of the distribution is deemed to be
zero (s 845). If, on the other hand, the asset is transferred at a value less than its
book value, the di
erence is deemed to be a distribution. 
e 2006 Act does not,
therefore, change the position where, as in
Aveling Barford
the company does not
7/20/2012 5:17:40 PM
Share capital
have distributable pro
ts. Finally, an important result of the 2006 modi
cations
is that companies can carry out such transfers without the need for revaluations
of the asset in question thereby reducing costs that might otherwise be payable to
professional advisers.
In
Progress Property Co Ltd v Moorgarth Group Ltd
(2011), a case brought before
7/20/2012 5:17:41 PM
Capital maintenance is largely irrelevant to the vast majority of private com-
panies and their creditors. This is recognised by the [1985] Act, which carves out
a number of exceptions to the capital maintenance rules for private compa-
nies only (para
4.8
); see also
Company Formation and Capital Maintenance
(October 1999);
Completing The Framework
(November 2000); and the Final
Report (2001).
7.22
e 2006 Act therefore contains a range of deregulatory measures that target
requirements that were considered unnecessary and burdensome for private
companies. However, as far as public companies are concerned, the provisions
generally restate the CA 1985 requirements (see in particular ss 642644 CA
2006).
7.23
Under the CA 2006 companies no longer need authority in the articles of associa-
tion which permit a reduction of capital although they are able to restrict or pro-
hibit the power if they wish (s 641(6)). Section 641(1) states the general rule that
private
limited company may reduce its capital by special resolution supported
by a solvency statement; but that
any
limited company may reduce its capital by
special resolution if con
rmed by the court. In other words, a private company
is not compelled to follow the new simpli
ed procedure but can opt instead to go
through the rather convoluted and expensive step of obtaining the courts con-
rmation as was required under the 1985 Act and which is preserved for public
companies.
(i) Private companies: reduction of capital supported by a solvency
statement
7.24
e simpli
ed procedure for private companies is detailed in ss 642644 of the
2006 Act. 
e solvency statement, as required for private companies under s 641,
must be made by all of the directors not more than 15 days before the date on
which the special resolution is passed (s 642(1)). If one or more of the directors
is not able or is not willing to make the statement, the company will not be able
to use the solvency statement procedure to e
ect a reduction of capital unless
the dissenting director or directors resign (in which case the solvency statement
must be made by all of the remaining directors). Where the special resolution is
passed as a
written
resolution, a copy of the directors solvency statement must
be sent or submitted to every eligible member at or before the time at which the
proposed resolution is sent or submitted to him or her (s 642(2)); if the resolution
is passed at a general meeting, a copy of the solvency statement must be made
available for inspection by members throughout the meeting (s 642(3)). However,
the validity of the resolution is not a
ected by a failure to comply with these
requirements (s 642(4)).
7/20/2012 5:17:41 PM
Share capital
7.25
Section 643 provides that the solvency statement must state that each of the direc-
tors has formed the opinion, taking into account all of the companys liabilities
(including any contingent or prospective liabilities), that:
as regards the companys situation at the date of the statement, that there
(a)
is no ground on which the company could then be found to be unable to pay
its debts; and
if it intended to commence the winding up of the company within twelve
(b)
months of that date, that the company will be able to pay its debts in full within
twelve months of the winding up or, in any other case, that the company will
be able to pay its debts as they fall due during the year immediately following
that date.
Section 644 lays down the 
ling requirements in respect of a reduction of capital.
Within 15 days a
er the special resolution is passed, the company must 
le with the
Registrar a copy of the solvency statement together with a statement of capital and
a statement of compliance. 
e special resolution itself must also be 
led in accord-
ance with s 30 CA 2006. 
e resolution does not take e
ect until these documents
are registered (s 644(4)).
7.26
If the directors make a solvency statement without having reasonable grounds for
the opinions expressed in it, and that statement is subsequently delivered to the
Registrar, every director who is in default commits an o
ence (see s 643(4); the
penalties, which may include imprisonment, are set out in s 643(5)).
(ii) Public companies: reduction of capital con
rmed by the court
7.27
As we have seen, public companies are required to have the special resolution for
the reduction of capital con
rmed by the court. 
e policy here is aimed at safe-
guarding the interests of creditors. Sections 645 and 646 (which restate s 136 of
the 1985 Act) specify the procedure for making such an application for an order
con
rming the reduction including the creditors right to object. 
e court will
settle a list of creditors with a view to ensuring that each one of them has con-
sented to the reduction. If a creditor does not consent the court may, in its discre-
tion, dispense with that creditors consent where the company secures the debt or
claim (s 646(4)). If, on such an application, an o
cer of the company intention-
ally or recklessly conceals a creditor or misrepresents the nature or amount of a
debt owed by the company, or is knowingly concerned in any such concealment
or misrepresentation he or she commits an o
ence (s 647).
7.28
e court may make an order con
rming the reduction of capital on such terms
and conditions as it thinks 
t (s 648(1)). However, it will not con
rm the reduction
7/20/2012 5:17:42 PM
unless it is satis
ed, with respect to every creditor of the company entitled to
object, that either his consent to the reduction has been obtained, or his debt or
claim has been discharged or secured (s 648(2)). 
e reduction will take e
ect on
registration of the court order con
rming the reduction (and statement of capi-
tal) by the Registrar (s 649(5)).
7.29
Where there is a reduction of capital, certain shares will be cancelled or reduced
in nominal value. In this regard, the main issue the court has to consider when
deciding whether or not to exercise its discretion to approve the reduction is
whether the proposal strikes a fair balance between the interests of the di
erent
classes of shareholders. It has long been established that the rule most likely to
achieve fairness is that money should be repaid in the order in which the classes
of shares would rank, as regards repayment of capital, on a winding-up, though if
the proposed reduction varies or abrogates class rights it may be possible to dis-
apply this prima facie approach. In
Re Chatterley-Whit
eld Collieries Ltd
(1948)
the companys coal-mining business had been nationalised and it proposed to
carry on operations on a reduced scale for which it would need less capital. It
therefore decided to reduce its capital by paying o
preference capital but keep-
ing its ordinary shareholders. 
e court con
rmed the reduction as fair because
it was carried out in accordance with the rights of the two classes of shareholders
in a winding-up. 
e observations of Lord Greene MR a
ord a good insight into
the judicial approach to reductions of capital:
A company which has issued preference shares carrying a high rate of dividend
and
nds its business so curtailed that it has capital surplus to its requirements
and sees the likelihood, or at any rate the possibility, that its preference capital
will not, if I may use the expression, earn its keep, would be guilty of
nancial
ineptitude if it did not take steps to reduce its capital by paying off preference
capital so far as the law allowed it to do so . . . The position of the company itself
as an economic entity must be considered, and nothing can be more destructive
of a companys
nancial equilibrium than to have to carry the burden of capital
which it does not need bearing a high rate of dividend which it cannot earn.
(See also
Re Saltdean Estate Co Ltd
(1968), considered in Chapter 9, Variation of
class rights.)
7.30
If the reduction of a public companys capital has the e
ect of bringing the
nominal value of its allotted share capital below the authorised minimum (see
para
7.12
, above), the Registrar must not register the court order con
rming the
reduction unless either the court so directs, or the company is 
rst re-registered
as a private company (s 650)). Section 651 provides for an expedited procedure for
re-registration as a private company.
7/20/2012 5:17:42 PM
Share capital
Returning funds to shareholders: redemption or
purchase by a company of its own shares
7.31
ere are other means of achieving the e
ect of a reduction of share capital with-
out having to obtain the courts approval. Although the common law prohibited
a company acquiring its own shares because of the risk to creditors
(Trevor v
Whitworth
(1887); see now s 658(1) of the 2006 Act), s 684(1) expressly permits
a limited company to issue shares that are to be redeemed at the option of the
company or the shareholder. A public company must be authorised by its articles
to issue redeemable shares (s 684(3)), but for private companies no such authorisa-
tion is required, although the articles may exclude or restrict their issue (s 684(2)).
Section 690(1) confers on limited companies the power to purchase their own
shares, although this is subject to any restriction or prohibition in the articles of
association. 
e di
erence between a redemption and a purchase of shares in this
context is that for the former, the shares will have been issued on the basis that they
are redeemable and so the holders will have been aware of the terms of the redemp-
tion from the outset; with respect to the latter, the parties will need to agree the
terms of the repurchase at the time the company seeks to exercise the power.
(i) Effecting a redemption of shares
7.32
For both public and private companies, the directors may determine the terms,
conditions and manner of the redemption if so authorised by the articles of asso-
ciation or by a resolution of the company (s 685(1)). An ordinary resolution is
required notwithstanding that its e
ect is to amend the articles (s 685(2)). Shares
may not be redeemed unless they are fully paid and the terms of the redemption
may provide that the amount payable on redemption may, by agreement between
the company and the shareholder concerned, be paid on a date later than the
redemption date (s 686(1) and (2)). Where the directors are authorised to deter-
mine the terms, conditions and manner of redemption, they must do so before
the shares are allotted and such details must be speci
ed in any statement of capi-
tal which the company is required to 
le (s 685(3)). When a company redeems
any redeemable shares it must within one month give notice to the Registrar
specifying the shares redeemed together with a statement of capital which details
the companys shares immediately following the redemption (s 689). If default is
made in complying with the notice requirements, an o
ence is committed by the
company and every o
cer of the company who is in default (s 689(4)).
(ii) Effecting a purchase by a company of its own shares
7.33
As noted above, s 690(1) authorises a limited company to purchase its
own shares including any redeemable shares, subject to any restriction or
7/20/2012 5:17:42 PM
7/20/2012 5:17:43 PM
Share capital
company must give notice to the Registrar; such notice must include a statement
of capital (s 708).
7.35
In certain circumstances a company which purchases its own shares need not
cancel them but can, instead, hold them in treasury from where they can be
either sold or transferred, for example to an employee share scheme. 
is relax-
ation, which took e
ect on 1 December 2003, was introduced by the Companies
(Acquisition of Own Shares) (Treasury Shares) Regulations 2003 (SI 2003/1116).
e regulations inserted ss 162A162G into the 1985 Act which are re-enacted
in ss 724732 of the CA 2006. For qualifying shares, as de ned in s 724(2), to
become treasury shares they must be purchased by the company out of dis-
tributable pro
ts. 
ere are a number of restrictions on the rights attaching to
treasury shares. For example, s 726(2) states that the company may not exercise
any right in respect of treasury shares. Any purported exercise of such a right
is void. Further, no dividend or other distribution may be paid to the company
(s 726(3)).
Financial assistance for the acquisition of
shares in a public company
Relationship to capital maintenance doctrine
7.36
e term 
nancial assistance refers to a company providing 
nancial assistance
for the purchase of its own shares. 
is could be by way of a gi
to a third party
on the understanding that the money would be used to buy the donor companys
shares or, for instance, through guaranteeing a potential purchasers borrowing
(for more examples see s 677 CA 2006, at para
7.43
below). While there are good
reasons for prohibiting such practices (for instance, a listed company could give
money to people to buy its shares and thus increase its share price, thereby creat-
ing a false indication of the true value of its shares), it is not immediately obvi-
ous why such provision infringes the capital maintenance doctrine. 
e 
nancial
assistance prohibition was 
rst introduced by the Companies Act 1929, s 45 and,
until the CA 2006, applied both to public and private companies, although with
respect to the latter there was relaxation (referred to as the whitewash procedure
(see CA 1985, ss 151 and 155158)). A consequence of the repeal of the prohibition
for private companies is that 
nancial assistance transactions or arrangements in
relation to the shares of a private company are no longer unlawful. However,
other general company law principles continue to apply. For example, the trans-
action or arrangement must be in the best interests of the company (see s 172 CA
7/20/2012 5:17:43 PM
Financial assistance for the acquisition of shares in a public company
2006, chapter 14). Further, the transaction or arrangement must not breach the
rules on distributions or otherwise constitute an illegal reduction of capital (see
7.137.35
, above).
e general prohibition against 
nancial assistance was enacted as a result of the
recommendations of the Greene Committee (Cmnd 2657, 1926), which described
the particular mischief to be addressed by it in the following terms:
A practice has made its appearance in recent years which we consider to be
highly improper. A syndicate appears to purchase from the existing sharehold-
ers suf
cient shares to control a company, the purchase money is provided by
a temporary loan from a bank for a day or two, the syndicates nominees are
appointed directors in place of the old board and immediately proceed to lend
to the syndicate out of the companys funds . . . the money required to pay off the
bank . . . Thus in effect the company provides money for the purchase of its own
shares (para 30).
e modern terminology to describe such arrangements is leveraged buyouts
which gives a clear indication that the acquisition is 
nanced by debt.
7.37
e Jenkins Committee, Report of the Company Law Committee (1962) put the
matter bluntly:
If people who cannot provide the funds necessary to acquire control of a com-
pany from their own resources, or by borrowing on their own credit, gain control
of a company with large assets on the understanding that they will use funds
of the company to pay for their shares, it seems to us all too likely that in many
cases the company will be made to part with its funds either on inadequate
security or for an illusory consideration.
e Committee took the view that the rationale underlying the prohibition was
not the need to maintain capital, but rather the potential dangers which indebted
acquirers pose to creditors.
7.38
A clear explanation of the mischief to which the prohibition is directed is pro-
vided by Arden LJ in
Chaston v SWP Group plc
(2002):
[It] is derived from section 45 of the Companies Act 1929 which was enacted as a
result of the previously common practice of purchasing the shares of a company
having a substantial cash balance or easily realisable assets and so arranging
matters that the purchase money was lent by the company to the purchas-
er . . . The general mischief . . . remains the same, namely that the resources of the
target company and its subsidiaries should not be used directly or indirectly
7/20/2012 5:17:44 PM
Share capital
to assist the purchaser
nancially to make the acquisition. This may prejudice
the interests of the creditors of the target or its group, and the interests of any
shareholders who do not accept the offer to acquire their shares or to whom the
offer is not made.
7.39
More recently, Toulson LJ explained in
Anglo-Petroleum Ltd v TFB (Mortgages)
Ltd
(2007), that the prohibition is aimed at preventing the resources of a target
company (and its subsidiaries) being enlisted, directly or indirectly, to assist the
purchaser 
nancially in his acquisition.
Commenting on the rationale for the rule, Professor Armour (2000) notes that:
The ambit of the
nancial assistance provisions is broader than is necessary to
ensure capital is not returned to shareholders. The basic prohibitions apply to
any assistance which depletes the companys net assets, regardless of whether it
has distributable pro
ts, and even to some transactionssuch as loanswhich
may not deplete its assets at all.
7.40
With respect to Armours example relating to loans, it should be noted that they
do not deplete a companys net assets. 
is is because although funds leave the
company their loss is matched in the companys accounts by the debt that is
thereby created. 
us, it can be seen that the prohibition on 
nancial assistance
is wider than that which would be required if the only policy in operation was
to maintain the companys share capital. But, as stressed by Arden LJ (above), it
recognises the need to protect shareholders and outsiders from misuse by the
company of its own assets to 
nance the purchase of its own shares, even if the
capital maintenance doctrine is not thereby infringed (in this regard, see also
Wallersteiner v Moir
(1974), in which Scarman LJ noted that the prohibition is
designed to protect company funds and the interests of shareholders as well as
creditors).
7.41
e 2005 White Paper, in line with the
Final Report
of the CLRSG, states that pri-
vate companies should no longer be prevented from providing 
nancial assist-
ance for the purchase of their own shares. It endorses the view expressed by the
Steering Group that creditors have other safeguards, such as the wrongful trad-
ing provision in the Insolvency Act 1986 (see Chapter 17, below), which render
the elaborate safeguards speci
cally directed at 
nancial assistance super
u-
ous. 
us, a major change introduced by the 2006 Act, and one described by
what is now called the Department for Business, Innovation and Skills (BIS)
as one of the key bene
ts of the Act for private companies (see Companies
Act 2006: Major Business Bene
ts) is that private companies are no longer pro-
hibited from giving 
nancial assistance for the purpose of acquiring their own
shares or those of their private company parent. In terms of transaction costs,
7/20/2012 5:17:44 PM
The prohibition and the exceptions
it has been estimated that this freedom will save private companies some 20
million per year (see the Regulatory Impact Assessment; see also
e Strategic
Framework
(1999)). However, the prohibition continues to apply to public com-
panies because of the need to comply with the Second Company Law Directive
(see para
7.11
, above).
The prohibition and the exceptions
The general prohibition
7.42
e statutory provisions are complex. 
e prohibition against public companies
providing 
nancial assistance is laid down by s 678(1) of the 2006 Act (implement-
ing the Second EC Company Law Directive (EEC 77/91 (OJ L26/1 31.1.1977)), art
23) which provides:
Where a person is acquiring or proposing to acquire shares in a public company,
it is not lawful for that company, or a company that is a subsidiary of that com-
pany, to give
nancial assistance directly or indirectly
for the purpose
of the
acquisition before or at the same time as the acquisition takes place [emphasis
supplied].
It is noteworthy that s 678(1) makes no reference to proof of improper intention. In
7/20/2012 5:17:45 PM
Share capital
the shares in D. E. Heald (Stoke on Trent) Ltd to OConnor. 
e price was 35,000
but they lent him 25,000 in order to enable him to complete the purchase. 
e
company thereby granted the vendors a 
oating charge over all of its assets by
way of security for the loan. 
us, if OConnor defaulted, the security would be
enforceable against the company. 
is was therefore held to be illegal.
7.44
A residual category falls within s 677(1)(d) which adds the following proscription:
any other 
nancial assistance given by a company where the net assets of the
company are reduced to a material extent by the giving of the assistance, or the
company has no net assets. 
erefore, even if a public company were in a position
to return funds to shareholders because it had distributable pro
ts, it would not
be able to provide any sort of 
nancial assistance for the acquisition of its own
shares which materially depleted its net assets. In this regard, s 677(2) and (3) state
that in determining the companys net assets it is the actual value of the assets
and liabilities, as opposed to their book value, that is to be applied (see
Parlett v
Guppys (Bridport) Ltd
(1996); and
Grant v Lapid Developments Ltd
(1996)).
The exceptions
7.45
Section 681 contains a wide list of unconditional exceptions. 
ose in sub-sec-
tion (2) are unexceptional: they mainly relate to procedures which are speci
cally
authorised elsewhere in the Act: for example, to e
ect a redemption of shares or
a reduction of capital. So-called conditional exceptions are listed in s 682. 
ey
therefore only apply if the company has net assets and either: (a) those assets
are not reduced by the giving of the 
nancial assistance, or (b) to the extent that
those assets are so reduced, the assistance is provided out of distributable pro
ts.
An example of a conditional exception is where the provision by the company
of 
nancial assistance is for the purposes of an employee share scheme provided
it is made in good faith in the interests of the company or its holding company (s
682(2)(b)); or which assists in the promotion of a policy objective such as facili-
tating the acquisition of the shares by an employees share scheme or by spouses
or civil partners, widows, widowers or surviving civil partners or children of
employees (see s 682(2)(c)).
7.46
Section 678(2) and (3), however, also contain the principal purpose and inci-
dental part of a larger purpose defences which are carried over from the 1985
Act. In essence, 
nancial assistance is
prohibited
if the principal purpose of the assistance is not to give it for the purpose of
an acquisition of shares, or where this assistance is incidental to some other
larger purpose of the company and,
7/20/2012 5:17:45 PM
The prohibition and the exceptions
in either case, where the 
nancial assistance is given in good faith in the
interests of the company.
7.47
e exceptions are designed to ensure that the prohibition in s 678(1) does not
also catch genuine commercial transactions which are in the interests of the
company. However attempting to assess a persons purpose is necessarily di
cult (for instance, the need to distinguish purpose from e
ect) because the court
will need to determine whether the giving of assistance for
the purpose
of an
acquisition of shares is an incidental part of
some larger purpose.
Something is
a purpose of a transaction between A and B if it is understood by both of them
that it will enable B to bring about the desired result (
Re Hill and Tyler Ltd
(2005);
and
Dyment v Boyden
(2005), see below)). 
e di
culties of assessing purpose
came to the fore in
Brady v Brady
(1989).
7.48
e scheme in issue in this case basically involved a companys business being
divided between two brothers, Jack (J) and Bob (B) who were the controlling
shareholders. 
ey were not on speaking terms and the deadlock between them
threatened the survival of the company and its subsidiaries. It was decided that
J should take the haulage business and B the so
drinks business. However, the
haulage business was worth more than the so
drinks business and so to make
the division fair and equal, extra assets had to be transferred from the haulage
business to the drinks business. In essence this involved the principal company,
Brady, transferring assets to a new company controlled by B. It was conceded that
s 151 CA 1985 (now s 678(1)) had been breached because the transfer involved
Brady providing 
nancial assistance towards discharging the liability of its hold-
ing company, M, for the price of shares which M had purchased in Brady. When
J sought speci
c performance of the agreement, B contended that it was an illegal
transaction. J argued, however, that the 
nancial assistance was an incidental
part of a larger purpose of the company, i.e. the removal of deadlock between the
two brothers which had threatened to result in the liquidation of the business.
Construing the phrase larger purpose (now re-enacted in s 678(2)(b)), Lord Oliver
observed:
My Lords, purpose is, in some contexts, a word of wide content but in constru-
ing it in the context of the fasciculus of sections regulating the provision of
nance by a company in connection with the purchase of its own shares there
has always to be borne in mind the mischief against which section 151 is aimed.
In particular, if the section is not, effectively, to be deprived of any useful ap-
plication, it is important to distinguish between a purpose and the reason why
7/20/2012 5:17:46 PM
Share capital
a purpose is formed. The ultimate reason for forming the purpose of
nancing
an acquisition may, and in most cases probably will, be more important to those
making the decision than the immediate transaction itself. But larger is not
the same thing as more important nor is reason the same as purpose. If one
postulates the case of a bidder for control of a public company
nancing his
bid from the companys own fundsthe obvious mischief at which the section is
aimedthe immediate purpose which it is sought to achieve is that of complet-
ing the purchase and vesting control of the company in the bidder. The reasons
why that course is considered desirable may be many and varied. The company
may have fallen on hard times so that a change of management is consid-
ered necessary to avert disaster. It may merely be thought, and no doubt would
be thought by the purchaser and the directors whom he nominates once he
has control, that the business of the company will be more pro
table under his
management than it was heretofore. These may be excellent reasons but they
cannot, in my judgment, constitute a larger purpose of which the provision of
assistance is merely an incident. The purpose and the only purpose of the
cial assistance is and remains that of enabling the shares to be acquired and the
nancial or commercial advantages
owing from the acquisition, whilst they
may form the reason for forming the purpose of providing assistance, are a by-
product of it rather than an independent purpose of which the assistance can
properly be considered to be an incident.
7.49
e House of Lords held that the purpose of the transaction was to assist in
nancing the acquisition of the shares: the essence of the reorganisation was
for J to acquire B Ltds shares and therefore the acquisition of those shares was
not incidental to the reorganisation. As Lord Oliver concluded, the acquisition
was not a mere incident of the scheme devised to break the deadlock. It was the
essence of the scheme itself and the object which the scheme set out to achieve.
(It should be borne in mind, that if the facts of
Brady
were to arise today, it would
not be caught by the prohibition because the case was concerned with a private
company.)
7.50
is interpretation of the purpose exceptions has been much criticised in that it
appears to restrict unduly the width of the defence and, indeed, it makes it very
hard to ascertain exactly what sort of situations would fall within its scope (see
Dyment v Boyden (Liquidator of Pathways Residential and Training Centres Ltd)
(2005), below).
7.51
An interesting case on the meaning of  nancial assistance is
Chaston v SWP
Group plc
(above), in which Arden LJ subjected
Brady
to considerable analysis
and came out in support of the reasoning of the House of Lords notwith-
standing the strength of criticism the decision has generated. C was a director
7/20/2012 5:17:46 PM
The prohibition and the exceptions
of DRC, a company which formed part of a group of which DRCH was the
parent. SWP, a listed company, wished to take over the DRC group by acquir-
ing the shares in DRCH and, as part of its due diligence exercise, it needed
a long form report on the DRC group for informational purposes. Deloitte
and Touche (D & T) prepared the report and C agreed that D & T should
invoice DRC for their fees. Invoices for fees of nearly 20,000 were submit-
ted and the acquisition was completed. SWP later claimed damages against
C for breach of 
duciary duty in having procured or connived in the grant by
DRC of  nancial assistance for the purpose of the acquisition by SWP of the
shares in DRCH. 
e alleged  nancial assistance was DRC incurring liability
to D &T for payment of their professional fees. 
e Court of Appeal held that
this was a breach of s 151. Arden LJ, noting that the term  nancial assistance
was not de ned by the 1985 Act, thought that it was clear from the authori-
ties that what matters is the commercial substance of the transaction (citing
Charterhouse v Tempest Diesels
(1986), in which Ho
mann J said that when
determining whether the prohibition has been breached: One must examine
the commercial realities of the transaction and decide whether it can properly
be described as the giving of  nancial assistance by the company, bearing in
mind that the section is a penal one and should not be strained to cover trans-
actions which are not fairly within it. Lord Ho
manns approach to the deter-
mination of  nancial assistance has been approved by the Court of Appeal in
Barclays Bank plc v British and Commonwealth Holdings plc
(1996)). Arden
LJ therefore took the view that as a matter of commercial substance  nancial
assistance was given on the facts of the case. D & T received payment for their
professional services and both SWP, the purchasers, and the vendors, DRCH,
were relieved of any obligation to pay for those services themselves: as a mat-
ter of commercial reality, the fees in question smoothed the path to the acqui-
sition of shares. She concluded:
Section 151 makes it clear that a transaction can fall within section 151 even if
only one of the purposes for which it was carried out was to assist the acquisition
of shares. Here the liability to pay the fees of D & T was clearly incurred for the
purpose of the acquisition by SWP of DRCHs shares.
Brady v Brady
also makes
it clear that an unlawful purpose is not removed by the fact that, as the judge
found here, the directors were motivated by the best interests of the company.
Their motivation was only a reason for their acts, not a purpose in itself (see
Brady v Brady
, above).
Finally, the transaction did not fall within the larger purpose exception as there
was no corporate purpose other than the acquisition of the shares in the parent
company. (See also,
Paros plc v Worldink Group plc
7/20/2012 5:17:47 PM
Share capital
7.52
Ascertaining whether or not the prohibition has been breached is necessarily
a fact-intensive exercise and previous decisions provide little guidance in pre-
dicting an outcome. However, the focus on commercial realities has enabled
the modern courts to narrow the scope of the prohibition. For example, in
Realisations Ltd v Digital Equipment Co Ltd
(2003), the issue in the case arose
out of a subsidiary company (MTR) paying sums owed under a secured loan to
its parent company. 
ese sums were used by the parent company to discharge
its liability incurred in acquiring its shares in the subsidiary. In fact, MTR paid
the sums directly to the vendor of the shares. In structuring the arrangement
this way, there was an appearance of MTRs funds being used to pay liabilities
arising on the acquisition of its shares. An action was brought on the basis that
this amounted to 
nancial assistance. Mummery LJ, delivering the principal
judgment, reasoned that on the commercial realities of the transaction, 
nancial
assistance had not been given by MTR for the purpose of reducing or discharg-
ing a liability incurred for the purpose of the acquisition of its shares. 
e par-
ent company did not receive anything beyond what it was legally entitled to as
secured creditor and structuring the arrangement so that the sums in question
were paid directly to the vendor was done merely for commercial convenience.
e judge concluded:
each case is a matter of applying the commercial concepts expressed in non-
technical language to the particular facts. The authorities provide useful illus-
trations of the variety of fact situations in which the issue can arise; but it is rare
to
nd an authority on s 151 which requires a particular result to be reached on
different facts.
More recently, in
Corporate Development Partners LLC v E-Relationship Marketing
Ltd
(2009), it was held that as a matter of commercial reality the payment of an
introduction fee by a company to an agent who introduced the company to the
buyer of its shares did not constitute 
nancial assistance. 
e agent had played no
part in the negotiation of the acquisition. Further, the payment of the fee was not
a condition of the acquisition nor did it serve to reduce the purchasers acquisition
obligations and it was neither intended to, nor did it, smooth the path towards
the acquisition. Although the payment was made because the agent had intro-
duced a party which had acquired the company, it was not for the purpose of the
acquisition.
7.53
An advantage of the emphasis now being placed upon the commercial sub-
stance or realities of a particular transaction or arrangement is that it facili-
tates an open-textured approach towards the determination of the purpose of
an acquisition. 
us, the court can examine, for example, whether or not the
prohibition is being enlisted expediently by a party with the aim of avoiding a
7/20/2012 5:17:47 PM
The prohibition and the exceptions
transaction freely entered into on the ground of illegality. In
Dyment v Boyden
(2005) the applicant and the two respondents were partners in a residential
nursing home, the freehold of which was owned by each in equal shares. 
e
home was run through a company of which the partners were directors. When
one of the respondents was charged with assault the local authority cancelled
the nursing homes registration under the Registered Homes Act 1984. As
a result, the partnership was dissolved by agreement whereby the respond-
ents transferred their shares in the company to the applicant in return for
which she transferred her interest in the freehold to the respondents. 
ey
then granted a lease of the property to the company at a rent considerably in
7/20/2012 5:17:47 PM
Share capital
above): it restricts the prohibition to UK public companies and their UK sub-
sidiaries. 
is comes about because s 1(1) of the 2006 Act de
nes company as
meaning a company formed and registered under the Act or under previous
UK Companies Acts. Further, the Court of Appeal has recently con
rmed in
AMG Global Nominees (Private) Ltd v Africa Resources Ltd
(2008), that where
an English parent company arranges for a wholly owned foreign subsidiary to
provide 
nancial assistance out of the subsidiarys assets for the purpose of
acquiring shares in its English parent company, this does not amount to the
giving of 
nancial assistance. It did not involve either an asset leaving the par-
ent or an assumption of liability by the parent company.
The sanctions
7.56
Section 680 makes breach of the prohibition a criminal o
ence with the company
being liable to a 
ne and every o
cer of it who is in default liable to imprison-
ment or a 
ne or both. 
e e
ect of this is to make the transaction unlawful
which can a
ect the enforceability of the underlying agreement. 
e following
conclusions can be derived from the cases (see
Davies
(2008), Chapter 13):
1 If the 
7/20/2012 5:17:48 PM
The prohibition and the exceptions
have been severed, the purchaser would have been able to keep the shares without
any payment being made for them. Lord Brightman, delivering the decision of the
Privy Council, stated:
as a general rule, where parties enter into a lawful contract of, for example,
sale and purchase, and there is an ancillary provision which is illegal but exists
for the exclusive bene
t of the plaintiff, the court may and probably will, if the
justice of the case so requires, and there is no public policy objection, permit the
plaintiff, if he so wishes, to enforce the contract without the illegal provision.
Applying this, the Privy Council severed the illegal charges and allowed the ven-
dors to sue for the purchase price.
7.57
In their approach to civil sanctions the courts have striven to give e
ect to
the policy of protecting a companys creditors and shareholders. An alter-
native route for achieving such protection lies within the realm of 
duciary
duties (see Chapter 14, below). In
MacPherson v European Strategic Bureau Ltd
(2002),
the Court of Appeal held that an agreement for the distribution by an
insolvent company of funds to shareholders amounted to an informal wind-
ing-up. As such, it failed to make proper provision for creditors. While it was
acknowledged that an e
ect of the agreement was that the company provided
 nancial assistance for the purpose of an acquisition of its shares, liability
was couched in terms of breach of 
duciary duty so that it was not necessary
to enlist the statutory provisions (see also, Lord Olivers remarks in
Brady
to
the e
ect that the words good faith in the interests of the company form, I
think, a single composite expression and postulate a requirement that those
responsible for procuring the company to provide the assistance act in the
genuine belief that it is being done in the companys interest. Side-stepping
the Act by recourse to the 
duciary obligations of directors gives rise to the
question whether the statutory provisions serve any useful purpose beyond
ensuring compliance with the Second Company Law Directive. Although the
requirements of the Directive have been the subject of limited relaxation fol-
lowing the report of the High Level Group of Company Law Experts in 2002
(see Directive 2006/68/EC), the UK has not assimilated the reforms into the
2006 Act given the complexity of the procedural requirements which were
introduced. 
e DTI took the view that the procedures for a shareholders
resolution authorising the board to engage in  nancial assistance were far
too onerous to be of practical bene
t to UK companies, especially those with
widely dispersed memberships.
From the perspective of company creditors, it can be argued that there are alterna-
tive common law remedies which o
er adequate protection. 
e requirements cov-
ering unlawful dividends, reductions of capital and the provisions in the insolvency
7/20/2012 5:17:48 PM
Share capital
legislation relating to transactions at preference are e
ective responses to the policy
considerations underlying the prohibition, particularly the need to protect corpo-
7/20/2012 5:17:49 PM
Self-test questions
SELF-TEST QUESTIONS
Why is the amount of a companys share capital important to its creditors?
from Fizz herself and a charge on the property of Max Ltd, a wholly owned subsidi-
ary of Tweenies plc. The purchase price was paid by a cheque from Tweenies plc
which was dishonoured.
Consider:
(a) which of these transactions amounted to
nancial assistance;
7/20/2012 5:17:49 PM
SUMMARY
Introduction
A companys constitution
Some elements of corporate theory
The articles of association
The contract of membership
A contract between the company and the members
A contract between the members?
Who can sue?
Outsider rights
Reform
Shareholder agreements and statutory effects
Introduction
8.1
In Chapter 1 we brie
y discussed the constitution of the company. In this chapter
we cover the constitution of the company in greater detail focusing particularly
on the articles of association, as they form the basis for much of the way the
directors, the shareholders and the company interact. A word of warning how-
ever: while the beginning of this chapter outlining the operation of the memo-
randum and the articles is straightforward, the law surrounding the operation of
the s 33 contract is complex, confusing, contradictory and frustrating. 
is is not
for the usual reason that it is a complex area and it takes some time to absorb. It is
rather because the law on s 33 is dominated by layer upon layer of contradictory
case law. 
e CLRSG and the Consultative Document, March 2005 did recognise
this problem and recommended some long-needed reforms. However, as we will
see, the 
nal reforms in the Companies Act 2006 are somewhat disappointing.
We discuss those reforms as they arise in the general course of the chapter.
The constitution of the
company: dealing with insiders
7/19/2012 2:19:10 PM
A companys constitution
A companys constitution
8.2
As we noted in Chapter 1 in order to form a company the Registrar of Companies
must be provided with the constitution of the company (this contains the inter-
nal rules of the company called the articles of association and any objects clause
limiting the power of the company the company may have, see below), a memo-
randum of association stating that the subscribers intend to form a company and
become members and an application for registration containing the company
name, its share capital, the address of its registered o
ce, whether its a private
or public company, that the liability of its members is limited, a statement of the
companys directors names and addresses and a statement of compliance with
the CA 2006. 
e subscribers to the memorandum are those who agree to take
some shares or share in the company. If the application to the Registrar is suc-
cessful the subscribers become the 
rst members of the company.
Choosing a name for a company is not as straightforward as one might assume.
ere are restrictions on the name a company can be given. As we discussed in
Chapter 1, private companies must have Ltd a
er their name and public com-
panies plc (CA 2006, ss 5859). 
e Registrar of Companies also keeps a list of
company names and will not register a company which has the same name as one
already on the register. 
e name of the company must also appear outside the
registered o
ce and appear on all correspondence (CA 2006, s 82).
8.4
ere are also further restrictions that can be imposed by the Secretary of State
(usually the Minister at the Department of Business, Innovation and Skills, BIS).
It is not possible to register a company with a name which in the opinion of the
Secretary of State would constitute a criminal o
ence or be o
ensive (see CA
2006, s 53). Examples are a name which is blasphemous, treasonous or likely to
incite racial hatred, or which contains the name of a proscribed organisation (e.g.
IRA Ltd would not be acceptable). 
e Secretary of States approval is speci
cally
needed for a name which would give the impression that the company was con-
nected with the Government or any local authority (CA 2006, s 54). 
ere is also
a speci
ed list of words which need approval. For example an application to form
a company with any of the following in the name, Police, Wales, Queen or Great
Britain would need the approval of the Secretary of State (CA 2006, ss 5456).
During the life of the company the members may only change the name of the
company by special resolution (CA 2006, s 77).
Succeeding in registering a company name will not, however, guarantee that the
name of your company is not in use by another business. If two businesses have
the same or similar names the issue is usually decided by the common law action
7/19/2012 2:19:12 PM
The constitution of the company: dealing with insiders
of passing o
. At common law a business cannot use a name so similar to the
name used by an existing business as to be likely to mislead the general public
into confusing the two concerns. It involves, in essence, an allegation that com-
pany B is trying to pass itself o
as company A by using the same or a similar
name and in e
ect trade on the reputation of company A. For example in
Exxon
Corpn
Exxon
Insurance
Consu
tants
Internationa
Ltd
(1982) the court granted
an injunction to an oil company (Exxon Corporation) restraining an insurance
company (Exxon Insurance Consultants International Ltd) from using the word
Exxon in its name. It may not be immediately obvious that an insurance company
could trade o
an oil companys name but many large companies have extremely
wide business interests which go beyond their core business.
8.6
Under s 9 the application sent to the Registrar must contain a statement of capi-
tal and initial shareholdings. Again as we noted in Chapter 1, it is common for
the share capital to be subdivided into small amounts. For example, the share
capital of X company is 1
million divided into 1 million shares of 1
each.
erefore, each share is allocated a par or nominal value which represents the
minimum amount for which the shares can be issued. In our example 1
is the
nominal value of the shares but the company could, if it wished, issue them for
each. Note though, it could not issue them for 75p. 
e shares can therefore
be issued for more than their nominal value but not for less. During the life of
the company the share capital can be increased if the company wishes to do so
(CA 2006, s 617). 
e application for registration also states the companys reg-
istered o
ce. In keeping with the public nature of the application documents
this is the address to which all correspondence can be addressed or notices
served (CA 2006, s 86). If the address changes the Registrar must be informed
(CA 2006, s 87).
8.7
Under the previous principal Companies Acts companies were required to spec-
ify their objects (what they were empowered to do, e.g. run a sweet shop, etc) in
the memorandum of association. In Chapter 2 we covered the origins of com-
panies. Initially companies were formed by charters or grants from the Crown
and Parliament. At 
rst they were granted speci
cally to organisations like the
Church or local authorities whose main function was to serve the public inter-
est. As time went by corporate status was conferred on private concerns that
were exploiting a particular invention through a patent grant or which had been
granted trade rights or rights to build a railway or canal. 
ese were still essen-
tially grants of corporate status to promote private businesses that were deemed
to be carrying out important public-related works.
ese charter or statute companies were formed with speci
c constitutions
designed for the particular venture. In those constitutions the purpose or object
7/19/2012 2:19:12 PM
A companys constitution
of the company was stated, i.e. to exploit trade in the East Indies or to build and
operate a railway between London and Manchester. 
eir objects were very
speci
c and the powers granted by the charter or statute had to be used to
promote that object. When the state introduced a general incorporation statute
which allowed company formations through simple registration, the objects
clause requirement remained but was dra
ed by the individuals forming the
company.
8.9
To take an example, if a company was formed to carry on a coal supply business
the objects clause in the memorandum of association would state something like,
to carry on the business of supplying coal and to carry out all such other activi-
ties as are necessary to the attainment of that object. However, the objects clause
also set the limits of the companys power, in that a company formed as a coal
supply business could not enter into transactions to breed racehorses. It would
simply have no legal capacity to do anything other than supply coal and carry
out transactions related to that object, e.g. buy a truck to transport the coal, etc.
e coal supply company could not suddenly transact to breed racehorsesit has
no legal capacity to do so and so all such transactions are ultra vires (beyond its
powers) and void.
8.10
e ultra vires issue became a problem because unlike public authorities from
whom the ultra vires principle was drawn, companies tended to take business
opportunities where they were pro
table. So as companies did increasingly
move away from their original objects, objects clauses in response grew in size
as they were dra
ed to include every type of business imaginable. 
is meant the
company could in e
ect move into any business listed in its objects. Problems
still remained and eventually the Companies Act 1989 introduced provisions
to reform ultra vires issues with regard to objects clauses (see Chapter 12). To
eliminate any remaining problems the CLRSG in the
Fina
Report
(July 2001
para 9.10) and the Consultative Document, March 2005 (ch 5) proposed that
companies be formed with unlimited capacity. 
e CA 2006 partly implements
the recommended approach (see Chapter 12). As such, new companies regis-
tered under the 2006 Act have unrestricted objects unless a company chooses to
have an objects clause restricting what it is empowered to do (CA 2006, s 31). A
company might do this if it had particular values it wished to enshrine, e.g. an
organic or fair-trade business. If a new company does choose to have an objects
clause and for companies formed under the previous Principal Acts (the vast
majority of existing companies) with an objects clause (unless these older com-
panies now remove their objects clause as they can do if they wish, see CA 2006,
s 31(2)) the objects clause forms part of the Articles of Association. (CA 2006,
s 28, see further Chapter 12.)
7/19/2012 2:19:12 PM
The constitution of the company: dealing with insiders
Some elements of corporate theory
8.11
is may be a good point to introduce some elements of corporate theory as the
articles of association o
er some good examples of particular issues in this area
(for a more detailed overview see Chapter 15). 
e original charter and statu-
tory companies were in no sense general trading companies and they are best
described in terms of what is known as the concession or 
ction theory (here-
er, concession or 
ction). 
is theory describes incorporation as a concession
granted or legal 
ction created by the state because of the public good being car-
ried out by the business. 
e state is central to its existence and the company
therefore only exists and is legitimised because it serves the public good. 
is
theory makes it relatively easy to justify the imposition of corporate regulations
aimed at promoting the public interest.
8.12
With the advent of the registered company in the mid-19th century it became
increasingly di
cult to 
t registered companies into the concession category.
ere was no speci
c charter or statute to form and regulate the company and
they were not special business ventures pursuing the public interest. Rather they
were easily registrable entities formed to pursue the entirely private concerns of
their members. Concession theory had real resonance when the state was deeply
involved in the incorporation process of a speci
c charter company. 
e advent
of general incorporation through a simple registration process changed that as
incorporation became available to all rather than just those deemed worthy by
the state. 
e state provided the general framework for incorporation but was
no longer involved in the detail of each corporate venture. Signi
cantly it gave
up the ability to set the objectives of a corporation. 
is was now done by those
setting up the company and framed in terms of their own private needs in the
objects clause.
8.13
A second theory called the corporate realism theory (herea
er, corporate real-
ism) was at least partly better suited to the registered company. It argued that the
company was no 
ction but had a real existence. It did not therefore depend on
its members or the state for its continued existence. 
e strength of corporate
realism is that it can best explain the separate existence of the corporation and
therefore justify departure from a shareholder-oriented focus for the corpora-
tion. However, the theory was somewhat malleable. Some who advocated cor-
porate realism argued that as a real person it could be subject to regulation by
the state to promote the public good but confusingly others argued that as a real
person it was an essentially private entity free from state control. In time however
both concession and corporate realism lost ground to the aggregate theory (here-
er, aggregate). 
at theory describes the company as the central institution
7/19/2012 2:19:12 PM
The articles of association
formed by the aggregation of private contracting individuals. 
at is, the mem-
bers come together to pool their investment on terms they all agree. 
e state
therefore has little to do with the corporation as a nexus of private contracting
individuals. Posner (1986) therefore describes the company as a method of solv-
ing problems encountered in raising substantial amounts of capital. As such it is
a kind of standard form contract. As a result it is also sometimes referred to as
contractarian theory.
8.14
As with all theories there is something in concession, corporate realism and
aggregate theory that informs and explains aspects of company lawotherwise
we would not be discussing them here. It is di
cult to deny that the state still has
a large role in creating and regulating corporations because they do not occur
in nature and run free. 
erefore concession theory still has something to o
er
in trying to understand company law. Corporate realism, while it has particular
resonance when dealing with corporate personality (see Chapter 2 on corporate
personality) or justifying manager-dominated companies (see Chapter 15 on cor-
porate governance), has diminished as a major in
uence. Aggregate theory how-
ever has come to dominate and the company is largely but not wholly (remember
annoyingly for contractarians, the state still does have a crucial role in creating
the company) seen as a private institution.
8.15
e theories matter because if the company is viewed as a public creation then
justifying state regulation of corporate a
airs is relatively easy. If it is viewed as a
private concern then the state interfering in its activities becomes more di
cult
to justify and the methods by which it is acceptable to do so become more restric-
tive. Mandatory rules which override any private agreements between contract-
ing parties sit easier with concession theory. Default rules which apply in the
absence of any agreement to the contrary and enabling rules which provide a
framework for private parties to carry out certain functions, for example regis-
tering the company, sit easier with aggregate theory. As we will see, company law
is a mix of all three types of rules. However the articles of association represent a
good example of aggregate theory default rules.
The articles of association
8.16
e articles of association are a set of rules governing the running of the com-
pany. A model set of articles (historically called Table A but now called the model
articles under the CA 2006, s 19 and the Companies (Model Articles) Regulations
2008 (SI 2008/3229)) has been provided by every principal Companies Act as
a default set of rules for those setting up a company (note the resonance with
7/19/2012 2:19:12 PM
The constitution of the company: dealing with insiders
aggregate theory). 
ose setting up the company are free to dra
their own set
of articles (rules) but if they do not provide such a set, then the model articles
will apply. In practice the model articles are generally adopted with some slight
amendments. As a result, even though the model articles are only a default set of
rules their almost universal adoption has meant that they form the core organi-
sational structure of the UK registered companythe Board of Directors (the
management committee or organ) and the general meeting (the members com-
mittee or organ) and allocate the powers of each one. Over time, as we will see,
the common law and the Companies Acts have added supplementary provisions
esh out the operation and application of the articles of association. For exam-
ple in
Cream
Ltd
Davenport
(2011) the court implied a term of coop-
eration and reasonableness into a set of Articles.
8.17
While previous Companies Acts have provided a single set of articles for private
and public companies, under the CA 2006 and the Companies (Model Articles)
Regulations 2008 (SI 2008/3229), as a response to criticism of this one size 
ts
all approach, public and private companies now have separate articles of asso-
ciation. 
e articles of association, as we noted in Chapter 1, deal with many of
the practicalities of running a business. Primarily, the articles provide for the
operation of two organs or committees to operate the companythose being the
general meeting and the board of directors. To take some examples with regard
to the general meeting, the model articles regulate the organisation of meetings
(arts 3741 private) (arts 2833 public) and voting at the meeting (arts 4247
private) (arts 3440 public). Similarly the model articles provide, with regard to
the board of directors, for the allocation of management power to the Board (arts
36 private and public), directors appointment (arts 1720 private) (arts 2024
public) and decision making by directors (arts 716 private) (arts 719 public). It
is important to note here that the articles do not provide for the general removal
of directors except in the case of incapacity or resignation (arts 18 private and
22 public). Director removal is covered by CA 2006, s 168 which gives members
the right by simple majority (more than 50 per cent of those who vote, vote for
the resolution) to remove a director for any reason whatsoever. 
is is by far the
greatest power of the general meeting.
8.18
e most important function of the articles of association is to allocate the power
of the company between the board and the general meeting. Historically, this
made the old Table A art 70 the most important article as it provided:
[s]ubject to the provisions of the [CA 1985], the memorandum and the articles
and to any directions given by special resolution, the business of the company
shall be managed by the directors who may exercise all the powers of the
company.
7/19/2012 2:19:12 PM
The articles of association
is delegation of power is now found in arts 3 and 4 of the model articles (public
and private) and states:
Directors general authority
3. Subject to the articles, the directors are responsible for the management of
the companys business, for which purpose they may exercise all the powers of
the company.
Shareholders (Members) reserve power
4. (1) The shareholders (Members) may, by special resolution, direct the direc-
tors to take, or refrain from taking, speci
ed action.
(2) No such special resolution invalidates anything which the directors have
done before the passing of the resolution.
ese articles provide the board of directors with the power to run the business.
Although that power is subject to quali
cations (the articles of the company and
any special resolutions) it is important to note that the board is as a result of art 3
the primary power-wielding organ of the company.
8.19
e extent of this delegation of power to the directors has been the subject of
much judicial deliberation. 
e key question is whether the delegation of power
to run the company to the board creates a substantially independent discretion
for the directors. In simple terms, could the directors take a decision which the
majority of the members disagreed with? In
Howard
Ltd
Ampo
Petro
eum
Ltd
(1974) Lord Wilberforce summed up the position:
[t]he constitution of a limited company normally provides for directors, with
powers of management, and shareholders, with de
ned voting powers having
power to appoint the directors, and to take, in general meeting, by majority
vote, decisions on matters not reserved for management . . . it is established
that directors, within their management
powers, may take decisions against
the wishes of the majority of shareholders, and indeed that the majority of
shareholders cannot control them in the exercise of these powers while they
remain in of
ce.
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The constitution of the company: dealing with insiders
of dividends. Although technically the general meeting declares the dividend it
cannot do so unless the board recommends a dividend. 
is may not seem like
a signi
cant power but it is another very important independent management
power exercised by the board. 
e model articles default rule thus recognises
that the board needs a signi
7/19/2012 2:19:13 PM
The contract of membership
shareholders (
Fina
Report
ch 8) and making institutional investors who hold
the vast majority of shares (insurance companies, pension funds and invest-
ment trusts, see Chapters 15 and 16) disclose their voting record (
Fina
Report
ch 6, paras 6.226.40). Currently institutional investors either dont vote or
vote with the directors a
er privately discussing important issues with them
behind the scenes. 
us there is at present a very large accountability problem
with the voting at the AGMs of public companies. If the CLRSG recommenda-
tions had been implemented shareholders would have been better informed
and institutions would have been e
ectively forced to vote and explain why
they voted a particular way. 
e CLRSG also recommended that public compa-
nies could also dispense with AGMs if all the shareholders agree (
Fina
Report
para 7.6). 
e White Paper that followed in 2002 (vol I, paras 2.62.48) adopted
all the procedural recommendations of the CLRSG regarding the general meet-
ing, except the recommendation to force institutional investors to disclose their
votes (para 2.47). In the Consultative Document, March 2005 (para 4.2) the
Government changed its mind as to the need for public companies to hold an
Annual General Meeting and the CA 2006 was implemented with the require-
ment for public companies to hold an Annual General Meeting still intact. 
e
recommendation to force institutional investors to disclose their voting record
was not revived.
The contract of membership
8.23
Under the previous Principal Companies Acts the constitution of the company
(at that time meaning the memorandum and the articles) bound the members of
the company and the company, thereby creating a statutory contract between the
members themselves and between each member and the company. Under the CA
1985, s 14 it was stated that:
[s]ubject to the provisions of this Act, the memorandum and articles, when
registered, bind the company and its members to the same extent as if they
respectively had been signed and sealed by each member, and contained
covenants on the part of each member to observe all the provisions of the
memorandum and of the articles.
Its replacement in CA 2006, s 33(1) similarly but perhaps more tidily states:
The provisions of a companys 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.
7/19/2012 2:19:13 PM
The constitution of the company: dealing with insiders
e 
rst thing to notice here is that it is an odd sort of contract. It can be constantly
varied by the members as the members may alter the articles by special resolution
if three-quarters of the members vote in favour of the resolution (s 21). 
is means
one might buy shares in a company because certain rights were conferred in its
articles but a
er joining, a special resolution was passed despite your voting against
the special resolution, which altered those rights and which bound you because of s
33 to observe the new provisions. It also binds parties who were not privy to it, for
example future shareholders in the company. 
e reason such an unusual contract
7/19/2012 2:19:13 PM
article was, therefore, contractually binding between the members and the com-
pany. Despite the judiciary clarifying this issue the opportunity was taken when
dra
ing CA 2006, s 33 to formally remedy this omission and the company has
now been happily added to the parties that are bound to abide by the constitution
of the company.
7/19/2012 2:19:13 PM
The constitution of the company: dealing with insiders
In
Axtens
Ltd
(1909) Farwell LJ considered Stirling Js words in
Wood
Odessa
and stated, I think that is accurate subject to this observation, that
it may well be that the Court would not enforce this covenant as between the indi-
vidual shareholders in most cases.
8.27
In
Ray
Hands
(1960) Vaisey J considered all the con
icting authorities (in
particular he focused on Lord Herschells statement above) on the issue and con-
cluded that there was a contract
inter
which was directly enforceable by one
member against another. Vaisey J did not however think that his view was of
general application, rather he emphasised the quasi-partnership nature of the
company he was dealing with.
8.28
ere is still confusion as to whether the contract is enforceable between
members. Barc and Bowen (1988) argue that Lord Herschells dicta, with the
quasi-partnership exception provided by Vaisey J, represents the correct posi-
tion. 
us in their view a member cannot enforce the articles of association
of a company directly against another member unless the company is a quasi-
partnership. 
e proper claimant in such a situation is the company itself.
However, Davies (2008) considers that a direct action between the sharehold-
ers concerned is here possible; and for the law to insist on action through the
company would merely be to promote multiplicity of actions and involve the
company in unnecessary litigation. 
e CLRSG in their
Fina
Report
recom-
mend the clari
cation of the nature of the companys constitution (currently
laid down by the outmoded and inadequate s 14), including increased cer-
tainty as to what rights are enjoyed and may be pursued by members per-
sonally under the constitution (para 2.26). 
e solution they recommended
was to allow all rights in the constitution to be enforced against the company
and the other members unless the constitution provides otherwise. 
is also
seemed to be re
ected in the Governments Consultative Document, March
2005 (para 5.1) although it is not entirely clear what the Government intended.
is lack of clarity continues in the CA 2006 as the guidance notes to the Act
state:
A companys articles are rules, chosen by the companys members, which
govern a companys internal affairs. They form a statutory contract between
the company and its members, and between each of the members, and are an
integral part of a companys constitution. (The Articles of Association, Note 67,
General)
is appears to indicate that the uncertainties about enforceability are resolved
but the wording of CA 2006, s 33 in terms of its central contract which replaced s
14 is almost unchanged (see para
above). 
is is a shame given that during
7/19/2012 2:19:13 PM
Who can sue?
the Grand Committee stage of the Bill in the House of Lords, Lord Wedderburn
tabled an amendment to s 33 (at the time numbered as clause 34) which would
have clari
ed the relationship between the company and the members. 
e
Government rejected the amendment stating notwithstanding the valuable work
7/19/2012 2:19:13 PM
The constitution of the company: dealing with insiders
breach complained of could be rati
ed by a majority resolution. On the other
hand, in
Pender
Lushington
(1877) a shareholders votes were refused at a
7/19/2012 2:19:13 PM
Outsider rights
Outsider rights
8.32
Another complication has been added to the s 33 debate by the fact that while
there is deemed to be a binding contract between the members and the com-
pany, that contract only binds the members in their capacity as members. Where
outsider rights are at issue the s 33 contract does not apply. For example in
Positive
Government
Security
Life
Assurance
(1876) the articles contained a
clause which ensured that a particular member of the company was appointed as
the companys solicitor. 
e member was not appointed as the companys solicitor
and sued for breach of contract. 
e court found that he could not rely on breach
of that clause in the articles as the cause of his action as there was no contractual
relationship between the member as solicitor and the company.
does not
directly address the s 33 point yet has been the basis of a number of other judg-
ments on the issue. In
Browne
Trinidad
(1887) a shareholder who had a right
to be a director conferred in the articles was removed by a valid resolution of
the general meeting. 
e court placed great emphasis on
in concluding that
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. He therefore could not enforce a right to be a director. By
1915 the court in
Hickman
Kent
Romney
Marsh
Sheep
Breeders
Association
(1915) considered the matter settled and stated:
this much is clear,
rst, 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 a 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.
In
oba
ecommunications
Ltd
mbury
Ltd
(2003) the court considered
the validity of a directors indemnity provision that had been placed in the com-
panys articles. 
e court found that such a provision would not be binding because
the articles do not constitute a contract between the company and its o
cers. It will
only bind the company if the provision is contained in a separate contract between
the company and the o
cer.
8.33
However, as you may have noticed by now s 33 matters are rarely straightfor-
ward. In
Beattie
Beattie
Ltd
(1938) the company was engaged in an action
against a director for the return of money it claimed was irregularly paid to him.
e articles of association contained a clause which referred any member disputes
7/19/2012 2:19:13 PM
The constitution of the company: dealing with insiders
to arbitration. 
e director who was also a member attempted to have the article
enforced and have his dispute referred to arbitration. 
e Court of Appeal rely-
ing heavily on
Hickman
held that he could not do so as the dispute related to his
status as a director. 
e Master of the Rolls in his judgment saw the issue as being
framed as a director-member action in which the enforcement of the directors
outsider rights were central rather than tangential. He suggested that had the
action been framed as a member-director action in which the central issue was a
member suing to enforce the articles which had the tangential e
ect of enforcing
an outsider right it might have been successful. 
is view has echoes of the ear-
lier decision of the House of Lords in
Axtens
Ltd
(1909
which
ultimately the Court of Appeal in
Beattie
chose to ignore by placing the emphasis
on the
Hickman
decision.
8.34
In
(above) the articles of association provided that the consent of both
managing directors was needed for certain decisions. Mr Salmon was a manag-
ing director and member of the company and he dissented from a decision to buy
and let some property. 
e general meeting then passed a resolution authorising
the purchase and letting of the property. Mr Salmon sued as a member to enforce
the article requiring his consent as managing director to the transactions. In this
situation the House of Lords accepted a general personal right of members to sue
to enforce the articles by allowing a member to obtain an injunction to stop the
completion of the transactions entered into in breach of the articles. Here the
court viewed the issue in terms of enforcing a member right which tangentially
ects his right as a director rather than in the
Beattie
case where they viewed it
as a director right which has a tangential e
ect on the membership.
8.35
e ignoring of the
case by the judiciary has become somewhat of a
cause
bre
for reform-minded academics. Lord Wedderburn (1957), as we discussed
brie
y above, in an article on
Foss
Harbott
(1843) made the important point
that in cases such as
and
Beattie
the courts have recognised a general per-
sonal right to have the articles enforced and that this was in fact the correct way
to deal with the matter. 
is is the case even though it would indirectly enforce an
outsider right. Others such as Goldberg (1972 and 1985), Prentice (1980), Gregory
(1981) and Drury (1989) have broadly agreed while adding their own particular
ourish.
Reform
8.36
Not unnaturally given the complexity of the area the CLRSG gave considera-
ble time to the issue of rights in the articles over the course of its deliberations.
In
Deve
the
Framework
(March 2000) they considered that the present
7/19/2012 2:19:13 PM
Shareholder agreements and statutory effects
position does nothing to resolve the critical question of what rights are personal
to the shareholder (see paras 4.724.99). 
ey then went on to recommend a
number of reforms. However, a
er the consultation period they dropped most
of these reforms and opted 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 (
Comp
7/19/2012 2:19:13 PM
The constitution of the company: dealing with insiders
of a shareholders agreement is that it does not bind the new owner of the shares.
Once a party to a shareholders agreement sells them on, the new owner has no
obligations under the shareholders agreement. Note here this is in contrast to
the way the s 33 contract operates to bind future shareholders to the companys
constitution.
8.38
Shareholder agreements purely between shareholders present little di
culty for
the parties involved. 
ey can agree the matters they wish and as long as they all
agree, they can also alter their agreement formally or informally (on the valid-
ity of unanimous informal alterations see
Euro
Brokers
Ltd
Monecor
(London
Ltd
(2003)). 
e courts have also been willing to enforce such agree-
ments. For example, in
Puddephatt
Leith
(1916) the court compelled a share-
holder to vote as was agreed in a shareholders agreement. However, agreements
purely between the shareholders can only attempt to regulate the rights and obli-
gations belonging to those shareholders. As those rights and obligations largely
concern the operation of a company it o
en makes sense to make the company
a party to the agreement. 
is adds an extra element of security to the agree-
ment as the company will still be bound by the agreement even if some of the
parties to the agreement sell their shares and the new shareholders do not join
the agreement. Here in practice we are probably talking about small to medium-
sized companies where there is little or no separation of ownership from control.
erefore the shareholders and directors will o
en be the same people and get-
ting the company to join the agreement is easily achieved.
8.39
Adding the company to the agreement, however, also adds an additional prob-
lem. 
at is, if the subject matter of the agreement a
ects a statutory obligation
of the company it may not be enforceable. As we discussed above, CA 2006, s 21
allows the company to alter its articles by special resolution if three-quarters of
the members vote in favour of the resolution. In
Punt
Symons
Ltd
(1903)
the court held that a company could not contract out of the right to alter its arti-
cles. 
is means in e
ect that a provision of a shareholders agreement which
binds the company not to alter its articles will not be enforceable. 
e company
would be in breach of contract if it does so but it is free to alter its constitution
(see also
Russe
ll
Northern
Deve
opment
Corpn
(1992)).
8.40
However, the courts once again have not been entirely consistent when dealing
with the question of the ability of the company to contract out of statutory provi-
sions. In
Bushe
ll
Faith
(1970) the articles contained a provision whereby in the
event of a resolution to remove a director that directors shares in the company
would be multiplied by three. 
is in e
ect entrenched the director on the board
of directors as the other shareholders could never outvote him. In e
ect the article
attempted to remove the ability of the members conferred by CA 2006, s 168 (in
1970 it was s 184 of the CA 1948) to remove a director for any reason whatsoever.
7/19/2012 2:19:13 PM
Shareholder agreements and statutory effects
e House of Lords in a very interesting judgment held that the article in ques-
tion was not inconsistent with the statutory power. 
e statute only speci
ed
the type of resolution needed to remove a director but was completely silent on
the matter of how the company allocated voting rights for such resolutions. In
essence the House of Lords treated the issue as no di
erent from a complaint
from a 49 per cent shareholder that a shareholder with 51 per cent of the shares
in the company could not be removed. Its not that they cannot be removed, its
simply that the other shareholder has not enough votes to remove the 51 per cent
shareholder. 
e same is true where weighted voting rights are concerned.
8.41
e issue was reconsidered in the context of a shareholders agreement in
Russe
ll
Northern
Deve
opment
Corpn
(1992). Here the House of Lords considered
a shareholders agreement where the company agreed not to increase the share
capital of the company without the agreement of all the parties to the share-
holders agreement. 
e company did attempt to increase the share capital of the
company and one of the shareholders who was a party to the shareholders agree-
ment objected and attempted to enforce the agreement. 
e statutory con
ict
here was between the agreement and CA 1985, s 121 which allowed companies
to increase their share capital if their articles contain an authority. 
e article
of the company did provide such an authorisation. 
e House of Lords found
that the companys agreement not to increase its share capital was contrary to
the statutory provision and, therefore, unenforceable. However, the court did not
declare the whole shareholders agreement invalid, just the companys agreement
not to increase the share capital. 
is meant that the shareholder who objected
could not enforce it against the company but could enforce it against the other
members. As all the members of the company were party to the shareholders
agreement this has the same e
ect as if the company was bound. 
e sharehold-
ers could not vote to increase the share capital.
8.42
It is important to note here that this judgment greatly enhances the ability of
shareholders agreements to contract out of statutory provisions. If the sharehold-
ers place a provision in the articles that purports to contract out of a statutory
provision it will probably be invalid, however if they place the same provision
outside the articles in a shareholders agreement and either all the sharehold-
ers or a large majority of them are party to it, the provision will be e
ective. It
represents only a private agreement between the shareholders as to how they will
exercise their voting rights. Tangentially this has an e
ect on lenders ability to
protect themselves by placing restrictions on the companys ability to change the
articles of association as a condition of their continued lending. A lender has no
way of knowing of or restricting shareholders private agreements which a
ect
the operation of the articles. 
e recommendation of the CLRSG
Fina
Report
(July 2001) (para 9.8) and the Governments Consultative Document of March
2005 (para 5.1) all agreed that allowing certain provisions of the articles to be
7/19/2012 2:19:13 PM
The constitution of the company: dealing with insiders
entrenched by allowing them to be changed only by unanimity would potentially
er a solution to the problem and the CA 2006 s 22 makes this possible.
Altering the constitution
8.43
e alteration of the articles, as we have also observed above, is allowed by CA
2006, s 21. 
is is normally e
ected by a special resolution at the general meeting.
However, sometimes the courts have allowed more informal resolutions to stand.
In
Duomatic
(1969) the court allowed a decision not made at the general meet-
ing but which clearly had the backing of all the shareholders to stand. As we have
also seen above the alterations to the articles must not con
ict with any statutory
provisions. However, there is one additional check on the members ability to
alter the articles which has an e
ect. 
at is, the members must exercise their
power to alter the articles in good faith. 
is power to alter the articles has been
famously expressed by Lindley MR in
Reefs
West
Africa
(1900)
as being:
exercised subject to those general principles of law and equity which are
applicable to all powers conferred on majorities enabling them to bind minorities.
It must be exercised, not only in the manner required by law, but also
bona
de
for the bene
t of the company as a whole, and it must not be exceeded. These
conditions are always implied, and are seldom, if ever, expressed.
8.44
e exercise of a members votes generally may also be subject to a bona 
des
quali
cation. In
emens
emens
Bros
Ltd
(1976) Foster J declined to recog-
nise the ability of a majority shareholder to authorise an allotment of shares,
the motive behind the share allotment being to dilute the voting power of the
minority shareholder claimant. Foster J considered that the majority share-
holder was not entitled to exercise her vote in any way she pleases. He based
his decision on what he termed equitable considerations and thus the mala
des element of the allotment precluded it from rati
cation (see also
Menier
Hooper
egraph
Works
(1874) and
Greenha
Arderne
Cinemas
Ltd
(1951))
(see also Chapter 11).
8.45
erefore, a special resolution passed altering the articles or even a resolution
exercising powers conferred in the articles may theoretically be challenged for a
lack of bona 
des. It must be said, however, that the courts are extremely reluc-
tant to overturn a decision of the general meeting on the grounds of a lack of
bona 
des, doing so in only a small number of cases (see
Brown
British
Abrasive
Whee
Ltd
(1919) and
Dafen
Tinp
Ltd
Stee
(1920)). One can
conclude that the courts in general view the alteration of the articles as a matter
7/19/2012 2:19:13 PM
Self-test questions
of upholding the principle of majority rule. As a result many of the challenges to
majority power fall under the remit of minority protection and will be further
discussed in Chapters 10 and 11.
8.46
e CLRSG in its
Fina
Report
(July 2001, paras 7.527.62) considered the bona
des issue but a
er an interesting discussion recommended little change. 
ey
did, however, recommend that the new constitution of the company be alter-
able by special resolution and that certain provisions of the articles could be
entrenched by requiring a unanimous resolution to change them (para 9.8). As
we noted above both those recommendations are now contained in the CA 2006,
ss 21 and 22.
FURTHER READING
This Chapter links with the materials in Chapters 6 and 7 of
Hicks and Goos Cases and
Materials on Company Law
(2011, Oxford University Press, xl +649p).
Companies (Model Articles) Regulations 2008 (SI 2008/3229) http://www.companie-
shouse.gov.uk/about/modelArticles/modelArticles.shtml
Company Law Reform Bill 2005,
HL Bill http://www.bis.gov.uk/policies/business-law/
company-and-partnership-law/company-law/publications-archive
Company Law Reform
(2005) Cm 6456 (Consultative Document, March 2005), paras
4.2, 4.3 and 5.1: http://www.bis.gov.uk/policies/business-law/company-and-
partnership-law/company-law/publications-archive
Davies
Gower and Davies Principles of Modern Company Law,
8th edn (London, Sweet
& Maxwell, 2008), ch 3.
Ferran The Decision of the House of Lords in
Russell v Northern Bank Development
Corporation Limited
[1994]
CLJ 343.
Wedderburn Shareholders Rights and the Rule in
Foss v Harbottle
[1957]
CLJ
194.
SELF-TEST QUESTIONS
What is the constitution of the company supposed to achieve?
Is there a statutory contract created by CA 2006, s 33?
Who does the statutory contract bind and in what capacity?
Are shareholders free to exercise their votes as they wish?
7/19/2012 2:19:13 PM
SUMMARY
Introduction
The legal nature of a share
Class rights
Preference shares
Variation of class rights
EU initiatives
Introduction
9.1
Unlike partnerships where the assets of the business are jointly owned by the
partners, shareholders do not have a proprietary interest in the property of the
company. Rather the relationship of a shareholder lies with the company as a
separate and distinct entity. A paradigm case is the House of Lords decision in
Macaura
Northern
Assurance
Ltd
(1925) which we considered in Chapter 2.
You will recall that the insured, Macaura, was an unsecured creditor and the only
shareholder in a limited company which owned a substantial quantity of timber,
much of which was stored on his land. Two weeks a
er e
ecting insurance poli-
cies with several companies in his own name, the timber was destroyed by 
re.
A claim brought by Macaura on the policies was disallowed on the ground that
he lacked insurable interest in the timber. Lord Sumner, proceeding on the basis
that neither the companys debt to the insured nor his shares were exposed to
re, observed: the fact that he was virtually the companys only creditor, while
the timber is its only asset, seems to me to make no di
erence . . . he was directly
prejudiced by the paucity of the companys assets, not by the 
re. His Lordship
stated that the insured stood in no legal or equitable relation to the timber at
all. He had no concern in the subject insured. His relation was to the company,
not to its goods.
Classes of shares and variation
of class rights
7/19/2012 2:19:45 PM
The legal nature of a share
9.2
e guiding principle here is, of course, pivoted upon the separate legal person-
ality accorded to companies. It was the company which owned the timber and
therefore had a proprietary interest in it, not its shareholder. 
e fact that the
timber was in his possession did not give him a proprietary interest. He merely
had a factual expectation of loss.
9.3
Sealy and Worthington (2010) attribute three principal functions to the concept
of a share. First, it denotes the quanti
cation of a shareholders 
nancial stake
in the company and it  xes his liability to contribute to the companys fund-
ing. Second, it is a measure of the shareholders interest in the company as an
association and his right to become a member and to exercise all rights inciden-
tal to membership. 
ird, and this is perhaps conceptually the most di
cult of
the three functions: it is a species of property, a chose in action (and therefore
not personality) which can be bought, sold and charged (see further,
Trustee
Stee
Bros
Ltd
(1901), discussed below at
9.5
9.4
A shareholder will thus have rights and liabilities which are the incident of the
general nature of a share. Additionally, he may also have particular rights and
liabilities by virtue of owning a particular type or class of share. Such class rights
may, subject to certain conditions, be varied or abrogated by the company. In
this chapter we will examine, 
rst, the legal nature of a shareholding, second, the
various types of share capital and typical class rights which attach thereto and,
nally, the statutory procedure which a company must go through in order to
ect a variation of shareholders class rights.
The legal nature of a share
9.5
As we discussed in Chapter 2, the primary characteristic of a share which serves
to distinguish it from other types of security issued by companies is that a share-
holder acquires rights
the company not simply
against
it as is the case with
debenture holders (see Chapter 6). For example, a shareholder will have 
nancial
rights, such as sharing in dividend distributions and any return of capital on a
winding-up, and participative rights, such as voting at general meetings. A share
therefore has various legal attributes which confer both property and contractual
rights on its holder. 
e Act is silent on the nature of a share except for declaring
that shares or other interest of a member in a company are personal property and
are not in the nature of real estate (CA 2006, s 541). However, the courts have not
been so reticent in this regard. For example, in
Trustee
Stee
Bros
Ltd
(1901), the articles of association provided that the shares of a member could
be compulsorily purchased by particular persons on the occurrence of certain
7/19/2012 2:19:47 PM
Classes of shares and variation of class rights
events, including bankruptcy, at a fair price not exceeding the par value. Borland,
who held 73 1.00 shares, was declared bankrupt and the company served notice
requiring the trustee in bankruptcy to transfer the shares. 
e trustee contended
that the relevant provision in the articles was void on the basis that it was repug-
nant to absolute ownership or alternatively, contrary to the rule against perpetu-
ity. Farwell J said that:
A share is the interest of a shareholder in the company measured by a sum of
money, for the purposes of liability in the
rst place, and of interest in the sec-
ond, but also consisting of a series of mutual covenants entered into by all the
shareholders
inter se
in accordance with section 16 of the Companies Act 1862
[now the Companies Act 2006, s 33]. The contract contained in the articles of
association is one of the original incidents of the share. A share . . . is an interest
measured by a sum of money and made up of the various rights contained in
the contract.
9.6
According to Farwell J a share therefore represents a bundle of contractual rights
conferred by the Companies Act 2006 and the companys constitution. In respect
of the latter, as seen in Chapter 8, such rights make up the statutory contract
between the members
inter
and the company (see also the speech delivered by
Lord Walker in
Grays
Timber
Products
Ltd
Revenue
Customs
(2010)).
In
Short
Treasury
Commissioners
(1948), the legal nature of a share and its mon-
etary valuation was subjected to considerable scrutiny by the court. In this case,
the government of the day purchased all of the shares in the company valuing
them on the basis of the quoted share price. 
e shareholders argued that because
the whole of the issued shares were being acquired then the entire undertaking
should be valued and the price apportioned between them. It was held, however,
that where a purchaser is buying control but none of the sellers holds a control-
ling interest, the higher price that control demands can be ignored. 
e Treasury
was therefore able to purchase the company for a price considerably less than its
asset value. Although shares are frequently described as property, we have seen
that they do not comprise any proprietary interest in the companys assets. Quite
simply, a shareholder pays a sum of money by way of investment from which he
hopes to earn a return.
Class rights
9.7
As between shareholders in a company there is a presumption of equality so that
they will enjoy equal rights in respect of voting and dividends when the company
7/19/2012 2:19:47 PM
Class rights
is a going concern and a right to participate in any surplus assets in the event of
it being wound up (collectively termed class rights: see
Birch
Cropper
(1889);
and
Cumbrian
Newspapers
Group
Ltd
Cumber
Westmore
Hera
Newspapers
Printing
Ltd
(1987), considered below at para
9.14
). However,
this presumption is rebutted if the company issues shares carrying di
erent class
rights. For example, preference shares generally carry preferential dividend rights
and priority to a return of capital in a winding-up. It should be noted that a com-
panys right to issue shares divided into di
erent classes is generally contained in
its constitution.
9.8
Where shares are issued with express provisions relating to class rights, such
statements are deemed to be exhaustive. 
is principle, which in essence is a
rule of construction, was forcefully stated by Sarjant J in
Nationa
ephone
(1914): the attachment of preferential rights to preference shares, on their
creation, is,
prima
facie
a de
nition of the whole of their rights in that respect,
and negatives any further or other right to which, but for the speci
ed rights,
they would have been entitled. 
e decision in
ll
United
Lankat
antations
Ltd
(1914) illustrates the point. Preference shares were issued which carried
an entitlement to a cumulative preferential dividend at the rate of 10 per cent
per annum on the amount for the time being paid up on such shares. 
e issue
before the House of Lords was whether the preference shareholders were also
entitled to share in any surplus pro
ts a
er the ordinary shareholders had also
received 10 per cent. It was held that they were not. Viscount Haldane LC said
that shares are not issued in the abstract and any priorities and rights attached
to them as regards dividends are to be ascertained in the terms of the issue.
e court cannot look beyond those express terms in order to imply additional
preferential rights.
9.9
ere are myriad reasons for the plurality of share classes. 
e companys orig-
inal subscribers of ordinary shares may be reluctant to issue further ordinary
shares to outsiders as a means of raising additional capital because that would
have the e
ect of diluting or destroying their control of the business. 
is dan-
ger arises because ordinary shares generally carry the majority of the voting
rights at meetings and also entitle their holders to the lions share of any declared
dividend. A solution, other than issuing debentures (see Chapter 6), is to issue
preference shares. 
e attraction of this option is that it a
ords a company an
accessible means of raising additional capital without conferring voting rights
equal to those of ordinary shareholders. Although the company will undertake to
pay a preferential cumulative dividend generally  xed at a pre-determined rate,
this may, in appropriate circumstances, be considered a relatively small price to
pay for a much needed injection of capital from which trading pro
ts can grow.
7/19/2012 2:19:47 PM
Classes of shares and variation of class rights
Examples of classes of shares
9.10
Provided a company is authorised by its constitution to issue shares with di
er-
ent class rights, it can divide its share capital into as many di
erent classes as it
wishes. 
e rights attaching to each class should be clearly stated either in the
companys constitution, or in the resolution authorising the share issue as well
as in the prospectus because, as seen above, it is a rule of construction that any
statement of class rights is presumed to be exhaustive.
Ordinary shares
9.11
Ordinary shares, commonly referred to as equities, are the default category of
shares. Holders of this class participate in the companys distributable pro
ts a
er
payment has been made of any  xed level of dividend to preference shareholders.
Where the company is enjoying handsome pro
ts ordinary shareholders are not
restricted to a pre-determined return on their investment. Ordinary sharehold-
ers rights to a return of capital are commonly deferred to preference sharehold-
ers, but as regards participation in any surplus in a solvent winding-up, they will
be able to claim a
er other shareholders have had their capital returned.
7/19/2012 2:19:47 PM
Preference shares
Scottish
Insurance
Corpn
Ltd
yde
Ltd
(1949)). Preference
shares generally have restricted voting rights so that they cannot vote in general
meetings unless, for example, their dividends are in arrears.
9.13
e position of preference shareholders is in some ways analogous to that of cred-
itors. Fixed rates for determining dividend entitlement are not dissimilar to  xed
rates of interest payable to lenders. Further, as with creditors, preference share-
holders enjoy priority over other classes of shareholders to a return of capital in a
winding-up although, of course, this priority does not extend over unsecured or
secured creditors.
Convertible shares
9.14
A company may, for example, issue preference shares which are capable of being
converted into ordinary shares either on a  xed date or at the option of the
shareholders themselves or, subject to certain conditions, at the option of the
company.
Redeemable shares
9.15
In brief, s 684 of the Companies Act 2006 provides that a company having a share
capital may issue shares which are to be redeemed or are liable to be redeemed at
the option of the company or the shareholder (see Chapter 7), subject to the fol-
lowing: 
rst, the articles of a private limited company may exclude or restrict the
issue of redeemable shares and, second, in the case of a public company, its arti-
cles authorise it to issue such shares (s 684(2) and (3)). But a company must always
have some non-redeemable issued shares (s 684(4)). Redeemable shares may not
be redeemed unless they are fully paid; and the terms of redemption must pro-
vide for payment on redemption (s 689(1)). Private companies may redeem shares
out of capital (s 687(1)) but public companies may only redeem redeemable shares
out of distributable pro
ts or from the proceeds of a new issue of shares which is
made for the purpose of redemption (s 687(2)).
Employees shares
9.16
Successive governments have encouraged companies to give employees a stake
in the business by issuing shares to them. Such shares enjoy certain tax advan-
tages. 
is is generally e
ected through an employees share scheme which
is de
ned as being a scheme for facilitating the holding of shares or deben-
tures in a company by or for the bene
t of: (a) bona 
de employees or former
employees of the company, including its subsidiary or holding company; or
(b) their spouses, civil partners, surviving spouses, surviving civil partners, or
minor children or stepchildren (s 1166). Employees shares are normally issued
7/19/2012 2:19:47 PM
Classes of shares and variation of class rights
as ordinary shares or preference shares and are typically subject to restrictions
relating to their disposal.
Variation of class rights
9.17
Section 630 of the Companies Act 2006 (which implements part of the Second
EC Company Law Directive) lays down the procedure for e
ecting a variation
of class rights in companies with a share capital. 
e objective of the statutory
requirements is to protect the class rights of shareholders so that they cannot be
varied or abrogated by the simple expedient of altering the companys constitu-
tion or the shareholders resolution in which they are contained.
Before examining the statutory procedure it is useful to consider two fundamental
7/19/2012 2:19:47 PM
Variation of class rights
Second are rights or bene
ts which, although contained in the articles, are con-
ferred on individuals not qua members or shareholders but, for ulterior reasons,
are connected with the administration of the companys a
airs. Scott J gave the
example of
Positive
Government
Security
Life
Assurance
Ltd
(1876) (see
para
8.32
), where the articles included a provision that the claimant should be
the company solicitor. Rights or bene
ts in this category cannot be regarded
as class rights. 
e third and 
nal category comprises rights or bene
ts that,
although not attached to any particular shares, are conferred on the bene
ciary
in his capacity as member or shareholder in the company. On the facts of the
case, it was held that provisions in the companys articles which gave the claim-
ant a pre-emptive right over the transfer of shares in the defendant company,
together with the right to nominate a director to its board so long as it held 10
per cent of the ordinary shares in the company, were class rights. Scott J cited
by way of example the House of Lords decision in
Bushe
ll
Faith
(1970) where
the articles gave a director weighted voting rights on a resolution to remove any
director from o
ce. 
e judge noted that in this case the right in question was
conferred on the director/bene
ciaries in their capacity as shareholders. 
e
article created, in e
ect, two classes of shareholdersnamely, shareholders who
were for the time being directors, on the one hand, and shareholders who were
not for the time being directors, on the other hand.
9.19
e signi
cance of the distinction drawn by Scott J lies in the protection a
orded
to the bene
ciaries of class rights because, as we shall see, such rights can only
be varied with their consent. Any other provision contained in the articles which
cannot properly be classi
ed as a class right can be altered by special resolution
under s 21 of the 2006 Act. 
e result of the decision in
Cumbrian
Newspapers
is that taking s 630 together with s 994 of the Companies Act 2006 (the main
minority shareholder protection provision, see Chapter 11), the rights of share-
holders are a
orded wide ranging protection (see
Smiths
Ltd
(2003), below).
Determining whether there is a variation or
abrogation of class rights
9.20
Whether or not a company has varied a shareholders class rights is not always
immediately apparent. In this respect the Companies Act 2006 is far from help-
ful. Section 630 lays down the procedure to be followed for a variation of class
rights but is silent on the nature and scope of a class right. 
e case law does,
however, provide some guidelines. It should be noted that the courts have gen-
erally adopted a restrictive approach and have sought to distinguish corporate
conduct which impacts upon the substance of a shareholders class right (which
7/19/2012 2:19:47 PM
Classes of shares and variation of class rights
would amount to a variation), from conduct which merely a
ects its exercise or
enjoyment. In
White
Bristo
Aerop
Ltd
(1953), the companys articles
(art 68) provided that the rights attached to any class of shares may be a
ected,
modi
ed, varied, dealt with, or abrogated in any manner with the approval of
an extraordinary resolution passed at a separate meeting of the members of that
class. 
e preference shareholders claimed that an issue of additional shares, both
preference and ordinary, a
ected their voting rights and therefore fell within art
68. 
e company argued that the proposal did not amount to a variation of class
rights but rather it was the e
ectiveness of the exercise of those rights which
had been a
ected and that therefore a separate meeting of the preference share-
holders was not required. 
e Court of Appeal agreed with the companys view.
Romer LJ stated:
[I]n my opinion it cannot be said that the rights of ordinary shareholders would
be affected by the issue of further ordinary capital; their rights would remain
just as they were before, and the only result would be that the class of persons
entitled to exercise those rights would be enlarged; and for my part I cannot
help thinking that a certain amount of confusion has crept into this case be-
tween rights on the one hand, and the result of exercising those rights on the
other hand.
(See also
Greenha
Arderne
Cinemas
Ltd
and
John
Tadcaster
Brewery
9.21
In order to prove that a proposed course of action constitutes a variation of class
rights, a shareholder will have to show that it will result in some substantive right
guaranteed in the companys constitution being modi
ed or abrogated altogether.
For example, a resolution proposing to reduce the  xed preferential cumula-
tive dividend to which a companys preference shareholders are entitled will, of
course, amount to a variation of class rights. Similarly, a proposal to change the
voting rights attaching to a particular class of share would also amount to a vari-
ation of their rights.
9.22
A successful claim was brought in
kstone
ieries
Ltd
(1954). As a
result of nationalisation, the companys colliery was taken into public ownership
by the National Coal Board. Pending the 
nal settlement of compensation, the
company had twice reduced its capital by returning part of the preference share-
holders capital investment. On both occasions the company had promised them
that they would not be bought out entirely but would remain as members so that
they could participate in the compensation scheme to be introduced under the
nationalisation legislation. Subsequently, it was proposed to reduce the compa-
nys capital for a third time by returning all outstanding capital to the preference
7/19/2012 2:19:47 PM
Variation of class rights
shareholders. 
e e
ect of this would be to cancel the class completely and they
would no longer qualify for compensation. 
e Court of Appeal, refusing to
sanction the reduction, held that the proposal amounted to an unfair variation of
class rights in so far as the preference shareholders had been promised that they
would be able to participate in the compensation scheme.
9.23
In general, however, a cancellation of a class of shares on a reduction of capital
will not be held to constitute a variation of class rights because such a course
of action must be viewed as consistent with the terms of issue of the particular
shares in question (
House
Fraser
ACGE
Investments
Ltd
(1987)). 
us in
tdean
Estate
Ltd
(1968), Buckley J said:
[I]t is said that the proposed cancellation of the preferred shares will constitute
an abrogation of all the rights attached to those shares which cannot validly
be effected without an extraordinary resolution of a class meeting of preferred
shareholders under article 8 of the companys articles. In my judgment, that
article has no application to a cancellation of shares on a reduction of capital
which is in accord with the rights attached to the shares of the company. Unless
this reduction can be shown to be unfair to the preferred shareholders on other
grounds, it is in accordance with the right and liability to prior repayment of
capital attached to their shares.
Buckley J went on to stress that the liability to prior repayment on a reduction
of capital corresponds with the right to prior return of capital in a winding-up.
Accordingly, the shareholders could not complain of an abrogation of class rights
because prior repayment on a reduction of capital was part of the bargain between
the shareholders and forms an integral part of the de
nition or delimitation of
the bundle of rights which make up a preferred share. Giving e
ect to it does not
involve the variation or abrogation of any right attached to such a share. However,
where a companys articles of association provide that a reduction of capital is to be
7/19/2012 2:19:48 PM
Classes of shares and variation of class rights
document is the articles of association and class rights can no longer be attached
by the memorandum. Section 630 provides that class rights may only be varied:
in accordance with the relevant provisions in the companys articles; or
(a)
if no such provision is made in the articles, if the holders of three-quarters
(b)
in value of the shares of that class consent either in writing or by special
resolution (passed at a separate meeting of the holders of such shares).
e company must then notify the Registrar of any variation of class rights within
one month from the date on which the variation is made (ss 637 and 640).
9.25
Although the CLRSG had recommended that the consent of 75 per cent of the
holders of the class a
ected should be a statutory minimum notwithstanding any
less onerous procedure contained in the companys articles, this was removed
from the Companies Bill at a fairly late stage. As a consequence, the companys
articles may specify either less or more demanding requirements for variation of
class rights than the default provisions laid down in the Act (see s 630(3)). 
is
has two important e
ects. First, if and to the extent that the company has adopted
a more onerous regime in its articles for the variation of class rights, for exam-
ple requiring a higher percentage than the statutory minimum, the company
must comply with the more onerous regime. Second, if and to the extent that the
company has protected class rights by making provision for the entrenchment of
those rights in its articles (see s 22 CA 2006), that protection cannot be circum-
vented by changing the class rights under s 630.
The common law requirements
9.26
e statutory procedure is supplemented by the common law requirement that
the shareholders voting at a class meeting must have regard to the interests of the
class as a whole. 
e principle here was explained by Viscount Haldane in
British
America
Nicke
Corpn
Brien
Ltd
(1927). Drawing the analogy between
shareholders voting for a special resolution to alter the articles of association and
voting on a resolution to vary class rights, he said:
There is, however, a restriction of such powers, when conferred on a majority of
a special class in order to enable that majority to bind a minority. They must
be exercised subject to a general principle, which is applicable to all authorities
conferred on majorities of classes enabling them to bind minorities; namely,
that the power given must be exercised for the purpose of bene
ting the class as
a whole, and not merely individual members only.
(See also
Investment
Trust
(1971), Megarry J.)
7/19/2012 2:19:48 PM
EU initiatives
Sealy and Worthington (2010) note that if taken to its logical conclusion, this rule
would have what must be the unintended consequence of not permitting a class
to subordinate its own interests to those of the company as a whole [so that] class
7/19/2012 2:19:48 PM
Classes of shares and variation of class rights
and information rights. It applies to traded companies, de
ned as those with
voting shares admitted to trading on an EEA regulated market, such as the UK
cial List. Following a consultation exercise carried out by BERR, (now the
Department for Business, Innovation and Skills), the Companies (Shareholders
Rights) Regulations 2009 (SI 2009/1632) came into force on 3 August 2009.
Although the Directive applies only to members of traded companies, the UK
Regulations introduce a number of changes which are of general application. In
essence, new voting procedures, including changes to returning proxy forms,
have been introduced, resulting in amendments to the relevant provisions of the
CA 2006. For example, a new s 360C permits the use of electronic voting for
shareholders in any company. For listed companies, changes have been made to
the notice periods for meetings (see ss 360C and 307A) and private companies
with traded shares are required to hold AGMs (see s 336(1A)). Other changes
include a new requirement to put information on the companys website.
FURTHER READING
This Chapter links with the materials in Chapter 9 of
Hicks and Goos Cases and
Materials on Company Law
, (2011, Oxford University Press, xl +649p).
Grantham The Doctrinal Basis of the Rights of Company Shareholders [1998]
CLJ
554.
Ireland Company Law and the Myth of Shareholder Ownership [1999]
MLR
32.
MacNeil Shareholders Pre-emptive Rights [2002]
JBL
78.
Polack Company LawClass Rights [1986]
CLJ
399.
Reynolds Shareholders Class Rights: A New Approach [1996]
JBL
554.
Rixon Competing Interests and Con
icting Principles: An Examination of the Power of
Alteration of Articles of Association [1986]
MLR
446.
Worthington Shares and shareholders: property, power and entitlement (Part I) [2001]
Co Law
258.
SELF-TEST QUESTIONS
What is meant by the term class right?
7/19/2012 2:19:48 PM
Self-test questions
over all shares issued by the company, and (ii) to nominate a director to the board
7/19/2012 2:19:48 PM
SUMMARY
Introduction
The rule in
Foss v Harbottle
: the proper claimant principle
The types of shareholder actions
Exceptions to the rule in
Foss v Harbottle
The statutory procedure: Companies Act 2006, Part 11
Section 996(2)(c) Companies Act 2006
Bars to a derivative action
Liability insurance and qualifying third party indemnity provisions
Conclusion
Introduction
10.1
We have come across the principle of majority rule in Chapter 1 in the context
of private companies and when discussing the s 33 contract in Chapter 8. It is
not overstating the matter to observe that the majority rule principle pervades
much of company law as it touches on the key issue of who owns and controls the
company. However, before embarking upon an examination of the majority rule
principle and the remedies available to shareholders when it is abused in this and
the next chapter, it is useful to consider brie
y the landscape against which the
relevant legal principles have developed.
10.2
As we observed in Chapter 2, one of the consequences of the doctrine of separate
personality is that a company can sue and be sued in its own name. 
e com-
pany as a legal entity can therefore sue to enforce its legal rights and can be sued
for breach of its legal duties. It is not generally open to individual shareholders
to initiate an action on the companys behalf. 
at decision must be le
to the
appropriate organ of the company (which is normally the board of directors). In
John Shaw & Sons (Salford) Ltd v Shaw
(1935), Greer LJ explained that:
Derivative claims
7/20/2012 5:20:04 PM
Introduction
If powers of management are vested in the directors, they and they alone can
exercise those powers. The only way in which the general body of the sharehold-
ers can control the exercise of the powers vested by the articles in the directors is
by altering the articles or . . . by refusing to re-elect the directors of whose powers
they disapprove. They cannot themselves usurp the powers by which the articles
are vested in the directors any more than the directors can usurp the powers
vested by the articles in the general body of shareholders.
(See also
Breckland Group Holdings Ltd v London & Su
olk Properties Ltd
7/20/2012 5:20:05 PM
Derivative claims
dispersed even those with less than an absolute majority in percentage terms (
de
facto
control) are nevertheless able to exercise disproportionate power by virtue
of the concentration of shares and consequent voting rights which they hold. In
ect smaller shareholders will not bother voting, which leaves larger but not
majority shareholders in a position to control the company. If no shareholder
has legal or
de facto
control the directors will have virtually unlimited decision-
making power. 
is will be the case where there are no larger shareholders, just
dispersed small shareholders (see further, Chapter 15 on the emergence of the
managerial corporation).
7/20/2012 5:20:05 PM
The rule in
Foss v Harbottle
: the proper claimant principle
within their powers, and in fact has no jurisdiction to do so. Again, it is clear law
that, in order to redress a wrong done to the company or to recover money or
damages alleged to be due to the company, the action should
prima facie
be
brought by the company itself.
10.6
In
Foss v Harbottle
(1843) two members of the Victoria Park Co brought an action
against the companys 
ve directors and promoters alleging that they had mis-
applied company assets and had improperly mortgaged its property. 
e action
sought to compel the defendants to make good the losses sustained by the com-
pany and also sought the appointment of a receiver. It was held that the injury in
question was not su
ered by the claimants exclusively, but was an injury against
the whole company. Further, given that it was open to the majority in general
meeting to approve the defendants conduct, the claimants action must fail: to
allow the minority to bring an action in these circumstances would risk frustrat-
ing the wishes of the majority. Wigram V-C observed:
[I]t is only necessary to refer to the clauses of the Act to show that, whilst the su-
preme governing body, the proprietors at a special general meeting assembled,
retain the power of exercising the functions conferred upon them by the Act of
Incorporation, it cannot be competent to individual corporators to sue in the
manner proposed by the plaintiffs on the present record . . . .The very fact that
the governing body of proprietors assembled at the special meeting may so bind
even a reluctant minority is decisive to show that the frame of this suit cannot
be sustained whilst that body retains its functions.
is point was again considered in
MacDougall v Gardiner
e chairman
7/20/2012 5:20:06 PM
Derivative claims
(See also the comments of Lord Cottenham LC in
Mozley v Alston
(1847); and Lord
Bingham in
Johnson v Gore Wood & Co
The types of shareholder actions
10.7
e rule in
Foss v Harbottle
(1843) is not an absolute bar to individual share-
holders bringing an action in respect of an alleged wrong. 
e various means by
which legal proceedings may be brought are outlined below. In broad terms we
can categorise such actions into two. 
e 
rst type is where a claim is brought to
vindicate a wrong done to the company. As we saw in Chapter 2, one consequence
of the
Salomon
principle is that the company, as a legal entity, can sue in order
to obtain redress for a wrong committed against it. A practical di
culty arises,
however, where the wrongdoers, for example the directors, control the company
and prevent it from bringing an action. 
ere are, therefore, a limited range of
principles, both common law and statutory, which are directed towards solving
this problem and, in this regard, the emphasis of this Chapter lies with consider-
ing the circumstances when individual shareholders may bring a derivative claim
on behalf of the company. 
is form of action has now been put on a statutory
footing by virtue of the Companies Act 2006, Part 11. 
e second type of action
arises where a shareholder complains that a wrong has been done to him or her
personally (as opposed to the company). Here the appropriate course of action
is to bring a personal or representative action (the reforms introduced by Part
11 of the 2006 Act do not apply to personal claims). Additionally, a shareholder
may also be granted standing by speci
c provisions contained in the CA 2006.
For example, we saw in Chapter 9 that s 633 CA 2006 gives the holders of not less
than 15 per cent of the issued shares of the class in question, the right to apply
to the court to have a variation of class rights cancelled. Further, s 994 provides
for a minority shareholder to apply to the court by petition to remedy unfairly
prejudicial conduct on the part of the majority (see Chapter 11, below).
Personal claims
10.8
It is evident from the judgment of Mellish LJ in
MacDougall v Gardiner
(1875),
para
10.6
, above) that where a right of a shareholder has been infringed by the
majority he can sue. Here the injury or wrong in question is not su
ered by the
company as such, but by the shareholder and, therefore, the anxiety underlying
Foss v Harbottle
(1843) does not arise. Shareholders rights can arise by virtue of
a contract (for example, as we discussed in Chapter 8, under the companys con-
stitution or a shareholders agreement): thus, where a dividend is declared but not
7/20/2012 5:20:06 PM
The types of shareholder actions
paid, then a shareholder can sue for payment by way of a legal debt (see, generally,
Wood v Odessa Waterworks Co
(1889);
Bond v Barrow Haematite Steel Co
(1902);
and
Lee v Sheard
(1956)).
Personal claims for re
ective loss
10.9
It should be noted that where the wrong results in a loss to the company and
the only loss alleged to have been su
ered by the shareholder is re
ected in the
loss sustained by the company the courts will not permit a personal action. 
e
principle was succinctly stated by the Court of Appeal in
Prudential Assurance
Co Ltd v Newman Industries Ltd (No 2)
(1982):
But what [a shareholder] cannot do is to recover damages merely because the
company in which he is interested has suffered damage. He cannot recover a
sum equal to the diminution in the market value of his shares, or equal to the
likely diminution in dividend, because such a loss is merely a re
ection of the
loss suffered by the company. The shareholder does not suffer any personal loss.
His only loss is through the company, in the diminution in the value of the net
assets of the company.
10.10
In
Stein v Blake (No 2)
(1998), Millett LJ unhesitatingly rejected a claim alleg-
ing wrongful misappropriation of the companys assets which resulted in a
diminution of shareholding value on the basis that the company was the
only
proper claimant. 
e particular claimants loss merely re
ected that sustained
by the company (for examples where the claimants action has been denied on
the no-re
ective loss principle, see
Rushmer v Mervyn Smith
(2009);
Rawnsley
v Weatherall Green & Smith
(2009) and
Gaetano Ltd v Obertor Ltd
(2009)). 
e
principal di
culty facing a shareholder in a company which has su
ered loss
as the result of the conduct of a third party, where, as in
Stein v Blake,
he too
claims to have su
ered loss from that conduct, is that of establishing causation
Gerber Garment Technology Inc v Lectra Systems Ltd
(1997)). A major hurdle,
as will be seen in Chapter 14, is the principle that directors owe their duties not
to individual shareholders but to the company (see, for example, s 170 CA 2006;
Percival v Wright
(1902) and
Peskin v Anderson
(2001)thus, the company itself
must sue for breach). But where the shareholder can establish that the defend-
ants conduct constituted a breach of some legal duty owed to him personally (for
example, under the law of contract, torts or, as in
Walker v Stones
(2001), trusts),
and the court is satis
ed that such breach of duty caused him personal loss, sep-
arate and distinct from that su
ered by the company, he will be permitted to
bring a personal action (see
Foss v Harbottle
(above);
Prudential Assurance Co
Ltd v Newman Industries Ltd (No 2)
(1982);
Walker v Stones
(above); and
Johnson
v Gore Wood & Co
(2002), Lord Millett). In the
Johnson
case the claimant, a
7/20/2012 5:20:06 PM
Derivative claims
majority shareholder in a company, sued a 
rm of solicitors in negligence on the
ground that their conduct has caused him loss personally. Parallel proceedings
brought by the company against the solicitors had been settled. 
e defendants
argued that the shareholders action brought on the same facts was an abuse of
process and amounted to a claim for re
ective loss. Lord Bingham summarised
the authorities as supporting three propositions:
(1) Where a company suffers loss caused by a breach of duty owed to it, only
the company may sue in respect of that loss. No action lies at the suit of a
shareholder suing in that capacity and no other to make good a diminution in
the value of the shareholders shareholding where that merely re
ects the loss
suffered by the company. A claim will not lie by a shareholder to make good
a loss which would be made good if the companys assets were replenished
through action against the party responsible for the loss, even if the company,
acting through its constitutional organs, has declined or failed to make good
that loss . . . (2) Where a company suffers loss but has no cause of action to sue to
recover that loss, the shareholder in the company may sue in respect of it (if the
shareholder has a cause of action to do so), even though the loss is a diminution
in the value of the shareholding . . . (3) Where a company suffers loss caused by a
breach of duty to it, and a shareholder suffers a loss separate and distinct from
that suffered by the company caused by breach of a duty independently owed
to the shareholder, each may sue to recover the loss caused to it by breach of
the duty owed to it but neither may recover loss caused to the other by breach
of the duty owed to that other.
7/20/2012 5:20:06 PM
The types of shareholder actions
10.11
e no re
ective loss principle has generated a signi
cant body of litigation in
which its contours have been subjected to considerable judicial scrutiny. In
Ellis
v Property Leeds (UK) Ltd
(2002),
the Court of Appeal held that the bar on such
claims applies equally where the claimant is suing qua director as to when he sues
qua shareholder. It will also trigger to prevent a claim brought qua creditor or
employee, and the fact that a company is in administrative receivership does not
prevent it from pursuing any claim for wrongdoing (see
Gardner v Parker
(2004),
in which the Court of Appeal also stressed that the bar is an obvious consequence
of the rule against double recovery). Nevertheless, as noted above, the prohibition
can be circumvented where the shareholder is able to bring a claim qua bene
ci-
ary of a trust of shares of which the wrongdoer is trustee (see
Walker v Stones
(above); and
Shaker v Al-Bedrawi
(2003)). 
ese decisions suggest that the need
to ensure proper trusteeship is the overriding policy consideration so that the no
re
ective loss principle must give way in such circumstances.
10.12
Notwithstanding the formidable array of barriers to claims for re
ective loss,
it is possible for a shareholder to overcome them. For example, in
Giles v Rhind
(2003), the company was insolvent due to a former directors breach of certain
duties (not to compete or misuse con
dential information). Both duties were also
express terms in a shareholders agreement to which the defendant and claimant
were parties. Although the company had initiated an action against its former
director, the administrative receivers discontinued it when the defendant direc-
tor applied for a security of costs order. In e
ect, the defendant had, by his breach
of duty, rendered the company incapable of seeking legal redress against him.
e claimant sought to recover losses to the value of his shareholding, loss of
remuneration and loss of the value of loan stock. 
e Court of Appeal, in placing
considerable emphasis on the fact that the defendants own wrongdoing had, in
ect, disabled the company from suing him for damages, found that this situa-
tion had not confronted the House of Lords in
Johnson v Gore Wood & Co
(above).
Given that the duties in question were expressly provided for in the sharehold-
ers agreement it was held that the claimant could pursue his claim for breach
of the agreement including his losses in respect of the value of his shareholding.
e claims for loss of remuneration and losses of capital and interest in respect
of loans made by him to the company did not, in any case, fall within re
ective
losses. 
us, in
Giles v Rhind (No 2)
(2003), the court awarded a substantial sum
by way of damages (see also,
Webster v Sandersons Solicitors
(2009)). 
e deci-
sion in
Giles
has not escaped criticism. In the decision of the Final Appeal Court
of Hong Kong in
Waddington v Chan Chun Hoo
(2008), Lord Millett took the
view that no such exception existed and that
Giles
had, therefore, been wrongly
decided. He concluded that to permit such an action would allow the plainti
to obtain by a judgment of the court the very extraction of value from the com-
pany at the expense of its creditors that it alleged the defendant had obtained by
7/20/2012 5:20:07 PM
Derivative claims
fraud. It is noteworthy, however, that the court in
Atlasview Ltd v Brightview Ltd
(2004) dismissed the argument that claims for re
ective loss fell outwith s 994
petitions. Should the English Supreme Court follow the position taken by Lord
Millett, actions falling within the
Giles v Rhind
exception may, therefore, have to
be brought under the unfair prejudice provision (see Chapter 11).
Representative actions (group litigation)
10.13
Where a representative action is brought, the claimant is suing on behalf of
himself and other members who have the same right which, it is alleged, has
been abused or infringed (it is more common for a whole class of shareholders
as opposed to any particular individual to be adversely a
ected by the conduct
which is called into question). In such a case an individual may bring an action
in a representative form. Civil Procedure Rule (CPR) 19.6, replacing Order 15,
rule 12(1) of the Rules of the Supreme Court (RSC), now governs representative
actions. CPR 19.6(1) provides that where more than one person has the same
interest in a claim: (a) the claim may be begun; or (b) the court may order that
the claim be continued, by or against one or more of the persons who have the
same interest as representatives of any other persons who have that interest. CPR
19.6(4) goes on to add that unless the court otherwise directs, any judgment or
order given in a claim in which a party is acting as a representative under this
rule is binding on all persons represented in the claim; but may only be enforced
by or against a person who is not a party to the claim with the permission of the
court. 
e danger of multiplicity of suits is therefore avoided (see, for example,
uin & Axtens Ltd v Salmon
(1909)).
Derivative claims: the statutory procedure and the shadow
of the common law
10.14
Derivative claims are de
ned by s 260(1) CA 2006 as proceedings brought by
a member of a company in respect of a cause of action vested in the company
and seeking relief on behalf of the company. 
e statutory provisions setting
out the procedural requirements do not replace the rule in
Foss v Harbottle
with a substantive rule but rather seek to implement the recommendations of
the Law Commission (see the LCCP No 142 (1996) and the ensuing Report,
No 246 (Cm 3769, 1997)) that there should be a new derivative procedure with
more modern, 
exible and accessible criteria. 
e Law Commissions Report
endorsed the proper claimant principle as sound, but criticised the rule in
Foss
v Harbottle
as complicated and unwieldy. More particularly, the Report con-
cludes that the procedural complexities were such that establishing
locus standi
to bring a derivative action results in a mini-trial which increases the length and
7/20/2012 5:20:07 PM
Exceptions to the rule in
Foss v Harbottle
cost of litigation. Because of amendments introduced at a fairly late stage as the
Companies Bill was proceeding through Parliament, the common law excep-
tions to the rule in
Foss v Harbottle
are, sadly, still material because the condi-
tions laid down for obtaining the courts permission to continue the claim are
rooted in the common law requirements. Consequently, we cannot jettison the
case law entirely given that the decisions o
er illustrations of the issues relevant
to the exercise of the discretion conferred on the court by ss 261264 of the 2006
Act (discussed below).
Exceptions to the rule in
Foss v Harbottle
10.15
Having restated the rule, Jenkins LJ in
Edwards v Halliwell
(1950) (above,
para
10.5
) considered the circumstances in which it will not operate to prevent a
shareholder from suing. In essence, he stated that there were four exceptions to
the rule in
Foss v Harbottle
(1843):
where the act complained of is illegal or is wholly ultra vires the
(i)
company;
where the matter in issue requires the sanction of a special majority, or
(ii)
there has been non-compliance with a special procedure;
where a members personal rights have been infringed;
(iii)
where a fraud has been perpetrated on the minority and the wrongdoers
(iv)
are in control.
7/20/2012 5:20:07 PM
Derivative claims
acting because it infringed his personal right as an investor to have the business
conducted in accordance with the memorandum and the articles of association.
However, where the shareholder is seeking damages for the loss su
ered by the
company as a result of a transaction actually entered into, the action will fail
if he does not satisfy the requirement of wrongdoer control: see below (
Taylor
v National Union of Mineworkers (Derbyshire Area)
(1985)). 
is is because
the wrong is done to the company directly, and so the company is the proper
claimant.
10.17
With respect to pure ultra vires acts, as distinct from illegality, the position
is now quali
ed by s 40(4) of the 2006 Act which provides that a member may
not bring proceedings in respect of an ultra vires act if it is to be done in ful
l-
ment of a legal obligation arising from a previous act of the company (see further,
Chapter 12).
(ii) Where the matter in issue requires the sanction
of a special majority, or there has been non-compliance
with a special procedure
10.18
An individual shareholder will have
locus standi
to sue where the act complained
of is one which requires the approval of a special majority of members and such
a resolution has not been obtained. In
Edwards v Halliwell
(1950) two members
of a trade union obtained a declaration that a resolution increasing members
subscriptions was invalid because the required two-thirds majority for such a
resolution had not been obtained. Jenkins LJ said that:
[T]he reason for [the] exception is clear, because otherwise, if the rule were ap-
plied in its full rigour, a company which, by its directors, had broken its own
regulations by doing something without a special resolution which could only
be done validly by a special resolution could assert that it alone was the proper
plaintiff in any consequent action and the effect would be to allow a company
acting in breach of its articles to do
de facto
by ordinary resolution that which
according to its own regulations could only be done by special resolution. That
exception exactly
ts the present case.
In other words, this is not a true exception to the rule in
Foss v Harbottle
7/20/2012 5:20:08 PM
Exceptions to the rule in
Foss v Harbottle
requiring a special resolution, the court may grant an injunction to an individual
member prohibiting the majority from acting in breach of the article in ques-
tion (
uin & Axtens Ltd v Salmon
(1909)). 
e decision in
Edwards v Halliwell
(1950) itself can be explained on the basis that the two members in question had
a personal right not to have their subscriptions increased without the proper
procedure being followed.
(iii) Where a members personal rights have been infringed
10.20
In these circumstances a member does not have an absolute right to sue. In
seeking to bring an action under this exception to the rule in
Foss v Harbottle
(1843) there are two hurdles which must be overcome: 
rst, the bar on enforcing
so-called outsider rights conferred on a member by the articles of association;
and second, the di
culty in predicting when the court will hold that the breach
of a provision in the companys constitution is a mere internal irregularity of
procedure, and therefore a wrong to the company, as opposed to a constitutional
infringement (a matter of substance) for which a member can sue. 
e distinc-
tion between these two types of irregularity can be obscure.
10.21
e 
rst hurdle referred to above encompasses the di
culties surrounding the
enforceability of rights purportedly conferred on a member by the articles of
association and, more particularly, the distinction between insider rights, which
are enforceable by virtue of the statutory contract, and outsider rights which,
traditionally at least, are viewed as not enforceable (see Chapter 8).
10.22
With respect to the second hurdle, in
MacDougall v Gardiner
(1875) the Court of
Appeal reasoned that if every irregularity could be litigated by a member then if
there happens to be one cantankerous member, or one member who loves litiga-
tion, everything of this kind [as on the facts] will be litigated (see also
Bamford
v Bamford
(1970), Harman LJ). On the other hand, in
Pender v Lushington
(1877)
Jessell MR held that a member has a personal right to have his vote counted and
could sue in the companys name and in his own name to enforce that right. It is
noteworthy that the judge placed emphasis on the fact that at issue was a ques-
tion of property rights. Attempts at reconciling the case law can be a frustrating
exercise. Sealy and Worthington ((2010) at 637) note that where the infringement
relates to a constitutional right which also carries an element of property, such
as the right to vote and be counted, or not to have ones union dues increased
without proper procedure (see
Edwards v Halliwell
(above, para
10.5
), or to have
a declared dividend paid in accordance with the articlesthen the courts rec-
ognise the right of an individual member to sue. But mere irregularities which
can be waived by a majority vote or, indeed, acquiesced in by the majority will
not support a members action (see
MacDougall v Gardiner
(1875) and
Mozley
7/20/2012 5:20:08 PM
Derivative claims
v Alston
(1847), above; and
Devlin v Slough Estates Ltd
(1983) in which, curi-
ously, the court held that a member could not sue personally, or bring a derivative
action, for breach of a statutory duty relating to the form and distribution of the
companys accounts).
(iv) A fraud has been perpetrated against the company
and the wrongdoers are in controlthe true exception to
Foss v Harbottle
10.23
It has been long settled that the one true exception to the rule in
Foss v Harbottle
(1843) is where a fraud has been perpetrated against the company by those who
hold and control the majority of shares in the company and will not permit
an action to be brought in the name of the company
(Burland v Earle
(1902),
Lord Davey).
10.24
e e
ect of the fraud here is to render any resolution purporting to ratify the
conduct voidable
(Brown v British Abrasive Wheel Co
(1919), Astbury J). Before
the introduction of the statutory procedure by the Companies Act 2006, the
exception operated as a procedural device whereby a shareholder could institute
a derivative action to enforce the companys rights. It was common in the early
case law to refer to this exception as being a fraud on the minority, however,
nothing turns on thisany fraud has, in truth, been perpetuated against the
company and the award will be in the companys name. 
is distinction should
be carefully observed.
Meaning of fraud
10.25
e judges have not set precise parameters on the meaning of fraud in this con-
text although it has been acknowledged that it is plainly wider than fraud at
common law. In
Estmanco (Kilner House) Ltd v Greater London Council
(1982),
Megarry V-C said that the essence of the matter seems to be an abuse or misuse
of power and that the term carried its wider equitable meaning. It therefore cov-
ers conduct that is plainly improper but not necessarily deceitful. Templeman J in
Daniels v Daniels
(1978) took the view that the exception would permit a minor-
ity to sue even in the absence of fraud where directors have abused their powers,
intentionally or unintentionally, fraudulently or negligently, in a manner which
bene
ts themselves at the expense of the company. 
e judge concluded that
fraud should extend to cases of self-serving negligence which is tantamount to
misappropriation of company assets. 
is accords with the view expressed by
Lord Davey in
Burland v Earle
(1902) who gave the following examples of fraudu-
lent conduct:
7/20/2012 5:20:08 PM
Exceptions to the rule in
Foss v Harbottle
[W]hen the majority are endeavouring directly or indirectly to appropriate to
themselves money, property or advantages which belong to the company or in
which the other shareholders are entitled to participate.
On the other hand, in
Pavlides v Jensen
(1956) Danckwerts J accepted that the forbear-
7/20/2012 5:20:08 PM
Derivative claims
(Cumming-Bruce, Templeman and Brightman LJJ) also took a realistic view of
the meaning of control noting that it should not necessarily be limited to
de jure
control, but that it could encompass the situation where the majority vote is made
up of those votes cast by the delinquent himself plus those voting with him as a
result of in
uence or apathy.
10.28
Some tempering of this dilution of the control requirement was undertaken by
Knox J in
Smith v Cro
(No 2)
(1988). He stated that if the majority of the remain-
ing shareholders who were independent of the wrongdoers (termed the majority
inside the minority) did not desire the proceedings for disinterested reasons,
the single member seeking to sue would be denied
locus standi.
Indeed, on the
facts of the case, the action did not proceed for this reason. In determining the
independence of the shareholders, Knox J was of the view that their:
votes should be disregarded if, but only if, the court is satis
ed either that the
vote or its equivalent is actually cast with a view to supporting the defendants
rather than securing bene
t to the company, or that the situation of the person
whose vote is considered is such that there is a substantial risk of that happen-
ing. The court should not substitute its own opinion but can, and in my view
should, assess whether the decision making process is vitiated by being or being
likely to be directed to an improper purpose.
10.29
Davies has observed that this development represents a signi
cant tightening of
the
locus standi
conditions to be met by an individual shareholder who wishes to
sue in order to vindicate a wrong to the company (whether it be by way of a fraud
(for example, expropriating an asset belonging to the company) or, as on the facts
of
Smith v Cro
(1986) itself, illegality and ultra vires). If a majority of the minor-
ity decide not to support the action, the individual shareholder will not be able
to initiate proceedings notwithstanding that he satis
es the requirements of
Foss
v Harbottle
(1843). 
e views of Knox J therefore went to the root of the deriva-
tive action in that the rati
ability of the wrongful act in question by the majority
in general meeting was no longer decisive. Indeed, even if the wrong was not
rati
able by the company in general meeting, if the majority inside the minor-
ity of independent shareholders decided against legal proceedings the individual
shareholder would not be permitted to enforce the companys rights. Davies con-
cludes that this development, together with the antipathy shown towards indi-
vidual shareholders who initiate actions (see, for example, the Court of Appeals
refusal to endorse the public spirit of the claimants in bringing the action in
Prudential Assurance),
highlights how the derivative action came to be seen not
as an integral part of the enforcement apparatus of the law but as a weapon of
last resort (Davies (2003), at 463). It was such criticisms that gave impetus to the
calls for a simpli
ed statutory derivative action which was embraced by the Law
Commission and endorsed by the CLRSG.
7/20/2012 5:20:08 PM
The statutory procedure: Companies Act 2006, Part 11
10.30
Before turning to consider the new statutory procedure, it should be noted that
in the cases following
Smith v Cro
(No 2)
the courts continued to develop strict
conditions for shareholder-claimants to meet. 
us, the view was taken that since
the origins of the derivative action are rooted in equity, its availability was a mat-
ter within the discretion of the court, and in exercising its discretion the court
would have regard to all circumstances, including the claimants conduct (i.e.
the clean hands maxim), his motives in seeking to sue and the availability of
alternative remedies. For example, in
Barrett v Duckett
(1995), Mrs Barrett (B)
and Mr Duckett (D) each owned 50 per cent of the shares in the company, Travel
Ltd. B initiated a derivative action against D, Ds wife, the company and another
company (X Ltd) controlled by D and his wife. B claimed that D and his wife had
set up X Ltd for the purpose of diverting business away from Travel Ltd to it. She
also claimed that D and his wife had pro
ted from various breaches of 
duciary
duty and had paid themselves excessive remuneration. 
e defendants presented
a claim for the winding-up of the company on the basis of the companys insol-
vency and, alternatively, the just and equitable ground on the basis of deadlock,
and applied to have Bs action struck out. 
e Court of Appeal held that the wind-
ing-up petition, which was lodged before Bs action was commenced and, indeed,
before B had intimated that she was considering bringing a derivative suit, was
an alternative remedy and therefore the derivative action ought to be struck out.
e court was also mindful of the fact that B was motivated not by the companys
interests, but by personal reasons following the divorce of her daughter from D
(see further,
Nurcombe v Nurcombe
(1985)).
10.31
e judgment of Peter Gibson LJ in
Barrett v Duckett
was considered at length
and applied in
Portfolios of Distinction Ltd v Laird
(2004). Launcelot Henderson
QC, sitting as a Deputy High Court Judge, stressed that in determining whether
to permit a derivative action to continue the shareholder must establish a posi-
tive case for being allowed to sue on behalf of the company, and that the share-
holder will be allowed to do so only if two conditions are satis
ed, namely that he
is bringing the action bona 
de for the bene
t of the company, and that no other
adequate remedy is available.
The statutory procedure: Companies
Act 2006, Part 11
10.32
As we saw above, s 260(1) CA 2006 de
nes derivative claims as proceedings
brought by a member of a company in respect of a cause of action vested in the
company and seeking relief on behalf of the company. 
e grounds for bringing
a derivative claim are laid down by s 260(3) which provides that such a claim may
7/20/2012 5:20:08 PM
Derivative claims
be brought
only
in respect of a cause of action arising from an actual or proposed
act or omission involving negligence, default, breach of duty or breach of trust
by a director of the company (the term director is broadly de
ned and includes
former directors and shadow directors (as to which, see Chapter 13). 
e provi-
sion has some signi
cant facets. It is clear that claims against directors for breach
of their duties owed to the company (now restated in Part 10 of the 2006 Act (see
Chapter 14)) fall within its scope and in this respect s 260(3) is wider than the
common law action it replaces in so far as it permits a derivative claim in cases
involving breach of the duty to exercise reasonable care, skill and diligence (see
s 174 CA 2006). Signi
cantly, under the statutory procedure there is no need to
demonstrate fraud on the minority and wrongdoer control, so that even where
the defendant director has acted in good faith and has not gained personally,
a claim can nevertheless be brought (
cf Pavlides v Jensen
(above, para
10.25
).
Section 260(3) also makes it clear that a derivative claim may be brought, for
example, against a third party who dishonestly assists a directors breach of 
du-
ciary duty or one who knowingly receives property in breach of a 
duciary duty
(see further, Chapter 14). Further, it is immaterial whether the cause of action
arose before or a
er the person seeking to bring or continue the derivative claim
became a member of the company (s 260(4)).
The application for permission to continue a derivative
claim: the two stage process.
10.33
e procedural rules are contained in CPR rules 19.9 to 19.F and Practice
Direction 19C. Section 261 states that once a derivative claim has been brought,
the member must apply to the court for permission to continue it. 
is is the 
rst
step in a two stage process. It is designed to enable the court to make a decision
quickly as to whether the permission application should be permitted to proceed
in the absence of the companys involvement. A paper hearing will take place
where the court considers the members evidence. 
e onus is on the member
to establish that he or she has a
prima facie
case for permission to continue the
derivative claim. If this is not demonstrated the court will dismiss the applica-
tion. If the application is dismissed at this stage, the applicant may request the
court to reconsider its decision at an oral hearing, although no new evidence
will be permitted at this hearing from either the member or the company. 
e
Practice Direction 19C, Derivative Claims, which amends Part 19 of the Civil
Procedure Rules (CPR), provides that this stage of the application will normally
be decided without submissions from the company. If the court does not dismiss
the application at this stage, the application will then proceed to the full permis-
sion hearing and the court may order the company to provide evidence at this
stage. In
Iesini v Westrip Holdings Ltd
(2009), the court, commenting on the 
rst
stage of the permission process, said:
7/20/2012 5:20:09 PM
The statutory procedure: Companies Act 2006, Part 11
The Act now provides for a two-stage procedure where it is the member him-
self who brings the proceedings. At the
rst stage, the applicant is required to
make a prima facie case for permission to continue a derivative claim, and the
court considers the question on the basis of the evidence
led by the applicant
only, without requiring evidence from the defendant company. The court must
dismiss the application if the applicant cannot establish a prima facie case. The
prima facie case to which s 261(1) refers is a prima facie case for giving permis-
sion. This necessarily entails a decision that there is a prima facie case both that
the company has a good cause of action and that the cause of action arises out
of a directors default, breach of duty (etc). This is precisely the decision that the
Court of Appeal required in
Prudential
Accordingly, the threshold test at the 
rst stage for permission is relatively low. 
e
role of the court is to 
lter out cases that stand little or no chance of success such
that they should not be permitted to proceed to the second stage. In practice, the
parties have been able to bypass the 
rst stage where the defendants concede that
there is a prima facie case (see, for example,
Franbar Holdings Ltd v Patel
or where the court is prepared to hear the 
rst and second stages for permission
together (see, for example,
Stimpson v Southern Landlords Association
(2010)). Such
con
ation of the two stage process has the advantage of saving costs. However, this
practice was severely criticised by the court in
Re Seven Holdings, Langley Ward Ltd
v Trevor
e judge said:
My experience in this case . . . suggests that applications of this sort are set fair to
become another time-consuming and expensive staple in the industry of satel-
lite litigation. In the present case, the court was presented with three lever-arch
les of pleadings, statements and documents in addition to detailed skeleton
arguments and extensive lists of authorities. The argument before me was con-
tained within a day, but only as the result of extensive (and underestimated)
pre-reading by the court . . . .
The inclusion in the Companies Act of an
ex parte
stage provides a hurdle
and
lter which in my view should not be dispensed with. As with any
ex parte
application the matter should be presented and explained transparently and
fairly so that the court can make a properly informed decision whether it is
right to put the company (and the potential defendant) to the expense and
inconvenience of considering and contesting the application. This can only be
achieved if the applicant sets out clearly and coherently the nature and basis
of each claim . . . .
[T]hose standards were not met in the present case. If they had been, the task
of the court would have been greatly simpli
ed, even though the case did not
in the event pass through the [second]
lter stage. Moreover, if that stage had
been observed, it seems to me likely that at least a large number of claims, and
7/20/2012 5:20:09 PM
Derivative claims
perhaps all of them, would have been eliminated then. Either way the cost and
time expended by the parties and court in this matter would have been signi
cantly reduced . . . .
10.34
Section 263(2) sets out the criteria which the court must take into account when
determining whether to grant permission to a member to continue a derivative
claim. It directs that permission must be refused if the court is satis
ed that:
a person acting in accordance with s 172 (duty to promote the success of
(a)
the company) would not seek to continue the claim; or
where the claim arises from an act or omission that is yet to occur, that
(b)
the act or omission has been authorised by the company; or
where the complaint arises from an act or omission that has already oc-
(c)
curred, that act or omission was authorised before it occurred, or has
been rati
ed since it occurred.
Accordingly, these factors represent a total bar to a derivative claim proceeding. 
e
requirement that the court should take into account the importance that a director
acting in accordance with the duty to promote the success of the company would
attach to the claim appears to dispense with the old common law prerequisite of
wrongdoer control. 
7/20/2012 5:20:09 PM
The statutory procedure: Companies Act 2006, Part 11
10.35
Provision is also made for an alternative member of the company to apply to the
court to continue a derivative claim originally brought by another member but
which is being poorly conducted by him or her. Section 264 provides that the
court may grant permission to continue the claim where the manner in which
the proceedings have been commenced or continued by the original claimant
amounts to an abuse of the process of the court, the claimant has failed to pros-
ecute the claim diligently, and it is appropriate for the applicant to continue the
claim as a derivative claim. Similarly, by virtue of s 262, where a company has ini-
tiated proceedings and the cause of action could be pursued as a derivative claim,
a member may apply to the court to continue the action as a derivative claim on
the same grounds listed in s 264. 
is addresses the situation where directors
fearing a derivative claim by a member seek to block it by causing the company
to sue but with no genuine intention of pursuing the action diligently.
10.36
If we compare the language of ss 261264 with the common law rules it replaces,
it is apparent that there is little or no change of emphasis in terms of formula-
tion. 
e focus of the rule laid down in
Foss v Harbottle
and its jurisprudence was
on prohibiting claims unless one of the exceptions to the rule was satis
ed. 
e
statutory language similarly proceeds from the rather negative standpoint that
the court
must
dismiss
the application or claim in the circumstances speci
ed in
ss 261(2), 262(3), 263(2)(3) and 264(3). It is noteworthy that during the course
of the Parliamentary debates on the Bill, the point was made that the new statu-
tory procedure carried the risk of increased litigation against directors which
could impede the e
cient management of companies (in this regard, it should
be recalled that the derivative claim has been expanded to include claims against
directors for negligence). One particular solution thought to o
er some safeguard
against this risk was introduced in the House of Lords, by way of amendment, in
the form of the additional procedural requirement contained in 263(4) (see paras
10.2830,
above).
10.37
Without doubt, the new procedural requirements, as was the case before their
introduction, represent signi
cant hurdles to be overcome and the early case
law decided under Part 11 of the Act shows that the courts are adopting a cau-
tious approach when called upon to exercise their discretion under ss 261264.
In
Mission Capital plc v Sinclair
(2008), two directors of Mission Capital were
dismissed from the board and their service contracts were terminated. 
e com-
pany later brought an action against them. 
ey counterclaimed seeking rein-
statement. Further, the former directors, who also held shares in the company,
launched a derivative claim against the continuing directors. In denying the
permission application, the High Court considered the discretionary factors to
be taken into account and decided that a notional director acting in accord-
ance with his s 172 duty to promote the success of the company would give
7/20/2012 5:20:09 PM
Derivative claims
little weight to continuing the claim. Further, as shareholders, they could pursue
their claims under the unfair prejudice provision. In
Franbar Holdings v Patel
(2008), the claimant was a shareholder of the corporate defendants and the other
defendants were directors. Disagreements arose about the way the business was
being managed and about the proper operation of a shareholders agreement.
e claimant brought an action for breach of the shareholders agreement, an
unfair prejudice petition and a derivative claim against the directors. In relation
to the derivative claim, the court found that the mandatory factors under s 263(2)
were not made out. With respect to the discretionary factors under s 263(3), the
court found that a notional director would not attach particular importance to
the continuation of the derivative claim because the matters complained of were
also covered by the action based on the shareholders agreement and the s 994
petition.
Similarly, permission was also refused in
Stimpson
Southern
Landlords
Association
(2010), where the applicants motives were a deciding factor in
7/20/2012 5:20:10 PM
The statutory procedure: Companies Act 2006, Part 11
to refuse leave. Similarly, in
Jafari-Fini v Skillglass
(2005) the Court of Appeal
upheld the judges refusal to allow the derivative claim to continue. Chadwick
LJ explained that the company itself would not bene
t from the action and
the claimant shareholder had alternative avenues open to him, in particular,
a personal claim (see also,
Harley Street Capital Ltd v Tchigirinsky
(2006), and
Barrett v Duckett
(1995), para
10.30
above).
However, in
Kiani v Cooper
(2010), limited permission to continue the claim down
to disclosure in the action was granted. 
e application by K, a director and share-
holder of the company, related to allegations of breaches of 
duciary duty by C, the
other director and shareholder in the company. It also extended to applications
restraining the presentation of winding-up petitions threatened by C and the third
defendant, DPM Property Services Ltd (DPM), a company in which C was both a
director and the majority shareholder. On the facts, Proudman J, having reviewed
s 263(3), identi
ed as crucial factors the requirement of good faith, the availabil-
ity of an alternative remedy, and, in particular, the attitude of a person acting in
accordance with the duties imposed by s 172 CA 2006. In her reasoning, the judge
7/20/2012 5:20:10 PM
Derivative claims
With respect to s 263(2)(a), Lewison J observed that there are a range of factors that
a director, acting in accordance with s 172, would consider in reaching his decision.
ey would include:
the size of the claim; . . . the costs of the proceedings; the companys ability to
fund the proceedings; the ability of the potential defendants to satisfy a judg-
ment; the impact on the company if it lost the claim and had to pay not only its
own costs but the defendants as well; any disruption to the companys activities
while the claim is pursued; whether the prosecution of the claim would damage
the company in other ways . . . and so on. The weighting of these considerations is
essentially a commercial decision, which the court is ill-equipped to take, except
in a clear case.
In my judgment therefore . . . section 263(2)(a) will apply only where the court
is satis
ed that
director acting in accordance with section 172 would seek to
continue the claim.
Following Lewison Js reasoning, Proudman J, stressing the very many factual dis-
putes between the parties, found that in the circumstances K was acting in good
faith and that a notional director acting in accordance with his duties under s 172
would pursue the action given the strength of the evidence in favour of the case
advanced by K. With respect to the availability of an alternative remedy (it was
argued that an unfair prejudice petition under s 994 CA 2006 was the proper rem-
edy available to K), the judge took the view that this was merely one of the factors to
7/20/2012 5:20:11 PM
The statutory procedure: Companies Act 2006, Part 11
In
Cinematic Finance Ltd v Ryder
(2010), on the other hand, permission was
refused by the court. Cinematic Finance (CF) Ltd granted loans to several invest-
ment companies. When these loans were not repaid, CF Ltd became the sole and
majority shareholder of those companies. It sought permission to pursue a deriva-
tive action against the former directors of the investment companies for alleged
breaches of their 
duciary duties. At the time, CF Ltd was having di
culties gain-
ing access to the companies books and records, but had not disclosed to the court
that it was the sole and majority shareholder. It claimed that there were exceptional
circumstances that made its derivative claim appropriate where it is likely that
the debtor companies were or would become insolvent. 
e court held that as the
7/20/2012 5:20:11 PM
Derivative claims
without the permission of the court. A practical hurdle which confronts a share-
holder litigant, and one which acts as a major disincentive to launching a deriva-
tive action, is the cost of a proposed action. Rule 19.9E covers costs. 
e court
may order the company to indemnify the claimant against any liability in respect
of costs incurred in the claim or in the permission application, or both. An
application for costs made at the time of applying for permission to continue the
claim is commonly called a pre-emptive costs order. It derives from the decision
Wallersteiner v Moir (No 2)
(1975)
where Buckley LJ observed that the share-
holder who initiates the derivative claim may be entitled to be indemni
ed by
the company at the end of the trial for his costs provided he acted reasonably in
bringing the action (for an example where a
Wallersteiner
order was refused: see
Halle v Trax BW Ltd
(2000)). 
e position in the event of the action failing was
also addressed by the court. Lord Denning MR said:
But what if the action fails? Assuming that the minority shareholder had rea-
sonable grounds for bringing the actionthat it was a reasonable and prudent
course to take in the interests of the companyhe should not himself be liable to
pay the costs of the other side, but the company itself should be liable, because
he was acting for it and not for himself. In addition, he should himself be indem-
ed by the company in respect of his own costs even if the action fails. It is a
well-known maxim of the law that he who would take the bene
t of a venture
if it succeeds ought also to bear the burden if it fails . . . In order to be entitled to
this indemnity, the minority shareholder soon after issuing his writ should apply
for the sanction of the court in somewhat the same way as a trustee does.
In
Smith v Cro
(1986), decided under the old RSC, Walton J held that the share-
holders personal means to 
nance the action was a relevant factor to be taken into
7/20/2012 5:20:11 PM
Section 996(2)(c) Companies Act 2006
I place a ceiling on the costs for which I grant an indemnity for the future . . .
There will be liberty to apply to extend the scope of that indemnity.
10.40
Legal aid has never been available to those seeking to bring a derivative action
and so in
Wallersteiner v Moir (No 2)
Lord Denning MR expressed the minority
view that contingency fees could be used to fund such an action. Buckley and
Scarman LJJ, however, held that contingency fee arrangements were unlawful
and therefore not available for derivative actions. By virtue of ss 58 and 58A of the
Courts and Legal Services Act 1990 and SI 1998/1860, conditional fee arrange-
ments are, subject to certain limited exceptions, now lawful in all proceedings.
us a solicitor may take on a case on the basis that they will only get paid if they
win the case.
10.41
e CA 2006 makes no speci
c provision for the remedies available in a deriva-
tive claim. However, given that such claims are based upon breaches of directors
duties (see s 260(3), above), s 178 CA 2006 no doubt applies. 
is provides that the
consequences of breach or threatened breach of the duties owed by directors to
the company are the same as would apply if the corresponding common law rule
or equitable principle applied (see Chapter 14).
Section 996(2)(c) Companies Act 2006
10.42
Where a minority shareholder has been unfairly prejudiced he may petition the
court which, under s 996, is empowered to make such order as it thinks 
t in the
circumstances (see Chapter 11). More speci
cally, s 996(2)(c) goes on to grant the
court the power to authorise civil proceedings to be brought in the name and
on behalf of the company by the prejudiced minority. Put simply, the court may
direct the petitioner to bring a derivative claim. 
is possibility is reinforced by
s 260(2)(b) which states that the only alternative to bringing a derivative claim
under Part 11, Chapter 1 of the Act is where it is brought in pursuance of a court
order under the unfair prejudice remedy. Given the array of remedies available to
the court under s 996, it is unlikely that this power will be used in a s 994 unfair
prejudice petition. In this respect it is noteworthy that in
Barrett v Duckett
(1995)
the Court of Appeal refused to allow the shareholder to bring a derivative action
when she could have sought a share purchase order under the unfair prejudice
provision. It is evident from the paucity of case law on the point that relief under
s 996(2)(c) has rarely been ordered in practice. Such a remedy can be a lengthy
and potentially expensive procedure as the petitioner is required to prove his
entire case under s 994 before an action on behalf of the company can be com-
menced. In circumstances where a wrong is done to the company and corporate
7/20/2012 5:20:11 PM
Derivative claims
relief is sought by a petitioner, it is di
cult to see why the cost and inconven-
ience of two sets of proceedings should be preferable to the court simply award-
ing corporate relief directly under s 996 (see
Re a Company (No 0052
7 of 19
5)
(1986)). Moreover, the chances of a petitioning shareholder wishing to undertake
a second piece of litigation are also extremely unlikely given the fact that in most
circumstances they are seeking to exit the company by obtaining a buy-out order
(see Chapter 11).
Bars to a derivative action
A company in liquidation
10.43
Where a company goes into liquidation the court will not allow a derivative
action to be brought or continued because the liquidator then has the statutory
power to litigate in the companys name (Insolvency Act 1986, s 165(3), s 167(1)
and Sch 4, para 4). 
e position was succinctly stated by Walton J in
Fargro Ltd v
Godfroy
(1986):
But once the company goes into liquidation the situation is completely changed,
because one no longer has a board, or indeed a shareholders meeting, which
is in any sense in control of the activities of the company of any description, let
alone its litigation. Here, what has happened is that the liquidator is now the
person in whom that right is vested.
e rationale for this is clear. Once a company goes into liquidation the liquidator
takes control of the companys a
airs. If the liquidator refuses to initiate litigation
a shareholder may apply to the court for an order directing the liquidator to sue, or
an order permitting the shareholder to bring proceedings in the name of the com-
pany (
Fargro Ltd v Godfroy
(1986)). Before granting such an order the court must
7/20/2012 5:20:12 PM
Conclusion
CA 1985. Section 232 CA 2006 renders void any provisions in the articles or in
any contract with the company (e.g. a service contract) that purport to exempt
a director from, or indemnifying him against, any liability that would other-
wise attach to him in connection with any negligence, default, breach of duty
or breach of trust in relation to the company. Indemni
cation by an associated
company is also prohibited (companies are treated as associated if they are in the
same group). However, ss 232(2)233 allow companies to purchase and maintain
insurance cover against such liability (so-called D & O liability cover). Similarly,
by s 234, the prohibition against provisions indemnifying directors laid down by
s 232(2) does not apply to qualifying third party indemnity provisions (QTPIPs).
For example, a provision will qualify if it indemni
es directors against liabilities
(damages, costs and interest), in a civil action by a person other than the com-
pany (i.e. a third party) or an associated company, and against the costs of their
defence, even if judgment is given against the directors or the litigation is settled
out of court or otherwise comes to an end without judgment being obtained.
Companies can also indemnify directors against costs incurred in connection
applications for relief from liability made under, for example, s 1157 (see Chapter
14). However, it must not cover any 
ne in criminal proceedings or any pen-
alty imposed by a regulator, or defence costs where the director is convicted. 
e
directors report in the companys annual report and accounts must disclose the
existence of a QTPIP (s 236).
10.45
ese provisions were introduced in the light of the 
ndings of the Higgs review
(see Chapter 16) together with the DTIs (now DBERR) own consultation exercise
that revealed two major di
culties a
ecting the recruitment and behaviour of
directors: 
rst, an increase in litigation against directors and, second, the cost
of defending lengthy proceedings which can result in 
nancial ruin. As a con-
sequence, it was thought that companies should be able to assist their directors
nancially while litigation or other proceedings are in progress, and to indem-
nify their directors against certain liabilities to third parties even if the directors
themselves are at fault.
Conclusion
10.46
ere was a consensus of opinion amongst academic commentators that the pro-
cedural complexities ranged against a minority shareholder who sought to insti-
tute a derivative action under the common law rules acted as a major deterrent
against enforcing company rights (although the task of impeaching directorial/
majority conduct in small private companies was made considerably easier by s
459 of the 1985 Act (now s 994 CA 2006, see Chapter 11; see also the comments
7/20/2012 5:20:12 PM
Derivative claims
of Lord Couls
eld in
Anderson v Hogg
(2001)). 
e e
ectiveness of the one true
exception to the rule in
Foss v Harbottle
(1843) as a safeguard against wrongdoing
was clearly dependent upon the vigilance of shareholders in detecting fraudu-
lent conduct on the part of the controllers. It was evident that shareholders were
ill-suited to perform the task of policing directorial wrongdoing particularly
in large public companies, given that as a body they are generally di
use with
limited access to material information. More generally, it was di
cult to under-
stand why a shareholder would wish to bring a derivative action. Apart from
the procedural hurdles and the issue of costs, the remedy was, and is, the com-
panys. 
us, a shareholder contemplating such an action must do so for altruistic
reasons since he will not bene
t directly from any award. 
e introduction of
the statutory procedure laid down in Part 11 of the Companies Act 2006 repre-
sents a lost opportunity to address many of these concerns. Certainly the CLRs
objectives of minimising complexity and maximising accessibility seem to have
been lost somewhere along the way. As a consequence, the e
ectiveness of the
derivative claim as a tool for ensuring good corporate governance remains highly
questionable. Further, the fear that the new statutory procedure would open the
oodgates of litigation against directors has not come to pass (see, in particu-
lar,
Mission Capital plc v Sinclair
(2008);
Franbar Holdings v Patel
(2008), and
Stimpson
Southern
Landlords
, para
10.37
, above).
FURTHER READING
This Chapter links with the materials in Chapter 13 of
Hicks and Goos Cases and
Materials on Company Law
(2011, Oxford University Press, xl +649p).
Baxter The Role of the Judge in Enforcing Shareholder Rights [1983]
CLJ
96.
Boyle, The New Derivative Action (1997) 18
Co Law
256.
Ferran, Litigation by Shareholders and Re
ective Loss [2001]
CLJ
245.
Hannigan Drawing Boundaries between Derivative Claims and Unfairly Prejudicial
Petitions [2009]
JBL
Keay and Loughrey, Derivative Proceedings in a Brave New World for Company
Management and Shareholders [2010]
JBL
151
Law Commission Consultation Paper No 142,
Shareholder Remedies
(1996).
Law Commission Report No 246,
Shareholder Remedies
(Cm 3769, 1997).
Mitchell, Shareholders Claims for Re
ective Loss [2004]
LQR
457.
von Nessen, Goo and Keong, The Statutory Derivative Action: Now Showing Near You
[2008]
JBL
627.
Prentice, Shareholder Actions: the rule in
Foss v Harbottle
[1988]
LQR
341.
7/20/2012 5:20:12 PM
Self-test questions
Reisberg,
Derivative Actions and Corporate Governance: Theory & Operation
(Oxford,
OUP, 2007).
Reisberg, Derivative Claims under the Companies Act 2006: Much Ado About Nothing?
in J Armour and J Payne (eds)
Rationality in Company Law: Essays in Honour of D D
Prentice
(Hart Publishing, 2008).
Reisberg, Funding Derivative Actions: A Re-examination of Costs and Fees as Incentives
to Commence Litigation [2004]
JCLS
345.
Reisberg, Judicial Control of Derivative Actions [2005]
ICCLR
335.
Sealy, Problems of Standing, Pleading and Proof in Corporate Litigation [1987]
Current
Legal Problems: Company Law in Change 1
Sullivan, Restating the Scope of the Derivative Action [1985]
CLJ
236.
Wedderburn, Shareholders Rights and the Rule in
Foss v Harbottle
[1957]
CLJ
154 and
[1958]
CLJ
219.
SELF-TEST QUESTIONS
What is a personal claim, a representative claim and a derivative claim?
The spectre of increased derivative claims is now a distinct probability in the light
of the 2006 reforms. Discuss.
Will the statutory procedure empower shareholders in large companies? Will it
alter their position in small companies?
Should judges adopt a more interventionist role in corporate affairs? If so, at what
7/20/2012 5:20:12 PM
Introduction
Just and equitable winding-up
11.1
As we saw in the previous chapter, given the procedural obstacles posed by the
rule in
Foss
Harbott
(1843) and the judicial timidity in interpreting the oppres-
sion remedy (s 210 CA 1948, the precursor of todays main minority shareholder
remedy in s 994 CA 2006, see below) aggrieved minority shareholders in small
private companies historically either su
ered their lot or sought relief through a
winding-up order on the just and equitable ground (now contained in s 122(1)(g)
of the Insolvency Act 1986 (the 1986 Act)). 
at is, they asked the court to end
the life of the company and distribute the remaining assets to the shareholders.
is remedy originates from the law of partnership in which the equity courts
retained jurisdiction to dissolve a partnership where the relationship between its
members had broken down.
Following the introduction of the unfair prejudice remedy by the Companies Act
1980, this avenue of redress has come to the fore so that the just and equitable wind-
ing-up remedy occupies a less prominent position in the minority shareholders
armoury, although it is by no means redundant (see
Ltd
(2002), below).
e pre-eminence which s 994 now enjoys must also be viewed against the Civil
Procedure Rules (CPR) whereby the courts take a proactive role in case manage-
ment (see, for example,
Rotadata
Ltd
(2000) in which Neuberger J stressed that
the CPR encouraged the court to take an active part in case management and this
SUMMARY
Introduction: just and equitable winding-up
Unfairly prejudicial conduct: Companies Act 2006, Part 30 (ss 994996)
Other speci
c statutory minority rights
The Law Commissions proposals for reforming the unfair prejudice provision
Statutory shareholder
remedies
7/19/2012 2:21:18 PM
Introduction
also included encouraging the parties to co-operate with each other in the conduct
of the proceedings; see further para
below).
11.2
Section 122(1)(g) of the 1986 Act provides that a company may be wound up
by the court if the court is of the opinion that it is just and equitable that the
company should be wound up. Since just and equitable winding-up is necessar-
ily draconian (in e
ect, ending the company and distributing the assets to the
shareholders) in nature it is obvious that there will have to be strong grounds to
convince the court to grant the remedy. In this respect the dire consequences for
a prosperous company which the presentation of a petition for winding-up car-
ries is compounded by s 127 of the 1986 Act which, in e
ect, renders the company
incapable of carrying on business freely. Section 127 provides that any disposi-
tion of the companys property, and any transfer of shares, or alteration in the sta-
tus of the companys members, made a
er the commencement of the winding up
is, unless the court otherwise orders, void (see further Chapter 17). Accordingly,
any disposition of company property a
er a petition has been brought requires
the courts consent. Further, any payments made out of the companys bank
account a
er the presentation of the petition can be set aside by the liquidator
once the company has been wound up. Banks therefore freeze company bank
accounts as soon as they receive notice of the presentation of the petition
(Re
XY
Ltd
(1987)).
Grounds for petition
11.3
e classic case on the remedy is
Ebrahimi
Westbourne
eries
Ltd
(1973)
in
which the scope of the courts jurisdiction under the just and equitable ground
was subjected to considerable scrutiny by the House of Lords. 
e company was
established in 1958 to take over the oriental rug business which the respondent
(Nazar) and the petitioner (Ebrahimi) had run in partnership for over a dec-
ade. Initially, the two were equal shareholders and the only directors. Eventually,
Nazars son joined the company as director and shareholder. 
e e
ect of this
was that Ebrahimi now became a minority both within the board and at the
general meeting where he could be outvoted by the combined shareholding of
Nazar and his son. Friction developed between the parties and Ebrahimi was
voted o
the board using the power conferred by s 303. A
er this, he was not
consulted on the running of the business and neither did he continue to share
in its pro
ts. No dividends were paid to him because all pro
ts were distributed
by way of directors remuneration. In consequence, Ebrahimi failed to obtain
any further return on his investment and he petitioned the court for a winding-
up order under s 122(1)(g) of the 1986 Act, and alternatively for relief under the
oppression remedy contained in the Companies Act 1948 (the predecessor of the
unfair prejudice remedy).
7/19/2012 2:21:20 PM
Statutory shareholder remedies
11.4
e House of Lords took the view that notwithstanding that Ebrahimi had been
removed by Nazar and his son in accordance with the Companies Act and the
articles of association, the just and equitable ground conferred on the court the
jurisdiction to subject the exercise of legal rights to equitable considerations. It
was held that because the petitioner had agreed to the formation of the company
on the basis that the essence of their business relationship would remain the same
as with their prior partnership, his exclusion from the companys management
was clearly in breach of that understanding, and it was therefore just and equita-
ble to wind up the company. Lord Wilberforce, who delivered the leading speech,
stressed that the remedy conferred a wide discretionary jurisdiction on the court.
He said: there has been a tendency to create categories or headings under which
cases must be brought if the clause is to apply. 
is is wrong. Illustrations may be
used, but general words should remain general and not be reduced to the sum of
particular instances.
e following are illustrations of the grounds which will support a petition under
s 122(1)(g) of the 1986 Act.
(i) Substratum has failed
11.5
is is arguably the narrowest of the grounds for just and equitable winding-
up. 
e petitioner will need to establish that the commercial object for which
the company was formed has failed or has been ful lled. In
German
Date
Co
(1882) the company was registered with the object of acquiring a
German patent for manufacturing a co
ee substitute from dates. 
e German
patent was not granted but a Swedish one was. Notwithstanding that the com-
pany had built a factory at Hamburg and was doing a prosperous trade in the
commodity, the Court of Appeal made a winding-up order on the basis that the
whole substratum of the company was gone. Jessell MR stated that the minor-
ity shareholders could maintain that they did not enter into partnership on
these terms . . . It was not a general partnership to make a substitute for co
ee
from dates, but to work a particular patent, and as that particular patent does
not exist, and cannot now exist, they are entitled to say the company ought
to be wound up. 
e courts approach the issue on the basis that a member
subscribes to a company on the understanding that it will engage in a par-
ticular business venture, so that if it fails to do this, the member is entitled to
recover his investment (see also
Virdi
Abbey
Leisure
Ltd
(1990) below; and
Perfectair
Ltd
(1990)).
11.6
is ground is now of much less importance especially in the light of s 31(1) CA
2006 which has reformed the law governing a companys objects clause. 
is pro-
vides that Unless a companys articles speci
cally restrict the objects of the com-
pany, its objects are unrestricted (see further, Chapter 12).
7/19/2012 2:21:20 PM
Introduction
(ii) Fraud
11.7
Where a company is formed to perpetrate a fraud and winding-up represents
the best means for its shareholders for recovering money invested by them from
its promoters, the court may grant a winding-up order on the just and equitable
ground. In
omas
Edward
Brinsmead
Sons
(1897) three men who were
named Brinsmead, and who were former employees of John Brinsmead & Sons,
a renowned piano manufacturing company, formed 
omas Brinsmead & Sons
to make pianos which were to be passed o
as manufactured by John Brinsmead
& Sons. Following a fraudulent promotion the public had subscribed for shares
worth some 35,000 in the new company. It was held to be just and equitable to
wind up the company.
(iii) Deadlock
11.8
In practice it is rare for there to be total deadlock in the management of a com-
pany because the chair of a meeting will generally have a casting vote. However,
where deadlock does occur, whether it be total or practical deadlock, the court
may order the company to be wound up. In
enidje
Tobacco
Ltd
(1916), two
tobacco manufacturers formed the company in order to merge their businesses.
ey were equal shareholders (with equal voting rights) and the only directors.
Relations between the two became acrimonious and they refused to communi-
cate with each other except through the company secretary. Although the com-
pany was enjoying substantial pro
tability the court ordered it to be wound up.
Lord Cozens-Hardy MR, who took as his starting point the law of partnership,
said that had this been a partnership where the relationship between the part-
ners had degenerated into a state of animosity with no hope of reconciliation, the
court would order a dissolution:
All that is necessary is to satisfy the Court that it is impossible for the part-
ners to place their con
dence in each other which each has a right to expect,
and that such impossibility has not been caused by the person seeking to take
advantage of it.
7/19/2012 2:21:20 PM
Statutory shareholder remedies
sell their shares at an undervalue, refused to declare dividends. Further, general
meetings were not called and accounts were not published. 
e Privy Council
ordered the company to be wound up. Lord Shaw said:
It is undoubtedly true that at the foundation of applications for winding-up,
on the just and equitable rule, there must lie a justi
able lack of con
dence in
the conduct and management of the companys affairs. But this lack of con-
dence must be grounded on conduct of the directors, not in regard to their
private life or affairs, but in regard to the companys business. Furthermore
the lack of con
dence must spring not from dissatisfaction at being outvoted
on the business affairs or on what is called the domestic policy of the com-
pany. On the other hand, wherever the lack of con
dence is rested on a lack
of probity in the conduct of the companys affairs then the former is justi
ed
by the latter, and it is under the statute just and equitable that the company
be wound up.
(v) Exclusion from participation in a small private company where
there was a relationship based on mutual con
dence
11.10
Typically in this situation the action is brought by the petitioner on the basis
that there was a fundamental understanding between the partners to the e
ect
that that he would be permitted to participate in management and this has been
broken. Unless the petitioner brought this state of a
airs about through his own
fault, the court will generally make a winding-up order. 
e classic example here
is
Ebrahimi
Westbourne
eries
(above), in which Lord Wilberforce listed the
typical elements in petitions brought under this ground:
the basis of the business association was a personal relationship and mu-
(i)
tual con
dence (generally found where a pre-existing partnership has
converted into a limited company);
an understanding that all or certain shareholders (excluding sleeping
(ii)
partners) will participate in management;
a restriction on the transfer of members interests preventing the peti-
(iii)
tioner leaving.
It is worth recalling that Lord Wilberforce, in noting that Ebrahimis removal
had been e
ected in accordance with the Companies Act, nevertheless stressed
that the court was entitled to superimpose equitable constraints upon the exer-
cise of rights set out in the articles of association or the Act. He went on to say
that the words just and equitable:
are a recognition of the fact that a limited company is more than a mere legal
entity, with a personality in law of its own: that there is room in company law
7/19/2012 2:21:20 PM
Introduction
for recognition of the fact that behind it, or amongst it, there are individu-
als, with rights, expectations and obligations
inter se
which are not necessarily
submerged in the company structure . . . The just and equitable provision does
not . . . entitle one party to disregard the obligation he assumes by entering the
company, nor the court to dispense him from it. It does, as equity always does,
enable the court to subject the exercise of legal rights to equitable considera-
tions . . . which may make it unjust, or inequitable, to insist on legal rights, or to
exercise them in a particular way.
is approach has coloured the jurisprudence on s 459 of the CA 1985, which is
now restated in s 994 of the 2006 Act (see below), in determining unfairly preju-
dicial conduct: see, for example,
Nob
Sons
Ltd
(1983)
and the
House of Lords decision in
Nei
ll
Phi
(1999), considered below.
11.11
Taking the typical elements listed above, Lord Wilberforce concluded that the
just and equitable ground for winding-up will assist the petitioner if:
he can point to, and prove, some special underlying obligation of his fellow
member(s) in good faith, or con
dence, that so long as the business continues
he shall be entitled to management participation, an obligation so basic that, if
broken, the conclusion must be that the association must be dissolved.
It should be noted that not every bona 
de exercise of majority power will be sub-
ject to equitable constraints. 
e overriding factors are the three typical elements
which were listed by Lord Wilberforce.
11.12
e decision in
Chewing
Ltd
(1975) is, arguably, a curious
application of the
Ebrahimi
principles. By virtue of a shareholders agreement the
petitioner, a USA public corporation which had provided one-third of the compa-
nys share capital, was entitled to appoint a director to the board but the majority
shareholders refused to give e
ect to the proposed appointment. Applying Lord
Wilberforces approach, a winding-up order was made on the basis of the peti-
tioners exclusion from management in breach of the fundamental understand-
ing from the outset that it would participate in management. 
is decision has
been criticised on the basis that an injunction to enforce the shareholders agree-
ment was the more appropriate remedy and would have avoided the dire con-
sequences of a winding-up order (see Womack (1975)). A more straightforward
illustration of the application of
Ebrahimi
is the decision in
Zinotty
Properties
Ltd
(1984) in which the court considered that it was just and equitable to wind up
the company despite the fact that it was in voluntary liquidation. 
e petitioners
allegation was based on breach of trust and con
dence on the grounds that he
had not been appointed as a director as he had expected; the company, a property
business, had not been dissolved when a site development was completed, as he
had assumed it would be, but rather interest-free unsecured loans had been made
7/19/2012 2:21:20 PM
Statutory shareholder remedies
to other businesses in which he had no interest; and the company had not main-
tained proper accounts nor called general meetings.
Extending the shadow of
Ebrahimi
beyond s 122
11.13
e question has arisen whether the principles promulgated by Lord Wilberforce
extend beyond the statutory context of just and equitable winding-up. 
e issue
arose in
emens
emens
Bros
Ltd
(1976). 
e claimant owned 45 per cent and
her aunt, Miss Clemens, owned 55 per cent of the shares in the company. 
e
articles of association contained a pre-emption clause and so the niece expected
to gain total control of the company upon her aunts departure. In the meantime
she exerted negative control, having the power to block a special resolution. 
e
board of directors, which was made up of the aunt and four non-shareholders,
decided to increase the companys share capital by issuing new shares to the
directors and to an employees trust. 
e appropriate general meeting resolu-
tion was passed by virtue of the aunts votes. 
e e
ect of this was to reduce the
claimants shareholding to below 25 per cent. Foster J, setting the resolutions
aside and adopting the terminology of Lord Wilberforce, stated that the general
voting rights of majority shareholders were subject . . . to equitable considera-
tions . . . which may make it unjust . . . to exercise [them] in a particular way. 
e
judge concluded that:
I do not doubt that Miss Clemens is in favour of the resolutions and knows and
understands their purport and effect; nor do I doubt that she genuinely would
like to see the other directors have shares in the company and to see a trust
set up for long service employees. But I cannot escape the conclusion that the
resolutions have been framed so as to put into the hands of Miss Clemens and
her fellow directors complete control of the company and to deprive the plaintiff
of her existing rights as a shareholder . . . [the resolutions were] speci
cally and
carefully designed to ensure not only that the plaintiff can never get control of
the company but to deprive her of what has been called her negative control.
Foster Js reasoning dovetails with that of the House of Lords decision in
Nei
ll
Phi
(1999), considered below. 
e view expressed by Plowman J in
Bent
Stevens
Jones
(1974) to the e
ect that the
Ebrahimi
principles should be con-
ned to their statutory context must now be doubted (for a critique of Foster Js
reasoning, see Sealy And Worthington (2010), p 217).
The right to petition
11.14
Section 124(1) of the 1986 Act provides that an application to the court for a
winding-up order may be made by a contributory. Contributory is de
ned as
7/19/2012 2:21:20 PM
Introduction
every person liable to contribute to the assets of a company in the event of it
being wound up, and the term also encompasses every present and past member
(s 74(1) and s 79(1)). For a fully paid-up member to have standing he/she must
show a tangible interest in the company by proving, on a balance of probabili-
ties, that there will be a surplus divisible among the shareholders a
er payment
of the companys debts, liabilities and the expenses of the liquidation (
Washing
(1879)
per
Jessel MR; and
Expanded
Ltd
(1966)).
More
recently, however, a broader approach has been taken to the meaning of tangible
interest. In
Chester
Catering
(1977) Oliver J did not limit its meaning
to the need to prove surplus assets but held that:
In order to establish his
locus standi
to petition a fully paid shareholder
must . . . show that he will, as a member of the company, achieve some advan-
tage, or avoid or minimise some disadvantage, which would accrue to him by
virtue of his membership of the company. For instance, a member of a company
might have a strong interest in terminating its life because he was engaged
in a competing business or because he was engaged in litigation with the
company . . .
By way of limited exception, Ho
mann J held in
Commercia
and
Industria
Insu
ations
Ltd
(1986) that if the petitioner cannot prove his tangible interest because
of the companys default in providing him with information to which as a member
7/19/2012 2:21:20 PM
Statutory shareholder remedies
normally result in the winding-up petition being struck out (
Company
(No
199
6)
(1997);
Woven
Ltd
(2008)). 
is is clearly the case where
the petitioner has an appropriate alternative remedy available to him. For exam-
ple, the articles of association may lay down a procedure whereby a shareholder
who is dissatis
ed with the way in which the company is being managed can sell
his shares at a fair price and without discount. Typically in such a case the court
will strike out the petition on the basis that the petitioner is acting unreasonably
in seeking a winding-up order. In
Company
(No
002
567
(1983), which
involved a breakdown of con
dence, Vinelott J held that since the petitioner had
indicated from the start that he would be prepared to sell his shares if a fair price
was o
ered, and having encouraged the respondents to continue managing the
company in the expectation that a fair valuation procedure would be agreed, and
having been o
ered a price for his shares which was negotiated in accordance with
the agreed procedure which provided for a valuation by an independent expert
without discount to re
ect his minority shareholding, he could not now have the
company wound up. On the other hand, in
Virdi
Abbey
Leisure
Ltd
(1990) the
company had been formed for a single venture, that of acquiring and running a
particular nightclub, the Pavilion. 
e controlling shareholders having sold the
Pavilion intended to reinvest the proceeds in another club. A winding-up peti-
tion was brought by V who held 40 per cent of the shares. 
e companys articles
contained a provision whereby a member wishing to sell his shares was required
er them to other members. 
e articles also laid down that the valuation
of such shares would be carried out by an accountant. 
e Court of Appeal held
that V was not acting unreasonably in refusing to sell his shares pursuant to the
articles of association. An accountant valuing Vs shares might apply a discount
to re
ect his minority holding whereas in a winding-up the liquidator would be
in a better position to ensure that the price paid to V was similar to that paid
to another shareholder for a similar stake. Balcombe LJ stressed that the com-
panys assets consisted almost entirely of cash which made it unreasonable for V
to accept the risk of his interest being discounted. It is noteworthy that in
Hawkes
Cuddy
(No
(2009), Stanley Burnton LJ (delivering the principal judgment of
the Court of Appeal), having reviewed the relevant case law on the point, reached
the conclusion that facts which were su
cient to justify a winding-up on the just
and equitable ground were not necessarily su
cient to give the court jurisdic-
tion to award relief under the unfair prejudice provision because the two jurisdic-
tions were parallel but not coterminous and a winding-up could be ordered under
s 122(1)(g) where no unfair conduct was alleged. Placing particular reliance on
Lord Ho
manns views expressed in
Nei
ll
Phi
(1999), to similar e
ect, the
judge stated:
Deadlock and the inability of a company to conduct its business as initially
contemplated when the parties trusted and had con
dence in each other may
7/19/2012 2:21:21 PM
Unfairly prejudicial conduct: CA 2006, Part 30 (ss 994996)
be inherent in the breakdown of that trust and con
dence, but in my judgment
do not without more satisfy the requirements of ss 994 and 996.
Stanley Burnton LJ did, however, acknowledge that in many cases one party will be
able to point to unfairness in the other partys reaction to the deadlock.
Relevance of petitioners own conduct
11.17
ere is some authority which suggests that if the petitioner is substantially at
fault for the breakdown in relations with his co-venturer he may be denied relief
under s 994 yet, paradoxically, succeed in a petition for just and equitable wind-
ing-up. In
Nob
Sons
Ltd
(1983) Nourse J held that the circum-
stances of the case justi
ed a winding-up order on the basis of a breakdown in
mutual con
dence between the companys two founding members (equal share-
holders) but not relief under the unfair prejudice provision. 
e petitioner by his
lack of interest in the management of the business had brought about his own
exclusion from it by the other member.
Unfairly prejudicial conduct: CA 2006,
Part 30 (ss 994996)
Introduction
11.18
A minority shareholder who feels aggrieved by virtue of unfairly prejudicial con-
duct on the part of the majority has a powerful avenue for redress in the form of
a petition brought under s 994(1). 
is provides that:
A member of a company may apply to the court by petition for an order . . . on
the ground
(a)
that the companys affairs are being or have been conducted in a manner
which is unfairly prejudicial to the interests of its members generally or of some
part of its members (including at least himself), or
(b)
that any actual or proposed act or omission of the company (including an
act or omission on its behalf) is or would be so prejudicial.
11.19
To appreciate the breadth of the modern unfair prejudice remedy it is useful to
consider brie
y its antecedents and to outline the role which its architects had in
mind when framing the remedy over 50 years ago. 
e genesis of the provision
can be traced to the Cohen Committee,
Report
Committee
Company
7/19/2012 2:21:21 PM
Statutory shareholder remedies
Law
Amendment
(Cmnd 6659, 1945) the terms of reference of which encompassed
shareholder remedies. 
e Committee, which took the rule in
Foss
Harbott
(1843) as the background for its deliberations, found that shareholders frequently
considered themselves impotent when seeking to institute an action challeng-
ing the conduct of the majority. 
e only real means of out
anking the rule was
to petition the court for a winding-up order. Yet, as far as the petitioner was
concerned, the deterrent value of this course of action was inherent in its very
nature for, [i]n many cases . . . the winding up of the company will not bene
t the
minority shareholders, since the break-up value of the assets may be small, or the
only available purchaser may be that very majority whose oppression has driven
the minority to seek redress. 
e Committee therefore went on to recommend
that the Court should be given unfettered discretion to impose upon the parties
to a dispute whatever settlement it considers just and equitable. 
is was trans-
lated into the so-called oppression remedy contained in s 210 of the Companies
Act 1948. It provided a discretionary remedy but which, by virtue of its dra
ing,
was expressly stated to be only available where the facts of the case justi
ed a
winding-up order.
11.20
However, due to the inadequacies of its dra
ing and the restrictive approach
adopted by the judges towards its interpretation, only two cases were successfully
brought under s 210 in its 32year history (
SCWS
Ltd
Meyer
(1959) and
Harmer
(1959)). 
e di
culty underlying s 210 was that the term oppression was
very narrowly construed. For example, in
SCWS
Ltd
Meyer
(1959) Lord Simonds
stated that it was restricted to conduct on the part of the majority which was bur-
densome, harsh and wrongful. 
is was compounded by the view expressed in
Harmer
Ltd
(1959)
that the conduct in question had to be of a continuous
nature. Unfairness was, of itself, therefore insu
cient to found a claim under the
oppression remedy. Consequently, petitions brought on the grounds of directors
awarding themselves excessive remuneration (
Jermyn
Street
Turkish
Baths
Ltd
(1971)) and mismanagement (
Minute
Car
Wash
Service
Ltd
(1966)) were
unsuccessful.
11.21
Given the failure of the section to provide adequate relief the Jenkins Committee
(Report
the
Company
Law
Committee
(Cmnd 1749 (1962)), which reviewed the
operation of the remedy, identi
ed a number of defects which it felt should be
addressed if it was to a
ord e
ective protection to minorities in circumstances
such as those with which it is intended to deal (para 201). 
e Committee felt
that the section must extend to cases in which the acts complained of fall short
of actual illegality (para 203). It therefore recommended its amendment to cover
complaints that the a
airs of the company were being conducted in a manner
unfair
prejudicia
the
interests
the
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Unfairly prejudicial conduct: CA 2006, Part 30 (ss 994996)
was re-enacted in Part XVII of the Companies Act 1985, s 459 (as amended by
the Companies Act 1989); and now it now appears in restructured form in s 994
of the Companies Act 2006.
11.22
An initial problem, resulting from judicial timidity in interpreting the provision
as originally dra
ed, was that s 75 and later, s 459, stated that a petition could
only be brought where the companys a
airs were being conducted in a manner
which is unfairly prejudicial to the interests of some part of the members. 
is
was construed to mean that a petitioner had to show discrimination. 
us in
Carrington
Viye
(1983) it was held that a breach of directors duties could
not form the basis of a s 459 petition since this,
facto
ects all shareholders;
and in
Company
(No
87)
(1988) Harman J held that the boards
failure to declare a dividend was not discriminatory between shareholders given
that all members were a
ected equally. Section 459 was therefore amended by
the Companies Act 1989 which, by inserting the words of its members generally,
reversed the requirement of discrimination. 
is wording has been retained by
the 2006 Act (see para
11.18
above). Since s 994 restates s 459 CA 1985 without
any substantive changes, the jurisprudence (and academic literature) surround-
ing the remedy continues to be relevant.
The constituent elements of s 994 CA 2006
(i) Conduct of the companys affairs
11.23
Section 994(1) states that a petitioner must establish unfairly prejudicial conduct
arising from some corporate act or omission, including any act or omission on the
companys behalf. Unlike the old oppression remedy it is not necessary to show a
continuing course of conduct, or indeed, unfairly prejudicial conduct subsisting
at the date of the petition. An isolated act or omission may, depending upon the
circumstances of the particular case, be su
cient (
Norvabron
Pty
Ltd
(No
(1987)). An interesting case is
oyd
Casey
(2001) because the court permitted
the petitioner to include allegations relating to conduct which took place before
he became a registered shareholder in the company on the basis that the section
states that the companys a
airs are being or
have
been
conducted
in an unfairly
prejudicial manner.
11.24
e meaning of conduct of the companys a
airs was considered in
Lega
Costs
Negotiators
Ltd
(1999). 
e company had been incorporated by four indi-
viduals who were equal shareholders; they were also its directors and employees.
Relations broke down with the fourth individual and he was dismissed as an
employee and he resigned from the board just before it was resolved to remove
him. However, he remained as a shareholder and refused to sell his shares to the
7/19/2012 2:21:21 PM
Statutory shareholder remedies
other three. 
e majority petitioned under s 459 seeking an order that he should
transfer his shares to them. 
e Court of Appeal rejected the petition on the basis
that as majority shareholders they could prevent any prejudice being in
icted by
him on the company. Simply remaining as a shareholder was not conduct relat-
ing to the companys a
airs. 
e Court stressed that the conduct complained of
must: relate to the a
airs of the company; be acts done by the company, i.e. by
those authorised to act as its organs; and it should not be referable to the conduct
of an individual shareholder acting in his private capacity.
11.25
A clear illustration of corporate conduct for the purposes of s 994 is a
orded by
Nicho
Soundcra
ectronics
Ltd
(1993) in which the Court of Appeal held
that the failure of a parent company (Electronics) to pay debts due to its subsidi-
ary (in which the petitioner was a minority shareholder) constituted acts done in
the conduct of the a
airs of the company. Fox LJ said:
It seems to me that Electronics, when it withheld payments from the [subsidiary]
company, was doing so as part of the general control of the
nancial affairs
of the company. It exercised that general control by deciding how much the
company should receive (by withholding sums due to the company) and restrict-
ing the companys ability to spend money (by the signature requirements on
cheques drawn by the company). In my view Electronics, when it withheld from
the company payments which were due to the company, was conducting the
affairs of the company.
11.26
An intriguing issue arose in
Gross
Rackind
(2005), namely whether conduct
within a subsidiary could be regarded as falling within the a
airs of the hold-
ing company. Judge Weeks, citing
Nicho
Soundcra
ectronics
Ltd
took the
view that in the right circumstances acts in the conduct of a subsidiarys a
airs
can also be acts in the conduct of the holding companys a
airs. He could see no
logical reason for protecting shareholders of a trading company by s 459 [s 994]
but not shareholders in a holding company. 
e facts were that the shares in the
holding company, Citybranch Group Ltd, were held in equal shares by the Gross
and Rackind families. 
e holding company had been incorporated in 2001 in
order to acquire two companies, Citybranch Ltd and Blaneland Ltd. 
e shares
in these companies had been held by two families. 
e relationship between the
families broke down and Mr Rackind (R), a director and shareholder of the hold-
ing company, decided to wind it up. 
e Gross family petitioned under s 994 on
the basis that R was in breach of 
duciary duty to Blaneland Ltd and had mis-
appropriated funds belonging to Citybranch Ltd. 
ey argued that Rs conduct
with respect to the subsidiaries amounted to conduct in relation to the a
airs of
the parent company. Rs application to strike out the petition on the basis that,
inter alia, it alleged unfairly prejudicial conduct in relation to the subsidiaries,
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Unfairly prejudicial conduct: CA 2006, Part 30 (ss 994996)
rather than the company itself, was dismissed. His appeal to the Court of Appeal
failed. Sir Martin Nourse, who delivered the only reasoned judgment, endorsed
the views of the trial judge that conduct taking place in relation to a subsidiary
could fall within the a
airs of the holding company. He agreed with Judge Weeks
that the decision in
Nicho
could support such a conclusion on the basis that it
is in line with the views expressed by Phillimore J in
Board
Trade
Martins
Preserving
Ltd
(1965):
The observations of Phillimore J demonstrate that the expression the affairs
of the company is one of the widest import which can include the affairs of a
subsidiary. Equally, I would hold that the affairs of a subsidiary can also be the
affairs of its holding company, especially where, as here, the directors of the
holding company, which necessarily controls the affairs of the subsidiary, also
represent a majority of the directors of the subsidiary. (In the case of Blaneland
they are identical.)
Sir Martin Nourse also felt that this approach is entirely consistent with
Commonwealth authorities, notably
Norvabron
Pty
Ltd
(1986) and
Dernacourt
Investments
Pty
Ltd
(1990), where petitions were brought under equiv-
alent provisions to s 994. In 
nding that R, as a director of the company, knew very
well what was happening in Citybranch and Blaneland given that he was the person
involved, the judge was particularly persuaded by the observations of Derrington J
in the
Norvabron
case to the e
ect:
It has been argued that this conduct upon which the application relies is lim-
ited to the affairs of Trans
eld (Qld) [the subsidiary of Norvabron], whereas
the application is necessarily directed at Norvabron, and the suggestion is that
the directors of Norvabron have not been shown to be at fault in the affairs
of that company in the same way as they were in respect of Trans
eld (Qld).
However, such an approach is arti
cial in the extreme. The technical answer is
that the directors of Norvabron knew very well what was happening in respect
of Trans
eld (Qld) because they were the persons involved.
11.27
Although there are English 
rst instance decisions (not considered by Sir Martin
Nourse) which took a contrary view, for example
Leeds
United
(1996) and
Reiner
Gershinson
(2004), the Court of Appeals somewhat open tex-
tured approach is in line with the 
exibility being taken in relation to corporate
conduct discernible in other decisions. 
us, it has been held that where a peti-
tioner withdraws from the management of the company in breach of an under-
taking given by him to his co-shareholder/director, although this is not strictly
an act of the company, nevertheless it did amount to him breaching an agreement
as to the conduct of the companys a
airs . . . [and] that, as such, was an act of
7/19/2012 2:21:21 PM
Statutory shareholder remedies
the company or conduct of the companys a
airs (
Phoneer
Ltd
(2002), per
Roger Kaye QC sitting as a deputy judge in the High Court). However, a strict
line is drawn where the conduct in question is that of a shareholder or director
in his private capacity. 
e action of the board of directors is clearly conduct of
the company, but disputes between shareholders relating to dealings with their
shares is not (
Uniso
Group
Ltd
(No
3)
(1994); and
Lega
Costs
Negotiators
Ltd
(above)). But a special resolution to amend the articles to exclude pre-emption
rights in a company could amount to unfairly prejudicial conduct
(Re
Smiths
Ltd
(2003)).
11.28
If the reasoning in the
Gross
judgments is accepted, many questions remain unan-
swered. For example, must the subsidiary company be wholly owned in order for
its a
airs to fall within those of the parent company? Must the subsidiary com-
panys directors also be directors of the parent company? Indeed, notwithstand-
ing
Nicho
uncertainty still remains with regard to the issue of whether parent
company actions can be regarded as falling within subsidiary company a
airs.
To be sure, employing s 994 to address problems arising within corporate groups
will o
en involve a di
cult choice between the consequences of preserving the
separate legal identity of group companies and acceding to the call for enhanced
protection of (minority) shareholders (see Goddard and Hirt (2005)).
e decision of Sales J in
Oak
Investment
Partners
Limited
Partnership
Boughtwood
(2009), o
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Unfairly prejudicial conduct: CA 2006, Part 30 (ss 994996)
conduct need not be as a director. Acting as a senior manager may be su
cient to
attract relief under the provision. In such situations the court may order the share-
7/19/2012 2:21:21 PM
Statutory shareholder remedies
the interests of a member are not necessarily limited to his strict legal rights
under the constitution of the company. The use of the word unfairly in section
459 [of the 1985 Act, now s 994], like the use of the words just and equitable
in [s. 122(1)(g)], enables the court to have regard to wider equitable considera-
tions . . . Thus in the case of a managing director of a large public company who
is also the owner of a small holding in the companys shares, it is easy to see the
distinction between his interests as a managing director employed under a serv-
ice contract and his interests as a member. In the case of a small private com-
pany in which two or three members have invested their capital by subscribing
for shares on the footing that dividends are unlikely but that each will earn his
living by working for the company as a director, the distinction may be more
elusive. The members interests as a member who has ventured his capital in the
companys business may include a legitimate expectation that he will continue
to be employed as a director and his dismissal from that ofce and exclusion
from the management of the company may therefore be unfairly prejudicial to
his interests as a member.
(See also,
Phoenix
Contracts
(Leicester
Ltd
(2010); and
Woven
Ltd
(2010)).
11.31
One particular feature of the wording of the provision is that the use of the term
interests is designed to be expansive in e
ect, thereby e
ectively avoiding the
straitjacket which terminology based on the notion of legal rights would impose
on the scope of the provision. 
is is manifest in Peter Gibson Js judgment in
Sam
Sons
Ltd
(1990) in which the judge observed that: [t]he word
interests is wider than a term such as rights, and its presence as part of the
test . . . to my mind suggests that Parliament recognised that members may have
erent interests, even if their rights as members are the same.
11.32
Obviously, the interests of a member can be discerned by reference to the com-
panys constitution which, by virtue of s 17, includes the articles of association
together with any resolutions of the company and any shareholders agreements.
It has also been held that a member will have an interest in the value of his or her
shares. 
us, in
Bovey
Hote
Ventures
Ltd
(1981) Slade J formulated the follow-
ing test for determining the issue:
Without prejudice to the generality of the wording of the section, which may
cover many other situations, a member of a company will be able to bring him-
self within the section if he can show that the value of his shareholding in the
company has been seriously jeopardised by reason of a course of conduct on the
part of those persons who have had
de facto
control of the company, which has
been unfair to the member concerned.
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Unfairly prejudicial conduct: CA 2006, Part 30 (ss 994996)
(See also
Gross
Rackind
(above).)
Legitimate expectations
11.33
An important question arising from the case law surrounding the provision is
the extent to which the courts will recognise a members so-called legitimate
expectations as falling within interests which may be unfairly prejudiced. In this
regard it will be recalled that in
Ebrahimi
Lord Wilberforce observed that behind
the corporate veil there are individuals with rights, expectations and obligations
inter
which are not necessarily submerged in the company structure (see para
11.10
above). In small private companies it is o
en unrealistic to sever the vari-
ous roles played by a petitioner for in such companies, termed quasi-partner-
ships, a petitioner will not only be a shareholder but frequently a director and
an employee of the business as well. However, and as has been seen, in
Ebrahimi
Lord Wilberforce stressed that although in most companies the members rights
under the articles of association and the Companies Act provide an exhaustive
statement of his interests, there are three typical cases in which equitable consid-
erations may be superimposed upon the strict legal rights of members. It will be
recalled that the three categories Lord Wilberforce listed were as follows:
the basis of the business association was a personal relationship and mu-
(i)
tual con
dence (generally found where a pre-existing partnership has
converted into a limited company);
an understanding that all or certain shareholders (excluding sleeping
(ii)
partners) will participate in management;
a restriction on the transfer of members interests preventing the peti-
(iii)
tioner leaving.
11.34
In examining the scope of shareholders obligations in these three categories the
court will look beyond the articles of the particular company. For example, even
if the parties have not expressly agreed that the petitioner will participate in the
management of the company, the court may imply such an undertaking from the
conduct of the parties. In
des
Bros
Ltd
(1970) Megarry J stated that:
It cannot be just and equitable to allow one party to come to the court and
require the court to make an order which disregards his contractual obliga-
tions. The same, I think, must apply to a settled and accepted course of conduct
between the parties, whether or not cast into the mould of a contract.
11.35
Although Lord Wilberforces reasoning in
Ebrahimi
was centred on the just and
equitable winding-up remedy, nevertheless it has fundamentally shaped the
development of the s 994 jurisprudence which has grown up around small owner-
7/19/2012 2:21:21 PM
Statutory shareholder remedies
managed companies. In
Company
(No
4377
86)
(1986) Ho
mann J con-
sidered that the language of s 994 facilitated the exercise by the court of its residual
equitable jurisdiction. He observed that the interests of a member are not neces-
sarily limited to the strict legal rights conferred by the constitution of a company.
Accordingly, a members interests can encompass the
egitimate
expectation
that
he will continue to participate in management as a director and his dismissal from
that o
ce and consequent exclusion from the companys management may be
unfairly prejudicial to his interests as a member. 
e rationale for this departure
from the rigidity of the capacity-based approach which had so thwarted the devel-
opment of the old oppression remedy was explained by Lord Grantchester QC in
Company
(No
4475
(1983) in the following terms:
It is obvious that in a small private company it is legalistic to segregate the separate
capacities of the same individual as shareholder, director or employee. His dis-
missal from the board or from employment by the company will inevitably affect
the real value of his interest in the company expressed by his shareholding.
Company
(No
(1986), Ho
mann J, again echoing Lord
Wilberforces reasoning, said that the courts jurisdiction under s 994 enables it to
protect not only the rights of members under the constitution of the company but also
the rights, expectations and obligations of the individual shareholders
inter
In the
typical case of the corporate quasi-partnership, these will include the expectations
that the member will be able to participate in the management of the company.
11.36
However, the House of Lords in
Nei
ll
Phi
(1999) expressed doubt over
whether the use of the term legitimate expectations was entirely appropriate.
e term had been imported from the realms of public law as a label for the cor-
relative right not to have a power conferred by the articles exercised in a manner
unfairly prejudicial to a particular member. Lord Ho
mann expressed the view
that its adoption was probably a mistake and that it is more accurate to speak of
equitab
restraints
which may make it unfair for a party to exercise rights under
the articles. He concluded that the notion of legitimate expectation is a conse-
quence, not a cause, of the equitable restraint . . . [i]t should not be allowed to lead
a life of its own, capable of giving rise to equitable restraints in circumstances to
which the traditional equitable principles have no application.
The limits of equitable restraints
11.37
In
Ebrahimi
Lord Wilberforce recognised that where, in a commercial enterprise,
the relationship between the members is governed by comprehensively dra
ed
articles of associationto this, shareholder agreements and service contracts
should be added
(Re
Ringtower
(1988))then the superimposition of
7/19/2012 2:21:21 PM
Unfairly prejudicial conduct: CA 2006, Part 30 (ss 994996)
equitable considerations would require something more. It follows that the scope
for the courts to 
nd legitimate expectations which go beyond strict contractual
rights under the companys constitution, yet which nevertheless fall within the
protection of s 994, is subject to strict limitation. In
Company
(No
4377
86)
(1987) the majority, including the petitioner, voted for a special resolution
to amend the companys articles so as to provide that a member, on ceasing to
be an employee or director of the company, would be required to transfer his or
her shares to the company. To remedy a situation of management deadlock, the
petitioner was dismissed as director and was o
ered 900 per share. When he
declined this o
er his shares were valued by the companys auditors in accord-
ance with the pre-emption clauses. He petitioned the court under s 459 (now s
994) to restrain the compulsory acquisition of his shares, arguing that he had a
legitimate expectation that he would continue to participate in the management
of the company which, he argued, was in essence a quasi-partnership. Ho
mann
J held that there could be no expectation on the part of the petitioner that should
relations break down the article would not be followed, [t]o hold to the contrary
would not be to superimpose equitable considerations on his rights under the
articles but to relieve him from the bargain he made.
11.38
It therefore seems that in applying equitable restraints to the exercise of a power
by the majority, the courts will seek to strike a balance between recognising the
supremacy of a companys constitution on the one hand (i.e. the statutory con-
tract, see Chapter 8), and a members extraneous expectations on the other. At its
crux the issue lies with the proper determination of at which point a members
interests or expectations are totally subsumed in the companys constitution. It is
not possible to glean a clear answer to this question from Ho
mann Js judgment
but it can be argued that if a petitioner expressly consents to a particular provi-
sion in the articles, as by voting for it, it will be impossible for him to avoid the
consequences which 
ow from his consent.
11.39
e scope for 
nding expectations which are supplementary to a members strict
legal rights is obviously greater in small quasi-partnership types of private limited
companies where joint venturers enter into business on the basis of certain funda-
mental understandings about management participation, than it is in public lim-
ited companies (see
Strahan
(2006), CA). In
Arrow
(1987) the
petitioner complained that her removal from the o
ce of permanent non-executive
president of the company constituted unfairly prejudicial conduct in that she had
the legitimate expectation of being consulted on company policy on a continuing
basis. Vinelott J, however, emphatically disagreed with this line of argument:
it must be borne in mind that this is a public company, a listed company, and a
large one, and that the constitution was adopted at the time when the company
7/19/2012 2:21:21 PM
Statutory shareholder remedies
was
rst
oated on the Unlisted Securities Market. Outside investors were enti-
tled to assume that the whole of the constitution was contained in the articles,
read, of course, together with the Companies Acts. There is in these circum-
stances no room for any legitimate expectation founded on some agreement
or arrangement made between the directors and kept up their sleeves and not
disclosed to those placing the shares with the public . . .
In
Posgate
Denby
(Agencies
Ltd
(1987) Vinelott J stated, in a similar vein,
that s 994 enables the court to give full e
ect to the terms and understandings on
which the members of the company became associated but not to rewrite them.
11.40
at the scope for applying equitable restraints is signi
cantly restricted in listed
public companies was again emphasised by the Court of Appeal in
Sau
Harrison
Sons
(1995). 
e petitioner complained that the prospects for the
companys business had for a number of years been so poor that any reasonable
board would have put it into voluntary liquidation and distributed its consider-
able assets to the shareholders. 
e essence of the petition was that the directors,
in allowing the company to continue trading, dissipated its assets so as to pre-
serve their in
ated salaries and perquisites. 
e Court of Appeal recognised that
the personal relationship between a petitioner and the controlling members may
be such that a legitimate expectation may be inferred which will e
ectively estop
the exercise of a legal power by the majority. However, Ho
mann LJ stressed
that in the absence of something more, there can be no basis for 
nding a legiti-
mate expectation which goes beyond the articles. On the facts of the case, it was
found that the petitioners rights were exhaustively laid down in the articles of
association. Consequently, her legitimate expectations did not extend beyond the
expectation that the board would manage the company in accordance with their
duciary duties, the Companies Act and the articles.
11.41
It is apparent from the Court of Appeals approach that the judges are anxious
to temper the scope of the concept of legitimate expectations lest it drive a coach
and horses through the contractual undertakings of members as contained in
the articles of association. In Ho
mann LJs analysis, if the conduct complained
of is in accordance with the companys constitution it cannot, as a general rule,
be viewed as unfair since there is no basis for a legitimate expectation that the
board and the company . . . will not exercise whatever powers they are given by
the articles of association. 
e rationale underlying this concern was previously
expressed by Ho
mann J in
Company
(No
86)
(1987) in which he
observed that while s 459 was a long-overdue reform the very width of the juris-
diction means that unless carefully controlled it can become a means of oppres-
sion (see also
Company
(No
4377
86)
(1987)). It is noteworthy that the
shares in
Sau
Harrison
were inherited by the petitioner. In such a situation,
7/19/2012 2:21:21 PM
Unfairly prejudicial conduct: CA 2006, Part 30 (ss 994996)
the scope for 
nding legitimate expectations is severely limited. For example, in
Jackman
Jackets
Enterprises
Ltd
(1977) the petitioners claim that her exclusion
from participating in the companys management constituted oppression was
dismissed. 
e court, in 
nding no such expectation on her part, had regard to
the fact that she had acquired her shares by way of gi
11.42
However, and as has been seen, there are two established categories of cases where
the courts are prepared to look beyond a companys constitution on the basis that
it may not necessarily be conclusive on the question of shareholder expectations:
rst, where the petitioner can demonstrate that a personal relationship exists
with the controlling members of the company which has given rise to a legitimate
expectation that a constitutional power will not be exercised; and second, where
a power contained in the articles is exercised for an improper purpose. In these
situations it will be just and equitable for the court to grant a remedy.
(iii) Unfair prejudice
11.43
e notion of unfairness was considered by the Jenkins Committee to be a vis-
ible departure from the standards of fair dealing and a violation of the conditions
of fair play on which every shareholder who entrusts his money to a company
is entitled to rely (at para 204,adopting the view expressed by Lord Cooper
in
Watson
Ltd
(1952)). With respect to s 994, the courts have
been striving to 
nd an appropriate de
nition and set of guidelines for the deter-
mination of when majority conduct will be considered unfairly prejudicial to
the interests of the minority. Initial judicial thinking tended towards objective
assessment as the governing criterion, but recent pronouncements have thrown
some doubt on the correctness of this approach.
An objective concept?
11.44
Although s 994 does not de ne unfairly prejudicial conduct, early case law
took the view that unfair prejudice should be objectively determined. In
Bovey
Hote
Ventures
Ltd
(1981) Slade J formulated the test in the following
terms:
The test of unfairness must, I think, be an objective, not a subjective, one . . . .the
test, I think, is whether a reasonable bystander observing the consequences of their
conduct, would regard it as having unfairly prejudiced the petitioners interests.
Prentice (1988), citing this passage, has noted that: [t]he focal point of the courts
enquiry in determining whether conduct has been unfairly prejudicial is its
impact and not its nature. 
is can be seen in
Nob
Sons
Ltd
7/19/2012 2:21:21 PM
Statutory shareholder remedies
(1983, above, para
11.15
). Nourse J, applying the objective test, held that a reason-
able man might well have thought that the conduct complained of was prejudicial
but would not have regarded it as unfair, for the petitioner, by his indi
erence,
had partly brought it upon himself. 
e objective approach to the determination
of unfair prejudice has been endorsed by Peter Gibson J in
Sam
(above);
and by Arden J in
Macro
(Ipswich
Ltd
(1994).
The move towards a more open-textured assessment of
unfair prejudice
11.45
e opportunity to re-examine the objective concept of unfair prejudice was taken
by the Court of Appeal in
Sau
Harrison
Sons
(1995). While Ho
mann
LJ recognised that the court has always determined the issue of unfairness objec-
tively for the purposes of s 994 petitions, he questioned whether such an approach
is necessarily the most illuminating way of putting the matter, and doubted
whether objective assessment is the most appropriate test in the circumstances:
For one thing, the standard of fairness must necessarily be laid down by the
court. In explaining how the court sets about
deciding what is fair in the con-
text of company management, I do not think that it helps a great deal to add
the reasonable company watcher to the already substantial cast of imaginary
characters which the law uses to personify its standards of justice in different
situations. An appeal to the views of an imaginary third party makes the con-
cept seem more vague than it really is.
Ho
mann LJ went on to lay down guidelines for determining unfairness, and
in so doing, rea
rmed the sanctity of the statutory contract. He stressed that
fairness for the purposes of s 994 must be viewed in the context of a commercial
relationship and that the articles of association are the contractual terms which
govern the relationship of shareholders with the company and
inter
se.
He said:
Since keeping promises and honouring agreements is probably the most im-
portant element of commercial fairness, the starting point in any case under
s 459 [now s 994] will be to ask whether the conduct of which the shareholder
complains was in accordance with the articles of association.
This approach was carried further in his pronouncement on the issue in
ONeill v Phillips (1999), the
rst appeal under s 994 to reach the House of Lords,
in which Lord Hoffmann noted that fairness was to be determined by reference
to traditional or general equitable principles.
11.46
In
Nei
ll
Phi
(1999) the respondent, P, originally held all of the issued share
capital in the company and was its sole director. 
e petitioner, O, was employed
7/19/2012 2:21:21 PM
Unfairly prejudicial conduct: CA 2006, Part 30 (ss 994996)
by the company in 1983 as a manual worker. P was favourably impressed by Os
ability and he received rapid promotion. In early 1985 O received 25 per cent of the
companys shares and he was made a director. In May 1985 O was informed by P
that he, O, would eventually take over the running of the companys business and
at that time he would receive 50 per cent of the pro
ts. In December 1985 P retired
from the board and O became sole director and e
ectively the companys man-
aging director. For a while the business enjoyed good pro
tability. However, its
fortunes declined and in August 1991, disillusioned with Os management of the
business, P used his majority voting rights to appoint himself managing director
and he took over the management of the company. O was informed that he would
no longer receive 50 per cent of the pro
ts but his entitlement would be limited to
his salary and dividends on his 25 per cent shareholding. Earlier discussions about
further share incentives when certain targets were met were aborted. O thereupon
issued a petition alleging unfairly prejudicial conduct on the part of P.
11.47
e trial judge dismissed the petition on the ground, inter alia, that the alleged
unfairly prejudicial conduct a
ected O qua employee not qua member. Os appeal
to the Court of Appeal was successful on the basis that as from 1985 O had the
legitimate expectation that he would receive 50 per cent of the pro
ts, and that as
from 1991 he had the legitimate expectation that he would receive 50 per cent of
the voting shares. P appealed to the House of Lords. 
e central issue was whether
Ps conduct was unfairly prejudicial. It was held that Ps conduct would have been
unfair had he used his majority voting power to exclude O from the business. 
is
he had not done, but had simply revised the terms of Os remuneration. Ps refusal
to allot additional shares as part of the proposed incentive scheme was not unfair
because the negotiations between them were not completed and no contractual
undertaking had been entered into by the parties. Nor was Ps decision to revise
Os pro
t-sharing arrangement unfair conduct. Os entitlement to 50 per cent of
the companys pro
ts was never formalised and it was, in any case, conditional
upon O running the business. 
at condition was no longer ful
lled because P
had to assume control over the running of the company. Although O argued that
he had lost trust in P, that alone could not form the basis for a petition under the
unfairly prejudicial conduct provision. 
e House of Lords took the view that to
hold otherwise would be to confer on a minority shareholder a unilateral right to
withdraw his capital. O therefore failed to prove that Ps conduct was both unfair
and prejudicial. Lord Ho
mann, in a closely reasoned speech, stressed that the
concept of fairness will depend upon the context in which it is being used and
also its background. He explained that in the case of s 994, the background has
two features:
First, a company is an association of persons for an economic purpose, usually
entered into with legal advice and some degree of formality. The terms of the
7/19/2012 2:21:21 PM
Statutory shareholder remedies
association are contained in the articles of association and sometimes in col-
lateral agreements between the shareholders. Thus the manner in which the
affairs of the company may be conducted is closely regulated by rules to which
the shareholders have agreed. Secondly, company law has developed seam-
lessly from the law of partnership, which was treated by equity, like the Roman
societas, as a contract of good faith. One of the traditional roles of equity, as a
separate jurisdiction, was to restrain the exercise of strict legal rights in certain
relationships in which it considered that this would be contrary to good faith.
These principles have, with appropriate modi
cation, been carried over into
company law.
The
rst of these two features leads to the conclusion that a member of a
company will not ordinarily be entitled to complain of unfairness unless there
has been some breach of the terms on which he agreed that the affairs of the
company should be conducted. But the second leads to the conclusion that there
will be cases in which equitable considerations make it unfair for those conduct-
ing the affairs of the company to rely upon their strict legal powers. Thus unfair-
ness may consist in a breach of the rules or in using the rules in a manner which
equity would regard as contrary to good faith.
11.48
Taking the decisions in
Sau
Harrison
and
Nei
ll
Phi
together, the posi-
tion appears to be that in order to establish unfair prejudice, a petitioner must
prove either a breach of contract (referable to the articles or a shareholders agree-
ment), or a breach of some fundamental understanding in which case equity will
intervene to preclude the majority from repudiating such an obligation despite
the fact that it lacks contractual force. In s 994 petitions, the court will begin by
looking at whether or not the conduct complained about is in accordance with
the articles. If it is not, the court will next consider the scope of any fundamental
understandings between the parties. Unfairness is not to be tested by reference
to subjective notions of fairness but is to be determined by applying settled equi-
table principles to see whether the majority had acted or was proposing to act in
a manner which equity would regard as contrary to good faith (
Guidezone
Ltd
(2000)). In
Sau
Harrison
Ho
mann LJ stressed that unlawful conduct will
not necessarily be unfairly prejudicial, and so trivial or technical infringements
of the articles may not give rise to s 994 petitions. To succeed in such cases a
petitioner will need to demonstrate either that he relied on some pre-association
understanding, or a post-association agreement that was either legally binding or
speci
cally relied on by him (for examples, see the approach of Jonathan Parker
J in
Guidezone
Ltd
(2000); and the comments of Auld and Jonathan Parker
LJJ in
Phoenix
ies
Ltd
Larvin
(2003) to the e
ect that a petitioner
cannot enlist s 994 to force a right of exit from the company that does not exist
under the companys constitution). On the other hand, the failure on the part of
the majority shareholders to hold meetings and to otherwise conduct the a
airs
7/19/2012 2:21:21 PM
Unfairly prejudicial conduct: CA 2006, Part 30 (ss 994996)
of the company as a going concern will be held to be unfairly prejudicial to the
interests of the minority (
Fisher
Cadman
(2005)).
e approach taken by the court in
Rahman
(2008), is of particular inter-
est in so far as it took into consideration the background of a Bangladeshi fam-
ily tied by blood, religion, culture and tradition and running a family business in
its 
nding that the petitioners interests had been unfairly prejudiced. 
e judge,
mindful of Lord Ho
manns observation in
Nei
Phi
that context and back-
7/19/2012 2:21:21 PM
Statutory shareholder remedies
decision in
Nob
Sons
Ltd
(above) was taken as authority
for the proposition that if the petitioner was partly to blame for bringing about
the deadlock in relations which resulted in his exclusion from management, no
unfair prejudice could be made out although, of course, the facts could justify a
winding-up order under the just and equitable ground. More recent authority,
however, points to the courts reluctance to become immersed in a quagmire of
evidence relating to fault. In
XY
Ltd
(No
4377
86)
(1987) Ho
mann
J drew the analogy between s 994 petitions and old-style divorce cases, and
alluded to the di
culties experienced by judges when called upon to attribute
fault. Indeed, it does not follow that simply because the petitioner is innocent, the
respondent is presumed to have been guilty of the relevant culpable conduct. 
e
judge remarked that:
There are many cases in which it becomes in practice impossible for two people
to work together without obvious fault on either side. They may have come
together with a con
dent expectation of being able to co-operate but found
that insurmountable differenc
es in personality made it impossible. In those cir-
cumstances the only solution is for them to part company. If one of them asks
the other to leave the business, I cannot accept that the former must auto-
matically be regarded as having acted in a manner unfairly prejudicial to the
interests of the latter.
11.51
is move away from a fault-based approach is also evident in the way in which
the courts now favour the view that a valuation of a petitioners shares should
normally be made without any discount being applied to re
ect his or her minor-
ity shareholding (see below). However, it was made clear by Lord Ho
mann in
Nei
ll
Phi
(1999) that the shi
from the fault-based approach stops short of
permitting a shareholder to withdraw unilaterally from a company and demand
that the majority should buy him out (see, for example,
Phoenix
ies
Ltd
Larvin
(above)). Similarly, the Law Commission did not favour the intro-
duction of no fault divorce which would permit a shareholder to exit at will (Law
Com No 246, para 3.66). In its view there are sound economic reasons against
allowing such a remedy and, as a matter of principle, it would fundamentally
contravene the statutory contract. In
Phoenix
ies
Ltd
Larvin
(2003)
the petitioner, who held one-third of the shares in the company, wished to ter-
minate his association with the business for personal reasons. He resigned his
employment and gave notice of his intent to resign his directorship once the sale
of his shares at their full value and without discount to re
ect his minority share-
holding had been agreed. He alleged that the remaining two directors (holding
between them two thirds of its issued share capital) had wrongfully excluded
him from his entitlement as director to access 
nancial information thereby pre-
venting him from protecting his interest as a shareholder. 
e Court of Appeal,
7/19/2012 2:21:21 PM
Unfairly prejudicial conduct: CA 2006, Part 30 (ss 994996)
reversing the trial judge, held that the conduct of the majority did not amount to
unfairly prejudicial conduct. Jonathan Parker LJ observed:
Thus the issue which lies at the heart of this appeal, as I see it, is whether sec-
tion 459 extends to affording a member of a quasi-partnership company who
wishes, for entirely his own reasons, to sever his connection with the company
and who
de facto
has done soan opportunity to put his shareholding onto
the other members at its full, undiscounted, value when he has no contractual
right to do so. I can for my part see no basis for concluding that section 459 can
have such a Draconian effect.
(See also
Parkinson
Euro
Group
Ltd
(2001).)
(ii) Mismanagement
11.52
e scope for 
nding that managerial incompetence falls within the ambit of s
994 is necessarily limited and on a number of occasions the courts have stressed
that ordinarily they would be very reluctant to 
nd that management decisions
could amount to unfair conduct. In
gindata
Ltd
(1991) Warner J observed
that the risk of poor management is an incident of share ownership given that
managerial competence will generally determine the value of the shareholders
investment in the company. Further, it has long been settled that the courts will
not interfere with a bona 
de business decision made by a companys board or
its majority shareholders (the internal management rule), except where there is
a clear con
ict of interests (
Nicho
Soundcra
ectronics
Ltd
(1993)). In
gindata
Ltd
(1991) it was alleged, inter alia, that the controlling director had
managed the company incompetently. Warner J refused to grant relief, stressing
that: [s]hort of a breach by a director of his duty of skill and care . . . there is prima
facie no unfairness to a shareholder in the quality of the management turning out
to be poor. It is noteworthy from this passage that proving breach of the com-
mon law duties of prudence is, as a general rule, the decisive factor, so that cases
where there is a disagreement between petitioners and respondents as to whether
a particular managerial decision was, as a matter of commercial judgement, the
right one to make, or as to whether a particular proposal relating to the conduct
of the companys business is commercially sound do not fall within s 994.
11.53
In
Macro
(Ipswich
Ltd
(1994) an allegation of mismanagement resulting in
economic loss to the company was found to amount to unfairly prejudicial con-
duct. 
e evidence of the events giving rise to the claim span a period of some 40
years. Central to the mismanagement allegations was the complaint that the sole
director of the two associated companies in question neglected his management
responsibilities and this was exploited by dishonest employees who stole commis-
sions earned by the estate agency arm of the business. It was successfully argued
7/19/2012 2:21:21 PM
Statutory shareholder remedies
by the petitioners that substantial 
nancial losses were su
ered by the companies
which unfairly prejudiced them. In granting relief, Arden J noted that the facts
before the court were analogous to the example formulated by Warner J in
gindata
Ltd
(1991) to the e
ect that absent breach by a director of his duty of
care and skill, the court might nonetheless 
nd that there was unfair prejudice to
minority shareholders where the majority, for reasons of their own, persisted in
retaining in charge of the management of the company a family member who was
7/19/2012 2:21:22 PM
Unfairly prejudicial conduct: CA 2006, Part 30 (ss 994996)
11.55
e case law therefore reveals that s 994 may be used to obtain a personal remedy
despite the proper claimant rule (see Chapter 10). In this respect, other exam-
ples of successful s 994 petitions brought for breach of 
duciary duties include
allegations that directors have made secret pro
ts (
Company
(No
87
85)
(1986);
Donne
ll
Shanahan
(2009) and
(UK
Ltd
(2005));
have exercised their powers to issue and allot shares for an improper purpose, for
example, to reduce the petitioners shareholding (
Cumana
Ltd
(1986),
(above)); have diverted a corporate opportunity (
(UK
Ltd
(2005);
Gerrard
Koby
(2004)); and have abused their powers by recommending
shareholders to accept the lower of two o
ers for the shares of the company with-
out disclosing that they were the promoters of the company making the lower
er (
Company
(No
85)
(1986)).
11.56
While loss of trust is not su
cient per se to found a petition under s 994 (
Jay
Construction
Ltd
(2003)), the point was made in
(UK
Ltd
(above), by George Bompas QC (sitting as a Deputy Judge of the High Court) that
in the case of a quasi-partnership company, a breach of duty by one participant
may lead to such a loss of con
dence on the part of the innocent participant and
breakdown in relations that the innocent participant is entitled to relief under s
996 of the CA 2006 (see below). 
e judge noted that, in e
ect, the unfairness lies
in compelling the innocent participant to remain a member of the company.
(iv) Excessive remuneration and the failure to pay dividends
11.57
A companys articles of association will generally provide that directors remu-
neration shall be determined by the general meeting. In practice, however, the
power to determine remuneration for directors is delegated to the board. Such
provisions, it will be recalled, form part of the statutory contract between the
shareholders and the company. In general, the court will be disinclined to inter-
fere with the business judgement of the board, and so provided it has honestly
and genuinely determined the level of remuneration the court will not enquire
whether the award was reasonable (
Garages
(19
64)
Ltd
(1982)).
11.58
at there is ample scope for abuse of this power by the board was recognised
by both the Cohen and the Jenkins Committees which considered the problem
of directors awarding themselves excessive remuneration, thereby leaving lit-
tle or no surplus pro
ts for distribution by way of dividends to shareholders. In
extreme cases the court will be prepared to hold that the failure to pay dividends
and/or excessive remuneration or fees amounts to unfairly prejudicial conduct
(for examples, see
Grace
Biagio
(2006);
Rahman
(2008);
McCarthy
Surfacing
Ltd
(2008) and
Cro
(2010), see para
11.72
, below;
West
Coast
Capita
(Lios
Limited
(2008), discussed in Chapter 14, at
14.23
, below). Prior to
the 1989 amendment of the unfair prejudice provision (see para
11.22
above),
7/19/2012 2:21:22 PM
Statutory shareholder remedies
claims under this head would fail on the basis that the conduct complained of
was not discriminatory between shareholders, although it could give rise to a just
and equitable winding-up order (
Company
(No
87),
ossop
(1988)). However, in
Sam
Sons
Ltd
(1990) Peter Gibson J refused
to strike out a petition alleging that the refusal of the majority shareholders to
increase the dividend yield which had remained the same for 37 years despite the
companys positive performance in the years leading up to the petition, while
they continued to draw directors remuneration and accumulating cash reserves,
amounted to unfairly prejudicial conduct.
11.59
Company
(No
199
6)
(1997) the Vice-Chancellor observed that
if remuneration and dividend levels cannot be justi
ed by objective commercial
criteria it would seem to follow that the a
airs of the company have been man-
aged in a way unfairly prejudicial to the interests of the shareholders who are not
directors. In
Cumana
Ltd
(1986) it was held that the payment of some 356,000
to the respondent over a 14month period was excessive and was unfairly prej-
udicial to the petitioner. Vinelott J said that the remuneration was plainly in
excess of anything the [respondent] had earned. On the other hand, in
Sau
Harrison
the same judge struck out a petition in which the allegations included
a claim that the directors had awarded themselves excessive remuneration. He
noted that the sums involved did not exceed those which other comparable com-
panies paid their executive directors. In
Anderson
Hogg
(2002), a Scottish deci-
sion of the Inner House, the payment by a director to himself of an unauthorised
and excessive sum as a redundancy payment was held to be unfairly prejudicial to
the petitioners interests. 
e decision again illustrates the trend towards bypass-
ing the proper claimant rule (see Chapter 10)
given that the remedy sought was
an order for payment to the company. Lord Prosser, dissenting, took the view that
the petitioner should have caused the company to initiate proceedings.
Locus standi
and procedural aspects of s 994
11.60
Section 994(1) states that a member of a company may petition for an order
under the provision. Section 112 de
nes a member as a subscriber to the com-
panys memorandum and [e]very other person who agrees to become a member
of the company and whose name is entered in its register of members. 
e section
is satis
ed whenever a person assents to become a member without the necessity
of a contract in the strict sense (
Nuneaton
Borough
Association
Footba
ll
Ltd
(1989)). In
Harris
Jones
(2011), Morgan J took the view that the right to
petition under s 994 extended to a person to whom shares have been transferred
but who has not been registered as a member. Further, by virtue of s 994(2),
those to whom shares in the company have been transferred or transmitted by
7/19/2012 2:21:22 PM
Unfairly prejudicial conduct: CA 2006, Part 30 (ss 994996)
operation of law have standing, and so, for example, the personal representa-
tives of a deceased or bankrupt member may bring a petition. On the other
hand, a bene
cial owner whose shares are held by a nominee will not qualify (
uickdome
Ltd
(1988)); while in
Brightview
Ltd
(2004), the court was of the
view that a nominee shareholder would have standing to petition. It is notewor-
thy that
John
Reid
Sons
(Strucstee
l)
Ltd
(2003), the petition was dismissed
because it principally concerned conduct related to the petitioners future status
as an employee of the company as opposed to his position as shareholder. In
Baker
Potter
(2005), David Richards J held that where the petitioner is seeking
nancial relief but has agreed to sell his share to the respondent, who, on the
facts, was the companys sole director and owned one share in it, such agreement
converted the petitioners interest in the company into a right to receive the
purchase price. Accordingly, if there had been a misappropriation of corporate
assets, for example by the respondent prior to the sale agreement, there might be
a case for 
nancial relief. But 
nancial relief is not appropriate where the alleged
unfairly prejudicial conduct occurs a
er the parties have concluded the agree-
ment, provided the petitioner was paid the agreed price, because he would not
have su
ered prejudice.
e issue has arisen whether an arbitration clause in a company membership
agreement, for example the Football Association rules, will operate to exclude
the statutory right of access to the courts under s 994. In
ham
Footba
ll
(19
87)
Ltd
Richards
(2011
, the trial judge, faced with con
icting authorities
namely,
Vocam
Europe
Ltd.
(1998) and
Exeter
City
Association
Footba
ll
Ltd.
Footba
ll
Conference
Ltd.
(200
, granted an application under s 9 of the
Arbitration Act 1996 to stay a petition brought under s 994, in circumstances
where rules had been agreed under which disputes would be referred to and
resolved by arbitration. On appeal it was argued that the petition should not have
been stayed and that the trial judge should have followed
Exeter
City
in which
HHJ Weeks QC held that the shareholders right to petition for relief under s 994
was inalienable and could not be diminished or removed by contract or oth-
erwise. 
e Court of Appeal, rejecting this argument, upheld the trial judges
decision to stay the petition.
Patten LJ, delivering the leading judgment, stated
that
Exeter
City
had been wrongly decided and observed that s 994 gave share-
holders an optional right to invoke the assistance of the court in cases of unfair
prejudice . . . there is nothing in the scheme of these provisions which . . . makes
the resolution of the underlying dispute inherently unsuitable for determination
by arbitration on grounds of public policy.
11.61
ere is no procedural requirement that a petitioner must satisfy the court that
he has an arguable case as is the situation with derivative actions. But a respond-
ent can apply to the court to have a summary judgment or to have a petition
7/19/2012 2:21:22 PM
Statutory shareholder remedies
struck out. 
e CPR (rule 3.4(2)) empowers the court, as was the case under the
old rules, to strike out statements of case which disclose no reasonable grounds
for bringing or defending the claim, or which are an abuse of the courts process
or likely to obstruct the just disposal of the proceedings. 
us, if the action is
brought in order to achieve some collateral purpose, for example to obtain repay-
ment of a loan to the petitioner, the court may strike out the petition as an abuse
of process (
ador
Ltd
(1965)). When considering a strike-out applica-
tion the court will look at the realities of the petitioners case and a petition will
not be allowed to proceed if the likelihood of the claimed relief being granted is
so remote that the case can be described as perfectly hopeless (
Lega
Costs
Negotiators
Ltd
(above
),
per
Peter Gibson LJ).
11.62
Further, the CPR, Part 24 allows the court to enter summary judgment with-
out the delay and expense of a trial. Summary judgment may be entered where
the petition or defence has no realistic prospect of success. 
ere is an overlap
between Part 24 and rule 3.4 (above) and in many cases applications are com-
bined under both provisions. A typical example of where a respondent might
apply for striking-out or summary judgment is where the petitioner seeks an
order to have his shares purchased, and he has refused a reasonable o
er for
his shares. Similarly, such an application might be made by a respondent where
the articles of association or a shareholders agreement contain a pre-emption
clause (whereby in the event of a shareholder wishing to sell his shares to an
outsider, the other members shall have the option to buy him out at a fair value
to be  xed by the auditors). 
us, if the petition is being brought as a means of
evading the contractual obligation, the court will not permit the action to pro-
ceed unless the petitioner can point to equitable considerations which render
the enforcement of the obligation unfairly prejudicial (
Nei
ll
Phi
(1999);
see also Ho
manns Js judgment in
Company
(No
86)
(1986)).
In
Furnishings
Ltd
(2006), the parties had agreed both the circum-
stances in which a shareholder would be compelled to transfer his shares and
the valuation procedure that would be followed. 
e applicants unsuccessfully
sought to strike out the action on the basis that it was an abuse of process. While
recognising that in the usual case where there is no question of any wrongdoing
by the majority it will normally be an abuse of process for a petition to proceed
where an o
er has been made to purchase the shares at a fair value, or where the
petitioner is contractually bound to sell his stake in given circumstances and
has agreed a fair valuation method, the judge went on to state that the continu-
ation of a petition will not, however, amount to an abuse of process if:
there is evidence to suggest that substantial assets of the company have
(a)
been misapplied as a result of the conduct of the majority; or
7/19/2012 2:21:22 PM
Unfairly prejudicial conduct: CA 2006, Part 30 (ss 994996)
the agreed valuer is not in a position to exercise independent judgement
(b)
on the question of value (as in
Boswe
ll
(Stee
Ltd
(1989) or
Ben
Greig
Group
(2000)).
11.63
Although disputes involving allegations of unfairly prejudicial conduct typically
arise between factions of shareholders, the company should always be joined as
a nominal party to the proceedings so that a court order is enforceable against it
Litt
ympian
Each
Ways
Ltd
(No
3)
(1995)). In petitions involving quasi-
partnership types of companies, generally all existing shareholders irrespective
of whether or not any wrongdoing is alleged, should be joined as respondents (
Company
(No
86)
(1987)). 
is is because a share purchase order
will normally be made against the current shareholders of the company. A past
member of a company may also be joined as a party if relief is sought against him
Company
(No
87
85)
(1986)).
Remedies
11.64
If the petitioner establishes unfairly prejudicial conduct, s 996(1) of the Companies
Act 2006 provides that the court may make such order as it thinks 
t for giving
relief in respect of the matters complained of. More particularly, s 996(2) goes on
to add that:
Without prejudice to the generality of subsection (1), the courts order may
(a) regulate the conduct of the companys affairs in the future;
(b) require the company
(i) to refrain from doing or continuing an act complained of, or
(ii) to do an act which the petitioner has complained it has omitted to do,
(c)
authorise civil proceedings to be brought in the name and on behalf of
the company by such person or persons and on such terms as the court
may direct;
(d)
require the company not to make any, or speci
ed, alterations in its arti-
cles without the leave of the court;
(e)
provide for the purchase of the shares of any members of the company by
other members or by the company itself and, in the case of a purchase by
the company itself, the reduction of the companys capital accordingly.
Unlike winding-up on the just and equitable ground, it is clear then that the court
7/19/2012 2:21:22 PM
Statutory shareholder remedies
it was observed by Mummery J in
Company
(No
Estate
Acquisition
and
Deve
opment
Ltd
(1991) that:
Under sections 459461 [now ss 994996] the court is not, therefore, faced
with a death sentence decision dependent on establishing just and equitable
grounds. The court is more in the position of a medical practitioner presented
with a patient who is alleged to be suffering from one or more ailments which
can be treated by an appropriate remedy applied during the course of the con-
tinuing life of the company.
Further, the breadth of the courts powers may extend to an award of damages for
re
ective loss (see
Brightview
Ltd
and Chapter 10, above). In
Ltd
(above), the petitioner sought a winding-up order on the just and equitable
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Unfairly prejudicial conduct: CA 2006, Part 30 (ss 994996)
11.67
e most common form of relief granted by the court is an order for the purchase
of the petitioners shares by the company or another shareholder (s 996(2)(e)).
Indeed, in
Grace
Biagio
(2006), the Court of Appeal a
rmed the view that
there is a presumption in favour of a buy-out order for successful unfair prejudice
petitions. 
e remedy is usually sought by shareholders in private or unlisted
companies who do not have the option of leaving the company by selling their
shares on the open market. Nourse J stressed in
Bird
Precision
Ltd
(1984) that in valuing the petitioners shares the guiding principle is to  x a price
that is fair in all the circumstances. A range of factors are taken into account by
the court, including the conduct and culpability of the parties. On this point,
Nourse J said that [a] shareholder who deserves his exclusion has, if you like,
made a constructive election to sever his connection with the company and thus
sell his shares (see also,
Richardson
ackmore
(2005)). We now turn to con-
sider the various factors which may inform share valuations in this context. In
framing an appropriate remedy under the provision the objective is achieving
fairness and in
Rahman
(para
11.49
, above), the court not only ordered
the wrongdoer to purchase the petitioners shares, but took into account divi-
dends which had not been paid to him and the under-declaration of pro
ts (see
also,
McCarthy
Surfacing
Ltd
(2008)).
Valuation of shares on a buy-out
11.68
For quoted companies valuing shares is a fairly straightforward exercise because
reference can be made to their market price. But for unquoted companies, and
the vast majority of s 994 petitions fall within this category, the valuation exercise
is a far more di
cult undertaking. 
e court has a wide discretion to do what
is fair and equitable in all the circumstances of the case and under the CPR the
court is expected to adopt a vigorous approach towards share valuation (
North
Ltd
Southern
Tropics
Ltd
(1999)).
11.69
Generally, of course, it will be the majority who are ordered to purchase the peti-
tioners shares, however there are rare examples where the converse has been
ordered, albeit subject to conditions. An order that the minority purchase the
majoritys shares would be particularly appropriate where the majority are incom-
petent to manage the companys a
airs (
Minute
Car
Wash
Service
Ltd
(1966)). Further, such an order was made by Harman J in
Nuneaton
Borough
Association
Footba
ll
Ltd
(1989) in which he found that the majority share-
holder was clearly at fault and had shown himself un
t to exercise control of the
company. Since the respondent had made substantial interest-free loans to the
company the judge found that it would not . . . be proper equitable relief to com-
pel the transfer of the controlling shares without arranging for the repayment
7/19/2012 2:21:22 PM
Statutory shareholder remedies
of the advances. Another example is
Investment
Partners
Limited
Partnership
Boughtwood
(para
11.28
, above), where, as commented above, the
court ordered the signi
cant shareholder to sell his shares to the petitioner. 
e
signi
cant shareholders appeal against the buy-out order was dismissed by the
Court of Appeal on the basis that the conduct in question made such an order
inevitable and unchallengeable (see
Boughtwood
Investment
Partners
Ltd
Partnership
(2010)).
11.70
Where the court in its determination of the value of the petitioners minority
shareholding takes into account that he has limited voting power and therefore
little control over the companys management, it is said that the shares are valued
on a discounted basis. Where, on the other hand, in the interests of arriving at
a fair and equitable result no discount is applied, the shares are said to be valued
on a pro rata basis (i.e. according to the value of all the issued share capital). As
far as it is possible to distil any general principle from the case law, it can be said
that normally no discount is applied by the courts to re
ect a petitioners minor-
ity shareholding where the company in question is a small quasi-partnership in
the
Ebrahimi
sense (
Virdi
Abbey
Leisure
Ltd
(1990);
McCarthy
Surfacing
Ltd
(2008)). Conversely, in
Irvine
Irvine
(2006), the court decided that for the
purposes of a buy-out order following a successful petition under what was then
s 459 CA 1985, a shareholding of 49.96% was to be valued as any other minority
holding, so that no premium should be attached to the shares simply because the
buyer was the majority shareholder who would gain control of the whole of the
issued share capital.
11.71
Nourse J in
Bird
Precision
Ltd
(1984) subjected the valuation proc-
ess to exhaustive examination. He noted that as far as petitioners in quasi-part-
nership companies are concerned, the sale is, in e
ect, being forced upon them
as a result of the unfairly prejudicial conduct and it would normally be most
unfair to impose a discounted price for their shares in such circumstances. 
e
Court of Appeal agreed. 
is approach was endorsed by the Privy Council in
CVC
Opportunity
Equity
Partners
Ltd
meida
(2002), on the basis that where
the petitioner was an unwilling seller the shares should normally be valued as a
rateable proportion of the value of the company as a going concern without any
discount for a minority holding. Valuation without discount now appears to be
generally applied in s 994 cases (see
Strahan
(2006), CA). Although,
where petitioners acquire their shares by way of investment and therefore without
any legitimate expectation of participating in management, they would have paid
a discounted price initially anyway to re
ect the value of the minority holding
acquired. In such cases it would be normally fair and appropriate for the court
to arrive at a discounted valuation (
Chemica
Ltd
(1988)). In
Crabtree
(2012), Lewison J considered the principles that should apply to the valuation
7/19/2012 2:21:22 PM
Unfairly prejudicial conduct: CA 2006, Part 30 (ss 994996)
of the shares of a petitioner who was to be bought out by the other 50 per cent
shareholder. 
e valuation was to be based on the value to the co-owner rather
than on an open market value and, subject to that, the petitioners interest was
to be  xed at one half of the valuation of the company as determined through its
statutory accounts.
11.72
A critical factor in the valuation process is the date at which the shares are to
be valued. Obviously the value of the shares may have 
uctuated considerably
between the launch of the petition and the date of the trial. 
e length and
expense of typical s 994 proceedings can cause the value of the companys shares
to decline sharply. 
e anxiety of the court in determining the relevant date at
which the valuation is to be  xed is, as we have seen, directed towards achieving
fairness. In
Abbington
Hote
Ltd
(2011), the court stated that 
e starting point
for the date of valuation of shares for a buy-out order under s.996 is the date of
judgment, but the court is free to choose such date as is most appropriate and just
in the circumstances of the case. In particular, the date should be that which best
remedies the unfair prejudice held to be established.
Subject then to the overriding requirement of achieving fairness by remedying the
unfair prejudice su
ered by the petitioner, the starting point is that prima facie an
interest in a going concern ought to be valued at the date on which it is ordered to
be purchased (
London
Schoo
ectronics
(1986) per Nourse J, approved by
Robert Walker LJ in
Pro
nance
Trust
adstone
(2002)). However, as com-
mented above, in seeking to achieve a fair valuation, the court may opt for a date that
pre-dates the unfairly prejudicial conduct in question (
Company
(No
In
Good
(2010) it was found that following the petitioners
exclusion from the management of the business the fortunes of the company had
declined to the point where it had entered insolvency. Although there was no evi-
7/19/2012 2:21:22 PM
Statutory shareholder remedies
7/19/2012 2:21:22 PM
Unfairly prejudicial conduct: CA 2006, Part 30 (ss 994996)
struck out (
Furnishings
Ltd
(above); and
Harborne
Road
Nominees
Ltd
Karvaski
(2011)). Strategically, respondents are well advised to make a fair
er for the petitioners shares, one which is based on Lord Ho
manns guide-
lines, before applying for striking-out. Should the expert valuer not be independ-
ent, the petitioner may have an arguable case of unfair prejudice. In
Ben
Greig
Group
(2002) the articles provided that on the death of a member the
shares held by the executors would become subject to compulsory transfer and
that the valuation would be carried out by the companys auditors who were
required to be independent. 
e petitioners, the deceaseds executors, sought to
challenge the auditors valuation on the basis that, having previously advised the
company immediately following the members death on how to achieve a low
valuation for the purposes of the Inland Revenue, their independence was com-
promised. 
e Court of Appeal held that the evidence disclosed a case that had a
real prospect of success.
Costs
11.74
It will be recalled that it is possible to petition under s 994 for breach of 
duciary
duties notwithstanding that such conduct is technically a wrong to the company
(see
London
Schoo
ectronics
Ltd
(above); and
Litt
ympian
Each
Ways
Ltd
(No
3)
(above)). It was seen in Chapter 10 that in
ersteiner
Moir
(No
(1975), Buckley LJ stated that the shareholder who initiates a derivative
action may be entitled to be indemni
ed by the company at the end of the trial
for his costs provided he acted reasonably in bringing the action. CPR 19.9(7)
covers costs. It states that the court may order the company to indemnify the
claimant against any liability in respect of costs incurred in the claim. An appli-
cation under CPR 19.9(7) may be made at the time of applying for permission to
continue the claim.
11.75
Given that s 994 is a personal remedy, the courts have resisted claims by petition-
ers that companies should pay their costs. 
is has been the case even where the
substance of the allegation is that directors had used their powers for an improper
purpose by issuing shares to alter the constitutional make-up of the company (i.e.
in breach of their 
duciary duties (see
Company
(1987); see further, Chapter
14). Although, as we commented above, where the court authorises a petitioner
to bring an action in the name of the company under s 996(2)(c), such a peti-
tioner may be entitled to a
ersteiner
order (
Sherborne
Park
Residents
Ltd
(1987)).
In
ark
(2003) the issue of funding a s 994 petition came
to the fore where the conduct complained of related to a director misappropriat-
ing substantial sums of money from the company without the knowledge of Mr
Clark, an equal shareholder and co-director. 
is clearly constituted a breach
7/19/2012 2:21:22 PM
Statutory shareholder remedies
of 
duciary duty and the petitioner brought a derivative action on behalf of the
company which was later consolidated with a petition under s 994. Arden LJ took
the provisional view that although a remedy was claimed under s 996 CA 2006
this was essentially for the bene
t of the company so that, therefore, the petitioner
could seek an order against the company for payment to him of costs unless, of
course, costs were recovered from the respondent, Mr Cutland. It therefore seems
that if the company bene
ts from the remedy sought, it may be ordered to pay the
petitioners costs. 
e point was also made that, when considering the range of
remedies available under s 996, the court can have recourse to those available on
a derivative action which may include those which are proprietary in nature.
More generally on the issue of s 994 costs, in
Southern
Counties
Fresh
Foods
Ltd
(2011) Warren J took the view that costs 
owing from an unfair prejudice petition
did not attract any special principles: the starting point was the general rule in
CPR r.44.3(2)(a) that the unsuccessful party will be ordered to pay the costs of the
successful party. However, an unsuccessful party did not bear an onus to demon-
strate that adopting the general rule would be unjust because it was for the court
to consider what departures from the general rule were appropriate in light of all
the circumstances of the case. In the case before him, the costs order had to re
ect
the fact that although C was successful in obtaining the relief sought, its success
was quali
ed as it had failed to establish many of its allegations of unfair prejudice.
ere was no way of sensibly apportioning the overall costs between general costs
and costs of speci
7/19/2012 2:21:22 PM
Unfairly prejudicial conduct: CA 2006, Part 30 (ss 994996)
course in a petition for unfairly prejudicial conduct is manifest from the follow-
ing practice direction, the CPR Practice Direction, Part 49B, para 9(1) (replacing
Chancery 1/90 (Practice Direction)):
Attention is drawn to the undesirability of asking as a matter of course for a
winding-up order as an alternative to an order under s. 459 of the Companies
Act 1985 [now s 994]. The petition should not ask for a winding-up order unless
that is the relief which the petitioner prefers or it is thought that it may be the
only relief to which he is entitled.
In
ham
Footba
Ltd
Richards
(2011) the court held that s 994 will
usually provide the source of a satisfactory alternative remedy such as a buy-out
order so that winding-up under s 122(1)(g) is therefore a last resort and an excep-
tional remedy to grant in the context of disputes between shareholders. 
e court
stated that this is con
rmed by the terms of the current Practice Direction 49B
which draws attention to the undesirability of asking, as a matter of course, for a
winding-up order as an alternative to an order under s 994.
(See also
Dineshkumar
Jeshang
Mahendra
Jeshang
(2010)).
11.77
us, in
Company
(No
199
6)
(1997) allegations concerning remu-
neration and dividends were held to constitute a prima facie case of unfairly prej-
udicial conduct and the court struck out the petition for winding-up on the just
and equitable ground (see also
Cope
Craddock
Ltd
(above)). 
e point
is reinforced by the Law Commissions Report No 246,
Shareho
Remedies
(1997), which recommended that winding-up should be speci
cally added to the
remedies available under s 996, subject to the petitioner being required to obtain
the leave of the court before seeking a winding-up order (para 4.44). As the lan-
guage of s 996 makes clear, this recommendation was not adopted. However,
winding-up may be an appropriate remedy for the court to at least consider
when determining the price to be paid for the petitioners shares under s 996. As
explained in
Sunrise
Radio
Ltd
(2010):
A winding-up, though producing a rateable proportion of the assets for all share-
holders, will often be at break-up value, and therefore not necessarily advanta-
geous to the shareholders. Nevertheless, in the case of a solvent company, I do
not see why the court should not direct the liquidator to carry on business in an
appropriate case, if necessary appointing a special manager to assist him, thus
preserving the value of the business which can be realised on a going concern
basis. Given that possible alternative, the court should not in general put a
shareholder in a worse position than would be the case in a winding-up, if the
facts would otherwise justify invocation of the just and equitable jurisdiction.
That does not mean, however, that winding-up should routinely be sought as
7/19/2012 2:21:22 PM
Statutory shareholder remedies
an alternative in s 994 cases. Rather, the potential availability of relief through
the winding-up process should in an appropriate case be taken into account in
fashioning the remedy, including the determination of the price, under s 996.
Finally, it is noteworthy that in
Amin
Amin
(2009) Warren J, 
nding that the peti-
tioners allegations of unfair prejudice were unfounded, nevertheless recognized
that the circumstances may well have supported a successful petition for just and
equitable winding-up, although the petitioners had not sought this. 
e judge went
on to observe that:
If the facts are such that a winding up petition on the just and equitable ground
would succeed but the majority refuse to agree to a winding-up out of court,
that conduct might amount to unfair pr
ejudice, the unfairness being to compel
the minority to continue to participate in the company when the court would,
on this hypothesis, wind it up.
Relevance of the petitioners conduct
11.78
It was settled by the House of Lords in
Nei
ll
Phi
(1999) that in determin-
ing the issue of unfair prejudice, the equitable principles laid down in
Ebrahimi
will necessarily come to the fore where the company in question is a small quasi-
partnership. Accordingly, where a petitioner seeks to rely on equity his conduct
becomes a relevant factor in the courts determination. It is also apparent from
the case law that regard will be had to the petitioners conduct when determining
the question of whether or not the respondents behaviour was unfair. It will be
recalled that in
Nob
Ltd
it was held that the petitioner by his own disin-
terest was to blame for his exclusion from management and so the respondents
conduct, although prejudicial, was not unfair (see
Jesner
Jarrad
Properties
Ltd
7/19/2012 2:21:22 PM
Other speci c statutory minority rights
(2004), the petition was presented some two years a
er the events complained of.
It then took another three years for it to reach the court. Mann J criticised the
delay but felt there were compelling reasons for excusing it, including fault on the
part of the respondents in failing to expedite the proceedings (see also,
Rahman
(para
11.49
, above). On the other hand, in
Grandactua
Ltd
(2006),
the petition was struck out where the allegation of unfairly prejudicial conduct
related to conduct in which the petitioners had participated without complaint
some nine years before the claim was presented. 
e judge explained that while
s 994 was not subject to any period of limitation, relief under the provision was
discretionary. He emphatically stated that a court should not countenance pro-
ceedings such as those before him where the petition was presented nearly ten
years a
er the events complained of.
Other speci
c statutory minority rights
Introduction
11.80
us far we have examined the principal substantive remedies available to
aggrieved minority shareholders. Additionally, the Companies Act contains a
number of provisions which grant rights to minority shareholders who dissent
from certain decisions taken by the company or who wish to require it to perform
certain statutory duties. For instance, the Act lays down speci
c procedures for
the alteration of a companys constitution which are aimed at preventing changes
being e
ected unless supported by 75 per cent of the general meeting. Other
speci
c statutory provisions include the right of shareholders to requisition an
extraordinary general meeting; demand a poll; and remove a director by a simple
majority of votes.
Alterations to the companys constitution
11.81
Minority shareholders are protected against alterations to the articles of asso-
ciation of the company being carried by a simple majority of the general meet-
ing. Subject to ss 631633 of the CA 2006, s 21 empowers a company to alter its
articles by special resolution. As we discussed in Chapter 8, this, of course, gives
rise to the curious result that, in contrast to the general law of contract, the statu-
tory contract found in s 33 can be changed without the unanimous consent of
the parties. However, an existing member is not bound by an alteration to the
articles which increases his liability to contribute capital unless he agrees in writ-
ing either before or a
er the alteration is made (s 25). By way of an additional
7/19/2012 2:21:22 PM
Statutory shareholder remedies
safeguard, it is possible to prevent provisions in the companys articles of asso-
ciation from being altered by special resolution by including a so-called provi-
sion for entrenchment to the e
ect that speci
ed provisions may be amended
or repealed only if conditions are met, or procedures are complied with, that
are more restrictive than those applicable in the case of a special resolution (s
22(1); see further, Chapter 8). But a company cannot restrict the right to alter its
articles by a declaration in the articles themselves, nor can it contract not to alter
its articles. 
us, in
London
Tramways
(1879) the court held that a
clause in the companys articles which declared that certain articles were essen-
tial and unalterable was ine
ective and Jessell MR placed considerable emphasis
on the fact that no company could contract itself out of its right to exercise the
powers conferred by statute (see further,
Punt
Symons
Ltd
(1903)). While
it seems settled that a company cannot bind itself not to exercise a statutory right,
an agreement outside of the articles between the shareholders
inter
as to how
they will exercise their voting rights on a resolution to alter the articles may be
enforceable as between themselves (
Russe
ll
Northern
Deve
opment
Corpn
Ltd
(1992)). In this way shareholders rights may be indirectly entrenched in so
far as the court will enforce such an agreement as between the members who
were parties to it although it will not be binding on their transferees or non-
assenting shareholders (
ery
(1897); see Chapter 8).
The right to requisition an extraordinary general meeting
11.82
Section 303 provides that shareholders may require the directors to convene a
general meeting of the company. 
e requisition, which must be supported by
holders of not less than 10 per cent of the voting paid-up capital or, in the case of
a company with no share capital, by members representing not less than 10 per
cent of the total voting rights in the company, must state the objects of the meet-
ing. If the directors fail to convene a meeting within 21 days from the date of the
requisition, the requisitionists may do so themselves. Finally, it is provided that
the meeting convened by the directors must take place within 28 days a
er the
date of the notice convening it (s 304).
The right to demand a poll
11.83
e practice in general meetings is for voting to take place on a show of hands,
a poll is taken only if a valid demand is made. On a show of hands each member
will have one vote irrespective of the number of shares held and normally a proxy
cannot vote at all. Where a poll is taken all members can cast their votes accord-
ing to the number of shares held and this therefore gives a more accurate pic-
ture of the opinion of the shareholders. Uncontroversial resolutions are normally
7/19/2012 2:21:22 PM
The Law Commissions proposals for reforming the unfair prejudice provision
voted on by a show of hands only but where an issue is disputed, a member can
demand that a poll be taken. Section 321 provides that notwithstanding anything
in the articles to the contrary, other than on a resolution to elect a chair or to
adjourn the meeting, a poll must be taken if demanded by any of the following:
not less than 
ve members having a right to vote at the meeting; members hold-
ing not less than 10 per cent of all voting rights that could be cast at the meeting;
members holding shares conferring a right to vote at the meeting on which the
aggregate sum paid up equals not less than 10 per cent of the total sum paid up
on all such shares.
The Law Commissions proposals for reforming
the unfair prejudice provision
11.84
e Law Commissions Consultation Paper No 142 (1996) and its ensuing
Report, No 246 (Cm 3769, 1997), which were considered in Chapter 10 in rela-
tion to reforming the derivative action, also encompassed statutory shareholder
remedies.
(i) Procedural reform
11.85
e principal concern of the Law Commission was not directed towards the
substantive remedy itself but rather towards the length and cost of typical unfair
prejudice actions and the destructive e
ect such proceedings had on small pri-
vate companies. 
e Consultation Paper gave a number of examples to highlight
this problem. For instance, it found that the trial in
gindata
Ltd
spanned
some 43 days with costs of 320,000 while the shares in the company, originally
purchased for 40,000, fell in value to 24,600. In
Macro
(Ipswich
Ltd
the
hearing of the petition and a related action lasted 27 days and the costs claimed
came to some 725,000. 
is did not include appeal costs. 
e Law Commission,
taking the Woolf Civil Justice Reforms as its backdrop (
Access
Justice
Fina
Report
the
Lord
the
Civi
Justice
System
(1996)), therefore recommends that the di
culties of length, cost and
complexity of s 459 (now s 994) proceedings should be addressed by active case
management by the courts. More particularly, the Commission took the view
that the courts should make greater use of the power to direct that preliminary
issues be heard, or that some issues be tried before others; to impose costs sanc-
tions; and to have the power to dismiss any claim or part of a claim or defence
thereto which, in the opinion of the court, has no realistic prospect of success at
full trial.
7/19/2012 2:21:22 PM
Statutory shareholder remedies
It is noteworthy that the length and costs of such proceedings are not the only
problems of which the courts and prospective parties to such proceedings need
to be aware. As Vinelott J observed in
Company
Burr
there is also [t]he
damaging e
ect which the presentation of the petition may have on the business of
a company, even if it is not advertised.
(ii) Substantive reform
11.86
The Commission noted from its statistical survey that the majority of peti-
tions were brought by minority shareholders in small private companies
seeking to have their shares purchased on the basis of exclusion from man-
agement. In order to attain the objectives of providing such petitioners with
a speedy and economical exit route, the Law Commission recommends that
the unfair prejudice provision should be amended so as to raise rebuttable
presumptions that where a shareholder has been excluded from participating
in management:
the a
airs of the company will be presumed to have been conducted in a
(a)
manner which is unfairly prejudicial to the petitioner; and
if the presumption is not rebutted and the court is satis
ed that it ought
(b)
to order a buy-out of the petitioners shares, it should do so on a pro rata
basis.
e presumption would only apply where the company is a private limited com-
pany in which the petitioner held shares in his sole name giving him not less than
7/19/2012 2:21:22 PM
Further reading
(iv) Exit articles
11.88
It also recommended that the model articles of association should be amended so
as to include an exit provision whereby shareholders would be encouraged from the
outset to provide for what is to happen in the event of a dispute. An exit article would
enable a shareholder to leave a company without necessarily having to resort to pro-
ceedings. 
e Law Commission states that the exit regulation would be conferred
by an ordinary resolution and that every shareholder who is to have or be subject to
exit rights must be named in the resolution and must consent to it. 
e resolution
must set out the events in which exit rights are to be exercisable and the shareholder
entitled to the right may require other shareholders named in the resolution to buy
his shares at a fair price. Such shares must be shares he held when the resolution
was passed or shares acquired in right of them, for example on a bonus issue. 
e
company will not be permitted to amend the resolution or the exit article without
the consent of the named shareholders. Further, the resolution must state how the
fair price is to be calculated and, if the shares are to be valued, how the valuer is to
be appointed. 
e purchase will need to be completed within three months.
e Law Commission concludes that at the minimum the exit provision would at
least prompt registration agents to advise their clients to consider entering into a
shareholders agreement as an alternative means of providing for dispute resolu-
tion. 
e e
ect of which would be that the current burgeoning case load would be
cantly reduced.
11.89
e CLRSGs proposals were broadly based on the principles put forward by the
Law Commission but di
ered in several key respects as a result of its consulta-
tion exercise. It is particularly noteworthy that the November 2000 Consultation
Paper,
Comp
7/19/2012 2:21:22 PM
Statutory shareholder remedies
Company Law Review Steering Group,
Modern Company Law For a Competitive Economy:
Completing the Structure
(DTI, November 2000). http://www.bis.gov.uk/policies/
business-law/company-and-partnership-law/company-law/publications-archive
Company Law Review Steering Group,
Modern Company Law For a Competitive
Economy: Developing the Framework
(DTI, March 2000). http://www.bis.gov.
uk/policies/business-law/company-and-partnership-law/company-law/
publications-archive
Company Lawyer.
Special issue [1997] (Vol 18, No 8).
Goddard and Hirt Section 459 and Corporate Groups [2005]
JBL
247.
Hirt In What Circumstances Should Breaches of Directors Duties Give Rise to a
Remedy Under ss 459461 of the Companies Act 1984? [2003]
Comp Law
100.
Law Commission Consultation Paper No 142,
Shareholder Remedies
(1996).
Law Commission Report No 246,
Shareholder Remedies
(1997, Cm 3769).
Lowry Mapping the Boundaries of Unfair Prejudice in John de Lacy (ed)
The Reform of
United Kingdom Company Law
(London, Cavendish, 2002).
Payne Shareholders Remedies Reassessed [2004]
MLR
500.
Prentice The Theory of the Firm: Minority Shareholder Oppression: Sections 459461
of the Companies Act 1985 [1988]
OJLS
55.
Reisberg Indemnity Costs Orders Under s 459 Petitions [2004]
Comp Law
116.
Reisberg Shareholders Remedies: In Search of Consistency of Principle in English Law
[2005]
European Business Law Review
1063.
Riley Implicit Dimensions of Contract and the Oppression of Minority Shareholders
7/19/2012 2:21:22 PM
Self-test questions
Rodney and Dell run a successful wholesaling partnership, specialising in high-
quality organic foods. Wishing to expand the business they invite Tracey to invest
50,000 in a joint venture with them. A new company, Grubber Ltd, is formed, with
the issued shares taken in three equal parts by Rodney, Dell and Tracey respectively.
be able to pay a
7/19/2012 2:21:23 PM
PART III
Issues of Corporate Authority
7/20/2012 5:21:36 PM
SUMMARY
Introduction
The ultra vires doctrine
The reform of ultra vires
Agency
Statutory authority
Introduction
12.1
e arti
cial nature of the company creates one very speci
c problemit does
not physically exist. If the organs of the company (the general meeting or the
board of directors) make a decision we can say that that decision is an act of the
company. However, most of the time dealings with outsiders (to buy, sell, etc.)
occur through individual o
cers (e.g. the managing director), agents (a simple
example is a travel agent) or employees (a stationery manager who buys station-
ery) of the company. 
is chapter is concerned with how the law determines
whether those transactions with those outside the company (called outsiders or
third parties) are legitimate and will be binding on the company.
12.2
As we observed brie
y in Chapter 8 and we will explore further below, histori-
cally the companys total power to do something was determined by its objects
clause (i.e. what business it was empowered by Parliament to carry out, e.g. to
7/20/2012 5:21:38 PM
The constitution of the company: dealing with outsiders
objects clause, see below para
12.20
) within the power conferred by Parliament
in that objects clause. A large part of that limited or unlimited power (but note
not all of it, see Chapter 8, para
8.18
) is then delegated in the articles to the board
who may exercise it itself or may delegate part of the power to the companys
agents or employees. 
ose agents and employees may then contract with outsid-
ers in the exercise of that delegated power. 
e power of the company in e
ect
gets narrower as it moves away from the original source. 
us, a stationery man-
ager when he transacts to buy stationery is exercising a minute part of the total
power of the company.
12.3
Historically, where there was some doubt as to whether a transaction was author-
ised two questions arose. First, was the act within the power of the company? If
the answer was yes then we moved to the second question. If the answer was no,
the transaction was void and unenforceablethis could have very serious con-
sequences as we will see. Second, if the act was within the power of the company
was the individual who contracted on the companys behalf authorised to do so?
If they were, the transaction was valid but if not it was voidable at the instance of
the company. As a result the area was full of uncertainty and danger for people
dealing with companies. However, over time some judicial intervention and a
largely successful reform process have combined to protect those dealing with
the company.
The ultra vires doctrine
12.4
As we discussed brie
y in Chapter 8, the 19th-century companies legislation cre-
ated registered incorporated companies with a requirement that the memoran-
dum of association specify the objects of the company. 
is was a hangover from
the period when companies were formed by charters or grants from the Crown
and Parliament. Organisations like the Church or local authorities whose main
function was to serve the public interest were among the 
rst to exploit corpo-
rate status. Over time this practice expanded to encompass trading companies
formed to exploit trade, transport or technology rights (for example the East
India Company, 
e Great Western Railway and the British Indian Submarine
Telegraph Company (now Cable and Wireless plc)). In theory these grants of
corporate status to private businesses were still granted primarily because of the
public interest in promoting a speci
c business venture. However, the registered
company was somewhat di
erent because those forming the company set out its
objects rather than Parliament itself which, in most cases, would have no public
interest element at all.
7/20/2012 5:21:38 PM
The ultra vires doctrine
12.5
Legal theory at the time the registered companies appeared was dominated, as
we observed in Chapter 8, by concession theory. Legal theorists considered that
companies were similar to public bodies. A public body is conferred with cer-
tain power by Parliament and cannot go beyond that power (termed an ultra
vires act). If it did act ultra vires that act was void. For public bodies to be subject
to such restrictions was necessary in order to safeguard democracy because if
a public body takes more power than the elected representatives of the people
have given it, an act in furtherance of that excessive power has no legitimacy.
ere was another reason why the ultra vires doctrine was deemed to apply to a
registered company, it was thought to protect the shareholders and the creditors.
If the company was restricted to one function, the members and the creditors
were protected because the directors were restricted in their choice of business
to that which the shareholders and the creditors had initially provided money to
fund.
12.6
However, as we will see historically three particular issues combined to make
ultra vires a very tricky problem for the courts. First, initially the objects clause
was unalterable and then only alterable in limited circumstances until 1989.
Second, unlike public bodies whose functions are relatively  xed (for example
BIS is unlikely to decide to become the Department of Education) registered
companies o
en did change the central nature of their business. 
is can happen
relatively easily, for example X Ltd is a coal-mining business with simple objects
stating it is to mine coal. It decides to move into coal delivery and ultimately 
nds
that transporting goods generally is more pro
table than mining coal. In order to
buy more trucks it gets a large loan from a bank. 
e delivery business is success-
ful for a while but the company goes into insolvent liquidation within three years.
e liquidator then notices that the objects clause is to mine coal and declares
all the contracts of the creditors of the company (including the bank) void and
unenforceable. On a classical interpretation of the ultra vires rule the liquidator
is correct.
12.7
ird, the doctrine of constructive notice could combine with the ultra vires
rule to leave unwary third parties with unenforceable contracts. 
e doctrine
applies to public documents (remember the documents required to form a
registered company, including the memorandum and the articles, are pub-
lic documents) and deems anyone dealing with registered companies to have
notice of the contents of its public documents. 
erefore, anyone dealing con-
tractually with a company was deemed to have knowledge of its objects clause
and was presumed to enter into the void transaction with that knowledge.
e doctrine makes it impossible for someone dealing with the company to
argue that they did not know that the company lacked capacity to enter the
transaction.
7/20/2012 5:21:39 PM
The constitution of the company: dealing with outsiders
The classic rule
12.8
As a result of the moveable nature of business, constructive notice and the fact
that the memorandum was unalterable for much of the 19th and 20th century,
the courts at 
rst had some di
culty applying the ultra vires principle strictly
to registered companies. In
Riche v Ashbury Railway Carriage & Iron Co
(1874)
the trial court adopted a 
exible approach to the concept by allowing the com-
pany to do anything not prohibited in its constitution. However, the judges rela-
tively simple solution to the problem did not ultimately 
nd favour when the
case reached the House of Lords. In
Ashbury Carriage Company v Riche
(1875)
the House of Lords took the opportunity to state clearly that the ultra vires doc-
trine did apply to registered companies. 
us, if a company incorporated by or
under statute acted beyond the scope of the objects stated in the statute or in its
memorandum of association such acts were void as beyond the companys capac-
ity even if rati
ed by all the members. 
is is a useful reminder that in this period
the judiciary still largely viewed the registered company as a part of the state and
applied a concession theory approach to its regulation.
12.9
However, the courts quickly began to recognise the di
culty with treating regis-
tered companies as if they were public bodies and started to erode that statement
of high principle by applying a certain ingenuity to avoid the ultra vires doctrine.
For example, in
A-G
v Great Eastern Rly
(1880) the House of Lords outlined a
very important broad interpretation of the powers that could be exercised in the
pursuit of its objects. 
ey considered a company could enter into transactions
which were fairly regarded as incidental or consequential to its objects. 
is pro-
vided companies with some room to manoeuvre.
12.10
While this represented some progress with the issue it still le
problems where
the object could not strictly be achieved. For example, in
Re German Date Co
ee
Co
(1882) the companys object was to acquire and exploit a German patent for
producing co
ee from dates. 
e company failed to get the German patent but
obtained a Swedish one instead. Despite the fact the company had a thriving
date co
ee business it was wound up by the court because it could not achieve
its stated object. As a result of the dangers posed to companies by this rule much
legal ingenuity went into framing objects clauses to minimise the impact of
the ultra vires rule. Some objects clauses listed a large number of activities the
company could carry on. 
is was sometimes successful but at other times the
courts interpreted anything following the main object as being only a power that
must be exercised in furtherance of the main object. In response companies then
dra
ed objects clauses which stated that each object or power was to be treated as
independent and in no way attached to the main object. In
Cotman v Brougham
(1918) the House of Lords reluctantly accepted an objects clause that was very
7/20/2012 5:21:39 PM
The ultra vires doctrine
widely dra
ed with a clause at the end stating that any of the objects listed could
be carried on as the companys main object.
12.11
By the 1960s companies had objects clauses which stated their objects widely,
generally concluding with the following statement:
to carry on any other trade or business whatsoever which can, in the opinion of
the board of directors, be advantageously carried on by the company in con-
nection with or as ancillary to any of the above businesses or the general busi-
ness of the company.
is clause was accepted as a valid one in
Bell Houses Ltd v City Wall Properties
Ltd
(1966). By the 1980s objects clauses had continued to grow in breadth. For
example:
to carry on business as bankers, capitalists,
nanciers, concessionaires and mer-
chants . . . and generally to undertake and carry out all such obligations and
transactions as an individual capitalist may lawfully undertake and carry out.
is clause was accepted in
Newstead v Frost
(1980) as allowing the company to
enter into a partnership in order to avoid a tax liability. It is worth noting here
that this acceptance of the wide objects clause also emphasises the private nature
of the company and represents a move 
rmly away from the concession theory
upon which the application of the public law concept of ultra vires was based.
12.12
As a result of the judicial acceptance of these wide clauses the courts were not
faced with objects issues as frequently as they once had been. However, the
problem did not go away and occasionally the courts would be presented with
an objects issue which no amount of 
exibility could solve. In
Re Jon Beauforte
(London) Ltd
(1953)
the companys objects stated it was to carry on a business
as gown makers but the business had evolved into making veneered panels. No
change had been made to the objects clause to re
ect this change. A coal mer-
chant had supplied coal to the company which was ordered on company note-
paper headed with a reference to the company being a veneered panel maker.
e coal merchant was deemed because of constructive notice to know of the
original objects clause and because of the headed notepaper to have actual notice
of the change in the business. As a result the transaction was ultra vires and void.
Another clear example of this is
Re Introductions Ltd v National Provincial Bank
(1970). 
is case concerned a company incorporated in 1951 around the time of
the Festival of Britain with the object of providing foreign visitors with accom-
modation and entertainment. A
er the Festival was over the company diversi
ed
and eventually devoted itself solely to pig breeding which the original framers
of the objects had not considered (naturally enough). 
e company had granted
7/20/2012 5:21:40 PM
The constitution of the company: dealing with outsiders
National Provincial Bank a debenture to secure a substantial overdra
which had
accumulated prior to its eventual insolvent liquidation. 
e company was held to
have acted ultra vires and therefore the transaction was void and the bank could
not enforce the debenture or even claim as a normal creditor in the liquidation
(see Chapter 17 on the statutory liquidation procedure).
Ultra vires and the bene
t of the company
12.13
Certain decisions of the company which have no immediate tangible bene
t to
the company have also fallen foul of the ultra vires doctrine. During their life-
time companies o
en make charitable donations, political donations and gra-
tuitous payments to employees (e.g. granting pensions or retirement gi
s). All of
this is generally deemed to be of bene
t to the company while it is a going con-
cern. However, once the company ceases to do business such payments become
problematic. In
Hutton v West Cork Rly Co
(1883) the court held that a railway
company, whose undertaking had been transferred to another company and
whose a
airs were being wound up, could not pay gratuitous compensation to its
former employees or to its directors for loss of employment. 
is was so despite
the fact that they had never been paid during the life of the company. 
e com-
pany was in liquidation and could not bene
t from the gi
to the directors, any
such transaction being ultra vires and void. 
is introduced a new formulation
into the objects debate to the e
ect that not only did the act of the company have
to be within the objects clause but the companys power had to be exercised bona
des for the bene
t of the company.
12.14
Similarly in
Parke v Daily News Ltd
(1962) the same issue arose out of the sale of
the newspaper, the
News Chronicle and Star.
e Cadbury family, who control-
led the selling company, wished to distribute the proceeds of the sale amongst
the employees who would be made redundant by the sale. A shareholder sued to
restrain them from doing so and was successful on the basis that the company
would receive no bene
t from the action so it was, therefore, ultra vires. 
e
introduction of the bene
t of the company criterion was clearly problematic for
companies and eventually led to a ra
of legislation to allow payments to be made
to employees both generally and speci
cally in a liquidation (CA 1985 s 309 now
contained in CA 2006, ss 172 and 247, and s 187 of the Insolvency Act 1986).
(Political donations engage a higher level of regulation and need shareholder
approval, CA 2006, Part 14.)
12.15
ere was however something odd about the addition of the bene
t of the com-
pany criterion to the ultra vires issue; clearly in the
Parke
case the act (paying
employees) was within the objects clause yet was found to be ultra vires. 
e
courts eventually decided (see
Rolled Steel Ltd v British Steel Corpn
(1986) and
7/20/2012 5:21:40 PM
The reform of ultra vires
Brady v Brady
(1988) (1989)) that these decisions are in fact not ultra vires cases at
all but are rather cases where the issue was whether directors exceeded their pow-
ers (as opposed to the companys power) or a question of whether they exercised
their power properly (see the Agency and Statutory Authority sections, paras
12.21
and
12.28
respectively, below). Corporate capacity questions were solely to
be determined by the construction of the objects clause. 
e question of whether
the power was exercised for the bene
t of the company had nothing to do with
whether the company had capacity to do the act in question.
The reform of ultra vires
12.16
e slow liberalisation of the judicial concession approach was accompanied by
occasional recommendations for reform of the area. In 1945 the Cohen Committee
(Cmnd 6659) recommended doing away with the ultra vires concept where third
parties were involved. However, nothing came of this recommendation and it was
not until the UK was forced to act as part of its obligations on joining the European
Community that legislation reforming ultra vires was introduced in s 9(1) of
the European Communities Act 1972. 
e domestication of the First European
Community Company Law Harmonisation Directive a version of which remains
in what is now CA 2006, s 39 (formerly contained in CA 1985, s 35) removed the
doctrine of constructive notice where it concerned the memorandum and arti-
cles of association. It also contained a saving provision for ultra vires transactions
where the transaction was dealt with by the directors and the third party was act-
ing in good faith (now CA 2006, s 40). While this reform narrowed the extent of
the ultra vires rule it still le
the potential for problems to arise. In 1986 the DTI
produced a report (the Prentice Report) recommending much deeper reforms.
e Prentice Report formed the basis of a number of provisions introduced in the
CA 1989 amending the CA 1985 with respect to its ultra vires sections.
12.17
e reforms had a dual approach. First, it made it easier for companies to arrange
their constitution to avoid ultra vires issues. 
us, s 110 of the CA 1989 intro-
duced a new s 4 into the CA 1985 which allowed the memorandum to be changed
by special resolution (now CA 2006, s 21). 
is had the e
ect of allowing compa-
nies who wished to diversify, to change the objects clause with relative ease. 
e
same section of the CA 1989 also introduced a new s 3A into the CA 1985 which
allowed companies to have an objects clause which stated that it was to carry on
business as a general commercial company. 
is allowed the company to carry
on any trade or business whatsoever and the company had the power to do all
such things as were incidental or conducive to the carrying on of any trade or
business.
7/20/2012 5:21:40 PM
The constitution of the company: dealing with outsiders
12.18
Second, it dealt directly with ultra vires transactions by repealing the old s 35 and
introducing new ss 35, 35A and 35B in the CA 1985. Section 35 stated:
(1)
The validity of an act done by a company shall not be called into question
on the ground of lack of capacity by reason of anything in the companys
memorandum.
As a result of this section a transaction which was technically ultra vires the
company was still valid and enforceable. 
e question became rather whether
those representing the company had the authority to enter into the contract. As
both statutory reforms introduced in ss 35A and 35B CA 1985 and subsumed into
the CA 2006 plus common law developments primarily dealt with this question
of internal authority we will deal with this issue in the section on Agency and
Statutory Authority below.
12.19
As we observed in Chapter 8, the memorandum and the articles form a statutory
contract between the company and the members and therefore if the company
entered into an ultra vires act it was bound to the outsider because of s 35 but the
same act would also breach the contract with the members for which the directors
were potentially liable. 
e amendments to the CA 1985 in 1989 dealt with this
issue in two ways. 
e 1989 amendments introduced a new s 35(2) whereby if a
member was aware of an imminent ultra vires act he could bring proceedings to
restrain the doing of that act. Second, s 35(3) was also introduced to emphasise that
the directors had a duty to observe any internal restrictions on their powers 
owing
from the memorandum. However, an ultra vires transaction could be rati
ed by a
special resolution of the general meeting but this would not a
ect the liability of the
directors for breach, thus a separate special resolution passed by the members was
the only way the directors could be relieved from liability for an ultra vires act.
12.20
While the 1989 amendments were on the whole largely successful there was
general agreement that the way this was achieved was unnecessarily complex.
e CLRSG in their
Final Report
(July 2001) (para 9.10) recommend simplifying
this and that any company formed under a new Companies Act have unlimited
capacity whether or not it chooses to have an objects clause. 
e White Paper
(2002) (Vol I, paras 2.2 and 6.2) and the Governments Consultative Document
of March 2005 (para 5.1) also broadly followed these recommendations. As a
result the CA 2006 attempted yet again to reform this area. As we have already
observed in Chapters 1 and 8 under the CA 2006 a companys constitution means
only the articles of association and associated resolutions of the general meeting
(CA 2006, s 17). 
e memorandum still exists but it is not part of the constitution
and acts purely as a statement by the founders of the company that they wish to
form the company and become members of it (CA 2006, s 8). Everything else that
was formerly in the memorandum now forms part of the articles of association
7/20/2012 5:21:41 PM
Agency
or the application for registration (CA 2006, s 9 and s 28). Under the CA 2006 all
companies are deemed to have unrestricted objects unless the companys articles
speci
cally restrict the objects of the company (CA 2006, s 31). As most compa-
nies currently in existence were formed under principal Companies Acts that
required an objects clause, this change will only really a
ect companies newly
incorporated under the CA 2006. For companies already in existence with an
objects clause, that clause still operates to restrict them, and will now become
part of their articles of association (CA 2006, s 28). Companies with such an
objects clause could if they wished choose to remove it but it is doubtful whether
there would be any particular advantage in doing this for companies with a gen-
eral objects clauseagain the vast majority. In recognition of the fact that a large
number of companies will still have an objects clause s 35 of the CA 1985 has
been replaced by an almost exact replica in s 39 which states:
(1)
The validity of an act done by a company shall not be called into question
on the ground of lack of capacity by reason of anything in the companys
constitution.
It is worth noting that the shareholder injunctive provisions and the directors
duty to observe internal restrictions which were in the CA 1985 s 35(2) and (3)
are not similarly repeated in the CA 2006. 
e Explanatory Notes to the CA 2006
er this explanation:
The section does not contain provision corresponding to section 35(2) and (3) of
the 1985 Act. It is considered that the combination of the fact that under the Act
a company may have unrestricted objects (and where it has restricted objects
the directors powers are correspondingly restricted), and the fact that a speci
c
duty on directors to abide by the companys constitution is provided for in sec-
tion 171, makes these provisions unnecessary.
However, given that the reason for replicating s 35 in the new s 39 was to cover
companies that retain a restrictive objects clause and thus to protect against the
problems that have historically been evident with restrictive objects, this seems
an odd omission.
Agency
As we discussed brie
y above, a company presents certain unique challenges
to the traditional interpretation of agency principles. Unlike humans it cannot
operate itself, it acts only through agents. Either it directly appoints an outsider
as an agent (for example a travel agent) or it authorises a director or employee to
7/20/2012 5:21:41 PM
The constitution of the company: dealing with outsiders
be its agent. 
erefore whenever we wish to attribute responsibility for a contract
to the company we must use agency principles. An agent is someone appointed by
a principal to act on their behalf. 
us, in our travel agent example, the company
or more usually its employee agent appoints an external travel agent to make its
travel arrangements. 
e company is the principal and 
rst party, the travel agent
is obviously the agent and second party and the third party being the person or
company on the other side of the contact (for example an airline). 
e contract
will be between the principal (the company) and the third party (airline) even
though it is the agent who has signed the contract. 
is is one of the features of
agency that the agent has the legal authority to enter into contracts on behalf of
the principal as if the principal had signed the contract personally. 
e agent has
no part in the contract other than to represent the principal.
12.22
However, companies are complex organisations. While the articles of association
create a simple organisational structure (general meeting and board of direc-
tors) this o
en only represents the root of the organisational structure of the
company. 
e articles delegate power to the board but the board will by necessity
have to delegate the day-to-day running of the company to managers who will in
turn delegate tasks to other sta
, who will in turn delegate and so on. Each layer
down in the organisational structure represents transference of authority from
one agent to another. Sometimes as we will see that transference of authority is
not entirely clear and questions may arise as to whether certain decisions or acts
taken or done can be attributed to the company.
12.23
e normal general principles of agency will then apply in order to determine
whether the company is bound by a particular transaction. A principal will be
bound by a contract entered into on his behalf by his agent if that agent acted
within either the actual scope of the authority given by the principal before the
contract or the apparent or ostensible scope of his authority. 
e principal may
also ratify a contract entered into without authority. While speci
c authority is
conferred on the board to run the company, once the authority goes below board
level actual authority in the context of a corporation or any other complex organ-
isation is somewhat misleading as speci
c authority to carry out some functions
may not be conferred.
12.24
A manager can be given a speci
c job description by the board but o
en much
of the actual authority is implied by the position held and by the custom in the
company or industry. For example Mike is a purchasing manager who used to
work for X Ltd as head of its purchasing department. Mike has just started work-
ing with Y Ltd in the same role and has found that although in his previous job
the personnel department did all the hiring, Y Ltd has only a small personnel
department and thus it is the practice in Y Ltd that all sta
ng issues are the
7/20/2012 5:21:41 PM
Agency
responsibility of individual department heads. Here Mike has actual authority to
hire employees even though his job description contains no such reference, it is
purely implied from the internal practice in Y Ltd.
12.25
Apparent or ostensible authority arises where, rather than any actual author-
ity being given, the board of directors or the general meeting allows someone
to hold themselves out as having such authority or allowing someone to hold
themselves out as having a position in the company that would have such author-
ity. For example in
Freeman & Lockyer v Buckhurst Park Properties Ltd
(1964)
rm of architects were engaged by a person acting as Buckhursts managing
director. Buckhurst would not pay the fees as it claimed he was not the managing
director as he had never been appointed managing director. 
e Court of Appeal
upheld the architects claim 
nding that the board had held out the person as
the managing director and that he therefore had ostensible authority to bind the
company. However, sometimes the line between actual authority that is implied
and ostensible authority is very 
ne. In
Hely-Hutchinson v Brayhead Ltd and
Richards
(1968) the Court of Appeal found that Richards who had acted as man-
aging director but had never been formally appointed had implied actual author-
ity to bind the company rather than ostensible authority. (See
MCI WorldCom
International Inc v Primus Telecommunications Inc
(2004) for an example of how
complex ostensible authority can be.)
12.26
Another problem for agency arose where the companys constitution sets out a
certain procedure before a transaction can be carried out by the company. Here
the doctrine of constructive notice, as we brie
y discussed above, had a poten-
tially drastic e
ect on outsiders as they were deemed to know about any internal
procedures in the constitution as it is a public document. So sometimes, even
though an action is within the capacity of the company, it may be outside the
powers of the individual representing the company because an internal procedure
was not complied with. For example in
ane Investments Ltd
(2003)
the court found that the directors failure to observe the articles rendered a con-
tract contrary to the articles unenforceable. If the doctrine of constructive notice
was applied strictly the outsider could not complain about the lack of authority
as they were deemed to know that there was a limit on the actual authority of
the companys agent. However, the courts were o
en keen to mitigate the e
ect
of constructive notice. In
Royal British Bank v Turquand
(1856) an action was
brought for the return of money borrowed by the company. 
e company argued
that it was not required to pay back the money because the manager who negoti-
ated the loan should have been authorised by a resolution of the general meet-
ing to borrow but he had no such authorisation. As a result of the doctrine of
constructive notice the bank was deemed to know this. 
e court held that the
public documents only revealed that a resolution was required not whether the
7/20/2012 5:21:41 PM
The constitution of the company: dealing with outsiders
resolution had been passed. 
e bank had no knowledge that the resolution had
not been passed and thus it did not appear on the face of the public documents
that the borrowing was invalid. Outsiders are therefore entitled to assume that
the internal procedures have been complied with. 
is is o
en called the indoor
management rule. 
e rule only applies to those acting in good faith or who
have no actual notice of the irregularity (see
Rolled Steel Ltd v British Steel Corpn
(1986)). It also has no application where the third party is an insider, for example
a director who enters into a contract with the company (see
Morris v Kanssen
(1946)).
12.27
As we will see below there have been a number of statutory provisions aimed at
protecting the third party when dealing with the board or those authorised by
it. 
ese statutory provisions are important but it should be noted that general
agency principles are still signi
cant. In particular the rule in
Turquand
is still
important where the third party has not dealt directly with the board or a ques-
tion of whether the agent was authorised by the board arises.
Statutory authority
12.28
As we noted above, the CA 1989 introduced further reform provisions to
deal with situations where internal irregularities might upset outsider rights.
Section 35A of the Companies Act 1985 was the result of these reforms and
stated:
(1)
[i]n favour of a person dealing with a company in good faith, the power of
the board of directors to bind the company, or authorise others to do so, shall
be deemed to be free of any limitation under the companys constitution.
(2) [f]or this purpose
(a)
a person deals with a company if he is a party to any transaction or
other act to which the company is a party;
(b)
a person shall not be regarded as acting in bad faith by reason only of
his knowing that an act is beyond the powers of the directors under the
companys constitution; and
(c)
a person shall be presumed to have acted in good faith unless the con-
trary is proved.
(3)
The references above to limitations on the directors powers under the com-
panys constitution include limitations deriving
(a)
from a resolution of the company in general meeting or a meeting of
any class of shareholders, or
7/20/2012 5:21:42 PM
Statutory authority
(b)
from any agreement between the members of the company or of
any class of shareholders.
(4)
Subsection (1) does not affect any right of a member of the company
to bring proceedings to restrain the doing of an act which is beyond the
powers of the directors; but no such proceedings shall lie in respect of an
act to be done in ful
lment of a legal obligation arising from a previous
act of the company.
(5)
Nor does that subsection affect any liability incurred by the directors, or
any other person, by reason of the directors exceeding their powers.
12.29
As we can see from the above the protection o
ered to the outsider by s 35A not
only covered the board but also recognised that the board o
en delegated some of
its functions to others. In particular it seems to be weighted heavily in favour of the
third party. Not only did it cover directors and agents actions but it set the standard
of bad faith fairly high as sub-s 2(b) speci
cally allowed third parties to have knowl-
edge that the transaction was irregular. 
is suggested that perhaps active dishon-
esty might have been required in order to qualify as bad faith (see
EIC Services Ltd v
Phipps
(2004)). In any case sub-s 2(c) set a presumption of good faith.
12.30
Section 35A also covered insiders, which the rule in
Turquand
does not. However
insiders may have more di
culty with the good faith requirement (see
Henniker-Major & Co
(2002) for an interesting attempt by an insider to use s
35A). For example, breach of duty by the insider will mean that the protections
of s 35A may not apply (see
Cooperative Rabobank Vechten Plassengebied BA v
Minderhoud
(1998) and
International Sales and Agencies Ltd v Marcus
(1982)).
Section 322A of the CA 1985 was also introduced by the CA 1989 and s 35A was
subject to it. 
e section provides that a transaction between the company and a
director or a person connected to him (family etc.) which exceeds the powers of
the board would be voidable at the instance of the company.
12.31
Section 35A(3) went on to provide a wide de
nition of limitation under the
constitution as including the memorandum, articles and shareholders resolu-
tions and agreements. 
is was a recognition that the delegation of the com-
panys powers to the board in the articles was subject to change by the general
meeting and that it could be a
ected by a shareholders agreement. Subsections
(4)(5) contained similar provisions to s 35(2)(4) (above, para
12.19
) whereby
members were able to bring a preemptive action to restrain a breach and the
subsection also emphasised the directors duty to observe the internal limits
on their powers. Unlike s 35, there were no rati
cation provisions speci
ed for
exceeding internal limitations on authority, thus an ordinary resolution would
su
ce to ratify and forgive directors where an internal limitation was at issue.
7/20/2012 5:21:42 PM
The constitution of the company: dealing with outsiders
12.32
Additionally the CA 1989 introduced two further sections into the 1985 Act to
deal with constructive notice. Section 35B of the CA 1985 stated:
[a] party to a transaction with the company is not bound to enquire as to wheth-
er it is permitted by the companys memorandum or as to any limitation on the
powers of the board of directors to bind the company or authorise others to do
so.
is was supposed to be reinforced by CA 1985, s 711A which was to abolish the
concept of constructive notice for corporations. However, s 711A has never been
implemented and so only s 35B dealt with constructive notice.
Statutory authority and the CA 2006 reforms
12.33
e CLRSG in its
Final Report
(July 2001, para 9.10), recommended that provi-
sions be introduced clarifying the law on when directors were deemed to have
authority to bind the company or authorise others to do so. 
e White Paper
(2002, Vol I, para 6.2) followed the CLRSG recommendations and provided in
clause 17 of its Dra
Bill a broad catch-all saving provision whereby the board
was deemed for the purposes of outsider transactions to exercise all the powers
of the company and to authorise others to do so. Insiders and connected persons
were speci
cally excluded from the saving provision. 
e CA 2006 did not follow
this formulation, instead preferring a more limited reform of essentially tidying
up and replicating the provisions of ss 35A and 35B in one new section (CA 2006,
s 40) which reads:
40 Power of directors to bind the company
(1)
In favour of a person dealing with a 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 companys constitution.
(2) For this purpose
(a)
a person deals with a company if he is a party to any transaction or
other act to which the company is a party,
(b) a person dealing with a company
(i)
is not bound to enquire as to any limitation on the powers of the
directors to bind the company or authorise others to do so,
(ii)
is presumed to have acted in good faith unless the contrary is
proved, and
(iii)
is not to be regarded as acting in bad faith by reason only of his
knowing that an act is beyond the powers of the directors under the
companys constitution.
7/20/2012 5:21:42 PM
Statutory authority
(3)
The references above to limitations on the directors powers under the
companys constitution include limitations deriving
(a) from a resolution of the company or of any class of shareholders, or
(b)
from any agreement between the members of the company or of
any class of shareholders.
(4)
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. But no such proceedings lie in respect of an act
to be done in ful
lment of a legal obligation arising from a previous
act of the company.
(5)
This section does not affect any liability incurred by the directors, or
any other person, by reason of the directors exceeding their powers.
(6)
This section has effect subject tosection 41 (transactions with direc-
tors or their associates), and section 42 (companies that are charities).
Additionally CA 1985, s 322A (connected persons) is also essentially tidied up
and replicated in a new section (CA 2006, s 41).
12.34
To sum up, the e
ect of the 1989 amendments was to negate questionable corporate
capacity and board or board-delegated authority issues for outsiders. Constructive
notice still operated, but the fact that knowledge of the irregularity would not a
ect
the outsiders good faith combined with no duty to enquire meant the outsider in
most cases was in a position to enforce an unauthorised act of the board or some-
one authorised by it. Where it was a question of the internal authority of an agent
and the outsider did not deal with the board or it was unclear if the board author-
ised the agent to deal with the outsider the common law rules would then impact
to provide a safety net. 
us as we have observed while the impact of these reforms
was to mostly negate corporate and agent capacity issues for outsiders, it did so in
a complicated way. 
e reform process leading to the 2006 Act had tried to tackle
this complexity but the CA 2006 oddly did not follow the recommendations of
the CLRSG on this. Instead we now have a two-tiered systemnewly incorporated
companies with unlimited capacity and companies incorporated under previous
Companies Acts with objects clauses for whom the previous complex 1985 Act
regime has been largely reincarnated in ss 39 and 40 of the CA 2006.
Other attribution issues
12.35
Agency, however, does not cover all situations where attribution is at issue. Tort
presented one such problem which the courts originally had great di
culty with
in the corporate context. At 
rst it was considered that a tort was an ultra vires
act in that a company could never be authorised by its objects clause to commit a
tort. However, in
Campbell v Paddington
(1911) the court accepted that companies
7/20/2012 5:21:43 PM
The constitution of the company: dealing with outsiders
could commit torts and the courts have subsequently applied the principle of
vicarious liability to the company as employer. 
us the company as principal
can be vicariously liable in tort for acts of its employees even though they may
not be speci
cally authorised but are nevertheless acting within the scope of their
employment. In general vicarious liability will not attribute criminal liability for
the act of an employee. Attribution in the context of a tort involves no fault on the
part of the company, it is just legally responsible for the acts of another. Where a
fault quali
cation or intention is required by law attribution of liability becomes
more complex. In these cases the courts began to develop what is known as the
alter ego or organic theory of the company.
12.36
In
Lennards Carrying Co Ltd v Asiatic Petroleum Co Ltd
(1915) the fault require-
ment arose in relation to a particular section of the Merchant Shipping Act 1894.
Viscount Haldane LC set out an organic theory of the corporation in order to
deal with the fault issue. He considered that:
[a] corporation is an abstraction. It has no mind or will of its own any more
than it has a body of its own; its active and directing will must consequently
be sought in the person of somebody who for some purposes may be called an
agent but who is really the directing mind and will of the corporation, the very
ego and centre of the personality of the corporation . . . somebody who is not
merely an agent or servant for whom the company is liable upon the footing
respondeat superior, but somebody for whom the company is liable because his
action is the very action of the company itself.
As a result, if one individual can be identi
ed who can be said to be essentially the
companys alter ego and that individual has the required fault, then the fault of
that individual will be attributed to the company. It is important to note here that
attribution is not as with tort because the company is responsible for the actions
of another. Here the individuals fault is attributed to the company because the
law treats the individual and the company as the same person. You might not
unnaturally wonder how this is compatible with the
Salomon
principle which
emphasises the separateness of the company from its members and o
cers. 
e
answer is that it is not compatible with it and the theory has probably caused
more problems than it solved.
12.37
is, however, did not stop the profusion of metaphors when attempts were made
to apply the concept. In
Bolton (Engineering) Co Ltd v Graham & Sons
(1957)
Lord Denning o
ered his particular view of the organic theory:
[a] company may in many ways be likened to a human body. It has a brain
and nerve centre which controls what it does. It also has hands which hold the
tools and act in accordance with directions from the centre. Some of the peo-
7/20/2012 5:21:43 PM
Statutory authority
ple in the company are mere servants and agents who are nothing more than
hands . . . and cannot be said to represent the mind and will of the company and
control what it does. The state of mind of these managers is the state of mind of
the company and is treated in law as such.
e di
culty with this attribution theory was that it required the identi
ca-
tion of a single individual in what was o
en a complex corporate organisational
structure. 
is was o
en not possible. In particular the criminal law has had
the greatest di
culty with the organic theory when attempting to determine the
companys
mens rea
or guilty mind.
12.38
In
Tesco Supermarkets Ltd v Nattrass
(1971) Tesco was charged with an o
ence
under the Trade Descriptions Act 1968. Tesco had advertised goods at a reduced
price but sold them at a higher price. In order to avoid conviction Tesco had to
show that they had put in place a proper control system. Tesco argued that they
had and that the manager of the store had been at fault. 
e court considered
whether the manager was acting as an organ of the company. Lord Reid found
that:
[a] living person has a mind which can have knowledge or intention or be neg-
ligent and he has hands to carry out his intentions. A corporation has none of
these; it must act through living persons, though not always one or the same
person. Then the person who acts is not speaking or acting for the company. He
is acting as the company and his mind which directs his acts is the mind of the
company. There is no question of the company being vicariously liable. He is
not acting as a servant, representative, agent or delegate. He is an embodiment
of the company or, one could say, he hears and speaks through the persona of
the company, within his appropriate sphere, and his mind is the mind of the
company.
In this case the manager who was at fault was not the guiding mind and therefore
Tesco could not be liable for his action. 
e application of the organic theory
acted e
ectively as an immunity from criminal prosecution for large complex
corporate organisations.
12.39
In the Privy Council decision in
Meridian Global Funds Management Asia Ltd
v Securities Commission
(1995) Lord Ho
mann considered that organic theory
provided a misleading analysis. 
e real issue was who were the controllers
of the company for the purposes of attribution. 
is was compatible with the
maintenance of the
Salomon
principle and had the advantage of being able to
attribute liability to the company for the actions of individuals lower down the
organisational structure. In the
Meridian
case the controllers were found to be
two senior managers. Lord Ho
manns approach was applied with some success
7/20/2012 5:21:43 PM
The constitution of the company: dealing with outsiders
in
McNicholas Construction Co Ltd v Customs and Excise Comrs
(2000). 
e case
concerned the operation of a VAT fraud and the knowledge of the companys site
managers was enough to attribute liability to the company for the fraud. (See
also
Crown Dilmun v Sutton
(2004),
Morris v Bank of India
(2005) and on the
complexities of attribution
Safeway Stores Ltd v Twigger
(2010).) Despite this the
idea of an alter ego or directing mind and will of a company still appears in the
case law from time to time. In
Stone & Rolls ltd v Moore Stephens
(2009) attribu-
tion through the use of the companys
alter ego
was crucial to the attribution
of liability. Similarly in
R v St Regis Paper Co Ltd
(2011) the lack of a directing
mind and will of the company proved fatal to the attribution of an o
ence. 
e
Law Commission is currently consulting on the reform of this area to remove
the current confusion. (See http://lawcommission.justice.gov.uk/consultations/
criminal-liability-in-regulatory-contexts.htm)
12.40
e application of the organic theory where crimes of violence are at issue still
remains a problem. 
ese crimes happen mainly in the workplace but occasionally
enter the public domain through major transport disasters like the Zeebrugge ferry
tragedy. Larger, more complex corporate organisations can never be attributed with
the required
mens rea
as identi
cation of an alter ego is impossible in such complex
delegated structures (see
Jenkins v
P & O European Ferries Ltd
(1990)). In response
to a number of high-pro
le disasters and the growing problem of workplace deaths,
the Government proposed the creation of a speci
c o
ence of corporate manslaugh-
(Reforming the Law on Involuntary Manslaughter: 
e Governments Proposals
(May 2000)). An o
ence of corporate manslaughter was introduced in the Corporate
Manslaughter and Corporate Homicide Act 2007 which came into force on 6 April
2008. 
e o
ence of corporate manslaughter is based around management fail-
ure of the company or its parent, leading to the cause of death. 
us if the way the
company is managed fails to protect the health and safety of those employed in or
ected by the companys activities and the manner in which its management fails
is far below the standards that would be reasonably expected of a company in such
circumstances it will be guilty of the o
ence. In
R v Cotswold Geotechnical Holdings
Ltd
(2012) a company was convicted of the 
rst ever manslaughter prosecution
under the 2007 Act and 
ned 385,000. For an overview of the issues see http://
www.youtube.com/watch?v=6ccNcbgMGuk&feature=related
FURTHER READING
This Chapter links with the materials in Chapters 3 and 5 of
Hicks and Goos Cases and
Materials on Company Law
(2011, Oxford University Press, xl +649p).
Company Law Reform
(2005) Cm 6456 (Consultative Document, March 2005), para
5.1: http://www.bis.gov.uk/policies/business-law/company-and-partnership-law/
company-law/publications-archive
7/20/2012 5:21:44 PM
Self-test questions
Ferran The Reform of the Law On Corporate Capacity and Directors and Of
cers
Authority Parts 1 and 2 [1992]
Co Law
124 and 177.
Hannigan Contracting with Individual Directors in Rider (ed)
The Corporate Dimension
(Bristol, Jordan Publishing, 1998).
Poole Abolition of the Ultra Vires Doctrine and Agency Problems [1991]
Co Law
43.
Munoz Slaughter Corporate Social Responsibility: a New Perspective [1997]
Co Law
313.
Sullivan Corporate KillingSome Government Proposals [2001]
Crim L Rev
31.
SELF-TEST QUESTIONS
Explain how you would decide if a particular transaction was outside the com-
panys objects clause.
7/20/2012 5:21:44 PM
Introduction
13.1
As we discussed extensively in Chapter 12, as arti
cial legal entities can only
function through the medium of human organs they invariably have a variety of
decision-makers ranging from shop-
oor supervisors to top executives. In small
private companies individuals will o
en perform several roles: worker, supervi-
sor, shareholder and director. In large public companies, however, the bounda-
ries between these roles are more clearly de
ned. 
e focus of this chapter is on
those individuals who are responsible for making key strategic decisions.
13.2
Corporate decision making is carried out by those o
cers who stand at the com-
panys helm, namely the members of its board of directors. Given the strategic
importance of directors in relation to corporate management it is curious that
the Companies Act is silent in several key respects on prescribing their role.
More fundamentally, the Act does not provide an exhaustive de
nition of the
term director beyond stating in s 250 CA 2006 that the term includes any per-
son occupying the position of director, by whatever name called. 
us, what-
ever term the articles use to describe the members of the companys board (for
SUMMARY
Introduction
The emergence of the professional managerial organ
The relationship between directors and the general meeting
Appointment of directors
The
duciary nature of the of
ce
Directors remuneration
Vacation and removal from of
ce
Disquali
cation of directors
Corporate management
7/19/2012 2:23:15 PM
The emergence of the professional managerial organ
example, governors, administrators, trustees), as far as the law is concerned they
are directors. Section 154 lays down the minimum number of directors which
companies must have (for public companies it is two and for private companies
the minimum is one). Although a company can be appointed a director, s 155(1)
CA 2006 now requires that every company must have at least one director who is
a natural person (see
13.14
below). Beyond laying down these basic requirements,
the Act does not attribute speci
c functions to company directors or to lay down
the structure and form of corporate management generally. 
is is le
to the
articles of association (see below).
13.3
e approach of UK company law legislation in failing to prescribe the structure
and functions of the board of directors stands in marked contrast to the company
law regimes found in other Member States of the EU, most notably Germany and
the Netherlands. While UK company law, at least as it applies to listed companies,
is apparently wedded to a governance system based upon a unitary board of direc-
tors in which the market acts as the supreme control device, corporate governance
in Germany is founded upon internal monitoring via a two-tier board: the super-
visory board which includes employee directors, and the management board. In
the majority of German public companies, the shareholders elect two-thirds of
the members of the supervisory board and one-third are elected by the companys
employees. 
e EC Dra
Fi
h Directive ([1972] OJ C131/49; which has undergone
various revisions since it was 
rst published, was intended to bring the boards of
English public companies broadly in line with this model but it seems that the
Dra
Directive has little prospect of ever being implemented. However, it is note-
worthy that following the spectacular corporate collapses of the 1980s (for exam-
ple, Blue Arrow, BCCI, Barlow Clowes, Polly Peck and Maxwell), there has been a
signi
cant shi
in UK corporate governance culture. One particular consequence
of this has been the recognition of the potential of non-executive directors to per-
form a monitoring role over executive directors albeit on a self-regulatory basis
and within the structure of a single-tier board (see Chapters 15 and 16).
The emergence of the professional managerial organ
13.4
e role and position of directors within the corporate management matrix is col-
oured by the fact that company law is rooted in the law of partnership which is
based upon agency principles. In partnership law each partner is an agent of his fel-
low partners. 
e 19th-century view of the role of company directors was that they
were merely the agents of the companys shareholders. As we have seen in previous
chapters, there are two primary collective corporate organs: the board of directors
and the shareholders (or company) in general meeting. Historically, the company
7/19/2012 2:23:18 PM
Corporate management
in general meeting had constitutional supremacy in so far as the directors, as its
agents, had to act strictly in accordance with its decisions (
Wight
Tahourdin
(1883)). 
is thinking was also re
ected in the legislation of the day: s 90
of the Companies Clauses Consolidation Act 1845 provided that the authority of
directors to manage the a
airs of the company was subject to the relevant legisla-
tion then in force and to the control and regulation of the general meeting.
The separation of ownership and control
13.5
is view of the pre-eminence of the company in general meeting was steadily
eroded over the course of the 20th century not by speci
c law reform but by
changing practice and social phenomena which judges were quick to recognise.
In listed companies share ownership is now more widespread and the atten-
tion of shareholders, both private and institutional, is, by and large, focused
upon investment returns rather than upon monitoring directorial conduct.
e general meeting in large public companies, particularly through the use
of proxy voting (where shareholders do not attend the meeting but rather send
in a written vote or, more usually, assign their votes to the board to exercise as
it wishes) o
en becomes little more than a forum for rubber-stamping board-
room decisions. 
is shi
of power from those who own the company to those
who control it was identi
ed by Berle and Means in their pioneering empirical
study conducted between 1929 and 1930 of the 200 largest US non-
nancial
corporations (Berle and Means (1932)) (see Chapter 15). 
ey argued that one of
the consequences of the separation of ownership from control, taken together
with the dispersion of share ownership, was that shareholders would no longer
be able to control the direction of the company. It was found that although the
directors in the companies surveyed had functional control, they had relatively
small personal shareholdings. A large dispersed shareholding in turn had nei-
ther the means nor the incentive to monitor these new powerful managers. In
other words, ownership was now separate from control. Berle and Means there-
fore argued that:
Economic power in terms of control over physical assets, is apparently respond-
ing to a centripetal force, tending more and more to concentrate in the hands of
a few corporate managements. At the same time, bene
cial ownership is centrif-
ugal tending to divide and subdivide, to split into even smaller units and to pass
freely from hand to hand. In other words, ownership continually becomes more
dispersed: the power formerly joined to it becomes increasingly concentrated.
13.6
e practical e
ect of this shi
in power is that the principal concern of share-
holders in large public companies is their investment returns, while the focus of
directors is centred on their power over the enterprise. If the shareholders disagree
7/19/2012 2:23:18 PM
The emergence of the professional managerial organ
with the directors management of the company, the only realistic option open
to them is to sell their shares and leave. 
e ground-breaking work of Berle and
Means has had an immense in
uence over the form and approach of modern
corporate governance regulation (see Chapter 15).
The recognition of directorial autonomy
13.7
e judicial break with the traditional view of equating shareholders with the com-
pany and treating directors as their agents is discernible in the Court of Appeals
decision in
Automatic
eansing
ter
Syndicate
Ltd
Cunninghame
(1906).
e issue in this case was whether or not the directors were bound to give e
ect to
a resolution of the company in general meeting. Collins MR, having reviewed the
authority given to the directors by the companys articles of association, observed
that unless the other powers given by the memorandum were invoked by a special
resolution, it was impossible for a mere majority at a meeting to override the views
of the directors. 
is line of reasoning was adopted by Buckley LJ in
Gramophone
Typewriter
Ltd
(1908) who said:
The directors are not servants to obey directions given by the shareholders as in-
dividuals; they are not agents appointed by and bound to serve the shareholders
as their principals. They are persons who may by the regulations be entrusted
with the control of the business, and if so entrusted they can be dispossessed
from that control only by the statutory majority which can alter the articles.
Directors are not, I think, bound to comply with the directions even of all the
corporators acting as individuals.
e board of directors therefore occupies a pre-eminent position in the manage-
ment of companies (see also
Towcester
Racecourse
Ltd
Racecourse
Association
Ltd
(2002), Patten J). 
e position is that directors, who are subject to being
7/19/2012 2:23:18 PM
Corporate management
7/19/2012 2:23:18 PM
(2)
No such special resolution invalidates anything which the directors
have done before the passing of the resolution.
13.9
We have seen above that the courts have taken the view that shareholders do
not have general supervisory powers over directors. 
is stance is re
ected in
the wording of the model art 70 of the 1985 Table A, and arts 3 and 4 of the
2008 model articles for pcls and plcs (see para
13.8
, above), which reserve to
shareholders only very limited means for intervening in management a
airs:
a special resolution must be carried by three-quarters of the votes of the mem-
bers entitled to vote and voting whether in person or by proxy (s 283 CA 2006).
Directors therefore enjoy wide-ranging management powers and, provided
they act within their powers, they may take decisions against the wishes of the
majority of shareholders (see
Gramophone
Typewriter
Ltd
(1908,
above), Buckley LJ and
Howard
Ltd
Ampo
Petro
eum
Ltd
(1974), Lord
Wilberforce (discussed in Chapter 14)). 
e practical e
ects of the boards
autonomy were explained by Greer LJ in
John
Shaw
Sons
(Sa
ford
Ltd
Shaw
(1935):
If powers of management are vested in the directors, they and they alone can
exercise these powers. The only way in which the general body of the sharehold-
ers can control the exercise of the powers vested by the articles in the directors is
by altering their articles, or, if opportunity arises under the articles, by refusing
to re-elect the directors of whose actions they disapprove. They cannot them-
selves usurp the powers which by the articles are vested in the directors.
Shareholders do not have executive authority and so the general meeting lacks
managerial power unless, exceptionally, there is su
cient support to secure the
passage of a
specia
resolution. Such a resolution may be passed in order to give
speci
c directions to the directors in relation to a particular matter, or to change
their mandate on a more fundamental basis by altering the articles of association
(s 21). 
e ultimate sanction which shareholders can exercise to express their
disapproval of a directors managerial conduct is, of course, to remove him from
ce (s 168, below).
13.10
However, executive power will revert to the members in general meeting where,
for example, the board is incapable of acting as such, or has fallen below the
required minimum number, or has become deadlocked. In the absence of an
ective board the general meeting has a residual authority to use the compa-
nys powers (
exander
Ward
Ltd
Samyang
Navigation
Ltd
(1975)). In
Barron
Potter
(1914) the companys two directors were not on speaking terms
and so e
ective board meetings could not be held. 
e claimant had requisi-
tioned a shareholders meeting at which additional directors had been appointed
to the board but the defendant objected on the ground that under the articles
only the directors could make such appointments. It was held that in the light of
7/19/2012 2:23:19 PM
Corporate management
the deadlock, the power to appoint additional directors reverted to the general
meeting and so the appointments were valid. Warrington J observed:
in ordinary cases where there is a board ready and willing to act it would [not]
be competent for the company to override the power conferred on the directors
by the articles except by way of special resolution for the purpose of altering the
articles. But the case which I have to deal with is a different one. For practical
purposes there is no board of directors at all . . . The directors in the present case
being unwilling to appoint additional directors under the power conferred on
them by the articles, in my opinion, the company in general meeting has power
to make the appointment.
13.11
As we saw in Chapter 10, an issue which has given rise to considerable judicial
debate has been the question of which organ, the board or the general meet-
ing, has the power to institute legal proceedings in the name of the company.
e basic principle is that where a wrong has been done against a company, the
proper claimant is the company itself (
Foss
Harbott
(1843), see s 260 CA 2006).
If the company has adopted art 70 of the 1985 Table A, or some such similar
article, or arts 3 of the 2008 model articles for pcls or plcs, the power to sue is
treated no di
erently from any other executive power and is thus vested in the
board (
Breck
Group
Ltd
London
Properties
Ltd
(1989)).
Should the board decide to bring proceedings the members in general meeting
cannot intervene to direct that they be discontinued. Conversely, a decision not
to sue, it being a management matter, cannot be challenged by the shareholders.
If, however, the wrongdoing directors hold the majority of shares themselves so
that they are in control, the minority shareholders may bring a derivative action
by way of exception to the proper claimant rule (see further Chapter 10).
Appointment of directors
General
13.12
e 2006 Act, like its predecessors, is far from prescriptive in relation to the
appointment of directors. Section 9, which deals with registration require-
ments, states that an application for registration must contain a statement of
the companys proposed o
cers, and this must give the required particulars
of the person who is, or persons who are, to be the 
rst director or directors of
the company (s 12(1)(a)). We have seen above that s 154 stipulates the minimum
number of directors for companies. Section 157 introduces a minimum age of
7/19/2012 2:23:19 PM
Appointment of directors
16 for appointment as a company director. However, an appointment can be
made below the minimum age provided it does not take e
ect until the person
attains the age of 16 (s 157(2)). Section 160 provides that for public compa-
nies the appointment of directors shall be voted on individually unless a block
resolution is unanimously agreed. A resolution moved in contravention of this
provision is void. Beyond these particular statutory provisions the Companies
Act is silent on boardroom appointments, leaving the issue to the articles of
association.
13.13
While the 
rst directors are appointed in accordance with s 9 CA 2006, their
successors are elected by the shareholders in general meeting. Article 73 of the
1985 Table A for public companies provides that at the 
rst annual general
meeting (AGM) all the directors shall retire from o
ce, and at every subse-
quent AGM one-third of the directors who are subject to retirement by rotation
(or if less than three or a multiple of three, the number nearest to one-third)
shall retire from o
ce. If there is only one director who is subject to retire-
ment by rotation, he shall retire. Article 21 of the 2008 model articles for plcs
provides:
(1)
At the
rst annual general meeting all the directors must retire from of
ce.
(2) At every subsequent annual general meeting any directors
(a)
who have been appointed by the directors since the last annual general
meeting, or
(b)
who were not appointed or reappointed at one of the preceding two
annual general meetings, must retire from of
ce and may offer them-
selves for reappointment by the members.
e 2008 model articles for pcls do not provide for retirement by rotation, the
assumption being that this is not required in most private companies.
e power of the majority to appoint directors must be exercised for the bene
t
of the company as a whole and not to secure some ulterior advantage (
Harmer
Ltd
(1959))
Casual vacancies arising before the next AGM may be 
lled
by the directors (art 79 of the 1985 Table A; art 20 of the 2008 model articles for
plcs; art 17(1) for pcls). In any case, a company in general meeting retains an
inherent power to 
ll board vacancies
(Worcester
7/19/2012 2:23:19 PM
Corporate management
Law
Reform
(DTI, 2005, para 3.3)). By way of compromise, s 155 requires that at
least one director be a natural person.
In summary, ss 154167 govern the appointment and registration of directors.
e principal requirements for appointment are:
(i) every private company is to have at least one director, and every public
company to have at least two (s 154);
(ii) 16 is set as the minimum age (as in Scotland) for a director to be appointed
(s 157) and the maximum age limit of 70 for directors of public compa-
nies is abolished;
(iii) the appointment of a director of a public company is to be voted on
individually, unless there is unanimous consent to a block resolution (s
160);
(iv) the acts of a person acting as a director are valid notwithstanding that it
is a
erwards discovered that there was a defect in his appointment, that
he was disquali
ed from holding o
ce, that he has ceased to hold o
ce,
or that he was not entitled to vote on the matter in question (s 161, replac-
ing s 285 of the CA 1985. See the construction given to the provision
in Morris v Kanssen (1946), where Lord Simonds drew the distinction
between a defective appointment and no appointment at all).
Categories of directors
Executive and non-executive directors
13.15
While the Companies Act 2006 does not categorise directors into executive and
non-executive directors, modern corporate practice, particularly in the light of
corporate governance reforms, recognises the division between the two types
(see further, Chapter 16). Executive directors are generally full-time o
cers of
the company who carry out the management of the companys business. As we
have seen, the articles typically give extensive management powers to them and
they will usually have separate service contracts with the company. 
e arti-
cles will also usually provide for the appointment of a managing director, o
en
referred to as chief executive, who has overall responsibility for the running of
the company.
13.16
Non-executive directors are normally appointed to the boards of larger compa-
nies to act as monitors of the executive management. 
ey are typically part-time
appointments. 
e corporate governance committees (the Cadbury Committee,
the Greenbury Study Group, the Hampel Committee and the more recent Higgs
7/19/2012 2:23:19 PM
Appointment of directors
Review) view non-executive directors as holding the potential to perform a mon-
itoring role over their executive brethren, ensuring that they act strictly in the
interests of the company (see now the UK Corporate Governance Code (FRC,
June 2010); see further, Chapters 15 and 16). As will be seen below, non-exec-
utive directors play a pivotal role in the determination of executive directors
remuneration.
De facto
directors
13.17
A
facto
director is one who has not been formally appointed as such (and
therefore is not a
jure
director) but has nevertheless acted as a director in so
far as he has openly undertaken a directorial role in the conduct of the companys
airs (
Kaytech
Internationa
(1999) CA). 
e notion of
facto
director-
ship was considered in
Canadian
Land
onising
(1880).
e liquidator brought a misfeasance action against two individuals who had
acted as directors of the company in question despite not holding the requisite
number of qualifying shares. Jessel MR observed:
No doubt they were not properly elected and were, therefore, not
de jure
directors of the company; but that they were
de facto
directors of the com-
pany is equally beyond all question. The point I have to consider is whether
the person who acts as de facto director is a director within the meaning of
[s 165 CA 1862 (misfeasance)], or whether he can afterwards be allowed to
deny that he was a director within the meaning of this section. I think he can-
not. We are familiar in the law with a great number of cases in which a man
who assumes a position cannot be allowed to deny in a Court of Justice that
he really was entitled to occupy that position. The most familiar instance is
that of executor de son tort. In like manner, it seems to me, in an application
under this section, the
de facto
director is a director for the purposes of this
section.
(See also,
Murray
Bush
(1872), Lord Hatherley.)
As can be seen from Jessel MRs judgment, the question of whether or not an
individual is a
facto
director generally arises in relation to the imposition
of liability (see also, for example,
Statek
Corp
ford
(2008), involving breach
of 
duciary duties; and
House
Ltd
(in
iquidation
ford
Barton
(2012), involving liability for misfeasance) and more particularly in the context of
disquali
cation orders under the Company Directors Disquali
cation Act 1986
(see below). 
e di
culty which has faced the courts has been to devise a satisfac-
tory test for determining whether or not an individuals conduct in relation to the
companys a
airs is such as to render him a
facto
director.
7/19/2012 2:23:19 PM
Corporate management
13.18
In
Hydrodam
(Corby
Ltd
(1994) Millett J, de
ning a
facto
director, stressed
the necessity of the person in question being held out as a director by the com-
pany. He went on to state that:
To establish that a person was a
de facto
director of a company it is necessary to
plead and prove that he undertook functions in relation to the company which
could properly be discharged only by a director. It is not suf
cient to show that
he was concerned in the management of the companys affairs or undertook
tasks in relation to its business which can properly be performed by a manager
below board level.
e requirement of holding out was criticised by Lloyd J in
Richborough
Furniture
Ltd
(1996). He preferred the latter part of Millett Js formulation whereby
emphasis was given to the functions performed by the individual concerned.
Lloyd J added that where it is unclear whether the acts of the individual were ref-
erable to an assumed directorship or to some other capacity, such as a shareholder
or (as on the facts of the case) a consultant, the person in question is to be given
the bene
t of the doubt. It is noteworthy that in
Secretary
for
for
Trade
Industry
Jones
(1999), where a management consultant was disquali
ed as a
facto
director of a company, Jonathan Parker J warned that if a substantial share-
holder in a small company took an active part in running the companys a
airs
in order to protect his investment, he will run the risk of being found to be a
facto
director and therefore subject to disquali
cation under the 1986 Act (see,
for example,
Secretary
for
Business
Enterprise
Regu
atory
Reform
Pou
ter
(2009)).
13.19
e tests formulated in
Hydrodam
and
Richborough
were reviewed by Jacob
J in
Secretary
for
Trade
Industry
Tjo
(1998) in which the judge
acknowledged the di
culties in framing a decisive test. He stressed that the nature
of the exercise was necessarily fact intensive and was a question of degree. Although
Jacob J doubted whether holding out in itself was decisive, it would certainly be a
factor in the courts determination and could raise a rebuttable presumption of a
facto
directorship. Other factors to be taken into account include whether the
person in question was in a position to commit the company to major obligations
on the basis of access to management accounts, whether he used the title of direc-
tor, and whether or not he took part in management decisions at boardroom level
albeit, as is the case with most boards of directors, he may have lacked equal power.
Jacob J concluded by noting that one asks was this individual part of the corporate
governing structure?, answering it as a kind of jury question. Jacob Js approach
was approved by the Court of Appeal in
Kaytech
Internationa
(1999).
13.20
In
Secretary
for
Trade
Industry
ier
(2006). Etherton J, hav-
ing made the point that no one can simultaneously be a
facto
and a shadow
7/19/2012 2:23:19 PM
Appointment of directors
director (see below), went on to state that although various tests have been laid
down for determining who may be a
facto
director there is no single touch-
stone. 
e key test is whether someone is part of the governing structure of
a company in that he participates in, or is entitled to participate in, collective
decisions on corporate policy and strategy and its implementation. He drew a
distinction between those who make decisions without being accountable to
others, and those who advise or otherwise act on behalf of a company (see also,
Mea
Corporation
Ltd
(2007)). Etherton Js approach can be seen to have
uenced the courts reasoning in
Gemma
Ltd
Davies
(2008). An action was
brought against a husband and wife for misfeasance in the management of a
company that had entered into a creditors voluntary winding-up. An issue was
whether the wife, who was company secretary but not appointed a director, was
nevertheless a
facto
director who could also be liable for misfeasance under s
212 of the Insolvency Act 1986 (see Chapter 17, para
17.74
, below). Holding that
the husband was liable, the judge reasoned that to establish that the wife was a
facto
director it was necessary to demonstrate that she performed functions
which could properly be discharged only by a director. For this it would have to
be shown that she exercised real in
uence in the governance of the company on
an equal footing with her husband. Holding her out was at best slight evidence
of her having acted as a director. She merely performed clerical tasks under
the direction of her husband and exercised no real decision-making powers.
Accordingly, she was not a
facto
director and was not liable for misfeasance.
Reviewing the modern case law, the judge derived the following propositions as
being material to the facts of the case:
(1)
To establish that a person was a de facto director of a company, it is neces-
sary to plead and prove that he undertook functions in relation to the com-
pany which could properly be discharged only by a director: per Millett J in
Re Hydrodam (Corby) Ltd
[1994] 2 BCLC 180 at 183.
(2)
It is not a necessary characteristic of a
de facto
director that he is held out as
a director; such holding out may, however, be important evidence in sup-
7/19/2012 2:23:19 PM
Corporate management
(Ch), [2007] Bus LR 352 at [68] and [69] explaining dicta of Timothy Lloyd
QC in
Re Richborough Furniture Ltd
[1996] 1 BCLC 507 at 524.
(5)
The person in question must be shown to have assumed the status and
functions of a company director and to have exercised real in
uence in the
corporate governance of the company: per Robert Walker LJ in
Re Kaytech
International plc
[1999] 2 BCLC 351 at 424.
(6)
If it is unclear whether the acts of the person in question are referable to
an assumed directorship or to some other capacity, the person in ques-
tion is entitled to the bene
t of the doubt (per Timothy Lloyd QC in
Re
Richborough Furniture Ltd
[1996] 1 BCLC 507 at 524), but the court
must be careful not to strain the facts in deference to this observation:
per Robert Walker LJ in
Re Kaytech International plc
[1999] 2 BCLC 351
at 423.
e decision of the Supreme Court in
Commissioners
for
Revenue
Customs
(2010) is of particular signi
cance because the highest UK
court was at long last a
orded the opportunity to review the case law on the
vexed issue of
facto
directorships. 
e question in the case was whether Mr
Holland (H), who was a
jure
director of a corporate director, was a
facto
director of its subject companies,
and therefore subject to the 
duciary duties
which would be owed to them. For Lord Collins this gave rise to both a question
of law and a question of principle. Having considered the case law, he took the
view that the basis of liability for a
facto
director is an assumption of liability
together with his being a part of a companys governance structure. As long
as the relevant acts were done by H entirely within the scope of his duties and
responsibilities as a director of the corporate director, it was in that capacity
that his acts had to be attributed. It had not been shown that H was acting as a
facto
director of the subject companies so as to make him responsible for the
misuse of their assets.
(See also,
Secretary
for
Trade
Industry
(2009).
Shadow directors
13.21
Sometimes a shareholder may deliberately try to avoid the legal duties borne
by directors by exercising in
uence over the board but without being formally
appointed as a director. So-called shadow directors will be subject to the
obligations and liabilities imposed by the Companies Act 2006, the Company
Directors Disquali
cation Act 1986 and the Insolvency Act 1986. With respect
to the latter, ss 214 and 214(7) provide that a shadow director may be liable to
contribute to the companys assets if it goes into insolvent liquidation and it is
proved that at some time before the liquidation he knew or ought to have known
7/19/2012 2:23:19 PM
Appointment of directors
that there was no reasonable prospect of avoiding insolvent liquidation. Shadow
directors may also be subject to the 
duciary duties owed by directors gener-
ally (
ukong
Line
Ltd
Korea
Rendsburg
Investments
Corpn
Liberia
(No
(1998)).
13.22
As the term shadow directors suggests, they are distinguishable from
facto
and
jure
directors by virtue of the fact they seek to evade the duties and
liabilities of directors by remaining in the background, instructing and direct-
ing the actions of the board members, while taking care to avoid directorial
appointment, whether on a
jure
or
facto
basis. Section 251(1) de
nes a
shadow director as a person in accordance with whose directions or instruc-
tions the directors are accustomed to act. 
e provision expressly excludes
from its de
nition those who provide professional advice (s 251(2)). However,
it has been held that if the conduct of an adviser is such that it goes beyond
the normal scope of his professional capacity and is tantamount to e
ectively
controlling the companys a
airs, he will be held to be a shadow director (
Tasbian
Ltd
(No
3)
(1993) in which an accountant controlled the companys
banking so as to decide which of the companys creditors should be paid and in
which order).
13.23
In
Hydrodam
(Corby
Ltd
(para
13.18
, above), the issue was whether two direc-
tors of the parent company could be deemed to be shadow directors of its subsidi-
ary company and therefore liable under s 214 of the Insolvency Act 1986. It was
held that their actions were not such as to render them shadow directors. Being
members of the parent companys board was not of itself su
cient. It would have
to be shown that they personally instructed and directed the subsidiarys board.
Millett J, considering the de
nition contained in s 251(1), took the view that
there are four indices. First, the
jure
and
facto
directors of the company
must be identi
able. Second, the person in question must have directed those
directors on how to act in relation to the companys a
airs or must have been
one of the persons who did. 
ird, the directors must have acted in accordance
with his instructions. Finally, they must have been accustomed so to act. 
e
judge concluded that a pattern of behaviour must be shown in which the board
did not exercise any discretion or judgement of its own but acted in accordance
with the directions of others. With respect to the fourth requirement, a course
of conduct must be shown on the part of the board in acting on the instruc-
tions of a shadow director. Controlling shareholders are perhaps the most obvi-
ous category of persons vulnerable to a 
nding of being shadow directors. But
merely controlling one director will not render the controller a shadow director;
he must exercise control over the whole board or at least a governing majority of
it (
ectric
Motors
Ltd
(1988);
Uniso
Group
Ltd
(No
(1993)). In
Secretary
Trade
for
Trade
Industry
Devere
ll
(1999) the Court of Appeal
7/19/2012 2:23:19 PM
Corporate management
held that the de
nition of a shadow director for the purposes of the Company
Directors Disquali
cation Act 1986, s 22(5), included anyone, other than pro-
fessional advisers, with real in
uence in the corporate a
airs of the company.
On the facts, both respondents were described as consultants and the companys
board was accustomed to act in accordance with their directions and sugges-
tions. 
ey were, therefore, shadow directors. In
traframe
(UK
Ltd
Fie
(2005), Lewison J, having noted that a governing majority of the board must be
accustomed to act in accordance with the directions of the alleged shadow direc-
tor, went on to consider the nature and scope of the duties of such directors. He
observed that from the time that it can be established that a person is a shadow
director, he will owe certain statutory duties and prohibitions to the company
(see, for example, s 170(5), which states that the general duties apply to shadow
directors where, and to the extent that, the corresponding common law rules or
equitable principles so apply: see further, Chapter 14). Applying
Paragon
Finance
akerar
(1999) and
Dubai
Ltd
aam
(2002),
the judge concluded that shadow directors would not usually owe 
duciary duties
to a company because they do not deal directly with corporate assets (see CA
2006, Part 10; Chapter 14, below). However, a shadow director will be required
to declare his interest in any contract with the company at a board meeting (see
s 177) and obtain members approval in relation to substantial property transac-
tions (see s 190).
Alternate directors
13.24
e o
ce of director is personal in character and so a director cannot appoint a
delegate to act in his place should he be prevented from attending board meet-
ings unless the companys articles of association or memorandum permit this.
Table A, arts 6569 (for both private and public companies) provide that a direc-
tor may appoint any other director or any other person approved by the board
to be his alternate. Article 25 of the 2008 model articles for public companies is
dra
ed in similar terms. An alternate director is entitled to receive notice of all
meetings of the board and its committees of which the appointing director is a
member and to attend and vote at all such meetings from which the appointing
director is absent. However, an alternate director is not entitled to remunera-
tion from the company for his services and he will cease to hold o
ce if the
appointing director ceases to be a director. Subject to anything in the articles to
the contrary, an alternate director is not deemed to be the agent of the director
appointing him, but is deemed for all purposes to be a director (and therefore
subject to the duties and liabilities of directors) and shall alone be responsi-
ble for his own acts and defaults (art 26 of the 2008 model articles for public
companies).
7/19/2012 2:23:19 PM
The duciary nature of the of ce
The
duciary nature of the of
ce
13.25
Directors stand in a 
duciary relationship with the company. While we deal with
the statutory codi
cation of the equitable and common law obligations of direc-
tors that arise from this 
duciary relationship in the next chapter, the nature
of this relationship is worth exploring further here before we continue to the
next section on directors remuneration. 
e early case law on 
duciary duties
owed by directors described them in terms of trustee status. 
is relates speci
cally to the origins of companies themselves. Companies, prior to the Joint Stock
Companies Act 1844, were unincorporated and the constitutional document was
a deed of settlement vesting the assets of the company in trustees. 
is practice of
describing directors as trustees continued even a
er the advent of the registered
company had done away with the need for a deed of settlement (see for example
fast
Corpn
(1855) and
Grimes
Harrison
(1859)).
13.26
However by the mid-1840s around the time when the registered company 
rst
appeared the term 
duciary began to be used by the judiciary to describe the
relationship between the directors and the company. By the 1920s there was
still some confusion as to whether directors were trustees. Romer J in
City
Equitab
Fire
Insurance
(1925) sought to clarify the issue. He stated:
[i]t is sometimes said that directors are trustees. If this means no more than that
directors in the performance of their duties stand in a
duciary relationship
with the company, the statement is true enough. But if the statement is meant
to be an indication by way of analogy of what those duties are, it appears to me
to be wholly misleading. I can see but little resemblance between the duties of
a director and the duties of a trustee of a will or of a marriage settlement. It is
indeed impossible to describe the duty of a director in general terms, whether by
way of analogy or otherwise.
Directors are not, therefore, trustees as such. Rather their 
duciary relationship
arises from their appointment and empowerment by the general meeting, in other
words from their status as a species of agent. For example, in
Lindgren
Estates
Ltd
(1968) an argument that directors-elect have a 
duciary relationship
with the company was rejected. 
e 
duciary relationship and thus the 
duciary
duties begin once the appointment takes place. As Davies (2008) comments:
[n]evertheless, to describe directors as trustees seems today to be neither strictly
correct nor invariably helpful. In truth, directors are agents of the company
rather than trustees of its property. But as agents they stand in a
duciary rela-
tionship to their principal, the company.
7/19/2012 2:23:19 PM
Corporate management
Directors remuneration
General
13.27
A director is not entitled as of right to be paid for his services unless the articles
of association or a service contract between him and the company provide oth-
erwise (
George
Newman
(1895);
Guinness
Saunders
(1990)). 
is is
a legacy from the law of trusts whereby a trustee is not entitled to remuneration
unless the trust instrument so providesa director, being a 
duciary, is therefore
in a similar position to a trustee. 
is is because, in e
ect, the trustee would be
applying trust funds for his own bene
t and not the bene
t of the bene
ciaries.
e orthodox view taken towards directors remuneration was stated by Bowen LJ
in
Hutton
West
Cork
(1883) who said that a director is not a servant; he
is a person doing business for the company, but not upon ordinary terms. It is not
implied from the mere fact that he is a director that he is to be paid for it. However,
the articles of association invariably provide for directors remuneration.
13.28
Article 82 of the 1985 Table A provides that directors shall be entitled to such
remuneration as the company may by ordinary resolution determine. A formal
resolution is not required if all the members entitled to vote on the matter give
their informal assent (
Duomatic
Ltd
(1969)). For the
Duomatic
principle to
apply, the consent must be unanimous (see
Extrasure
Trave
Insurances
Ltd
Scattergood
(2003), discussed in Chapter 14; and
Reiner
Gershinson
(2004)).
Further, members can only assent where they have full knowledge of the facts
(EIC
Services
Ltd
Phipps
(2003)). While the question of remuneration is a con-
stitutional matter, it is nevertheless subject to certain statutory restrictions (in
particular, ss 188189 and ss 227230 (service contracts); considered below).
Further, Table A, art 83 requires the company to pay all travelling, hotel, and
other expenses properly incurred by directors in connection with their attend-
ance at meetings of directors or committees of directors or general meetings or
separate meetings of the holders of any class of shares or of debentures of the
company or otherwise in connection with the discharge of their duties (see also
art 20 for pcls; art 24 for plcs of the 2008 model articles). It is noteworthy that arts
19 and 23 of the 2008 model articles for pcls and plcs respectively, provide that
directors are entitled to such remuneration as the directors determine for their
services. Vesting this power in the directors gives rise to an obvious con
ict of
interest. In public companies this is dealt with by delegating the determination
of remuneration to a remuneration committee as required by the UK Corporate
Governance Code, para D.2.1 (see
13.37-13.38
, below and Chapter 16). For listed
companies there are also disclosure requirements in relation to directors remu-
neration (see
13.3913.41
, below).
7/19/2012 2:23:19 PM
Directors remuneration
13.29
e power to set the level of a directors remuneration will, of course, depend
upon the proper construction of the articles where it is contained.
Guinness
Saunders
(1990) concerned the claim by a director, W, to remuneration for his
services in successfully negotiating a takeover by Guinness for Distillers Co plc.
e House of Lords, having found that W was not entitled to remuneration under
the terms of the companys articles, also refused to grant him in the alternative
any form of allowance for the work he had undertaken for the company. 
is
aspect of the decision is particularly harsh given that Guinness bene
ted from
the advice and services provided by W for free. Taking Ws claim for a
quan
tum
meruit
rst, he sought to rely inter alia on
Craven
Canons
Ltd
(1936).
In this case the claimant was awarded a
quantum
meruit
for work done as the
managing director of a company although he had failed to obtain the necessary
quali
cation shares within two months of his appointment as required by the
companys articles of association. Lord Templeman concluded that because the
claimant was not a director:
there was no con
ict between his claim to remuneration and the equitable doc-
trine which debars a director from pro
ting from his
duciary duty, and there
was no obstacle to the implication of a contract between the company and the
plaintiff entitling the plaintiff to claim reasonable remuneration as of right by
an action in law.
e anxiety of the House of Lords in refusing to grant W a
quantum
meruit
was
that to do so would run counter to the no-pro
t rule which lies at the root of the
duciary duties applicable to directors.
Ws claim to an equitable allowance was similarly rejected. Lord Go
, mind-
ful that the exercise of this discretion could constitute interference in company
airs, doubted whether it would ever be exercised in favour of a company direc-
tor. Lord Templeman stated that he could not envisage circumstances in which a
court of equity would exercise a power to award remuneration to a director when
the relevant articles of association con
ded that power to the board of directors.
Service contracts
13.30
A directors service contract with a company is de
ned as a contract whereby: (a)
a director undertakes personally to perform services for the company; or (b) serv-
ices (as a director or otherwise) that he undertakes personally to perform are made
available by a third party to the company, or to a subsidiary of the company (s 227
CA 2006). It is common practice for executive directors to have a service contract
with the company which sets the level of remuneration. 
e articles of association
7/19/2012 2:23:19 PM
Corporate management
commonly provide for the terms of such service contracts to be set by the board of
directors or a committee of the board. In the exercise of this power they must act
bona 
de in the interests of the company (
Safety
Group
Ltd
Heane
(1998)).
However, beyond the requirement that there must be a genuine exercise of the power,
the courts have shown little inclination to intervene in matters concerning directors
remuneration particularly in relation to the amount awarded which is viewed as a
matter of company management (
Garage
(19
64)
Ltd
(1982), Oliver J).
13.31
As commented above, the Companies Act 2006 imposes a number of controls on
directors service contracts and salaries by prescribing certain disclosure obli-
gations. To prevent directors entrenching themselves by long-term service con-
tracts which would attract signi
cant compensation packages (so-called golden
parachute payments), ss 188189 require shareholder approval of any service
contract which may run for more than two years (under the 1985 Act the period
was 
ve years). Failure to obtain such approval renders the relevant terms void
and the contract is deemed to contain a term entitling the company to termi-
nate it at any time by the giving of reasonable notice. 
e requirement applies
to both contracts of service and contracts for services (s 227) and also applies to
shadow directors. Section 188 is the sole statutory exception to the principle that
the terms of directors employment contracts should be le
to the board.
13.32
Where the service contract is between the director and a subsidiary of the com-
pany of which he is a director, both companies must pass resolutions. Approval
is by an ordinary resolution (s 218(3)), although the articles of association may
impose a stricter requirement. For private companies, approval may be by writ-
ten resolution (s 188(5)(a)).
13.33
Section 412 CA 2006 requires disclosure in the annual accounts of the aggregate
amount of directors emoluments, including present and past directors pensions
and compensation for loss of o
ce. Further, ss 228230 provides that the terms
of a directors service contract must be made available for inspection by the mem-
bers. A shadow director is treated as a director for the purposes of these provi-
sions (s 230). Breach of this requirement may result in a 
ne on conviction and
the court can order an inspection (s 229(4) and (5)).
The Greenbury Committee
13.34
e wider issues arising from the corporate governance debate and the reports
of the committees established in the 
rst half of the 1990s, namely Cadbury
(December 1992) and Hampel (January 1998) which, together with the Greenbury
Study Group on directors remuneration (July 1995), culminated in the adoption
by the London Stock Exchange of the
Princip
Governance
and the
7/19/2012 2:23:19 PM
Directors remuneration
Code
Best
Practice
Combined
Code
see
13.37
, below)), together with the
Higgs Report which was published in January 2003 (see Chapter 16). One par-
ticular aspect of corporate governance which became a major cause of public
and shareholder concern in the late 1980s and early 1990s was the high levels of
remuneration being awarded to directors particularly in the then newly priva-
tised utilities. 
is anxiety, which also found support in Parliament and much of
the press, centred on the apparent lack of any link between boardroom remuner-
ation and performance, and the lack of procedural transparency in the determi-
nation of directors remuneration. As a reaction to these concerns the Greenbury
Committee was established in January 1995 by the Confederation of British
Industry (CBI). It was charged with reporting on best practice in determining
directors remuneration and dra
ing a code of practice for use by public compa-
nies. Its report and
Code
Best
Practice
were published in July 1995 (
Directors
Remuneration
Report
the
Study
Group
chaired
Richard
Greenbury
13.35
Before Greenbury, the Cadbury Committee (the Committee on 
e Financial
Aspects of Corporate Governance, chaired by Sir Adrian Cadbury (1992)) had
recommended that quoted companies should adopt a committee system as a
means of improving the e
ectiveness of the board structure and enhancing the
strength and in
uence of non-executive directors. As part of this system, a remu-
neration committee was proposed, dominated in its membership by non-execu-
tive directors, to advise the board on the remuneration (in all its various forms)
of executive directors. 
e aim here was to address the perception of directors
ectively determining their own pay. Greenbury noted in 1995 that most quoted
companies had established remuneration committees.
13.36
e Greenbury report concluded that accountability, transparency and linkage
to performance should be the axioms underlying the determination of directors
remuneration. To this end its
Code
Best
Practice
stated:
to avoid potential con
7/19/2012 2:23:19 PM
Corporate management
remuneration committees should consult the company Chairman and/or
Chief Executive about their proposals and have access to professional ad-
vice inside and outside the company.
The Combined Code
13.37
e Combined Code
(published in 2008)
laid down the principle that companies
should establish a formal and transparent procedure for developing policy on
executive remuneration and that that principle governed the setting of remu-
neration packages of individual directors. It also stated that no director should
be involved in deciding his own remuneration (Principle B.2). 
e Code required
boards of directors to set up remuneration committees of independent non-exec-
utive directors. While the Listing Rules themselves do not require companies to
set up a remuneration committee they did, however, require companies to state
whether or not they complied with the Code, and to give reasons for any non-
compliance.
Following a review of the Combined Code by the Financial Reporting Council in
2009 (in the a
ermath of the 
nancial crisis) and consultation on a revised Code
that ended in March 2010, the FRC published the UK Corporate Governance
Code in May 2010 (which replaces the Combined Code). It applies to 
nancial
years beginning on or a
er 29 June 2010. It was announced that the Code would
in future be known as the UK Corporate Governance Code, in order to make
the Codes status as the UKs recognised corporate governance standard clearer
to foreign investors, and to foreign companies listed in the UK that, as a result
of changes to the FSAs Listing Regime, now need to report on how they have
applied the Code if they have a Premium Listing of equity shares.
UK
Corpora
ernan
Code
(J
une
13.38
e Code is discussed in Chapter 16 in some detail and so our examination at
this point is restricted to the requirements set out in Section D relating to direc-
tors remuneration. 
e relevant provisions of the Code are complex and it is not
practicable to set them out in full here. Rather, we consider briey the principles
and include references to the code provisions. Main principle D.1 acknowledges
that levels of remuneration should be set so as to attract and motivate directors of
quality, but that companies should avoid paying more than is necessary for this
purpose. It goes on to state that a signi
cant percentage of the remuneration of
executive directors should be linked to corporate and individual performance.
e Supporting Principle explains that the performance-related elements of
executive directors remuneration should be stretching and designed to promote
the long-term success of the company. It goes on to add that the remuneration
7/19/2012 2:23:19 PM
Directors remuneration
committee should judge where to position their company relative to other com-
panies although caution should be exercised when carrying out comparisons
given the risk of an upward ratchet of remuneration levels with no correspond-
ing improvement in performance. On the question of procedure, Main Principle
D.2, states that:
There should be a formal and transparent procedure for developing policy on
executive remuneration and for xing the remuneration packages of individual
directors. No director should be involved in deciding his or her own remunera-
tion.
Paragraphs D.2.1-D.2.2 lay down detailed rules about the role of remuneration
committees. A premium listed companys board should establish a remuneration
committee made up only of independent non-executive directors [NEDs] to set
the remuneration levels of executive directors and the chairman and recommend
and monitor the remuneration for senior management. Paragraph D.1.3 discour-
ages all forms of performance-related remuneration for NEDs, including share
options. 
e remuneration of NEDs should be set by the board, or a committee
of the board, unless the articles require their remuneration to be determined by
the shareholders (para D.2.3).
losure
remunera
: th
ire
ors
emunera
epor
13.39
A remuneration report was made mandatory in 2002 for all quoted companies
for 
nancial years ending on or a
er 31 December 2002 by statutory instrument
(the Directors Remuneration Report Regulations 2002 (SI 2002/1986)), which
came into force on 1 August 2002. 
is is now incorporated into the Companies
Act 2006 (see s 420). By virtue of s 421 the Secretary of State has laid regula-
tions determining how the remuneration report should be presented and which
parts of the report are to be auditable (the Large and Medium-sized Companies
and Groups (Accounts and Reports) Regulations 2008, Sch 8). 
e remunera-
tion report must be approved by the board of directors and signed on behalf of
the board by a director or secretary of the company (s 422(1)). Where a direc-
tors remuneration report is approved but it does not comply with the statutory
requirements, every director of the company who knew of its non-compliance,
or was reckless as to whether it complied, and failed to take reasonable steps to
secure compliance or to prevent the report from being approved, commits an
ence punishable by 
ne (s 422). Section 439 goes on to provide that prior to
the accounts meeting, a quoted company must give to those members entitled
to receive it notice of its intention to move an ordinary resolution approving the
directors remuneration report for the 
nancial year. Failure to comply with this
requirement is an o
ence punishable by 
ne (s 440)).
7/19/2012 2:23:19 PM
Corporate management
13.40
ese measures broadly implement the DTIs proposals made in its consulta-
tive documents,
Directors
Remuneration
(URN 99/923) (London, DTI, 1999)
and (URN 01/1400) (London DTI, 2001). 
e DTI (now BIS) had commis-
sioned PricewaterhouseCoopers to monitor compliance by a group of quoted
companies with the best practice framework. 
e statistics prepared by
PricewaterhouseCoopers demonstrated, in the Governments view, that while
many listed companies complied with the letter of the Listing Rules, a high
proportion failed to respond adequately to the spirit of the Greenbury prin-
ciples of accountability, transparency and linkage to performance. Part 2 of
Sch 8 of the Large and Medium-sized Companies and Groups (Accounts and
Reports) Regulations 2008 (which came into force on 6 April 2008), there-
fore requires the remuneration report to contain information relating to four
broad areas:
(i) the circumstances surrounding the consideration by the directors of
matters relevant to directors remuneration: for example, the name of
each director who was a member of the remuneration committee and the
name of any person who provided the committee with advice;
(ii) a statement of the companys policy on directors remuneration for the
following 
nancial year;
(iii) a performance line graph which sets out the total shareholder return of the
company on the class of equity share capital, if any, which caused the com-
pany to fall within the de
nition of quoted company; and
(iv) details concerning each directors contract of service or contract for serv-
ices such as the date of the contract, its unexpired term, notice periods,
and any provision for compensation upon early termination (see below).
e 2006 Act, together with the regulations laid under it, also requires detailed
information to be set out concerning emoluments, share options, long-term
incentive plans, pensions, compensation and excess retirement bene
ts of each
director and, in some instances, past directors (discussed further below). 
e
regime increases signi
cantly the legal disclosure requirements of quoted com-
panies with respect to directors remuneration and has acted as a catalyst for
increasing company accountability and e
ective shareholder engagement (White
Paper,
Company
Law
Reform
DTI, 2005, at p 10).
13.41
e e
ectiveness of these provisions became apparent during the  rst gen-
eral meeting season following their implementation around April/May 2003.
Press and radio reports were  lled with details of directors apparently reap-
ing rewards for failure. For example, in late May 2003 a shareholder revolt at
GlaxoSmithKline plc culminated in it becoming the  rst company to have
its executive remuneration package rejected by shareholders. Further, Digby,
7/19/2012 2:23:19 PM
Directors remuneration
Lord Jones of Birmingham, then Director General of the CBI, speaking at the
Institute of Directors 2003 annual convention, urged investors to seek details
on directors contracts before they are signed in order to curb the criticism
over fat cat pay (
Times
1 May 2003). An independent report published
by Deloitte and Touche,
Report
the
Impact
the
Directors
Remuneration
Report
Regu
ations
(November 2004), found that the regulations have had a
positive impact in so far as they facilitate the scrutiny by shareholders of
directors remuneration.
Notwithstanding these  ndings, the issue of directors remuneration
has continued to generate political controversy which has led to further
Government initiatives. In September 2011 the Government launched a
consultation exercise on executive remuneration to explore the apparent
disconnect between levels of pay for directors and the performance of their
companies. In the light of the responses to this consultation, BIS outlined
in January 2012 a series of measures to address perceived weaknesses in the
corporate governance framework in relation to executive remuneration. 
is
was followed in March 2012 by a consultation paper on the Governments
proposals to increase shareholder voting rights on executive pay policies and
exit payments worth more than one years salary. In essence, the proposed
measures are:
(i) Companies will be required to obtain 75 per cent (up from 50 per cent)
shareholder support for the vote on executive pay policies to be passed.
e Government will also look at requiring clawback clauses in all con-
tracts whereby pay can be recovered if a company performs poorly.
(ii) Greater transparency via increased disclosures in the annual report by
requiring more information on what benchmarks a company uses to set
executive pay and how pay policy relates to the companys strategy and
performance. Companies will be required to produce a single 
gure for
total pay and show how spend on executive pay compares with other pay-
outs such as dividends and business investment.
(iii) 
e drive for greater boardroom diversity to be renewed by getting more
people from di
erent professional backgrounds onto company boards.
(iv) To further employee engagement, companies will be required to explain
how they have consulted employees and taken account of employee pay
when setting board pay.
e consultation period closed on 27 April 2012 and the Government is prepar-
ing the necessary legislation. Primary legislation will be required to amend the
Companies Act 2006 for the shareholder approval requirements. Changes to the
disclosure requirements can be made by new regulations. 
e FSA will also need
to review the Listing Rules to ensure they are consistent with the new measures.
7/19/2012 2:23:20 PM
Corporate management
e Government expects that the new legislation will come into force in the
spring of 2013.
Vacation and removal from of
ce
Retirement, resignation and vacation
13.42
As commented above, arts 7380 of the 1985 Table A (for public companies) pro-
vide for the retirement of all directors at the 
rst annual general meeting and
therea
er for the retirement by rotation of one-third of the directors (or such
number as may be speci
ed) each year. Retiring directors remain eligible for
re-election and will be automatically reappointed should another appointment
not be made (Table A, art 75 (public companies; for the position under the 2008
model articles for plcs, art 21, see
13.13
, above).
13.43
A director may also resign his o
ce. 
e articles of association will normally
require notice in writing to the board, the e
ect of which is that the director is
deemed to have vacated his o
ce (art 81(d) of the 1985 Table A for both private
and public companies; arts 18(f) and 22(f) of the 2008 model articles for pcls and
plcs respectively). Additionally, both Table A and the 2008 model articles go on to
list a number of other instances where a director will be deemed to have vacated
his o
ce. 
ese include becoming a bankrupt or su
ering from a physical or men-
tal disorder such as to render the director incapable of acting as such for more
than three months, or being made subject to a court order for his detention or for
the administration of his property. More generally, the articles of association may
include a provision that the o
ce of a director will be vacated if he is requested in
writing to resign by all his co-directors. Such a power must be exercised in the best
interests of the company (
Wen
Hsien
(1985) PC).
Removal
13.44
Section 168(1) of the Companies Act 2006 provides that a company may by ordi-
nary resolution remove a director before the expiration of his period of o
ce,
notwithstanding anything in any agreement between him and the company.
Special notice must be given of the resolution, that is to say that at least 28 days
notice must be given before the meeting at which the resolution is to be moved
(ss 168(2) and 312). 
e director concerned is entitled to address the meeting at
which it is proposed to remove him (s 169(2)). He may also require the company
to circulate to the shareholders his representations in writing provided they are
7/19/2012 2:23:20 PM
Vacation and removal from of ce
of a reasonable length, unless the court is satis
ed that this right is being abused
to secure needless publicity for defamatory matter (s 169(3)).
13.45
Although the power contained in s 168 cannot be ousted by the articles, it is pos-
sible for a director of a private company to entrench himself by including in the
articles a clause entitling him to weighted voting in the event of a resolution to
remove him. In
Bushe
ll
Faith
(1970) the articles provided that on a resolution to
remove a particular director, his shares would carry the right to three votes per
share. 
e result was that he was able to outvote the other shareholders who held
200 votes between them and so the ordinary resolution could be blocked by him.
At 
rst instance, Ungoed-
omas J held that the article in question was invalid on
the basis that it would make a mockery of the law if the courts were to hold that in
such a case a director was to be irremovable. However, the Court of Appeal and
the House of Lords approved the clause. Lord Upjohn reasoned that: Parliament
has never sought to fetter the right of the company to issue a share with such
rights or restrictions as it may think 
t. He went on to state that, in framing s 303
CA 1985 (now s 168 CA 2006), all that Parliament was seeking to do was to make
an ordinary resolution su
cient to remove a director and concluded that: Had
Parliament desired to go further and enact that every share entitled to vote should
be deprived of its special rights under the articles it should have said so in plain
terms by making the vote on a poll one vote one share. Nowadays, however, while
weighted clauses are commonly encountered in private companies of a quasi-part-
nership nature, they are expressly prohibited by the Listing Rules.
13.46
A major consideration for companies seeking to remove a director is the amount
of damages or compensation which may become payable to him upon his termi-
nation. 
is is because the power conferred by s 168 does not deprive the director
of a claim for damages for a breach of his service contract (s 168(5);
Southern
Foundries
(192
6)
Ltd
Shir
(1940)). To prevent directors awarding themselves
long-term service contracts in order to obtain in
ated compensation payments
in the event of dismissal, s 188 provides that where a directors service contract
or contract for services is for a period in excess of two years and contains a term
whereby it cannot be terminated by the company giving notice, or that it can be
so terminated but only in speci
ed circumstances, the contract must be approved
by the company in general meeting. A term in contravention of this section is
void and the contract is deemed to contain a term entitling the company to ter-
minate it at any time by giving reasonable notice (s 189). In
Wright
Wright
(Europe
Ltd
(1999) the Court of Appeal held that the purpose of s 188 was to
protect and bene
t shareholders and so the requirement of formal approval by
the general meeting could be waived where there was informal approval of the
service contract by the entire body of shareholders.
7/19/2012 2:23:20 PM
Corporate management
13.47
It should be noted that in appropriate circumstances a company which decides
to remove a director, particularly if the company is a small quasi-partnership,
may face the prospect of a claim for relief by the ousted director under the unfair
prejudice provision contained in s 994. In such cases the court has a wide discre-
tion in framing a remedy to suit the particular circumstances (see Chapter 11,
above).
Compensation payments to directors on loss of of
ce
13.48
One of the anxieties which Greenbury sought to address was shareholder and
public concern at the size of some compensation payments given to directors on
loss of o
ce and what was perceived to be, in many cases, a lack of justi
cation
in terms of directorial performance. 
e Hampel Committee made the point that
the notice period required by an employer has become a 
ction in so far as nei-
ther party expects the notice period in a directors service contract to be worked
out; and in this regard it has become merely a device for the payment of money.
Hampel concluded that service contracts should make detailed provision at the
outset for the payments to which the director would be entitled if at any time he
were removed from o
ce, except for misconduct. 
e UK Corporate Governance
Code encompasses these points (see, for example, para D.14).
13.49
Additionally, there are a number of provisions in the Companies Act which cover
compensation for loss of o
ce (ss 215222). 
e object of the statutory provisions
is to make payments to directors for loss of o
ce or as consideration for or in
connection with retirement from o
ce unlawful unless there has been prior dis-
closure and approval. More particularly, s 217 prohibits a company from making
any payment to a director by way of compensation for loss of o
ce without par-
ticulars of the proposed payment being disclosed to and approved by the com-
pany. Payments made to a person connected with the director, or at the direction
of the director, may also be treated as payments to the director, and if regarded
as sums paid by way of compensation for loss of o
ce, will also require member
approval (s 215(3)). Sections 218219 extend the prohibition to cover payments
made in a takeover situation. 
e prohibition in s 217 does not apply to pay-
ments which the company is legally obliged to make as a result, for example, of
a contractual undertaking (s 220; see
Taupo
Timber
Ltd
Rowe
(1978), Lord
Wilberforce). Further, s 220(1) excludes from the general prohibition any bona
de payment by way of damages for breach of contract or by way of pension for
past services.
13.50
In addition to the above disclosure requirements, the Listing Rules require listed
companies to include in the remuneration report details of compensation for loss
of o
ce and payments for breach of contract or other termination payments in
7/19/2012 2:23:20 PM
Disquali cation of directors
respect of each director by name. 
e report should also include details of any
directors service contract with a notice period exceeding one year, together with
details of any provisions for pre-determined compensation on termination which
exceed one years salary and bene
ts in kind. Finally, the report should state the
unexpired term of any service contract of a director proposed for election or re-
election at the next AGM. 
e Listing Rules also go on to require companies to
make copies of each directors service contract available for inspection.
Disquali
cation of directors
13.51
As we have seen in Chapter 3, the protection a
orded by limited liability is open to
abuse. A major anxiety of the Cork Committee was the ease with which a director
could carry on business through the agency of a limited liability company, allow
it to slide into insolvency, form a new company and carry on in business as before
leaving behind him a trail of unpaid creditors (
Report
the
Review
Committee
Inso
vency
Law
Practice
(the Cork Committee), Cmnd 8558, para 1813). As
a result of the Cork Report recommendations the provisions for the disquali
ca-
tion of directors contained in the Companies Act 1985 and the Insolvency Act
1985 were reinforced and consolidated in the Company Directors Disquali
cation
Act 1986 (herea
er the CDDA 1986). 
e policy underlying the disquali
cation
regime was explained by Ho
mann J in
Ipcon
Fashions
Ltd
(1989):
The public is entitled to be protected not only against the activities of those
guilty of the more obvious breaches of commercial morality, but also against
someone who has shown in his conduct . . . a failure to appreciate or observe the
duties attendant on the privilege of conducting business with the protection of
limited liability.
us, the CDDA regime, together with provisions contained in the Insolvency
Act 1986 (see Chapter 17), is designed to protect the public against abuses of
limited liability. Against this, of course, is the need to strike a balance so as not
to stultify all enterprise (
Doug
Construction
Ltd
(1988), Harman J). As
will be seen below, the judges have long sought to formulate a satisfactory test for
determining whether commercial morality has been breached.
The effect of a disquali
cation order
13.52
e CDDA 1986 lays down a regime designed to address the need to protect the
general public against abuses of the corporate form. 
e e
ect of a disquali
cation
7/19/2012 2:23:20 PM
Corporate management
order is that a person shall not, without the leave of the court, be a director of a
company, or a liquidator or administrator of a company, or be a receiver or man-
ager of a companys property or, in any way, whether directly or indirectly, be con-
cerned or take part in the promotion, formation or management of a company, for
a speci
ed period beginning with the date of the order (s 1(1)). A disquali
ed per-
son is therefore precluded from acting in any of the alternative capacities listed and
so, for example, a disquali
ed director cannot then participate in the promotion
of a new company during the disquali
cation period (
Receiver
Hannan
(1997)). Nor can he be concerned or take part in the management of a company
by virtue of acting in some other capacity such as a management consultant (
Campbe
ll
(1984)). It is noteworthy that the CDDA also extends to corporate direc-
tors, i.e. companies that hold director positions (
Receiver
Brady
(1999)).
e Secretary of State maintains a register of disquali
cation orders which is
open for public inspection at the Companies Houses in London, Cardi
and
Edinburgh, and at the Royal Courts of Justice (s 18). When an order ceases to be
in force such entry must be deleted.
Grounds for disquali
cation
Discretionary orders
Conviction of an offence
13.53
Section 2 CDDA 1986 provides that the court may, in its discretion, issue a dis-
quali
cation order against a person convicted of an indictable o
ence (whether on
indictment or summarily) in connection with the promotion, formation, manage-
ment, liquidation or striking-o
of a company, or with the receivership or man-
agement of a companys property. 
e o
ence does not have to relate to the actual
management of the company provided it was committed in connection with its
management (see, for example,
Creggy
(2008)). It has therefore been held to
include insider dealing (
(1994)). 
e maximum period of disquali-
cation is 
ve years where the order is made by a court of summary jurisdiction
and 15 years in any other case (s 2(3)). It will not necessarily amount to an abuse of
process for civil proceedings to be brought under s 6 of the CDDA 1986 (disquali-
cation for un
tness, below) where a director has been disquali
ed under s 2 given
that s 6 is not concerned with criminality but with un
t conduct (
Cedarwood
Productions
Ltd
Secretary
for
Trade
Industry
Rayna
(2004)).
Persistent breaches of the companies legislation
13.54
e court may disqualify a person where it appears that he has been persistently
in default in relation to provisions of the companies legislation requiring any
7/19/2012 2:23:20 PM
Disquali cation of directors
return, account or other document to be 
led with, delivered or sent, or notice
of any matter to be given, to the Registrar (s 3(1)). Persistent default will be pre-
sumed by showing that in the 
ve years ending with the date of the application
the person in question has been convicted (whether or not on the same occasion)
of three or more defaults (s 3(2)). Otherwise, persistent has been construed as
meaning some degree of continuance or repetition (see
Arctic
Engineering
Ltd
(No
(1986) in which the failure to send 35 required returns to the Registrar was
held to be su
cient evidence of persistent default). Section 5 goes on to provide
that a disquali
cation order for persistent default can be made by a magistrates
court (in England and Wales) at the same time as a person is convicted of an
ence relating to the 
ling of returns etc.
Fraud
13.55
e court may make a disquali
cation order against a person if, in the course of
the winding-up of a company, it appears that he:
(a)
has been guilty of an offence for which he is liable (whether he has been
convicted or not) under s 993 of the Companies Act 2006 (fraudulent trad-
ing), or
(b)
has otherwise been guilty, while an of
cer or liquidator of the company or
receiver or manager of its property, of any fraud in relation to the company
or of any breach of his duty as such of
cer, liquidator, receiver or manager
(s 4).
e maximum period for disquali
cation on this ground is 15 years (s 4(3)).
Where a person has been found liable under s 213 or s 214 of the Insolvency Act
1986, respectively the fraudulent trading and wrongful trading provisions (see
Chapter 17), the CDDA 1986 gives the court a discretion to disqualify such per-
son for a period of up to ten years.
Disquali
cation after investigation of the company
13.56
Section 8 provides that if it appears to the Secretary of State from a report follow-
ing a BIS investigation that it is expedient in the public interest that a disquali
cation order should be made against any person who is or has been a director or
shadow director of any company, he may apply to the court for a disquali
cation
order. 
e court can disqualify such person for up to 15 years if it is satis
ed that
his conduct in relation to the company makes him un
t to be concerned in the
management of a company. 
is power has been used where, following a BIS
investigation, it was apparent that a director had abused his power to allot shares
in order to retain control of the company (see
Looe
Fish
Ltd
(1993);
Secretary
for
Trade
Industry
Carr
(2007); see also,
Secretary
for
Business
Enterprise
Regu
atory
Reform
(2008)). In
Secretary
for
7/19/2012 2:23:20 PM
Corporate management
Business
Innovation
(2010), the application by the Secretary
of State for a disquali
cation order was brought under s 8 following an investiga-
tion of the company. Norris J found the director, S, to be un
t to be concerned in
the management of a company. S was culpable in seeking to establish a business
by widespread misrepresentation of the nature of the risk which customers ran in
buying a
er the event insurance. 
e judge noted that disquali
cation under s 8
was not mandatory (as under s 6, below), but in the case before him there was no
doubt that the need to protect the public and to deter other directors from engag-
ing in similar conduct required a period of disquali
cation.
Mandatory disquali
cation orders for un
tness
13.57
e Insolvency Act 1985 introduced un
tness as a ground for disquali
ca-
tion. 
is is now contained in s 6(1) of the CDDA 1986 which provides that the
court shall make a disquali
cation order against a person in any case where it is
satis
ed:
(a)
that he is or has been a director of a company which has at any time become
insolvent (whether while he was a director or subsequently), and
(b)
that his conduct as a director of that company (either taken alone or taken
together with his conduct as a director of any other company or companies)
makes him un
t to be concerned in the management of a company.
e minimum period of disquali
cation is two years and the maximum period
is 15 years (s 6(4)). In contrast with the other grounds for disquali
cation
noted above, s 6 is restricted to directors or shadow directors, including
facto
directors. Commenting on the policy underlying s 6, Dillon LJ said in
Sevenoaks
Stationers
(Retai
l)
Ltd
(1991) that its purpose is to protect the
public, and in particular potential creditors of companies, from losing money
through companies becoming insolvent when the directors of those companies
are people un
t to be concerned in the management of a company. 
e policy
of protecting the public is not limited to the British public (
Westminster
Property
Management
Ltd
(No
(2001)); and cannot be avoided by a control-
ling director resigning and then running the company as a shareholder without
incurring the liabilities of being a
facto
or shadow director (
Windows
West
Ltd
(2002)).
13.58
An application under s 6 must be brought by the Secretary of State or, if the com-
pany is in compulsory liquidation, by the O
cial Receiver, if it appears to him
that it is expedient in the public interest that a disquali
cation order should be
made against any person (s 7(1)). An insolvent company is de ned as including a
company which goes into liquidation at a time when its assets are insu
cient to
meet the payment of its debts, liabilities and liquidation expenses (s 6(2)).
7/19/2012 2:23:20 PM
Disquali cation of directors
13.59
Disquali
cation proceedings are civil and consequently the standard of proof
is that a directors un
tness must be established on a balance of probabilities.
However, because of the serious nature of the allegations made during such pro-
ceedings the court will be loath to 
nd un
tness unless the misconduct in ques-
tion is clearly made out (
Verby
Print
for
Advertising
Ltd
(1998)).
In
Secretary
for
Trade
Industry
7/19/2012 2:23:20 PM
Corporate management
culpability in concluding a transaction which is liable to be set aside as a fraud
on the creditors (paras 2 and 3); and the extent of the directors responsibility
for any failure by the company to comply with the numerous accounting and
publicity requirements of the CA 1985 (paras 4 and 5). 
ose matters to which
regard is to be had when the company is insolvent are listed in Part II of Sch 1 and
include: the extent of the directors responsibility for the causes of the company
becoming insolvent (para 6); and the extent of the directors responsibility for any
failure by the company to supply any goods or services which have been paid for,
in whole or in part (para 7). In
(Manchester
Ltd
(in
Receiver
Watson
(2008), the company, AG, went into liquidation with a de
ciency of
81.2 million. It was alleged that W, the 
nance director and CEO, had, with two
others, including L a director and widow of the companys founder, usurped the
functions of the board to an inner group of directors which made all the strategic
and 
nancial decisions, including the decision to authorise dividends amount-
ing to some 11.2 million and the entry into an Employee Bene
t Fund for the
personal bene
t of all of the directors and their families as an o
shore vehicle for
undisclosed payment of remuneration. It was also alleged that some of the divi-
dends were unlawful given that distributable reserves were insu
cient and that
he had provided misleading information to the companys auditors by sending
them what purported to be a full and complete record of all meetings of direc-
tors and shareholders including false minutes of full board meetings apparently
approving payment of dividends.
Patten J made the disquali
cation orders. It was the duty of a 
nance director
properly to assess a companys ability to pay dividends and other expenses and
to inform the board, and through it the shareholders, of any concerns which
might exist about the a
ordability of the proposals. If the shareholders were
nevertheless determined to pay themselves dividends at a level which the com-
pany could not a
ord and were prepared to overrule any objections which the
board might have, then the directors had no option but to resign. It was a der-
eliction of duty to acquiesce in dividend decisions without actively considering
the obligation to ensure that the company operated on a solvent basis and in
accordance with the Companies Acts. On the evidence it was clear that W was
in breach of his standard of care having acquiesced in a system of governance
which permitted a trust to be set up and dividends paid which he ought to have
realised were illegal. He had allowed his incentive for personal pro
t to blind
him to his obligation to challenge these arrangements. L, like the other direc-
tors, was content to leave strategic decisions to the inner group and failed to
act independently and in the best interests of the company by ensuring that
decisions of the kind in question were brought to the full board on a properly
informed basis. Her abdication of responsibility amounted to un
tness and she
was disquali
ed for four years.
7/19/2012 2:23:20 PM
Disquali cation of directors
13.63
e courts have also provided guidance as to what should render a person
t to be concerned in the management of a company although the adage
that each case depends upon its facts should be borne in mind. For example,
in
Line
ectric
Motors
Ltd
(1988) Sir Nicholas Browne-Wilkinson V-C
said that while ordinary commercial misjudgement is not in itself su
cient,
conduct which displays a lack of commercial probity or conduct which is
grossly negligent or displays total incompetence would be su
cient to justify
disquali
cation. On the particular facts of the case, the judge observed that
the director:
has been shown to have behaved in a commercially culpable manner in trading
through limited companies when he knew them to be insolvent and in using the
unpaid Crown debts to
nance such trading.
(See also
Baker
Secretary
for
Trade
Industry
(2001); and
Secretary
for
Trade
Industry
(2006).)
In
Secretary
for
Trade
Industry
(2003), the Chief Registrar
explained that commercial misjudgement does not amount to either dishonesty
or incompetence such as to support the Secretary of States claim that it was in
the public interest to disqualify the directors. A stark illustration of dishonest
conduct such as to render the director in question un
t to be concerned in the
management of a company is a
orded by the facts of
Secretary
for
Trade
Industry
(2005). 
e defendant director of a company in insolvent
liquidation had removed a substantial amount of stock and attempted to con-
ceal its whereabouts from the liquidator. On the basis that he had eventually
admitted the charges brought, the court disquali
ed him for six years. District
Judge Mithani observed that the defendant had deliberately concealed assets
belonging to the company in order to bene
t personally at the expense of the
creditors:
Misappropriation by a director is always serious. Creditors would legitimately
feel aggrieved at others . . . bene
ting at their expense . . . It is a very serious al-
legation in respect of which disquali
cation is entirely justi
ed. The allegation
of concealment is no less serious . . . . I have little doubt that where, as in the
present case, there has been an attempt by a director to deliberately conceal
assets from [the liquidator] or to deliberately mislead him about the affairs of a
company with a view to obtaining
nancial or other bene
t, the imposition of a
disquali
cation order will almost always be appropriate.
(See also,
City
Truck
Group
Ltd;
Secretary
for
Trade
Industry
(2007); and
Vintage
mark
Secretary
for
Trade
Industry
Grove
(2008)).
7/19/2012 2:23:20 PM
Corporate management
13.64
Ho
mann J has observed that there must be some conduct which though not
dishonest must fall below standards of commercial morality or at least amounts
7/19/2012 2:23:20 PM
Disquali cation of directors
run. A cheque signatory is not a 
nance director and is therefore not expected to
possess such expertise. With respect to the cheques for school fees, H had acted
on the advice of the accountant and had reported the payments to the board. 
is
allegation was therefore also rejected. Similarly, in
Dawson
Print
Ltd
(1987),
the director had used moneys which represented Crown debts (VAT, NICs, PAYE
and rates) to 
nance company operations and Ho
mann J was not inclined to
nd this as being culpable conduct:
The fact is that [the tax authorities] have chosen to appoint traders to be tax
collectors on their behalf with the attendant risk . . . There is as yet no obligation
upon traders to keep such moneys in a separate account as there might be if
they were really trust moneys, they are simply a debt owed by the company. I
cannot accept that failure to pay the debts is regarded in the commercial world
generally as such a breach of commercial morality that it requires in itself a
conclusion that the directors concerned are un
t.
A case which fell on the other side of the line is
Secretary
for
Trade
Industry
ornbury
(2008), also involving the non-payment of Crown debts
(VAT and PAYE/NIC). While it was accepted that the director in question, T,
was unaware of the problems over the debts in so far as he did not have actual
knowledge, the court accepted the Secretary of States alternative argument that
T ought to have known. He took no steps beyond speaking to his colleagues of
ascertaining what the true 
nancial position of the company was. He did not
check to see whether the Crown debts, or even any debts, were being paid. His
questions were of a general nature merely seeking the verbal assurances of his fel-
low directors. While directors are entitled to rely on their colleagues, that did not
mean they could abdicate all responsibility. T was guilty of a culpable failure to
make enquiries, he allowed the company to trade to the detriment of the Crown,
and was, therefore, un
t.
It is apparent that the judges in determining un
tness frequently examine direc-
torial behaviour on a subjective basis. In this regard, it is interesting to note that
in
Dawson
Print
Ltd
Ho
mann J observed that having seen the director in the
witness box, I thought he was a great deal more intelligent than many directors
of successful companies that I have come across.
13.66
In
Bradcrown
Ltd
(2001), Lawrence Collins J held that a 
nance director who
had exercised no independent judgement on the e
ect of transactions entered
into by the company by which it transferred most of its assets to other companies
in the group, leaving it with a burdensome lease and no assets, was un
t to act
as a director and was therefore disquali
ed for two years. Although the 
nance
director had not participated in the decision-making process, he was aware of
the scheme but took no steps to satisfy himself that the proposal was in the best
7/19/2012 2:23:20 PM
Corporate management
interests of the company. He could not rely on the fact that the companys solici-
tors had failed to alert him to the pitfalls of the scheme. He had abrogated his
responsibility throughout the process. (See also
Ipcon
Fashions
Ltd
(1989);
ueens
Moat
Houses
(No
(2005); and
(Manchester
Ltd
(in
Receiver
Watson
13.61
, above).)
13.67
An interesting decision is
Secretary
for
Trade
Industry
Swan
(No
7/19/2012 2:23:20 PM
Disquali cation of directors
for
Trade
Industry
Rogers
(1996), Scott V-C;
Receiver
Cooper
(1999),
Jonathan Parker J). In
Rogers
the Court of Appeal stressed that the procedure did
not operate to remove a judges discretion to overturn the agreed statement of facts
entered into between the Secretary of State and the director, nor did it preclude a
judge from 
xing another disquali
cation period.
e
Carecra
procedure has now been superseded by disquali
cation undertak-
ings introduced by the Insolvency Act 2000 (see below).
Leave to act
13.70
Notwithstanding that a disquali
cation order is mandatory if the directors con-
duct is such as to make him un
t to be concerned in the management of a com-
pany, s 17 nevertheless allows a disquali
ed director to apply to the court for leave
to act. In granting leave the court will invariably attach conditions in order to
ensure, as far as possible, that the overriding policy of the Act of protecting the
general public against miscreant directors continues to be met
(Re
Davies
Ltd
(1995)). Typically the court will impose conditions relating to the control of the
companies in question and the appointment of additional directors to the board,
such as a 
nance director (see, for example,
Line
ectric
Motors
Ltd
(1988);
and
Brian
Sheridan
Cars
Ltd
Receiver
Sheridan
(1996)). In deciding
whether or not to grant leave the court will consider the probability of the director
re-o
ending (
Grayan
Services
(1995)). In
Secretary
for
Trade
Industry
ins
(1999), Peter Gibson LJ stated that it was highly desirable that
a director who was facing a possible disquali
cation order but who, in the event
of such an order being granted, intended to seek leave to act, should apply early
enough to enable the same judge to hear both sets of proceedings. He stressed that
an application for leave should be supported by clear evidence as to the precise role
he would play and up-to-date and adequate information about the company (see
Henne
Uti
ities
Ltd
(2004)). In
Hease
Secretary
for
Trade
Industry
(2005) the court held that an application under s 17 required it to consider the
public interest and to balance such interest against any private interests involved. It
should be noted that where the Secretary of State considers that the judge has erred
in granting leave, it is open to him to appeal against the decision.
(See also
Rea
isations
Ltd
(2000).)
Criminal penalties
13.71
If a person acts in contravention of a disquali
cation order he is guilty of a crimi-
nal o
ence and is liable to imprisonment or a 
ne or both (s 13). Further, he
7/19/2012 2:23:20 PM
Corporate management
will be personally liable for all the relevant debts of the company, i.e. those debts
incurred at a time when he was acting in contravention of a disquali
cation order
(s 15). 
e company is jointly and severally liable with the disquali
ed director
for the debts incurred during the disquali
cation period (see
Sharma
ard
(2005)).
13.72
Personal liability also extends to those persons who act or are willing to act on
instructions given without the leave of the court by a person known to be subject
to a disquali
cation order or known to be an undischarged bankrupt (s 15(1)
(b)). It is a criminal o
ence for a person who is an undischarged bankrupt to act
as a director of, or directly or indirectly to take part in or be concerned in the
promotion, formation or management of, a company, except with the leave of the
court (s 11). Liability is joint and several (s 15(2)). Section 11 is an o
ence of strict
liability and whether the defendant director was concerned in the management
of the company is a question of fact for the jury; the fact that he did not realise he
was doing acts which constituted management is irrelevant (
Brock
(1994);
Doring
(2002)).
Disquali
cation undertakings: the Insolvency Act 2000
13.73
e Insolvency Act 2000, which came into force on 2 April 2001, contains provi-
sions which amend the CDDA 1986. 
e Act introduces a procedure whereby in
the circumstances speci
ed in ss 7 and 8 of the 1986 Act, the Secretary of State
may accept a disquali
cation undertaking by any person that, for a period speci-
ed in the undertaking, the person will not be a director of a company, or act as
a receiver, or in any way, whether directly or indirectly, be concerned or take
part in the promotion, formation or management of a company unless (in each
case) he has the leave of the court (s 6(2) of the 2000 Act, inserting s 1A into the
CDDA 1986). 
e Secretary of State may still require the director to submit a
statement of grounds for the undertaking along the lines of those required under
the
Carecra
procedure (
ackspur
Group
(2001);
ackspur
Group
(No
4)
(2004)).
In determining whether to accept a disquali
cation undertaking by any person,
the Secretary of State may take account of matters other than criminal convic-
tions, notwithstanding that the person may be criminally liable in respect of
those matters.
13.74
It is further provided that if it appears to the Secretary of State that the conditions
mentioned in s 6(1) are satis
ed with respect to any person who has o
ered to give
him a disquali
cation undertaking, he may accept the undertaking if it appears
to him that it is expedient in the public interest that he should do so (instead of
7/19/2012 2:23:20 PM
Disquali cation of directors
applying, or proceeding with an application, for a disquali
cation order) (s 6(3)
of the 2000 Act, inserting s 7(2A) into the CDDA 1986).
13.75
Section 8 of the CDDA 1986 is amended so that where it appears to the Secretary
of State from the report of a DTI investigation that, in the case of a person who
has o
ered to give him a disquali
cation undertaking that: (a) the conduct of
the person in relation to a company of which the person is or has been a direc-
tor or shadow director makes him un
t to be concerned in the management of
a company; and (b) it is expedient in the public interest that he should accept
the undertaking (instead of applying, or proceeding with an application for a
disquali
cation order), he may accept the undertaking (s 6(4) of the 2000 Act,
inserting s 8(2A) into the CDDA 1986).
13.76
Section 8A of the CDDA 1986 provides that the court may, on the application of
a person who is subject to a disquali
cation undertaking: (a) reduce the period
for which the undertaking is to be in force; or (b) provide for it to cease to be in
force (s 6(5) of the 2000 Act; see, for example,
I.N.S.
Rea
isations
Ltd;
Secretary
for
Trade
Industry
Jonk
(2006)).
13.77
ese reforms are designed to save court time so that in the speci
ed circum-
stances, disquali
cation can be achieved administratively without the need
to obtain a court order. 
e anxiety of the legislature (and the judges, see the
comments of the Court of Appeal in
Secretary
Davies
(1998)), is to
reduce the burgeoning CDDA case load (see, also, the explanatory notes to the
Insolvency Bill as brought from the House of Lords, 27 July 2000). 
e number of
disquali
cation orders over the last eight years or so displays a marked increase
as a result of the increase in investigations being undertaken by the Insolvency
Service (these account for some 95 per cent of all disquali
cation orders) into
failed companies. 
us, allowing the company to continue trading while insol-
vent is now the most common reason for a 
nding of un
tness under s 6 and the
average disquali
cation period is 6.5 years.
13.78
e introduction of disquali
cation undertakings by the 2000 Act has been a
success in terms of reducing the case load:
2001022,063 disquali
cation notices of which 1,281 were undertakings
2002031,911 disquali
cation notices of which 1,468 were undertakings
2003041,710 disquali
cation notices of which 1,278 were undertakings
For 200405 there was a fall in the number of disquali
cation orders. Of
1,320 disquali
cation notices received by the Registrar, 945 were by way of
undertakings.
7/19/2012 2:23:20 PM
Corporate management
Competition disquali
cation orders
13.79
Directors who have breached competition law may also be disquali
ed by vir-
tue of s 204 of the Enterprise Act 2002 which inserts ss 9A9E into the CDDA
1986 with e
ect from June 2003. Section 9A places the court under a duty to
make a disquali
cation order against a director of a company which commits a
breach of competition law, provided that the court considers that his conduct as
a director makes him un
t to be concerned in the management of a company.
e maximum period for disquali
cation is 15 years. Application for a disquali-
cation order on this ground may be made by the O
ce of Fair Trading (OFT)
and certain other speci
ed regulators (including, among others, the Director
General of Telecommunications, the Gas and Electricity Markets Authority and
the Rail Regulator). 
e 2002 Act also introduces a parallel scheme for compe-
tition disquali
cation undertakings under s 9B as there is for disquali
cation
undertakings introduced by the Insolvency Act 2000. 
e OFT or a speci
ed
regulator may accept a disquali
cation undertaking for up to 15 years from a
director instead of applying for a court order. Section 9C provides that if the OFT
(or speci
ed regulator) has reasonable grounds for suspecting that a breach of
competition law has occurred, it may carry out an investigation for the purpose
of deciding whether to make an application under s 9A for a disquali
cation
order.
13.80
In May 2003 the OFT published a detailed guide to the new competition dis-
quali
cation orders (CDOs),
7/19/2012 2:23:21 PM
Further reading
disquali
cation undertaking which, if accepted, will mean that a CDO will not
be sought against him.
In August 2009 the OFT announced that it is considering widening its use of
CDOs. As seen above (para
13.79
), currently, directors are, in practice, only likely
to face disquali
cation for breach of competition law if they are found to have
personal responsibility for their companies breach of the competition rules. 
e
OFT wants to improve company and boardroom compliance. It thinks that the
way in which it has used its powers to seek CDOs so far has not had the desired
deterrent e
ect. 
e OFT therefore proposes a new approach by seeking a CDO
where a director ought to have known of or should have taken steps to prevent
a breach of competition (antitrust) law, even if the director was not personally
involved in the breach.
To encourage the early o
ering of information on cartels, the OFT would not
seek disquali
cation of 
rst whistle-blowers or in other cases where a company
has quali
ed for the highest levels of leniency.
FURTHER READING
This Chapter links with the materials in Chapters 8 and 11 of
Hicks and Goos Cases and
Materials on Company Law
(2011, Oxford University Press, xl +649p).
Berle and Means
The Modern Corporation and Private Property
(New York, Harcourt,
1932; revised edition 1968).
Bradley Enterprise and Entrepreneurship: The Impact of Director Disquali
cation
[2001]
JCLS
53.
Finch, Disquali
cation of Directors: a Plea for Competence [1990]
MLR
385.
Hicks Disquali
cation of Directors40 Years on [1988]
JBL
27.
Lowry, The whistle-blower and the non-executive director [2006]
Journal of Corporate
Law Studies
249.
Lowry A.K. De Facto Directorships: Multiple Tests Prevail (2011) 8
194.
Milman Personal Liability and Disquali
cation of Company Directors: Something Old,
Something New [1992]
NILQ
Noonan and Watson Examining Company Directors through the Lens of De Facto
Directorship [2008]
JBL
587.
Sullivan The Relationship Between the Board of Directors and the General Meeting in
Limited Companies (1977) 93
LQR
569.
7/19/2012 2:23:21 PM
Corporate management
The UK Corporate Governance Code (June 2010) - available on the FRC website at:
http://www.frc.org.uk/documents/pagemanager/Corporate_Governance/UK%20
Corp%20Gov%20Code%20June%202010.pdf
Wheeler Directors Disquali
cation: Insolvency Practitioners and the Decision-making
Processes [1995]
SELF-TEST QUESTIONS
7/19/2012 2:23:21 PM
Directors duties
SUMMARY
Introduction
The
duciary position of directors
To whom do directors owe their duties?
The general duties of directors: CA 2006, Part 10
Remedies
Accessory liability
Consent, approval or authorisation by members
Substantial property transactions
Loans, quasi-loans and credit transactions
Rati
cation of acts giving rise to liability
Relief from liability
Introduction
14.1
In this chapter we consider the duties which a director owes to the company. In
Chapter 13 we explained that directors are 
duciaries and so much of the case
law on their duties is founded on principles originating from the law of trusts
and agency. We also saw that the early part of the 20th century marked a signi
cant shi
in the way the judges viewed the o
ce of director. In tandem with this
development the courts adopted a stricter approach towards the standard of care
and skill expected of directors in the performance of their management roles.
A concern of both equity and common law courts was to develop a corpus of
rules designed to prevent directors abusing their considerable powers. 
e policy
objective is based on prophylaxis and the result is a formidable body of reported
decisions in which the judges have been developing the contours of directors
liabilities. In addition to the work of the courts, legislation has also imposed a
range of duties, devised principally as reactive measures against speci
c abuses
by directors, particularly in relation to fraudulent asset stripping. Confronted
7/19/2012 2:29:44 PM
Directors duties
with this considerable body of law, it came as little surprise that the Company
Law Review, in line with its objectives of maximising clarity and accessibility,
recommended that the duties of directors should be codi
ed by way of a statutory
restatement. 
us, the general duties of directors now appear in Part 10 of the
2006 Act.
14.2
By way of background, it is noteworthy that the issue of restating directors duties
in statutory form caused considerable controversy and generated widespread
debate. It was a question 
rst considered by the Law Commission and the Scottish
Law Commission in their joint report,
Company
Directors:
Regu
Con
icts
Interests
And
Formu
Statement
Duties
(Nos 261 and 173, respectively).
e Law Commissions examination of directors duties was already under way
at the time of the Governments announcement in March 1998 of the company
law review. As part of this wider project the Law Commissions undertook to
place their 
nal report before the Company Law Review Steering Group. 
e
Commissions were charged with the objective of determining whether or not the
relevant law could be reformed, made more simple or dispensed with altogether
(see the Law Commissions Consultation Paper No 153, para 1.7 (the LCCP)). 
e
report was lodged with the CLRSG in July 1999 and informed its deliberations in
several key respects.
14.3
e Law Commissions examined the case for restating directors duties in stat-
ute. Arguments against this were founded on loss of 
exibility, while those in
favour saw advantages in terms of certainty and accessibility. 
e Commissions
conclusion was that the case for legislative restatement was made out and that the
issue of in
exibility could be addressed by:
(i)
ensuring the restatement was at a high level of generality by way of a state-
ment of principles; and
(ii)
providing that it was not exhaustive:
i.e.
while it would be a comprehen-
sive and binding statement of the law in the
eld covered, it would not
prevent the courts inventing new general principles outside the
eld.
Much of the Law Commissions joint report is devoted, amongst other things, to
achieving the principle of e
cient disclosure on the part of directors. 
e hall-
mark of their approach is the emphasis placed on the wider economic context in
which company law, particularly that regulating directors, operates. It is asserted
that in regulating the enterprise, the law should operate e
ciently, promoting
prosperity (para 2.8). More particularly, Part 3 of the LCCP recommended that
the law should move towards a general principle of meaningful
disc
osure
that
approva
rules should be seen as the exception (Law Com Nos 261 and 173,
para 3.72).
7/19/2012 2:29:46 PM
The duciary position of directors
14.4
e proposals put forward by the Law Commissions were broadly endorsed by
the CLR. In its
Fina
Report
(at Chapter 3), the Steering Group recommended a
legislative statement of directors duties for three principal reasons:
to provide greater clarity on what is expected of directors and to make the
law more accessible. More particularly, it would help to improve standards
of governance and provide authoritative guidance and clari
cation on
issues such as scope
in whose interests should companies be run?
in a way which re
ects modern business needs and wider expectations of
responsible business behaviour;
to enable defects in the common law to be corrected in important areas where
it no longer corresponds to accepted norms of modern business practice;
to make development of the law in this area more predictable (but without
hindering its development by the courts).
e Government accepted these proposals and it is clear that the approach taken
by the Law Commissions and the CLR shaped the framing of Part 10 of the 2006
Act. To aid our understanding of the equitable principles which underpin the
statutory provisions, we 
rst consider the nature of the 
duciary relationship that
exists between a director and the company.
The
duciary position of directors
14.5
As we saw in Chapter 13, it has long been settled that directors are viewed as
agents of the company and as such they are subject to the full rigour of the 
duci-
ary duties developed by equity to ensure strict compliance with the overriding
principle that 
duciaries must not bene
t from their position of trust. 
e clas-
sic statement on the position of directors was given by Lord Cranworth LC in
Aberdeen
Bros
(1854):
The directors are a body to whom is delegated the duty of managing the gen-
eral affairs of the company. A corporate body can only act by agents, and it is
of course the duty of those agents so to act as best to promote the interests of
the corporation whose affairs they are conducting. Such agents have duties to
discharge of a
duciary nature towards their principal.
14.6
One consequence of this 
duciary relationship has been the judicial juxtaposi-
tion of the terms 
duciary and trustee when referring to the legal status of com-
pany directors. In tracing the origins of the director/trustee concept, Sealy (1967)
7/19/2012 2:29:46 PM
Directors duties
points to the widely held view that the concept had its origin in the fact that,
in the earliest companies, the director
was
a trustee in the full technical sense.
Before the modern process of incorporation was introduced most companies
were established by a deed of settlement, and the deed almost invariably declared
the directors to be trustees of the funds and assets of the business venture (see,
for example,
Charitab
Corpn
Sutton
(1742)). 
e courts therefore called direc-
tors to account on a trustee basis. In
Lands
otment
(1894) Lindley LJ
explained that:
Although directors are not properly speaking trustees, yet they have always
been considered and treated as trustees of money which comes to their hands or
which is actually under their control; and ever since joint stock companies were
invented directors have been held liable to make good moneys which they have
misapplied upon the same footing as if they were trustees.
14.7
e earliest cases in which the equitable or 
duciary duties were developed
relate to the usual 18th and 19th century uses of equity namely, regulating the
conduct of trustees of family trusts (see, for example, the leading trust case of
Keech
Sandford
(1726)). Adopting this case law by analogy, the courts used it as
the template for framing the 
duciary obligations of directors. However, unlike
trustees, directors do not hold the legal title to the property under their control
which, as we saw in Chapter 2, belongs to the company as a separate legal per-
son. But, directors are analogous to trustees because they have the duty to man-
age the companys a
airs in the interest of the company (see
Bairstow
ueens
Moat
Houses
(2001)). As explained by Mummery LJ in
Towers
Premier
Waste
Management
Ltd
(2011), the 
duciary nature of the o
ce of director can
be summed up thus:
A director of a company is appointed to direct its affairs. In doing so it is his
duty to use his position in the company to promote its success and to protect its
interests. In accordance with equitable principles the special relationship with
the company generated
duciary duties on the part of a director. His
duciary
commitments to the company took the form of a duty of loyalty and a duty to
avoid a con
ict between his personal interests and his duty to the company.
Given the wealth of case law which spans almost two hundred years the CLRSGs
task of restating it cannot be underestimated. Before examining the duties of
directors set out in ss 171177 CA 2006 and related provisions, we begin by
addressing the key anterior question, one which was identi
ed by the CLRSG
as holding the potential to clarify the scope and nature of the duties generally,
namely: to whom are the duties owed?
7/19/2012 2:29:46 PM
To whom do directors owe their duties?
To whom do directors owe their duties?
14.8
Section 170(1) CA 2006 provides that the general duties speci
ed in ss 171177 are
owed by a director of a company to the company. 
e general duties also apply to
shadow directors (s 170(5), see Chapter 13, above). A breach of duty is therefore a
wrong done to the company and the proper claimant in proceedings in respect of
the breach is the company itself (see the rule in
Foss
Harbott
(1843) and Part 11
CA 2006; Chapter 10, above). Section 170(1) gives statutory e
ect to the decision
in
Perciva
Wright
(1902). 
e shareholders accepted an o
er for the purchase
of their shares by the defendants, the directors of the company. 
e directors had
not disclosed that at the time of the purchase they were negotiating with an out-
sider for the sale of the companys undertaking at a higher price. 
e shareholders
claimed that the defendants stood in a 
duciary relationship with them and the
purchase ought to be set aside for non-disclosure. 
e court rejected this argu-
ment. Swinfen Eady J stressed that to hold otherwise would place directors in a
most invidious position, as they could not buy or sell shares without disclosing
negotiations, a premature disclosure of which might well be against the best inter-
ests of the company. It should be noted, however, that in reaching its decision the
court stressed that there was no unfair dealing by the directors. Further, the fact
that the shareholders had themselves 
rst approached the directors requesting the
share purchase was material to the courts deliberations.
(See also,
Gas
Petrochemica
Ltd
Gas
Petrochemica
Services
Ltd
(1983), in which Dillon LJ explained, that: directors
indeed stand in a 
duciary relationship to the company, as they are appointed to
manage the a
airs of the company and they owe 
duciary duties to the company
though not to the creditors, present or future, or to individual shareholders).
It was con
rmed by the Court of Appeal in
Hawkes
Cuddy
(No
(2009), that
the fact that a director was nominated by a shareholder did not, of itself, impose
any duty owed to his nominator by the director. A nominee director could take
into account the interests of his nominator without being in breach of his duties
to the company, provided that his decisions as a director were taken in what he
considered to be in the best interests of the company.
14.9
To say that directors owe their duties to the company is not particularly illu-
minating. It leaves the key question central to corporate theory unanswered (see
Chapter 15). 
at is, what are the companys interests? Do the shareholders, as a
contractarian analysis would demand, constitute the companys interests, or is a
more pluralist approach adopted by realist theory whereby the companys inter-
ests are aligned with those of the shareholders, creditors, employees and the gen-
eral public, correct? 
e courts have cleverly fudged the answer. In
Greenha
7/19/2012 2:29:46 PM
Directors duties
Arderne
Cinemas
Ltd
(1951) Evershed MR took the view that: the phrase the
company as a whole does not . . . mean the company as a commercial entity, dis-
tinct from the corporators: it means the corporators as a general body. 
us, he
rules out a free 
oating corporate interest that corporate realists would advocate
and identi
es the companys interests with the shareholders as a general body
indicating a contractarian bias. However, that has not been the end of the matter.
Detailed consideration was given to the meaning of the interests of the company
in the Report of the Second Savoy Hotel Investigation (
Savoy
Hote
Ltd
the
Berke
Hote
Co.
Ltd
Report
Investigation
under
section
6)
the
Companies
Act
48
(London, HM Stationery O
ce, 1954)). 
ere, a Board of
Trade Inspector was appointed to report on the legality of the directors actions
in trying to remove an asset from the companys control so as to take it beyond
the reach of a takeover bidder. 
e Report considered that it was not enough for
directors to act in the short-term interests of the company alone, regard must be
taken of the long-term interests of the company. 
e basis for this is that the duty
is not con
ned to the existing body of shareholders, even future shareholders
must be considered (see Grantham (1993)). We return to this issue in relation to
s 172 (see para
14.26
, below).
14.10
Notwithstanding the broad statement of principle by s 170(1) CA 2006
there
are certain limited circumstances, notably takeover situations, where the courts
have been prepared to 
nd that 
duciary duties . . . carry with them a duty of
disclosure to shareholders. For example, it has been held that directors in recom-
mending that a takeover o
er should be accepted owe a duty to the shareholders
which includes a duty to be honest and not to mislead (
7/19/2012 2:29:46 PM
To whom do directors owe their duties?
Commenting on Browne-Wilkinson V-Cs observations in the
Nico
case
and on the decision in
eman
Myers
(1977), David Mackie QC (sitting as a
deputy judge in the High Court) in
att
att
(1999) stressed that:
[t]hese are, however, cases of the highest persuasive authority and . . . plainly right.
Accordingly, the fact that the relationship between director and shareholder
does not of itself give rise to a
duciary duty does not prevent such an obligation
arising when the circumstances require it. In so far as
Percival v Wright
(1902)
indicates otherwise this is only because of the signi
cance attached to the head-
note which . . . is broader than is justi
ed by the underlying decision.
(See also
Pty
Ltd
Strata
Conso
idated
Pty
Ltd
(1993); and
Brunning
hausen
avanics
(1999).)
14.12
It would be stretching these decisions too far to conclude that directors owe a
parallel 
duciary duty to shareholders. What they show is that where directors
take it upon themselves to give advice to current shareholders . . . they have a duty
to advise in good faith and not fraudulently, and not to mislead whether delib-
erately or carelessly (
Dawson
Internationa
Coats
Patons
(1989), Lord
Cullen). 
is apart, Lord Cullen stressed that directors have but one master, the
company. 
e resonance of Lord Cullens view is clearly evident in the approach
adopted by Neuberger J in
Peskin
Anderson
(2000), which was a
rmed by
the Court of Appeal. 
e dispute arose out of the demutualisation of the Royal
Automobile Club (RAC) in which the members at the time of the sale received
substantial payments. Former members of the club claimed that the directors
were in breach of 
duciary duty in failing to disclose their plans to demutualise.
ey argued that had they known of the proposal they would have been able to
make a properly informed choice as to whether to remain members. 
e judge,
dismissing the claims, held that the directors did not owe any 
duciary duty to
the members who had terminated their membership of their own motion when
no speci
c proposal was in contemplation. 
e judge stated:
I am satis
ed, both as a matter of principle and in light of the state of the
authorities, that
Percival v Wright
is good law in the sense that a director of
a company has no general
duciary duty to shareholders. However, I am also
satis
ed that, in appropriate and speci
c circumstances, a director can be under
duciary duty to a shareholder. To hold that he has some sort of general
duciary duty to shareholders (a) would involve placing an unfair, unrealistic
and uncertain burden on a director and (b) would present him frequently with a
position where his two competing duties, namely his undoubted
duciary duty
to the company and his alleged
duciary duty to shareholders, would be in
ict.
7/19/2012 2:29:46 PM
Directors duties
14.13
Apart from restating the common law in s 170(1), the provision goes on to address
a range of issues that came to light during the various consultation exercises on
whether or not the Act should set out in the form of a restatement the general
duties of directors. A point of contention that emerged during both the Law
Commissions and the CLRs consultations was whether the statutory statement
of duties should be exhaustive. Section 170(3) attempts to settle the matter in two
ways. First, it provides that the general duties are based on certain common law
rules and equitable principles governing the behaviour of directors. Secondly, it
states that the statutory restatement shall have e
ect in place of those principles.
Indeed, even in current litigation where the events in issue may have occurred
before Part 10 of the 2006 Act entered into force, the statutory language will
nevertheless in
uence the approach of the courts. In
Towers
Premier
Waste
Management
Ltd
(2011), Mummery LJ observed that:
I have described the equitable principles and duties in the past tense because,
under the codi
cation measures in Chapter 2 of the Companies Act 2006, a
directors general duties to the company are now statutory. The codi
ed duties
are expressly derived from common law rules and equitable principles as they
apply to directors. The relevant events in this litigation occurred in 2003, well
before those provisions of the 2006 Act were brought into force. Although the
pre-2006 Act common law rules and equitable principles continue to apply to
a pre-2006 Act case, it is unrealistic to ignore the terms in which the general
statutory duties have been framed for post-2006 Act cases. They extract and
express the essence of the rules and principles which they have replaced.
Section 170(3) has to be read together with s 170(4) which directs the courts to
interpret and apply the general duties having regard to the pre-existing case law
and thus the signi
cant body of jurisprudence surrounding directors duties is by
no means redundant. In
Eastford
Ltd
espie
(2010), Lord Hodge, considering
s. 170(4), observed that it:
seeks to address the challenge which the Law Commissions and the Company
Law Review had identi
ed, namely of avoiding the danger that a statutory state-
ment of general duties would make the law in
exible and incapable of develop-
ment by judges to deal with changing commercial circumstances. Parliament
has directed the courts not only to treat the general duties in the same way as
the pre-existing rules and principles but also to have regard to the continued
development of the non-statutory law in relation to the duties of other
duciar-
ies when interpreting and applying the statutory statements. The interpretation
of the statements will therefore be able to evolve.
Taking these two subsections together, some doubt remains over the extent to
which the restated duties merely replicate or, indeed, replace the pre-existing
7/19/2012 2:29:46 PM
The general duties of directors: CA 2006, Part 10
duties: for example, it will be seen that the duties of directors encapsulated in
ss 175 and 176 (respectively, the no-con
ict duty and the prohibition against
accepting bene
ts from third parties) are not framed so as to re
ect the applica-
ble equitable principles found in the case law. Such uncertainty runs counter to
the declared objectives of the CLR to provide greater clarity on what is expected
of directors and to make the law more accessible. On the other hand, in the inter-
ests of clarity, s 170(2) does restate the point that emerges from the case law that
the duties encompassed in ss 175 and 176 continue to apply a
er a person ceases
to be a director:
(a) as regards the exploitation of any property, information or opportunity
of which he became aware at a time when he was a director (duty to
avoid con
icts of interests), and
(b) as regards things done or omitted by him before he ceased to be a direc-
tor (duty not to accept bene
ts from third parties).
Finally, it is also noteworthy that s 179 states that, except as otherwise provided,
more than one of the general duties may apply in any given case. 
e duties are
thus cumulative. Depending on the particular circumstances, directors may,
therefore, be liable under one or more of the provisions contained in Part 10 of
the Act.
The general duties of directors: CA 2006, Part 10
(i) Duty to act within powers
14.14
Section 171 CA 2006 provides that a director of a company must
(a) act in accordance with the companys constitution, and
(b) only exercise powers for the purposes for which they are conferred.
Part (a) of s 171 restates the common law principle that directors must act within
the limits of the companys constitution which is de
ned by s 17 as including
the companys articles and any shareholder resolutions and agreements (see
further, Chapter 8). Part (b) restates the so called proper purposes doctrine
formulated by Lord Greene MR in
Fawcett
Ltd
(1942), in which he
explained that:
[Directors] must exercise their discretion
bona
de
in what they considernot
what a court may consideris in the interests of the company, and not for any
collateral purpose.
7/19/2012 2:29:46 PM
Directors duties
ere are two limbs to Lord Greenes statement of the duty. 
e 
rst relates to
good faith which falls within the scope of s 172 (see below), while the duty not to
act for a collateral purpose is encompassed in s 171. 
e two elements are distinct
duties (
Bishopsgate
Investment
Management
Ltd
Maxwe
ll
(1993)), and it is logi-
cal that they should be accorded separate provision in the Act.
14.15
e proper purposes doctrine has frequently been applied, although not exclu-
sively, in relation to the power to issue shares; an obvious consequence of which
is that the voting rights of an existing majority shareholder may be adversely
ected. While a majority shareholder or controlling interest does not have a
right of property to prevent a further allotment of shares being made, such a
shareholder is entitled to demand that the power be exercised lawfully. Share
issues aside, the application of the doctrine arose in
Extrasure
Trave
Insurances
Ltd
Scattergood
(2002) which concerned the power of directors to deal with cor-
porate assets. 
e directors of Extrasure had transferred company funds, some
200,000, to another company in the group, Citygate Insurance Brokers Ltd (the
parent company), to enable it to pay a creditor who had been pressing for pay-
ment. One of the arguments put forward by the claimant was that the directors
had exercised their powers for an improper purpose.
14.16
ere is a tension between the duty of good faith (now contained in s 172, below)
on the one hand, and the proper purposes doctrine on the other, in so far as the
latter operates to limit the authority of directors even if their action was carried
out in what they bona 
de believed to be in the best interests of the company. If
a power is exercised primarily for some collateral purpose (which is objectively
determined as a matter of construction of the articles), the directors are guilty
of an abuse of power and their action can be set aside. 
us, for example, while
the directors may believe it is in the best interests of the company to defeat a
takeover by allotting shares to shareholders who they trust to reject the bid, that
will probably be viewed as an improper exercise of the power to allot shares as it
was originally conferred to raise capital: not to increase the voting rights of cer-
tain shareholders for some collateral purpose. As was pointed out by Wilson J in
Whitehouse
Car
Hote
Pty
(1987), it is no part of the function of directors as
such to favour one shareholder or group of shareholders by exercising a 
duciary
power to allot shares for the purpose of diluting the voting power attaching to the
issued shares held by some other shareholder or group of shareholders.
14.17
As seen above, the duty evolved out of disputes in which it was typically argued
that the power to issue shares is conferred on directors in order to raise capital
for the company and that a share allotment for any other purpose is necessarily
improper. For example, in
Hogg
Cramphorn
(1967) a share allotment was held
invalid notwithstanding that the directors had acted in good faith on the basis
7/19/2012 2:29:46 PM
The general duties of directors: CA 2006, Part 10
that their primary motive was to forestall a takeover bid and remain in control.
Another clear illustration of self-interest being the principal motivating factor in
the exercise of the power to issue shares is a
orded by
Piercy
Ltd
(1920).
e directors allotted shares although the company was not in need of
additional capital. 
e court held, setting aside the allotment, that this was done
simply and solely for the purpose of retaining control in the hands of the existing
directors.
14.18
A relatively modern and authoritative view on the approach to be taken towards
the proper purposes doctrine was delivered by Lord Wilberforce in the Privy
Council decision in
Howard
Ltd
Ampo
Petro
eum
Ltd
(1974). Two share-
holders, Ampol Ltd and its associated company Bulkships, held 55 per cent of
the shares in R W Miller (Holdings) Ltd. Ampol and Howard Smith made rival
takeover o
ers for Miller. Preferring the latters bid because it was more gener-
ous than Ampols, and because they believed that the long-term future of the
company would be more secure in its hands, Millers directors issued shares to
Howard Smith which had the e
ect of diluting Ampols shareholding from 55
per cent to 36 per cent. Ampol sought a declaration that the share allotment was
invalid as being an improper exercise of power. 
e directors contended that the
allotment was made primarily in order to obtain much needed capital for the
company.
Both at 
rst instance and on appeal it was accepted that the directors were not
motivated by self-interest. However, it was held that the share allotment was not
made to satisfy Millers need for further capital but to destroy Ampols majority
shareholding in the company. 
e share issue was therefore invalid.
14.19
Lord Wilberforce stated that when the exercise of a particular power is chal-
lenged, the determination of whether or not it had been exercised for an improper
purpose is a twofold process. First, it is necessary to consider the power in ques-
tion in order to ascertain, on a fair view, its nature and the limits within which it
may be exercised. Second, the substantial purpose for which the power was exer-
cised should be examined so as to determine whether that particular purpose
was proper or not. 
e court will necessarily give credit to the
opinion
of the directors, if such is found to exist, and will respect their judgement as to
matters of management; having done this, the ultimate conclusion has to be as
to the side of a fairly broad line on which the case falls. Although the court will
not challenge the commercial judgement of the directors nevertheless in rela-
tion to the second stage, i.e. determining the substantial purpose for the par-
ticular exercise of a power, Lord Wilberforce stressed that it is entitled to take an
objective approach in order to estimate how critical or pressing, or substantial or,
per contra, insubstantial an alleged requirement may have been. In this regard,
7/19/2012 2:29:46 PM
Directors duties
Kirby P explained in
Advance
Austra
Ltd
FAI
Insurances
Austra
Ltd
(1987), that:
statements by directors about their subjective intention, whilst relevant , are not
conclusive of the bona
des of the directors or of the purposes for which they
acted as they did. In this sense, although the search is for the subjective inten-
tions of the directors, it is a search which must be conducted objectively as the
court decides whether to accept or discount the assertions which the directors
make about their motives or purposes.
On the facts of
Ampo
Petro
eum
, the Privy Council concluded that:
Just as it is established that directors, within their management powers, may
take decisions against the wishes of the majority of shareholders, and indeed
that the majority of shareholders cannot control them in the exercise of these
powers while they remain in of
ce (
Automatic Self-Cleansing Filter Syndicate
Co Ltd v Cunninghame
[above]), so it must be unconstitutional for directors to
use their
duciary powers over the shares in the company purely for the pur-
pose of destroying an existing majority, or creating a new majority which did
not previously exist. To do so is to interfere with that element of the companys
constitution which is separate from and set against their powers.
erefore, it is not su
cient for directors to act in what they believe is in the
best interests of the company unless they can also establish that their actions are
within the scope of the powers conferred on them.
14.20
It was long thought that the e
ect of an improper exercise of power was to render
the directors conduct capable of rati
cation by the company in general meeting. In
Hogg
Cramphorn
the Court of Appeal declined to set a disputed allotment aside
until a general meeting of the company, as it was before the disputed share issue
was made, had had the opportunity to either approve or disapprove of the share
issue. In fact the directors conduct was duly rati
ed by the company. 
is was fol-
lowed in
Bamford
Bamford
(1970). However, in
Sherborne
Park
Residents
Ltd
(1987) a shareholder petitioned the court under s 459 (now s 994 CA 2006, the
unfair prejudice provision, see Chapter 11, above) in order to restrain an allotment
of new shares which would alter the balance of power in the company. 
e court
took the view that the petitioners complaint was not that a wrong had been done
to the company but that his personal rights qua shareholder had been infringed.
Although the alleged breach of duty might in theory be a breach of duty owed to
the company, Ho
mann J held that in substance it was an infringement of a share-
holders contractual rights under the articles of association. On this analysis the
issue of rati
cation by the general meeting of the directors conduct does not arise
since a member will have a personal cause of action.
7/19/2012 2:29:46 PM
The general duties of directors: CA 2006, Part 10
14.21
In summary, the decision in
Howard
lays down that where directors exer-
cise a power with mixed motives the court will seek to determine the principal
purpose of their conduct. If that is found to be improper, the exercise of the power
in question will be voidable
(Bamford
Bamford
As has been seen in Chapter 11,
a member may also petition the court under s 994 on the basis that the improper
use of a power constitutes unfairly prejudicial conduct.
Howard
should not
be taken as holding, without more, that directors can only legitimately exercise
the power to issue shares in order to raise additional capital. Nor should it be
simply construed as laying down an absolute prohibition against directors issu-
ing shares to change the balance of control of the company. In this regard, the
High Court of Australia has acknowledged that the power to issue shares may
be exercised for reasons other than the raising of capital provided those reasons
relate to a purpose of bene
ting the company as a whole, as distinguished from a
purpose, for example, of maintaining control of the company in the hands of the
directors themselves or their friends (
Har
owe
Nominees
Pty
Ltd
Woodside
(Lake
Entrance
(1968); see also
Mutua
Life
Insurance
New
ork
Rank
Organisation
Ltd
(1985)):
If Company A and Company B are in business competition, and Company A
acquires a large holding of shares in Company B with the object of running
Company B down so as to lessen its competition, I would have thought that the
directors of Company B might well come to the honest conclusion that it was
contrary to the best interests of Company B to allow Company A to effect its
purpose . . . If, then, the directors issue further shares in Company B in order to
maintain their control of Company B for the purpose of defeating Company As
plans and continuing Company B in competition with Company A, I cannot see
why that should not be a perfectly proper exercise of the
duciary powers of the
directors of Company B. The object is not to retain control as such, but to pre-
vent Company B from being reduced to impotence and beggary, and the only
means available to the directors for achieving this purpose is to retain control.
This is quite different from directors seeking to retain control because they think
that they are better directors than their rivals would be (
Cayne v Global Natural
Resources plc
(1984) per Sir Robert Megarry V-C)).
14.22
In
Teck
Corpn
Ltd
(1972), noted by Lord Wilberforce in
Howard
as being a decision in line with English and Australian authority, the British
Columbia Supreme Court held that an allotment of shares designed to defeat a
takeover was proper even though it was made against the wishes of the existing
shareholder and deprived him of control. Berger J criticised
Hogg
Cramphorn
as
laying down the principle that directors have no right to issue shares in order to
defeat a takeover bid even if they consider that in doing so they are acting in the
companys best interests. He took the view that this was inconsistent with the law
7/19/2012 2:29:46 PM
Directors duties
as laid down by Lord Greene MR in
Fawcett
Ltd.
Berger J stressed that
directors are entitled to consider the reputation, experience and policies of any-
one seeking to take over the company and to use their power to protect the com-
pany if they decide, on reasonable grounds, that a takeover will cause substantial
damage to the company. Declining to follow
Hogg
Cramphorn
he reasoned:
How can it be said that directors have the right to consider the interests of
the company, and to exercise their powers accordingly, but there is an excep-
tion when it comes to the power to issue shares, and that in the exercise of
such power the directors cannot in any circumstances issue shares to defeat an
attempt to gain control of the company?
e judge concluded that directors must act in good faith and must have rea-
sonable grounds for their belief. 
e absence of reasonable grounds will jus-
tify a 
nding that the directors were actuated by an improper purpose. Citing
Austra
Metropo
itan
Life
Assurance
Ltd
(1923), Berger J said that the
onus of proof is on the person challenging an exercise of power. On the particular
facts of
Teck
it was held that the plainti
has failed to show that the directors had
no reasonable grounds for believing that a takeover by Teck would cause substan-
tial damage to the interests of [the company] and its shareholders.
14.23
e tests for determining whether or not a power has been exercised for
an improper purpose came to the fore in
Extrasure
Trave
Insurances
Ltd
Scattergood
(above). Jonathan Crow QC, sitting as a deputy judge of the High
Court, stated that:
The law relating to proper purposes is clear, and was not in issue. It is unneces-
sary for a claimant to prove that a director was dishonest, or that he knew he
was pursuing a collateral purpose. In that sense, the test is an objective one. It
was suggested by the parties that the court must apply a three-part test, but it
may be more convenient to add a fourth stage. The court must:
1. identify the power whose exercise is in question;
identify the proper purpose for which that power was delegated to the
directors;
3.
identify the substantial purpose for which the power was in fact exercised;
4. decide whether that purpose was proper.
Applying this four-part test to the facts, the judge reasoned that the power in
question was the directors ability to deal with the assets of Extrasure in the
course of trading. He noted that the purpose for which that power was conferred
on the directors was broadly to protect Extrasures survival and to promote its
7/19/2012 2:29:47 PM
The general duties of directors: CA 2006, Part 10
commercial interests in accordance with the objects set out in its memorandum.
Finding that the defendants substantial purpose in making the transfer was to
enable Citygate to meet its liabilities, not to preserve the survival of Extrasure,
the judge concluded that the purpose for which the transfer was made was plainly
an improper one.
e proper purposes doctrine as manifested in the second limb of s 171 was
recently considered in
West
Coast
Capita
(Lios
Limited
(2008), by the Court of
Session. Tesco Holdings Ltd was prevented from obtaining complete control of
Dobbies Garden Centres plc, in part, because a rival bidder, West Coast Capital
(WCC), purchased shares in the market at above the o
er price. Although Tesco
achieved a 65% holding, WCC remained a signi
cant minority shareholder. 
e
new board of Dobbies announced that it would not be paying dividends and pro-
posed to raise 150 million by way of an issue of new shares. WCC petitioned
under s 994 CA 2006 (the unfair prejudice provision, see Chapter 11, above), on
the basis that it was highly unusual for companies to cease to pay dividends when
they have not su
ered a poor operating performance and so the court should
infer a sinister intent in this regard. WCC also argued that the current directors
consistently exercised their powers in Tescos interests to the prejudice of other
shareholders, including themselves, rather than for the purposes for which those
powers were conferred and the proposed share allotment made no commercial
sense. On the evidence, the petition was unsuccessful. However, for our current
purposes, the observations of Lord Glennie about s 171 are of particular interest.
He noted that the statutory provision did little more than set out the pre-existing
law. Citing
Howard
Ltd
Ampo
Petro
eum
Ltd
, it was accepted by the
court that the test under s 171(b) was subjective and that it was necessary to con-
sider the actual motivation of the directors. 
e judge concluded the point thus:
The test . . . is essentially one of looking at the purpose or purposes for which the
directors were exercising their powers,
i.e.
their motivation. If an improper moti-
vation can be shown, if only by inference from an objective assessment of all the
surrounding circumstances, the basis of [liability] . . . might be established.
14.24
An unusual illustration of improper purposes, at least in so far as Hart J, at 
rst
instance, and the Court of Appeal were concerned, arose in relation to so-called
poison pill arrangements in
Criterion
Properties
Stratford
Properties
LLC
(2004). While such arrangements are extremely rare in the UK (indeed, the
City
Code
Takeovers
Mergers
prohibits action by the board of directors
of an o
eree company which might frustrate a bona 
de o
er for the company
(see General Principle 7, and Rule 21)), they are commonly encountered in North
American jurisdictions. In essence a poison pill is a mechanism designed to deter
hostile takeovers by making the target company unattractive. Typically a poi-
son pill, also known as a shareholder rights plan, is used to prevent corporate
7/19/2012 2:29:47 PM
Directors duties
raiders from gaining control by making it prohibitively expensive for the raider
to acquire su
cient interest in the target company to gain control over it. 
is is
achieved in numerous ways. Commonly, it is done by diluting the acquiring com-
panys interest in the target company or by allowing target shareholders to buy
shares in the acquiring company at bargain prices (for a full examination of poi-
son pills, see Lowry (1992)). In
Criterion
Properties
Stratford
Properties
LLC
, two companies, Oaktree (O), an American company, and Criterion (C), a
UK company, were parties to a joint venture for investment in real property. 
ey
entered into a supplementary agreement intended to protect C against takeo-
ver and change of management by what is termed a poison pill arrangement.
Its e
ect was to give O the right to have its interest in the joint venture bought
out at a very favourable price (i.e. above market valuation) should another party
gain control of C or in the event of N or G ceasing to be directors or employees
or involved in the management of C. 
is agreement achieved its objective of
deterring a takeover. Subsequently, the parties began negotiations to rescind it.
ese broke down and C brought an action to have the agreement set aside. 
e
Court of Appeal upheld Hart Js 
nding that the supplementary agreement was
an improper use of the directors power to bind C because, unlike the authorities
considered above, this agreement:
involved not the issue of shares, but the gratuitous disposition of the companys
assets . . The buyback provision could be triggered by any takeover, not only by
a hostile predator, but even one regarded as wholly bene
cial . . . Furthermore,
it could be triggered by the departure of N or G, even in circumstances which
had nothing to do with a change of control, for example, death or dismissal due
to misconduct.
While the Court of Appeals analysis of the purpose behind the exercise of
the power in question is of interest, it should be noted that the House of Lords
approached the issue on the basis of directors authority, i.e. whether the direc-
tors had actual, apparent or ostensible authority to sign the agreement (see fur-
ther Chapter 12). Since this could not be decided on the evidence available, the
case was remitted for trial.
14.25
Directors frequently have an interest as shareholders in the company, and the
courts recognise that in promoting the interests of the company they will also
necessarily promote their own interests. In this regard a realistic view is taken
that does not require detached altruism on the part of directors, so that in deter-
mining whether they have acted in the best interests of the company or for some
improper purpose, the test is [W]hat was the moving cause of the action of
the directors?
(Mi
(1938), Latham CJ citing Lord Shaw in
Hind
John
Cotton
Ltd
(1919)). 
us, the fact that a director derives some incidental bene-
t from the action taken will not in itself mean that the 
duciary duty has been
7/19/2012 2:29:47 PM
The general duties of directors: CA 2006, Part 10
broken
(Madden
Dimond;
Rudo
Macey
(1905), Martin J). 
e appropriate test
in such circumstances seems to be along the lines of the but for test of causation
familiar to tort lawyers. In
(1938, above), the court upheld a resolu-
tion to distribute bonus shares even though it had the e
ect of consolidating the
majority voting power of the companys managing director. Dixon J said:
but if, except for some ulterior and illegitimate object, the power would not
have been exercised, that which has been attempted as an ostensible exercise
of the power will be void, notwithstanding that the directors may incidentally
bring about a result which is within the purpose of the power and which they
consider desirable.
(ii) Duty to promote the success of the company
14.26
e CLR considered whether to retain the traditional understanding that com-
panies should be run for the bene
t of shareholders or whether a broader stake-
holder approach should be adopted. By way of a limited compromise it proposed
that directors should promote enlightened shareholder value (see
Deve
the
Framework
, paras 2.192.22; and
Comp
7/19/2012 2:29:47 PM
Directors duties
directors who might happen to be shareholders themselves (6 February 2006
(column 256)).
14.27
Looking to the case law upon which s 172 rests, it was long settled that the pivotal
duty of a director is to act honestly and in good faith in the best interests of the
company and are thus precluded from exercising their powers to further their
own interests or the interests of some third party (ie. it encapsulates the over-rid-
ing duty of loyalty directors owe to the company). 
e classic formulation, upon
which s 172(1) is based, was made by Lord Greene MR in
Fawcett
Ltd
(1942) who said that directors must exercise their discretion
in what
they considernot what a court may consideris in the interests of the com-
pany. As is apparent from this statement, and its statutory manifestation, the
court will not substitute its own view about which course of action the directors
should have taken in place of the boards own judgementto this extent the duty
is subjective. In
Regentcrest
(2001), Jonathan Parker J explained that:
The question is not whether, viewed objectively by the court, the particular act
or omission which is challenged was in fact in the interests of the company; still
less is the question whether the court, had it been in the position of the direc-
tor at the relevant time, might have acted differently. Rather, the question is
whether the director honestly believed that his act or omission was in the inter-
ests of the company. The issue is as to the directors state mind.
(See also
Extrasure
Trave
Insurances
Ltd
Scattergood
(2002), discussed below;
and
Southern
Counties
Fresh
Foods
Ltd
(2008).)
14.28
However, objective considerations are hard to avoid in determining compli-
ance. In
Charterbridge
Corpn
Ltd
oyd
Ltd
(1970) Pennycuick J stated
that the test for determining whether this duty has been discharged must be
whether an intelligent and honest man in the position of a director of the com-
pany concerned, could, in the whole of the existing circumstances, have reason-
ably believed that the transactions were for the bene
t of the company. 
us,
if a director embarks on a course of action without considering the interests of
the company and there is no basis on which he or she could reasonably have
come to the conclusion that it was in the interests of the company, the director
will be in breach (
Item
So
ware
(UK
Ltd
Fassihi
(2004), Arden LJ; see also,
Berry
Books
Ltd
Books
Ltd
(2009), see para
14.67
, below)). Further, in
Item
So
ware
(UK
Ltd
Fassihi
the Court of Appeal found that directors are
under a 
duciary duty to disclose a breach of duty, and this duty is a facet of the
core duty of loyalty. Fassihi was employed as the sales and marketing director of
the claimants. He set out to disrupt the claimants renegotiation of their distri-
bution agreement for so
ware products with Isograph Ltd. He 
rst unsuccess-
fully attempted to procure the contract for RAMS International Ltd, a company
7/19/2012 2:29:47 PM
The general duties of directors: CA 2006, Part 10
he established for that purpose. 
erea
er, he persuaded the claimants to adopt
a tough bargaining stance with Isograph. Notwithstanding these breaches of
duciary duty, Item could not establish any resultant loss. 
e negotiations with
Isograph failed because the claimants had pressed them too hard, not because of
Fassihis in
uence and Isograph did not contract with RAMS. It was therefore
critical to identify a further basis of liability to which Items loss of the contract
might be attributed. At 
rst instance, the trial judge held that Fassihi was owed
a superadded duty (both as employee and director) to disclose his misconduct.
Had he done so, this would have caused the claimant to accept Isographs pro-
posed terms. It therefore followed that the claimant was entitled to recover for the
particular losses 
owing from Isographs termination. On appeal, the existence
in law of a duty to disclose misconduct came to the fore. Arden LJ, rejecting the
argument that such a separate and independent duty exists, took the view that
the disclosure duty is intrinsic to the over-arching duty of loyalty and, therefore,
Fassihi was in breach of his duty of loyalty, by failing to tell Item that he had set
up RAMS and planned to acquire the contract for himself. Recently, in
GHLM
Trading
Ltd
Maroo
(2012), Newey J, considering the directors duty of good faith
noted that:
it can be incumbent on a
duciary to disclose matters other than wrongdo-
7/19/2012 2:29:47 PM
Directors duties
terminated and that 100,892 be paid to him as compensation. It was held that
the defendant was not acting in what he honestly and genuinely considered to be
the best interests of the company but rather was acting exclusively to further his
own personal interests (see also
Harrison
(Properties
Ltd
Harrison
(2002),
below). Similarly, a director who borrows money ostensibly for the bene
t of
company A but then transfers it to bene
t company B which was insolvent and in
which he held a substantial shareholding is not acting bona 
de in the interests of
company A
(Knight
Frost
(1998)). Further, a director exploiting the goodwill of
the companys business for his own bene
t by registering a trade mark linked to
the companys business in his own name is in clear breach of his 
duciary duty
ll
Project
Ltd
(2002), Laddie J).
14.30
Provided directors act in good faith and in the interests of the company and are
not wilfully blind to the companys interests they will not be liable for breach of
duciary duty if they make a mistake and act unreasonably, but may be liable
for breach of their duty of care
(Co
Gwyer
Associates
Ltd
London
Wharf
(Limehouse
Ltd
(above), per Leslie Kosmin QC, sitting as a deputy judge in the
High Court).
14.31
A further issue that arises in the context of this duty, and one that serves
to show how directors may  nd themselves placed in an invidious position,
concerns groups of companies. Here the question is, in whose interests should
the directors act? It will be recalled that in
Extrasure
Trave
Insurances
Ltd
Scattergood
(2002), the directors of Extrasure had transferred company funds,
some 200,000, to another company in the group, Citygate Insurance Brokers
Ltd (the parent company), to enable it to pay a creditor who had been pressing
for payment. It was held that the directors had acted without any honest belief
that the transfer was in the interests of the transferor company. 
e decision
serves to illustrate that where a company is one of a number in a group struc-
ture, the directors must act bona 
de in the interests of that company. 
is is,
er all, a straightforward application of the decision in
(see Chapter
2). 
ere may be situations, however, where acting in the interests of the group
furthers the interests of the particular company. For example, if a subsidiary
company is owed money by its parent company which is in  nancial di
culty,
the failure on the part of the directors to take action to recover its debts may be
in the interests of the subsidiary if, on balance, it would be adversely a
ected
by the liquidation of the parent company (see
Nicho
Soundcra
ectronics
Ltd
(1993), considered in Chapter 11). It is noteworthy that in
Extrasure
the
judge emphasised that mere incompetence will not constitute a breach of 
du-
ciary duty provided the director honestly believed he was acting in the best
interests of the company. As commented above, on the facts, however, the pay-
ment of a debt owed by the parent company was not in the best interests of
7/19/2012 2:29:47 PM
The general duties of directors: CA 2006, Part 10
the subsidiary company. 
e directors were therefore ordered to pay equitable
compensation.
Enlightened shareholder value
14.32
e CLRs objective that the statutory formulation of the good faith duty (which
it termed the duty of loyalty) should promote enlightened shareholder value
resonates with the approach taken by the Supreme Court of Canada in
Peop
Department
Stores
Wise
(2004), in which the Court stated that acting in the best
interests of the company required directors to maximise the value of the corpora-
tion. 
is did not mean acting solely in the interests of the shareholders or in any
one stakeholders interest. Rather, as Major and Deschamps JJ explained:
We accept as an accurate statement of law that in determining whether they
are acting with a view to the best interests of the corporation it may be legiti-
mate, given all the circumstances of a given case, for the board of directors
to consider,
inter alia
, the interests of the shareholders, employees, suppliers,
creditors, consumers, governments and the environment . . . At all times, direc-
tors and of
cers owe their
duciary duties to the corporation. The interests of
the corporation are not to be confused.
14.33
Section 172(1) goes on to give content to the notion of enlightened shareholder
value by listing a range of factors which, in the discharge of this duty, directors
are to have regard (amongst other matters) to:
the likely consequences of any decision in the long term,
(a)
the interests of the companys employees,
(b)
need to foster the companys business relationships with suppliers, cus-
(c)
tomers and others,
the impact of the companys operations on the community and the
(d)
environment,
the desirability of the company maintaining a reputation for high stand-
(e)
ards of business conduct, and
the need to act fairly as between members of the company.
(f)
e phrase have regard to was explained by Margaret Hodge, then Minister of
State for Industry and the Regions:
The words have regard to means think about; they are absolutely not about
just ticking boxes. If thinking about leads to the conclusion, as we believe it will
in many cases, that the proper course is to act positively to achieve the objects
in the [provision], that will be what the directors duty is. In other words have
7/19/2012 2:29:47 PM
Directors duties
regard to means give proper consideration to . . . .(Hansard, HC, vol 450, col 789
(17 October 2006)).
e list of factors set out in s 172 is
not exhaustive but is indicative of the impor-
tance that the CLR paid to the wider expectations of responsible business behav-
iour (see the White Paper, 2005, para 3.3). 
e framing of s 172(1) is intended
to place beyond doubt that the need to have regard to the speci
ed factors is
subject to the overriding duty to act in the way the director considers, in good
faith, would be most likely to promote the success of the company (a
er all, the
duties are owed directly to the company (s 170)). However, in discharging this
duty and, more particularly, in taking account of the factors, directors are bound
to exercise reasonable care, skill, and diligence (see s 174, below). If challenged
on this ground, a director will, therefore, need to demonstrate that the interests
listed informed his or her deliberations. 
is may well lead to changes in the
way directors document their decisions and more elaborate paper trails. In this
regard, it is noteworthy that the requirement for a business review introduced
by s 417 (though not applying to small companies and is quali
ed with respect
to medium-sized companies) speci
es that its purpose is to inform members of
the company and help them assess how the directors have performed their duty
under section 172 . . . .
14.34
As noted above, this provision attracted signi
cant debate while the Bill was going
through Parliament and was the cause of considerable anxiety amongst interested
parties. For example, the Law Society thought that s 172 might open the com-
mercial decision-making of directors to judicial challenge (see, the Law Societys
Proposed Amendments and Brie
ng for Parts 10 & 11 (issued 23 January 2006)).
To allay the fear that directors would be exposed to increased litigation and to aid
understanding of the statutory statement of directors duties, DBERR (now BIS)
published a compilation of Ministerial statements on the meaning of the relevant
provisions (June 2007). In the Minister of States introduction to the document
she places particular emphasis on s 172 explaining that it captures a cultural
change in the way in which companies conduct their business. Accordingly, she
states that there was a time when business success in the interests of shareholders
was thought to be in con
ict with societys aspirations for people who work in the
company or supply chain companies, for the long-term well-being of the commu-
nity and the environment: Pursuing the interests of shareholders and embrac-
ing wider responsibilities are complementary purposes, not contradictory ones.
7/19/2012 2:29:47 PM
The general duties of directors: CA 2006, Part 10
formulation of the duty with Lord Greene MRs statement of the duty in
Fawcett
Ltd
and concluded that they amounted to the same thing, although the
court acknowledged that the statutory provision gave a more readily understood
de
nition of the scope of the duty. Indeed, proof that s 172 will not lead to an
opening of the 
oodgates of litigation against directors is evident from the short
shri
given by Mr Justice Sales to the claimant in
(on
the
ication
Peop
7/19/2012 2:29:47 PM
Directors duties
argument against going further than that that there would be a risk of trying to
press the RBS Board beyond the limits of their own duties, and in my view that
is all that has been said in paragraph 13(e) of the Green Book assessment, read
in its proper context as one reason among others. In my view, on a fair reading
of that document, it was not being said that there was an absolute legal bar to
the introduction of a different policy, but rather that was a good reason for not
pressing the RBS Board by means of a more interventionist policy for UKFI.
14.35
Taking account of the interests of employees as required by s 172(1)(b) has long
been a statutory requirement. Section 309 CA 1985 had provided that the mat-
ters to which the directors of a company are to have regard in the performance
of their functions include the interests of the companys employees in general, as
well as the interests of its members. 
ere were two signi
cant problems with
this duty. 
e 
rst related to its enforceability because it could only be enforced
in the same way as any other 
duciary duty owed to a company by its directors (s
309(2) CA 1985). Either the company had to sue for its breach, or a shareholder
had to bring a derivative action (although see
fab
Engineers
Ltd
((1990),
considered below). Second, it was di
cult to identify the precise scope of the duty
for the purposes of determining whether it had been discharged or not. Directors
were not bound to give the interests of employees priority over those of share-
holders. 
e CLR therefore reached the conclusion that the provision should be
repealed on the basis, as we have seen, that directors should consider employees
interests only as an incident of promoting the companys success for the bene
t
of its members
Strategic
Framework
(1999), paras 5.1.205.1.23). However, s
247 CA 2006 does permit directors to make provision for the bene
t of employ-
ees and former employees of the company or any of its subsidiaries on the ces-
sation or transfer of the whole or part of the undertaking of the company or the
subsidiary. Signi
cantly, s 247(2) states that the power can be exercised even if it
will not promote the success of the company in accordance with s 172.
Creditors
14.36
As a separate constituency creditors do not appear in the list of factors contained
in s 172(1), although some of the categories listed such as employees, suppliers
and customers may indeed be creditors. However, s 172(3) provides that the duty
imposed by this section has e
ect subject to any enactment or rule of law requir-
ing directors, in certain circumstances, to consider or act in the interests of credi-
tors of the company. In this regard, in
Ltd
Moore
Stephens
(2009),
Lord Mance (dissenting) stressed that:
Section 172(1) of the Companies Act 2006 now states the duty, in terms expressly
based on common law rules and equitable principles (see s 170(3)), as being to
act in the way he considers, in good faith, would be most likely to promote the
7/19/2012 2:29:47 PM
The general duties of directors: CA 2006, Part 10
success of the company for the bene
t of its members as a wholea duty made
expressly subject to any enactment or rule of law requiring directors, in certain
circumstances, to consider or act in the interests of creditors of the company
(see s 172(3)).
e reference to any enactment encompasses, for example, the wrongful trad-
ing provision in s 214 of the Insolvency Act 1986 (see Chapter 17); while the
reference to any rule of law encompasses the case law in which the courts have
recognised that where the company is insolvent, or is of doubtful solvency, the
interests of creditors supersedes those of the companys members so that the
focus of the duty switches accordingly. 
e concern of creditors in this situation
lies with ensuring that company assets, to which they will look for payment of
their loans, are not dissipated by the directors.
14.37
ere is now signi
cant dicta in a number of English and Antipodean cases in
which the judges recognise that directors should have regard to the interests
of creditors where the companys fortunes have declined into insolvency. 
e
position was succinctly stated by Street CJ in
Kinse
Russe
ll
Kinse
Pty
Ltd
(1986):
In a solvent company the proprietary interests of the shareholders entitle them
as a general body to be regarded as the company when questions of the duty of
directors arise . . . But where a company is insolvent the interests of the creditors
intrude. They become prospectively entitled, through the mechanism of liqui-
dation, to displace the power of the shareholders and directors to deal with the
companys assets. It is in a practical sense their assets and not the shareholders
assets that, through the medium of the company, are under the management
of the directors pending either liquidation, return to solvency, or the imposition
of some alternative administration.
is passage was cited with approval by the Court of Appeal in
West
Mercia
Safetywear
Ltd
Dodd
(1988) which stressed that shareholders do not have the
power to absolve directors from a breach of duty to the creditors so as to bar the
liquidators claim. Indeed, in
Winkworth
Edward
Baron
Deve
opment
Ltd
(1987) Lord Templeman went further by stating that directors owe a duty to the
company and to its creditors to ensure that its a
airs are properly administered
and that its property is not dissipated.
14.38
e parameters of this duty are still being con
gured by the courts and the
Explanatory Notes to the CA 2006 state that s 172(3) will leave the law to develop
in this area. It is clear that in contrast to the duty owed directly to the company
during solvency, the duty owed to creditors is indirect because their interests
are represented through a liquidator. In
ukong
Line
Ltd
Korea
Rendsburg
7/19/2012 2:29:47 PM
Directors duties
Investment
Corpn
Liberia
(No
(1998), Toulson J held that a director of an
insolvent company who breached his 
duciary duty to the company by transfer-
ring assets beyond the reach of its creditors owed no corresponding 
duciary
duty to an individual creditor of the company. 
e creditor could not therefore
bring an action against the director for breach of duty. 
e appropriate cause
of action would lie with the liquidator under s 212 of the Insolvency Act 1986
(misfeasance proceedings, see Chapter 17). 
e issue has come to the fore in two
decisions of the Companies Court. In
Pantone
485
Ltd
(2002) Richard Reid
QC, sitting as a deputy judge in the High Court, observed that:
In my view, where the company is insolvent, the human equivalent of the com-
pany for the purposes of the directors
duciary duties is the companys creditors
as a whole, i.e. its general creditors. It follows that if the directors act consist-
ently with the interests of the general creditors but inconsistently with the inter-
est of a creditor or section of creditors with special rights in a winding-up, they
do not act in breach of duty to the company.
14.39
Further, in
Gwyer
Associates
Ltd
London
Wharf
(Limehouse
Ltd
(2003), it was held that a resolution of the board of directors passed without proper
consideration being given by certain directors to the interests of creditors would
be open to challenge if the company had been insolvent at the date of the resolu-
tion. Leslie Kosmin QC, sitting as a deputy judge in the High Court, stated that:
In relation to an insolvent company, the directors when considering the com-
panys interests must have regard to the interests of the creditors. If they fail to
do so, and therefore ignore the relevant question, the [
Charterbridge Corpn Ltd
v Lloyds Bank Ltd
(1970)] test can be applied with the modi
cation that in con-
sidering the interests of the company the honest and intelligent director must
have been capable of believing that the decision was for the bene
t of the credi-
tors. In my view the
Charterbridge Corporation
test is of general application.
(See also
Wha
(Liquidator
MDA
Investment
Management
Ltd
Doney
(2003).)
14.40
In summary, it seems that the obligation in s 172(3) is 
duciary in nature; that,
as with members, the duty is not owed to any individual creditor but only to the
general body of creditors; and that for insolvent companies the duty to act in the
best interests of the company (see below) requires the substitution of the word
creditors for the word company in s 172(1). Whether or not creditors need this
additional protection is questionable given the fraudulent trading and wrong-
ful trading provisions contained in the Insolvency Act 1986 together with s 212
(misfeasance proceedings) of the 1986 Act (considered in Chapter 17; see Finch
(1995)).
7/19/2012 2:29:47 PM
The general duties of directors: CA 2006, Part 10
14.41
ese points aside, while s 172(3) settles the point that directors of insolvent or
prospectively insolvent companies owe duties to creditors, the relevant deci-
sions upon which the provision is based do not lay down any guidance as to
when directors should shi
their attention away from the company qua body
of shareholders towards the interests of its creditors. Clearly this depends upon
the companys solvency. But identifying the point in time when a company is
insolvent (i.e. when debts cannot be met) is, in practical terms, fraught with
culty (see the Cork Report, Cmnd 8558 (1982), discussed in Chapter 13,
above).
(iii) Duty to exercise independent judgement
14.42
Section 173(1) provides that a director must exercise independent judgement. 
is
codi
es the principle of law whereby directors must not fetter the future exercise
of their discretion unless, as laid down in subsection (2), they are acting:
in accordance with an agreement duly entered into by the company that
(a)
restricts the future exercise of discretion by its directors, or
in a way authorised by the companys constitution.
(b)
is is an incident of the over-arching duty to promote the success of the
company laid down in s 172. 
e duty operates to prevent directors fetter-
ing their discretion by, for example, contracting with a third party as to how
a particular discretion conferred by the articles will be exercised
(Kregor
ins
(1913); see also,
Kuwait
Asia
Nationa
Mutua
Life
Nominees
Ltd
(1990)). In
ting
Association
Cinematograph
evision
ied
Technicians
(1963), Lord Denning explained the nature of the duty in typically
clear terms:
It seems to me that no one, who has duties of a
duciary nature to discharge,
can be allowed to enter into an engagement by which he binds himself to dis-
regard those duties or to act inconsistently with them. No stipulation is lawful
by which he agrees to carry out his duties in accordance with the instructions of
another rather than on his own conscientious judgment; or by which he agrees
to subordinate the interests of those whom he must protect to the interests of
someone else.
14.43
But where the board is able to establish that it was in the best interests of the com-
pany to enter into such an agreement, the duty will not be broken. For example,
the directors may be able to point to some commercial bene
t accruing to the
company as a result of their undertaking to the third party. In
ham
Footba
ll
Ltd
Cabra
Estates
(1994) four directors of Fulham Football Club agreed
7/19/2012 2:29:47 PM
Directors duties
with Cabra, the clubs landlords, that they would support Cabras planning appli-
cation for the future development of the clubs grounds rather than the plan put
forward by the local authority. In return for this undertaking, Cabra paid the
football club a substantial fee. 
e directors subsequently sought to renege on
this promise and argued that it was an unlawful fetter on their powers to act in
the best interests of the company. 
e Court of Appeal, rejecting this argument,
stated that:
It is trite law that directors are under a duty to act bona
de in the interests of
their company. However, it does not follow from that proposition that direc-
tors can never make a contract by which they bind themselves to the future
exercise of their powers in a particular manner, even though the contract taken
as a whole is manifestly for the bene
t of the company. Such a rule could well
prevent companies from entering into contracts which were commercially ben-
cial to them.
14.44
Neil LJ endorsed the view of Kitto J in the Australian case
orby
dberg
(1964) who had stated that:
There are many kinds of transaction in which the proper time for the exercise of
the directors discretion is the time of the negotiation of a contract and not the
time at which the contract is to be performed . . . If at the former time they are
bona
de
of opinion that it is in the interests of the company that the transac-
tion should be entered into and carried into effect I see no reason in law why
they should not bind themselves.
Further, the duty prohibits directors delegating their powers unless the compa-
nys articles provide otherwise. It has been suggested that s 173 casts doubt on the
extent to which a director can rely on other directors (for example, a managing
director or a colleague with specialist expertise in relation to a matter requiring
a decision of the board) or external consultants (see the Law Societys Proposed
Amendments and Brie
ng for Parts 10 and 11 CA 2006, (23 January 2006)).
Responding to this anxiety, Lord Goldsmith, in the Lords Grand Committee (6
February 2006 (col 282), explained that:
The duty does not prevent a director from relying on the advice or work of
others, but the
nal judgment must be his responsibility. He clearly cannot be
expected to do everything himself. Indeed, in certain circumstances directors
may be in breach of their duty if they fail to take appropriate advicefor ex-
ample, legal advice. As with all advice, slavish reliance is not acceptable, and
the obtaining of outside advice does not absolve directors from exercising their
judgment on the basis of such advice.
(See further,
Westmid
Packing
Services
Ltd
(1998)).
7/19/2012 2:29:47 PM
The general duties of directors: CA 2006, Part 10
(iv) Duty to exercise reasonable care, skill and diligence
14.45
Section 174(1) provides that a director of a company must exercise reasonable care,
skill and diligence. Section 174(2) goes on to state that this means the care, skill
and diligence that would be exercised by a reasonably diligent person with
(a)
the general knowledge, skill and experience that may reasonably be
expected of a person carrying out the functions carried out by the director
in relation to the company, and
(b)
the general knowledge, skill and experience that the director has.
e pre-existing case law on the common law duty can be divided into two
streams. First, those decisions handed down principally during the 19th century
when the courts generally had low expectations of the standard of care to be
expected of directors and, second, those cases decided a
er the landmark deci-
sion in
Donoghue
Stevenson
(1932).
14.46
To understand the former category, it should be recalled that the early companies
frequently appointed a director by virtue of his social standing. 
ey were, there-
fore, generally symbolic appointments only. For example, in
Cardi
Savings
Marquis
case (1892), the Marquis had been appointed president of
the bank when six months old and had attended only one board meeting in 39 years.
It was held that he did not share responsibility for the banks heavy losses resulting
from the irregular conduct of its trustees and managers. Stirling J formulated what
has been described as the intermittent theory of directors dutiesnamely, that a
director must exercise care at the meetings at which he is actually present, but owes
no duty to attend any speci
c meeting, or even any meeting at all.
14.47
e concern of the courts was to frame the standard of care in terms that were
appropriate to company directors who, as commercial risk-takers, should not be
held to the same performance standards as trustees. In
Forest
Dean
Mining
(1878), Jessel MR stated that directors are commercial men and that
an ordinary director who only attends board meetings periodically cannot be
expected to devote as much time and attention to the business as the sole man-
aging partner of an ordinary partnership, but they are bound to
use
reasonab
igence
in the management of their companys a
airs, and to act
honestly. Recourse to objective assessment can therefore be seen in Jessel MRs
reasoning; a view which seems to have presaged the approach of Neville J in
Brazi
Rubber
antations
Estates
Ltd
(1911) in which the judge laid down
a semi-subjective standard of care which was to be determined according to the
expertise of the particular director:
He is not, I think, bound to take any de
nite part in the conduct of the com-
panys business, but so far as he does undertake it he must use reasonable care
7/19/2012 2:29:47 PM
Directors duties
in its despatch. Such reasonable care must, I think, be measured by the care an
ordinary man might be expected to take in the same circumstances on his own
behalf. He is clearly, I think, not responsible for damages occasioned by errors
of judgment.
14.48
ese early decisions were considered by Romer J in
City
Equitab
Fire
Insurance
Ltd
(1925) in which he attempted to formulate de
nable criteria for
the requisite duties of care, skill and diligence. In this case the companys man-
aging director, B, had been convicted of fraud and his fellow directors, who had
acted honestly, were alleged to have been negligent in leaving the running of the
company in Bs hands. Romer J, having reviewed the relevant authorities, said:
In discharging the duties of his position thus ascertained a director must, of
course, act honestly; but he must also exercise some degree of both skill and
diligence. To the question of what is the particular degree of skill and diligence
required of him, the authorities do not, I think, give any very clear answer. It
has been laid down that so long as a director acts honestly he cannot be made
responsible in damages unless guilty of gross or culpable negligence in a busi-
ness sense.
To this broad statement Romer J added three guiding principles for the deter-
mination of the directors duty of care. First, [a] director need not exhibit in
the performance of his duties a greater degree of skill than may reasonably be
expected from a person of his knowledge and experience. He noted that a direc-
tor of a life insurance company, for example, does not guarantee that he has the
skill of an actuary or of a physician. Second, Romer J stated that a director is not
bound to give continuous attention to the a
airs of his company. He added that
a directors duties are of an intermittent nature to be performed at periodical
board meetings and at committees of the board although he is not, however,
bound to attend all such meetings, though he ought to attend whenever, in the
circumstances, he is reasonably able to do so. Finally, Romer J stated the position
with respect to delegation by a director of certain duties: [I]n respect of all duties
that, having regard to the exigencies of business, and the articles of association,
may properly be le
to some other o
cial, a director is, in the absence of grounds
for suspicion, justi
ed in trusting that o
cial to perform such duties honestly.
14.49
Romer Js judgment was delivered some seven years before the landmark deci-
sion in
Donoghue
Stevenson
(above) in which the House of Lords triggered the
existence of a general duty of care based upon reasonable foresight. Since 1932
the reach of the law of negligence has ebbed and 
owed but it seems certain that
directors will not be somehow ring-fenced from its reach so that they are deemed
to owe di
erentand, history would suggestlower duties of care than non-
duciaries (Worthington (1997);
Finch (1992)). Since the decision in
City
7/19/2012 2:29:47 PM
The general duties of directors: CA 2006, Part 10
Equitab
the law has of course continued to evolve, a process which gained con-
siderable momentum from the corporate governance debate (see Chapters 15 and
16), and, as re-stated by s 174, has reached the stage of holding directors account-
able along the lines of traditional negligence principles. For example, in
Danie
Anderson
(1995) the New South Wales Court of Appeal held that directors owe a
common law duty to take reasonable care. Clarke and Sheller JJA stated that: 
e
law of negligence can accommodate di
erent degrees of duty owed by people
with di
erent skills but that does not mean that a director can safely proceed on
the basis that ignorance and a failure to inquire are a protection against liability
for negligence.
14.50
Unlike actions for breaches of 
duciary duties, there is a paucity of case law in
which directors have been challenged for negligent management (although the
unfair prejudice remedy may now be seen as the preferred guise for bringing
such actions, see Chapter 11; further, the derivative action can now be brought
against directors for negligence: see s 260(3) CA 2006, discussed in Chapter 10).
However, over the last decade or so several cases have been brought success-
fully against directors for breach of their common law duties of care and skill
in which the standard of care was not measured solely by reference to subjective
factors. 
e approach taken in this second stream of decisions clearly informed
the dra
ing of s 174. In
Norman
eodore
Goddard
(1991) Ho
mann J accepted
counsels submission that the appropriate test was accurately stated in s 214(4)
of the Insolvency Act 1986, which de
nes negligent conduct for the purposes of
wrongful trading:
the facts which a director of a company ought to know or ascertain, the conclu-
sions which he ought to reach and the steps which he ought to take are those
which would be known or ascertained, or reached or taken, by a reasonably
diligent person having both: (a) the general knowledge, skill and experience
that may reasonably be expected of a person carrying out the same functions as
are carried out by that director in relation to the company; and (b) the general
knowledge, skill and experience that that director has.
In
Jan
London
Ltd
(1994) Ho
mann LJ, relying on s 214(4) of the 1986
Act, held a director negligent and prima facie liable to the company for losses
caused as a result of its insurers repudiating a 
re policy for non-disclosure. 
e
director had signed the inaccurate proposal form without 
rst reading it (see
below on the issue of relief from liability).
14.51
e e
ect of s 174(2), which adopts Lord Ho
manns position and mirrors the
wrongful trading provision, is that a directors actions will be measured against
the conduct expected of a reasonably diligent person (see
Gregson
Trustees
Ltd
(2008), in which the court con
rmed that s 174 codi
es the pre-existing law).
7/19/2012 2:29:47 PM
Directors duties
However, subjective considerations will also apply according to the level of any
special skills the particular director may possess. 
ere is also a synergy between
s 174 and cases brought under the Company Directors Disquali
cation Act 1986
(CDDA) particularly in relation to Romer Js third proposition relating to delega-
tion. Inactivity on the part of directors is not acceptable so that short shri
is
given to any contention to the e
ect that the director was unaware of a state of
airs because he had trusted others to manage the company
(Re
Peppermint
Park
Ltd
(1998);
Park
House
Properties
Ltd
(1998);
Brian
Pierson
(Contractors
Ltd
(2001); and
Landhurst
Leasing
(1999). Or had relied on professional
advice as in
ASIC
Hea
(2011), discussed by Lowry (2012); and
Bradcrown
Ltd
(2001), discussed at
13.65,
above). In
Barings
(No
5)
(1999), proceed-
ings were brought under the CDDA for the disquali
cation of directors of the
Barings Bank following the spectacular losses resulting from the unauthorised
dealings of a trader, Nick Leeson, who was based in the banks Singapore o
ce.
One of the issues in the case was what level of supervision should be expected of
T, the deputy chairman of the Barings Group, chairman of Barings Investment
Bank and chairman of the Barings Investment Bank Managing Committee. T
had argued that in view of the size of the banks operations his role was basically
reactive and that he was justi
ed in trusting delegatees until matters came to his
attention which required his response. 
is would appear to accord with Romer
Js view of delegation. However, it was held that in determining the period for
disquali
cation, the guiding principle is that directors, collectively and individu-
ally, had a duty to acquire and maintain a su
cient knowledge of the companys
business so as to enable them to discharge their responsibilities. 
e power to
delegate did not absolve directors from the duty to supervise the way in which
delegated functions are carried out. For the duty to be discharged it now seems
that proactive monitoring of the operations of delegatees must be demonstrated.
e courts will not countenance the argument that the director lacked su
cient
time to undertake this task.
14.52
e
Barings
approach can also be seen to have overshadowed the thinking of
the Commercial Court in
Equitab
Life
Assurance
7/19/2012 2:29:47 PM
The general duties of directors: CA 2006, Part 10
2000 the House of Lords held that the directors had no power under the articles
to devalue guaranteed rates and that di
erential bonus rates were contrary to the
terms of the guaranteed annuity policies (see
Equitab
Life
Assurance
7/19/2012 2:29:47 PM
Directors duties
(v) Duty to avoid con
icts of interest; duty not to pro
t
personally and the duty to declare an interest in a proposed
or existing transaction or arrangement
14.53
Section 175 (duty to avoid con
icts of interest) and ss 177 and 182 (duty to declare
an interest in proposed or existing transaction or arrangement) are framed to
encompass the equitable obligations which are generally described, respec-
tively, as the no-con
icts rule, the no-pro
ts rule and the self-dealing rule.
ese principles can all be classi
ed as incidents of the core 
duciary duty of
loyalty (see
Bristo
West
7/19/2012 2:29:48 PM
The general duties of directors: CA 2006, Part 10
allowed to put himself in a position where his interest and duty con
ict. More
recently, Millett LJ (as he then was) explained in
Bristo
West
7/19/2012 2:29:48 PM
Directors duties
to whether the errant director was acting in good faith. 
is absolutist applica-
tion of 
duciary standards is regarded, at least in the orthodox legal canon, to be
the minimum necessary to provide an e
ective deterrent and ensure the highest
degree of loyalty. 
at said, as we shall see, s 175(4) relaxes the duty in so far that
a breach can be authorised by directors.
14.57
Section 175(2) re
ects the equitable rule that it is immaterial whether the company
could take advantage of the property, information or opportunity which has been
diverted away from it by the errant director. 
e leading company law decision
is
Rega
(Hastings
Ltd
iver
(1942). 
e company, Regal, owned a cinema in
Hastings and its directors wished to acquire two additional local cinemas in order
to facilitate the sale of the whole undertaking as a going concern. 
ey therefore
formed a subsidiary company in order to take a lease of the other two cinemas.
However, the landlord was not prepared to grant the subsidiary a lease on these
two cinemas in the absence of a personal guarantee by the directors unless its
paid-up capital was 5,000. 
e company was unable to inject more than 2,000
in cash for 2,000 shares, and given that the directors did not wish to grant their
personal guarantees, the original scheme was changed. It was decided that Regal
would subscribe for 2,000 shares and the outstanding 3,000 shares would be taken
up by the directors and their associates. Later, the whole undertaking was sold
by way of takeover and the directors made a handsome pro
t. 
e purchasers
of Regal installed a new board of directors and the company brought this action
against its former directors claiming that they should account for the pro
t they
had made on the sale of their shares in the subsidiary. 
e House of Lords found in
favour of Regal. Lord Russell of Killowen stated that the opportunity and special
knowledge to obtain the shares had come to the directors qua 
duciaries:
I am of the opinion that the directors standing in a
duciary relationship to
Regal in regard to the exercise of their powers as directors, and having obtained
these shares by reason of the fact that they were directors of Regal, and in the
course of the execution of that of
ce, are accountable for the pro
ts which they
have made out of them.
is was so despite the fact that the directors had acted bona 
de throughout
the process, had used their own money, and had not denuded Regal of an oppor-
tunity because the company itself was 
nancially incapable of purchasing the
shares. Consequently, Regal itself did not su
er any actual loss. Lord Russell
enunciated the principle of law thus:
The rule of equity which insists on those, who by use of a
duciary position
make a pro
t, being liable to account for that pro
t, in no way depends on
fraud, or absence of
bona
des
; or upon such questions or considerations as
whether pro
t would or should otherwise have gone to the plaintiff, or whether
7/19/2012 2:29:48 PM
The general duties of directors: CA 2006, Part 10
the pro
teer was under a duty to obtain the source of the pro
t for the plaintiff,
or whether he took a risk or acted as he did for the bene
t of the plaintiff, or
whether the plaintiff has in fact been damaged or bene
ted by his action. The
liability arises from the mere fact of a pro
t having, in the stated circumstances,
been made.
14.58
e fact that the companys claim was unjust and that the purchasers had received
an unexpected windfall was an issue which was taken up only by Lord Porter,
who said that the purchasers of Regal receive[d] in one hand part of the sum
which ha[d] been paid by the other. Having identi
ed the obvious lack of merit
in the claim, he nevertheless went on to conclude that whether it be so or not,
the principle that a person occupying a 
duciary relationship shall not make a
pro
t by reason thereof is of such vital importance that the possible consequence
in the present case is in fact as it is in law an immaterial consideration. Equitys
inexorable rule was thus applied without regard to the resulting anomalies.
14.59
e no-con
ict and no-pro
t rules have in recent times manifested themselves
under the guise of the so-called corporate opportunity doctrinea term which
has been imported from North American jurisprudence. Although the doctrine
no doubt has its origins in the no-con
ict rule it is, however, distinguishable. As
will be seen, the Companies Act and the courts will tolerate directors being inter-
ested in transactions with the company provided certain disclosure and approval
requirements are satis
ed. 
is tolerance does not extend to directors who usurp
a corporate opportunity.
Corporate opportunities
14.60
Professor Prentice (1974) de
nes the corporate opportunity doctrine as a prin-
ciple which makes it a breach of 
duciary duty by a director to appropriate for
his own bene
t an economic opportunity which is considered to belong rightly
to the company which he serves. As is made clear by s 175(2), a corporate oppor-
tunity is regarded as an asset belonging to the company which may not therefore
be misappropriated by the directors.
Cook
Deeks
(1916) is a paradigm case. 
e
Toronto Construction Co had secured a series of contracts with Canadian Paci
c
(CP) to build various stretches of railway line. 
ree of the companys directors,
the defendants, decided to sever their links with the fourth director, Cook, and
proceeded to incorporate another company, the Dominion Construction Co.
e defendants informed CP that their new company would be undertaking the
work. 
e Privy Council held that the defendants held the contract on behalf of
the Toronto Construction Co. Lord Buckmaster said that the directors:
while entrusted with the conduct of the affairs of the company [had] deliber-
ately designed to exclude, and used their in
uence and position to exclude, the
company whose interest it was their
rst duty to protect . . . men who assume
7/19/2012 2:29:48 PM
Directors duties
the complete control of a companys business must remember that they are not
at liberty to sacri
ce the interests which they are bound to protect, and, while
ostensibly acting for the company, divert in their own favour business which
should properly belong to the company they represent.
14.61
e central thrust of equity in relation to corporate opportunities lies in its pro-
phylactic anxiety aimed at preventing directors being unjustly enriched. It is not
restricted in scope to only prescribing pro
ts being made at the expense of the
company. 
e prohibition against usurping a corporate opportunity extends to
situations where an opportunity is presented to a director personally and not in
his capacity as director of the company. In
Industria
Deve
opment
Consu
tants
Ltd
(1972) the defendant, who was managing director of Industrial
Development Consultants Ltd (IDC), a design and construction company, failed
to obtain for the company a lucrative contract to undertake work for the Eastern
Gas Board. 
e Gas Board subsequently approached Cooley indicating that they
wished to deal with him personally and would not, in any case, contract with
IDC. Cooley did not disclose the o
er to the company, but promptly resigned
his o
ce so that he could take up the contract having deceived the company into
thinking he was su
ering from ill health. Roskill J held that he was accountable
to the company for all of the pro
ts he received under the contract. Information
which came to Cooley while he was managing director and which was of concern
to the claimants and relevant for the claimants to know, was information which
it was his duty to pass on to the claimants. It was irrelevant to the issue of liability
that Cooley had been approached in his personal capacity and that the Gas Board
would not have contracted with IDC. Roskill J concluded that if the defendant
is not required to account he will have made a large pro
t as a result of having
deliberately put himself into a position in which his duty to the plainti
s [claim-
ants] who were employing him and his personal interests con
icted.
14.62
Compared with the strict approach that characterises English decisions on cor-
porate opportunities, modern Commonwealth courts have adopted a less restric-
tive view towards the issue of liability. In determining whether or not a director
has usurped a corporate opportunity, Canadian and Australian courts will have
regard to the line of business of the particular company and, signi
cantly, to the
des of the director whose conduct has been challenged. In
Peso
ver
Mines
Cropper
(1966) Pesos board was o
ered the opportunity to buy 126 mining
claims, some of which were on land which adjoined the companys own mining
territories. 
e board bona 
de declined the o
er on the basis of the then 
nan-
cial state of the company, and also because there was some doubt over the value of
the claims which therefore rendered them a risky proposition. Subsequently, the
companys geologist formed a syndicate with the defendant and two other Peso
directors to purchase and work the claims. When the company was taken over,
7/19/2012 2:29:48 PM
The general duties of directors: CA 2006, Part 10
the new board brought an action claiming that the defendant held his shares on
constructive trust for the company. 
e action was unsuccessful and the Supreme
Court of Canada dismissed the appeal by the company. It was held that the deci-
sion of the Peso directors to reject the opportunity had been made in good faith
and for sound commercial reasons in the interests of the company. 
ey could
therefore exploit the opportunity themselves.
14.63
is wider approach was again picked up by the Canadian Supreme Court in
Canadian
Aero
Service
Ltd
(1973)
Canaero
)
even though the defend-
ant directors in question were held liable. Two directors resigned their posts with
Canaero in order to secure a contract in their own right which the company had
been actively seeking. It was, in fact, unlikely that the company would have won
the contract in question. Distinguishing the facts before it from those in
Peso
the Court awarded the company damages based on the pro
ts earned by the
two directors. Further, it was held that Canaero did not have to prove that it
would have gained the contract or to establish what its pro
t would have been
had it secured the contract. Of particular signi
cance, however, is the approach
adopted by Laskin J to the determination of liability. He stated that the Court
should give cognisance to all the circumstances surrounding a particular breach
including the directors 
des:
The general standards of loyalty, good faith and avoidance of a con
ict of duty
and self interest . . . must be tested in each case by many factors . . . . Among them
are the factor of position or of
ce held, the nature of the corporate opportunity,
its ripeness, its speci
cness and the directors or managerial of
cers relation
to it, the amount of knowledge possessed, the circumstances in which it was
obtained and whether it was special or indeed even private.
14.64
Such an open-textured approach to liability contrasts sharply with the orthodox
English position which focuses solely upon the capacity of the individual con-
cerned. Yet, together with the
Peso
line of reasoning, Laskin Js approach seems
to underlie the Privy Council decision in
ueens
Mines
Ltd
Hudson
(1978).
Hudson was the managing director of Queensland Mines which had been nego-
tiating with the Tasmanian Government for mining exploration licences. 
e
company decided not to pursue the opportunity due to a lack of capital and the
signi
cant risks involved in the development. Hudson thereupon used his own
resources to prove the value of the mineral deposits in his own name. Resigning
as Queenslands managing director, Hudson formed his own company and sold
the licences to an American company for a signi
cant pro
t. Queensland Mines
sought to make Hudson liable to account. 
e Privy Council held that he was not
liable. 
e company was fully informed that Hudson was seeking this oppor-
tunity, having rejected it itself. In reaching its decision, the Privy Council was
7/19/2012 2:29:48 PM
Directors duties
mindful that Hudson had also incurred signi
cant potential personal liability in
the event that the mineral deposits had proved inadequate.
14.65
Some support for the 
exibility evidenced in
Peso
and
Canaero
can be found in
English High Court decisions. In
Export
Finance
Ltd
Umunna
(1986),
Hutchinson J said:
It would . . . be surprising to
nd that directors alone, because of the
duciary
nature of their relationship with the company, were restrained from exploiting
after they had ceased to be such any opportunity of which they had acquired
knowledge while directors. Directors, no less than employees, acquire a general
fund of knowledge and expertise in the course of their work, and it is plainly in
the public interest that they should be free to exploit it in a new position.
Similarly, the shadow of the Canadian approach can also be discerned in
ston
Ltd
Head
ters
Ltd
(1990). Head (H), a director of the plainti
company,
agreed to lease certain commercial premises in order to start up his own busi-
ness. He then resigned from the company although, unlike Cooley, he had not
at that stage decided upon the nature of the business he would enter. However,
shortly a
er his resignation, one of Balstons customers contacted H a
er being
told that the company would be discontinuing its supply to him of a certain type
of 
lter tube. H therefore began manufacturing the 
lters and supplied them to
the customer. Balston sought to hold him liable to account. Falconer J held that
it was not a breach of 
duciary duty for a director to start up a business in com-
petition with his former company a
er his directorship had ceased, even where
the intention to commence business was formed prior to the resignation. On
the evidence, Head had not attempted to divert to himself a maturing business
opportunity, an opportunity which was in the contemplation of Balston Ltd (see
also
Fram
ington
Group
Anderson
(1995)). A curious decision which illus-
trates a very open-textured approach being adopted by the Court of Appeal is
Group
Ltd
Pyke
(2002). 
e defendant, Pyke, and Plank were the only two
directors and shareholders of the claimant company. A stroke in 1996 resulted
in the defendant being unable to work. His absence continued when his work-
ing relationship with Plank broke down early in 1997. From that time until the
defendant formally resigned, he was e
ectively excluded from decision making
and participation in the management of the claimant companys a
airs. In June
1997, during his period of exile, the defendant incorporated his own company,
John Pyke Interiors Ltd, through which he procured and discharged a contract
worth 200,000 with Constructive Ltd, a customer of
Group
Ltd.
It was
alleged, therefore, that this was done in breach of duty to the claimant company.
e evidence from the correspondence between Constructive Ltd and the claim-
ants suggested that the relationship between the two had deteriorated to such an
extent that it was highly unlikely that further contracts would be placed with the
7/19/2012 2:29:48 PM
The general duties of directors: CA 2006, Part 10
claimants. On a pure application of
this, in itself, would not absolve Pyke.
Yet the Court of Appeal, by di
ering routes, exonerated him. First, the Court
enlisted
Mashona
Exp
oration
Ltd
New
Mashona
Exp
oration
Ltd
(1891) (considered below) that has been taken as holding that directors can
hold competing directorships. Further, Sedley LJ, while acknowledging that Pyke
successfully poached a customer, nevertheless took the view that:
Quite exceptionally, the defendants duty to the claimants had been reduced to
vanishing point by the acts (explicable and justi
able as they may have been)
of his sole fellow director and fellow shareholder Mr Plank . . . . The defendants
role as a director of the claimants was throughout the relevant period entirely
nominal, not in the sense [in] which a non-executive directors position might
(probably wrongly) be called nominal but in the concrete sense that that he was
entirely excluded from all decision-making and all participation in the claimant
companys affairs. For all the in
uence he had, he might as well have resigned.
In his reasoning, Brooke LJ called in aid the observation of Lord Upjohn in
Phipps
Boardman
(above), to the e
ect that the circumstances of each case must be
carefully examined to see whether a 
duciary relationship exists in relation to
the matter of which complaint is made. He laid particular emphasis on the fact
that following his stroke Pyke had been e
ectively expelled from the company
some six months prior to any of the events in question. Brooke LJ stressed that
although the defendant had invested a signi
cant sum of money in the compa-
nies of which he was a director and on favourable interest-free terms, he was not
permitted to withdraw any of it and he was denied any remuneration. Further,
at the time of the contract with Constructive he was not using any of the claim-
ants property nor was he using any con
dential information which came to him
qua director of the companies. He therefore concluded that in contracting with
Constructive, Mr Pyke was not in breach of 
duciary duty.
14.66
It is curious that the Court of Appeal did not follow the more principled route
of 
nding the director liable but granting him relief under s 1157 CA 2006 (dis-
cussed below), or, indeed, holding that the appropriate cause of action was for
Pyke to petition for relief under s 994 (see Chapter 11). Exclusion from manage-
ment is, a
er all, a paradigm illustration of unfairly prejudicial conduct.
14.67
On the other hand, the courts continue to harness equitys strict prophylac-
tic view of 
duciary liability where a director has misappropriated a corporate
opportunity for his own bene
t (see
Don
Productions
Inc
Warren
(2000)
CA and
ACP
Ltd
(2000)). 
us, in
CMS
Ltd
7/19/2012 2:29:48 PM
Directors duties
company established by him following his resignation from C. It was argued that
S had resigned in order to acquire for himself the opportunity sought by C and
that he had diverted parts of Cs business, and taken its sta
with him, to his new
company. Lawrence Collins J held that a directors power to resign from o
ce
is not a 
duciary power and a director is entitled to resign even if it might have
a disastrous e
ect on the business or reputation of the company and he was not
precluded from using his general fund of skill and knowledge to compete with
his former company. However, appropriating a maturing business opportunity
belonging to C was a misuse of its property for which S was liable (see below).
Similar reasoning can be seen in
Crown
Sutton
(2004). 
e dispute
centred on the
50m sale of Fulham Football Clubs Craven Cottage ground. As
managing director of Crown Dilmun, Suttons primary role was to identify suit-
able investment opportunities for the claimant company. Acting in this capac-
ity, he 
rst declined the development proposal of Craven Cottage on behalf of
the claimant company. 
erea
er, he pursued negotiations for a revised devel-
opment project through the medium of the second defendant company which
Sutton established speci
cally for this purpose. Peter Smith J dismissed Suttons
evidence of his genuine belief that the company would not have been interested
in the development opportunity, 
nding it to be untrue and dishonest. Echoing
the reasoning of Roskill J in
(above), he said:
Given my decision that Mr Sutton had no right to make any decision to take
opportunities which came his way whilst he was a director of the claimants, the
parties all agree that he came under a duty not to take opportunities which
arose that might put him in con
ict with his duties to the claimants. As a direc-
tor of the claimants, he had a duty to exploit every opportunity that he became
aware of for the bene
t of the claimants. The only exception is if they permit
him to take such opportunities after he has made full and frank disclosure and
they have given full and informed consent.
(See also,
Berry
Books
Ltd
Books
Ltd
(2009)
per
Judge Hodge QC:
A director . . . is subject to a fundamental duty of loyalty, which requires him to
act in what he in good faith considers to be the best interests of his company.
He should not undermine the company . . . by competing with it. It is contrary to
his duty of loyalty for a director to:
(1)
act contrary to the best interests of his company;
(2)
seek to make a pro
t for himself through the use of his companys corpo-
rate assets, information, or maturing business opportunities; or
(3)
solicit or procure his existing companys staff to work for his new
company).
7/19/2012 2:29:48 PM
The general duties of directors: CA 2006, Part 10
14.68
If rea
rmation of the strict approach taken in cases such as
Rega
and
was
found to be necessary, it is at least implicit in the Court of Appeals reasoning in
Bhu
Bhu
(2003). Silvercrest (S), a company controlled by the two appel-
lants, acquired a property, White Hall Mill, at a time that they, along with other
family members who included the respondents, were directors of Bhullar Bros
Ltd (B Ltd). 
e objects of B Ltd included the acquisition of investment property.
It already owned property in the vicinity of White Hall Mill; and in evidence the
appellants conceded that its acquisition would have been commercially worth-
while. One of them even sought legal advice on the propriety of Silvercrest enter-
ing into the transaction. However, before the purchase, B Ltds board resolved to
divide its business, and refrain from making any further property acquisitions.
e appellants therefore resisted B Ltds claim to White Hall Mill, because, they
argued, its purchase was not related to that companys a
airs, nor could it be
described as a maturing business opportunity available to it. Counsel for B Ltd
countered with a submission based upon
ey:
that a director may come under a positive duty to make a business opportu-
nity available to his company if it is in the companys line of business or if the
director has been given responsibility to seek out particular opportunities or the
company and the opportunity concerned is of such a nature as to fall within the
scope of that remit.
e approach of the Court of Appeal owes much to the traditional line of author-
ity on 
duciary obligations, including
Aberdeen
Bros
(above),
Rega
(Hastings
Ltd
(above) and
Phipps
Boardman
(above). 
is being so, the
Court noted that reasonable men looking at the facts would have concluded that
the appellants faced a real sensible possibility of con
ict of interest. 
e Courts
reasoning a
rms counsels preference for a broad, capacity-based approach as
articulated by Roskill J in
ey.
It thus seems that any opportunity within the
companys line of business is o
-limits to the director unless the companys per-
mission to proceed is 
rst obtained. (See also
uarter
Master
Ltd
Pyke
(2005), and the Court of Appeals approach in
Wrexham
Association
Footba
ll
Ltd
Crucia
Move
Ltd
(2006).) More recently, the strict approach seen in
Bhu
towards the liability of directors who bene
t from a corporate opportu-
nity notwithstanding the fact that the company itself could not have bene
ted
from it was also taken by the Court of Appeal in
Donne
ll
Shanahan
(2009),
where the action against the directors was brought under the unfair prejudice
provision (see Chapter 11). Rimer LJ observed that:
the rationale of the no con
ict and no pro
t rules is to underpin the
duciarys
duty of undivided loyalty to his bene
ciary. If an opportunity comes to him in
his capacity as a
duciary, his principal is entitled to know about it. The director
7/19/2012 2:29:48 PM
Directors duties
cannot be left to make the decision as to whether he is allowed to help himself to
its bene
t. (See also,
Towers v Premier Waste Management Ltd
(2011)).
Post-resignation breach of duty
14.69
It will be recalled that s 170(2) provides that a person who ceases to be a director
continues to be subject to the duty in s 175 (and s 176, see below). As we have seen
the judges have been confronted with the issue of post-resignation breaches of
duty time and again and future courts may draw lessons from this line of cases.
It seems safe to conclude that the statutory formulation of the no-con
ict duty
does not prevent a director from forming the intention, while still a director, to
set up in competition a
er his directorship has ceased nor do they prevent him
from taking
pre
iminary
steps to investigate or forward that intention provided
he did not engage in any actual competitive activity while his directorship con-
tinued, provided, of course, any contract of service does not prohibit such activ-
ity. 
e position was explained by Falconer J in
ston
Ltd
Head
ters
Ltd
(above):
In my judgment an intention by a director of a company to set up business in
competition with the company after his directorship has ceased is not to be
regarded as a con
icting interest within the context of the principle, having
regard to the rules of public policy as to restraint of trade, nor is the taking of
any preliminary steps to investigate or forward that intention so long as there
is no actual competitive activity, such as, for instance, competitive tendering or
actual trading, while he remains a director.
Similarly, in
Fram
ington
Group
Anderson
(above), Blackburne J reasoned
that in the absence of special circumstances, such as a prohibition in a service
contract, a director commits no breach of duty merely because, while a director,
he take steps so that, on ceasing to be a director . . . he can immediately set up
business in competition with that company or join a competitor of it. Nor is he
obliged to disclose to that company that he is taking those steps.
(See also,
eman
Taymar
Ltd
Oakes
(2001); and
Services
Ltd
Brown
(2003).)
14.70
Further, a director can utilise con
dential information or know-how acquired
while working for the company a
er he departs but not trade secrets
(Dranez
Ansta
Hayek
(2002), per Evans-Lombe J;
FSS
Trave
Leisure
Systems
Ltd
Johnson
(1998), per Mummery LJ). Typical examples of trade secrets include
company databases, customer lists, suppliers agreements and business and sales
strategy (see
Item
So
ware
(UK
Ltd
Fassihi
(2003); and
uarter
Master
Ltd
Pyke
(2004)).
7/19/2012 2:29:48 PM
The general duties of directors: CA 2006, Part 10
14.71
More recently, in
Foster
Bryant
Surveying
Ltd
Bryant
(2007),
Rix LJ con
rmed
the need for a nuanced approach to be taken towards allegations of post-resigna-
tion breaches. Drawing on Lawrence Collins Js reasoning in
CMS
Ltd
7/19/2012 2:29:48 PM
Directors duties
that they should be free to exploit it in a new position. After ceasing the rela-
tionship by resignation or otherwise a director is in general (and subject of
course to any terms of the contract of employment) not prohibited from using
his general fund of skill and knowledge, the stock in trade of the knowledge
he has acquired while a director, even
including such things as business con-
tacts and personal connections made as a result of his directorship.
7.
A director is however precluded from acting in breach of the requirement at
2 above, even after his resignation where the resignation may fairly be said
to have been prompted or in
uenced by a wish to acquire for himself any
maturing business opportunities sought by the company and where it was
his position with the company rather than a fresh initiative that led him to
the opportunity which he later acquired.
8.
In considering whether an act of a director breaches the preceding principle
the factors to take into account will include the factor of position or of
ce
held, the nature of the corporate opportunity, its ripeness, its speci
cness
and the directors relation to it, the amount of knowledge possessed, the
circumstances in which it was obtained and whether it was special or indeed
even private, the factor of time in the continuation of the
duciary duty
where the alleged breach occurs after termination of the relationship with
the company and the circumstances under which the breach was termi-
nated, that is whether by retirement or resignation or discharge.
9.
The underlying basis of the liability of a director who exploits after his resigna-
tion a maturing business opportunity of the company is that the opportunity
is to be treated as if it were the property of the company in relation to which
the director had
duciary duties. By seeking the exploit the opportunity after
resignation he is appropriating to himself that property. He is just as account-
able as a trustee who retires without properly accounting for trust property.
10.
It follows that a director will not be in breach of the principle set out as point
7 above where either the companys hope of obtaining the contract was not
a maturing business opportunity and it was not pursuing further business
orders nor where the directors resignation was not itself prompted or in
u-
enced by a wish to acquire the business for himself.
11.
As regards breach of con
dence, although while the contract of employment
subsists a director or other employee may not use con
dential information
to the detriment of his employer, after it ceases the director/employee may
compete and may use know-how acquired in the course of his employment
(as distinct from trade secretsalthough the distinction is sometimes dif
cult
to apply in practice).
(See also,
Berry
Books
Ltd
Books
Ltd
(2009); and
ermascan
Ltd
Norman
(2011)).
7/19/2012 2:29:48 PM
The general duties of directors: CA 2006, Part 10
e pragmatic approach taken by the judges in these modern decisions is mani-
fested in s 175(4)(a) which states that the no-con
ict duty is not infringed if the
situation cannot reasonably be regarded as likely to give rise to a con
ict of inter-
est. 
e provision thus acknowledges that cases involving breaches of 
duciary
duty by a director are indeed fact-sensitive. As Moses LJ in
Foster
Bryant
con-
cluded, this tends to make one almost nostalgic for the days when there were
exible rules, inexorably enforced by judges who would have shuddered at the
reiteration of the noun-adjective.
Con
icts of interest and duty and con
icts of duties
14.73
Section 175(7) states that any reference in this section to a con ict of inter-
est includes a con ict of interest and duty and a con ict of duties. 
is at
last injects a long awaited measure of cohesion in to the law and settles a long
running dispute surrounding what was seen to be an anomalous decision of
Chitty J in
London
Mashona
Ltd
New
Mashona
Exp
oration
Ltd
(1891). 
e claimant company sought an injunction to prohibit one of
its directors, Lord Mayo, from holding such o
ce with the defendant com-
pany, a business rival. In April 1891, one month a
er the claimant companys
registration, its directors resolved to appoint Lord Mayo as director and chair-
man of the board. In July of the same year, the defendant company issued
its prospectus which contained Lord Mayos name at the head of its list of
directors. 
e claimant was unable to prove that any con
dential information
had been disclosed to the defendant company. Chitty J refused the injunction,
reasoning that even if Lord Mayo had been duly appointed to the claimant
companys board, its articles did not contain any provision which required
him to give any part of his time . . . to the business of the company, or which
prohibited him from acting as a director of another company; neither was
there any contract . . . to give his personal services to the plainti
company and
to another company. 
is decision was approved by the House of Lords in
ll
Lever
Bros
Ltd
(1932).
14.74
While
Mashona
has long been accepted as authority for the proposition that
a director is not placed in breach of duty by acting as director for a competing
companydouble employment nevertheless, on its facts, no actual con
ict arose
because the defendant company had not commenced business and therefore no
damage had been sustained by the claimant. In any case, if
Mashona
was
authority for permitting double employment, a director of two competing com-
panies would have to walk a 
ne line to avoid a 
nding of con
ict of duty: [a]t
all times . . . he metaphorically wears both hats and owes duties in both capaci-
ties
(Gwembe
Deve
opment
Ltd
Koshy
(1998), Harman J). Further,
Millett LJ in
Bristo
West
7/19/2012 2:29:48 PM
Directors duties
Group
Ltd
Pyke
7/19/2012 2:29:48 PM
The general duties of directors: CA 2006, Part 10
start-up activity by existing directors and that the statutory statement of duties
should only prevent the exploitation of business opportunities where there is a
clear case for doing so (
Comp
7/19/2012 2:29:48 PM
Directors duties
14.77
e statutory statement of directors duties does not follow the common law posi-
tion in this regard and, indeed, substantially modi
es it insofar as self-dealing is
removed from the realms of directors 
duciary duties and replaced with a statu-
tory obligation to disclose an interest. Section 175(3) makes it clear that the duty
to avoid con
icts of interest contained in s 175(1) does not apply to a con
ict of
interest arising in relation to a transaction or arrangement with the company.
Rather, self-dealing falls within s 177(1) which provides that: [i]f a director is in
any way, directly or indirectly, interested in a proposed transaction or arrange-
ment with the company, he must declare the nature and extent of that interest to
the other directors. In similar terms s 182 applies to cases where a director has
an interest in a transaction a
er it has been entered into by the company. 
e
provisions do not apply to substantial property transactions, loans, quasi-loans
and credit transactions which require the approval of the companys members
(see ss 190203, below).
14.78
Sections 177 and 182 re
ect the common practice that companies (see, for exam-
ple, art 85 of the 1985 Table A and s 317 CA 1985) generally permitted direc-
tors to have interests in con
ict transactions, provided they were declared to the
board. 
e reason why the common law tolerated such relaxation of the rule was
explained by Upjohn LJ in
ting
Association
Cinematograph
evision
ied
Technicians
(above):
It is frequently very much better in the interests of the company . . . that they
should be advised by someone on some transaction, although he may be inter-
ested on the other side of the fence. Directors . . . may sometimes be placed in
such a position that though their interest and duty con
ict, they can properly
and honestly give their services to both sides and serve two masters to the great
advantage of both. If the person entitled to the bene
t of the rule is content
with that position and understands what are his rights in the matter, there is no
reason why he should not relax the rule, and it may commercially be very much
to his advantage to do so.
14.79
e principal distinction between the two statutory provisions is that whereas
breach of s 177 carries civil consequences (s 178), breach of s 182 results in crim-
inal sanctions (s 183). More particularly, s 178 states that the consequences of
breach (or threatened breach) of ss 171177 are the same as would apply if the
corresponding common law rule or equitable principle applied. 
is is subject to
the proviso introduced by s 180(1) that, subject to any provision to the contrary in
the companys constitution, if s 177 is complied with, the transaction is not liable
to be set aside by virtue of any common law rule or equitable principle requiring
the consent of members. We explore this provision further below, but for present
purposes it is noteworthy that under s 317 CA 1985, the predecessor to both the
7/19/2012 2:29:48 PM
The general duties of directors: CA 2006, Part 10
ss 177 and 182, it was settled that a directors breach of the statutory duty of dis-
closure triggers only the criminal sanctions provided for, and not any civil conse-
quences
per
e contract itself is valid until avoided by the company (
Guinness
Saunders
(1990);
Hutchinson
Brayhead
Ltd
(1968)). As a condition of
rescission of a voidable contract there must be
restitutio
integrum:
the parties
must be put in
status
quo;
for this purpose a court of equity can do what is practi-
cally just, even though it cannot restore the parties precisely to the state they were
in before the contract (
Guinness
Saunders
Lord Go ). In
Craven
Texti
Engineers
Ltd
Footba
ll
Ltd
(2000) the issue was whether H, a former
director of the defendant football club, could claim payment of unpaid invoices
for goods and work and materials supplied to the club, even though he had failed
to disclose his interest as a director and principal shareholder of the claimant
company, Craven. 
e Court of Appeal held that notwithstanding Hs failure to
disclose his interest in the contracts, the football club should pay the outstand-
ing invoices. Clarke LJ, citing Lord Go s statement of principle in
Guinness
Saunders
said that [i]t is important to note that the court does not have a gen-
eral discretion to do what seems fair and just in all the circumstances. 
e court
will only treat the company as entitled to avoid the contract if it can do what is
practically just to restore the parties to the position which existed before. Finally,
commenting on the consequences which 
ow from a breach of the statutory duty
of disclosure, the judge in
eman
Taymar
(above) observed that it does not give
the company a separate right of action for damages against the director: [a]ny
right of action arises from the breach of 
duciary duty and not from the section
[317 CA 1985]. Now that the self-dealing rule is outwith the no-con
icts rule, it
would seem that the civil consequences for failing to declare an interest under s
177 are extremely limited.
14.80
An issue which came before the courts under s 317 CA 1985 was whether it
required disclosure at a formal board meeting in cases where all the directors of
a company have informal notice of the con
ict-transaction. It was held at 
rst
instance in
Guinness
Saunders
(1990) that compliance with s 317 requires
disclosure to a duly convened and constituted board meeting, a function which
cannot be delegated to a sub-committee of the board. 
e issue was not directly
addressed in the House of Lords decision. Fox LJ in the Court of Appeal opined
that even if all the members of the board had known of a contract this would not
validate payments made thereunder. Whether or not a director should make for-
mal disclosure of interests which are patently obvious, such as his interest in his
own service contract which is generally known to all boardroom colleagues, has
been a matter on which the judges have di
ered. In two 1990s cases it was said
that in such circumstances formal disclosure is not required
(Lee
Panavision
Ltd
Lighting
Ltd
(1992);
Runciman
ter
Runciman
(1992)). On the other
hand, in
Neptune
(Vehic
Washing
Equipment
Ltd
Fitzgera
(1995), Lightman
7/19/2012 2:29:48 PM
Directors duties
J held that strict compliance with the statutory disclosure requirement was nec-
essary even in the case of companies with a sole director. Such a director should
make the declaration to himself and record the declaration in the minutes. 
is
was reluctantly applied by the court in
Neptune
(Vehic
Washing
Equipment
Ltd
Fitzgera
(No
(1995), although the court expressed the view that a bet-
ter solution would be to require disclosure by a sole director to the members in
7/19/2012 2:29:48 PM
Remedies
doing) anything as director. 
is duty is an element of the wider no-con
ict duty
laid down in s 175 and it too will not be infringed if acceptance of the bene
t can-
not reasonably be regarded as likely to give rise to a con
ict of interest. It should
be noted that it applies only to bene
ts conferred because the director is a direc-
tor of the company or because of something that the director does or does not
do as director. 
e word bene
t, for the purpose of this section, is not de
ned
in the Act although during the Parliamentary debates on the Bill it was made
clear that it includes bene
ts of any description, including non-
nancial bene
ts
cial Report, 9/2/2006; coll GC330 (Lord Goldsmith). While s 175(5) provides
for board authorisation in respect of con
icts of interest, this is not the case with
this particular duty. However, the company may authorise the acceptance of
bene
ts by virtue of s 180(4) (see below). Section 176(2) de
nes a third party
as a person other than the company or its holding company or its subsidiaries
and thus s 176(3) provides that bene
ts provided by the company fall outside the
prohibition.
Remedies
14.83
e remedies for breach of directors duties have not been incorporated into the
statutory statement of directors duties but, as we have seen, s 178(1) CA 2006
provides that the consequences of breach (or threatened breach) of ss 171 to 177
are the same as would apply if the corresponding common law rule or equitable
principle applied. With respect to the no-con
ict duty, it has long been settled
that a director must disgorge any secret pro
t resulting from his breach of duty
unless it was authorised (see s 175(4)(b) CA 2006, above). 
e liability to account
arises even where the director acted honestly and where the company could
not otherwise have obtained the bene
t
(Rega
(Hastings
Ltd
iver;
In
Murad
Saraj
(2005) Arden LJ explained the policy underlying
such liability:
It may be asked why equity imposes stringent liability of this nature . . . equity
imposes stringent liability on a
duciary as a deterrent
pour encourager les
autres
. Trust law recognises what in company law is now sometimes called the
agency problem. There is a separation of bene
cial ownership and control and
the shareholders (who may be numerous and only have small numbers of shares)
or bene
cial owners cannot easily monitor the actions of those who manage
their business or property on a day to day basis. Therefore, in the interests of
ef
ciency and to provide an incentive to
duciaries to resist the temptation to
misconduct themselves, the law imposes exacting standards on
duciaries and
an extensive liability to account.
7/19/2012 2:29:48 PM
Directors duties
In
eman
Taymar
Ltd
Oakes
(above), Robert Reid QC, sitting as a deputy judge
of the High Court, stated that a company is entitled to elect whether to claim dam-
ages (equitable compensation) or an account of pro
ts against a director who, by
abusing his position, makes a secret pro
t. However, even though the pro
t may
arise out of the use of position as opposed to the use of trust property, the judges
have typically resorted to the language of the constructive trust as the means for
fashioning a remedy
(Boardman
Phipps
although, Lord Guest excepted, all of
the judges spoke of the defendants liability to account). In
for
Hong
Reid
(1992), Lord Templeman explained that
Boardman
demonstrates the strict-
ness with which equity regards the conduct of a 
duciary and the extent to which
equity is willing to impose a constructive trust on property obtained by a 
duciary
by virtue of his o
ce. And in
Zacharia
I (1983) Deane J stated that any
bene
t or gain is held by the 
duciary as constructive trustee . . . and it is immate-
rial that there was no absence of good faith or damage [to the company].
14.84
In
Harrison
(Properties
Ltd
Harrison
(2002) a director usurped a corporate
opportunity by acquiring for his own bene
t development land owned by the
company. At the time of valuation he failed to disclose that planning permis-
sion was forthcoming which, once granted, would greatly in
ate its value. 
e
company, having unsuccessfully applied for planning permission a couple of
years earlier, was unaware that local authority policy in this respect had changed.
e director purchased the land from the company in 1985 for 8,400. Having
obtained planning permission through, to add insult to injury, use of the com-
panys resources, he then resold part of it for 110,300 in 1988 and the rest in 1992
for 122,500. 
e director resigned and the company sought to hold him liable as
a constructive trustee. Chadwick LJ, citing Millett LJ in
Paragon
Finance
akerar
(1999), said:
It follows . . . from the principle that directors who dispose of the companys property
in breach of their
duciary duties are treated as having committed a breach of trust
that, a director who is, himself, the recipient of the property holds it upon a trust for
the company. He, also, is described as a constructive trustee . . . The reason is that a
director, on appointment to that of
ce, assumes the duties of a trustee in relation
to the companys property. If, thereafter, he takes possession of that property his
possession is coloured from the
rst by the trust and con
dence by means of which
he obtained it. The true analysis is that his obligations as a trustee in relation to
that property predate the transaction by which it was conveyed to him.
14.85
In the
CMS
case (above), Lawrence Collins J subjected the issue of rem-
edies for diverting a corporate opportunity to detailed analysis. He held that
S was a constructive trustee of the pro
ts referable to exploiting the corporate
opportunity and, in general, it made no di
erence whether the opportunity is
7/19/2012 2:29:48 PM
Remedies
rst taken up by the wrongdoer or by a corporate vehicle established by him
for that purpose: I do not consider that the liability of the directors in
Cook
Deeks
would have been in any way di
erent if they had procured their new
company to enter the contract directly, rather than (as they did) enter into it
themselves and then transfer the bene
t of the contract to a new company.
Further, the director is:
accountable for the pro
ts properly attributable to the breach of
duciary duty
taking into account the expenses connected with those pro
ts and a reason-
able allowance for overheads (but not necessarily salary for the wrongdoer),
together with a sum to take account of other bene
ts derived from those con-
tracts. For example, other contracts might not have been won, or pro
ts made
on them, without (eg) the opportunity or cash
ow bene
t which
owed from
contracts unlawfully obtained. There must, however, be some reasonable con-
nection between the breach of duty and the pro
ts for which the
duciary is
accountable.
e basis of a directors liability in this situation is that, as seen in
Cook
Deeks
the
opportunity in question is treated as if it were an asset of the company in relation
to which the director had 
duciary duties. He thus becomes a constructive trus-
tee of the fruits of his abuse of the companys property (per Lawrence Collins J,
above). 
e decision in
Investments
(UK
Ltd
Versai
Trading
Finance
Ltd
(2011), is signi
cant because the Court of Appeal has explained the distinc-
tion that should be drawn between personal liability to account for unauthorised
pro
t as opposed to the Privy Councils view in
Reid
that liability is proprietary.
Lord Neuberger MR, delivering the leading judgment, held that a bene
ciary of
duciarys duties has no proprietary interest in any money or asset acquired
by the 
duciary in breach of his duties, unless the asset or money is or has been
bene
cially the property of the bene
ciary or the trustee acquired the asset or
money by taking advantage of an opportunity or right which was properly that
of the bene
ciary, even if the 
duciary could not have acquired the asset had
he not been a 
duciary. In 
nding that the appropriate remedy is an equitable
account, the Court of Appeal did not follow the decision in
Attorney
Genera
for
Hong
Reid
(above),
preferring its own decision in
Lister
(1890). 
e Master of the Rolls added that if it is a matter of equitable policy that
duciary should not be allowed to pro
t from his breach of duties, that can be
achieved by extending or adjusting the rules relating to equitable compensation
rather than those relating to proprietary interests. 
e judge explained that:
[I]t seems to me that there is a real case for saying that the decision in
Reid
. . . is
unsound. In cases where a
duciary takes for himself an asset which, if he chose
to take, he was under a duty to take for the bene
ciary, it is easy to see why
7/19/2012 2:29:49 PM
Directors duties
the asset should be treated as the property of the bene
ciary. However, a bribe
paid to a
duciary could not possibly be said to be an asset which the
duci-
ary was under a duty to take for the bene
ciary. There can thus be said to be a
fundamental distinction between (i) a
duciary enriching himself by depriving
a Claimant of an asset and (ii) a
duciary enriching himself by doing a wrong
to the Claimant.
(See also,
Cadogan
Petro
eum
(2011)).
As Penner (2012) comments at 12.83, the decision in
seems to draw a
distinction between those cases in which the asset which constitutes the unau-
thorised pro
t would have gone to the [company] but for its interception by the
[director], and those cases in which the 
duciary enriches himself in the course
of doing a wrong to the [company].
14.86
As was commented in Chapter 13, the court, exercising its inherent jurisdic-
tion, has the power to grant an equitable allowance to a 
duciary. In
Phipps
Boardman
(above), the trustees who acted in breach of the no-con ict rule
thereby created a handsome pro
t for the trust. 
ey had acted honestly
throughout and, though liable, were awarded an allowance on a liberal scale
to take account of their special expertise. Such an allowance may be awarded
if it was thought that justice between the parties so demands
ivan
Management
Agency
Music
Ltd
(1985)). However, in the case of direc-
tors the scope of this jurisdiction has now been severely limited following Lord
Go s remarks in
Guinness
Saunders
(above) to the e
ect that it should
be restricted to those cases where it cannot have the e
ect of encouraging the
trustees [or directors] in any way to put themselves in a position where their
interests con ict with their duties as trustees [or directors]. Further, the House
of Lords, mindful that the exercise of this discretion could constitute interfer-
ence in company a
airs, doubted whether it would ever be exercised in favour
of a company director. Mindful of Lord Go s speech in
Guinness
Paul Morgan
QC, sitting as a deputy judge of the High Court, in
uarter
Master
Ltd
Pyke
(2005) stated that:
I hold on the facts of the present case that the fundamental principle should
prevail that a director is not to bene
t from his breach of
duciary duty and
that no allowance is to be made.
The judge concluded that the fact that the company would not itself have
other wise received the benefits which flowed from the breach made no dif-
ference (see also the remarks of Peter Smith J in
Crown
Sutton
(above)).
7/19/2012 2:29:49 PM
Accessory liability
Accessory liability
Knowing assistance
14.87
In certain circumstances those who assist a director in the course of a breach
of duty will also be held liable for breach of 
duciary duty (see
Barnes
Addy
(1874), Lord Selborne LC). 
e test for determining dishonesty for the purposes
of determining the liability of an accessory to the directors breach of duty (tra-
ditionally termed
knowing
assistance
)
was formulated by Lord Nicholls in
Roya
Brunei
Air
ines
Sdn
Tan
(1995). He stated that dishonesty should be judged
according to whether an honest person in the defendants position would have
acted in the way that the defendant acted. If he had acted in the same way, then
the defendant will not be liable (see
Dubai
Ltd
aam
(1999);
Grupo
Torras
Sabah
(2001); and
Scot
Ltd
(2001)). Lord
Nicholls objective test was considered by the House of Lords in
Twinsectra
Ltd
ard
(2002). Con
rming that the Privy Councils decision was also the law
in England and Wales, the majority favoured a test of dishonesty that is neither
purely objective nor subjective but one which depends upon what Lord Hutton
called the combined test. 
is asks, 
rst, whether the defendants conduct was
objectively dishonest by reference to the ordinary standards of reasonable peo-
ple. If the answer is in the a
rmative, the second step of the combined test is
applied by determining whether there is evidence that the defendant realised
that he had behaved dishonestly in the circumstances. Lord Ho
mann explained
that the principles require more than simply showing dishonest conduct, [t]hey
require a dishonest state of mind, that is to say, consciousness that one is trans-
gressing ordinary standards of behaviour. 
e observations of Lord Hutton
and Lord Ho
mann were considered in
owes
Internationa
Eurotrust
Internationa
(2005) PC, where the panel included Lord Nicholls and Lord
Ho
mann. 
e Privy Council stated that it was unnecessary for the defendants
to have considered what these ordinary standards of honest behaviour were, it
was enough that the defendant was conscious of those parts of the transaction
which rendered participation in it a breach of ordinary standards of honest behav-
iour. 
e panel also took the view that someone can be held to know or suspect
that undertaking an act will render assistance in the misappropriation of funds
even if that person is unaware that the funds are held on trust or, indeed, what
a trust involves. Further, in response to the academic criticism that
Twinsectra
had changed the law by inviting enquiry not merely into the defendants mental
state about the nature of the transaction in which he was participating but also
into his views about generally accepted standards of dishonesty, Lord Ho
mann
explained that the principles laid down in
Twinsectra
were no di
erent from the
7/19/2012 2:29:49 PM
Directors duties
principles stated in
Roya
Brunei
Accordingly, emphasis was given to the objec-
tive nature of the test for dishonest assistance.
Knowing receipt
14.88
In
Ltd
Chief
Akinde
(2000), Nourse LJ, delivering the principal judg-
ment of the Court of Appeal, held that there should be a single test for
knowing
receipt
namely that the recipients state of knowledge had to make it
unconscion
for him to retain the bene
t of the receipt (see also
Houghton
Fayers
(2000)).
e principle here was explained by Buckley LJ in
Finance
Corpn
Ltd
iams
Furniture
Ltd
(No
(1980) in the following terms:
So, if the directors of a company in breach of their
duciary duties misapply the
funds of their company so that they come into the hands of some stranger to the
trust who receives them with knowledge (actual or constructive) of the breach,
he cannot conscientiously retain those funds against the company unless he has
some better equity. He becomes a constructive trustee for the company of the
misapplied funds.
is, with respect, is meaningless. Indeed, Penner (2010) criticises the test of
unconscionability on the basis that it gives no guidance to a court attempting
to delineate the appropriate degree of intent for the purposes of establishing lia-
bility. It is suggested that a single test for all accessory liability, whether know-
ing assistance or knowing receipt, in line with that stated in
Twinsectra
has the
advantage of practicality and certainty.
14.89
A signi
cant case dealing with knowing receipt is
Brown
7/19/2012 2:29:49 PM
Consent, approval or authorisation by members
not dependent upon receipt of trust property [and] arises even though no trust
property has reached the hands of the accessory. Although in such situations
the courts frequently resort to the constructive trust, it is suggested that what
is meant is that the accessorys liability to account is similar in nature. Indeed,
Ungoed-
omas J in
United
Rubber
Estates
Ltd
Cradock
(No
3)
(1968)
was moved to observe that the use of the term constructive trustee in this con-
text is nothing more than a formula for equitable relief. 
us, where no trust
property is passed to the accessory, the companys claim is personal not propri-
7/19/2012 2:29:49 PM
Directors duties
or any provision in the companys articles which require the authorisation or
approval of members. As Lord Goldsmith explained:
Section 175 permits director authorisation of what would otherwise be imper-
missible con
icts of interest. Section 177 requires declarations of interest in pro-
posed company transactions. In both those cases, the general duty no longer
requires the consent of members.
The common law rules or principles that refer to the failure to have had a
ict of interest approved by the members of a company under certain cir-
cumstances need to be set aside. If they are not, although the Act provided that
it was all right for there to be an authorisation, it might be suggested that the
director should still be capable of being impeached by reference to this common
law rule or principle. However, s 180(1) goes on to say: This is without prejudice
to any enactment, or provision of the
companys constitution, requiring such
consent or approval.
Certainly, the companys constitution can reverse the change and can insist
on certain steps being taken requiring the consent of the members in certain
circumstances. In that event, that provision would have to be given effect to.
That is the consequence of the change of approachand therefore a change
of approach to the appropriate consequence of there not being members ap-
proval in particular cases because it would no longer be required. (See, Of
cial
Report, 9/2/2006; coll GC337.)
Section 180(3) states that compliance with the general duties does not remove
the need for the approval of members to the transactions falling within Chapter
4. Further, s 180(2) provides that the general duties apply even though the trans-
action falls within Chapter 4, except that there is no need to comply with ss 175
or 176 where the approval of members is obtained. Section 180(4) preserves the
common law position on
prior
authorisation of conduct that would otherwise
be a breach of the general duties. 
us, companies may, through their articles,
go further than the statutory duties by placing more onerous requirements on
their directors (e.g. by requiring shareholder authorisation of the remunera-
tion of the directors (see Chapter 13, above)). It also makes it clear that the
companys articles may not dilute the general duties except to the extent this
is explicitly permitted. 
e e
ect of this provision seems to be that interested
members can vote on a resolution to approve a prospective breach of the statu-
tory duties, but cannot do so to ratify a breach a
er the event (see section 239,
below).
e requirements for approving long-term service contracts and payments for
loss of o
ce were discussed in Chapter 13. Here we outline the provisions deal-
ing with substantial property transactions and loans, quasi-loans and credit
transactions.
7/19/2012 2:29:49 PM
Substantial property transactions
Substantial property transactions
14.93
Sections 190196, which replace ss 320322 CA 1985, require substantial property
transactions involving the acquisition or disposal of substantial non-cash assets
by directors or connected persons (including shadow directors (s 223(1)(b)) to be
approved in advance by the companys members. A substantial property transac-
tion is de
ned as arising where the market value of the asset exceeds the lower of
100,000 or 10 per cent of the companys net asset value if more than 5,000 (s 191).
e principal features of the regime are:
it permits a company to enter into a contract which is conditional on mem-
ber approval. 
is implements a recommendation of the Law Commissions
e company is not to be liable under the contract if member ap-
proval is not forthcoming (s 190(3));
7/19/2012 2:29:49 PM
Directors duties
In
Duckwari
(No
(above) and
Duckwari
(No
3)
(1999) the Court
of Appeal stated that to be recoverable the loss or damage had to result from the
arrangement or transaction identi
ed as falling within s 190; and the loss may be
measured by reference to any depreciation in value of the asset acquired in con-
travention of the provision. 
e court was concerned with a transaction involving
the acquisition of property rather than the borrowing or use of monies to 
nance
its acquisition. 
e indemnity covered the di
erence between the purchase price
and its proceeds of sale taking account of any expenditure incurred in increasing
the propertys value, but excluding the 
nance costs of the acquisition.
Loans, quasi-loans and credit transactions
14.95
e regulation of loans by companies to their directors dates back to the
Companies Act 1948 and was severely tightened in the CA 1980 in order to
address the growing problem identi
ed in a series of DTI investigations of direc-
tors secretly directing money to themselves under the guise of loans on highly
favourable terms from their companies (see the White Paper,
Conduct
Company
Directors
(Cmnd 7037, 1977)). In contrast to the CA 1985, ss 197214
CA 2006 do not impose an absolute prohibition on loans to directors (including
shadow directors, (s 223(1)(c)) and connected persons but make such transac-
tions subject to the approval of the companys members by resolution and, in
certain circumstances, also subject to the approval by the members of its holding
company. Further, there are no criminal sanctions for breach of the provisions
but rather s 213 provides for civil consequences only and s 214 also provides for
subsequent a
rmation. 
e requirement for members approval of loans apply to
all UK registered companies with the exception of wholly-owned subsidiaries (s
195(7)). 
e provisions relating to quasi-loans and credit transactions apply only
to public companies and associated companies (ss 198203).
14.96
e are a number of exceptions to the requirement for members approval which
have been consolidated (see ss 204209). 
ese cover expenditure on company
business (s 204); expenditure on defending proceedings etc (s 205); expenditure
in connection with regulatory action or investigation (s 206); expenditure for
minor and business transactions (s 207); expenditure for intra-group transac-
tions (s 208); and expenditure for money-lending companies (s 209).
14.97
e e
ect of a breach of ss 197, 198, 200, 201 or 203 is that the transaction or
arrangement is voidable at the instance of the company (s 213(2)). Further, regard-
less of whether the company has elected to avoid the transaction, an arrangement
or transaction entered into in contravention of the provision renders the director
7/19/2012 2:29:49 PM
Rati cation of acts giving rise to liability
(together with any connected person to whom voidable payments were made and
any director who authorised the transaction or arrangement) liable to account to
the company for any gain he made as well as being liable to indemnify the company
for any loss or damage it sustains as a result of the transaction or arrangement
(s 213(4)). A director who is liable as a result of the company entering into a transac-
tion with a person connected with him has a defence if he can show that he took all
reasonable steps to secure the companys compliance with ss 200, 201 or 203.
14.98
e Act does not de
ne loan, although s 199 does de
ne the term quasi-loan
and related expressions (see s 199). Some guidance was provided in
Champagne
Perrier
Jouet
Finch
Ltd
(1982) in which the court explained that a loan
is a sum of money lent for a period of time to be returned in money or moneys
worth. In general, whether or not a payment to a director by the company is a
loan for the purposes of s 197 as opposed to remuneration for work done is a
fact-intensive exercise. 
e distinction is not always obvious. In
Currencies
Direct
Ltd
(2002) the defendant, a shareholder and director of the claimant com-
pany, received sums in cash or payment by way of expenses incurred by him.
When he was excluded from the management of the company it sought repay-
ment of 253,000 arguing that the sums were loans. 
e defendant argued that
the money received was remuneration. 
e trial judge held that the company
could only recover 43,117 that the defendant acknowledged was a loan, the bal-
ance being remuneration. 
e companys appeal to the Court of Appeal was dis-
missed. Mummery LJ stated that it is a misconception that a payment can only
be properly characterised as remuneration if there is a speci
c agreement  xing
the level or rate of remuneration or de
ning a formula for ascertaining a de
nite
amount to be paid. 
e essence of remuneration is that it is consideration for
work done or to be done . . . [it] may take di
erent forms. It is not necessarily in
the conventional form of a direct payment of a regular wage. 
e evidence was
plain, particularly the minutes of the board, that the payments were made as
remuneration.
Rati
cation of acts giving rise to liability
14.99
Section 239 puts the process of rati
cation by members of a breach of duty by direc-
tors onto a statutory footing. While broadly based on equitable rules, it imposes
stricter requirements and s 239(7) makes it clear that to the extent that the statu-
tory process is more lax, if at all, than the equitable rules and those in any enact-
ment, then those rules prevail so as to supplement or increase the requirements
laid down in the provision. Section 239(1) applies to the rati
cation by a com-
pany of conduct by a director amounting to negligence, default, breach of duty
7/19/2012 2:29:49 PM
Directors duties
or breach of trust in relation to the company. It therefore extends the rati
cation
process to all breaches of the duties set out in the CA 2006, Part 10. It should also
be recalled that rati
cation is also relevant to the courts consideration of whether
or not to allow a derivative claim to succeed under s 263 (see Chapter 10).
14.100
e notice convening the members meeting must state in explicit terms the pur-
pose for which the meeting is being called in so far that it must provide a fair,
candid, and reasonable explanation of the business proposed (
Kaye
Croydon
Tramways
(1898)). Failure to comply with this requirement will result in the
resolution, if passed, being held ine
ective as against those shareholders who dis-
sented or who were absent from the meeting.
14.101
Section 239(2) provides that the decision of the company to ratify such conduct
must
be made by a resolution of the members. 
is appears to be based on the
equitable rule noted by Lord Russell in
Rega
(Hastings
Ltd
iver
(above),
that the directors could, had they wished, have protected themselves by a resolu-
tion . . . of the Regal shareholders in general meeting. On the other hand, where a
director has fraudulently expropriated a company asset, the breach is non-rati
able (
Cook
Deeks
(above)).
14.102
Sections 239(3) and (4) provide that the rati
cation is e
ective only if the votes
of the director (qua
member) in breach (and any member connected with him)
are disregarded. 
is changes the pre-existing law (see, for example,
North
West
Transportation
Ltd
Beatty
(1887)), by disenfranchising the defaulting
director. Section 239(6) provides that nothing in the provision a
ects the law on
unanimous consent. 
is presumably means that the restrictions in ss 239(3)(4)
on who may vote on a resolution will not apply when every member (including
a director qua shareholder) votes, whether by informal means or otherwise, in
favour of the resolution. In this regard it is settled that a breach of duty is rati
able
by obtaining the informal approval of
every
member who has a right to vote on
such a resolution
(Re
Duomatic
Ltd
(19
e
Duomatic
rule only applies where
unanimous consent can be shown to exist, it will not validate majority decisions
made informally (see
Investments
Ltd
(2002) and
Extrasure
Trave
Insurances
Ltd
Scattergood
(above); further, members must have full knowledge
of the circumstances surrounding the breach and be aware of the fact that their
assent is being sought:
EIC
Services
Ltd
Phipps
(2003)).
Relief from liability
14.103
Section 1157 CA 2006, which replaces s 727 CA 1985, confers on the court the
7/19/2012 2:29:49 PM
Relief from liability
for negligence, default, breach of duty or breach of trust where it appears to the
court that the o
cer has acted
honest
reasonab
and that, having regard to
all the circumstances of the case, he ought fairly to be excused on such terms as
the court thinks 
t. Although there is a dearth of case law on the provision, some
parameters surrounding the type of conduct for which relief will be denied have
emerged. 
e courts will not grant relief where directors have abused their posi-
tion for 
nancial gain. In
Neptune
(Vehic
Washing
Equipment
Ltd
Fitzgera
(No
(1995), a sole director, in breach of his 
duciary duties, had secured com-
pany resolutions in order to obtain the payment to himself of 100,892 for the
termination of his service contract. He could not be said to have acted reasonably.
Similarly, relief was refused in
Guinness
Saunders
(1990), on the basis that
it was out of the question to relieve a director who retained 5.2m paid to him,
allegedly by way of remuneration, under a void contract. In
Duckwari
(No
(1998), the point was made
obiter
that a director who intends to pro
t by way of
a direct or indirect personal interest in a substantial property transaction could
not be said to have acted reasonably and therefore would be denied relief under
s 1157. Further, the discretion to relieve a director from liability will not be exer-
cised merely because of the absence of any 
nding of bad faith or actual con
ict
and the absence of quanti
able loss by the company or because of the negligible
pro
t to the defendant director (per Mummery LJ in
Towers
Premier
Waste
Management
Ltd
(2011)).
14.104
e section requires a director seeking relief from liability to prove honesty and
reasonableness. In
fab
Engineers
Ltd
(1990), the directors of a company
which had been trading at a loss sold its principal asset for the lower of two com-
peting bids on the understanding that the company would continue to be run
as a going concern. Shortly a
erwards the company went into liquidation and
the liquidator brought misfeasance proceedings against the directors. It was held
that the directors had not acted in breach of duty in accepting the lower o
er
but, even if they had, it was a case in which relief would be granted under s 1157.
Ho
mann J took the view that the directors were motivated by an honest and
reasonable desire to save the business and the jobs of the companys employees.
14.105
e requirement of reasonableness contained in s 1157 has presented the judges
with the apparent conundrum of 
nding negligent conduct reasonable. 
e judicial
response appears to suggest a willingness to dilute the objective character of the con-
cept of reasonableness when determining the availability of relief. 
is is particu-
larly discernible in Ho
mann LJs judgment in
Jan
London
Ltd
(1994), where
he fashioned a solution based upon a subjective consideration of the directors con-
duct. A straightforward proposal form for property insurance contained numerous
factual errors. 
e insurers subsequently repudiated liability on the policy when the
company claimed for 
re damage. 
e controlling director had signed the proposal
7/19/2012 2:29:49 PM
Directors duties
without reading it. Ho
mann LJ thought that it was the kind of mistake that could
be made by any busy man. In granting the director partial relief from liability, the
court had regard to the fact that he held 99 of the companys shares (his wife held the
other), and therefore the economic reality was that the interests the director had put
at risk were those of himself and his wife. 
e judge observed:
It may seem odd that a person found to have been guilty of negligence, which
involves failing to take reasonable care, can ever satisfy the court that he acted
reasonably. Nevertheless, the section clearly contemplates that he may do so
and it follows that conduct may be reasonable for the purposes of section 727
[now s 1157] despite amounting to lack of reasonable care at common law.
14.106
Similarly, in
Brian
Pierson
(Contractors
Ltd
(2001), Hazel Williamson QC,
sitting as a deputy High Court judge, applying
Jan
London
Ltd
observed
that reasonableness for the purpose of s 1157 must be meant to be capable
of being satis
ed by something less than compliance with the common law
standard of care in negligence (see also,
Paycheck
Services
Ltd
(2009)). 
e
reasoning in these decisions discloses that the court can take into account con-
siderations such as directors favouring corporate stakeholders, and the degree of
culpability of his or her conduct when determining whether or not it is reason-
able and therefore excusable. In the latter type of case, an honest but negligent
director might therefore be relieved from liability provided the negligence in
question was not gross but the kind of thing that could happen to any busy
person (cf.
Dorchester
Finance
Ltd
(1989)). Complete inactivity
as a director is clearly unreasonable and cannot, therefore, be enlisted for the
purposes of s 1157 to support the contention that the director had acted hon-
estly and reasonably (
(in
admin
Luqman
(2007); see also,
Brian
Pierson
(Contractors
Ltd
(above)). Subjectivity also signi
cantly and
peculiarly coloured the interpretation of s 1157 by the trial judge in
Box
(Diamonds
Ltd
(2000). Peter Smith QC, sitting as a deputy judge of the
Chancery Division, expressed the view that s 1157 is designed to achieve fair-
ness as between wrongdoers. 
e judge thought it fair to grant partial relief to
a 19-year-old director against the consequences of the actions, which were not
caused by any direct fault on his part, but arose from the conduct of his father in
whom he reposed too much trust. In the event, relief became irrelevant because
the Court of Appeal found that the director was not liable at all
(Cohen
(2001)).
14.107
However, Lord Ho
manns subjective approach has been challenged. In
Bairstow
ueens
Moat
Houses
(2001), the directors, acting on the companys 1991
accounts that incorrectly showed in
ated pro
ts, unlawfully paid dividends which
exceeded the available distributable reserves (see Chapter 7). Robert Walker LJ
7/19/2012 2:29:49 PM
Further reading
refuted the notion that reasonableness is capable of being satis
ed from an essen-
tially subjective point of view (see also
MDA
Investment
Man