La3021 Vle

Company law
Alan Dignam
John Lowry
Chris Riley
This module guide was prepared for the University of London by:
u Alan Dignam, BA, (TCD), PhD (DCU), Professor of Corporate Law, Queen Mary,
University of London
and
u John Lowry, Cheng Yu Tung Visiting Professor, Faculty of Law, Hong Kong University,
and Emeritus Professor, Faculty of Laws, University College London.
The 2016, 2017, 2018, 2019 and 2020 updates were prepared by:
u Chris Riley, LLB, Associate Professor, Durham Law School, University of Durham.
This is one of a series of module guides published by the University. We regret that owing
to pressure of work the authors are unable to enter into any correspondence relating to,
or arising from, the guide. If you have any comments on this module guide, favourable or
unfavourable, please use the form at the end of this guide.
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Published by: University of London
© University of London 2016. Reprinted with minor revisions in 2017, 2018, 2019 and 2020
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Company Law page i
Contents
Module descriptor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
1.1 Company law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
1.2 Approaching your study . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
2 Forms of business organisation . . . . . . . . . . . . . . . . . . . . . . 7

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
2.1 The sole trader . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
2.2 The partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
2.3 The company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
2.4 Some general problems with the corporate form . . . . . . . . . . . . . . 13
Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
3 The nature of legal personality . . . . . . . . . . . . . . . . . . . . . 19

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
3.1 Corporate personality . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
3.2 Salomon v Salomon & Co . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
3.3 Other cases illustrating the Salomon principle . . . . . . . . . . . . . . . . 22
3.4 Limited liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
4 Lifting the veil of incorporation . . . . . . . . . . . . . . . . . . . . . 27

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
4.1 Legislative intervention . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
4.2 Judicial veil lifting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
4.3 Actions in tort . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
5 Company formation, promoters and pre-incorporation contracts . . . 39

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
5.1 Determining who is a promoter . . . . . . . . . . . . . . . . . . . . . . . 41
5.2 The fiduciary position of promoters . . . . . . . . . . . . . . . . . . . . . 41
5.3 Duties and liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
5.4 Pre-incorporation contracts . . . . . . . . . . . . . . . . . . . . . . . . . 42
5.5 Freedom of establishment . . . . . . . . . . . . . . . . . . . . . . . . . . 44
6 Raising capital: equity . . . . . . . . . . . . . . . . . . . . . . . . . . 49

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
6.1 Private and public companies . . . . . . . . . . . . . . . . . . . . . . . . 51
6.2 Raising money from the public . . . . . . . . . . . . . . . . . . . . . . . . 52
6.3 Insider dealing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
6.4 Regulating takeovers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
page ii University of London
7 Raising capital: debentures . . . . . . . . . . . . . . . . . . . . . . . 61

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
7.1 Debentures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
7.2 Company charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
7.3 Priority . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
7.4 Avoidance of floating charges . . . . . . . . . . . . . . . . . . . . . . . . 68
8 Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
8.1 Overview – the maintenance of capital doctrine . . . . . . . . . . . . . . . 75
8.2 Raising capital: shares may not be issued at a discount . . . . . . . . . . . . 75
8.3 Returning funds to shareholders . . . . . . . . . . . . . . . . . . . . . . . 76
8.4 Prohibition on public companies assisting in the acquisition of
their own shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81
9 Dealing with insiders: the articles of association and shareholders’

agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88
9.1 The operation of the articles of association . . . . . . . . . . . . . . . . . . 89
9.2 The articles of association . . . . . . . . . . . . . . . . . . . . . . . . . . 89
9.3 The contract of membership . . . . . . . . . . . . . . . . . . . . . . . . . 91
9.4 Shareholders’ agreements . . . . . . . . . . . . . . . . . . . . . . . . . . 94
9.5 Altering the articles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
10 Class rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100
10.1 Shares and class rights . . . . . . . . . . . . . . . . . . . . . . . . . . . 101
10.2 Classes of shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102
10.3 Variation of class rights . . . . . . . . . . . . . . . . . . . . . . . . . . . 103
Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107
11 Majority rule and wrongs against the company . . . . . . . . . . . . 109

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110
11.1 The rule in Foss v Harbottle – the proper claimant rule . . . . . . . . . . . . 111
11.2 Forms of action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112
11.3 Derivative claims: introduction . . . . . . . . . . . . . . . . . . . . . . . 116
11.4 A short excursion into the former common law . . . . . . . . . . . . . . . 116
11.5 The statutory procedure: Part 11 of the CA 2006 . . . . . . . . . . . . . . 118
11.6 The proceedings, costs and remedies . . . . . . . . . . . . . . . . . . . . 121
12 Statutory minority protection . . . . . . . . . . . . . . . . . . . . . 125

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126
12.1 Winding up on the ‘just and equitable’ ground . . . . . . . . . . . . . . . 127
12.2 Unfair prejudice – s.994 CA 2006 . . . . . . . . . . . . . . . . . . . . . . 129
Company Law page iii
13 Dealing with outsiders: ultra vires and other attribution issues . . . . 139
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140
13.1 The objects clause problem . . . . . . . . . . . . . . . . . . . . . . . . . 141
13.2 Reforming ultra vires . . . . . . . . . . . . . . . . . . . . . . . . . . . . 142
13.3 Other attribution issues . . . . . . . . . . . . . . . . . . . . . . . . . . 145
14 The management of the company . . . . . . . . . . . . . . . . . . . 151

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 152
14.1 Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153
14.2 Categories of director . . . . . . . . . . . . . . . . . . . . . . . . . . . . 156
14.3 Disqualification of directors . . . . . . . . . . . . . . . . . . . . . . . . 158
15 Directors’ duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 166
15.1 Directors’ duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167
15.2 The restatement of directors’ duties: Part 10 of the CA 2006 . . . . . . . . . 169
15.3 Relief from liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 184
15.4 Specific statutory duties . . . . . . . . . . . . . . . . . . . . . . . . . . 185
16 Corporate governance . . . . . . . . . . . . . . . . . . . . . . . . . 191

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 192
16.1 Introducing corporate governance . . . . . . . . . . . . . . . . . . . . . 193
16.2 The shareholder–stakeholder debate in the UK . . . . . . . . . . . . . . . 195
16.3 UK corporate governance developments . . . . . . . . . . . . . . . . . . 195
17 Liquidating the company . . . . . . . . . . . . . . . . . . . . . . . . 205

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206
17.1 Liquidating the company . . . . . . . . . . . . . . . . . . . . . . . . . . 207
17.2 The liquidator . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209
17.3 Directors of insolvent companies . . . . . . . . . . . . . . . . . . . . . . 211
17.4 Reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 211
Feedback to activities . . . . . . . . . . . . . . . . . . . . . . . . . . . 215

Chapter 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217
Chapter 3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217
Chapter 4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 218
Chapter 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 218
Chapter 6 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 219
Chapter 7 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 220
Chapter 8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 221
Chapter 9 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 221
Chapter 10 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 222
Chapter 11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 223
Chapter 12 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 223
page iv University of London
Chapter 13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224
Chapter 14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 225
Chapter 15 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 226
Chapter 16 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 228
Chapter 17 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 228
Company Law page v
Module descriptor
GENERAL INFORMATION
Module title
Company law
Module code
LA3021
Module level
6
Contact email
The Undergraduate Laws Programme courses are run in collaboration with the
University of London. Enquiries may be made via the Student Advice Centre at:
https://sid.london.ac.uk/sid
Credit
30
Courses on which this module is offered

LLB, EMFSS
Module prerequisite
None
Notional study time

300 hours
MODULE PURPOSE AND OVERVIEW

Company law is offered as an optional module to students studying on the Standard
Entry and Graduate Entry LLB courses. It is also offered as an Individual Module. Credits
from an Individual Module will not count towards the requirements of the LLB.
Company law is a vital module for anyone intending to operate in a commercial field.
The syllabus centres on the way the law regulates companies and the facilities that
company law offers, such as limited liability and transferability of shares, as well as
corresponding burdens such as duties of disclosure and compliance with statutory
procedures.
MODULE AIM
The module aims to introduce students to the nature, and the regulation, of the
modern business company. It will enable students to understand what is distinctive
about the company, the advantages it enjoys as a way of running a business and the
policy issues that its existence raises. Students should learn to understand some
of the central concepts relevant to the company, such as limited liability and legal
personality, the competing interests of different groups of individuals who are
affected by a company’s operations, such as its directors, shareholders, creditors and
employees, and the role that the law can play in protecting such individuals.
page vi University of London
LEARNING OUTCOMES: KNOWLEDGE

Students are expected to have knowledge and understanding of the main concepts,
principles and rules that make up company law, as well as the policy issues that the
regulation of companies raises. In particular they should be able to:
1. Explain the main concepts that underpin company law, including separate legal
personality and limited liability;
2. Comprehend the policy issues that arise regarding the regulation of companies,
including the views of different commentators about those policy issues;
3. Discuss the main principles and rules that seek to regulate and protect different
participants within companies, especially their directors, shareholders and
creditors;
4. Summarise the issues that arise in respect of large, widely owned, public
companies and the strategies that have been developed to ensure such companies
are well governed.
LEARNING OUTCOMES: SKILLS

Students completing this module should be able to demonstrate the ability to:
5. Identify the legal issues raised by complex hypothetical ‘problem question’

scenarios, and apply their knowledge of the main principles and rules of company
law to articulate well-argued solutions to those questions;
6. Critically analyse and evaluate selected areas of company law and place the policy
issues raised by company law in their social, economic and political contexts;
7. Develop well-reasoned analysis and arguments for the reform of selected areas
of company law, including by engaging critically with the arguments of other
commentators;
8. Critically read case law and other materials and construct answers to questions set.
BENCHMARK FOR LEARNING OUTCOMES

Quality Assurance Agency (QAA) benchmark statement for Law 2019.
MODULE SYLLABUS
(a) The nature of legal personality and lifting the veil of incorporation. Incidents of
corporate personality. Differences between incorporated and unincorporated
associations. The rule in Salomon v Salomon & Co Ltd and its development. Tortious
liability as an alternative to veil lifting.
(b) The formation of the company. The suitability of the company as a legal vehicle for
different types of business. The registration process, including the memorandum
and articles of association. Pre-incorporation contracts. The duties and liabilities of
promoters.
(c) The relations between the company and outsiders. The growth and decline of
the doctrines of ultra vires and constructive notice. The Turquand rule and the
application of principles of agency. The commission of crimes and torts by the
company. Vicarious liability and the alter ego doctrine.
(d) The relations between the company and its members and among the members inter
se. The nature of and principles governing the statutory contract between the
company and its members. Different capacities of members and relations between
one member and another. Alteration of the statutory contract and remedies for
breach.
(e) Management of the company. Directors and other officers. Appointment.

Retirement. Dismissal. Disqualification. Meetings. Voting. Resolutions. Division of
functions among officers and organs of the company.
Company Law page vii
(f) Directors’ duties. The general duties of directors, and the codification of those
duties. Statutory controls on directors, including rules on self-dealing and the
criminalisation of insider trading. The enforcement of directors’ duties, including
the rule in Foss v Harbottle and the statutory derivative claim.
(g) The protection of minority shareholders. The statutory remedies for the protection of
minority shareholders. Shareholders’ personal rights, including under the statutory
contract.
(h) Corporate governance. Corporate accountability (stakeholder v shareholder

issues). Problems arising from the separation of ownership and control, including
executive compensation and shareholder engagement. The role of hostile
takeovers in disciplining management. Reforming the role and composition of
boards. UK corporate governance codes (e.g. the UK Corporate Governance Code
and the Stewardship Code). The Company Law Review Steering Group. Company
discloslure.
(i) Shares and Debentures. Differences between shares and debentures. Registration.
Different classes of shares. Rights of different classes and the variation of share
rights.
(j) Capital. Raising, maintaining and reducing the capital of the company. Discounts.
Premiums. Payment of dividends and purchase by the company of its shares.
Financial assistance for the purchase of its shares. Raising capital from the public:
the requirements for prospectuses and listing particulars.
(k) Winding-up. Types of winding-up. The powers and duties of the liquidator.
LEARNING AND TEACHING
Module guide
Module guides are the students’ primary learning resource. The module guide covers
the entire syllabus and provides the student with the grounding to complete the
module successfully. It sets out the learning outcomes that must be achieved as
well as providing advice on how to study the module. It also includes the essential
reading and a series of self-test activities together with sample examination questions,
designed to enable students to test their understanding. The module guide is
supplemented each year with the pre-exam update, made available on the VLE.
The Laws Virtual Learning Environment

The Laws VLE provides one centralised location where the following resources are
provided:
u a module page with news and updates, provided by legal academics associated
with the Laws Programme;
u a complete version of the module guides;
u pre-exam updates;
u past examination papers and reports;
u discussion forums where students can debate and interact with other students;
u Computer Marked Assessments – multiple choice questions with feedback

are available for some modules allowing students to test their knowledge and
understanding of the key topics.
The Online Library

The Online Library provides access to:
u the professional legal databases LexisLibrary and Westlaw;
u cases and up-to-date statutes;

page viii University of London
u key academic law journals;
u law reports;
u links to important websites.
Core text
Students should refer to the following core text and specific reading references are
provided for this text in each chapter of the module guide:
¢ Dignam, A. and J. Lowry Company law. (Oxford: Oxford University Press, 2020)
11th edition [ISBN 9780198848455].
ASSESSMENT
Formative assessment is conducted through tasks in the module guide, which include
self-assessment activities with feedback. There are additional online activities in the
form of multiple choice questions. The formative assessment will prepare students to
reach the module learning outcomes tested in the summative assessment.
Summative assessment is through a three hour and fifteen minute unseen

examination. Students must answer four questions out of eight: at least one question
from Part A (essay questions) and at least two questions from Part B (problem
questions).
Permitted materials
Students are permitted to bring into the examination room the following document:
¢ Core statutes on company law 2020–21 (Palgrave Macmillan).
Please be aware that the format and mode of assessment may need to change in
light of extraordinary events beyond our control, for example, an outbreak such as
the coronavirus (COVID-19) pandemic. In the event of any change, students will be
informed of any new assessment arrangements via the VLE.
1 Introduction
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
1.1 Company law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
1.2 Approaching your study . . . . . . . . . . . . . . . . . . . . . . . . . . 3

page 2 University of London
Introduction
This module guide acts as a focal point for your study of Company law. It is intended
to aid your comprehension by taking you carefully through each aspect of the
subject. Each chapter also provides an opportunity to digest and review what you
have learned by allowing a pause to think and complete activities. At the end of
each chapter there are sample examination questions to attempt once you have
completed and digested the further reading.
Company law requires students to develop their existing understanding of tort,

contract, equity, statutory and common law interpretation. It also provides students
with new conceptual challenges such as corporate personality. This combination
of development and new challenge can initially be a difficult one and the initial
learning period will be greatly eased if you understand the everyday context within
which company law issues affect businesses. All of the major national newspapers
cover company law issues in their business sections. Keeping on top of business and
general news developments will help to put your learning into context and aid your
comprehension of the subject. It may even stimulate your enjoyment of company law!
Learning outcomes
By the end of this chapter and the relevant readings , you should be able to:
u approach the study of Company law in a systematic way
u understand what the various elements of the module guide are designed to do
u begin your study of Company law with confidence.
Company Law 1 Introduction page 3
1.1 Company law

Company law is about the formation of companies, their continuing regulation during
their life and the procedures for dealing with their assets when they are terminated
in a liquidation. The state (the Government) consequently plays a major role in
company law. However, self-regulation, as we will see, also plays a significant part in
the regulation of larger companies and is widely discussed in the theoretical literature.
Company law is one of those subjects that students describe as difficult and lecturers
describe as challenging. The difficulty or challenge involved for the student in
understanding company law is to overcome the attitude that law is somehow
compartmentalised. Most of your previous undergraduate teaching has tended to
package subjects neatly – tort, contract, equity, etc. While this provides a nice orderly
initial learning experience it is unhelpful for students when they come to subjects like
company law where tort, contract, and equity all combine. The result can be an initial
disorientation which clears over time. As such, it is important that you have a good
knowledge of tort, contract and equity, and understand how the common law works,
before you tackle this subject.
1.1.1 Reforming company law

After the election of the Labour government in 1997 there was an ongoing review of
company law which resulted in the Companies Act 2006 (CA 2006). It is very important
that any student of company law has a knowledge of this reform project. The various
consultation papers and the Final Report of the Department for Business Enterprise and
Regulatory Reform (BERR)† Company Law Review Steering Group (CLRSG) are available †
BERR used to be the
at http://webarchive.nationalarchives.gov.uk/20100202121952/http://berr.gov.uk/ Department for Trade and
whatwedo/businesslaw/co-act-2006/clr-review/page22794.html Industry (DTI). In June 2009
BERR became the Department
The Final Report forms the basis of the Government’s 2002 and 2005 White Papers.
for Business, Innovation
These are also available at the same web address. The proposals of the CLRSG and the
and Skills (BIS) and is now
Government’s response, together with the relevant provisions of the CA 2006, are
known as the Department
discussed where they impact on each individual chapter, but we also expect you to go for Business, Energy and
through these background documents yourself. They provide a wealth of analysis of Industrial Strategy (BEIS).
different areas of company law, and of proposals for reform. Studying them will give
you some of the knowledge and ideas you need for success on this course.
The CA 2006 was brought into force during the period 2007–09.
Further reading
You will also find further ideas in the following two pieces of reading:
¢ Goddard, R. ‘Modernising Company Law: the Government’s White Paper’ (2003)

Modern Law Review 402–24 (available in the Online Library).
¢ Reisberg, A. ‘Corporate law in the UK after recent reforms: the good, the bad and
the ugly’ (2010) Current Legal Problems 315 (available in LexisLibrary).
1.2 Approaching your study

This guide is designed to be your first reference point for each topic covered on the
course. Read through each chapter carefully. The activities occur at points in each
chapter where you need to pause and digest the information you have just covered.
That means you should stop and think about what you have just learned. Feedback
to many of the activities is provided at the end of the guide. However, try not to read
the feedback immediately. Use the activity to aid your reflection. Read it and think
generally about the issues it is trying to address.
Do this throughout the chapter and when you have completed it move to the Core
text. After this give yourself some time to think about what you have learned or if
things are unclear you may need to read over certain points again. Once you have read
the chapter and the Core text, attempt, in writing, the chapter’s activities. Use them as
an opportunity to test your understanding of the area. At this point read the feedback
provided to see if you are on the right track. Once you have completed this, move to
the Further reading. Again, after completing the Further reading, give yourself time to
think and re-read. Finally, you should attempt the sample examination question at the
end of each chapter. Use the ‘Reflect and review’ section at the end of each chapter to
keep track of your progress.
Go through the guide like this, covering each chapter in turn. Each chapter builds up
your knowledge of the subject and so dipping into the guide as you feel like it will not
work. Later chapters presume you have covered and understood the earlier ones. As
we explain below, you will also have to monitor case developments, reform initiatives
and seek out new company law writing to flesh out your understanding of the subject
and develop your independence of thought.
1.2.1 Readings
Core text
¢ Dignam, A. and J. Lowry Company law. (Oxford: Oxford University Press, 2020)
11th edition [ISBN 9780198848455].
This module guide is centred on this textbook, which was written by the authors
of this guide. References in the text to ‘Dignam and Lowry’ are references to this
textbook. You may have an earlier edition of this textbook. You will be able to find the
relevant readings for this course by using the contents list and index of any earlier
edition.
It is your core reading and so much of your study time should be taken up reading the
textbook, though you will also have to study numerous case reports, complete the
further reading and keep up to date with academic company law writing.
Further reading
¢ Davies, P.L. and S. Worthington Gower and Davies: principles of modern company
law. (London: Sweet & Maxwell, 2016) 10th edition [ISBN 9780414056268].
This is a very comprehensive and authoritative textbook. It is very detailed, but it is a

good source to look at when you are struggling with a point. Readings from Davies and
Worthington (‘Davies and Worthington’) are specified in the Further reading at the
end of each chapter. Like ‘Dignam and Lowry’ this book is cited using just the authors’
names.
¢ Reisburg, A. and A. Donovan Pettet, Lowry and Reisburg’s company law:

company law & corporate finance. (Harlow: Pearson, 2018) fifth edition
[ISBN 9781292078632].
This text is particularly interesting as it fleshes out the interaction of company law
with capital markets and securities regulation.
¢ Worthington, S. Sealy & Worthington’s text, cases and materials in company law.
(Oxford: Oxford University Press, 2016) 11th edition [ISBN 9780198722052].
¢ Dignam, A. Hicks & Goo’s cases and materials on company law. (Oxford: Oxford
University Press, 2011) seventh edition [ISBN 9780199564293].
¢ Kershaw, D. Company law in context: text and materials. (Oxford: Oxford

University Press, 2012) second edition [ISBN 9780199609321].
This book places the study of company law in its economic, business and social
context. This makes the cases, statutes and other forms of regulation that make up
company law more accessible and relevant.
Three significant books are also drawn to your attention. We don’t suggest you buy
these texts but rather that you use them in a library (if you can get access to one).
¢ Parkinson, J.E. Corporate power and responsibility: issues in the theory of company
law. (Oxford: Clarendon Press, 1995) [ISBN 9780198259893].
Company Law 1 Introduction page 5
¢ Cheffins, B.R. Company law: theory, structure and operation. (Oxford: Oxford
University Press, 1997) [ISBN 9780198764694].
¢ Dignam, A. and Galanis, M. The globalization of corporate governance. (Farnham:

Ashgate, 2009) [ISBN 9780754646259].
Parkinson (1995) examines the corporate law issues surrounding the ‘stakeholder’
debate in the UK (there is more on this in Chapter 16 on corporate governance, but
for now it refers to a debate about whether ‘stakeholders’, such as employees and
consumers, and issues raised by environmentalists and public interest bodies should
be the focus of the exercise of corporate power). John Parkinson also chaired the
corporate governance group as part of the Department of Trade and Industry’s (now
called the Department for Business, Energy and Industrial Strategy (BEIS)) CLRSG
Review of UK company law. His views are therefore important in understanding the
CLRSG findings and the corporate governance provisions in the CA 2006.
The second book we would draw your attention to here is Cheffins (1997). The
company law and economics school is a growing and influential one in UK company
law. Knowledge of it is essential to an understanding of many of the current debates in
company law.
The third book, Dignam and Galanis (2009), provides a perspective on the corporate
governance material used in this module guide, based around the globalisation of
product and securities markets.
A statute book is a good addition to your personal company law library. These are
generally updated every year and it is important that you use the most up to date
version. A good choice is:
¢ Core statutes on company law 2020–21 (Palgrave Macmillan).
You are currently allowed to bring this book into the examination. Check the
Regulations for up to date details of what you are allowed to bring into the
examination with you.
Please note that you are allowed to underline or highlight text in these documents –
but you are not allowed to write notes or attach self-adhesive notelets, etc. on them.
See the Regulations for further guidance on these matters.
Legal journals
A good Company law student is expected to be familiar and up to date with the latest
articles and books on company law. Company law articles often appear in the main
general UK legal academic journals:
¢ Modern Law Review (MLR)
¢ Oxford Journal of Legal Studies (OJLS)
¢ Journal of Law and Society (JLS)
¢ Law Quarterly Review (LQR)
¢ Cambridge Law Journal (CLJ).
It is essential that you keep up to date with developments reported in these journals.
Specific dedicated company or business law journals are also very useful for company
law students. The Company Lawyer, Journal of Corporate Law Studies, European Business
Organisation Law Review and Journal of Business Law are among the best, combining
current academic analysis of issues with updates on case law and statute.
Other sources
Your understanding of many of the issues we will study will be aided immeasurably if
you understand the context within which company law issues affect businesses. All
major national newspapers cover these issues in their business sections. In an ideal
world you would read these sections each day, either by buying a newspaper, reading
it online or going to the library to go through them.
However, we do not live in an ideal world, so a good compromise is to buy or read in

a library the Saturday version of the Financial Times or view it online. It contains an
update on all the week’s business and general news developments. If you can manage
to do this over the academic year, it will help to put your learning into context and aid
your comprehension of the course.
While company law cases appear in the main law reports there are two dedicated
company law reports, British Company Law Cases (BCC) (published yearly by Sweet
& Maxwell) and Butterworth’s Company Law Cases (BCLC), which are very useful.
Online sources such as Westlaw and Lexis, which you can access through the Online
Library, also carry these reports as well as unreported cases. You might also find it
useful sometimes to dip into texts such as Palmer’s Company Law (Sweet & Maxwell)
(available in Westlaw via the Online Library) or Gore-Browne on Companies (Jordan
Publishing) in a good law library (if you can access one). These are practitioner texts
which are regularly updated and contain a wealth of up to date information.
2 Forms of business organisation
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
2.1 The sole trader . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
2.2 The partnership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
2.3 The company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
2.4 Some general problems with the corporate form . . . . . . . . . . . . . 13
Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Introduction
Companies are the dominant form of business association in the UK. They are not,
however, the only form of business association. Sole traders and partnerships also
exist as specific legal forms of business. In this chapter we explore the place of the
company within the various legal forms of business organisation available in the UK in
order to provide some insight as to how the company has come to be the dominant
form. In doing so we will consider the various forms of business organisation from the
point of view of their ability to raise capital (money), their ability to minimise risk and
their ability to provide some sort of clear organisational structure. We will also explore
some of the general problems that the corporate form poses for businesses.
In general this subject is not a course in the detailed procedural aspects of company
law. Having said that, in this chapter, more than any other in the guide, we will touch
upon procedural matters as they arise. This is because key aspects of the procedural
nature of setting up a company are very useful for understanding later chapters such
as Chapter 5: ‘Company formation, promoters and pre-incorporation contracts’ and
Chapter 9: ‘Dealing with insiders’. Some of you may find this procedural detail off-
putting, but bear with it and complete the activities. It will pay dividends in the later
chapters.
Learning outcomes
By the end of this chapter and the relevant readings, you should be able to:
u illustrate the differences between the major forms of business organisation in
the UK
u describe the advantages and disadvantages of each form of business
organisation
u explain the different categories of company
u demonstrate the difficulties small businesses have with the company as a form
of business organisation.
Core text
¢ Dignam and Lowry, Chapter 1: ‘Introduction to company law’.
Company Law 2 Forms of business organisation page 9
2.1 The sole trader

A sole trader is a very simple legal form of business. As such there is very little for us to
discuss here beyond its advantages and disadvantages. It is, as the name suggests, a
one-person business.
Advantages
u No legal filing requirements or fees and no professional advice is needed to set it
up. You just literally go into business on your own and the law will recognise it as
having legal form.
u Simplicity – one person does not need a complex organisational structure.
Disadvantages
u It is not a particularly useful business form for raising capital (money). For most
sole traders the capital will be provided by personal savings or a bank loan.
u Unlimited liability – the most important point to note in terms of comparing

this form to the company is that there is no difference between the sole trading
business and the sole trader himself. The profits of the business belong to the sole
trader but so do the losses. As a result he has personal liability for all the debts of
the business. If the business collapses owing money (an insolvent liquidation – see
Chapter 17) then those owed money by the company (its creditors) can go after the
personal assets of the sole trader (e.g. his car or house) in order to get their money
back.
Activity 2.1
From the point of view of raising capital, minimising risk and providing an
organisational structure, assess the merits of a sole trading concern.
No feedback provided.
2.2 The partnership

The second legal vehicle to consider is a partnership. In the UK, there are different
types of partnership. Here, we are considering a ‘general’, or ‘unlimited’, partnership,
which is governed by the Partnership Act 1890. Partnerships are very flexible legal
business forms. While we are more familiar with complex partnerships such as law
firms or accountancy firms, partnerships can also be very simple affairs. Section 1 of the
Partnership Act 1890 defines a partnership as ‘the relationship which subsists between
persons carrying on a business in common with a view of profit’. This is a very broad
category and sometimes causes problems (see disadvantages below).
Advantages
u No formal legal filing requirement involved in becoming a partnership beyond the
minimum requirement that there be two members of the partnership. Once there
are two people who form the business it will be deemed a legal partnership.
u It facilitates investment as it allows two or more people to pool their resources.

The maximum number of partners allowable is, since 2002, unlimited. Prior to that
it was 20 unless you were a professional firm – solicitors, accountants etc.
u If you are aware of the problems the Partnership Act can cause (see disadvantages
below) then you can draft a partnership agreement to vary these terms of the
Act and provide an accurate reflection of your intentions when entering the
partnership. The partnership agreement can therefore be used to provide a very
flexible organisational structure although this usually involves having to pay for
legal advice.
Disadvantages
u The Partnership Act 1890 can be a danger to the unwary. The broad definition of a
partnership is a particular problem. For example, three people going into business
together without forming a company will be partners whether they know it or not.
This can cause problems, as the Partnership Act 1890 imposes certain conditions
for the continued existence of the partnership. If one of our three unknowing
partners dies, the Partnership Act will deem the partnership (even though the
participants did not know they were partners) to have ended. This is the case even
where a successful business is being operated through the partnership. As a result
of these types of problems those who choose to be partners will usually draft a
more formal arrangement called a partnership agreement specifying the terms
and conditions of the partnership. The Act also entitles each partner:
u to participate in management
u to an equal share of profit
u to an indemnity in respect of liabilities assumed in the course of the

partnership business
u not to be expelled by the other partners.
u A partnership will end on the death of a partner. If you are unaware of this when
the partnership is formed, the rigidity of the Act may not reflect the intention of
the partners.
u The partners are jointly and severally liable for the debts of the partnership. This
means that each partner can be sued for the total debts of the partnership. In
essence, partnerships are founded on relationships of trust. If that trust is breached
then the remaining partner or partners can pay a heavy price as they must pay
all the debts owed. However, if that relationship of trust is maintained then the
partnership effectively reduces the risk of doing business compared to that taken
by a sole trader because partners share the risk.
Activity 2.2
organisational structure, assess the merits of a partnership.
2.3 The company

A company is formed by applying to the registrar of companies, providing a
constitution (essentially a set of rules for the company similar to a public law
conception of a constitution, see below), the names of the first directors and members
plus a small fee. This formation process is called incorporation. The registered
company has become the dominant legal business form in the UK. The reasons for this
are not as obvious as one might assume, as we will explore in this section.
2.3.1 Categories of company

Company law is mainly concerned with the company 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). There are also companies limited by
guarantee. These companies were designed for charitable or public interest ventures
where no profit is envisaged. As a result the people behind the venture guarantee
to pay a certain amount towards the debts of the company should it fail. Companies
limited by shares are also subdivided into public and private companies limited by
shares.
Differences between public and private companies limited by shares

u Before 1992 you needed two shareholders to form a private company limited by
shares. The Twelfth EC Company Law Directive (89/667) changed this requirement.
Similarly, until the Companies Act 2006 (CA 2006) was enacted, you still needed
two shareholders to form a public limited company. Now, under the CA 2006, both
private and public companies can be formed with a single shareholder (although
of course many have lots of shareholders).
u In private companies investment comes either from the founding members in the
form of personal savings or from a bank loan. Private companies are prohibited
from raising capital from the general public.
u Public companies, on the other hand, are formed specifically to raise large
amounts of money from the general public.
u Private companies can restrict their membership to those the directors approve
of or insist that those who wish to leave the company first offer their shares to
the other members. Public companies could also do this but, as their aim is to
raise money from the general public, a restriction on the sale of shares would not
encourage the general public to invest.
u Public companies have a minimum capital requirement of £50,000 (s.763 CA 2006).

That capital requirement does not have to be fully paid – it just needs one quarter
of the £50,000 to be paid and an ability to call on the members for the remaining
amount. Private companies have no real minimum capital requirements. For
example a private company can have an authorised share capital of £1 subdivided
into shares of 1p each. Because public companies raise capital from the general
public there is a raft of extra regulations that affects their activities. This is
discussed extensively in Chapter 6 on raising equity.
u Public companies are generally subject to a lot more regulation than private
companies. For example, public companies must have at least two directors;
private companies need have only one. Public companies must have a ‘company
secretary’. Private companies can choose whether or not to have one.
u Private companies can also adopt a more streamlined procedure for passing
shareholder resolutions. Instead of having to pass resolutions at a meeting at
which shareholders are physically present, Part 13 of the CA 2006 allows most
resolutions, in private companies, to be passed ‘in writing’.
Limited liability
One of the most obvious differences between the company and other forms of
business organisation is that the members of both private and public companies have
limited liability. This means that the members of the company are only liable for the
amount unpaid on their shares and not for the debts of the company. We will explore
how this operates in some detail in the next chapter. In order to warn those who
might deal with a company that the members have limited liability the word ‘limited’
or ‘Ltd’ must appear after a private company’s name or ‘plc’ after a public company
(ss.58 and 59 CA 2006).
2.3.2 The constitution of the company

As part of the registration procedure both public and private companies must provide
a constitution which sets out the powers of the company and allocates them to
the company’s organs, usually the general meeting and the board of directors. This
constitution historically consisted of two documents: the memorandum of association
and the articles of association. The CA 2006 requires just a single document that
replaces the current constitution (see s.18 CA 2006). The memorandum still exists as a
separate document as part of the registration requirements under the 2006 Act (see
Chapters 9 and 13).
The memorandum
Prior to the CA 2006, the memorandum was a fairly substantial document which those
forming a company needed to prepare. It contained a lot of information, including
details of the company’s share capital, its registered office and the ‘objects’ of the
company (see below). The CA 2006 changed this. Now, most of this information is
contained either in the company’s articles of association, or in the application form
that must be submitted to register the company. Now, the memorandum only needs
to state:
u that the ‘subscribers’ (i.e. those forming the company) wish to form a company;
and
u if the company is to have a share capital, that each subscriber agrees to take at
least one share in the company.
At least one person must ‘subscribe’ to the memorandum (this used to mean they had
to ‘sign’ it; now they need only ‘authenticate’ it). In essence, they agree to take some
shares or share in the company and become its first shareholders.
Share capital in public and private companies

Until the CA 2006, the memorandum had to include quite a lot of details about the
company’s share capital. Now, less information is required, and the information that
must be sent is put not in the memorandum itself, but only in a separate form, known
as ‘the statement of capital and initial shareholdings’. That form must say how many
shares the subscribers are taking and the ‘nominal’ value of those shares (that is their
‘face’ value, rather than the actual amount the subscribers are paying for them).
It used to be the case that companies had to fix, and state in their memorandum, an
‘authorised’ amount of capital. This was the maximum amount of share capital the
company could raise (although the figure could be increased later). It is no longer
necessary for companies to have an authorised share capital (but a company that was
formed before the CA 2006 came into force would have declared what its authorised
capital was, and such companies are still limited to that amount unless they either
increase it, or remove the limit entirely). Shares can be fully paid, partly paid or even
unpaid. With partly 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.
We will discuss share capital extensively in Chapter 8.
The articles of association

The articles of association are a set of rules for running the company. They set out the
heart of any company’s organisational structure by allocating power between the
board of directors (the main management organ) and the general meeting (the main
shareholder organ). Those forming a company can provide their own articles but,
if they do not, there are ‘model articles’ that are supplied by the state, by statutory
instrument, and these will apply ‘by default’. Prior to 2009, the same set of model
articles was made available for both public and private companies. It was known
as ‘Table A’. From October 2009 onwards, different model articles are available for
private, and for public, companies, and they are now (rather unimaginatively) known
simply as ‘the Model Articles’. Most companies (and especially private companies)
tend to adopt the Model Articles either without any changes, or with a few minor
alterations.
A company can alter its articles. A resolution to do so must be passed by a ‘special

†
resolution’ of the shareholders (s.21 CA 2006). Such a resolution requires a 75 per cent A simple majority vote is
majority of votes cast. Additionally s.168 CA 2006 gives members the right to remove a where more than 50 per cent
director for any reason whatsoever by simple majority.† Therefore, while the board is of those who vote at the
the primary management organ, the membership of the board is subject to the general meeting agree with
continuing approval of the shareholders in general meeting. As noted above, one the resolution. In this case
clause that used to have to appear in a company’s memorandum was its ‘objects where more than 50 per cent
vote to remove a director.
clause’. This was a statement of the objects (i.e. the activities) the company was being
set up to pursue. Now, companies can choose whether to have any statement of their
objects, but if they decide to do so, such a clause must now to be put in the company’s
articles, rather than its memorandum. We shall examine the legal consequences of
either including, or not including, such a clause in Chapter 13, when we consider the
so-called ultra vires doctrine.
Advantages
u Companies are designed as investment vehicles. Companies have the ability
to subdivide their capital into small amounts, allowing them to draw in huge
numbers of investors who also benefit from the sub-division by being able to sell
on small parts of their investment.
u Limited liability also minimises the risk for investors and is said to encourage
investment. It is also said to allow managers to take greater risk in the knowledge
that the shareholders will not lose everything.
u The constitution of the company provides a clear organisational structure which is

essential in a business venture where you have large numbers of participants.
Disadvantages
u Forming a company and complying with company law is more expensive and
time-consuming.
u It also appears to be an inappropriately complex organisational form for small

businesses, where the board of directors and the shareholders are often the same
people (we discuss this further below).
Activity 2.3
a. What are the advantages and disadvantages of each form of business
organisation?
b. With a view to recommending a particular form of business organisation to a

client wishing to set up a cyber-café, compare and contrast each of the types
discussed above.
c. Explain the difference between a private and a public company.
2.4 Some general problems with the corporate form

The dominance of the corporation as the preferred mechanism for organising a
business in the UK has thrown up some important problems for company law. The
problems stem from the ‘one size fits all’ nature of the corporate form. While there is
a distinction between public and private registered companies, that distinction masks
the fact that the basic legal model provided for public and private companies is very
similar. As a result the statutory framework has historically applied to one-person
private companies and large public companies as if they were similar in nature. The
problem is that they are not.
The key difficulty arises because the statutory model assumes a separation of
ownership from control. That is, it assumes that the investors are residual controllers
exercising control once a year at the annual general meeting (AGM) and that the
day-to-day management of the business is carried out by professional managers
(directors). For large companies this is the case but for the vast majority of companies
in the UK this separation of ownership from control does not exist (see Chapter 14).
To illustrate this we need to examine how, for both a large and a small company,
company law presumes the ownership and control system within the statutory model
operates.
2.4.1 A large company

u The general meeting meets once a year (this is the annual general meeting or AGM)
primarily to elect the directors to the board.
u The directors will be a mix of professional managers (executive directors) and

independent outsiders (non-executive directors); see Chapter 14.
u The executive directors will normally have a small shareholding but not usually a
significant one.
u The shareholders are also provided with an annual report from the directors
outlining the performance of the company over the past year and the prospects
for the future (like a sort of report card on their performance). At the heart of the
report are the accounts certified by the auditor (an independent accountant who
checks over the accounts prepared by the directors).
u In between AGMs the directors run the company with little involvement by the
shareholders.
u 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 company’s employees.
†
u The directors in carrying out their function stand in a fiduciary† relationship with A fiduciary is a person
the company. They therefore owe a duty to act bona fides (in good faith) in the who is bound to act in the
interests of the company (this generally means the shareholders’ interests) and not interests and for the benefit
for any other purpose (such as self-enrichment – see Chapter 15). of another; trustees also have
fiduciary duties.
u The employees who are authorised to carry out the company’s business are the
company’s agents and therefore the company will be bound by their actions (see
Chapter 13).
2.4.2 A small company

The same company law model applies to a small company but with significant
differences in effect.
u The shareholders and directors will often be the same people.
u The same people will also be the only employees of the company.
u There is no separation of ownership from control, the shareholders are the

managers and therefore most of the statutory assumptions about the company’s
organisational structure will not hold.
These differences (in effect the requirements for meetings and accounts), which
are based on a presumption of the managers being different people from the
shareholders, became a burden for small companies. As a result, over many years, UK
company law was modified in an attempt to reduce some of the requirements and
burdens on private companies. The CA 2006 continued this process, under the slogan
of ‘Think Small First’ (see below).
2.4.3 The Freedman study

In an extremely interesting study, Freedman (1994) found that 90 per cent of all
companies in the UK were small private concerns. She also surveyed small businesses
as to the advantages and disadvantages of forming and running a company.
Advantages
u Prestige. The small businesses surveyed considered that one of the major
advantages (in fact possibly the only advantage) of forming a company was that it
conferred prestige, legitimacy and credibility on the venture.
u Limited liability. The ability of those who are behind the company to walk away
from the company’s debts. However for small businesses this was potentially
negated by the practice of banks requiring the shareholders to provide guarantees

for bank loans (a common source of finance among small businesses). Thus any
debts owed to the banks could be reclaimed from the personal assets of the
shareholders if the company was in insolvent liquidation.
Disadvantages
u Burdensome regulatory requirements (meetings, accounts, etc.).
u Expensive as they had to pay for professional advice to deal with the regulatory
requirements.
Solutions
Historically company law has not ignored this problem. Many changes were made,
even before the CA 2006 was enacted. For example, the CA 1985 allowed private
companies to adopt what it called ‘the elective regime’, in s.379A. This allowed private
companies to have simpler and less burdensome rules governing:
u shareholder meetings
u timing of meetings
u laying of accounts.
However, these concessions were largely seen as insufficient. The CLRSG (the body
that was in charge of developing proposals for what would become the CA 2006)
recommended, in its Final Report (Modern Company Law for a Competitive Economy:
Final Report (2001), Chapters 2 and 4) that more statutory requirements be simplified
for small businesses, covering:
u decision-making
u accounts
u audit
u constitutional structure
u dispute resolution.
The CLRSG also recommended that legislation on private companies should be made
easier to understand. In particular, there should be a clear statement of the duties of
directors. As we shall see, many of these recommendations were followed, and the CA
2006 does quite a lot to simplify the law for private companies.
But concerns still remain that company law is too burdensome for the smaller
company and the effort to reduce the ‘regulatory burden’ continues. In recent years,
the UK Government has carried out a number of public consultations to discover
whether further relaxations in the law for private companies are appropriate. And in
2015, it enacted the Small Business, Enterprise and Employment Act which reduced the
amount of information that must be ‘filed’ with the Registrar of Companies.
Minority issues
The fact that there are so few participants in a small business presents another
problem for company law. That is, sometimes they disagree and if this continues, a
minority shareholder can easily be excluded from the running of the company while
remaining trapped within it. This occurs because 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 shareholders holding
51 per cent (simple majority voting power) of the shares in the company 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. Thus the 49 per
cent shareholder would be unrepresented on the board and powerless in the general
meeting.
These situations are worse in private companies where the minority shareholder often
needs board approval for the sale of shares to an outsider or must offer the shares to
the other members first. If the other members are obstructive then this pre-emption
process can leave the minority shareholders trapped. Of course the fact that the
majority holder is behaving badly will make it difficult to find a buyer willing to put
themselves into a similarly weak position. One limited source of protection that has
long been available to minority shareholders is that they are allowed (in some cases at
least) to enforce any personal rights they enjoy under the company’s constitution (see
Chapters 11 and 12). However, for reasons which will be explored later, that protection
is often ineffective for a minority, especially where the minority’s complaint relates
to misbehaviour by the company’s directors (see Chapters 14 and 15). Eventually, a
statutory remedy was introduced in s.459 CA 1985 and is now contained in s.994 CA
2006 to make it easier for shareholders to bring an action.
Activity 2.4
organisational structure, assess the merits of a registered company.
Activity 2.5
Is the corporate form suitable for small companies?
Summary
The importance of this chapter is that it forms a context within which we can place
the company and its success as a business form. The sole trader may be a suitable
approach for informal one-person ventures, where the capital is mostly provided by
the sole trader’s savings or a bank loan. It is unsuitable for larger organisational or
investment purposes.
The partnership is a very good business form which has many advantages over a
company, particularly for small- and medium-sized businesses. However, compared
to the company, it is now used less frequently, and the company in turn has come to
dominate.
However the company as a form of business organisation is not without its problems.
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 effective separation of ownership from control and is therefore largely
unsuitable for the majority of its users, who are small businesses. In many ways a
partnership would be more suitable for an entrepreneur and less onerous for small
businesses generally, especially given that limited liability is rarely a reality for these
types of businesses. However, the continued use of the corporate form by small
companies seems secure given the prestige attached to the tag ‘Ltd’. The CA 2006 has
gone some way towards meeting the needs of small businesses.
Further reading
¢ Freedman, J. ‘Small businesses and the corporate form: burden or privilege?’
(1994) 57 MLR 555–84.
¢ Freedman, J. and M. Godwin ‘Incorporating the micro business: perceptions and

misperceptions’ in Hughes, A. and D.J. Storey (eds) Finance and the small firm.
(London: Routledge, 1994) [ISBN 9780415100366].
¢ Davies and Worthington, Chapter 1: ‘Types and functions of companies’ and

Chapter 2: ‘Advantages and disadvantages of incorporation’.
Sample examination question

In what way does company law facilitate the small business and is it adequate?
Advice on answering the question

The key points to cover in your answer are the following.
u The distinction company law makes between public and private companies.
u The historical concessions in the elective regime in s.379A CA 1985 and Table A,
Article 53.
u Minority protection concessions for small businesses and the fact that the CLRSG
and the 2006 Act increase protection for minorities.
u A discussion of the CLRSG’s ‘think small first’ approach and its effect in the CA 2006.
Reflect and review

Look through the points listed below.
Are you ready to move on to the next chapter?
Ready to move on = I am satisfied that I have sufficient understanding of the

principles outlined in this chapter to enable me to go on to the next chapter.
Need to revise first = There are one or two areas I am unsure about and need to revise
before I go on to the next chapter.
Need to study again = I found many or all of the principles outlined in this chapter
very difficult and need to go over them again before I move on.
Ready to Need to Need to

move on revise study
first again
I can illustrate the differences between the major
forms of business organisation in the UK.   
I can describe the advantages and disadvantages of

each form of business organisation.   
I can explain the different categories of company.   

I can demonstrate the difficulties small businesses
have with the company as a form of business   
organisation.
If you ticked ‘need to revise first’, which sections of the chapter are you going to
revise?
Must Revision
revise done
2.1 The sole trader  
2.2 The partnership  
2.3 The company  
2.4 Some general problems with the corporate form  

3 The nature of legal personality
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
3.1 Corporate personality . . . . . . . . . . . . . . . . . . . . . . . . . . 21
3.2 Salomon v Salomon & Co . . . . . . . . . . . . . . . . . . . . . . . . . . 21
3.3 Other cases illustrating the Salomon principle . . . . . . . . . . . . . . 22
3.4 Limited liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

Introduction
In this chapter we explore the related concepts of corporate legal personality and
limited liability. These concepts are central to developing understanding of company
law and it is essential that you take time here to absorb these fundamental principles.
Learning outcomes
u explain what is meant by ‘corporate legal personality’
u illustrate the key effects of corporate legal personality in relation to liability.
Core text
¢ Dignam and Lowry, Chapter 2: ‘Corporate personality and limited liability’.
Cases
¢ Salomon v Salomon & Co [1897] AC 22
¢ Macaura v Northern Assurance Co [1925] AC 619
¢ Lee v Lee’s Air Farming [1961] AC 12
¢ Barings plc (In Liquidation) v Coopers & Lybrand (No.4) [2002] 2 BCLC 364
¢ Giles v Rhind [2003] 2 WLR 237
¢ Shaker v Al-Bedrawi [2003] 2 WLR 922
¢ Hashem v Shayif [2008] EWHC 2380 (Fam).

Company Law 3 The nature of legal personality page 21
3.1 Corporate personality

Corporate personality refers to the fact that, as far as the law is concerned, a company
really exists. This means that a company can sue and be sued in its own name, hold its
own property and – crucially – be liable for its own debts. It is this concept that allows
limited liability for shareholders as the debts belong to the legal entity of the company
and not to the shareholders in that company.
The history of corporate personality

Corporate legal personality arose from the activities of organisations, such as religious
orders and local authorities, which were granted rights by the government to hold
property, sue and be sued in their own right and not to have to rely on the rights of
the members behind the organisation. Over time the concept began to be applied to
commercial ventures with a public interest element, such as rail building ventures and
colonial trading businesses. However, modern company law only began in the mid-
19th century when a series of Companies Acts were passed which allowed ordinary
individuals to form registered companies with limited liability. The way in which
corporate personality and limited liability link together is best expressed by examining
the key cases.
3.2 Salomon v Salomon & Co

It was fairly clear that the mid-19th century Companies Acts intended the virtues
of corporate personality and limited liability to be conferred on medium to large
commercial ventures. To ensure this was the case there was a requirement that there
be at least seven members of the company. This was thought to exclude sole traders
and small partnerships from utilising corporate personality. However, as we will see
below in the case of Salomon v Salomon & Co [1897] AC 22, this assumption proved to be
mistaken.
Mr Salomon carried on a business as a leather merchant. In 1892 he formed the

company Salomon & Co Ltd. Mr Salomon, his wife and five of his children held one
share each in the company. The members of the family held the shares for Mr Salomon
because the Companies Acts required at that time that there be seven shareholders.
Mr Salomon was also the managing director of the company. The newly incorporated
company purchased the sole trading leather business. The leather business was
valued by Mr Salomon at £39,000. This was not an attempt at a fair valuation; rather
it represented Mr Salomon’s confidence in the continued success of the business.
The price was paid in £10,000 worth of debentures (a debenture is a written
acknowledgement of debt like a mortgage – see Chapter 7) giving a charge over all the
company’s assets (this means the debt is secured over the company’s assets and Mr
Salomon could, if he is not repaid his debt, take the company’s assets and sell them to
get his money back), plus £20,000 in £1 shares and £9,000 cash. Mr Salomon also at
this point paid off all the sole trading business creditors in full. Mr Salomon thus held
20,001 shares in the company, with his family holding the six remaining shares. He was
also, because of the debenture, a secured creditor.
However, things did not go well for the leather business and within a year Mr Salomon
had to sell his debenture to save the business. This did not have the desired effect
and the company was placed in insolvent liquidation (i.e. it had too little money to
pay its debts) and a liquidator was appointed (a court-appointed official who sells
off the remaining assets and distributes the proceeds to those who are owed money
by the company – see Chapter 17). The liquidator alleged that the company was but a
sham and a mere ‘alias’ or agent for Mr Salomon and that Mr Salomon was therefore
personally liable for the debts of the company. The Court of Appeal agreed, finding
that the shareholders had to be a bona fide association who intended to go into
business and not just hold shares to comply with the Companies Acts.
The House of Lords disagreed and found that:
u the fact that some of the shareholders were only holding shares as a technicality
was irrelevant; the registration procedure could be used by an individual to carry
on what was in effect a one-man business
u a company formed in compliance with the regulations of the Companies Acts is a

separate person and not the agent or trustee of its controller. As a result, the debts
of the company were its own and not those of the members. The members’ liability
was limited to the amount prescribed in the Companies Act (i.e. the amount they
invested).
The decision also confirmed that the use of debentures instead of shares can further
protect investors.
Activity 3.1
Read Salomon v Salomon & Co [1897] AC 22.
a. Describe the key effects of the change in status from a sole trader to a limited
company for Mr Salomon.
b. What are the key principles that we can draw from the case?
c. Should Mr Salomon have been liable for the debts of the company?
3.3 Other cases illustrating the Salomon principle
3.3.1 Macaura
The principle in Salomon is best illustrated by examining some of the key cases that
followed after. In Macaura v Northern Assurance Co [1925] AC 619 Mr Macaura owned an
estate and some timber. He agreed to sell all the timber on the estate in return for the
entire issued share capital of Irish Canadian Saw Mills Ltd. The timber, which amounted
to almost the entire assets of the company, was then stored on the estate. On 6
February 1922 Mr Macaura insured the timber in his own name. Two weeks later a fire
destroyed all the timber on the estate. Mr Macaura tried to claim under the insurance
policy. The insurance company refused to pay out arguing that he had no insurable
interest in the timber as the timber belonged to the company. Allegations of fraud
were also made against Mr Macaura but never proven. Eventually in 1925 the issue
arrived before the House of Lords who found that:
u the timber belonged to the company and not Mr Macaura
u Mr Macaura, even though he owned all the shares in the company, had no insurable
interest in the property of the company
u just as corporate personality facilitates limited liability by having the debts belong
to the corporation and not the members, it also means that the company’s assets
belong to it and not to the shareholders.
More modern examples of the Salomon principle and the Macaura problem can be
seen in cases such as Barings plc (In Liquidation) v Coopers & Lybrand (No.4) [2002]
2 BCLC 364. In that case a loss suffered by a parent company as a result of a loss at
its subsidiary (a company in which it held all the shares) was not actionable by the
parent – the subsidiary was the proper plaintiff. In essence you can’t have it both
ways – limited liability has huge advantages for shareholders but it also means that the
company is a separate legal entity with its own property, rights and obligations (see
also Giles v Rhind [2003] 2 WLR 237, Shaker v Al-Bedrawi [2003] 2 WLR 922 and Hashem v
Shayif [2008] EWHC 2380 (Fam)).
3.3.2 Lee
Another good illustration is Lee v Lee’s Air Farming [1961] AC 12. Mr Lee incorporated a
company, Lee’s Air Farming Ltd, in August 1954 in which he owned all the shares. Mr
Lee was also the sole ‘Governing Director’ for life. Thus, as with Mr Salomon, he was
in essence a sole trader who now operated through a corporation. Mr Lee was also
employed as chief pilot of the company. In March, 1956, while Mr Lee was working, the
company plane he was flying stalled and crashed. Mr Lee was killed in the crash leaving
a widow and four infant children.
The company, as part of its statutory obligations, had been paying an insurance policy
to cover claims brought under the Workers’ Compensation Act. The widow claimed
she was entitled to compensation under the Act as the widow of a ‘worker’. The issue
went first 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. The case was
appealed to the Privy Council in London. They found that:
u the company and Mr Lee were distinct legal entities and therefore capable of
entering into legal relations with one another
u as such they had entered into a contractual relationship for him to be employed as
the chief pilot of the company
u he could in his role of Governing Director give himself orders as chief pilot. It was
therefore a master and servant relationship and as such he fitted the definition of
‘worker’ under the Act. The widow was therefore entitled to compensation.
Activity 3.2
Read Macaura v Northern Assurance Co [1925] AC 619 and Lee v Lee’s Air Farming [1961]
AC 12 carefully and then write a brief 300-word summary of each case.
Re-read Dignam and Lowry, Chapter 2, paras 2.2–2.12 and paras 2.32–2.45.
3.4 Limited liability

As we showed above, separate legal personality and limited liability are not the
same thing. Limited liability is the logical consequence of the existence of a separate
personality. The legal existence of a company (corporation) means it can be
responsible for its own debts. The shareholders will lose their initial investment in
the company but they will not be responsible for the debts of the company. Just as
humans can have restrictions imposed on their legal personality (as with children, for
example), a company can have legal personality without limited liability if that is how
it is conferred by the statute. A company may still be formed today without limited
liability as a registered unlimited company (s.3(4) CA 2006).
Summary
There are some key points to take from this chapter. First, it is important at this stage
that you grasp the concept of corporate personality. If at this stage you do not, then
take some time to think about it and when you are ready come back and re-read
Dignam and Lowry, Chapter 2, paras 2.2–2.12. Second, having grasped the concept of
corporate personality you also need to understand its consequences (i.e. the fact that
the company can hold its own property and be responsible for its own debts).
Further reading
¢ Ireland, P. et al. ‘The conceptual foundations of modern company law’ (1987) 14
JLS 149–65.
¢ Pettit, B. ‘Limited liability – a principle for the 21st century’ (1995) CLP 124.
¢ Grantham, R.B. and E.F. Rickett ‘The bootmaker’s legacy to company law
doctrine’ in Grantham, R.B. and E.F. Rickett (eds) Corporate personality in the 20th
century. (Oxford: Hart Publishing, 1998) [ISBN 9781901362831].
¢ Davies and Worthington, Chapter 2: ‘Advantages and disadvantages of

incorporation’ and Chapter 8: ‘Limited liability and lifting the veil at common
law’.

‘The Salomon decision was a scandalous one which unleashed a tidal wave of
irresponsibility into the business community.’
Discuss.
Advice on answering this question

Start by setting out your position on this provocative statement. Do you agree with it
or not? Either way you must take a position and argue it consistently. There are two
parts to the statement – (1) is it scandalous? and (2) did it unleash a ‘tidal wave of
irresponsibility’? Make sure you address the points separately and tie them together in
your conclusion.
Go through the facts of Salomon with particular emphasis on the aspects of the case
that might be scandalous (i.e. Mr Salomon’s evasion of personal liability for the debts
of his one man company and his over-valuation of the business).
Discuss whether a ‘tidal wave of irresponsibility’ was unleashed into the business
community. Points to make here are that creditors may lose out but investment and
management risk-taking is facilitated.
Reflect and review



first again
I can explain what is meant by ‘corporate legal
personality’.   
I can illustrate the key effects of corporate legal

personality in relation to liability.   
revise?
Must Revision
revise done
3.1 Corporate personality  
3.2 Salomon v Salomon & Co  
3.3 Other cases illustrating the Salomon principle  
3.4 Limited liability  

4 Lifting the veil of incorporation
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
4.1 Legislative intervention . . . . . . . . . . . . . . . . . . . . . . . . . . 29
4.2 Judicial veil lifting . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
4.3 Actions in tort . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

Introduction
As we observed in Chapter 3 the application of the Salomon principle has mostly
(remember Mr Macaura) beneficial effects for shareholders. The price of this benefit
is often paid by the company’s creditors. In most situations this is as intended by
the Companies Acts. Sometimes, however, the legislature and the courts have
intervened where the Salomon principle had the potential to be abused or has unjust
consequences. This ‘intervention’ can take many different forms. Sometimes, for
example, it may involve holding individuals inside the company liable – either to the
company itself, or to a third party who has been injured. And sometimes it may involve
simply refusing to treat a company as a separate legal personality, and working out
what rights and liabilities people have as if the company did not exist at all. We shall
refer to all these types of intervention as ‘lifting the veil of incorporation’. (Some
people have suggested that the term ‘lifting the veil’ should be used only where the
company’s separate existence is being ignored. Strictly speaking, this is probably true.
However, since many writers do use this term in a rather wider and ‘catch all’ way, that
is how it will be used in this chapter too.)
Learning outcomes
u describe the situations where legislation will allow the veil of incorporation to
be lifted
u explain the main categories of veil lifting applied by the courts.
Core text
¢ Dignam and Lowry, Chapter 3: ‘Lifting the veil’.
Cases
¢ Gilford Motor Company Ltd v Horne [1933] Ch 935
¢ Jones v Lipman [1962] 1 WLR 832
¢ DHN Ltd v Tower Hamlets [1976] 1 WLR 852
¢ Woolfson v Strathclyde RC [1978] SLT 159
¢ Adams v Cape Industries plc [1990] 2 WLR 657
¢ Creasey v Breachwood Motors Ltd [1992] BCC 638
¢ Ord v Belhaven Pubs Ltd [1998] 2 BCLC 447
¢ Williams v Natural Life Health Foods Ltd [1998] 2 All ER 577
¢ Anglo German Breweries Ltd (in liquidation) v Chelsea Corp Inc [2012] EWHC 1481 (Ch)
¢ Gramsci Shipping Corp v Lembergs [2013] EWCA Civ 730
¢ VTB Capital plc v Nutritek International Corp [2013] UKSC 5
¢ Petrodel Resources Ltd v Prest [2013] UKSC 34
¢ Chandler v Cape plc [2012] EWCA Civ 525
¢ Thompson v Renwick Group Ltd [2014] EWCA Civ 635
¢ Okpabi v Royal Dutch Shell plc [2018] EWCA Civ 191
¢ Lungowe v Vedanta Resources plc [2017] EWCA Civ 1528.
¢ AAA v Unilever plc [2018] EWCA Civ 1532.
Additional cases
¢ Re Todd Ltd [1990] BCLC 454
¢ Re Patrick & Lyon Ltd [1933] Ch 786

Company Law 4 Lifting the veil of incorporation page 29
¢ Re Produce Marketing Consortium Ltd (No.2) [1989] 5 BCC 569
¢ Trustor AB v Smallbone [2002] BCC 795
¢ Noel v Poland [2002] Lloyd’s Rep IR 30
¢ Daido Asia Japan Co Ltd v Rothen [2002] BCC 589
¢ Standard Chartered Bank v Pakistan National Shipping Corp (No.2) [2003] 1 AC 959
¢ R v K [2005] EWCA Crim 619
¢ MCA Records Inc v Charly Records Ltd (No.5) [2003] 1 BCLC 93
¢ Koninklijke Philips Electronics NV v Princo Digital Disc GmbH [2004] 2 BCLC 50
¢ Re a Company [1985] 1 BCC 99421
¢ National Dock Labour Board v Pinn & Wheeler Ltd [1989] BCLC 647
¢ Lubbe v Cape Industries plc [2000] 1 WLR 1545.
4.1 Legislative intervention

As corporate affairs became more complex and group structures emerged (that
is, where a parent company organises its business through a number of subsidiary
companies in which it is usually the sole shareholder) the Companies Acts began to
recognise that treating each company in a group as separate was misleading. Over
time a number of provisions were introduced to recognise this fact. For example:
u s.399 CA 2006 provides that parent companies have a duty to produce group
accounts
u s.409 CA 2006 also requires the parent to provide details of the shares it holds in
the subsidiaries and the subsidiaries’ names and country of activity.
However, it was the possibility of using the corporate form to commit fraud that
prompted the introduction of a number of civil and criminal provisions. These
provisions operate to negate the effect of corporate personality and limited liability in:
u s.993 CA 2006 which provides a not much used criminal offence of fraudulent
trading
u ss.213–215 Insolvency Act 1986 which contain the most important statutory
provisions.
4.1.1 Insolvency Act, s.213

Section 213 of the Insolvency Act 1986 was designed to deal with situations where the
corporate form was used as a vehicle for fraud. It is known as the ‘fraudulent trading’
provision. If, in the course of the winding up of a company, it appears to the court that
any business of the company has been carried on with intent to defraud creditors of
the company or creditors of any other person, or for any fraudulent purpose, anyone
involved in the carrying out of the business can be called upon to contribute to the
debts of the company. This is most likely to be shareholders or directors but can also
be employees and creditors. In Re Todd Ltd [1990] BCLC 454, for example, a director was
found liable to contribute over £70,000 to the debts of the company because of his
activities. There is also the possibility that criminal liability could follow, with a term
of imprisonment as the ultimate penalty (s.993 CA 2006). While the criminal penalty
was intended to act as a strong deterrent to fraudulent behaviour, it proved to have
the unfortunate effect of neutralising the effectiveness of s.213 as the courts set a very
high standard of proof for ‘intent to defraud’ because of the possibility of a criminal
charge also arising. In Re Patrick & Lyon Ltd [1933] Ch 786, this involved proving ‘actual
dishonesty, involving, according to current notions of fair trading among commercial
men, real moral blame’. This standard proved very difficult to obtain in practice and
a new provision was introduced in s.214 of the Insolvency Act 1986 which covered the
lesser offence of ‘wrongful trading’.
4.1.2 Insolvency Act, s.214

Wrongful trading does not require proving an intent to defraud. Rather it simply
requires that a director, at some time before the commencement of the winding
up of the company, knew or ought to have concluded that there was no reasonable
prospect that the company would avoid going into insolvent liquidation, but
continued to trade. The section operates on the basis that at some time before
the company entered insolvent liquidation there will have been a point where the
directors knew it was hopeless and the company could not trade out of the situation.
The reasonable director would not at this point continue to trade. If he does continue
to trade he risks having to contribute to the debts of the company under s.214.
In Re Produce Marketing Consortium Ltd (No.2) (1989) 5 BCC 569 over a period of seven
years the company slowly drifted into insolvency. The two directors involved did
nothing wrong except that they did not put the company into liquidation after
the point of no return became apparent. They were therefore liable under s.214 to
contribute £75,000 to the debts of the company.
Sections 213 and 214 differ in the way they affect the Salomon principle. Section 213
applies to anyone involved in the carrying on of the business and therefore directly
qualifies the limitation of liability of members. Section 214 does not directly affect
the liability of members as it is aimed specifically at directors. In small companies,
directors are usually also the members of the company and so their limitation of
liability is indirectly affected. Parent companies may also have their limited liability
affected if they have acted as a shadow director. (A shadow director being anyone
other than a professional advisor from whom the directors of the company are
accustomed to take instructions or directions – see Chapter 14.)
Activity 4.1
a. Explain the difference between ss.213 and 214 of the Insolvency Act 1986.
b. Why was s.213 relatively unsuccessful?
c. What is s.214 designed to achieve?
Summary
The legislature has always been concerned to minimise the extent to which the
Salomon principle could be used as an instrument of fraud. As a result it introduced the
offence of fraudulent trading now contained in s.213 of the Insolvency Act 1986.
The requirement to prove ‘intent to defraud’ became too difficult in practice

because of the possibility of a criminal offence arising and so the lesser offence of
‘wrongful trading’ was introduced in order to provide a remedy where directors had
behaved negligently rather than fraudulently. Thus if a director continued to trade
in circumstances where a reasonable director would have stopped, the director
concerned will be liable to contribute to the company’s debts under s.214.
4.2 Judicial veil lifting

Veil lifting situations often present the judiciary with difficult choices as to where
a loss should lie. As we observed with the Salomon, Lee and Macaura cases, the
consequences of treating the company as a separate legal entity or not can be
extreme. Over time the judiciary have varied in their attitudes, sometimes holding
more strictly to the Salomon principle, and at other times taking a more interventionist
approach and being prepared to lift the veil to try to achieve justice in a particular
situation. In recent years, as we shall see below, they seemed to have very clearly
reverted to a stricter application of Salomon, and been prepared to lift the corporate
veil much less frequently. First, however, let’s look at some of the older cases which
should give a flavour of the types of situations that have arisen and the approach taken
by the judiciary over time.
In Gilford Motor Company Ltd v Horne [1933] Ch 935 a former employee who was bound
by a covenant not to solicit customers from his former employers set up a company
to do so. He argued that while he was bound by the covenant the company was not.
The court found that the company was merely a front for Mr Horne and issued an
injunction against both him and the company, even though the company itself had
never signed any covenant not to solicit Gilford’s customers.
In Jones v Lipman [1962] 1 WLR 832 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. The judge found the company was but a façade or front for Mr
Lipman and granted an order for specific performance.
By the 1960s the increasingly sophisticated use of group structures was beginning to
cause the courts some difficulty with the strict application of the Salomon principle.
Take, for example, a situation where Z Ltd (the parent or holding company) owns
all the issued share capital in three other companies – A Ltd, B Ltd and C Ltd. These
companies are known as wholly owned subsidiaries (s.1159(2) CA 2006). Z Ltd controls
all three subsidiaries. In economic reality there is just one business but it is organised
through four separate legal personalities. In effect this structure allows the advantages
of limited liability to be availed of by the legal personality of the parent company. As
a result the parent could choose to conduct its more risky or liability-prone activities
through A Ltd. The strict application of the Salomon principle would mean that if things
go wrong the assets of Z Ltd, as a shareholder of A Ltd with limited liability, in theory
cannot be touched.
In DHN Ltd v Tower Hamlets [1976] 1 WLR 852 Lord Denning argued that a group of
companies was in reality a single economic entity and should be treated as one.
However, this willingness to disregard the normal legal consequences of creating
separate companies, and to follow instead the ‘economic realities’, was not universally
approved. And only two years later the House of Lords, in Woolfson v Strathclyde RC
[1978] SLT 159, specifically disapproved of Denning’s views on group structures, and
declared that the veil of incorporation could be lifted only if a company was a façade.
We can now turn to what remains arguably the most significant case in this area,
Adams v Cape Industries plc [1990] 2 WLR 657. This was a decision of the Court of Appeal,
and it is important for two reasons. First, it represents a significant move by the senior
judiciary towards introducing more certainty into the law. The feeling had grown
that earlier cases did not identify with enough clarity and precision when the veil
could be lifted. The outcome of each individual case might then depend too much on
the subjective opinion of the particular judge hearing that case. Second, the Court of
Appeal clearly preferred a narrower and more restrictive approach to when the veil
could be lifted.
4.2.1 Adams v Cape Industries plc (1990)

Adams is a complex case but, broadly, the following occurred. Until 1979, Cape, an
English company, mined and marketed asbestos. Its worldwide marketing subsidiary
was another English company, named Capasco. Cape also had a US marketing
subsidiary incorporated in Illinois, named NAAC. In 1974 in Texas, some 462 people
sued Cape, Capasco, NAAC and others 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 US to minimise Cape’s presence there, in respect of taxation
and other liabilities. Between 1978 and 1979, Mr Adams, and many other claimants,
commenced a number of further actions against Cape and Capasco. Cape and Capasco
did not settle these actions, but nor did they defend the actions in the American
courts. As a result, Adams and the other claimants got ‘default judgments’, in the US,
against Cape and Capasco.
In 1979 Cape sold its asbestos mining and marketing business and therefore had no
assets in the US. As a result, Adams, if he were to get any money out of Cape, would
have to enforce his US judgment in the UK, and through the UK courts. That is where
Cape’s assets were located. The UK courts would only do this, however, if either Cape
had taken part in the US proceedings (which it had not) or if Cape was itself ‘present’ in
the US. Cape argued that it was not itself present there. It pointed out that Cape itself
did not own property, or carry on any business, in the US. All property in the US, and all
activities there, were owned and carried on only by subsidiary or related companies,
but these were separate legal entities. Their presence in the US did not make Cape
present in the US.
It was in order to try to show that Cape was in fact present in the US that Mr Adams
sought to lift the corporate veil. The argument was essentially that the separation
between Cape, and these other group companies, should be ignored. The presence
of the other companies in the US would then make Cape present. Notice that he was
doing this not in order to establish that Cape was liable to him. Liability had already
been established, in the US, by default. The legal question was not: is Cape liable? It
was only: is Cape present in the US?
The Court of Appeal held in favour of Cape. That was clearly unfortunate for Mr Adams,
but what matters for us, as company lawyers, is what the court said about the grounds
when the veil can be lifted. First, the court declared that the veil cannot be lifted just
because a judge believes that it would be ‘in the interests of justice’ to do so. The
‘interests of justice’ is too vague and unpredictable a ground on which to lift the veil.
Second, the court decided that the mere fact that a group of companies constituted a
‘single economic unit’ was also not itself sufficient to allow the veil to be lifted. In this
respect, the court clearly followed the decision in Woolfson (above). The court decided
that where, in previous decisions (such as DHN, above), the veil had apparently
been lifted on this ground, this had in fact happened not merely because a group of
companies constituted a single economic unit, but rather because there also existed
some statute, or some contractual document which, on a proper interpretation of its
terms, required two or more companies in a group to be treated as one entity.
In rejecting these two grounds for veil lifting, the court concluded that:
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 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.
The Court of Appeal did recognise that there was one well-established exception to
the Salomon principle, namely where a company was a ‘mere façade concealing the
true facts’. The case of Jones v Lipman (1962) above is the classic example. But the Court
of Appeal was aware that this ground was potentially rather open-ended, and itself
lacked ‘predictability’. It therefore sought to define this ground with more certainty,
suggesting that a company would be considered a mere façade where it was being
used to enable someone to avoid a pre-existing obligation (i.e. an obligation that
they had already incurred themselves). When the court then applied this test to Cape,
it held that Cape had not used any of its subsidiary or related companies to avoid
any pre-existing obligation which Cape already had. Instead, Cape had used other
companies only to shield itself from liabilities which might be incurred in the future.
And although that might make the company morally culpable there was nothing
legally wrong in doing this, and using other companies to shield Cape from future
liabilities did not make those companies mere façades.
The court then finally considered the ‘agency’ argument. This was a straightforward
application of agency principle. If the subsidiary was Cape’s agent and acting within its
actual or apparent authority, then the actions of the subsidiary would bind the parent.
The court found that the subsidiaries were independent businesses free from the day-
to-day control of Cape and with no general power to bind the parent. Therefore Cape
could not be present in the US through its subsidiary agent.
Adams therefore narrows the situations where the veil of incorporation is in effect
lifted to three situations:
u where the court is interpreting a statute or document
u where the company is a mere façade (for other examples of where a company was
held to be a façade, see Anglo German Breweries Ltd (in liquidation) v Chelsea Corp Inc
[2012] EWHC 1481 (Ch) and Trustor AB v Smallbone [2002] BCC 795)
u where the subsidiary is an agent of the company.
The Court of Appeal’s judgment in Adams laid down reasonably clear, and clearly
restrictive, grounds for veil lifting. And, with a few exceptions, later courts have
largely followed, and affirmed, the Adams approach. One such exception is Creasey
v Breachwood Motors Ltd [1992] BCC 638, but that case was in turn overruled by Ord v
Belhaven Pubs Ltd [1998] 2 BCLC 447. Other exceptions include Ratiu v Conway (2006)
1 All ER 571 and Samengo-Turner v J&H Marsh & McLennan (Services) Ltd (2007) 2 All ER
(Comm) 813.
However, the general approach has been to follow Adams, and two recent decisions
of the Supreme Court have strongly affirmed its principles: see VTB Capital plc v
Nutritek International Corp [2013] UKSC 5, and Petrodel Resources Ltd v Prest [2013] UKSC
34. Petrodel is the more important of these two cases. In Petrodel, Lord Sumption
distinguished between what he referred to as the ‘evasion’ principle, and the
‘concealment’ principle. The veil could be pierced, he argued, only on the evasion
principle – where the controller of a company was using that company to evade an
obligation which the controller already had. However, for the veil to be pierced, it was
not necessary that the company which was being used in this way had been formed to
enable an obligation to be evaded. It was sufficient simply that it was now being used
to enable its controller to escape their obligation.
By the concealment principle, Lord Sumption referred to the court’s ability to see
through someone’s attempt to hide their behaviour. There are, of course, many ways
in which a person might conceal their actions. Lord Sumption was noting that using a
company was one such way. In Lord Sumption’s view, the court always has the power
to see through such a use, and in doing so identify what someone is really doing. The
court does not need to pierce the veil to do this: the court can simply get to the ‘truth’
of a person’s behaviour. If, for example, I decide to blackmail someone, and make my
victim pay the money I demand over to a company I own, the court can still regard me
as a blackmailer and receiver of that money, even though I have used a company to try
to conceal my receipt.
Activity 4.2
Read Dignam and Lowry, Chapter 3, paras 3.10–3.35 then write a short answer
considering the following statement.
‘The Court of Appeal’s decision in Adams takes an overly cautious approach to veil
lifting which does little to serve the interests of justice.’
4.3 Actions in tort

Actions in tort against those involved in the running of a company provide another
means of avoiding the Salomon principle. If a person commits a tort in the course of
acting for a company, they will often be liable under the law of tort for the injuries they
cause. The fact that they were acting for a company at the time will not prevent that
personal, tortious, liability. A bus driver who negligently injures a pedestrian will be
personally liable for that tort, notwithstanding they were employed by a bus company
(the bus company will be vicariously liable, too).
Does the same apply to directors, when the actions and decisions they take as directors
harm others? The position is less straightforward. One situation in which this might
arise is where the manager, acting on behalf of the company, misleads a third party.
This was the situation in Williams v Natural Life Health Foods Ltd [1998] 2 All ER 577. There
the House of Lords emphasised the Salomon principle in the context of a negligent
misstatement claim. The managing director of Natural Life Health Foods Ltd (NLHF)
was also its majority shareholder. The company’s 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 included detailed financial projections. The managing director had
provided much of the information for the brochure. The claimant had not dealt with
the managing director but only with an employee of NLHF. The claimant entered into
a franchise agreement with NLHF but the franchised shop ceased trading after losing
a substantial amount of money. He subsequently brought an action against NLHF for
losses suffered as a result of negligent information contained in the brochure. NLHF
subsequently ceased to trade and was dissolved. The claimant then continued the
action against the managing director and majority shareholder alone, alleging he had
assumed a personal responsibility towards the claimant.
The House of Lords seemed particularly aware that the effect of this claim was to
try to nullify the protection offered by limited liability. In its judgment the House of
Lords considered 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 between them. There 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 (see also Noel v Poland [2002] Lloyd’s Rep IR 30).
Other recent cases suggest that if the tort is deceit rather than negligence the courts
will more readily allow personal liability to flow to a director or employee. (See Daido
Asia Japan Co Ltd v Rothen [2002] BCC 589 and Standard Chartered Bank v Pakistan
National Shipping Corp (No.2) [2003] 1 AC 959.)
However, directors’ liability in tort has generally proved to be less than settled. In
MCA Records Inc v Charly Records Ltd (No.5) [2003] 1 BCLC 93 a director had authorised a
number of infringing acts under the Copyright Designs and Patent Act 1988. The 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.
The court concluded:
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.
The court then went on to find the director liable as a joint tortfeasor. (See also
Koninklijke Philips Electronics NV v Princo Digital Disc GmbH [2004] 2 BCLC 50, where a
company director was also held personally liable.)
Could shareholders be held liable in tort? Suppose that you own shares in a company
that operates an unsafe work system, as a result of which employees are injured. If
you are only a shareholder, it is quite unlikely you will be taking any of the decisions
that led to the unsafe work practices. Your case is more one of ‘nonfeasance’ (you
failed to stop the company operating unsafely) rather than misfeasance. In the
important decision in Chandler v Cape plc [2012] EWCA Civ 525, however, the Court of
Appeal decided that a shareholder could nevertheless be liable, if the shareholder
herself owed a duty of care to those who were injured. The Court found this duty of
care would only arise, however, for parent companies, for injuries caused by their
subsidiaries, and then only if several other conditions were satisfied. These were that
the parent itself operated in ‘the same industry as the subsidiary’, that the parent did
know, or ought to have known, as much about health and safety as did the subsidiary,
that the parent knew or ought to have known that the subsidiary’s operations were
unsafe, and the subsidiary or the employee were relying on the parent to safeguard
the employee’s health and safety.
Cases decided after Chandler, however, seem to indicate a growing reluctance on the
part of UK courts to impose a duty of care on parent companies. In Thompson v Renwick
Group Ltd [2014] EWCA Civ 635, for example, the Court of Appeal refused to impose a
duty of care on a parent within a corporate group that acted only as a ‘pure holding
company’. The parent, in other words, carried on no business itself but merely owned
the shares in the subsidiary companies, which conducted all the group’s business.
This approach was also followed in Okpabi v Royal Dutch Shell plc [2018] EWCA Civ
191. Moreover, although Chandler suggested that a parent company might be liable
for ‘non-feasance’ – for its failure to prevent a subsidiary from harming others – it
now appears that a parent will be liable only where it is itself guilty of some active
misfeasance. In AAA v Unilever plc [2018] EWCA Civ 1532, the court suggested the parent
would typically owe a duty of care to those injured by a subsidiary’s negligence only if
either of the two following situations existed:
a. where the parent had in substance taken over the management of the subsidiary’s
activity, which led to the injury; or
b. where the parent had taken over the management of the particular activity of the
subsidiary, which caused the injury.
In one respect at least, however, the decision in Chandler has been broadened a little.
In Chandler the duty was expressed only as one owed towards employees. However,
in Lungowe v Vedanta Resources plc [2017] EWCA Civ 1528 the court refused to strike out
a claim brought by neighbours of a subsidiary company. The court noted that while a
claim was ‘more likely to succeed’ if brought by employees, nevertheless, a claim by
residents might still be arguable depending on the facts of the case.
Activity 4.3
Read Dignam and Lowry, Chapter 3, paras 3.36–3.56 and consider whether
involuntary creditors are adequately protected by the Adams decision.
Summary
It is important that you get a solid understanding of the issues facing the judiciary
in this area. In essence the judiciary are being asked to decide who loses out when
a business ends. In normal commercial situations this will be as the Companies Act
intends – therefore the burden falls on the creditors. However if there is a suggestion
that the company has been used for fraud or fraud-like behaviour (e.g. Jones v Lipman)
the courts may lift the veil. At various times, however, the Salomon principle was
only a starting point and the courts would lift the veil in a number of situations if the
interests of justice required them to do so. This led to great uncertainty which has
been redressed by the restrictive case of Adams. Adams has been affirmed by recent
Supreme Court decisions, such as VTB Capital and Prest v Petrodel Resources Ltd.
Faced with the difficulty of lifting the veil, some claimants have sought to use claims
in tort as an alternative. This strategy was successful in the important case of Chandler,
where the employees of a subsidiary company were able to establish that its parent
company owed them a direct duty of care, which the parent had breached when it
failed to stop its subsidiary operating in an unsafe way that injured the employees.
Further reading
¢ Ottolenghi, S. ‘From peeping behind the corporate veil to ignoring it completely’
(1990) MLR 338.
¢ Gallagher, L. and P. Zeigler ‘Lifting the corporate veil in the pursuit of justice’
(1990) JBL 292.
¢ Muchlinski, P.T. ‘Holding multinationals to account: recent developments in

English litigation and the Company Law Review’ (2002) Company Lawyer 168.
¢ Lowry, J.P. and R. Edmunds ‘Holding the tension between Salomon and the
personal liability of directors’ (1998) Can Bar Rev 467.
¢ Petrin, M. ‘Assumption of responsibility in corporate groups: Chandler v Cape plc’

(2013) 76 MLR 603.
¢ Hansmann, H. and R. Kraakman ‘Toward unlimited shareholder liability for

corporate torts’ (1991) 100(7) Yale Law Journal 1879.
¢ Tan, C-H. ‘Veil piercing – a fresh start’ (2015) JBL 20.
¢ Davies and Worthington, Chapter 8: ‘Limited liability and lifting the veil at
common law’ and Chapter 9: ‘Personal liability for abuses of limited liability’.
Sample examination questions

Question 1 John and Amanda are brother and sister and have been running the
family business Rix Ltd for 10 years. They both sit on the board of directors of Rix
Ltd and each holds 30 per cent of the shares in the company. The remaining shares
are held equally by their father, Jim, and uncle, Tom. Jim and Tom used to run the
company but have retired now. They still have seats on the board of directors. For
the first five years after the retirement of Jim and Tom the company made an annual
profit of approximately £100,000. After that the profits declined for three years and
in the last two years the company has made losses of £50,000 and £100,000. John
and Amanda have grave concerns about the future of the business but, at a board
meeting to discuss ceasing trading, Jim and Tom insist that things will get better.
The board resolves to continue trading.
Consider the implications for the board members of this decision.
Question 2 Dick and his wife Bunny are owed £25,000 by Bio Ltd. Bio Ltd has
refused to pay the money owed and Dick and Bunny have initiated a court action
to recover the moneys owed to them. Bounce Ltd is the parent company of Bio Ltd
and has recently been advised by its accountant that it could reduce its tax liability
for the year 2008–2009 by removing all the assets from Bio Ltd and closing it down.
Bounce Ltd has decided to follow that advice.
Discuss the implications of this decision for Dick and Bunny.
Advice on answering these questions

Question 1 It appears that there is no suggestion of fraud here; rather it fits more with
the case law on the application of s.214 IA 1986.
Apply s.214 to the facts of this question.
Does the board meeting represent the necessary ‘point of no return’?
Consider the possible voting at the meeting. If it was unanimous, there is no problem
and the wrongful trading provisions apply to them all. However, boards vote by simple
majority and so the possibility remains that one of the directors could have dissented.
What would be that director’s position under s.214 if he or she wished to cease trading
but the rest of the board voted to continue? If that director continues to carry out
their role after the vote is he or she equally liable under s.214?
Question 2 This is a relatively straightforward question similar on its facts to the Ord
and Creasey cases.
Ord follows Adams strictly and finds that a group reorganisation to minimise financial
liability is allowable and will not engage a veil lifting exercise.
Creasey is a rogue case but it is worth applying here as an alternative, in which case
Dick and Bunny might be able to recover from the parent company. However, you
should note the more recent case law such as Ratiu v Conway (2006) 1 All ER 571 which
seems to be moving away from the narrow approach in Adams.
Reflect and review


Ready t Need to Need to

first again
I can describe the situations where legislation will
  
allow the veil of incorporation to be lifted.
I can explain the main categories of veil lifting applied

  
by the courts.
revise?
Must Revision
revise done
4.1 Legislative intervention  
4.2 Judicial veil lifting  
4.3 Actions in tort  

5 Company formation, promoters and
pre-incorporation contracts
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
5.1 Determining who is a promoter . . . . . . . . . . . . . . . . . . . . . 41
5.2 The fiduciary position of promoters . . . . . . . . . . . . . . . . . . . 41
5.3 Duties and liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
5.4 Pre-incorporation contracts . . . . . . . . . . . . . . . . . . . . . . . 42
5.5 Freedom of establishment . . . . . . . . . . . . . . . . . . . . . . . . 44

Introduction
In this chapter we consider the issues that arise when people (called promoters) go
though the process of incorporating a company and launching its business operations.
We examine their duties and the legal consequences that arise from contracts entered
into by promoters on behalf of the putative company prior to its registration (termed
pre-incorporation contracts).
Learning outcomes
u explain when a person will be treated as a promoter
u describe the duties and liabilities of promoters
u describe the issues arising from pre-incorporation contracts
u assess the impact of s.51 CA 2006 on pre-incorporation contracts and the liability
of promoters.
Core text
¢ Dignam and Lowry, Chapter 4: ‘Promoters and pre-incorporation contracts’.
Cases
¢ Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218
¢ Gluckstein v Barnes [1900] AC 240
¢ Kelner v Baxter (1866–67) LR 2 CP 174
¢ Phonogram Ltd v Lane [1982] QB 938
¢ Braymist Ltd v Wise Finance Co Ltd [2002] 1 BCLC 415
¢ Überseering BV v Nordic Construction Co Baumanagement GmbH (Case 208/00)

[2002] ECR I–9919
¢ Kamer van Koophandel en Fabrieken voor Amsterdam v Inspire Art Ltd (Case
C-167/01) [2003] ECR I–10155.
Company Law 5 Company formation, promoters and pre-incorporation contracts page 41
5.1 Determining who is a promoter

A person who takes the necessary steps to form a company is called a ‘promoter’. In
Whaley Bridge Calico Printing Co v Green (1879) 5 QBD 109, Bowen J explained that: ‘the
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’. The promotion process generally
involves the following activities.
u Registering the company with Companies House.
u Entering into pre-incorporation contracts.
u In the case of public companies, issuing a prospectus.
u Appointing directors and finding shareholders wishing to invest in the new

company.
The CA 2006 does not define the term promoter. However, the judges have, on
occasions, framed tests for determining whether a person’s activities relate to the
promotion of a company. The classic statement in this regard was made by Cockburn
CJ in Twycross v Grant (1876–77) LR 2 CPD 469, who said 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 accomplish that purpose… and so long as
the work of formation continues, those who carry on that work must, I think, retain the
character of promoters. Of course, if a governing body, in the shape of directors, has once
been formed, and they take, as I need not say they may, what remains to be done in the
way of forming the company, into their own hands, the functions of the promoters are at
an end.
The definition is necessarily broad so as to prevent persons taking steps to avoid

falling within a more tightly framed proposition in order to avoid the duties borne
by promoters. The breadth of the definition is a legacy of a number of 19th-century
cases involving fraudulent schemes being perpetrated against investors. The judges
responded by holding that promoters were ‘fiduciaries’ by analogy with trustees
(see below) and thus subject to a range of duties aimed at ensuring high standards of
behaviour.
5.2 The fiduciary position of promoters

It has long been settled that promoters are fiduciaries.
They stand, in my opinion, undoubtedly in a fiduciary position. They have in their hands
the creation and moulding of the company; they have the power of defining how, and
when, and in what shape, and under what supervision, it shall start into existence and
begin to act as a trading corporation.
(Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218, per Lord Cairns LC.)
The term ‘fiduciary’ is best explained by reference to the particular obligations a

†
fiduciary owes to his or her principal.† As we will see in Chapter 15: ‘Directors’ duties’, For more on the fiduciary
fiduciary obligations are obligations owed to a principal to act with loyalty and with relationship, see the LLB
good faith. These obligations entail more than just acting honestly and fairly. module guide Law of
Fiduciaries must act solely in the interests of the principal and must not allow their trusts, Chapter 4: ‘The trust
own self-interests to dictate their behaviour in any way that might conflict with the relationship’.
principal’s best interests.
Activity 5.1
Read Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218.
Describe how the House of Lords reached the conclusion that the syndicate, as
promoters of the new company, stood in a fiduciary position to it and outline the
content of the core fiduciary duty owed by promoters.
5.3 Duties and liabilities

As indicated in the preceding section, the core duty of a promoter is that of loyalty and
good faith. Given the activities of promoters in bringing a company into existence, a
process which often involves acquiring property for the yet unformed corporation,
the core duty is translated into a prohibition against making secret profits from such
transactions. The anxiety of the law in this regard is directed towards addressing the
problem of promoters selling property to the company in which they have a personal
interest and from which they make a profit. Promoters are therefore required to
make full disclosure of any such profit to an independent board of directors once the
company comes into existence. Failure to make such disclosure enables the company
to bring an action for rescission.
In Erlanger v New Sombrero Phosphate Co, a syndicate purchased a mine for £55,000.
The syndicate then formed a company and through a nominee sold the mine to it
for £100,000 without disclosing their interest in the contract. The mining operations
were fruitless and the shareholders removed the original directors and the new board
successfully brought an action to have the sale rescinded. In Salomon v Salomon &
Co Ltd [1897] AC 22 (see Chapter 3), the House of Lords took the view that if the board
was not independent, disclosure of all material facts should be made to the original
shareholders. But note that in Gluckstein v Barnes [1900] AC 240 the House of Lords
refined the duty further by holding that disclosure to the original shareholders will not
be sufficient if they are not truly independent and the scheme as a whole is designed
to defraud the investing public.
As we saw above (Erlanger v New Sombrero Phosphate Co), where full disclosure is not
made by the promoters the contract is voidable at the company’s option. However,
the right to rescind will be lost where:
u the company affirms the contract (Re Cape Breton Co (1885) 29 Ch D 795)
u the company delays in exercising its right to rescind the contract.
For rescission to be available 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 Co v Lagunas Syndicate [1899] 2 Ch 392). Finally,
it should be noted that where the contract has been affirmed, the company can
nevertheless sue the promoter to account for the secret profit.
Activity 5.2
Read Gluckstein v Barnes [1900] AC 240.
What are the consequences of a promoter making a secret profit from a transaction
with the company?
5.4 Pre-incorporation contracts

Obviously a company does not come into existence until the promoters have
completed the registration requirements and the Registrar of Companies issues
a certificate of incorporation. Prior to this time a company cannot be bound by
contracts entered into in its name or on its behalf. In practice, however, promoters
will need to contract with third parties for such things as a lease of premises, business
equipment and connection to utilities so that once the certificate of incorporation is
issued the company can begin trading.
The problem that arises in relation to pre-incorporation contracts is whether

promoters can avoid being personally liable on such contracts notwithstanding that
the company did not exist at the time such contracts were concluded on its behalf.
Quite clearly, an agent (the promoter) cannot bind a non-existent principal (the
company) to contracts. The common law addressed the problem by applying settled
principles of contract and agency, but partial reform was implemented by s.9(2) of the
European Communities Act 1972, now found in s.51 CA 2006.
5.4.1 The common law position

It is a fundamental principle of the law of contract that a party must be in existence in
order for an agreement (offer and acceptance) to crystallise into a binding contract.
Given that at the time of a pre-incorporation contract the company does not exist, it
becomes a stranger to the contract once it comes into existence: the privity doctrine
operates to prevent rights and liabilities being conferred or imposed on the company
(Kelner v Baxter (1866–67) LR 2 CP 174, see below). The Contracts (Rights of Third 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 benefit on the third party,
does not apply to pre-incorporation contracts.
As indicated above, the law of agency takes the view that a person cannot be an agent
of a non-existent principal and so a company cannot acquire rights or obligations
under a pre-incorporation contract. The common law position is illustrated by the
decision in Kelner v Baxter. The promoters of a hotel company entered into a contract
on its behalf for the purchase of wine. When the company formally came into
existence it ratified the contract. The wine was consumed but before payment was
made the company went into liquidation. The promoters, as agents, were sued on the
contract. They argued that liability under the contract had passed, by ratification, to
the company. It was held, however, that as the company did not exist at the time of
the agreement it would be wholly inoperative unless it was binding on the promoters
personally and a stranger cannot by subsequent ratification relieve them from that
responsibility.
On the other hand, a promoter can avoid personal liability if the company, after
incorporation, and the third party substitute the original pre-incorporation contract
with a new contract on similar terms. 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 (Re Patent Ivory Manufacturing Co, Howard v Patent Ivory Manufacturing
Co (1888) 38 Ch D 156). However, novation is ineffective if the company adopts
the contract due to the mistaken belief that it is bound by it (Re Northumberland
Avenue Hotel Co Ltd (1886) 33 Ch D 16). A promoter can also avoid personal liability
on a contract where he signs the agreement merely to confirm the signature of the
company because in so doing he has not held himself out as either agent or principal.
The signature and the contractual document will be a complete nullity because the
company was not in existence (Newborne v Sensolid (Great Britain) Ltd [1954] 1 QB 45).
As noted above, the common law position has now been modified, as a result of the
UK’s implementation of the First European Community Directive on Company Law, by
s.51 CA 2006 (replacing s.36C CA 1985). The provision seeks to protect the third party
by making promoters personally liable when the company, after incorporation, fails to
enter into a new contract on similar terms.
5.4.2 Companies Act 2006, s.51

Section 51(1) 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 effect, subject to any agreement to the contrary, as
one made with the person purporting to act for the company or as agent for it, and he is
personally liable on the contract accordingly.
The meaning of s.51 was considered by the Court of Appeal in Phonogram Ltd v Lane
[1982] QB 938. Lord Denning MR took the phrase ‘subject to any agreement to the
contrary’ to mean that for a promoter to avoid personal liability the contract must
expressly provide for his exclusion. The Court also held that it is not necessary for
the putative company to be in the process of creation at the time the contract was
entered into. In Braymist Ltd v Wise Finance Co Ltd [2002] 1 BCLC 415, an 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. It was held that although the terms
of the first Directive referred only to liability and not to enforcement, 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. The words in the section ‘and
he is personally liable on the contract accordingly’ did not operate to negate this
view. Rather the phrase merely serves to emphasise the abolition of the common
law distinction between agents who incurred personal liability on pre-incorporation
contracts and those who did not. The section is thus double-edged so that a party who
is personally liable for the contract is also able to enforce it.
5.5 Freedom of establishment

Companies are no longer static entities whose operations are confined to the
jurisdiction in which they were incorporated. In furtherance of the internal market
goal, the EC Treaty creates a common market with free movement of goods, persons,
services and capital. Articles 2, 43 and 48 of the EC Treaty seek to confer a right of
establishment on natural persons and companies alike to carry on business in any
Member State. The fundamental requirement is that companies must have been
formed according to the law of a Member State and that they have their registered
office, or centre of administration or principal place of business within the European
Community (article 48 EC Treaty). A Member State which seeks to impede the right
of a company registered in another Member State from carrying on business in its
jurisdiction will be held to be acting in breach of its EC Treaty obligations. For example,
in Centros Ltd v Erhversus-og Selkabssyrelsen (Case C-2212/97) [2002] 2 WLR 1048, the ECJ
held that Denmark was in breach of EU law in refusing to allow Centros Ltd, a private
company registered in England, to establish a branch in Denmark, even though
Denmark was in fact its primary operational establishment. The Court rejected the
argument of the Danish authorities that the Danish owners of Centros Ltd had chosen
the UK as the state of incorporation of its undercapitalised company in order to avoid
the minimum capital requirements required under Danish law. The motives of the
owners could not be regarded as abusive but were a consequence of their freedom to
incorporate a company in one Member State and set up a secondary establishment in
another.
See Überseering BV v Nordic Construction Co Baumanagement GmbH (Case 208/00) [2002]

ECR I–9919, ECJ and Kamer van Koophandel en Fabrieken voor Amsterdam v Inspire Art Ltd
(Case C-167/01) [2003] ECR I–10155, ECJ. See further, Lowry (2004).
The pan-European business entity, the European Company (SE), which became
available in October 2004, will address the concerns of those Member States wishing
to regulate under-capitalised companies operating within their jurisdictions. Further,
the draft 14th EC Company Law Harmonisation Directive aims to facilitate corporate
migration. A company will be able to move its registered office between Member
States without having to disrupt its operations by reincorporating in the host
jurisdiction.
Activity 5.3
Read Phonogram Ltd v Lane [1982] QB 938 and Braymist Ltd v Wise Finance Co Ltd
[2002] 1 BCLC 415.
Re-read Dignam and Lowry, Chapter 4, paras 4.14–4.21.
What is the policy underlying s.51 CA 2006?
Summary
The key point to understand is that promoters are fiduciaries. Where promoters fail to
disclose a profit to an independent board of directors the company can require them
to account for it (i.e. to disgorge the profit). Section 51 of the CA 2006 is designed to
protect third parties contracting with promoters by making the promoters personally
liable on pre-incorporation contracts.
Further reading
¢ Davies and Worthington, Chapter 5: ’Promoters’.
¢ Dyrberg, P. ‘Full free movement of companies in the European Community at

last’ (2003) ELR 528.
¢ Green, N. ‘Security of transaction after Phonogram’ (1984) MLR 671.
¢ Griffiths, A. ‘Agents without principals: pre-incorporation contracts and section

36C of the Companies Act 1985’ (1993) LS 241.
¢ Gross, N. ‘Pre-incorporation contracts’ (1971) LQR 367.
¢ Lowry, J. ‘Eliminating obstacles to freedom of establishment: the competitive

edge of UK company law’ (2004) CLJ 331.
¢ Twigg-Flesner, C. ‘Full circle: purported agent’s right of enforcement under

section 36C of the Companies Act 1985’ (2001) Company Lawyer 274.
¢ Worthington, S. Sealy & Worthington’s text, cases and materials in company law.
(Oxford: Oxford University Press, 2016) 11th edition [ISBN 9780198722052].

Gerald, Jill and Harry form a syndicate. They pool their savings and buy catering
equipment. They run a business from an old school kitchen which Jill bought for
£5,000. They supply pies and sandwiches to local hotels. The business is successful
and they decide to form a company. Jill sells the kitchen to the company for
£10,000. Gerald buys three vans for £5,000 each and resells them to the company
for £6,000 each. Harry instructs British Telecom to install a telephone. He tells
them that the company, when formed, will take over the liabilities in respect of
telephone bills. Harry pays £100 deposit for the installation of the telephone.
The company is incorporated and Harry, Jill and Gerald are named as sole directors.
Harry telephones British Telecom and instructs them to bill the company in future.
They do so but £500 worth of bills remain unpaid.
The company has now failed and a liquidator has been appointed. Advise all parties
as to their rights and liabilities.

This question is wide ranging and requires you to define promoters, explain their
fiduciary duties with particular reference to the duty of disclosure to an independent
board and to discuss the liability of promoters for secret profits.
You need to discuss what ‘promoters’ are: see Twycross v Grant. The liquidator will be
concerned with:
u Jill’s sale of the kitchen to the company
u Gerald’s sale of the vans to the company
u Harry’s transaction with British Telecom.
Both Jill and Gerald are promoters and owe fiduciary duties to the company. They
are therefore precluded from making secret profits unless full disclosure of the
transaction is made to an independent board which consents to the profits (Erlanger
v New Sombrero Phosphate Co). However, the question states that Jill, Harry and Gerald
are the sole directors. As such, are they independent? If you conclude they are not, you
should discuss Salomon v Salomon. If they are also its sole members then, according
to Gluckstein v Barnes, disclosure to them will not suffice either because they are not
truly independent. In this situation you should argue whether Gluckstein should be
distinguished – if the company is private so that the scheme is not designed to defraud
the investing public, the court may distinguish Gluckstein on its facts.
You will need to consider the company’s remedies of rescission and accounting of
profits (Lagunas Nitrate Co v Lagunas Syndicate). Note the circumstances in which
rescission may be lost (Re Cape Breton Co) and that for rescission to be available it must
be possible to restore the parties to their original position unless, due to the fault of
the promoter, this possibility has been lost: Lagunas Nitrate Co v Lagunas Syndicate.
Even if the respective contracts with Jill and Gerald have been affirmed, the company
can nevertheless sue them to account for their secret profits.
Harry has entered into a pre-incorporation contract. Because the company did not
exist at the time of this contract, can it be bound by it? You need to discuss Kelner
v Baxter. Further, you will need to consider s.51 CA 2006, which makes a promoter
personally liable unless there is an agreement with the third party, British Telecom, to
the contrary (see Phonogram Ltd v Lane). For Harry to avoid liability the company must
enter into a new contract with British Telecom on the same terms as that made by him
(novation).
Reflect and review



first again
I can explain when a person will be treated as a
promoter.   
I can describe the duties and liabilities of promoters.   
I can describe the issues arising from pre-

incorporation contracts.   
I can assess the impact of s.51 CA 2006 on pre-

incorporation contracts and the liability of promoters.   
revise?
Must Revision
revise done
5.1 Determining who is a promoter  
5.2 The fiduciary position of promoters  
5.3 Duties and liabilities  
5.4 Pre-incorporation contracts  
5.5 Freedom of establishment  

Notes
6 Raising capital: equity
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
6.1 Private and public companies . . . . . . . . . . . . . . . . . . . . . . 51
6.2 Raising money from the public . . . . . . . . . . . . . . . . . . . . . . 52
6.3 Insider dealing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
6.4 Regulating takeovers . . . . . . . . . . . . . . . . . . . . . . . . . . . 56

Introduction
Companies can raise money in a number of ways. For small companies the owner’s
savings or bank loans usually provide the necessary finance. However, as companies
grow they may also wish to raise capital in the form of equity (shares) from the general
public. In this chapter we will examine the legal issues surrounding raising equity from
the general public.
Learning outcomes
u distinguish between raising capital for public and private companies
u outline the relevant methods of selling shares to the general public
u describe how the listing regime protects investors
u explain the sanctions available where insider dealing has occurred.
Core text
¢ Dignam and Lowry, Chapter 5: ‘Raising capital: equity and its consequences’.
Company Law 6 Raising capital: equity page 51
6.1 Private and public companies
6.1.1 Restriction on private companies

As we discussed in Chapter 2, companies can be either private or public. A key distinction
between the two types of registered company is that in terms of equity or capital raising
the law presumes that in private 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 usually also restrict the ability of their shareholders to transfer
their shares (see Dignam and Lowry, Chapter 1, para 1.15). Crucially, private companies are
prohibited from raising capital from the general public (s.755 CA 2006). 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. The Listing Rules of the London Stock
Exchange (LSE) (the most sophisticated market for raising public funds) require that a
company be a public company.
Public companies are designed to secure investment from the general public. As such
they can advertise the fact that they are offering shares to the public. In doing so the
company must issue a prospectus giving a detailed and accurate description of the
company’s 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 noted in Chapter 2, there is a minimum capital requirement of
£50,000 (s.763 CA 2006). However, the capital requirement may be partly paid so the
company does not actually have to have £50,000; it just needs one-quarter of that to
be ‘paid up’, plus the ability to call on the members for the remaining amount (s.586 CA
2006). While there is no formal limitation on public companies preventing them from
transferring shares as private companies do, it would be highly unusual, given that the
aim is to raise money from the general public, who would be discouraged by such a
restriction. In any case, if the public company is listed on the LSE such restrictions on
transfer will be prohibited. Public companies also attract a higher level of regulation.
6.1.2 Public companies and the public interest

Public companies have a much greater potential to affect the general public than
private companies because of their capital-raising activities. As a result the state has
taken a greater interest in investor protection where public companies are concerned.
For example, the CLRSG in its consultation document Completing The Structure (para
2.73) identified tighter accounting rules, a more onerous capital maintenance regime
and stricter rules for the board of directors as three distinct areas where public
companies were subject to enhanced regulation.
Public companies are not necessarily listed on the stock exchange, but as we noted
above, some public companies may decide to raise capital on the LSE. This involves
applying to the LSE and fulfilling a very strict set of criteria to ensure the business
is a sound one. A listing on the stock exchange is essentially a private contractual
arrangement between a public company and the LSE (itself a listed public company)
to gain access to a very sophisticated market for its shares. The public company, once
it gains access to the stock market, is then generally known as a listed company
and its shares as listed shares or securities. The LSE offers the facility of a secondary
market, that is, a place where shares can be traded after 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. A listing also has
the advantage that investors will have greater confidence 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. The shareholders of listed companies tend to be what are called
institutional investors. These institutional investors are made up of pension funds,
insurance companies, professional management funds who are investing funds on
behalf of individuals and, increasingly, the investment vehicles of foreign states, which
are usually referred to as ‘Sovereign Wealth Funds’
Activity 6.1
Explain the differences between a private and a public company for capital raising
purposes.
Summary
There are several distinctions between public and private companies. Perhaps the key
distinction is that private companies cannot raise funds from the general public. As a
result public companies are the major vehicles for capital (equity) raising in the UK.
If a public company wishes to raise large amounts of equity then it might consider
applying to be listed on the LSE.
6.2 Raising money from the public

While a public company seeking a listing on the LSE must comply with the regulations
of the LSE the company must also choose a way to sell its shares to the general public.
This can be done a number of ways and the following are the most relevant here.
u The company could offer its shares for subscription itself. This is done by issuing a
prospectus and advertising in the trade or general press.
u An offer for sale. This is where the company has an agreement with an issuing
house (a merchant bank) whereby it will allot its entire issue of shares to the
issuing house. The issuing house will then try to sell the shares to its clients and the
general public. The advantage of this type of sale is that the issuing house takes the
risk that the shares will not sell.
u A placing. Here the shares may not be offered to the general public at all, but are
‘placed’ with the clients of a merchant bank or group of merchant banks.
u The company could raise money through a rights issue. This is where new
shares are offered to the existing shareholders in proportion to their existing
shareholding. These pre-emption rights are conferred on shareholders by s.561
CA 2006. Once a company is listed, further capital raising is more straightforward
without the complication of the initial listing process.
6.2.1 The FCA, the FSA and the LSE

The Financial Conduct Authority (FCA) is now the main UK financial services regulator
and therefore the listed market comes within its ambit. Previously, the FCA’s
responsibilities were carried out by the Financial Services Authority (FSA). However,
UK financial regulation was substantially overhauled in the wake of the financial crisis
of 2008, and that overhaul involved replacing the FSA with, among other bodies, the
FCA. Until May 2000 the LSE was also the UK’s ‘competent authority for listing’ with
responsibility for admitting securities (shares and debentures) to listing, making the
Listing Rules and policing compliance with them. Following enactment of the Financial
Services and Markets Act 2000 (FSMA), which replaced the Financial Services Act 1986,
this function was transferred to the FSA, and subsequently to the FCA, which is now
the UK Listing Authority. The LSE is the principal Recognised Investment Exchange (RIE)
for trading securities of UK and foreign companies, government stocks and options to
trade company securities in the UK. Some 1,800 companies registered in the UK have
listed securities.
Once a company has obtained a listing by complying with the listing rules it can only
maintain listed status if it complies with the continuing obligations specified in the
listing rules. The LSE’s statutory obligation to operate an orderly market also obliges it
to monitor listed companies on an ongoing basis. As such the LSE and the FCA have an
important co-operative role.
Activity 6.2
a. What is a listed company?
b. Why are private companies prohibited from becoming listed companies?
c. What are the major forms of selling shares to the general public?
d. Who has responsibility for regulating the UK’s public markets?
6.2.2 Obligations when listing

While the compliance regulations for companies seeking a listing are complex and
voluminous they broadly cover the availability of past accounts, compliance with a
minimum market capitalisation and a minimum ‘proportion of the shares in public
hands’ requirement. The Listing Rules focus specifically on the information that must
be made available to the public by a company when its shares are being listed. These
disclosure requirements operate on the principle that all documents issued must:
contain all such information as investors and their professional advisers would reasonably
require, and reasonably expect to find there, for the purpose of making an informed
assessment of: (a) the assets and liabilities, financial position, profits and losses, and
prospects of the issuer of the securities; and (b) the rights attaching to those securities.
s.80(1) FSMA 2000.
Thus the requirements aim to provide potential investors with such core information
about the company’s activities as will allow them to make an informed investment
decision. If shares by listed companies are offered to the public a prospectus (the
document issued to the public inviting them to invest in the shares) submitted to,
and approved by, the FCA is required. Since 2005 and the implementation of the
Prospectus Directive (Directive 2003/71/EC) 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 offerings.
6.2.3 Continuing obligations

Once a company has achieved a listing it continues to be subject to a number of
obligations to disclose information necessary to maintain an orderly market and to
protect investors. The continuing obligations require listed companies to publish
half-yearly reports on their activities, together with profits and losses made during the
first six months of each financial year. Further, by way of an additional requirement
to the duty to issue full annual accounts and reports, a listed company must also
publish a preliminary statement of the annual results. Directors of listed companies
must also produce a ‘strategic report’ covering the development and performance of
the business which identifies the principal risks and uncertainties ahead (see Chapter
15 on the link between this report and the directors’ duty under s.172 CA 2006, and
Chapter 16 on the social reporting requirements for companies). The continuing
obligations also operate as a means of preventing insider dealing (see below) as
the Listing Rules require a listed company to publish price-sensitive information
(information that may result in substantial movement in the price of its securities) as
quickly as possible. Failure to comply with the listing regime carries the possibility that
the FCA will sanction the company or individuals responsible for the failure. This could
lead to a wide range of criminal and civil sanctions.
On 20 January 2007 a version of the Transparency Directive (2004/109/EC) was

implemented for UK listed companies. Part 43 of the CA 2006 amends Part VI of the
FSMA in a number of ways to implement the requirements of the Directive. It requires
companies to produce periodic financial reports and specifies the minimum content
of those reports. It requires major shareholders to disclose their holdings at certain
thresholds. On the implementation of the Directive, responsibility for the shareholding
disclosures was moved from the DTI (now the Department for Business, Energy and
Industrial Strategy (BEIS)) to the FCA. The Directive also requires that companies
disclose information to investors on a fast, non-discriminatory and pan-European

basis. Additionally the Transparency regime provides for criminal and civil penalties for
non-compliance.
6.2.4 Reforming the regulatory structure

The CLRSG considered the current regulatory arrangement for public companies in
‘Regulatory and institutional framework for company law’ (Chapter 12 of Completing
the structure). It concluded after much discussion that it did not ‘see any need for any
more extensive redrawing of the regulatory “map”’ (paras 12.112–113). The Companies
Act 2006 did not, as a result, affect the regulatory structure within which listed
companies operate. However, the credit crisis in Autumn 2008 led to a major overhaul
of the structure of financial regulation in the UK. The Financial Services Act 2012 was
enacted, introducing major changes to the Financial Services and Markets Act 2000.
The FSA was replaced by two new regulatory bodies. The first was the Prudential
Regulation Authority (PRA), which is a subsidiary of the Bank of England, and is
responsible for promoting the stable and prudent operation of the financial system
through regulation of all deposit-taking institutions, insurers and investment banks.
The other regulatory body we have noted already, namely the FCA. It is responsible
for regulation of conduct in retail, as well as wholesale, financial markets and the
infrastructure that supports those markets. As we have seen, it acts as the UK Listing
Authority.
Activity 6.3
What is the listing regime trying to achieve by emphasising disclosure before and
after listing?
Summary
When listing, a company has a number of possible methods of selling its shares:
offering its shares itself for subscription, an offer for sale, a placing or a rights issue if
already listed. The FCA is the UK’s main financial regulator and is the listing authority in
the UK. By necessity it works closely with the LSE to ensure that the listing regime, with
its emphasis on disclosure, operates effectively.
6.3 Insider dealing

Having a company’s shares listed on a stock exchange – while advantageous for raising
capital – also carries with it the risk that insiders may wish to take advantage of their
access to privileged confidential information by buying and selling shares on the basis
of that information. Every country in the world with a major stock exchange has made
this practice illegal because of its potential to destroy public confidence in the stock
exchange. As we discussed above with regard to the continuing obligations of listed
companies, the FCA and the LSE also attempt to ensure that opportunities to insider
deal are minimised by requiring that companies disclose any significant information
that might affect share prices as quickly as possible.
6.3.1 Criminal sanctions for insider dealing

Part V of the Criminal Justice Act 1993 contains the main criminal provisions specifically
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.
The insider will also be guilty of an offence if they induce others to deal in price-
sensitive securities on a regulated market, whether or not the insider knows the
information to be price sensitive (i.e. the information would make the share price
go up or down) (s.52(2)(a)). It is also an offence just to disclose price sensitive

information to another person in an irregular manner (s.52(2)(a)). If found guilty a
fine or imprisonment for up to seven years is possible. However the criminal standard
of proof proved very difficult to achieve because of the complexity of many insider
dealing situations. As a result a civil offence was introduced.
6.3.2 The civil sanction regime

The criminal provisions against insider dealing, described in 6.3.1, have not proved
terribly effective. Enforcement has been problematic, partly because of the criminal
burden of proof that must be satisfied. Moreover, there are other ways, besides insider
dealing, through which share markets may be manipulated or distorted. This might be
done, for example, by releasing false information to the market in order to affect share
prices.
Because of these problems with the criminal ‘insider dealing’ regime, UK law has been
extended to cover ‘market abuse’ more generally. The legislation imposes a range of
penalties on those engaging in market abuse, including civil penalties and statements
of censure.
Market abuse was first regulated by the Financial Services and Markets Act 2000
(FSMA). Section 123 of the FSMA empowers the FCA to impose penalties for market
abuse. However, much of the detail of the regulation here is not to be found in the
FSMA itself. Some is contained in regulations that have been made under the FSMA
(the Financial Services and Markets Act 2000 (Market Abuse) Regulations 2005 (SI
2005/381) and 2016 (SI 2016/680). And many of the relevant rules are now found in
an EU regulation that was introduced in 2014, namely the Market Abuse Regulation
(Regulation 596/2014/EU) (MAR). MAR is complex, and it makes many changes to the
fine details of the regulation of market abuse. Fortunately, you do not need to learn
this in detail.
What counts as ‘market abuse’ is now defined by MAR. Essentially, it covers two types
of behaviour: insider dealing and ‘market manipulation’. To qualify as market abuse,
the behaviour must not only fall into one of these two categories, but must also
relate to trading in ‘financial instruments’ on certain specified markets. The financial
instruments that are covered include shares in a company, while the markets that are
covered include the London Stock Exchange’s Main Market. The fact that the regulation
of market abuse is limited to trading on formal markets shows that the purpose of the
regulation is not so much about ensuring fairness in individual transactions, but rather
about protecting the integrity of the market as a whole.
The principal penalty for market abuse is a fine, which can be imposed on any person
who has engaged in market abuse or has required or encouraged any other person
to do the same. In addition, the FCA may censure those who have engaged in market
abuse, and the Secretary of State may also apply to the court for a restitution order in
favour of those injured by the market abuse. However, the FSMA makes no provision
for an individual shareholder who has suffered a loss as a result of breach of the
market abuse provisions described above to bring proceedings to recover such loss.
Activity 6.4
Why is insider dealing illegal?
Summary
Insider dealing is where insiders in a company seek to benefit from their access to
privileged confidential information by buying and selling shares which would be
affected by the privileged information. As a result criminal provisions were introduced
in order to deal with this problem. These provisions proved unsuccessful as the
standard of proof was too difficult to achieve. Civil sanctions were introduced in the
FSMA to provide a lesser offence of market abuse.
6.4 Regulating takeovers

One of the consequences of listing on the LSE is that the shares of the company can
be easily bought and sold. This also means that the entire listed shareholding can be
bought in the listed marketplace, thus effecting a takeover of the company.
Strangely, given the importance of this area, the Companies Act contains relatively few
provisions on the regulation of takeovers.
u Section 219 CA 2006 contains disclosure requirements for directors’ salaries.
u The Transparency Directive requires anyone acquiring a 3 per cent holding in a

company to disclose their interest to the company and again every time their
interest increases or decreases by 1 per cent.
u Section 979 CA 2006 governs post-takeover compulsory purchase of a dissenting

minority.
Additionally, ss.895–901 CA 2006 and s.110 Insolvency Act 1986 allow effective
takeovers of companies in crisis and liquidation. The conduct of the takeover itself,
which is of greatest concern to shareholders and companies, is left to the self-
regulatory system to govern.
Since 1968 the conduct of takeovers has been governed by the Panel on Takeovers and
Mergers (the Panel). The Panel administers the rules on takeovers called the City Code
on Takeovers and Mergers (the Code). The Panel and the Code aim to achieve equality
of treatment and opportunity for all shareholders in a takeover bid. The Code, while
flexible, emphasises a number of general principles. These are:
u equality of treatment and opportunity for all shareholders in takeover bids
u adequate information and advice to enable shareholders to assess the merits of

the offer
u no action which might frustrate an offer is taken by a target company during the
offer period without shareholders being allowed to vote on it
u the maintenance of fair and orderly markets in the shares of the companies
concerned throughout the period of the offer.
Until the CA 2006 the Panel was a non-statutory body but its decisions were subject
to judicial review because of the public nature of its regulatory role (see R v Panel on
Takeovers and Mergers ex p Datafin (1987) QB 815). However, the courts would only hear
the review after the takeover was complete, thus eliminating the use of the courts
in a tatical sense during the progress of a takeover bid. Prior to 2006 the Panel had
no formal power to sanction but was held in great respect by the financial services
sector. As a result the Panel had a number of actions it could take. First, the Panel could
issue critical statements about the conduct of a bid which would alert shareholders
to irregularities. Second, the Panel’s role was recognised by the FSA (as it was then
called), the various self-regulatory bodies licensed by the FSA and the professional
bodies. This means that the Panel could pass the matter to these bodies requesting a
sanction. For example, a listed company that did not follow the Code could have the
LSE remove or suspend its listing and the company’s professional advisers could have
disciplinary proceedings brought against them by their professional body. The FSA
might also have withdrawn its investment authorisation (see below) from any person
who is the subject of an adverse ruling of the Panel.
6.4.1 The reform of takeovers

The reform of takeovers in the EU has been a subject of much discussion since 1989
when the European Commission put forward a draft directive on European takeovers.
Unfortunately there are very different views on takeovers within the EU member
states and for more than a decade no progress was made. Eventually in 2001 political
agreement was reached on a text of the Draft Directive by the Council of Ministers
but it was rejected by the European Parliament. In April 2004 a much compromised
Directive was eventually agreed (Directive 2004/25/EC of the European Parliament and
of the Council of 21 April 2004 on Takeover Bids).
The Directive requires the establishment of a statutory body which would oversee
statutory takeover provisions. The CA 2006 Part 28, as a result, converted the self-
regulating Panel (s 942 CA 2006) into just such a statutory body to oversee takeovers in
the United Kingdom on 6 April 2007. Under the Takeover Directive reforms, the Panel
now has its own range of sanctions contained in ss.952-956 CA 2006. Thus 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.
This means that the Panel can take action itself or pass the matter to other regulators
requesting a sanction. For example, a listed company that does not follow the Code
could face:
u the LSE removing or suspending its listing
u disciplinary proceedings being brought against the company’s professional

advisers by their professional body.
†
The FCA might also withdraw its investment authorisation† from any person who is the This is necessary for all those
subject of an adverse ruling of the panel. who deal in the securities
market.
Further reading
¢ Bagge, J., C. Evans, G. Wade and M. Lewis ‘Market abuse: proposals for the new
regime’ (2000) X1(9) PLC 35.
¢ Campbell, D. ‘Note: what is wrong with insider dealing’ (1996) Legal Studies 185.
¢ Davies and Worthington, Chapter 25: ‘Public offers of shares’ and Chapter 30:
‘Insider dealing and market manipulation’.
¢ Marsh, J. ‘Disciplinary proceedings against authorised firms and approved

persons under The Financial Services and Markets Act 2000’ in de Lacy, J.
(ed.) The reform of United Kingdom company law. (London: Cavendish, 2002)
[ISBN 9781859416938].
¢ McVea, H. ‘What’s wrong with insider dealing?’ (1995) Legal Studies 390.
¢ Morse, G.K. ‘The City code on takeovers and mergers – self regulation or self
protection?’ (1991) JBL 509.
Sample examination question† †

The areas covered in
George is the managing director of Flub plc, a UK listed company which Sections 6.1 and 6.2 above
manufactures a range of medical products. On the morning of 4 July 2002 George have historically provided
the context for your general
received news that the company’s new wonder drug had failed a crucial test and
understanding of company
would not be going into production for years, if ever. The news is to be released the
law rather than being an
next day at mid-day. George went to a party that evening where he met his friend
examinable area in itself.
Martha who commented that George seemed a bit ‘down’. George replied that
As such the core text and
‘things had not been going well with some of the company’s new products’. Martha
the activities above should
had shares in Flub plc and phoned her broker the next morning to discuss selling
provide that context. Sections
her shares. In the course of this conversation she mentions George’s comment
6.3 and 6.4 are examinable
the night before. The broker advises her to sell fast. Martha sells her shares before
and so you should attempt
mid-day and avoids a huge loss when the bad news about Flub’s wonder drug is the following question.
announced.
Discuss the insider dealing implications of the above.

Apply the criminal sanction first (s.52 Criminal Justice Act 1993).
Go through the facts carefully and decide who might have dealt as an insider here –
George? Martha? The broker? Follow the price sensitive information and what each
character does with it.
Remember the insider will also be guilty of an offence if he induces others to deal
(whether they know the information is price sensitive or not) in price sensitive
securities on a regulated market (s.52(2)(a)). It is also an offence just to disclose price
sensitive information to another person in an irregular manner (s.52(2)(a)).
Will the standard of proof be a problem here?
Go through the civil market abuse offence. This is more straightforward but again
apply it to all the characters in the question.
Reflect and review



first again
I can distinguish between raising capital for public and
private companies.   
I can outline the relevant methods of selling shares to

the general public.   
I can describe how the listing regime protects

investors.   
I can explain the sanctions available where insider

dealing has occurred.   
revise?
Must Revision
revise done
6.1 Private and public companies  
6.2 Raising money from the public  
6.3 Insider dealing  
6.4 Regulating takeovers  

Notes
7 Raising capital: debentures
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
7.1 Debentures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
7.2 Company charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
7.3 Priority . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
7.4 Avoidance of floating charges . . . . . . . . . . . . . . . . . . . . . . 68

Introduction
We saw in Chapter 6 that a company raises capital by issuing shares. Another way for
companies to raise money is by borrowing. In fact the majority of companies in the
UK are private, with an issued share capital of £100 or less. For such companies loan
capital is therefore a crucial means of financing their business activities and typically
they approach high street banks for loans. Since banks are generally risk-averse,
particularly since the onset of the global credit crisis, they will require security for
their loans. In this chapter we therefore consider corporate borrowing by way of
debentures or debenture stock and the types of charge that companies can issue to
lenders as security.
Learning outcomes
u explain what is meant by the term debenture
u describe the nature of fixed and floating charges and the distinction between
them
u explain what is meant by book debts and outline the debate surrounding the
issue of granting a fixed charge over them
u outline the priority of charges and the statutory registration scheme
u describe and assess the proposals for reform.
Core text
¢ Dignam and Lowry, Chapter 6: ‘Raising capital: debentures: fixed and floating
charges’.
Cases
¢ Re Yorkshire Woolcombers Association [1903] 2 Ch 284
¢ Siebe Gorman & Co Ltd v Barclays Bank Ltd [1979] 2 Lloyd’s Rep 142, 10 LDAB 94
¢ Chalk v Kahn [2000] 2 BCLC 361
¢ Re New Bullas Trading Ltd [1994] 1 BCLC 485
¢ Ashborder BV v Green Gas Power Ltd [2005] BCC 634
¢ Queens Moat Houses plc v Capita IRG Trustees Ltd [2004] EWHC 868 (Ch)
¢ Agnew v Commissioner of Inland Revenue [2001] 2 AC 710, PC
¢ National Westminster Bank plc v Spectrum Plus Ltd [2005] UKHL 41.
Additional cases
¢ Arthur D Little Ltd v Ableco Finance LLC [2002] 2 BCLC 799
¢ Smith v Bridgend County Borough Council [2002] 1 BCLC 77
¢ Re Harmony Care Homes Ltd [2009] EWHC 1961.

Company Law 7 Raising capital: debentures page 63
7.1 Debentures
Put simply, a debenture is the document that evidences, or acknowledges, the
company’s debt (Levy v Abercorris Slate and Slab Co (1887) 36 Ch D 215, per Chitty J; see
also Knightsbridge Estates Trust v Byrne [1940] AC 613). The definition provided by s.738
CA 2006 is far from helpful: ‘…“debenture” includes debenture stock, bonds and any
other securities of a company, whether constituting a charge on the assets of the
company or not’. Thus a mortgage of freehold property by a company falls within the
statutory definition as it is a security and a charge on its assets. A charge or security
interest is a right in rem† created by a grant or declaration of trust which, if fixed, †
in rem (Latin) – meaning
implies a restriction on the debtor’s dominion over the asset(s) in question (Goode ‘the thing’ as opposed to the
(2003)). person (in personam).
Debenture stock is money borrowed from a number of different lenders on the same
terms. Such lenders form a ‘class’ who usually have their rights set out in a trust deed.
The trustee, often a bank, represents their interests as a whole. The trust deed will
generally set out the following terms.
u The obligation to pay the principal sum with interest.
u The security, if any, that is given for the loan.
u The events that will trigger the enforcing of the security.
7.2 Company charges

Creditors will often require security from a borrower before lending money, so that in
the event of a default on repayment the creditor can enforce the security interest. By
requiring security from a debtor-company the creditor seeks to ensure priority over
the general body of creditors should the company be wound up.
The granting of security by a company does not mean that the title to the secured
asset passes to the creditor. Instead it creates an encumbrance on the property. The
creditor gets a right to have the security made available by an order of the court
(National Provincial Bank v Charnley [1924] 1 KB 431, Atkin LJ). For companies, the most
common species of charges given as security interests are fixed and floating charges.
7.2.1 Fixed and floating charges
Fixed charges
A company may grant a fixed charge to a creditor over certain property such as a
warehouse. Such a charge is similar to a mortgage in that the rights of the creditor (the
chargee) attach immediately to the property and the company’s (the chargor’s) power
to deal with the asset is restricted. In Agnew v Commissioner of Inland Revenue [2001] 2
AC 710 Lord Millett stated that:
A fixed charge gives the holder of the charge an immediate proprietary interest in the
assets subject to the charge which binds all those into whose hands the assets may come
with notice of the charge.
Floating charges
As its name suggests, a floating charge floats over the whole or a part (class) of
the chargor’s assets, which may fluctuate as a result of acquisitions and disposals.
Corporate property that can be made subject to a floating charge includes stock in
trade, plant (machinery), and book debts (receivables). The distinguishing feature
of a floating charge is that the company can continue to deal with the assets in the
ordinary course of business without having to obtain the chargee’s permission.
In Ashborder BV v Green Gas Power Ltd [2005] BCC 634, Etherton J reviewed the
characteristics of the floating charge and examined the notion of the chargor being
allowed to deal with the charged assets in the ‘ordinary course of business’. The judge
noted that whether a transaction was within the ordinary course of business is a mixed
question of fact and law and the viewpoint of the objective observer on the facts is a
useful aid.
A floating charge converts to a fixed charge over the assets within its scope upon the
occurrence of a ‘crystallising’ event such as a default on repayment or the winding up
of the company.
The impact of liquidation

The distinction between a fixed and floating charge assumes critical importance if the
company goes into liquidation (see Chapter 17) because of the ranking of chargees
against the general body of creditors. In Re Yorkshire Woolcombers Association [1903] 2
Ch 284, Romer LJ listed the following distinguishing features of a floating charge.
u It is a charge on a class of assets of a company present and future.
u That class is one which, in the ordinary course of the business of the company,
would be changing from time to time.
u By the charge it is contemplated that, until some future step is taken by or on

behalf of those interested in the charge, the company may carry on its business in
the ordinary way as far as concerns the particular class [charged].
In determining whether a charge is fixed or floating the courts will look to the
substance of the matter irrespective of what description the parties use to categorise
it. In this regard Lord Millett explained, in Agnew v Commissioner of Inland Revenue, that:
In deciding whether a charge is a fixed or a floating charge, the Court is engaged in a

two-stage process. At the first 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 fixed
or a floating charge. It is to ascertain the nature of the rights and obligations which the
parties intended to grant 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 instrument, is to
grant the company rights in respect of the charged assets which are inconsistent with the
nature of a fixed charge, then the charge cannot be a fixed charge however they may have
chosen to describe it.
Lord Millett noted that Romer LJ’s third distinguishing feature (see above) is the
classic hallmark of a floating charge. More recently, in National Westminster Bank plc v
Spectrum Plus Ltd [2005] UKHL 41, Lord Phillips MR explained that:
Initially it was not difficult to distinguish between a fixed and a floating charge. A fixed
charge arose where the chargor agreed that he would no longer have the right of free
disposal of the assets charged, but that they should stand as security for the discharge of
obligations owed to the chargee. A floating charge was normally granted by a company
which wished to be free to acquire and dispose of assets in the normal course of its
business, but 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 floating 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 ‘floated’.
In Arthur D Little Ltd v Ableco Finance LLC [2002] 2 BCLC 799 the chargor, Arthur D Little
Ltd, guaranteed the liabilities of its two parent companies to Ableco by creating a
charge, described as a first fixed charge, over its shareholding in a subsidiary company,
CCL. The chargor company retained both its voting and dividend rights with respect
to the shares until default. The company’s administrator argued that it was a floating
charge. It was held, applying Lord Millett’s reasoning in Agnew, that whether or not
the charge was fixed or floating is a question of law and the particular charge in issue
was fixed. It did not float over a body of fluctuating assets and, notwithstanding the
company’s 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. The asset was therefore under the control of the chargee.
In Queens Moat Houses plc v Capita IRG Trustees Ltd [2004] EWHC 868, 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 fixed charge a floating charge.
Activity 7.1
What are the principal characteristics of a floating charge and how does it differ
from a fixed charge?
Summary
Whereas a fixed charge over an asset attaches immediately, a company has the
freedom to continue to deal in the ordinary course of business with assets which are
subject to a floating charge.
7.2.2 Book debts

Book debts are ‘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’ (Official Receiver v Tailby
(1886) 17 QBD 88). It is common for a company to have debts continuously owed to
it by customers for goods and services that the company has rendered. Rather than
wait for payment a company can borrow money from creditors against the debts that
remain unpaid. A question that has frequently come before the courts is whether a
fixed charge can be created over book debts. Although the issue has now been settled
by the Privy Council in Agnew v Commissioner of Inland Revenue [2001] 2 AC 710, PC and,
more significantly, by the House of Lords in National Westminster Bank plc v Spectrum
Plus Ltd (discussed below), it is worthwhile considering the cases that gave rise to the
problem in order to understand the reasoning of the House of Lords in Spectrum.
In Siebe Gorman & Co Ltd v Barclays Bank Ltd [1979] 2 Lloyd’s Rep 142, the company
granted a debenture in favour of Barclay’s Bank. The security was expressed to be
a ‘first fixed charge’ over all of its present and future book debts. The debenture
required the company to pay the proceeds of all book debts into its Barclays account
and it prohibited the company from charging or assigning its book debts without
first obtaining the bank’s consent. It was held that the company’s charge over its
receivables was fixed. The judge reasoned that taking the restrictions placed on the
company’s power to deal with the proceeds of the debts, together with the bank’s
right to prevent the company making withdrawals from the account even when it
was in credit, gave the bank a degree of control that was inconsistent with a floating
charge. On the other hand, in Chalk v Kahn [2000] 2 BCLC 361 under the terms of the
charge, described as a fixed charge, the chargor was required to pay the proceeds into
a specified account not held with the chargee bank but with another bank. Since the
chargee had no control over the account it was held that the charge was a floating
charge. A particularly contentious decision is that reached by the Court of Appeal in
Re New Bullas Trading Ltd [1994] 1 BCLC 485, in which it was held that it was possible to
create a combined fixed and floating charge over book debts. Here a fixed charge was
created over uncollected book debts but as soon as the proceeds of the debts were
credited to a specified bank account a floating charge took effect over them.
The decision in Re New Bullas attracted much criticism and in Agnew, Lord Millett
declared New Bullas ‘to be fundamentally mistaken’. In Agnew the debenture was
so drafted as to mirror that in New Bullas but the Privy Council held that where the
chargor company is free to deal with the charged asset(s) in the ordinary course
of business it must be construed as a floating charge. However, where the chargee
retains control over the debts and their proceeds so as to severely restrict the
company’s freedom to deal with them, as in Siebe Gorman, it will be a fixed charge. The
notion of a combined charge was rejected by the Privy Council.
In National Westminster Bank plc v Spectrum Plus Ltd [2005] UKHL 41, the chargor,
Spectrum, granted a fixed (specific) charge to the bank over its book debts to secure
an overdraft of £250,000. The debenture stated that the security was a specific 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. The debenture did not specify any
restrictions on the company’s operation of the account.
Spectrum’s 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 fixed charge over the company’s book debts and their proceeds. The Crown,
however, argued that the debenture merely created a floating charge so that its claims
in respect of tax owed by the company took priority over the bank. The trial judge,
applying Brumark and declining to follow Bullas, held 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 floating charge. In so holding the Vice-Chancellor also declined to
follow Siebe Gorman.
The bank successfully appealed to the Court of Appeal. Lord Phillips MR, delivering the
leading judgment (Jonathan Parker and Jacob LJJ concurring), 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 fixed. He explained that it was not, as a matter of precedent, open
to the Court of Appeal to hold that Bullas was wrongly decided even though the Privy
Council had, in Brumark, expressed the view that the decision was mistaken. Further,
Siebe Gorman was correctly decided given that the debenture in that case clearly
restricted the company’s ability to draw on the bank account into which the proceeds
of its book debts were paid. The Court of Appeal noted that the form of debenture
used in Siebe 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
Siebe Gorman:
Slade J could properly have held the charge on book debts created by the debenture to
be a fixed 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
fixed charge over book debts.
A seven-member House of Lords, as expected, overturned the decision of the Court

of Appeal and overruled Siebe Gorman and Bullas. Following the line of reasoning
adopted by the Privy Council in Brumark, it held that although it is possible to create
a fixed charge over book debts and their proceeds (Tailby v Official Receiver (1888)),
the charge in the present case was a floating charge. Lord Scott delivered the leading
judgment. He stressed that the ability of the chargor to continue to deal with the
charged assets characterised it as floating. For a fixed charge to be created over book
debts, the proceeds must, therefore, be paid into a ‘blocked’ account (see Re Keenan
[1986] BCLC 242). Lord Scott reasoned that:
The bank’s 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 in [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 charger can
draw on the account. If the chargor’s bank account were in debit and the charger 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
Ltd [above]. But so long as the charger 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 charger.
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 this case there was no good reason for postponing the effect
of overruling Siebe Gorman.
For a case in which a lender did, unusually, have sufficient control over the book debts
that had been charged by a borrower for that charge to be a fixed one, see Re Harmony
Care Homes Ltd [2009] EWHC 1961.
Activity 7.2
Read the Privy Council’s opinion delivered in Agnew v Commissioner of Inland
Revenue [2001] 2 AC 710.
What does Agnew tell us about the classification of securities?
7.3 Priority
The general rule is that security interests are prioritised according to the order of
their creation. However, as we saw above, a feature of the floating charge is that
the company can continue to deal with the charged assets in the ordinary course
of business. Therefore a fixed charge can be created which will take priority over an
earlier floating charge. In order to protect their priority, floating chargees can insert
a so-called ‘negative pledge’ clause in the charge that prohibits the chargor from
creating a charge that ranks equally with (pari passu) or in priority to the earlier
floating charge.
Such a restriction is not inconsistent with the nature of a floating charge (Re Brightlife
Ltd [1987] Ch 200). However it should be noted that the subsequent chargee will not
lose priority unless he has actual notice of the negative pledge clause. Mere notice of
the earlier floating charge is not sufficient (Wilson v Kelland [1910] 2 Ch 306). Where
there are competing floating charges the governing principle is that the earliest
created takes priority. However, the parties may agree that the company may create a
subsequent floating charge which will take priority or rank pari passu with the earlier
floating charge (Re Benjamin Cope & Sons Ltd [1914] 1 Ch 800).
7.3.1 Registration
Understandably, a creditor who is considering lending money to a company may
wish to find out the extent of its indebtedness. Companies are therefore required to
register certain details of mortgages over their their assets, under s.859A CA 2006.
(‘Mortgages’ is a broad term, likely to cover most types of charges a company would
create. Section 859A replaced s.860 CA 2006, which contained a much longer list of
different types of charge subject to registration.)
The 21-day registration requirement

Part 25 of the CA 2006 lays down the registration requirements. The principal
obligations are contained in s.859A-Q, which provide that prescribed particulars of
certain categories of charges created by a company, together with the instrument
creating it, must be delivered to, or received by, the Companies Registrar within 21
days of the creation of the charge. Failure to deliver the particulars to the Registrar
within the 21-day period renders the charge void against (see s.874):
u a liquidator
u any creditor of the company (see Smith v Bridgend County Borough Council [2002] 1
BCLC 77).
Note that the loan is not void for want of registration of the charge, but rather the
failure to register results in the lender ranking as an unsecured creditor.
Previously, if a charge was not registered, the company and every defaulting officer is
liable to a fine (s.860(4)). This criminal sanction has now been repealed.
Once registered, the charge is valid from the date of its creation. This results in what
has been termed the 21-day invisibility problem (see the CLRSG’s consultation
document Registration of Company Charges (October 2000), para 3.79). This is because
whenever a person checks the register it cannot be assumed that it is comprehensive
because there may be a charge for which the 21-day period is still running.
Section 859A also requires companies to maintain at its registered office a register
containing certain prescribed particulars of all registrable mortgages. The failure to
keep such a register does not affect the validity of the charge.
When a charge is registered the Registrar must issue a certificate stating the amount
secured by the charge. The certificate is conclusive evidence that the statutory
registration requirements have been complied with. The charge cannot then be set
aside if the particulars are incorrect.
See, for example:
u Re Eric Holmes (Property) Ltd [1965] Ch 1052
u Re CL Nye Ltd [1971] Ch 442.
Registration is a perfection requirement. It does not determine priority which, as

we saw above, depends upon the date the charge was created. Creditors who ought
reasonably to have searched the register will be deemed to have constructive notice
of the charge (Siebe Gorman, above).
Rectification of the register may be possible where the court is satisfied that the
failure to register within the required period or that an omission or misstatement of
any particular was accidental or inadvertent, or is not of a nature to prejudice creditors
or shareholders of the company, or that on other grounds it is just and equitable to
grant relief (s.873). Generally, leave to register out of time is granted by the courts
subject to the rights of intervening secured creditors and provided the company is
solvent (see, for example, Re IC Johnson & Co Ltd [1902] 2 Ch 101).
7.4 Avoidance of floating charges

Section 245 of the Insolvency Act 1986 invalidates a floating 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. The ‘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 floating 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. The term ‘connected person’ is defined 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. The object of s.245 is to prevent an
unsecured creditor obtaining a floating charge to secure his or her existing loan at the
expense of other unsecured creditors.
Activity 7.3
Explain the so-called 21-day ‘invisibility’ problem.
Further reading
¢ Beale, H. ‘Reform of the law of security interests over personal property’ in
Lowry, J. and L. Mistelis (eds) Commercial law: perspectives and practice. (London:
LexisNexis Butterworths, 2006) [ISBN 9781405710077].
¢ Berg, A. ‘Brumark Investments Ltd and the “innominate charge”’ (2001) JBL 532.
¢ Capper, D. ‘Fixed charges over book debts – back to basics but how far back?’
(2002) LMCLQ 246.
¢ Davies and Worthington, Chapter 31: ‘Debentures’ and Chapter 32: ‘Company
charges’.
¢ de Lacy, J. ‘Reflections on the ambit and reform of Part 12 of the Companies Act
1985 and the doctrine of constructive notice’ in de Lacy, J. (ed.) The reform of
United Kingdom company law. (London: Cavendish, 2002) [ISBN 9781859416938].
¢ Ferran, E. ‘Floating charges – the nature of the security’ (1988) CLJ 213.
¢ Ferran, E. and L.C. Ho Principles of corporate finance law. (Oxford: Oxford

University Press, 2014) second edition [ISBN 9780199671359].
¢ Goode, R.M. ‘Charges over book debts: a missed opportunity’ (1994) LQR 592.
¢ Gregory, R. and P. Walton ‘Book debt charges – the saga goes on’ (1999) 115 LQR 14.
¢ Gullifer, L. Goode and Gullifer on legal problems of credit and security. (London:
Sweet & Maxwell, 2018) sixth edition [ISBN 9780414066007].
¢ McCormack, G. ‘Extension of time for registration of company charges’ (1986)

JBL 282.
¢ Worthington, S. Sealy & Worthington’s text, cases and materials in company

law. (Oxford: Oxford University Press, 2016) 11th edition [ISBN 9780198722052],
Chapter 9.
¢ Worthington, S. ‘Fixed charges over book debts and other receivables’ (1997)
LQR 562.
¢ Worthington, S. ‘Floating charges – an alternative theory’ (1994) CLJ 81.
¢ Worthington, S. ‘An “unsatisfactory area of the law” – fixed and floating charges
yet again’ (2004) International Corporate Rescue 175.

Bill and Bob are the directors of Bank Finances plc (‘the company’) which is a long-
established merchant bank that trades globally. In order to finance margin calls
required by their Singapore office they agreed on 1 January 2003 to create a floating
charge over the company’s entire undertaking (in England) in favour of Ratfink
Bank Ltd in return for a loan of £1,000,000,000 (£1 billion). The floating charge
contained a clause providing that it would crystallise in the event of any default
or enforcement proceedings being taken against the company. This charge was
registered on 21 January 2003.
On 14 January 2003 the company refurbished its head office in London. In order
to finance the interior design project Bill and Bob withheld money due to the
Government in the form of VAT and PAYE and also obtained a loan from Beckley’s
Bank for £1,000,000. This loan was secured over the book debts of the company.
The charge was registered on 17 January 2003.
On 15 February, John demanded payment for the office furniture that his firm had
supplied to the company. Following advice from the company’s finance director
the board secured the amount outstanding to John by a fixed charge over the
company’s factory. The finance director also advised the board ‘that the company is
in a position whereby it is unlikely to pay all its creditors and this financial situation
is unlikely to be resolved’.
The company continued to trade until November 2003 when it went into
liquidation.
Advise the liquidator.

You will need to begin by describing the features of fixed and floating charges. The
question also requires you to explain:
i. the rules governing priority between such charges
ii. the position of such charges as against preferential and unsecured creditors
iii. automatic crystallisation of floating charges
iv. avoidance of floating charges under the 1986 Insolvency Act, s.245.
Ratfink charge: expressed as a fixed charge but is this conclusive of the issue? See Re
Yorkshire Woolcombers Association and Agnew v Commission of Inland Revenue. Is the
charge properly registered?
Beckley’s charge: it is secured on book debts but what type of charge is it? See Siebe
Gorman & Co Ltd v Barclays Bank Ltd and Agnew v Inland Revenue Commissioners. You
should also consider the priority issue between Ratfink and Beckley.
John: is it a fixed charge? You will need to discuss the priority issues between fixed and
floating charges.
Section 245 of the Insolvency Act 1986 should be considered – can the liquidator avoid
the floating charges? Finally, mention should be made of preferential creditors and the
effect of the Insolvency Act 2006.
Reflect and review



first again
I can explain what is meant by the term debenture.   
I can describe the nature of fixed and floating charges
and the distinction between them.   
I can explain what is meant by book debts and outline

the debate surrounding the issue of granting a fixed   
charge over them.
I can outline the priority of charges and the statutory

registration scheme.   
revise?
Must Revision
revise done
7.1 Debentures  
7.2 Company charges  
7.3 Priority  
7.4 Avoidance of floating charges  

Notes
8 Capital
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
8.1 Overview – the maintenance of capital doctrine . . . . . . . . . . . . . 75
8.2 Raising capital: shares may not be issued at a discount . . . . . . . . . . 75
8.3 Returning funds to shareholders . . . . . . . . . . . . . . . . . . . . . 76
8.4 Prohibition on public companies assisting in the acquisition

of their own shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81

Introduction
In this chapter we consider a range of broadly related issues concerning the capital
of a company. The underlying theme is the doctrine of maintenance of capital. This is
directed towards ensuring that shareholders pay the price for their shares in money or
money’s worth and that the company’s capital is not illegally returned to them.
Learning outcomes
u explain the objectives of the doctrine of maintenance of capital
u state the rule proscribing shares being issued at a discount
u describe the rules relating to dividend payments
u describe the procedure for reducing capital
u explain the regime governing financial assistance for the purchase of shares.
Core text
¢ Dignam and Lowry, Chapter 7: ‘Share capital’.
Cases
¢ Bairstow v Queens Moat Houses plc [2001] 2 BCLC 531
¢ Re Exchange Banking Co, Flitcroft’s Case (1882) 21 ChD 519
¢ Re Halt Garage (1964) Ltd [1982] 3 All ER 1016
¢ Aveling Barford Ltd v Perion Ltd [1989] BCLC 626
¢ Re Chatterley-Whitfield Collieries Ltd [1948] 2 All ER 593
¢ Brady v Brady [1989] AC 755
¢ Chaston v SWP Group plc [2003] 1 BCLC 675
¢ Parlett v Guppy’s (Bridport) Ltd [1996] 2 BCLC 34
¢ MT Realisations Ltd v Digital Equipment Co Ltd [2003] EWCA Civ 494
¢ Dyment v Boyden [2005] 1 WLR 792; Carney v Herbert [1985] AC 301.
Additional cases
¢ Guinness v Land Corporation of Ireland (1883) 22 ChD 349
¢ Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447.

Company Law 8 Capital page 75
8.1 Overview – the maintenance of capital doctrine

The legal rules governing maintenance of share capital are a mixture of legal and
accounting principles that are aimed at ensuring that the company’s capital is not
dissipated on activities beyond its objects (Guinness v Land Corporation of Ireland (1883)
22 ChD 349). While a company’s capital may be spent in carrying out its legitimate
business activities no part of it can be returned to a member so as to subtract from
the fund from which creditors are to be paid. Shareholders also benefit from the
doctrine because the objective of the capital maintenance regime is to ensure that
their investment is used only for the objects stated in the company’s constitution
(assuming the constitution restricts its objects; see Chapter 13, below).
It should be noted that a company’s share capital is not kept in a ring-fenced bank
account to be drawn upon only in the event of winding up, in order to meet the claims
of creditors. Rather, it is a book-keeping entry which serves as the basis for measures
of profitability such as return on capital employed (ROCE). Before any returns (e.g.
dividends) are paid to shareholders the accounts must show that the value of the
company’s assets exceeds the value of its share capital. As indicated above, the law
is directed towards preventing illegal returns of capital to shareholders and there
are numerous ways in which shareholders may receive legitimate returns on their
investment: for example, by way of a dividend payment (see below).
We now turn to consider the maintenance regime. It should be noted that the law
distinguishes between private and public companies. It should also be borne in mind
that, when reading the case law decided under the CA 1985 and its predecessors, the
law was notoriously complex. In this respect, it should be noted that in accordance
with the policy objectives of the company law review, the 2006 reforms are directed
towards removing requirements that are ‘unnecessary and burdensome for private
companies’.
8.2 Raising capital: shares may not be issued at a discount

The rule in Ooregum Gold Mining Company v Roper [1892] AC 125, which is now codified
in s.552 of the CA 2006, is that shares may not be issued at a discount to their nominal
value. Accordingly, a shareholder must pay the full nominal value of the shares he
or she holds. But the rule does not require that the share is paid for in full when it is
issued because payment may be deferred. Thus, there can be paid-up and unpaid-up
capital where the shareholder remains liable to contribute the balance outstanding
(i.e. the difference between the amount actually paid and the nominal value). From
the outsider’s perspective, the consequence of the rule is that he or she can be sure
that the company has received (or has enforceable claims for) at least the sum total
of its issued share capital. The consideration paid for a share does not have to be in
money and so goods or services may be the price paid. In Re Wragg Ltd [1897] 1 Ch 796
the court held that the judgment of the directors – which was made in good faith –
that the benefit received in return for the shares was equal in value to their nominal
value was not open to challenge.
Because of the scope this gives for abuse, public companies must satisfy strict
statutory requirements where the consideration for shares is other than money
(the decision in Re Wragg only applies to private companies). For example, for
public companies s.593 CA 2006 requires an independent valuation of any non-cash
consideration. Failure to comply with this provision renders the allottee/holder and
any subsequent holder liable to pay again in cash together with interest (see ss.588
and 593(3) CA 2006). Thus, the allottee/holder could end up paying twice for the
shares. The policy here is directed towards preventing public companies from issuing
shares at a discount.
The 2005 consultative document states that the requirement of ‘authorised share
capital’ 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. This is achieved by Part 17 of
the CA 2006 which abolishes the concept of authorised share capital but retains the
concept of nominal value. Thus, s.542(1) requires companies to issue shares with a
fixed nominal value. The requirement for public companies to have a minimum share
capital (£50,000 or euro equivalent, currently fixed at €65,000) is retained by the
2006 Act (see ss.761 and 763).
Activity 8.1
Read Re Wragg Ltd [1897] 1 Ch 796.
What approach did the Court of Appeal take towards the price a company may pay
for property?
8.3 Returning funds to shareholders
8.3.1 Dividends
Part 23 of the CA 2006 codifies the common law by requiring that dividends may only
be paid out of distributable profits (see, in particular, s.830). Thus, dividends may
only be paid out of accumulated profits and not if the effect would be to reduce the
company’s net assets below the value of its share capital.
A dividend paid in breach of this rule is unlawful and ultra vires. A director who knew
(or ought to have known) that the payment amounted to a breach is liable to repay
the dividends (see Bairstow v Queens Moat Houses plc [2001] 2 BCLC 531; and Re Exchange
Banking Co, Flitcroft’s Case (1882) 21 ChD 519).
In Bairstow v Queens Moat Houses plc, the directors, who acted on the company’s 1991
accounts that incorrectly showed inflated profits, paid dividends that exceeded the
available distributable reserves. The Court of Appeal held that their liability was not
limited to the difference between the unlawful dividends and the dividends that could
have been lawfully paid. Directors owe fiduciary duties to the company and therefore
have trustee-like responsibilities arising out of their duty to manage the company in
the interests of all its members. They were therefore ordered to pay the company over
£78 million. A shareholder who, with knowledge of the facts, receives an improper
dividend payment will be held liable to repay it as a constructive trustee (Precision
Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447; see also, IRC v Richmond
[2003] EWHC 999).
In It’s a Wrap (UK) Ltd v Gula [2005] EWHC 2015, 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 which there were no profits available
for distribution, the company’s accounts showed that dividends had nevertheless
been paid to the defendants. When the company went into insolvent liquidation,
the liquidator claimed that the dividends had been paid in contravention of s.263(1)
CA 1985 (now s.830(1) CA 2006) and were therefore recoverable under s.277 CA 1985
(now s.847 CA 2006). The 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 efficient. The court dismissed the liquidator’s
claim. On the evidence it was clear that the defendants had sought to gain a proper
tax advantage and had not deliberately set out to contravene the Act. The words ‘is
so made’ contained in s.277(1) (now s.847(2)) 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. Not surprisingly, the Court of Appeal
reversed the judge’s decision and held that the defendants’ ignorance of the law was
no defence. Arden LJ stated that s.277 (now s.847) had to be interpreted in a manner
consistent with Article 16 of the Second Company Law Harmonisation Directive which
it is designed to implement. On this particular issue she concluded that:
Section 277 [now s.847] must be intrepreted 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.
8.3.2 Other examples of illegal returns of capital
Disguised gifts out of capital

In Re Halt Garage (1964) Ltd [1982] 3 All ER 1016, the court held that where the directors
of a company are also shareholders their remuneration might be viewed as a
‘disguised gift out of capital’. In this case the director who had received remuneration
(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 liquidation.
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 was therefore liable to repay the balance.
In Aveling Barford Ltd v Perion Ltd [1989] BCLC 626, Aveling Barford Ltd (AB Ltd) and
Perion Ltd (P Ltd) were owned and controlled by Mr Lee. Aveling Barford Ltd, while
not technically insolvent, did not have any distributable reserves. It did, however,
own a sports ground for which planning permission for residential redevelopment
had been granted. In October 1986 its directors decided to sell the sports ground,
valued at £650,000, to Perion Ltd for £350,000. The sale was completed in February
1987. In August 1987 Perion Ltd resold it for £1.52 million. When Aveling Barford Ltd
went into liquidation, the liquidator successfully sued to have Perion Ltd declared a
constructive trustee of the proceeds of sale on the ground that the transaction was an
unauthorised return of capital by Aveling Barford Ltd to Lee, its sole shareholder, via
Perion Ltd.
The decision in Aveling Barford has proved controversial because of its impact on
companies in a group who want to transfer assets to each other. In Completing The
Structure (November 2000) the CLRSG concluded that Part VIII of the Companies Act
1985 should be changed to enable intra-group transfer of assets to proceed in a more
straightforward way. This has been implemented by ss.845-846 CA 2006.
8.3.3 Reduction of share capital

The CA 2006 contains a range of deregulatory measures that target the requirements
contained in the CA 1985 that were considered unnecessary and burdensome for
private companies. However, with respect to public companies, the provisions
generally restate the pre-existing regime (see ss.642–644 CA 2006).
Under CA 2006 companies no longer need authority in the articles of association

which permit a reduction of capital, although they are able to restrict or prohibit
the power if they wish (s.641(6)). Section 641(1) states the general rule that a 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 confirmed by the court. In other words, a private company is not compelled to
follow the new simplified procedure but can opt instead to go through the rather
convoluted and expensive step of obtaining the court’s confirmation, as was required
under the 1985 Act and which is preserved for public companies.
Private companies: reduction of capital supported by a solvency statement

The simplified procedure for private companies to reduce their capital is detailed in
ss.642–644 CA 2006. The 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 effect 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 them (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
affected by a failure to comply with these requirements (s.642(4)).
Section 643 provides that the solvency statement must state that each of the directors
has formed the opinion, taking into account all of the company’s liabilities (including
any contingent or prospective liabilities), that:
a. as regards the company’s situation at the date of the statement, there is no ground
on which the company could then be found to be unable to pay its debts; and
b. if it intended to commence the winding up of the company within 12 months of

that date, the company will be able to pay its debts in full within 12 months of the
winding up or, in any other case, 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 filing requirements in respect of a reduction of capital. Within
15 days after the special resolution is passed, the company must file with the Registrar
a copy of the solvency statement together with a statement of capital and a statement
of compliance. The special resolution itself must also be filed in accordance with s.30 CA
2006. The resolution does not take effect until these documents are registered (s.644(4)).
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 offence (see s.643(4); the penalties, which
may include imprisonment, are set out in s.643(5)).
Public companies: reduction of capital confirmed by the court

As we have seen, public companies are required to have the special resolution for
the reduction of capital confirmed by the court. The policy here is that the interests
of creditors are safeguarded. Sections 645 and 646 CA 2006 (which restate s.136
of the 1985 Act) specify the procedure for making such an application for an order
confirming the reduction, including the creditors’ right to object. The court will settle
a list of creditors with a view to ensuring that each one of them has consented to the
reduction. If a creditor does not consent the court may, in its discretion, dispense with
that creditor’s consent where the company secures the debt or claim (s.646(4)). If,
on such an application, an officer of the company intentionally 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 offence (s.647).
The court may make an order confirming the reduction of capital on such terms and
conditions as it thinks fit (s.648(1)). However, it will not confirm the reduction unless it is
satisfied, 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)). The reduction will take effect on registration of the court order
confirming the reduction (and statement of capital) by the Registrar (s.649(5)).
Where there is a reduction of capital, certain shares will be cancelled or reduced in

nominal value. Here 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 different 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. However if the proposed reduction varies or abrogates class
rights it may be possible to disapply this prima facie approach. In Re Chatterley-Whitfield
Collieries Ltd [1948] 2 All ER 593 the company’s 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 off preference capital but
keeping its ordinary shareholders. The court confirmed the reduction as fair because
it was carried out in accordance with the rights of the two classes of shareholders in a
winding up (see also Re Saltdean Estate Co Ltd [1968] 1 WLR 1844).
If the reduction of a public company’s capital has the effect of bringing the nominal
value of its allotted share capital below the authorised minimum, the Registrar must
not register the court order confirming the reduction unless either the court so
directs, or the company is first re-registered as a private company (s.650). Section 651
provides for an expedited procedure for re-registration as a private company.
8.3.4 Redemption or purchase by a company of its shares

Court approval for a reduction of capital can be avoided where the reduction is
achieved through a redemption or purchase by a company of its own shares. The
common law prohibited a company acquiring its own shares because of the risk to
creditors (Trevor v Whitworth (1887) 12 App Case 409). This is given statutory effect
by s.658(1) CA 2006. However, s.684 expressly allows a limited company to issue
shares that are to be redeemed at the option of the company or the shareholder. A
public company, however, must be authorised by its articles to issue redeemable
shares (s.684(3)). For private companies no such authorisation is required, although
their articles may exclude or restrict the issuing of redeemable shares (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.
The difference between a redemption and a purchase of shares in this context is
that for a redemption, 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 redemption
from the outset. For a purchase of shares, the parties will need to agree the terms of
the repurchase at the time the company seeks to exercise the power.
The scope of the general prohibition contained in s.658(1) was considered in Acatos
and Hutcheson plc v Watson [1994] BCC 446. It was held that it was not unlawful
for a company to purchase another company whose only asset was a significant
shareholding (nearly 30 per cent) in the purchasing company. This was so even though
it would have been unlawful for the purchasing company to buy its own shares
directly. Lightman J observed that to hold otherwise would permit target companies
to protect themselves against a takeover bid by the simple device of buying shares in
the purchasing company. He described this result as being ‘absurd’.
As a result of the need for companies, particularly private companies, to have greater
flexibility over their capital structure, the rule in Trevor v Whitworth has, as mentioned
above, been relaxed.
Effecting a redemption of shares

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
association or by a resolution of the company (s.685(1)).
An ordinary resolution is required even though its effect 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 determine the terms, conditions and manner of
redemption, they must do so before the shares are allotted and such details must be
specified in any statement of capital which the company is required to file (s.685(3)).
When a company redeems any redeemable shares it must give notice to the Registrar
within one month, specifying the shares redeemed together with a statement of capital
which details the company’s shares immediately following the redemption (s.689). If
default is made in complying with the notice requirements, an offence is committed by
the company and every officer of the company who is in default (s.689(4)).
Effecting a purchase by a company of its own shares

As noted above, s.690(1) authorises a limited company to purchase its own shares,
including any redeemable shares, subject to any restriction or prohibition in the
company’s articles. Further, a company may not purchase its own shares if as a result
there would no longer be any issued shares other than redeemable shares (s.690(2)).
Only fully paid shares can be purchased and they must be paid for on purchase
((s.691); payment by instalments is not, therefore, permissible (see Pena v Dale [2004]
EWHC 1065 (Ch)). A company cannot subscribe for its own shares but is restricted to
purchasing them from existing members (see Re VGM Holdings Ltd [1942] Ch 235).
With respect to financing the purchase, a public company must use distributable
profits or the proceeds of a fresh share issue made for the purpose of financing the
purchase (s.692(2)). However, a private company may, as under the CA 1985, purchase
its own shares out of capital (s.692(1) and s.709).
As mentioned above, the main difference introduced by the 2006 Act for a private
company is that the power to purchase its own shares need no longer be contained
in the articles. The articles may, however, restrict or prohibit the exercise of this
statutory power. Where a private company purchases its own shares out of capital,
then ordinarily the use of capital must be a ‘permissible capital payment’ under s.709,
and the company and its directors must comply with a number of safeguards designed
to protect the company’s creditors in such a case. However, for ‘small’ buy-backs,
a private company can pay for the shares it is repurchasing out of capital, without
complying with such safeguards (see s.692 CA 2006). A small buy-back is one where the
amount paid does not exceed (the lower of) £15,000 or 5 per cent of the company’s
share capital.
For larger repurchases, where the company is using a permissible capital payment
under s.709, the directors are required to make a statement specifying the amount of
the permissible capital payment for the shares in question. Section 714 provides that
this statement must also confirm that the directors have made a full enquiry into the
affairs and prospects of the company and that they have formed the opinion:
a. as regards the company’s situation immediately after the date on which the
payment out of capital is made, there will be no grounds on which the company
could then be found unable to pay its debts; and
b. as regards the company’s prospects for the year immediately following that date,
the company will be able to continue to carry on business as a going concern and
be able to pay its debts as they fall due in the year immediately following the date
on which the payment out of capital is made.
In forming their opinion on the company’s solvency and prospects, the directors must
take into account all of the company’s liabilities (including contingent and prospective
liabilities).
Directors who make this statement without reasonable grounds for their opinion
commit an offence (s.715).
As an additional safeguard, s.714(6) provides that the directors’ statement must have
annexed to it a report by the company’s auditor confirming its accuracy. Further, the
payment out of capital must be approved by a special resolution of the company
which must be passed on the date of the directors’ statement or within the week
immediately following (s.716). The holders of the shares in question are barred from
voting on the resolution (s.717). Within the week immediately following the date of
the s.716 resolution, the company must give public notice in the London Gazette (the
official newspaper of record for the UK) and in an appropriate national newspaper
of the proposed payment. This must also state that any creditor may apply to court
under s.721 within five weeks of the resolution for an order preventing the payment
(s.719). Following the purchase, the company must give notice to the Registrar. Such
notice must include a statement of capital (s.708).
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. This relaxation, which
took effect on 1 December 2003, was introduced by the Companies (Acquisition
of Own Shares) (Treasury Shares) Regulations 2003 (SI 2003/1116). The regulations
inserted ss.162A – 162G into the 1985 Act which are re-enacted in ss.724-732 CA 2006.
For ‘qualifying shares’, as defined in s.724(2), to become treasury shares they must
be purchased by the company out of distributable profits. There 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)).
8.4 Prohibition on public companies assisting in the acquisition

of their own shares
8.4.1 Financial assistance

A company might wish to provide financial assistance for the purchase of its own
shares by, for example, giving a gift to a third party on the understanding that the
money would be used to buy the donor company’s shares or, for instance, through
guaranteeing a potential purchaser’s borrowing. This is prohibited by the Companies
Act 2006.
The policy underlying the prohibition is explained by Arden LJ in Chaston v SWP Group
plc [2003] 1 BCLC 675:
[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 purchaser… The general mischief…
remains the same, namely that the resources of the target company and its subsidiaries
should not be used directly or indirectly to assist the purchaser financially 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.
A loan does not deplete a company’s net assets because, although funds leave the
company, their loss is matched in the company’s accounts by the debt to the company
that is thereby created. Thus, the prohibition on financial assistance in the Act is wider
than that which would be required if the only policy in operation was to maintain
the company’s share capital. As stressed by Arden LJ (above), it recognises the need
to protect shareholders and outsiders from the company misusing its assets to
finance the purchase of its own shares, even if the capital maintenance doctrine is not
thereby infringed (see also the comments of Peter Smith J in Anglo Petroleum Ltd v TFB
(Mortgages) Ltd [2006] EWHC 258 (Ch)).
8.4.2 The statutory provisions prohibiting financial assistance

The prohibition against public companies providing financial assistance is laid down
by s.678(1) of the 2006 Act 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 company, to give
financial assistance directly or indirectly for the purpose of the acquisition before or at the
same time as the acquisition takes place [emphasis supplied].
(Prior to the CA 2006 the prohibition also extended to private companies: see s.151 CA
1985.)
It is noteworthy that s.678(1) makes no reference to proof of improper intention.

Breach is therefore determined objectively from the surrounding circumstances.
Section 678(3) broadens the prohibition so as to cover situations where assistance is
provided by a private company in order to discharge a liability incurred by a purchaser
for the purpose of acquiring shares, but which, at the time the post-acquisition
assistance is given, has re-registered as a public company.
Section 678(1) is supplemented by s.679(1), which extends the prohibition to cover

financial assistance (directly or indirectly) provided by a public company which is a
subsidiary of a private company for the purpose of acquiring shares in that private
company before or at the same time as the acquisition takes place. Section 679(3)
extends the prohibition to cover after the event financial assistance given by a public
company to its private holding company.
Section 677 (together with s.683(1) and (2)) seeks to limit the scope of the meaning
of ‘financial assistance’ by listing certain forms or ways in which it can arise. Examples
include:
u the giving of a guarantee, security or indemnity, other than an indemnity in respect

of the indemnifier’s own neglect or default, or
u by way of release or waiver, or by way of loan.
The giving of a security is illustrated by Heald v O’Connor [1971] 1 WLR 497. Mr and Mrs
Heald sold all of the shares in D.E. Heald (Stoke on Trent) Ltd to O’Connor. The price was
£35,000 but they lent him £25,000 in order to enable him to complete the purchase.
The company thereby granted the vendors a floating charge over all of its assets
by way of security for the loan. Thus, if O’Connor defaulted, the security would be
enforceable against the company. This was held to be illegal.
A residual category falls within s.677(1)(d) which proscribes ‘any other financial
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’.
Therefore, even if a public company were in a position to return funds to shareholders
because it had distributable profits, it would not be able to provide any sort of
financial 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 company’s
‘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 Guppy’s (Bridport) Ltd (1996); Grant v Lapid
Developments Ltd [1996] 2 BCLC 24).
The exceptions
Section 681 contains a wide list of ‘unconditional’ exceptions. Those in s.681(2) are
unexceptional. They mainly relate to procedures which are specifically authorised
elsewhere in the Act: for example, to effect a redemption of shares or a reduction of
capital. So-called ‘conditional exceptions’ are listed in s.682. They therefore only apply
if the company has net assets and either:
a. those assets are not reduced by the giving of the financial assistance, or
b. to the extent that those assets are so reduced, the assistance is provided out of
distributable profits.
An example of a ‘conditional exception’ is where the provision of financial assistance

by the company 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 facilitating 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)).
Section 678(2) and (3), however, also contain the ‘principal purpose’ and ‘incidental
part of a larger purpose’ defences which are carried over from the 1985 Act. In essence,
financial assistance is not prohibited:
u 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,
u in either case, where the financial assistance is given in good faith in the interests
of the company.
The 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 person’s ‘purpose’ is necessarily difficult (for instance,
the need to distinguish purpose from effect) 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. The difficulties of assessing ‘purpose’ came to the fore in Brady v
Brady [1989] AC 755.
In Brady v Brady [1989] AC 755 the scheme involved a company’s business being divided
between two brothers, Jack and Bob Brady, who were the controlling shareholders.
They were not on speaking terms and the deadlock between them threatened the
survival of the company and its subsidiaries. It was decided that Jack should take the
haulage business and Bob the soft drinks business. However, the haulage business was
worth more than the soft 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.
This involved the principal company, Brady, transferring assets to a new company
controlled by Bob. It was conceded that s.151 (now s.678) had been breached because
the transfer involved Brady providing financial assistance towards discharging the
liability of its holding company, M, for the price of shares which M had purchased in
Brady. When Jack sought specific performance of the agreement, Bob, who by now
had decided against the arrangement, contended that it was an illegal transaction.
Jack argued, however, that the financial 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).
The House of Lords held that the purpose of the transaction was to assist in financing
the acquisition of the shares: the essence of the reorganisation was for Jack to acquire
Brady Ltd’s shares and therefore the acquisition of those shares was not incidental
to the reorganisation. Lord Oliver concluded that 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.’
This approach means that in looking for some larger overall corporate purpose,
it is necessary to distinguish ‘purpose’ from the reason why a purpose is formed.
The commercial advantages flowing from providing the financial assistance for the
acquisition of the shares may be the reason for providing it but the commercial
advantages are a by-product of providing the assistance – they are not an independent
purpose to which the financial assistance can be considered incidental.
The approach of the House of Lords in Brady towards the interpretation of the ‘purpose
exceptions’ has been criticised on the basis that it unduly restricts the width of the
defences (see s.678, above), and, indeed, it makes it very hard to ascertain exactly what
sort of situations would fall within these exceptions.
Ascertaining whether or not the prohibition has been breached is a fact-intensive

exercise and the case law provides little guidance in predicting an outcome. In MT
Realisations Ltd v Digital Equipment Co Ltd [2003] EWCA Civ 494, Mummery LJ stressed
that:
each case is a matter of applying the commercial concepts expressed in non-technical

language to the particular facts. The authorities provide useful illustrations of the variety
of fact situations in which the issue can arise; but it is rare to find an authority… which
requires a particular result to be reached on different facts.
The facts of Dyment v Boyden [2005] 1 WLR 792 (CA) provide an interesting illustration of
how an allegation of financial assistance can arise. The Court of Appeal had to consider
whether rent which was significantly greater than the market value of the premises in
question constituted a breach of s.678 (s.151 of the 1985 Act). Because of local authority
rules the transfer of shares had to be undertaken in order that the respondents no
longer retained an interest in the company. The Court of Appeal held that the trial
judge was right in finding that the company’s entry into the lease was ‘in connection
with’ the acquisition by the appellant of the shares but was not ‘for the purpose of that
acquisition’. His finding that the entry into the lease was for the purpose of acquiring
the premises rather than the shares was a finding of fact with which the Court of
Appeal should not interfere.
The sanctions for breach

Section 680 CA 2006 makes breach of the prohibition a criminal offence with the
company being liable to a fine ‘and every officer of it who is in default liable to
imprisonment or a fine or both’. The effect of this is to make the transaction unlawful
which can affect the enforceability of the underlying agreement.
In Carney v Herbert [1985] AC 301, the Privy Council had to decide if the vendors of
shares in A Ltd could sue the purchaser (or the guarantor thereof) for the purchase
price when a subsidiary of A Ltd had provided illegal financial assistance in relation
to the purchaser’s acquisition (by charging land owned by it as security for the
purchaser’s promise to pay for the shares). If the agreement could not 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
benefit 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.
The Privy Council therefore severed the illegal charges and allowed the vendors to sue
for the purchase price.
Activity 8.2
Read Brady v Brady [1989] AC 755, [1988] 2 All ER 617.
Write a short essay of not more than 300 words explaining how Lord Oliver defined
the concept of ‘larger purpose’.
Summary
For financial assistance to be unlawful under s.678 CA 2006 the company’s net assets
must be reduced to a material extent (Parlett v Guppy’s (Bridport) Ltd [1996] 2 BCLC 34).

To what extent, if at all, is the law on financial assistance destructive of genuine
transactions? Is there any rational policy running through the legislation or case
law? How could the law in this area be improved?

This is a wide-ranging question and your answer will require careful planning if you are
to cover its scope in the time allowed. The principal points you should address are the
following.
u An examination of the policy concerns underlying the capital maintenance

doctrine.
u The prohibition in s.678 CA 2006 against providing financial assistance for the
acquisition of shares. You should describe what amounts to financial assistance.
Note ‘pre’ and ‘post’ acquisition assistance.
u The policy underlying s.678 (see Chaston v SWP Group plc).
u The principal purpose exception. Analyse Brady v Brady with particular reference to
Lord Oliver’s speech.
Reflect and review



first again
I can explain the objectives of the doctrine of
maintenance of capital.   
I can state the rule proscribing shares being issued at

a discount.   
I can describe the rules relating to dividend payments.   
I can describe the procedure for reducing capital.   
I can explain the regime governing financial assistance

for the purchase of shares.   
revise?
Must Revision
revise done
8.1 Overview – the maintenance of capital doctrine  
8.2 Raising capital: shares may not be issued at a discount  
8.3 Returning funds to shareholders  
8.4 Prohibition on public companies assisting in the  

acquisition of their own shares
9 Dealing with insiders: the articles of association
and shareholders’ agreements
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88
9.1 The operation of the articles of association . . . . . . . . . . . . . . . . 89
9.2 The articles of association . . . . . . . . . . . . . . . . . . . . . . . . 89
9.3 The contract of membership . . . . . . . . . . . . . . . . . . . . . . . 91
9.4 Shareholders’ agreements . . . . . . . . . . . . . . . . . . . . . . . . 94
9.5 Altering the articles . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

Introduction
In Chapter 2 we briefly touched upon the constitution of the company. In this chapter
we continue our examination of the company’s constitutional structure with a
particular focus on how corporate power is allocated internally between the general
meeting and the board of directors (these bodies are often called the ‘organs’ of the
company).
Learning outcomes
u explain the function of the articles of association
u describe the problems that arise with enforcing the contract of membership
u explain why shareholder agreements have become increasingly common
u describe the mechanisms for altering the articles and any restrictions on
alteration.
Core text
¢ Dignam and Lowry, Chapter 8: ‘The constitution of the company: dealing with
insiders’.
Cases
¢ Salmon v Quin & Axtens Ltd [1909] 1 Ch 311
¢ Rayfield v Hands [1960] Ch 1
¢ Foss v Harbottle [1843] 2 Hare 461
¢ Eley v Positive Government Security Life Assurance Co [1876] 1 Ex D 20
¢ Punt v Symons & Co Ltd [1903] 2 Ch 506
¢ Russell v Northern Bank Development Corporation [1992] BCLC 431
¢ Re Duomatic [1969] 2 Ch 365
¢ Allen v Gold Reefs Co of West Africa [1900] 1 Ch 656
¢ Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286.
Additional cases
¢ MacDougall v Gardiner [1875] 1 Ch D 13
¢ Pender v Lushington [1877] 6 Ch D 70
¢ Hickman v Kent or Romney Marsh Sheep-Breeders’ Association [1915] 1 Ch 881
¢ Puddephatt v Leith [1916] 1 Ch 200
¢ Menier v Hooper’s Telegraph Works [1874] LR 9 Ch D 350
¢ Clements v Clements Bros Ltd [1976] 2 All ER 268
¢ Brown v British Abrasive Wheel Co Ltd [1919] 1 Ch 290
¢ Dafen Tinplate Co. Ltd v Llannelly Steel [1920] 2 Ch 124
¢ Globalink Telecommunications Ltd v Wilmbury Ltd [2003] 1 BCLC 145
¢ Re Charterhouse Capital Ltd [2014] EWHC 1410 (Ch).

Company Law 9 Dealing with insiders: the articles of association and shareholders’ agreements page 89
9.1 The operation of the articles of association

The articles of association are the internal rules of the company. They contain the
central governance arrangements for the interaction of the:
u shareholders
u company
u board.
On incorporation the founders of a company can provide their own set of articles. If
they do not, model articles provided by the law apply by default. Until 2009, there
was a single set of model articles, applicable to both public and private companies,
called Table A. For companies formed after 1 October 2009, there now exist separate
models, known as the Model Articles for Public Companies Limited by Shares, and
the Model Articles for Private Companies Limited by Shares. These are contained
in the Companies (Model Articles) Regulations 2008. The model articles, with some
amendments, are usually adopted. Because of this, the model articles effectively
provide the key legislative model for the running of the company. While companies
often have very complex organisational structures, the allocation of power in the
model articles between the general meeting and the board of directors is at the core
of every corporate structure.
It is this allocation of power that is the central function of the articles of association.
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 organisational structure of the
UK registered company:
u the board of directors (the management organ)
u the general meeting (the members organ).
The model articles also allocate the powers of each organ. The following are the most
important provisions in the articles.
9.2 The articles of association
9.2.1 The model articles

With regard to the general meeting, the model articles regulate the organisation of
meetings (article 38-42 private, article 28-33 public) and voting at the meeting (article
43-48 private, article 34-40 public). Similarly, the model articles provide, with regard to
the board of directors, for the allocation of management power to the board (article
3-6 private and public), directors’ appointment (article 17-20 private, article 20-24
public) and decision making by directors (article 7-16 private, article 7-19 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 (articles 18 private and 22
public). Direct removal is covered by s.168 CA 2006, which gives members the right by
simple majority (a vote for the resolution of more than 50 per cent of those who vote)
to remove a director for any reason whatsoever.
Key management powers

Historically the most important allocation of power in the articles was contained in
Article 70 of the old Table A. Article 70 provided that:
‘[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.’
This is now contained in articles 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
company’s business, for which purpose they may exercise all the powers of the company.
Shareholders’ reserve power
4. (1) The shareholders may, by special resolution, direct the directors to take, or refrain
from taking, specified action.
(2) No such special resolution invalidates anything which the directors have done
before the passing of the resolution.
As a result, the board is empowered to run the company, subject to:
u certain qualifications (i.e. the memorandum) and specifically the objects of the
company and any other articles restricting directors’ powers† †
It is common, for example,
to restrict the board’s ability
u special resolutions, directions from the shareholders and the Companies Act.
to borrow up to a certain
Although the power to run the company is subject to qualifications, it is important to amount without shareholder
note that the board is the primary power-wielding organ of the company. In Howard approval.
Smith Ltd v Ampol Petroleum 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 defined 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 office.
The power delegated to the board derives from the total power the company actually
has, thus the power they wield is always limited by the objects clause. It is also worth
noting that the discretion is, of course, tempered by the very practical fact that s.168
CA 2006 allows the majority of the members to remove the board. Thus the board
cannot stray too far from the shareholders’ wishes if they are to keep their jobs.
The board is also given, by virtue of articles 30 (private) and 70 (public), the power to
decide whether to distribute any surplus profits to the shareholders in the form of
dividends. Although technically the general meeting declares the dividend it cannot
do so unless the board recommends a dividend. This may not seem like a significant
power but it is a very important independent management power exercised by the
board. The shareholders cannot therefore get any income from their shareholding
unless the directors allow it.
Key shareholder powers

While s.336 CA 2006 does mean that private companies are no longer required to
hold an annual general meeting, it is important to note that the meeting is, in theory,
designed to fulfill an important supervisory function for public companies. The general
meeting is in effect the residual power organ which meets once a year (s.336 CA 2006)
to exercise its continued supervision over the board (article 3).
Significantly, the general meeting has certain other powers. For example its most
important power is the power to elect and remove directors (article 20 (public) gives
both the shareholders and the board the power to elect directors but the CA 2006, s
168 provides that only shareholders may remove directors). It may also issue shares
(article 43 (public), although this is commonly altered to give the board that power).
Section 437 CA 2006 requires that the annual accounts and reports be put before the
annual general meeting of a public company (there is however no requirement for
a vote on these reports but it is common practice for larger companies to require a
vote). Section 420 CA 2006 requires the directors of a quoted company to prepare
a remuneration report each year (identifying the remuneration being paid to
directors) and s.439 CA 2006 requires this report to be approved by shareholders in a
general meeting. The general meeting is also empowered by s.21 CA 2006 to alter the
articles if three-quarters of the members (by a special resolution,) vote in favour of

the resolution. Thus in effect the members can alter the internal rules by which the
company’s power is allocated.
9.2.2 General reform

The CLRSG addressed two key issues with regard to the operation of the articles
of association. First they found that the general meeting was a burden on small
companies and recommended doing away with the need for a general meeting for
private companies unless the company wished to have one (Final Report, July 2001,
Chapter 2). The CLRSG also recommended that public companies could dispense with
annual general meetings if all the shareholders agree (Final Report, para 7.6). This has
been implemented for private companies but public companies, as we noted above,
are still required to hold an annual general meeting (s.336 CA 2006.).
For most public companies the general meeting, in theory, fulfils an important
accountability function. In reality, however, large shareholders don’t tend to vote,
leading to accountability problems. The CLRSG recommended that institutional
investors who hold the vast majority of shares (insurance companies, pension funds
and investment trusts) should disclose their voting record at general meetings to
increase accountability and transparency (Final Report, Chapter 6 paras 6.22–6.40). The
White Paper (2002, Vol I, paras 2.6–2.48) adopted all the procedural recommendations
of the CLRSG regarding the general meeting except the recommendation to force
institutional investors to disclose their votes (para 2.47) and the CA 2006 does not
contain a provision requiring compulsory disclosure.
Activity 9.1
a. What is the function of the articles of association?
(No feedback provided.)

b. Get a copy of the model articles and read through it. Try to identify what it is that
each article is trying to achieve.
Summary
The articles of association form a core part of company law as they allocate corporate
power between the management and the shareholder organs. It is an area where the
reform driver of ‘think small first’ has been particularly successful.
9.3 The contract of membership

The shareholders and the company are said to have a contract with each other. This
consists of the constitution of the company (the memorandum and articles). At the
heart of this contract is s.33(1) CA 2006, which states:
The provisions of a company’s constitution bind the company and its members to the
same extent as if there were covenants on the part of the company and of each member
to observe those provisions.
This rather odd statutory contract was introduced in the 19th century to automatically
bind the shareholders and the company together to observe the constitution of the
company (see Hickman v Kent or Romney Marsh Sheep-Breeders’ Association (1915) 1 Ch
881). It is an odd contract, as it can be varied without the consent of all the parties
to it by special resolution. It also binds future members. It does, however, have a key
advantage far beyond just the observation of the constitution. When new members
join the company by buying shares, the constitution will automatically bind them to
observe the pre-existing constitution.
As such, it removes the possibility of re-negotiating the rules every time a new
shareholder arrives. This facilitates the development of the share market as the
shares are more transferable where they come with a fixed set of rights. However, as
we will discover below, unlike a normal contract the operation of the s.33 contract is
surrounded by a great deal of uncertainty.
9.3.1 A contract inter se?

One of the first questions the courts were asked to deal with was whether the s.33
contract and its predecessors bound the shareholders to each other (inter se). If
so, a shareholder could enforce the contract directly against another shareholder.
This would mean that enforcing articles was more straightforward. If not, only the
company can do so and that would be a more complex matter, involving approval
from the board or general meeting for such an action. This is an important issue for
minority shareholders as the majority shareholders might not wish to enforce the
articles. Unfortunately the answer to this question is unclear as there is conflicting
case law on the point. For example, in Salmon v Quin & Axtens Ltd [1909] 1 Ch 311, Farwell
LJ found that the contract was unenforceable between members. On the other hand,
in Rayfield v Hands [1960] Ch 1, Vaisey J considered that there was a contract inter se
which was directly enforceable by one member against another. The CLRSG in their
Final Report (para 2.26) recommend clarifying the issue by allowing all rights in the
constitution to be enforced against the company and the other members unless the
constitution provided otherwise. However, this has not been followed through in the
Companies Act 2006 (CA 2006) (see Section 9.3.4).
9.3.2 Who can sue?

Continuing the complexity of the issue of enforcement of the s.33 contract is the
question of who can sue to enforce the contract. Can a member of the company enforce
the contract against the company? The answer to the question seems to depend
on whether the breach complained of is a wrong to the company or a wrong to the
individual. As we will see in Chapter 11 this concerns a central aspect of company law –
majority rule. As a general rule individual shareholders are not empowered to initiate
proceedings for a wrong to the company. This is known as the rule in Foss v Harbottle
(1843) 2 Hare 461. Only the company through its organs – the board or the general
meeting – can sue on such a wrong (see Chapter 11 for a detailed analysis of majority
rule). So if the article that has been breached is classified as a corporate right then only
the company can enforce it. However, a shareholder may be able to enforce the contract
against the company directly if the article in question constitutes a personal right.
Lord Wedderburn (1957) suggests that the following have been considered personal
rights in the past.
u Voting rights.
u Share transfer rights.
u A right to protect class rights.
u Pre-emption rights.
u The right to be registered as a shareholder.
u The right to obtain a share certificate.
u The right to enforce a dividend that has been declared.
u The right to enforce the procedure for declaring the dividend.
u The right to have directors appointed in accordance with the articles.
u Other procedural rights such as notices of meetings.
While this offers a good overview of the characteristics of personal rights in the articles
the case law on the matter is still somewhat confused (see the contrasting views in
MacDougall v Gardiner (1875) 1 Ch D 13 and Pender v Lushington (1877) 6 Ch D 70).
9.3.3 Outsider rights

To add to the confusion surrounding the enforcement of the s.33 contract is the
question of whether everything contained in the articles falls within the s.33 contract.
Companies have sometimes added what are called outsider rights to the articles.
These are rights that have nothing to do with the membership of the company but
may cover a wide range of other issues. For example, in Eley v Positive Government
Security Life Assurance Co (1876) 1 Ex D 20 the articles contained a clause which ensured
that a particular member of the company was appointed as the company’s solicitor.
The member was not appointed as the company’s solicitor and sued for breach of
contract.
The 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. However, again here the courts have been somewhat
contradictory. In Salmon v Quin & Axtens Ltd [1909] 1 Ch 311 the articles of association
provided that the consent of both managing directors was needed for certain
decisions. Mr Salmon was a managing director and member of the company and he
dissented from a decision to buy and let some property. The 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 coming to their decision 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 matter was viewed by the judges in terms of enforcing a
member right which tangentially affected his right as a director, rather than a director
right which has a tangential effect on the membership. (For a more recent example
see Globalink Telecommunications Ltd v Wilmbury Ltd [2003] 1 BCLC 145).
9.3.4 Reform
The CLRSG’s Final Report (July 2001 paras 7.34–7.40) recommended clarifying the s.14
issues by allowing all the articles to be enforceable by the members against the
company and each other unless the contrary was provided. The courts would also
be able to strike out trivial actions. These same recommendations are present in the
Government’s Consultative Document March 2005 (para 5.1). However, strangely, the
CA 2006 simply reworded the old problematic s.14 of the CA 1985.
Thus after nearly a decade of examining the failings in the area the Government was
content to ignore the CLRSG and its own White Papers to leave the issues in this area
unresolved.
Activity 9.2
Why is the enforcement of the s.33 contract so complex?
Summary
The s.33 contract fulfils a useful function. It ensures that all the members (even
future ones) and the company are bound to observe the constitution. It is an unusual
contract in that:
u it binds future parties who cannot renegotiate it
u it can be continually altered by special resolution.
As a result, not all the parties to the contract have to agree to the alteration yet will be
bound by the new terms. However it is the enforcement of the statutory contract that
has exercised much judicial and academic thought. Can it be enforced by a member
against another member? Can a member enforce it against the company? Are all the
articles, even outsider articles, enforceable? Unfortunately the CA 2006 leaves these
questions unresolved.
9.4 Shareholders’ agreements

Given the confusion surrounding the enforcement of the s.33 contract it is
unsurprising that shareholders began to take things into their own hands by forming
shareholders’ agreements. Shareholders’ agreements are agreements between
shareholders themselves (that is all the shareholders or just between some of them)
or between the company and the shareholders (all of them or just some of them). The
agreement usually concerns the exercise of the shareholder’s rights in certain given
situations. For example, to only allow an increase in the authorised share capital of
the company if all the parties to the shareholders’ agreement agree, or to exercise
votes at the general meeting in a particular way. The key advantage of a shareholders’
agreement is that it is easily enforceable against another party to the agreement (see
Puddephatt v Leith [1916] 1 Ch 200).
In small- to medium-sized companies it is also common to add the company to the

agreement for security. Companies may, however, be limited in what they can agree
to do. For example in Punt v Symons & Co Ltd [1903] 2 Ch 506 the court held that a
company could not contract out of the right to alter its articles. This means in effect
that a provision of a shareholders’ agreement which binds the company not to alter its
articles will not be enforceable. However, here we find somewhat contradictory case
law once again.
In Russell v Northern Bank Development Corporation [1992] BCLC 431 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
shareholders’ agreement. The company did attempt to increase the share capital
of the company and one of the shareholders who was a party to the shareholders’
agreement objected and attempted to enforce the agreement. The statutory conflict
here was between the agreement and s.121 CA 1985, which allowed companies to
increase their share capital if their articles contain an authority (note s.617 CA 2006 has
amended this provision so authority is now unnecessary). The article of the company
did provide such an authorisation. The House of Lords found that the company’s
agreement not to increase its share capital was contrary to s.121 and, therefore,
unenforceable. However, the court did not declare the whole shareholders’ agreement
invalid – just the company’s agreement not to increase the share capital. This 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 effect as if the company was
bound. The shareholders could not vote to increase the share capital.
9.5 Altering the articles

One of the odd features of statutory contract in s.33 is that the contract can be varied
by the members by special resolution (s.21 CA 2006). Sometimes the courts have
allowed more informal methods of change to occur. In Re Duomatic [1969] 2 Ch 365
the court allowed a decision not made at the general meeting, but which clearly had
the backing of all the shareholders, to stand. However, there are restrictions on the
shareholders’ ability to alter the articles. As we have observed above, the alterations
to the articles must not conflict with any statutory provisions. Further, the members
must exercise their power to alter the articles in good faith. This power to alter the
articles has been famously expressed by Lindley MR in Allen v Gold Reefs Co of West
Africa [1900] 1 Ch 656 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 fide for the benefit of the company
as a whole, and it must not be exceeded. These conditions are always implied, and are
seldom, if ever, expressed.
However, minority shareholders wishing to challenge an alteration of the articles

on the ground that it fails the Allen test, because it was not passed ‘bona fide for
the benefit of the company as a whole’ have rarely succeeded. They have met two
problems. First, the courts have applied this test in what we might call a ‘qualified
subjective’ way. They have said that what matters is not whether the judge herself
thinks the alteration was, objectively speaking, for the benefit of the company. Instead,
the judge should ask whether some reasonable shareholder could think it would
benefit the company. The idea is that there might be a range of different, reasonable,
opinions. Some reasonable shareholders might think the alteration harmful. But
provided that some shareholder could, reasonably, conclude the alteration was of
benefit to the company, the court should not strike it down. This makes it much more
difficult to challenge an alteration: it has to be much more clearly harmful before the
courts will intervene.
The second problem concerns what is meant by ‘for the benefit of the company as
a whole’. The court noted, in Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286, that
many alterations do not really affect the company itself, as a separate commercial
entity. Instead, they merely adjust the respective rights of the shareholders, with little
impact on the company. The court therefore said that the test should be whether
the alteration was ‘discriminatory’ between the shareholders. However, it seems that
proving discrimination is difficult. In Greenhalgh itself for example, the court refused
to find such discrimination, notwithstanding that the alteration clearly benefitted the
majority shareholder and left the minority worse off.
One area where the courts have been somewhat readier to strike down alterations is
where they are being made to enable the shares of a member to compulsorily bought
off them: see Brown v British Abrasive Wheel Co Ltd [1919] 1 Ch 290 and Dafen Tinplate
Co Ltd v Llannelli Steel [1920] 2 Ch 124. Perhaps changing the articles to allow for this is
seen as simply too great an attack on the fundamental property rights of a member.
However, even in this context the minority is not sure to win; see for example Re
Charterhouse Capital Ltd [2014] EWHC 1410 (Ch).
We have been considering a minority’s right to challenge shareholder votes, but

specifically where the vote is to alter the articles. Can other shareholder resolutions
be challenged on the grounds that they were not passed bona fide for the benefit of
the company as a whole? In general, the answer is ‘no’. Shareholders are usually free to
vote ‘selfishly’. For example, shareholders voting to remove a director under s.168 do
not need to show that they passd the vote bona fide for the benefit of the company.
However, one case in which the bona fides of a shareholder resolution was reviewed,
even though the resolution did not involve the alteration of the articles, was Clements
v Clements Bros Ltd [1976] 2 All ER 268. Foster J declined to recognise 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 plaintiff. Foster
J considered that the majority shareholder 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 fides (bad faith) element of the allotment precluded it from
ratification (see also Menier v Hooper’s Telegraph Works (1874) LR 9 Ch D 350.
Activity 9.3
a. What are the main advantages and disadvantages of a shareholders’ agreement?
b. Are there any restrictions on a shareholder’s ability to exercise his votes as he

wishes?
Summary
As a result of the uncertainty surrounding the s.33 contract, shareholders have formed
contractually binding agreements which the courts have been willing to enforce. The
only real complication with these agreements is where the company is a party to the
agreement and some or all of the agreement is contrary to a statutory provision. In
such a case the company cannot contract out of its statutory obligation.
Alteration of the company’s constitution normally occurs by special resolution.
However, sometimes the courts have allowed more informal processes to stand. There
may also be restrictions on the ability of shareholders to vote if a statutory obligation
is affected or a minority shareholder is disadvantaged.
Further reading
¢ Baxter, C.R. ‘The role of the judge in enforcing shareholder rights’ (1983) 42
Cambridge LJ 96.
¢ Davies and Worthington, Chapter 3: ‘Sources of company law and the company’s
constitution’.
¢ Drury, R.R. ‘The relative nature of a shareholder’s right to enforce the company
contract’ (1986) CLJ 219.
¢ Ferran, E. ‘The decision of the House of Lords in Russell v Northern Bank

Development Corporation Limited’ (1994) CLJ 343.
¢ Goldberg, G.D. ‘The enforcement of outsider rights under section 20(1) of the
Companies Act 1948’ (1972) MLR 362.
¢ Goldberg, G.D. ‘The controversy on the section 20 contract revisited’ (1985) MLR
158.
¢ Gregory, R. ‘The section 20 contract’ (1981) 44 MLR 526.
¢ Prentice, G.N. ‘The enforcement of “outsider” rights’ (1980) 1 Company Lawyer

179.
¢ Wedderburn, K.W. ‘Shareholders’ rights and the rule in Foss v Harbottle’ (1957)
CLJ 194.

Roy, John and Sarah are the directors of Abbot Ltd, a company that manufactures
horseshoes. They also each hold one-third of the shares in the company. The
articles of association are the model articles for private companies amended by the
following clause:
‘All decisions of the board are by majority vote except for votes on transactions
with a value greater than £50,000. In such a case a decision is only valid if all the
directors consent to the transaction.’
Roy, John, Sarah and the company are also the only parties to a shareholders’
agreement in which all the parties agree not to increase the share capital of the
company without the agreement of all the parties to the shareholders’ agreement.
Roy has recently returned from holiday and found that during his absence there
had been a board meeting which approved the purchase of a large tract of land
for development purposes worth £100,000. The board also proposes funding the
purchase by increasing the share capital of the company.
Roy is very unhappy about these developments and wishes to stop them.
Advise him about his options.

Discuss the enforcement of the articles first, comparing our facts with Salmon v Quin
& Axtens Ltd [1909] 1 Ch 311 and the other contradictory case law. There are lots of
commentaries on this issue in your further reading so it’s a good idea to include some
of these views.
On the shareholder agreement issue again here discuss the facts in the question in
comparison with Russell v Northern Bank Development Corporation [1992] BCLC 431 and
the other contradictory case law.
Reflect and review



first again
I can explain the function of the articles of association.   
I can describe the problems that arise with enforcing

the contract of membership.   
I can explain why shareholder agreements have

become increasingly common.   
I can describe the mechanisms for altering the articles

and any restrictions on alteration..   
revise?
Must Revision
revise done
9.1 The operation of the articles of association  
9.2 The articles of association  
9.3 The contract of membership  
9.4 Shareholders’ agreements  
9.5 Altering the articles  

10 Class rights
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100
10.1 Shares and class rights . . . . . . . . . . . . . . . . . . . . . . . . . 101
10.2 Classes of shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102
10.3 Variation of class rights . . . . . . . . . . . . . . . . . . . . . . . . . 103
Reflect and review . . . . . . . . . . . . . . . . . . . . . . . . . . . 107

Introduction
In this chapter we consider the nature of a share and the interest that a shareholder
has in the company. We go on to examine how the capital of a company may be
divided into various classes carrying with them different rights for their holders.
Finally, we consider how the company may vary the rights attaching to a class of
shares.
Learning outcomes
u explain the legal nature of a share
u describe the various classes of shares
u describe how class rights attaching to shares are determined
u outline the procedure for varying class rights.
Core text
¢ Dignam and Lowry, Chapter 9: ‘Classes of shares and variation of class rights’.
Cases
¢ Borland’s Trustee v Steel Bros & Co Ltd [1901] 1 Ch 279
¢ Scottish Insurance Corp Ltd v Wilson and Clyde Coal Co Ltd [1949] 1 All ER 1068
¢ Cumbrian Newspapers Group Ltd v Cumberland and Westmoreland Herald

Newspapers and Printing Co Ltd [1987] Ch 1
¢ White v Bristol Aeroplane Co Ltd [1953] Ch 65
¢ Greenhalgh v Arderne Cinemas Ltd [1946] 1 All ER 512.
Additional cases
¢ Re National Telephone Co [1914] 1 Ch 755
¢ Macaura v Northern Assurance Co Ltd [1925] AC 619.

Company Law 10 Class rights page 101
10.1 Shares and class rights

In small quasi-partnership type private companies (see Chapter 12) a small number
of shares may be issued to the ‘partners’/directors in order to give them complete
control over the enterprise. Such companies usually look to the banks to finance
the business operations of the company by means of loan capital (see Chapter 7). In
large companies, however, shares are generally issued as a major source of capital. It
is because shareholders bear the ultimate risk should the economic fortunes of the
company fail that residual control over management is vested in them (see Chapter
14). It was recognised in Andrews v Gas Meter Co [1897] 1 Ch 361 that a company may
issue shares with different rights attaching to them. Such class rights (for example,
the preferential dividend rights attaching to preference shares) are largely a matter of
contract between the member and the company and, as we will see below, a company
seeking to vary such rights must go through a statutory procedure.
10.1.1 The nature of a share

A share is both a contract between the shareholder and the company (see Chapter 9)
and a right of property, somewhat unhelpfully termed a ‘chose in action’, which can be
bought, sold and charged. The classic definition of a share was delivered by Farwell J in
Borland’s Trustee v Steel Bros & Co Ltd [1901] 1 Ch 279:
A share is the interest of a shareholder in the company measured by a sum of money, for
the purpose of liability in the first place, and of interest in the second, but also consisting
of a series of mutual covenants entered into by all the shareholders inter se in accordance
with [section 16CA 1862, now s.33 CA 2006]. The contract contained in the articles of
association is one of the original incidents of the share. A share is not a sum of money…
but an interest measured by a sum of money and made up of various rights contained in
the contract, including the right to a sum of money of a more or less amount.
We saw in Chapter 3 that shareholders do not have an interest in the property

belonging to the company (see Macaura v Northern Assurance Co Ltd [1925] AC 619);
rather their relationship is with the company as a separate and distinct entity in its
own right. A shareholder thus has rights in the company not against it as in the case of
debenture holders (see Chapter 7).
In Short v Treasury Commissioners [1948] 1 KB 116 (affirmed by the House of Lords [1948]
AC 534) the legal nature of a share was subjected to considerable examination by
the court in relation to its valuation. The Government purchased all of the shares in
the company, valuing them on the basis of the quoted share price. The 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 controlling interest, the higher price that ‘control’ demands can be ignored.
The Treasury was therefore able to purchase the company for a price considerably less
than its asset value.
Activity 10.1
Explain the nature of a share.
Summary
An important feature of a share is that it represents the yardstick for measuring the
member’s interest in the company. For example, it determines the voting rights of the
holder at general meetings and the right to participate in surplus capital in the event
of the company being wound up. Finally, a share is a species of property (a chose in
action) that can be purchased, sold, bequeathed and mortgaged.
10.2 Classes of shares

As seen above, broadly speaking it can be said that a shareholder has rights and
liabilities that arise from the general nature of a share. There is a presumption of
equality between shareholders so that they are deemed to enjoy equal voting and
dividend rights, when the company is a going concern, and equal rights to participate
in any surplus assets should the company be wound up. This presumption of equality
will be rebutted where a company issues shares that carry different class rights. For
example, the holders of preference shares generally enjoy preferential dividend rights
and priority in the return of capital in a winding up.
Generally, the articles of association give the company the power to issue shares with
such rights or restrictions as the company may by ordinary resolution determine. The
different classes of shares commonly issued are ordinary, preference, redeemable and
employees’ shares.
10.2.1 Ordinary shares

The basic class will be ordinary shares (often termed equities), which is the default
category. Ordinary shareholders participate in any dividends after payment has been
made to preference shareholders. Ordinary shareholders also participate in any
surplus should the company be wound up, after preference shareholders have had
their capital returned. The holders of ordinary shares control the general meeting on
the basis of one vote per share.
10.2.2 Preference shares

Holders of preference shares have certain preferential rights attached to their shares.
A fixed preferential cumulative dividend will be paid to them in any year in which
the company has distributable profits. The cumulative element means that arrears
become payable in respect of those years in which a dividend was not declared. It is
presumed that preference shares are cumulative (Webb v Earle (1875) LR 20 Eq 556).
Where preference shares are participating as to dividend, they have the right to a
further dividend payment after the ordinary shareholders have received a distribution
equivalent to their initial fixed rate. Preference shareholders are also generally entitled
to a return of capital on a winding up in priority to the ordinary shareholders, but
unless they have an express right of participation, they do not have a claim to any
surplus assets (Scottish Insurance Corpn Ltd v Wilson and Clyde Coal Co Ltd [1949] 1 All ER
1068). Preference shares generally have restricted voting rights so that their owners
cannot vote in general meetings unless, for example, their dividends are in arrears.
10.2.3 Redeemable shares

Section 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. Such shares may not be redeemed unless they
are fully paid and the terms of redemption must provide 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 profits or from
the proceeds of a new issue of shares that is made for the purpose of redemption
(s.687(2)).
10.2.4 Employees’ shares

To give employees a ‘stake’ in the business, companies may issue shares to them. Such
shares enjoy certain tax advantages. Employee shares are generally issued through
an ‘employee share scheme’ which is defined as being a scheme for facilitating the
holding of shares or debentures in a company by or for the benefit of:
a. bona fide 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 step-children under the age of 18 (s.1166).
Such shares are normally issued as ordinary shares or preference shares and are
typically subject to restrictions relating to their disposal.
10.3 Variation of class rights

Section 630 of the CA 2006 lays down the procedure for effecting a variation of class
rights. The 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 memorandum, the articles or the shareholders’ resolution in which they
are contained. Before turning to the procedure it is useful to consider two questions.
1. What are class rights?
2. What course of conduct will amount to a variation or abrogation of class

rights?
10.3.1 What are class rights?

In Cumbrian Newspapers Group Ltd v Cumberland and Westmoreland Herald Newspapers
and Printing Co Ltd [1987] Ch 1, Scott J stated that rights or benefits conferred by a
company’s articles of association can be classified into three distinct categories:
u Rights or benefits which are annexed to particular shares, such as dividend rights,
and rights to participate in surplus assets on a winding up. Where the articles
provide that particular shares carry particular rights, these are class rights for the
purposes of s.125 CA 1985 (see now s.630 CA 2006).
u Rights or benefits that, although contained in the articles, are conferred on †

‘qua members’ – ‘in the
individuals who are not qua members† or shareholders but, for ulterior reasons, are
capacity of members’.
connected with the administration of the company’s affairs (see Chapter 9).
u Rights or benefits that, although not attached to any particular shares, are
conferred on the beneficiary in his or her capacity as member or shareholder in the
company.
On the facts of the case it was held that provisions in the articles which gave the
claimant 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, were class rights. Scott J said:
A company which, by its articles, confers special rights on one or more of its members in
the capacity of member or shareholder thereby constitutes the shares for the time being
held by that member or members a class of shares for the purposes of section 125. The
rights are class rights.
In determining the scope of class rights the courts have developed certain rules of
construction. For example it is presumed that any rights attaching to a share are
exhaustive (i.e. comprehensive) (see Re National Telephone Co [1914] 1 Ch 755). However,
preference shares are presumed to be entitled to a cumulative dividend even if the
terms of issue are silent on the matter (Webb v Earle (1875) LR 20 Eq 556).
10.3.2 What amounts to a variation or abrogation of class rights?

While s.630 stipulates the procedure to be followed in order to effect a variation
of class rights, the CA 2006 offers little insight into the meaning of variation or
abrogation. Guidance must therefore be drawn from the case law. The courts have
adopted a restrictive approach and have drawn a distinction between conduct which
impacts upon the substance of a shareholder’s class right (which would amount to
a variation) and conduct which merely affects its exercise or enjoyment. In White v
Bristol Aeroplane Co Ltd [1953] Ch 65, article 68 of the company’s articles of association
provided that the rights attached to any class of shares may be ‘affected, modified,
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. The preference
shareholders argued that an issue of additional shares, both preference and ordinary,
‘affected’ their voting rights and therefore fell within article 68. However, the company
contended that the proposal did not amount to a variation of class rights but rather
it was the effectiveness of the exercise of those rights that had been affected and
therefore a separate meeting of the preference shareholders was not required.
The Court of Appeal rejected the preference shareholders’ contention. Romer LJ

explained that the proposal would not affect the rights of the shareholders: ‘the only
result would be that the class of persons entitled to exercise those rights would be
enlarged…’ (see also Greenhalgh v Arderne Cinemas Ltd [1946] 1 All ER 512).
A successful claim was brought in Re Old Silkstone Collieries Ltd [1954] Ch 169. The
company’s colliery was nationalised by the government of the day. While waiting for
the final settlement of compensation, the company had twice reduced its capital by
returning part of the preference shareholders’ capital investment. On both occasions
the company had promised the shareholders that they would not be bought out
entirely but that they would retain their membership so that they could participate
in the compensation scheme to be introduced under the nationalisation legislation.
Subsequently, it was proposed to reduce the company’s capital for a third time by
returning all outstanding capital to the preference shareholders. The effect of this would
be to cancel the class completely and they would no longer qualify for compensation.
The Court of Appeal refused to sanction the reduction, holding that the proposal
amounted to an unfair variation of class rights in so far as the preference shareholders
had been promised that they would participate in the compensation scheme.
But note that a cancellation of a class of shares on a reduction of capital will not generally
be held to constitute a variation of class rights. Such a course of action is viewed as
consistent with the terms of issue of the particular shares in question (see House of Fraser
plc v ACGE Investments Ltd [1987] BCLC 293; Re Saltdean Estate Co Ltd [1968] 3 All ER 829).
Activity 10.2
Explain what is meant by ‘class rights’.
10.3.3 The statutory procedure for effecting a variation of class rights

As commented above, the procedure for varying class rights is set out in s.630 CA 2006.
The provision is far more straightforward than its predecessor (see s.125 CA 1985).
Section 630 provides that class rights may only be varied:
(a) in accordance with the relevant provisions in the company’s articles; or
(b) if no such provision is made in the articles, if the holders of three-quarters 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.
The 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).
Although the CLRSG had recommended that the consent of 75 per cent of the holders
of the class affected should be a statutory minimum, notwithstanding any less onerous
procedure contained in the company’s articles, this was removed from the Companies
Bill at a fairly late stage. As a consequence, the company’s 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)). This has two important effects.
u 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 example requiring a higher
percentage than the statutory minimum, the company must comply with the more
onerous regime.
u 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 circumvented by changing the class rights under s.630.
It should be noted that the 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 (British America Nickel Corpn v MJ O’Brien Ltd [1927] AC
369, Viscount Haldane; and Re Holders Investment Trust [1971] 2 All ER 289, Megarry J).
10.3.4 The right of a minority to object to a variation

Section 633 of the CA 2006 provides that, whether a variation has been effected
through the statutory procedure or under a provision contained in the company’s
constitution, the holders of not less than 15 per cent of the issued shares of the class
affected may, if they did not consent to or vote in favour of the variation, apply to
the court within 21 days of the resolution to have it cancelled. The effect of such
an application is to suspend the variation until it is confirmed by the court. If, on
hearing the application and having regard to all the circumstances of the case, the
court is satisfied that the variation would unfairly prejudice members of the class of
shareholders represented by the applicant, it shall disallow the variation (s.633(5)). If it
is not so satisfied, the court must confirm it.
Activity 10.3
Why is it important to identify a class right?
Further reading
¢ Davies and Worthington, Chapter 19: ‘Controlling members’ voting’ and Chapter
23: ‘The nature and classification of shares’.
¢ Grantham, R.B. ‘The doctrinal basis of the rights of company shareholders’ (1998)
CLJ 554.
¢ Ireland, P. ‘Company law and the myth of shareholder ownership’ (1999) MLR 32.
¢ MacNeil, I. ‘Shareholders’ pre-emptive rights’ (2002) JBL 78.
¢ Polack, K. ‘Company law – class rights’ (1986) CLJ 399.
¢ Rixon, F. ‘Competing interests and conflicting principles: an examination of the

power of alteration of articles of association’ (1986) MLR 446.
¢ Worthington, S. Sealy & Worthington’s text, cases and materials in company

law. (Oxford: Oxford University Press, 2016) 11th edition [ISBN 9780198722052],
Chapter 11.
¢ Worthington, S. ‘Shares and shareholders: property, power and entitlement

(Part I)’ (2001) Company Lawyer 258.

Explain what is meant by a class right, and what restrictions govern the alteration of
class rights?

You should begin by defining what is meant by class rights attaching to a share. Discuss
Scott J’s formulation in Cumbrian Newspapers Group Ltd v Cumberland and Westmoreland
Herald Newspapers and Printing Co Ltd.
Explain what amounts to a variation or abrogation of class rights.
Discuss the statutory procedure which the company must follow in order to vary class
rights.
Reflect and review



first again
I can explain the legal nature of a share.   
I can describe the various classes of shares.   
I can describe how class rights attaching to shares are

determined.   
I can outline the procedure for varying class rights.   
revise?
Must Revision
revise done
10.1 Shares and class rights  
10.2 Classes of shares  
10.3 Variation of class rights  

Notes
11 Majority rule and wrongs against the company
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110
11.1 The rule in Foss v Harbottle – the proper claimant rule . . . . . . . . . . 111
11.2 Forms of action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112
11.3 Derivative claims: introduction . . . . . . . . . . . . . . . . . . . . . 116
11.4 A short excursion into the former common law . . . . . . . . . . . . . 116
11.5 The statutory procedure: Part 11 of the CA 2006 . . . . . . . . . . . . 118
11.6 The proceedings, costs and remedies . . . . . . . . . . . . . . . . . . 121

Introduction
We are concerned here primarily with one particular aspect of majority rule: how it
affects action taken for wrongs done to the company. The most important example of
such a wrong would be where the directors have breached their duties to the company
(see Chapter 15). As we saw in Chapter 3, a consequence of the Salomon doctrine is that
a company can sue in its own right to vindicate a wrong done to it. Thus, whenever a
wrong has been committed against the company, the proper claimant is the company
itself. However, a company is a metaphysical person and as such it must act through
its organ of management (the directors) and the decision to bring legal proceedings
is generally vested in the board (see the model articles of association for private and
public companies, article 3 (directors’ general authority). But what if the wrongdoers
are the directors themselves who, controlling the company, prevent it from seeking
legal redress against them? In this chapter we consider how the law seeks to solve this
problem by permitting minority shareholders, in certain exceptional circumstances, to
bring a derivative action on the company’s behalf.
It is worth bearing in mind here when examining this issue that there is a tension
between the theory of corporate personality and majority rule. As a result this is a
conceptually difficult and technical topic that requires concentrated study. Given its
complexity, you will need to read and reflect on these conceptual tensions. Don’t be
put off if you do not understand the topic immediately – take a break and then re-read
the material. You will find that patiently working through the chapter (perhaps several
times) will pay dividends.
Learning outcomes
u describe the rule in Foss v Harbottle (the proper claimant rule) and the policies
that underlie it
u describe and critically assess the exceptions to the rule in Foss v Harbottle
u describe the various types of shareholder actions
u outline the difficulties which confront a shareholder who seeks to initiate
litigation when a wrong has been done to the company by those in control
u assess the statutory procedure for bringing a derivative claim.
Core text
¢ Dignam and Lowry, Chapter 10: ‘Derivative claims’.
Cases
¢ Foss v Harbottle (1843) 2 Hare 461
¢ Edwards v Halliwell [1950] 2 All ER 1064
¢ MacDougall v Gardiner (1875) 1 ChD 13
¢ Sharp v Blank [2015] EHWC 3220 (Ch)
¢ Estmanco (Kilner House) Ltd v GLC [1982] 1 WLR 2
¢ Wallersteiner v Moir (No.2) [1975] 2 QB 373
¢ Prudential Assurance Co Ltd v Newman Industries Co Ltd (No.2) [1980] 2 All ER 841;
[1982] Ch 204 CA
¢ Smith v Croft (No.2) [1988] Ch 114
¢ Johnson v Gore Wood & Co [2001] 1 All ER 481
¢ Ellis v Property Leeds (UK) Ltd [2002] 2 BCLC 175
¢ Giles v Rhind [2001] 2 BCLC 582
¢ Re Singh Brothers Contractors (North West Limited) [2013] EWHC 2138 (Ch)
Company Law 11 Majority rule and wrongs against the company page 111
¢ Iesini v Westrip Holdings Ltd [2009] EWHC 2526 (Ch)
¢ Mission Capital plc v Sinclair [2008] EWHC 1339 (Ch)
¢ Franbar Holdings v Patel [2008] EWHC 1534 (Ch)
¢ Kleanthous v Paphitis [2011] EWHC 2287 (Ch).
Additional cases
¢ Mumbray v Lapper [2005] EWHC 1152 (Ch)
¢ Re Down’s Wine Bar [1990] BCLC 839
¢ Day v Cook [2002] 1 BCLC 1
¢ Walker v Stones [2001] 2 WLR 623 CA
¢ Shaker v Al-Bedrawi [2002] EWCA Civ 1452
¢ Re Fort Gilkicker Ltd [2013] EWHC 348 (Ch)
¢ Abouraya v Sigmund [2014] EWHC 277 (Ch)
¢ Bhullar v Bhullar [2015] EWHC 1943 (Ch)
¢ Cullen Investments Ltd v Brown [2015] EWHC 473 (Ch)
¢ Breeze v Chief Constable of Norfolk [2018] EWHC 485 (QB)
¢ Sevilleja Garcia v Marex Financial Ltd [2018] EWCA Civ 1468.
11.1 The rule in Foss v Harbottle – the proper claimant rule

The rule in Foss v Harbottle (1843) 2 Hare 461 is that when a wrong has been committed
against the company, the proper claimant in respect of that wrong is the company
itself. The rationale for the rule is twofold:
u it prevents a multiplicity of legal proceedings being brought in respect of the same

issue – if minority shareholders were permitted to initiate such proceedings there
could be hundreds of actions
u it upholds the principle of majority rule: if the majority of shareholders do not wish
to pursue an action then the minority is bound by that decision.
Saying that the company is ‘the proper claimant’ begs the question of who is to decide
if the company will sue. It should be noted that the model articles of association for
private and public companies (see article 3) place the management of companies into
the hands of their directors and the decision whether to sue a third party who has
committed a wrong against the company or, on the other hand, to defend an action
brought against the company falls within the remit of the board. Consequently, even
where the directors do not hold a majority of shares (as is common in large private
companies and public companies) the shareholders cannot generally direct them to
sue or defend an action (Breckland Group Holdings Ltd v London and Suffolk Ltd (1988)
4 BCC 542). (For a very good discussion of whether the board is the best body to take
the decision that the company will, or will not, sue a director, see Kershaw (2012),
pp.589–95.)
In essence, the rule in Foss v Harbottle is a procedural device. As explained by Jenkins LJ

in Edwards v Halliwell [1950] 2 All ER 1064, it has two limbs.
The proper plaintiff in an action in respect of a wrong done to a company is prima facie the
company itself.
Where the alleged wrong is a transaction which might be made binding on the company
and all its members by a simple majority of the members, no individual member of the
†
company is allowed to maintain an action in respect of that matter ‘for the simple reason ‘Cadit quaestio’ (Latin) – ‘The
that, if a mere majority of the members of the company… is in favour of what has been matter (literally ‘question’)
done, then cadit quaestio† (in other words, the majority rule). falls’.
In Foss v Harbottle (1843) 2 Hare 461 the claimants were two shareholders in the
Victoria Park Company. They brought an action against the company’s five directors
and promoters, alleging that the defendants had misappropriated assets belonging
to the company and had improperly mortgaged its property. The claimants sought an
order to compel the defendants to make good the losses suffered by the company.
They also applied for the appointment of a receiver. It was held that the action
must fail. The harm in question was suffered by the whole company, not just by the
two shareholders. It was open to the majority in general meeting to approve the
defendants’ conduct. To allow the minority to bring an action in these circumstances
would risk frustrating the wishes of the majority.
A clear application of the rule that illustrates how it fits with the principle of majority
rule is MacDougall v Gardiner (1875) 1 ChD 13. The chairman of the Emma Silver Mining Co
had adjourned a general meeting of the company without allowing a vote to be taken
on the issue of adjournment as requested by a shareholder, MacDougall. He therefore
brought an action claiming first, a declaration that the chairman had acted improperly
and second, an injunction to restrain the directors from taking any further action. The
Court of Appeal held that the basis of the complaint was something that in substance the
majority of the shareholders were entitled to do and there was no point in suing where
ultimately a meeting has to be called at which the majority will, in any case, get its way.
Against this background Lord Davey in Burland v Earle [1902] AC 83 formulated what has
become a classic statement of the rule:
It is an elementary principle of the law relating to joint stock companies that the Court will
not interfere with the internal management of companies acting 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.
(See also Mozley v Alston (1847) 1 Ph 790; Gray v Lewis (1873) 8 Ch App 1035; Re Down’s
Wine Bar [1990] BCLC 839.)
Activity 11.1
Consider the key differences between private companies and public companies.
Do you think the relationship between the board of directors and the shareholders
may depend upon the size of the company?
Activity 11.2
Read MacDougall v Gardiner (1875) 1 Ch D 13.
Upon what basis did Mellish LJ reach the conclusion that the Rule in Foss v Harbottle
operated to defeat the claim? When, in his view, may a minority sue?
11.2 Forms of action

It will be useful here to describe a number of different types of action that might be
brought.
Corporate actions
This is an action brought by the company itself, so that the company will be named as
the claimant. As we have seen, according to the rule in Foss, this is the type of action
that should be brought where a wrong has been done to the company. It must be
authorised by whoever within the company has the authority to decide the company
will sue, and this ordinarily will be the board of directors.
The derivative action/claims

This is the name for proceedings brought by one or more shareholders, but to enforce
a cause of action that the company itself has. So, unlike a personal action, considered
next below, the shareholder is not suing to enforce their own rights, but is instead
suing to enforce the company’s rights – say in respect of a breach of duty owed to the
company by a director. And if successful, the benefits will go to the company, not the
shareholder. As hopefully will be clear, such proceedings are an exception to Foss, for
they allow a shareholder to sue for a wrong done to the company. We will consider
below the restrictive conditions that must be satisfied before such proceedings can be
brought.
As we shall see, those conditions used to be set out in the common law, when the
proceedings were called derivative actions. The rules have now been incorporated
into legislation, and the name of such proceedings changed to derivative claims.
Personal actions
This is an action brought by, and in the names of, an individual shareholder or group
of shareholders. They sue to enforce their own rights, and for their own benefit. As we
have seen, according to the rule in Foss, shareholders cannot bring a personal action
in respect of a wrong done to the company. However, there may be situations where
the misconduct that has occurred does not constitute a wrong to the company but
is instead an infringement of the personal rights of the shareholder. In that case, the
shareholder can sue personally, and the rule in Foss does not prevent her doing so. As
Mellish LJ observed in MacDougall v Gardiner (above), where the right of a shareholder
has been infringed by the majority, he can sue. Here, the injury or wrong in question is
not suffered by the company as such, but by the shareholder personally. Therefore, the
anxiety underlying Foss v Harbottle does not arise.
A shareholder’s rights can arise by virtue of a contract, for example, under the
company’s constitution or a shareholders’ agreement. Thus, where a dividend is
declared but not paid, a shareholder can sue personally for payment by way of a legal
debt. See, for example, Wood v Odessa Waterworks Co (1889) 43 Ch D 636 (Ch D)).
The representative action

A representative action is brought by a shareholder on behalf of himself and all other
members who have an interest in the litigation (r.19.6 Civil Procedure Rules). For
example, where a class of shareholders allege that a class right has been infringed (see
Chapter 10).
The action avoids the costs of multiple suits. The court’s judgment will be binding on
those represented (see, for example, Quin & Axtens Ltd v Salmon [1909] 1 Ch 311). Thus, a
representative action is brought where a wrong has been committed by the company
to a class of shareholders (see Pender v Lushington).
Personal actions for reflective loss

We have seen that, according to Foss, a wrong done to the company should give rise
to a corporate action. Shareholders can only bring a personal claim if their personal
rights have been infringed. But imagine this situation. Suppose directors have
breached their duties – say they have defrauded the company of several millions of
pounds. The company has clearly been harmed, and according to Foss, it is the one
that should sue to recover those losses. But could not a shareholder argue that they
too have been individually, personally, harmed because their shares in the company
are now worth much less as a result, allowing them to bring a personal action for their
own personal loss?
The shareholder will find two difficulties in using that argument. The first reflects what
we have discussed so far in this chapter. The shareholder may be out of pocket, but
cannot easily point to the breach of any duty owed to them personally. The directors’
fraud will be a breach of their duties, but these duties are owed only to the company
itself (see Chapter 15). Directors do not owe duties directly to individual shareholders.
So, legally speaking, the wrong can be said to be done only to the company (even
though it leaves the shareholders out of pocket).
This first difficulty might not be insurmountable, however. In some (exceptional) cases,
the shareholder might be able to show that, alongside the duties which the director
owes to their company, they do also owe duties directly to individual shareholders.
There are a number of grounds on which directors might come to owe duties directly
to shareholders (although it is important to emphasise that all of the grounds apply
only exceptionally). First, directors may owe a duty of care to shareholders in tort. That
duty would include not misleading the shareholders, for example by giving careless
advice to shareholders about how they might vote at a shareholders’ meeting: see
Sharp v Blank [2015] EWHC 3220 (Ch).
Another way is if the directors were to enter into a sufficiently close relationship
with shareholders to give rise to duties owed directly to them. This has sometimes
happened where directors are closely advising shareholders on the sale of their shares:
see the discussion in Section 15.1.2. A final ground might arise where there is some
separate contract between the directors and the shareholders, and that contract
imposes obligations on the directors in favour of the shareholders. See the case of Giles
v Rhind, below, for an example of this. See also Platt v Platt [1999] 2 BCLC 745. However,
even if the shareholder were able to establish that, exceptionally, the directors did
owe the shareholders some duties (over and above the duties the directors owed to
the company), the shareholders would still face a second difficulty.
The second difficulty is this: where a wrong results first in a loss to the company
and this leads in turn to a diminution in the value of a member’s shareholding, the
shareholder’s loss has been termed ‘reflective loss’ by Lord Bingham and Lord Millett in
Johnson v Gore Wood & Co [2001] 1 All ER 481. The shareholder’s loss merely reflects the
loss caused first to the company. And in Prudential Assurance Co Ltd v Newman Industries
Ltd (No.2) [1982] 1 All ER 354, the Court of Appeal held that a shareholder cannot sue for
such reflective loss. Quite simply, the rule in Foss v Harbottle means that the company
is the proper claimant and the shareholder’s reflective loss will be remedied if the
company sues the wrongdoer.
However, if the court is satisfied that a member suffered a personal loss which is
separate and distinct from that sustained by the company (and provided of course
that the member can show this arose from the breach of a duty owed personally to
them, so they can overcome the first difficulty noted above), then the member will
be able to sue (Johnson v Gore Wood & Co). The authorities were summarised by Lord
Bingham in the Johnson decision as supporting three propositions.
(i) 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 (i.e. a shareholder is not entitled to sue merely as a shareholder)
to make good a diminution in the value of the shareholder’s shareholding where that
merely reflects 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 company’s 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…
(ii) 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…
(iii) 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.
Recently, the no reflective loss principle has been subjected to considerable judicial
scrutiny. These cases suggest that the principle is of wide application and will readily
be invoked by the courts. The essential point is that the courts prefer the company
itself to sue for the loss it has suffered, rather than permitting (potentially many)
individual personal actions to be brought by those who have suffered some harm
as a result of the loss caused to the company. In Ellis v Property Leeds (UK) Ltd [2002]
2 BCLC 175, the Court of Appeal held that the principle applies equally where the
claimant is suing qua director as to when he sues qua shareholder. Moreover, it was
held in Sevilleja Garcia v Marex Financial Ltd [2018] EWCA Civ 1468, that the principle also
prevents a creditor from suing personally for reflective loss and it does so whether or
not the creditor is a shareholder in the company. The principle also applies even if the
company happens to be in administrative receivership, for being in administrative
receivership does not prevent the company itself from pursuing any claim it may have
for harm done to it (see Gardner v Parker [2004] EWCA Civ 781, in which the Court of
Appeal also stressed that the bar is an obvious consequence of the rule against double
recovery). However, the prohibition can be circumvented where the shareholder is
able to bring a claim qua beneficiary of a trust of shares of which the wrongdoer is
trustee (see Walker v Stones [2001] 2 WLR 623, CA; Shaker v Al-Bedrawi [2002] EWCA Civ
1452).
In Breeze v Chief Constable of Norfolk [2018] EWHC 485 (QB), the court confirmed that the
reflective loss principle is not restricted to cases where there is a breach of directors’
duties. Rather, the principle applies to ‘any situation where a company (whether or
not it actually sues) has a cause of action in respect of an actionable wrong, which,
if pursued to its fullest extent, would enable it to seek to recoup the loss’. (In this
particular case, the claim the company itself could have sued for was ‘misfeasance in a
public office’.)
One exception to the reflective loss principle was established in the case of Giles v Rhind
[2001] 2 BCLC 582. The company was insolvent due to a former director’s breach of
certain duties (not to compete or misuse confidential 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 director applied for a
security of costs order. In effect, the defendant had, by his breach of duty, rendered the
company incapable of seeking legal redress against him. The claimant brought a personal
action against the former director to recover losses to the value of his shareholding,
loss of remuneration and loss of the value of loan stock. The Court of Appeal, in placing
considerable emphasis on the fact that the defendant’s own wrongdoing had, in effect,
disabled the company from suing him for damages, found that this situation had not
confronted the House of Lords in Johnson v Gore Wood & Co. Given that the duties in
question were expressly provided for in the shareholders’ 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. However, in Sevilleja (see above) the court also
held that this exception must be construed narrowly. In particular, the court said that the
company’s inability to sue must be ‘legal’ rather than merely ‘factual’. In other words, the
effect of the wrongdoing against the company must be such as to create a legal barrier
to the company suing, and not merely to cause ‘factual’ difficulties (such as a lack of the
necessary funds to pursue the action).
Activity 11.3
Try to summarise Lord Bingham’s three propositions in Johnson in simple language.
Summary
In Johnson v Gore Wood & Co the House of Lords explained that the reason for
disallowing the shareholder’s claim for reflective loss is that if a member could
sue there would be a risk of double recovery. As pointed out by Arden LJ in Day v
Cook [2002] 1 BCLC 1, the member’s claim is ‘trumped’ by the company’s. Thus, for
a shareholder to bring a personal claim for a loss it must be shown that there was
breach of a duty owed personally to him or her and that a personal loss was suffered
which is separate from any loss suffered by the company.
Activity 11.4
Read Giles v Rhind [2003] 1 BCLC 1.
What was the issue that came before the Court of Appeal in this case which had not
been addressed by the House of Lords in Johnson v Gore Wood & Co?
11.3 Derivative claims: introduction

Having dealt with personal claims, we can now return to the main theme of this
chapter, namely derivative proceedings. We have noted above their essential
characteristics, and these are reflected in s.260(1) CA 2006, which defines them 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.
UK company law has long permitted them. Prior to the CA 2006, however, the rules
governing derivative actions (as they were then known) were found not in the Companies
Acts, but were instead established only by case law. These rules were much criticised
(consider for example the views of the Law Commission (see the LCCP No.142 (1996) and
the ensuing Report, No.246 (Cm 3769, 1997)). It was felt that the rules, being buried in case
law, were inaccessible and often unclear. It was also felt that the rules were too restrictive,
and made it too difficult for shareholders to succeed in bringing such actions.
The Law Commission did not recommend abandoning the rule in Foss v Harbottle itself,
and its requirement that a company should be the claimant where the company had
been wronged. It felt the rule itself was sound. Derivative proceedings should remain an
exception to that rule – a procedural device that would enable individual shareholders
to take action for the company, to ensure the company’s rights were vindicated. But
there should be ‘a new derivative procedure with more modern, flexible and accessible
criteria’. This was achieved by introducing a new statutory ‘derivative claim’, in Part 11
CA 2006. The common law derivative action has, therefore, almost been completely
replaced by the new statutory claim. Almost, but not entirely: what are termed ‘multiple
derivative actions’ are not covered by the statutory provisions of Part 11. A multiple
derivative action is one brought by a shareholder of a parent company in respect of a
wrong done to the company’s subsidiary, or its sub-subsidiary, and so on. Such claims
must still be brought under the old common law procedure: see Re Fort Gilkicker Ltd
[2013] EWHC 348 (Ch) and Abouraya v Sigmund [2014] EWHC 277 (Ch).
When a derivative claim is brought, the company itself is joined as a defendant.

It cannot be joined as a claimant. That would only be possible if the board had
authorised this, and if a derivative claim is being brought, we must assume the board
is refusing to do that. By being joined as a defendant to the action, however, the
company can still be bound by the judgment and can enforce any remedy awarded.
The wrongdoers will also be joined as defendants.
11.4 A short excursion into the former common law

We noted above that the common law rules were criticised for being unclear and
restrictive, making it difficult for shareholders successfully to bring such actions.
It would be tempting to hope that the old rules are now just a matter of history.
Unfortunately, that is not yet so. First, as we have seen, the old rules remain applicable
to multiple derivative claims. Secondly, the old rules may still influence judges
when they apply the new statutory provisions. So, we need to spend a few moments
examining the old rules. Doing that will also let us see whether Part 11 turns out to be
an improvement on what went before.
At common law, the derivative action was available only where there was ‘fraud on
the minority’. It became known, then, as the fraud on the minority exception to Foss.
It appears in a longer list of ‘exceptions to Foss’ which Jenkins LJ set out in Edwards v
Halliwell [1950] 2 All ER 1064. These were:
u where the act complained of is illegal or is wholly ultra vires the company (this is
discussed further in Chapter 13)
u where the matter in issue requires the sanction of a special majority, or there has
been non-compliance with a special procedure
u where a member’s personal rights have been infringed
u where a fraud has been perpetrated on the minority and the wrongdoers are in
control.
(Attempts to add a fifth exception – where it would be in the interests of justice to

relax the rule – were roundly rejected by the Court of Appeal in Prudential Assurance v
Newman (No.2) [1982] 1 All ER 354.)
This list of ‘exceptions’ is useful, but it is important to see, as Wedderburn noted in

his frequently cited article, ‘Shareholders’ rights and the rule in Foss v Harbottle’ [1957]
CLJ 194 and [1958] CLJ 93, that only fraud on the minority is a ‘true’ exception. There,
the wrong is indeed done to the company, the company itself should ordinarily sue,
and to permit a shareholder to sue instead must be an exception to Foss. In the first
three cases, the wrong is not being done to the company; in truth, it is the shareholder
personally who is being wronged.
11.4.1 Fraud on the minority

At common law, then, a shareholder was allowed to bring a derivative action where
the company had been wronged, but only if that wrong amounted to a ‘fraud’ and
if those who had wronged the company were in control of it and preventing it from
suing. These twin elements – a wrong that constituted fraud, and wrongdoer control
– defined the preconditions for a successful derivative action. Unfortunately, the
meaning of each was unclear and restrictive.
The meaning of ‘fraud’

Not all breaches of duty by directors amounted to fraud, however, but which ones did,
and which did not, was never clear. It was sometimes said that only breaches which
cannot be ratified by the majority (see Cook v Deeks, in Chapter 15) amounted to fraud.
But this merely begs the question: which duties cannot be ratified by the majority (and
therefore amount to fraud)? Megarry V-C in Estmanco (Kilner House) Ltd v GLC [1982] 1
WLR 2 explained that:
‘Fraud’ in the phrase ‘fraud on a minority’ seems to be being used as comprising not only
fraud at common law but also fraud in the wider equitable sense of that term…
So, we know that ‘fraud’ here does not necessarily mean that the breach of duty was
dishonest or deceitful, but that still gives little positive guidance. The judges perhaps
deliberately left the definition of fraud in this context open, although some guidelines
were laid down. In Burland v Earle (above), fraud was defined as: ‘when 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’.
In Daniels v Daniels [1978] Ch 406, Templeman J expressed the view that the term
‘fraud’ should extend to cases of self-serving negligence. He said that the fraud on the
minority principle would be satisfied: ‘where directors use their powers intentionally or
unintentionally, fraudulently or negligently in a manner which benefited themselves at
the expense of the company.’ But note that negligence per se is not sufficient. In Pavlides
v Jensen [1956] Ch 565 Danckwerts J accepted that the forbearance of shareholders
extends to directors who are ‘an amiable set of lunatics’. In this case, although the
directors were negligent, they did not derive any personal benefit. Contrast the
common law position with the reforms introduced by the CA 2006, Part 11 (below).
The meaning of ‘wrongdoer control’

Like fraud, wrongdoer control was also unclear in its meaning.
There was judicial debate over whether actual (de jure) control was required (for
example whether the wrongdoers needed to control 51 per cent or more of the votes),
or whether de facto control sufficed. In Prudential Assurance Co Ltd v Newman Industries
Co Ltd (No.2) (above), the Court of Appeal adopted a restrictive approach to the issue
and this lead was followed by Knox J in Smith v Croft (No.2) [1988] Ch 114, who stated
that if the majority of the shareholders who were independent of the wrongdoers did
not wish the action to proceed ‘for disinterested reasons’, as occurred on the facts of
the case, the single member who sought to initiate the proceedings would be denied
standing to sue (locus standi). The logic of this was that if a majority of disinterested
shareholders were against action by the company, then the company was being
stopped from suing (or ‘controlled’) not by the wrongdoers, but by non-wrongdoing
shareholders. This attempted to reassert the importance of majority rule, but rule by
a majority of disinterested and impartial shareholders. The judge went on to observe
that in determining the independence of the shareholders who did not support an
action being brought against the wrongdoers: ‘[their] votes should be disregarded if,
but only if, the court is satisfied either that the vote or its equivalent is actually cast
with a view to supporting the defendants rather than securing benefit to the company’.
Summary
At common law, a shareholder would be permitted to sue on behalf of the company, as
an exception to Foss, in a derivative claim, but only if she could establish that the wrong
to the company amounted to ‘fraud’, and the company could not itself sue because
it was controlled by the wrongdoer(s). But these conditions were unclear in their
meaning, and restrictively applied. The hope was that the new statutory derivative claim
procedure, in Part 11 CA 2006, would be both clearer, and give the individual shareholder
a greater chance of success. We must now see if this has proved to be the case.
11.5 The statutory procedure: Part 11 of the CA 2006

As noted above, s.260(1) CA 2006 defines 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.
The grounds for bringing a derivative claim are laid down by s.260(3), which provides
that such a claim may 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.
It is clear that claims against directors for any breach of their duties owed to the
company fall within its scope. In this respect s.260(3) is wider than the common law
action it replaces. The breach no longer needs to be one that is considered ‘fraud’
(with all the uncertainty about what fraud actually meant). On a practical level, this
means that a derivative claim now can be brought for a breach of the duty to exercise
reasonable care, skill and diligence (see s.174 CA 2006) whether or not that breach is
‘self-serving’ (compare the case of Pavlides v Jensen, above). Section 260(3) also makes
it clear that a derivative claim may be brought, for example, against a third party who
dishonestly assists a director’s breach of fiduciary duty or one who knowingly receives
property in breach of a fiduciary duty.
It is also immaterial whether the cause of action arose before or after the person seeking
to bring or continue the derivative claim became a member of the company (s.260(4)).
Finally, note that CA 2006 does not say that the shareholder bringing the derivative
claim must show that the wrongdoers are in control of the company (recall that
establishing ‘wrongdoer control’ was one of the conditions under the common law
rules). However, it is less clear whether this means this condition no longer applies to
the new statutory claim: see Kershaw, D. ‘The rule in Foss v Harbottle is dead; long live
the rule in Foss v Harbottle’ (2015) Journal of Business Law 274.
The application for permission to continue a derivative claim

Section 261 states that once a derivative claim has been brought, the member must
apply to the court for permission to continue it.
This entails a two stage process. The first stage involves a paper hearing, where the
court considers the member’s evidence. The onus is on the member to establish that
they have a prima facie case for permission to continue the derivative claim. If this is
not demonstrated the court will dismiss the application. 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. The 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 second
stage, which is a full permission hearing, and here the court may order the company to
provide evidence at this stage.
Sections 263(2) and (3) 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.
Section 263(2) contains three criteria that operate as what might be called ‘mandatory
bars’, in the sense that if any one of these criteria applies, the court must then refuse
its permission to continue the claim. So, permission must be refused if the court is
satisfied that:
u a person acting in accordance with s.172 (duty to promote the success of the
company) would not seek to continue the claim; or
u where the claim arises from an act or omission that is yet to occur, that the act or
omission has been authorised by the company; or
u where the complaint arises from an act or omission that has already occurred,
that act or omission was authorised before it occurred, or has been ratified since it
occurred.
For an example of a case where the court found that the breach of duty had been
authorised or ratified by the shareholders, see Re Singh Brothers Contractors (North
West Limited) [2013] EWHC 2138 (Ch). In Cullen Investments Ltd v Brown [2015] EWHC 473
(Ch) the court made clear that for an authorisation to be effective, the director would
have to show that he had made a ‘full and frank disclosure’ to the shareholders about
his conduct. The same point would presumably apply to a ratification.
For the first of these mandatory bars (whether a person is acting in accordance with
s.172, etc.), the issue here is really whether continuing the claim would be in the
best interests of the company. In Iesini v Westrip Holdings Ltd [2009] EWHC 2526 (Ch),
Lewison J listed the considerations to take into account in deciding whether it would
be in the company’s interests to continue, or to stop, the proceedings. These included:
u the size of the claim
u the strength of the claim
u the cost of the proceedings
u the company’s ability to fund the proceedings
u the ability of the potential defendants to satisfy a judgment
u the impact on the company if it lost the claim and had to pay not only its own costs
but the defendant’s as well
u any disruption to the company’s activities while the claim is pursued

u whether the prosecution of the claim would damage the company in other ways
(e.g. by losing the services of a valuable employee or alienating a key supplier or
customer).
However, Lewison J also noted that a judge should only refuse permission under this
mandatory bar if ‘no reasonable director’ would think it worth proceeding with the
claim. In other words, if there were a reasonable doubt about whether it was in the
company’s best interests to continue the claim, then the judge ought not to stop
proceedings on this ground.
Where none of the mandatory bars apply, the judge is not compelled to refuse
permission. But nor are they compelled to give permission to let it continue. Instead,
the judge now has a discretion what to do, and to exercise that discretion, they must
move on and apply a list of ‘discretionary factors’, set out in s.263(3). These factors are:
u whether the member is acting in good faith
u the importance that a person acting in accordance with s.172 (duty to promote the
success of the company) would attach to pursuing the action
u whether prior authorisation or subsequent ratification of the act or omission

would be likely to occur
u whether the company has decided not to pursue the claim
u whether the shareholder could pursue the action in their own right.
In a number of cases, the courts have decided that the shareholder would be better
off pursuing an action in their own right. The action that the court has in mind here is
a claim under s.994 CA 2006 for ‘unfair prejudice’ (see Chapter 12). See, for example,
Mission Capital plc v Sinclair [2008] EWHC 1339 (Ch) and Franbar Holdings v Patel [2008]
EWHC 1534 (Ch).
The reference above to whether ‘the company’ has decided not to pursue the claim
means the board of directors. In Kleanthous v Paphitis [2011] EWHC 2287 (Ch) the court
placed some weight on this factor, with the judge noting that the company’s directors
were better placed than the judge to determine the likely impact upon the company
of either continuing, or stopping, the claim.
Section 263(4) goes on to add the requirement, as laid down in Smith v Croft (No.2)
(above), that the court ‘shall have particular regard’ to any evidence before it as to
the views of members who have no personal interest in the derivative claim. There
will need to be a factual enquiry into whether or not the breach is likely to be ratified.
In practice the courts will probably adjourn the permission hearing in order for the
question of ratification to be put to the company.
Provision is also made for a 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 prosecute 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 initiated 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. This 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.
In assessing the statutory reforms it is noteworthy that there is little or no change of

emphasis in terms of formulation. The 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 satisfied. The statutory language similarly proceeds from the rather negative
standpoint that the court must dismiss the application or claim in the circumstances
specified in ss.261(2), 262(3), 263(2)–(3) and 264(3).
The modern case law, though decided prior to the 2006 Act, suggests that the
mandatory requirement for permission cannot be dismissed as a mere technicality. It
reflects the real and important principles that the Court of Appeal reaffirmed in Barrett
v Duckett and underlines the need for the court to retain control over all the stages
of a derivative action (see Portfolios of Distinction Ltd v Laird). Against the background
of the statutory criteria for granting permission to continue the claim, the decision
in Jafari-Fini v Skillglass [2005] EWCA 356, is of interest. The Court of Appeal upheld the
judge’s refusal to allow the derivative claim to continue. Chadwick LJ explained that
the company itself would not benefit from the action and the claimant shareholder
had alternative avenues open to him, specifically a personal claim.
A major deterrent against speculative claims is, of course, costs. Although CPR, r.19.9E
enables the court to order the company to indemnify the member, in practice such an
order will rarely be granted where permission is denied. Finally, it is also noteworthy
that the law on ratification has been tightened and the votes of the ‘wrongdoers’ will
no longer be counted on such ordinary resolutions (although such members may be
counted towards the quorum and may participate in the proceedings; see further,
ss.175 and 239 CA 2006).
11.6 The proceedings, costs and remedies

If permission is granted to continue the claim the member will bring the action on
the company’s behalf. The Civil Procedure (Amendment) Rules 2007 (SI 2007/2204),
r.7 and Schedule 1 substitute CPR 19.9 and inserts new CPR rr.19.9A – 19.9F. As noted
above, the company for whose benefit a remedy is sought must be made a defendant
in the proceedings in order formally to be a party to the action and be bound by any
judgment.
If permission is granted to continue the claim the member will bring the action on
the company’s behalf. Unless otherwise permitted or required by r.19.9A or r.19.9C,
the claimant may take no further action in the proceedings without the permission
of the court. A practical hurdle which confronts a shareholder litigant is the cost of
a proposed action. This is covered by r.19.9E. The 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] 2 QB 273, where
Buckley LJ observed that the shareholder who initiates the derivative claim may be
entitled to be indemnified by the company at the end of the trial for his costs provided
he acted reasonably in bringing the action. The position in the event of the action
failing was also considered by the court. Lord Denning MR said:
But what if the action fails? Assuming that the minority shareholder had reasonable
grounds for bringing the action – that it was a reasonable and prudent course to take
in the interests of the company – he 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 indemnified 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 benefit 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 Croft (No.2) (above), decided under the old RSC (Rules of the Supreme
Court), Walton J held that the shareholder’s personal means to finance the action was
a relevant factor to be taken into account by the court in determining the need for an
indemnity. The judge also added that even where the shareholder is impecunious, he
should still be required to meet a share of the costs as an incentive to proceed with
the action with due diligence.
Finally, in Bhullar v Bhullar [2015] EWHC 1943 (Ch), the court refused to award an
indemnity where it felt that the claimant was using the derivative claim as a tactic
to pressurise the majority, and that the dispute between the parties was likely to be
settled under s.994 CA 2006 (unfair prejudice proceedings).
Summary
If you have understood the rationale underlying the Rule in Foss v Harbottle,
together with the fundamental principles of company law that underpin it, you
clearly understand the proper claimant rule. If at this stage you still have difficulties
understanding this area don’t worry – it is a notoriously difficult topic. If you are still
having difficulties, re-read Dignam and Lowry, Chapter 10 before going on to read the
other sources listed in ‘Further reading’ below. Also, as you reflect on the rule, bear in
mind that the judges do not see themselves serving as appeal tribunals for the benefit
of dissenting minority shareholders (Carlen v Drury (1812) 1 Ves & B 154; see Dignam
and Lowry, Chapter 10, para 10.3). The statutory procedure at least sets out the steps to
be followed in an accessible way. We await the case law it will generate with interest,
particularly with respect to how the judges will exercise their discretion in granting (or
refusing) permission to continue the claim.
Further reading
¢ Almadani, M. ‘Derivative actions: does the Companies Act 2006 offer a way
forward?’ (2009) Company Lawyer 131.
¢ Arsalidou, D. ‘Litigation culture and the new statutory derivative claim’ (2009)
30 Company Lawyer 205.
¢ Arsalidou, D. ‘Directors’ fiduciary duties to shareholders: the Platt and Peskin

cases’ (2002) 23 Company Lawyer 61.
¢ Boyle, A.J. ‘The new derivative action’ (1997) 18 Company Lawyer 256.
¢ CLSRG Developing the Framework, para 4.127; Completing the Structure, paras
5.86–5.87; Final Report, para 7.46.
¢ Ferran, E. ‘Litigation by shareholders and reflective loss’ (2001) CLJ 245.
¢ Hannigan, B. ‘Drawing boundaries between derivative claims and unfairly

prejudicial petitions’ (2009) J Business Law 606.
¢ Keay, A. and J. Loughrey ‘Something old, something new, something borrowed:

an analysis of the new derivative action under the Companies Act 2006’ (2008)
124 LQR 469.
¢ Keay, A. and J. Loughrey ‘Derivative proceedings in a brave new world for

company management and shareholders’ (2010) J Business Law 151.
¢ Kershaw, D. ‘The rule in Foss v Harbottle is dead; long live the rule in Foss v
Harbottle’ (2015) JBL 274–302.
¢ Lord Wedderburn ‘Shareholders’ rights and the rule in Foss v Harbottle’ (1957) CLJ
194 and (1958) CLJ 93.
¢ Law Commission Consultation Paper No.142.
¢ Law Commission Report No.246.
¢ Riley, C.A. ‘Derivative claims and ratification: time to ditch some baggage’ (2014)
34 Legal Studies 582.

‘The view has been expressed that Part 11 of the Companies Act 2006 (“Derivative
Claims And Proceedings By Members”) will lead to a spate of speculative or
vexatious litigation.’
Discuss.

This is a wide-ranging question and you will need to organise your answer carefully. It
requires detailed consideration of the statutory procedure for bringing a derivative
claim and the ‘old’ case law surrounding the rule in Foss v Harbottle. Your answer
should:
u outline the new statutory procedure
u discuss what the rule in Foss v Harbottle is and identify its purpose (Edwards v
Halliwell and MacDougall v Gardiner)
u assess the case law surrounding the exceptions to the rule and consider, against
this background, whether the judges, in exercising their discretion under Part 11
CA 2006, are likely to open the floodgates of litigation or whether they are likely to
adopt a strict approach towards granting permission to continue the claim.
You should conclude by considering the vexed question of costs. What incentive is
there for bringing an action on behalf of the company?
Reflect and review



first again
I can describe the rule in Foss v Harbottle (the proper
claimant rule) and the policies that underlie it.   
I can describe and critically assess the exceptions to

the rule in Foss v Harbottle.   
I can describe the various types of shareholder actions.   

I can outline the difficulties which confront a
shareholder who seeks to initiate litigation when a
wrong has been done to the company by those in   
control.
I can assess the statutory procedure for bringing a

derivative claim.   
revise?
Must Revision
revise done
11.1 The rule in Foss v Harbottle – the proper claimant rule  
11.2 Forms of action  
11.3 Derivative claims: introduction  
11.4 A short excursion into the former common law  
11.5 The statutory procedure: Part 11 of the CA 2006  
11.6 The proceedings, costs and remedies  

12 Statutory minority protection
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126
12.1 Winding up on the ‘just and equitable’ ground . . . . . . . . . . . . . 127
12.2 Unfair prejudice – s.994 CA 2006 . . . . . . . . . . . . . . . . . . . . 129

Introduction
In this chapter we examine the statutory rights of minority shareholders. What rights
do they have? How can they enforce them and against whom? What remedies are
appropriate and available? You should bear in mind that minority shareholders in an
owner-managed private company often depend upon the way the company is run for
their living; such shareholders frequently work for the company and participate in its
management. As a result the stakes can be extremely high when a minority dispute
occurs in such a company.
Learning outcomes
u describe the range of statutory remedies available to minority shareholders
u explain the ‘just and equitable’ winding up remedy
u state the main grounds for a just and equitable winding up
u describe the scope of the unfair prejudice remedy
u describe the remedies available under the unfair prejudice provision.
Core text
¢ Dignam and Lowry, Chapter 11: ‘Statutory shareholder remedies’.
Cases
¢ Ebrahimi v Westbourne Galleries Ltd [1973] AC 360
¢ Virdi v Abbey Leisure Ltd [1990] BCC 60
¢ Nicholas v Soundcraft Electronics Ltd [1993] BCLC 360
¢ Re City Branch Group Ltd [2004] EWCA Civ 815
¢ Re Ghyll Beck Driving Range Ltd [1993] BCLC 1126
¢ Re Elgindata Ltd [1991] BCLC 959
¢ Phoenix Office Supplies Ltd v Larvin [2002] EWCA Civ 1740
¢ Re Macro (Ipswich) Ltd [1994] 2 BCLC 354
¢ Re London School of Electronics Ltd [1986] Ch 211
¢ Re Saul D Harrison & Sons plc [1995] 1 BCLC 14 CA
¢ O’Neill v Phillips [1999] 1 WLR 1092
¢ Re Sam Weller & Sons Ltd [1989] 5 BCC 810
¢ Anderson v Hogg [2002] BCC 923
¢ Grace v Biagioli [2006] 2 BCLC 70
¢ Richardson v Blackmore [2006] BCC 276
¢ Re OC (Transport) Services Ltd [1984] BCLC 251
¢ Fulham Football Club (1987) Ltd v Richards [2011] EWCA Civ 855
¢ Re Bird Precision Bellows Ltd [1984] Ch 419
¢ Re Blue Index Ltd [2014] EWHC 2680 (Ch)
¢ Re Paramount Powders (UK) Ltd [2019] EWCA Civ 1644.
Additional cases
¢ Re Yenidje Tobacco Co Ltd [1916] 2 Ch 426
¢ Re a Company (No.00477 of 1986) [1986] BCLC 376
¢ Re Blue Arrow plc [1987] BCLC 585
¢ Harding v Edwards [2014] EWHC 247 (Ch)
¢ Graham v Every [2014] EWCA Civ 191

Company Law 12 Statutory minority protection page 127
¢ Re CF Booth Ltd [2017] EWHC 457 (Ch)
¢ Hawkes v Cuddy (No.2) [2009] EWCA Civ 291
¢ Re Tobian Properties Ltd [2012] EWCA Civ 998
¢ Ng v Crabtree [2011] EWHC 1834 (Ch)
¢ Re Home & Office Fire Extinguishers Ltd [2012] EWHC 917 (Ch)
¢ Harborne Road Nominees Ltd v Karvaski [2011] EWHC 2214 (Ch)
¢ Re AMT Coffee Ltd [2019] EWHC 46 (Ch)
¢ Waldron v Waldron [2019] EWHC 115 (Ch)
¢ Estera Trust (Jersey) Ltd v Singh [2018] EWHC 1715 (Ch).
12.1 Winding up on the ‘just and equitable’ ground
12.1.1 Defining just and equitable grounds

Section 122(1)(g) of the Insolvency Act 1986 (IA 1986) 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’. The provision derives from partnership law
where the court had equitable jurisdiction to dissolve a partnership where relations
had broken down between the partners and the only alternative was to dissolve the
business. For companies the remedy has come to the fore in relation to small private
companies termed quasi-partnerships. Such companies are akin to partnerships
because the personal relationships between the directors (who generally have a
number of roles, for example as both shareholders and employees) are so crucial to
the effective operation of the company’s business that if confidence breaks down
between them the company is effectively disabled. A company that begins as a quasi-
partnership might cease to be so as the relationship between its members changes
(becoming, perhaps, based less on personal trust and confidence, and more on formal
agreements between the parties): Re AMT Coffee Ltd [2019] EWHC 46 (Ch). A company
might be a quasi-partnership as between some of the members (who have a close
personal relationship) but not as between others (who may lack that close personal
relationship): Waldron v Waldron [2019] EWHC 115 (Ch).
It should be noted, however, that given the range of remedies available under the
unfair prejudice provision (see 12.2 below) that provision has now become the
dominant means available to minority shareholders seeking redress. However, it does
not provide for winding up and so s.122(1)(g) IA 1986 is still of relevance.
Winding up on the just and equitable ground was subjected to extensive analysis by
the House of Lords in Ebrahimi v Westbourne Galleries Ltd [1973] AC 360. The company
was incorporated to take over the Oriental rug business which N and the petitioner,
E, had been running as a partnership for some 10 years. Initially N and E were equal
shareholders and the only directors. When N’s son joined the company as director and
shareholder, E became a minority both within the board and at the general meeting,
where he could be outvoted by the combined shareholding of N and his son. Relations
between E on the one hand, and N and his son on the other, broke down and E was
voted off the board using the power conferred by s.303 CA 1985 (now s.168 CA 2006).
It was held that even though E had been removed from the board 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. Since E 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 company’s management was clearly
in breach of that understanding. It was therefore just and equitable to wind up the
company. Lord Wilberforce listed the typical elements in petitions brought under the
just and equitable ground.
u The basis of the business association was a personal relationship and mutual
confidence (generally found where a pre-existing partnership has converted into a
limited company).
u An understanding that all or certain shareholders (excluding ‘sleeping’ partners)

will participate in management.
u There was a restriction on the transfer of members’ interests preventing the

petitioner leaving.
Lord Wilberforce stressed that the court was entitled to superimpose equitable
constraints upon the exercise of rights set out in the articles of association or the
Companies 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 for recognition of the
fact that behind it, or amongst it, there are individuals, with rights, expectations and
obligations inter se which are not necessarily submerged in the company structure…
It should be noted that Lord Cross stressed that petitioners under s.122(1)(g) IA 1986
should come to court with ‘clean hands’. If a petitioner’s own misconduct led to the
breakdown in relations relief will be denied.
The following are illustrations of the grounds which will support a petition under
s.122(1)(g).
i. The company’s substratum has failed
The petitioner will need to establish that the commercial object for which the
company was formed has failed or has been fulfilled (see Re German Date Coffee Co
(1882) 20 Ch D 169; Virdi v Abbey Leisure Ltd [1990] BCLC 342; Re Perfectair Holdings Ltd
[1990] BCLC 423).
ii. Fraud
The remedy will enable shareholders to recover their investment where the company
was formed by its promoters in order to perpetrate a fraud against them (see Re
Thomas Edward Brinsmead & Sons [1887] 1 Ch 45).
iii. Deadlock
If the relationship between the parties has broken down with no hope of
reconciliation, the court may order a dissolution (see Re Yenidje Tobacco Co Ltd [1916]
2 Ch 426). However, in Re Paramount Powders (UK) Ltd [2019] EWCA Civ 1644, the court
held that a petitioner had no automatic right to have a company wound up merely
because there had been a breakdown in mutual trust and confidence between the
members. The court might refuse a winding up in such a case if, for example, the
petitioner were responsible for that breakdown.
iv. Justifiable loss of confidence in the company’s management
Winding up may be ordered where there is a lack of confidence in the competence or

probity of its management, provided the company is, in essence, a quasi-partnership
(see Loch v John Blackwood Ltd [1924] AC 783).
v. Exclusion from participation in a small private company where there was a

relationship based on mutual confidence
A classic example is the case of Ebrahimi v Westbourne Galleries (above).
12.1.2 Relationship with other remedies

Winding up is a measure of last resort. Thus where the petitioner is acting
unreasonably in seeking to have the company wound up instead of seeking an
alternative remedy, such as a purchase of their shares, or an order under s.994 CA 2006
(see below) the petition may be struck out (s.125(2) IA 1986). However, for a situation
where the court decided that the company should be wound up, because of the depth
of the shareholders’ disagreement and their inability to agree a method for valuing the
minority’s shares, see Harding v Edwards [2014] EWHC 247 (Ch).
Activity 12.1
Read Re a Company (No.004415 of 1996) [1997] 1 BCLC 479.
Why did the court strike out the winding up petition?
Activity 12.2
Read Virdi v Abbey Leisure Ltd [1990] BCC 60.
Why was winding up under s.122(1)(g) IA 1986 considered to be an appropriate
remedy?
12.2 Unfair prejudice – s.994 CA 2006

Section 994(1) CA 2006, replacing s.459 CA 1985, provides that:
A member of a company may apply to the court by petition for an order… on the ground
that the company’s 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
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.
Although, as will be seen, s.996 provides for a range of remedies, petitioners generally
seek an order requiring the respondents, who are usually the majority shareholders, to
purchase their shares.
The courts have adopted a flexible approach towards what constitutes ‘the company’s
affairs’. Thus, in Nicholas v Soundcraft Electronics Ltd [1993] BCLC 360, the Court of Appeal
held that the failure of a parent company (Soundcraft Electronics) to pay debts due
to its subsidiary (in which the petitioner was a minority shareholder) constituted acts
done in the conduct of the affairs of the company. In Re City Branch Group Ltd [2004]
EWCA Civ 815, the Court of Appeal held that an order under s.994 could be made
against a holding company where the affairs of a wholly-owned subsidiary have been
conducted in an unfairly prejudicial manner and the directors of the holding company
are also the directors of the subsidiary.
However, in Graham v Every [2014] EWCA Civ 191, the court held that an alleged breach
of a pre-emption provision in the company’s articles did not constitute the conduct of
the company’s affairs, as it concerned only the rights of the shareholders themselves.
See also, Re Phoneer Ltd [2002] 2 BCLC 241; Gross v Rackind [2004] 4 All ER 735, CA; Re
Legal Costs Negotiators Ltd [1999] 2 BCLC 171, CA.
12.2.1 The elements of the remedy

The petitioner must establish that his or her interests as a member have been unfairly
prejudiced.
‘Interests’
Although the petitioner must be a shareholder in order to bring the action, the
conduct which forms the basis of his complaint need not affect him in his capacity as
a member. For example, exclusion from the management of the company, which is
conduct affecting the petitioner qua director, will suffice (O’Neill v Phillips [1999] 1 WLR
1092). The use of the term ‘interests’ is expansive in effect, thereby effectively avoiding
the straitjacket which terminology based on the notion of ‘rights’ would impose on
the scope of the provision (Re Sam Weller & Sons Ltd [1989] 5 BCC 810; see also Re a
Company (No.00477 of 1986) [1986] BCLC 376).
In Ebrahimi v Westbourne Galleries, Lord Wilberforce recognised that in most

companies, irrespective of size, a member’s rights under the articles of association and
the Companies Act could be viewed as an exhaustive statement of his or her interests
as a shareholder. However, as we saw above, he went on to list three situations in
which equitable considerations could be ‘superimposed’.
1. Where there is a personal relationship between shareholders which involves

mutual confidence.
2. Where there is an agreement that some or all should participate in the

management.
3. Where there are restrictions on the transfer of shares which would prevent a
member from realising his or her investment.
This element of Lord Wilberforce’s speech received extensive consideration by the

House of Lords in O’Neill v Phillips [1999] 1 WLR 1092, in which it was concluded that for
the purposes of s.994 the court can apply equitable restraints to contractual rights.
Re Ghyll Beck Driving Range Ltd [1993] BCLC 1126 is an excellent example of a s.994 case.
A father and son, along with two other people, incorporated a company to operate a
golf range. They were each equal shareholders and directors. Within six months of the
company’s existence the relationship between the parties had become acrimonious
due mainly to disagreements over business strategy which left the petitioner feeling
‘isolated’. Following a fight between the father and the petitioner the business was
managed without consulting him. It was held that the petitioner had been unfairly
excluded from the management of the company when from the start it had been
anticipated that all four would participate in managing the business. The court
therefore ordered the majority to purchase the petitioner’s shares on the basis that
the affairs of the company had been conducted in a manner unfairly prejudicial to his
interests.
However, it should be noted that s.994 does not mean that the judges administer
arbitrary justice without reference to the commercial relationship that exists between
the parties. Indeed, Lord Wilberforce had recognised in Ebrahimi that the starting
point for the court was always to look to the agreement between the parties, for
example, as contained in the articles.
In Re a Company (No.004377 of 1986) [1987] BCLC 94, the majority, including the
petitioner, voted for a special resolution to amend the company’s 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 offered
£900 per share. When he declined this offer the company’s auditors valued his shares
in accordance 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. Hoffmann 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. The
judge stressed that s.994 could not be used by the petitioner to relieve him from the
bargain he made. Further, in Re Saul D Harrison & Sons plc [1995] 1 BCLC 14, Hoffmann
LJ laid down guidelines for determining unfairness. 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
relationships of the shareholders with the company and each other. The first question
to ask, therefore, is whether the conduct of which the shareholder complains was in
accordance with the articles of association.
See also Re Posgate & Denby (Agencies) Ltd [1987] BCLC 8; Re Blue Arrow plc [1987] BCLC
585; Strahan v Wilcock [2006] EWCA Civ 13.
Summary
The interests of members include rights derived from the company’s constitution
or statute or a shareholder’s agreement or some general equitable duty owed by
the directors to the company. A member will also have an interest in maintaining
the value of his or her shares, as was shown in Re Bovey Hotel Ventures Ltd July 31, 1981
(unreported) cited by Nourse J. in Re RA Noble & Sons (Clothing) Ltd [1983] BCLC 273.
Further, as seen in Re Ghyll Beck Driving Range Ltd, a member’s ‘interests’ may also
encompass the expectation that they will continue to participate in management (see
also Re a Company (No.003160 of 1986) [1986] BCLC 391; Re a Company (No.004475 of 1982)
[1983] Ch 178).
Unfair prejudice
The petitioner must establish that the conduct in question is ‘both prejudicial (in the
sense of causing prejudice or harm) to the relevant interests and also unfairly so’ (Re
a Company, ex p Schwarcz (No.2) [1989] BCLC 427, per Peter Gibson J). In Re Ringtower
Holdings plc (1988) 5 BCC 82, Peter Gibson J stated that ‘the test is unfair prejudice, not
of unlawfulness, and conduct may be lawful but unfairly prejudicial…’ The notion of
unfairness was considered by the Jenkins Committee (Cmnd. 1749, 1962) to be ‘a visible
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’ (para 204, adopting the view expressed by Lord Cooper in Elder v Elder & Watson
Ltd [1952] SC 49). Although there is no requirement that the petitioner should come to
court with ‘clean hands’, his or her conduct will be relevant in assessing whether the
conduct of the company, though prejudicial, is unfair.
In O’Neill v Phillips [1999] WLR 1092 (the only House of Lords decision on the unfair
prejudice remedy so far) Lord Hoffmann held that fairness was to be determined by
reference to ‘traditional’ or ‘general’ equitable principles. He stressed that company
law developed from the law of partnership – which was treated by equity as a contract
of good faith. The facts of O’Neill v Phillips were that the company, Pectel Ltd, provided
asbestos stripping services to the construction industry. In 1983 the issued share
capital of the company, 100 £1 shares, was owned entirely by Mr Phillips (P). Mr O’Neill
(O) was employed by the company in 1983 as a manual worker. P was favourably
impressed by O and he received rapid promotion.
In early 1985 O received 25 per cent of the company’s 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 company’s business and at that time would receive 50 per cent of the
profits. In December 1985 P retired from the board and O became sole director and
effectively the company’s managing director.
The business enjoyed good profitability for a while, but its fortunes declined during
the economic recession of the late 1980s. In August 1991, disillusioned with O’s
management of the business, P used his majority voting rights to appoint himself
managing director and took over the management of the company. O was informed
that he would no longer receive 50 per cent of the profits but his entitlement would
be limited to his salary and dividends on his 25 per cent shareholding. Early 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.
The House of Lords found that P’s conduct would have been unfair had he used his
majority voting power to exclude O from the business. He had not done this, but had
simply revised the terms of O’s remuneration. P’s refusal to allot additional shares as
part of the proposed incentive scheme was not unfair as the negotiations were not
completed and no contractual undertaking had been entered into by the parties.
Nor was P’s decision to revise O’s profit-sharing arrangement considered to be unfair
conduct. O’s entitlement to 50 per cent of the company’s profits was never formalised
and it was, in any case, conditional upon O running the business. That condition
was no longer fulfilled as P had to assume control over the running of the business.
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. To hold otherwise would
be to confer on a minority shareholder a unilateral right to withdraw his capital.
O’s petition therefore failed. He did not prove that P’s conduct was both unfair and
prejudicial.
Thus, a petitioner will need to demonstrate either that they relied on some pre-
association understanding, or a post-association agreement that was either legally
binding or that they specifically relied on. (For recent examples, see the approach of
Jonathan Parker J in Re Guidezone Ltd [2000] 2 BCLC 321 and the comments of Auld and
Jonathan Parker LJJ in Phoenix Office Supplies Ltd v Larvin [2002] EWCA Civ 1740 to the
effect that a petitioner cannot enlist s.994 to force a right of exit from the company
that does not exist under the company’s constitution.) On the other hand, the failure
on the part of the majority shareholders to hold meetings and to otherwise conduct
the affairs of the company as a going concern will be held to be unfairly prejudicial to
the interests of the minority (Fisher v Cadman [2005] EWHC 377 (Ch)).
A mere breakdown in relationship between the shareholders, which is not caused by

conduct in the company’s affairs that is unfairly prejudicial, is insufficient (although
such a breakdown might, if sufficiently serious, justify a winding up order under
s.122(1)(g) Insolvency Act 1986); see Hawkes v Cuddy (No.2) [2009] EWCA Civ 291.
Examples of unfair prejudice include the following.
u Exclusion from management, which is a typical s.994 complaint (see Re XYZ

Ltd (No.004377 of 1986) [1987] 1 WLR 102; Re Ghyll Beck Driving Range Ltd (above);
Brownlow v GH Marshall Ltd [2001] BCC 152; Phoenix Office Supplies Ltd v Larvin [2002]
EWCA Civ 1740).
u Mismanagement (breach of the directors’ duties of care and skill) (see Re Elgindata
Ltd [1991] BCLC 959; and Re Macro (Ipswich) Ltd [1994] 2 BCLC 354).
u Excessive remuneration taken by the directors and the failure to pay dividends
(see Re Sam Weller & Sons Ltd [1990] Ch 682; Re a Company (No.004415 of 1996) [1997]
1 BCLC 479; Re Cumana Ltd [1986] BCLC 430; Anderson v Hogg [2002] BCC 923; Grace v
Biagioli [2006] 2 BCLC 70; Re Tobian Properties Ltd [2012] EWCA Civ 998; Re CF Booth Ltd
[2017] EWHC 457 (Ch)).
u Breach of fiduciary duties – the case law shows that s.994 may be used to obtain
a personal remedy despite the rule in Foss v Harbottle (see Re London School of
Electronics Ltd [1986] Ch 211; Re Little Olympian Each-Ways Ltd (No.3) [1995] 1 BCLC 636).
u See also, Re Baumler (UK) Ltd [2005] 1 BCLC 92; Re Cumana Ltd [1986] BCLC 430, CA. It
should be noted that in Re Baumler (UK) Ltd, George Bompas QC (sitting as a Deputy
Judge of the High Court) observed that in the case of a quasi-partnership company,
a breach of duty by one participant may lead to such a loss of confidence 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). The judge
noted that, in effect, the unfairness lies in compelling the innocent participant to
remain a member of the company.
Summary
In Re Saul D Harrison and O’Neill v Phillips Lord Hoffmann took the opportunity to inject
content into the concept of fairness. He reaffirmed the sanctity of the s.33 contract
(see Chapter 9 of this guide). The House of Lords stressed that the remedy did not
confer on the petitioner a unilateral right to withdraw his capital. In order to succeed
under s.994 a petitioner will need to prove either a breach of contract (including the
s.33 contract) or breach of a fundamental understanding which, although lacking
contractual force, makes it inequitable for the majority to go back on the ‘promise’.
See also, Re Guidezone Ltd and the comments of Auld and Jonathan Parker LJJ in Phoenix
Office Supplies Ltd v Larvin.
This emphasis on respecting the parties’ own agreements seems also to be evident
in the case of Fulham Football Club (1987) Ltd v Richards [2011] EWCA Civ 855, where the
court upheld a provision in the company’s articles which obliged a member to refer
disputes to arbitration rather than seeking relief under s.994.
Activity 12.3
Read Re Macro (Ipswich) Ltd [1994] 2 BCLC 354.
a. What was the principal allegation of the petitioners?
b. How did Arden J approach the issue of assessing whether the conduct was
unfairly prejudicial?
c. What remedy was sought?
12.2.2 Remedies
Section 996(1) CA 2006 provides that the court:
may make such order as it thinks fit for giving relief in respect of the matters
complained of.
Section 996(2) goes on to add that:
Without prejudice to the generality of subsection (1), the court’s order may:
regulate the conduct of the company’s affairs in the future;
require the company–
to refrain from doing or continuing an act complained of, or
to do an act which the petitioner has complained it has omitted to do,
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;
require the company not to make any, or specified, alterations in its articles without the
leave of the court;
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 company’s capital accordingly.
Note the width of the court’s powers under s.996(1) (compare the winding up remedy,
above). In Re Phoneer Ltd, the petitioner sought a winding up order on the just and
equitable ground and the respondent cross-petitioned for winding up under s.994.
Roger Kaye QC, granting a winding up order since both parties obviously desired it,
noted that ‘section 996 enables, but does not compel, the court to make an order
under that section’. Although the respondent held 70 per cent of the shares, the judge
felt that on the facts of the case ‘justice is served by ordering the winding up of the
company… on the basis of a 50/50 split’. The court can fashion a remedy to the wrong
done: see Re A Company ex parte Estate Acquisition & Development Ltd [1991] BCLC 154.
Section 996(2) specifies certain remedies available (see above). The most common
remedy sought is that under s.996(2)(e) (purchase of shares). Indeed, in Grace v
Biagioli [2005] EWCA Civ 1222 , the Court of Appeal affirmed the view that there is a
presumption in favour of a buyout order for successful unfair prejudice petitions.
Valuation of shares
Valuing shares in quoted companies is a fairly straightforward exercise because
reference can be made to their market price. For unquoted companies – and the
vast majority of s.994 petitions fall within this category – the valuation exercise is a
far more difficult undertaking. The court has a wide discretion to do what is fair and
equitable in all the circumstances of the case and under the Civil Procedure Rules
the court is expected to adopt a vigorous approach towards share valuation (North
Holdings Ltd v Southern Tropics Ltd [1999] BCC 746).
In Re Bird Precision Bellows Ltd [1984] Ch 419, affirmed by the Court of Appeal [1985] 3 All
ER 523, the court reviewed the approach to be adopted towards valuing shares. It was
stressed that the overriding objective was to achieve a fair price and that normally
no discount would be applied. Thus, a 49 per cent shareholding in the company will
be valued pro rata, being worth 49 per cent of whatever the company as a whole is
worth. This (generous) approach was justified on the grounds that the petitioner is an
unwilling vendor of what is, in effect, a partnership share. One issue that has generated
a considerable amount of case law is whether this presumption in favour of a pro rata
valuation should apply to all companies or only to those companies that are quasi-
partnerships. In Irvine v Irvine [2006] EWHC 1875 (Ch), the High Court had suggested that
this pro rata principle would apply only in a quasi-partnership. In Re Blue Index Ltd [2014]
EWHC 2680 (Ch), on the other hand, the court felt that restricting the pro rata approach
to quasi-partnerships was inappropriate and declared that the pro rata principle would
apply in all companies. However, in Estera Trust (Jersey) Ltd v Singh [2018] EWHC 1715
(Ch), the court suggested, again, that the pro rata presumption applied only to quasi-
partnerships. The law on this point, then, remains rather uncertain. Even where the pro
rata presumption does apply, it is rebuttable if there are good reasons for applying a
discount. If, for example, the minority shareholder acquired her shares by way of an
investment then a discount may, in the circumstances, be fair so as to reflect the fact that
the petitioner has little control over the company’s management (see the speech of Lord
Hoffmann in O’Neill v Phillips; see also, Profinance Trust SA v Gladstone [2002] 1 BCLC 141, CA).
See also Richardson v Blackmore [2006] BCC 276; Re OC (Transport) Services Ltd [1984]
BCLC 251; Ng v Crabtree [2011] EWHC 1834 (Ch); Re Home & Office Fire Extinguishers Ltd
[2012] EWHC 917 (Ch) and Harborne Road Nominees Ltd v Karvaski [2011] EWHC 2214 (Ch).
Further reading
¢ Boyle, A.J. ‘O’Neill v Phillips: unfair prejudice in the House of Lords’ (2000) 21
Company Lawyer 253-54.
¢ Davies and Worthington, Chapter 20: ‘Unfair prejudice’.
¢ Lowry, J. ‘Mapping the boundaries of unfair prejudice’ in de Lacey, J. (ed.) The

reform of United Kingdom company law. (London: Cavendish, 2002).
¢ Lowry, J. ‘Reconstructing shareholder actions: a response to the Law †

You should read this
Commission’s Consultation Paper’ (1997) 18 Company Lawyer 247.†
volume of the Company
¢ Lowry, J. ‘Stretching the ambit of s.459 of the Companies Act 1985: the elasticity Lawyer because it is
of unfair prejudice’ (1995) LMCLQ 337. devoted to reviewing the
Law Commission’s reform
¢ McVea, H. ‘Section 994 of the Companies Act 2006 and the primacy of contract’
proposals.
(2012) 75 MLR 1123.
¢ Prentice, D.D. ‘The theory of the firm: minority shareholder oppression: sections
459–461 of the Companies Act 1985’ (1988) OJLS 55.
¢ Reisberg, A. ‘Indemnity costs orders under s.459 petitions’ (2004) Comp Law 116.
¢ Reisberg, A. ‘Shareholders’ remedies: in search of consistency of principle in

English law’ (2005) European Business Law Review 1063.
¢ Riley, C. ‘Contracting out of company law: s.459 of the Companies Act 1985 and
the role of the courts’ (1992) MLR 782.

Wheels Ltd was formed five years ago to provide lorry transport facilities to the
computer industry. It has an issued share capital of £500 divided into 300 ‘A’ shares
of £1 each and 400 ‘B’ shares of 50 pence each. Alf, Bob and Colin are the directors
of the company. Alf and Bob each hold half the ‘A’ shares and Colin holds all the ‘B’
shares. The articles of association of the company provide that:
a. the ‘A’ shares carry two votes each and the ‘B’ shares carry one vote each
b. Colin is to be a director of the company at a salary of £20,000 per year.
Until 2016 the three directors worked well together and the company prospered.
However, at a board meeting in August of that year, Alf and Bob disagreed with
Colin over a fundamental matter of business policy and the meeting ended abruptly
when Colin hit Alf. Colin was later fined £50 for assault by local magistrates. Since
then Alf and Bob have continued to run the company but the business policy
pursued after the meeting in August 2016 has clearly proved unsuccessful and,
although the company is still solvent, it has made no profits since then. Colin
continued to receive his salary after the August meeting but has attended no board
meetings since then, even though Alf and Bob have periodically invited him to do so.
Three months ago Alf and Bob stopped payment of Colin’s salary. Colin is now saying
that he will attend the next board meeting as he intends to ‘make one last effort to
lick the company into shape’. Alf and Bob do not want him back and want to run the
company without him.
Advise Alf and Bob and Colin.

This question requires you to discuss the particular issues relating to unfairly
prejudicial conduct that arise in relation to small ‘quasi-partnership’ type of
companies. Of particular significance here are:
u the exclusion from management
u the remedies available under s.996 CA 2006
u the enforceability of rights provided by the articles of association.
You must examine the elements of the unfair prejudice remedy. In considering the
approach of the court towards s.994 petitions you will need to discuss, in particular,
Lord Wilberforce’s speech in Ebrahimi v Westbourne Galleries Ltd, Lord Hoffmann’s
speech in O’Neill v Phillips and the decision in Re Saul D Harrison. More particularly
the focus of the claim will centre on exclusion from management, which is a typical
s.994 complaint (Re Ghyll Beck Driving Range Ltd), and mismanagement (breach of the
directors’ duties of care and skill) (Re Elgindata Ltd and Re Macro (Ipswich) Ltd).
Finally, your answer should address the range of remedies available under s.996 with
emphasis given to buyout orders, together with how the court may value Colin’s
shares (Re Bird Precision Bellows Ltd and O’Neill v Phillips).
Reflect and review



first again
I can describe the range of statutory remedies
available to minority shareholders.   
I can explain the ‘just and equitable’ winding up

remedy.   
I can state the main grounds for a just and equitable

winding up.   
I can describe the scope of the unfair prejudice

remedy.   
I can describe the remedies available under the unfair

prejudice provision.   
revise?
Must Revision
revise done
12.1 Winding up on the ‘just and equitable’ ground  
12.2 Unfair prejudice – s.994 CA 2006  

Notes
13 Dealing with outsiders: ultra vires and other
attribution issues
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140
13.1 The objects clause problem . . . . . . . . . . . . . . . . . . . . . . . 141
13.2 Reforming ultra vires . . . . . . . . . . . . . . . . . . . . . . . . . . 142
13.3 Other attribution issues . . . . . . . . . . . . . . . . . . . . . . . . . 145

Introduction
As we discussed briefly in Chapter 9, companies were at one time conferred with the
power in their constitutional documents to carry out certain specific functions (the
objects) by a specific statute or grant from the Crown.
The objects clause was a necessary part of the constitutional documents of early
charter and statute companies as they were formed to carry out certain functions by a
specific charter or statute. However, as the registered company opened up corporate
status to ordinary businesses, a particular problem arose. These registered companies
were also required to have specific purposes (objects) in their memorandum but
were much more likely to change the nature of their business over time. This was
both a problem for companies who legitimately wished to change the nature of their
business and for outsiders who were dealing with the company and were in danger of
having unenforceable contracts because the company was acting outside its powers.
Over time the courts became somewhat flexible about the issue but eventually
statutory intervention was needed to solve the remaining problems. The chapter also
considers how responsibility is attributed to the company for tortious and criminal
actions.
Learning outcomes
u explain why the objects clause issue has caused such difficulty
u describe the effect of the legislative reform process on the ultra vires issue
u discuss the recommendations of the CLRSG and the reforms in the Companies Act
2006 as they impact on ultra vires issues
u explain why attribution in other areas was and is similarly problematic.
Core text
¢ Dignam and Lowry, Chapter 12: ‘The constitution of the company: dealing with
outsiders’.
Cases
¢ Ashbury Carriage Company v Riche [1875] LR 7 HL 653
¢ Re Jon Beauforte (London) Ltd [1953] Ch 131
¢ Re Introductions Ltd v National Provincial Bank [1970] Ch 199
¢ Royal British Bank v Turquand [1856] 6 E & B 327
¢ Campbell v Paddington [1911] 1 KB 869
¢ Lennard’s Carrying Co Ltd v Asiatic Petroleum Co Ltd [1915] AC 705
¢ Freeman & Lockyer v Buckhurst Park Properties Ltd [1964] 2 QB 480
¢ Tesco Supermarkets Ltd v Nattrass [1971] 2 All ER 127
¢ Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 2 AC

500.
Additional cases
¢ Re German Date Coffee Co [1882] 20 Ch D 169
¢ McNicholas Construction Co Ltd v Customs and Excise Commissioners (2000) STC 553
¢ P & O European Ferries Ltd [1990] 93 CrApp R 72 (CA)
¢ MCI WorldCom International Inc v Primus Telecommunications Inc [2004] 1 BCLC 42
¢ EIC Services Ltd v Phipps [2004] 2 BCLC 589
¢ Morris v Bank of India [2005] 2 BCLC 328.

Company Law 13 Dealing with outsiders: ultra vires and other attribution issues page 141
13.1 The objects clause problem

Two key issues combined in this area to cause problems. First, in the 19th century it
was impossible to change a company’s objects clause. This was modified somewhat
in the 20th century, but until 1989 the objects clause could only be changed in very
limited circumstances. Second, the doctrine of constructive notice could combine
with the ultra vires rule to leave outsiders with unenforceable contracts. The doctrine
of constructive notice applies to public documents. A company’s memorandum
and articles of association are public documents which are provided as part of the
registration process and constructive notice deems anyone dealing with registered
companies to have notice of the contents of its public documents. As a result an
outsider dealing with a company is deemed to have knowledge of its objects clause
and has therefore entered into the unenforceable contract with that knowledge.
In the late 19th century the courts adopted a fairly strict interpretation of the ultra
vires rule. In Ashbury Carriage Company v Riche (1875) LR 7 HL 653 the House of Lords
considered that the ultra vires doctrine did apply to registered companies. 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 company’s capacity even if ratified by all the members. Over the course
of the 20th century the courts retreated from this strict position, allowing companies
to carry out transactions reasonably incidental to the objects of the company and
eventually accepting very wide objects clauses as being valid – either a list of all
possible commercial activities or a statement that the company could carry out any
commercial venture it wished. However, problems still remained.
Some examples
In Re Jon Beauforte (London) Ltd [1953] Ch 131 the company’s objects stated that 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 reflect this
change. A coal merchant had supplied coal to the company which was ordered on
company notepaper headed with a reference to the company being a veneered panel
maker. The 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.
In Re Introductions Ltd v National Provincial Bank (1970) Ch 199 the case concerned a
company incorporated in 1951, around the time of the Festival of Britain, with the
specific object of providing foreign visitors with accommodation and entertainment.
After the Festival was over the company diversified and eventually devoted itself
solely to pig breeding, which the original framers of the objects had not considered
(naturally enough). The company had granted National Provincial Bank a debenture
(see Chapter 7) to secure a substantial overdraft which had accumulated prior to its
eventual insolvent liquidation. The 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).
As a result of cases like this it was generally agreed that only legislative intervention
could solve the problem in the long term.
Activity 13.1
a. Read Re German Date Coffee Co [1882] 20 Ch D 169. Do you consider this a harsh
application of the ultra vires doctrine?
b. Read Re Jon Beauforte (London) Ltd (1953) Ch 131 and Re Introductions Ltd v
National Provincial Bank (1970) Ch 199. Write a 300 word summary of each.
Summary
The issue of ultra vires stems primarily from a historical hangover from charter or
statute companies. At first the courts applied the doctrine strictly to registered
companies, despite the harshness of its effect. Over time, however, the courts began
to loosen their interpretation of the objects clause where they could. They also began
to accept very widely drafted objects clauses. However, as we have seen, problems
occasionally still arose which had a drastic effect on the outsider’s ability to enforce a
contract. Statutory reform was needed.
13.2 Reforming ultra vires
13.2.1 Changes following EC membership

In 1972 the UK joined the European Community and as part of its obligations on entry
it introduced legislation reforming ultra vires in s.9(1) of the European Communities
Act 1972. This removed the doctrine of constructive notice where it concerned the
memorandum and articles 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 acting in good faith. While this reform narrowed the extent of the
ultra vires rule it still left the potential for problems to arise. In 1989 further reforms
were introduced which allowed the memorandum to be easily changed and for the
company to have a general wide objects clause (ss.4 and 3A CA 1985). Three new
sections (ss.35, 35A and 35B) were also introduced. Section 35 thus became the main
saving provision for outsiders in classic ultra vires situations. It 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 company’s memorandum.
Under the CA 1985 the memorandum formed part of the company’s constitution. Now,
however, s.8 of the CA 2006 has reduced the memorandum of association to a more
limited function. The 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. The
subscribers to the memorandum are those who agree to take some shares or share
in the company, thus becoming its first members. If the application to the Registrar
is successful the subscribers become the first members of the company and the
proposed directors become its first directors.
To eliminate any remaining problems with the objects clause the CLRSG, in the Final
Report (July 2001 para 9.10) and the Consultative Document (March 2005, Chapter 5),
proposed that companies be formed with unlimited capacity. The CA 2006 partly
implements the recommended approach. Companies registered under the 2006 Act
have unrestricted objects unless a company chooses to have an objects clause stating
what it is empowered to do (s.31 CA 2006). If a company does choose to have an objects
clause, and for companies formed under the previous Principal Acts in 1948 and 1985 with
an objects clause (unless these companies now remove their objects clause (s.31(2) CA
2006)), the objects clause forms part of the articles of association (s.28 CA 2006).
As most companies currently in existence were formed under principal Companies

Acts that required an objects clause, this change will only really affect 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 (s.28 CA 2006). In recognition of the fact that a large
number of companies will still have an objects clause, s.35 CA 1985 has been replaced
by an almost exact replica in s.39 CA 2006 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 company’s constitution.
As a result of the reform process, what were traditional ultra vires actions became a
question of whether the required internal authority to transact was given to those
who transacted with the outsider.
13.2.2 Internal authority

When examining issues of internal corporate authority, agency principles and specific
statutory provisions will usually determine the outcome. Normal principles of agency
provide that 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.
The principal may also ratify a contract entered into without authority. Companies,
because of their complexity, pose certain problems for agency principles. While
specific 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 organisation can be difficult to locate conclusively. This is because authority
to carry out some functions may not be specifically conferred but rather is implicit
in the nature of the job. A ‘stationery manager’ may not have any actual authority to
purchase stationery, yet it is implicit in his appointment that he is empowered to do
so. Further authorisation can be given through apparent or ostensible authority. This
arises when no actual authority is conferred, yet the company allows someone to hold
themselves out as having that authority – for example, allowing someone to act as
managing director even though they have never been appointed (see, for example,
Freeman & Lockyer v Buckhurst Park Properties Ltd [1964] 2 QB 480; MCI WorldCom
International Inc v Primus Telecommunications Inc [2004] 1 BCLC 42).
Here again the company’s constitution can cause problems for outsiders dealing
with the company. Sometimes the constitution will specify a procedure that has to
be carried out before authority is conferred. For example, it is common for directors
to have to seek approval of the general meeting for large loans. Again the doctrine
of constructive notice could potentially be problematic here. In Royal British Bank v
Turquand (1856) 6 E & B 327 an action was brought for the return of money borrowed
by the company. The company argued that it was not required to pay back the money
because the manager who negotiated the loan should have been authorised by a
resolution of the general meeting to borrow but he had no such authorisation. As
a result of constructive notice the bank was deemed to know this. In attempting to
mitigate this effect the court held that the public documents only revealed that a
resolution was required, not whether the resolution had been passed. The 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.
This is known as the indoor management rule.
The Companies Act 1989 introduced ss.35A and 35B into the CA 1985. Both these
sections concern the issue of internal authority.
Section 35A states:
(1) In 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 company’s 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 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 company’s
constitution; and
(c) a person shall be presumed to have acted in good faith unless the contrary is
proved.
The section had the effect of protecting outsiders who deal either directly with the
board or those authorised to bind the company. It is worth noting that the section set
the standard of bad faith fairly high as sub-s.2(b) specifically allowed third parties to
have knowledge that the transaction was irregular. As a result it implied that active
dishonesty might be required in order to qualify as bad faith (see EIC Services Ltd v
Phipps [2004] 2 BCLC 589). To further emphasise the lower good faith requirement sub-
s.2(c) set a presumption of good faith.
The section also contained a similar provision to s.35 allowing shareholders to

prevent an imminent irregular transaction and protected insiders who deal with the
company, which the indoor management rule did not. However, s.322A CA 1985 was
also introduced as an amendment to the CA 1985 by the CA 1989 and s.35A was subject
to it. That section provided that a transaction between the company and a director or
a person connected to him (family, etc.) which exceeded the powers of the board was
voidable at the instance of the company.
Section 35B CA 1985 also attempted to deal with the issue of constructive notice. It
states:
[a] party to a transaction with the company is not bound to enquire as to whether it is
permitted by the company’s memorandum or as to any limitation on the powers of the
board of directors to bind the company or authorise others to do so.
This was intended to act in tandem with s.711A CA 1985 to abolish the concept of
constructive notice for corporations. However, s.711A has never been implemented
and so only s.35B deals with constructive notice (s.40 CA 2006 (see below)).
13.2.3 Further internal authority reform in the CA 2006

With regard to internal authority the CA 2006 makes little change to previous law
simply replicating the provisions of ss.35A and 35B CA 1985 in one new section (s.40 CA
2006).
40 Power of directors to bind the company
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 company’s constitution.
For this purpose—
a person “deals with” a company if he is a party to any transaction or other act to which
the company is a party,
a person dealing with a company—
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,
is presumed to have acted in good faith unless the contrary is proved, and
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 company’s constitution.
The references above to limitations on the directors’ powers under the company’s
constitution include limitations deriving—
from a resolution of the company or of any class of shareholders, or
from any agreement between the members of the company or of any class of
shareholders.
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 fulfilment of a legal obligation arising
from a previous act of the company.
(4) This section does not affect any liability incurred by the directors, or any other person,
by reason of the directors’ exceeding their powers.
(5) This section has effect subject to— section 41 (transactions with directors or their
associates), and section 42 (companies that are charities).
Additionally s.322A CA 1985 (connected persons) is also replicated in a new section

(s.41 CA 2006).
Activity 13.2
Have the reforms described above solved the ultra vires problem for companies?
Activity 13.3
a. How did the 1989 reforms attempt to deal with the remaining ultra vires
problems?
b. Describe the different types of authority that can be conferred by a company.
c. Explain how the indoor management rule works.
d. Describe the latest reforms in this area.
Summary
The issue of ultra vires in the context of companies, while once a significant danger, has
largely been dealt with by statutory reform. Further reform as a result of the work of
the CLRSG has followed in due course in the CA 2006. The area remains an important
one in the context of company law as it offers a very good illustration of how authority
is conferred on the company and legitimately exercised by its agents who deal with
the outside world.
13.3 Other attribution issues
13.3.1 Vicarious liability in tort

Agency and statutory provisions, however, have not solved all the problems inherent
in attributing responsibility to a company for its actions. Corporate liability for tort was
one such problem that the courts originally had great difficulty with in the corporate
context. At first the courts 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] 1 KB 869 it was accepted that companies could commit
torts and the courts have subsequently applied the principle of vicarious liability to
the company as employer. As a result a company can be vicariously liable in tort for the
acts of its employees, even though they may not be specifically authorised to carry out
the act that leads to the tort but are nevertheless acting within the scope of their
employment. It is important to note here that attribution through vicarious liability in
the context of a tort involves no fault on the part of the company: it is simply legally
responsible for the acts of another. Where a fault qualification or intention is required
by law, attribution of liability becomes more complex. As a result, vicarious liability will
not attribute criminal liability for the act of an employee. Where fault or intention is
needed the courts began to develop a complex attribution concept known as the alter
†
ego† or ‘organic’ theory of the company. ‘Alter ego’ (Latin) – another
(alternative) self.
13.3.2 The ‘organic’ theory

One of the first examples of this concept occurred in Lennard’s Carrying Co Ltd v Asiatic
Petroleum Co Ltd [1915] AC 705. In that case the fault requirement 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 ‘Respondeat superior’ (Latin)
liable because his action is the very action of the company itself. – ‘the superior is responsible’.
This is the doctrine that an
employer is responsible for
As a result, if one individual can be identified who can be said to be essentially the
things done by his or her
company’s alter ego and that individual has the required fault, then the fault of that
employees as part of their
individual will be attributed to the company. The attribution of responsibility here is
employment.
very different than through vicarious liability in tort, where the company is responsible
for the actions of another. The individual’s fault here is attributed to the company
because the law treats the individual and the company as the same person. There is,
however, a central problem with the alter ego theory in that it required the
identification of a single individual in what was often a complex corporate
organisational structure. This was often not possible unless a very small company was
at issue. The theory has been particularly problematic in attributing criminal
responsibility to companies, especially when attempting to determine the company’s
mens rea or guilty mind.
In Tesco Supermarkets Ltd v Nattrass [1971] 2 All ER 127 Tesco was charged with an offence
under the Trade Descriptions Act 1968. They 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. The 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 negligent 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. Subsequently the application of the organic
theory has effectively acted as an immunity from criminal prosecution for large
complex corporate organisations where it is impossible to identify a single individual
responsible for the company’s action.
13.3.3 The issue of control

Relatively recently the courts have moved away from viewing fault or intention
attribution for companies in this narrow way. In the Privy Council decision in
Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 2 AC 500
Lord Hoffmann considered that the organic theory provided a misleading analysis.
The real issue was: who were the controllers of the company for the purposes of
attribution? This 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 Hoffmann’s approach
has subsequently been applied with some success in McNicholas Construction Co
Ltd v Customs and Excise Commissioners [2000] STC 553. There the knowledge of the
company’s site managers of a VAT fraud was enough to attribute liability to the
company for the fraud. (See also Crown Dilmun v Sutton [2004] 1 BCLC 468, ChD and
Morris v Bank of India [2005] 2 BCLC 328.)
13.3.4 Corporate responsibility for injury and death

The application of the organic theory where crimes of violence are at issue still
remains a particularly difficult problem. Such crimes happen mainly in the workplace
but occasionally enter the public domain through major transport disasters like the
Zeebrugge ferry tragedy (the sinking of the ‘Herald of Free Enterprise’). Larger more
complex corporate organisations can never be attributed with the required mens rea
as identification of an alter ego is impossible in such complex delegated structures
(see P & O European Ferries Ltd (1990) 93 Cr App R 72 (CA)). In response to a number of
high-profile disasters and the growing problem of workplace deaths, the Government
proposed the creation of a specific offence of corporate manslaughter (Reforming
the law on involuntary manslaughter: the Government’s proposals (May 2000). The new
offence of corporate manslaughter was introduced in the Corporate Manslaughter and
Corporate Homicide Act 2007, which came into force on 6 April 2008. The offence of
corporate manslaughter is based around ‘management failure’ of the company or its
parent, leading to the cause of death. Thus, if the way the company is managed fails
to protect the health and safety of those employed by the company or affected by its
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 offence.
Activity 13.4
Read Lord Hoffmann’s judgment in Meridian Global Funds Management Asia Ltd v
Securities Commission [1995] 2 AC 500 and prepare a 300-word summary on his view
of the corporate attribution issue.
Summary
Attributing law designed to apply to humans to the corporate form has continued to
be a difficult task. Vicarious liability in tort has proved an elegant solution, but where
fault or intention is necessary the courts have yet to find a similarly elegant solution.
The Meridian case has certainly moved things forward from the difficulties created by
the alter ego or organic theory. However, the court’s failure to find a way of attributing
crimes of violence to the corporate form has instigated a statutory reform process
which is still under way.
Further reading
¢ Davies and Worthington, Chapter 7: ‘Corporate actions’.
¢ Ferran, E. ‘The reform of the law on corporate capacity and directors’ and
officers’ authority’, Parts 1 and 2 (1992) Company Lawyer 124 and 177.
¢ Hannigan, B. ‘Contracting with individual directors’ in Rider, B.A.K. (ed.) The

corporate dimension. (Bristol: Jordan Publishing, 1998) [ISBN 9780853084761].
¢ Munoz Slaughter, C. ‘Corporate social responsibility: a new perspective’ (1997)

Company Lawyer 313.
¢ Poole, J. ‘Abolition of the ultra vires doctrine and agency problems’ (1991) Company
Lawyer 43.
¢ Sullivan, B. ‘Corporate killing – some government proposals’ (2001) Crim L Rev 31.

Question 1 The objects clause of Robin Ltd states that the company is to carry on a
business as a supplier of diving equipment. Additionally the company’s borrowing
is limited to a maximum of £100,000 by a clause in the memorandum. Ranjid
has recently been appointed the managing director of Robin Ltd. His contract of
employment states that ‘the managing director of Robin Ltd is empowered to the
full and usual extent of a managing director’. Ranjid immediately plans to expand
the business to include the provision of diving lessons. This involves the hiring of
three diving instructors and the purchase of a premises worth £200,000, which will
be funded through a bank loan. Ranjid also plans to donate £50,000 to the Save the
Coral Reef Foundation, a registered charity.
Sean is one of the major shareholders in Robin Ltd and although he approved the
appointment of Ranjid he is very concerned by the plans of the new managing
director.
Sean comes to you for advice. Advise him concerning the issues raised in this
question.
Question 2 The objects clause of Ram Ltd provides that:
a. The business of the company shall be the construction of churches and all other
forms of religious accommodation.
b. The company may make whatever borrowings and charge whatever of its assets
as the directors may consider desirable.
Although never formally appointed managing director, Brian, to the knowledge

and with the full agreement of his co-directors, Bernice and Camilla, carries out the
day-to-day management of Ram Ltd. Brian, acting on behalf of Ram Ltd, agreed that
the company would manufacture and supply 5,000 deck chairs for the Brighton
Local Authority beachfront. To finance this operation he borrowed £50,000 from
Y Bank plc to enable Ram to purchase the machinery to carry out this agreement.
The loan was evidenced by a debenture which was signed on Ram’s behalf by Brian
and Bernice. Owing to serious mismanagement the company incurred considerable
losses and with only 1,000 deck chairs completed was found to be hopelessly
insolvent and put into compulsory liquidation.
Advise the liquidator.
Advice on answering the questions

Question 1 Address the issue of whether the giving of diving lessons is ultra vires. If it
is, would the statutory provisions save any transaction that was outside the objects?
Does Ranjid have the authority to authorise the bank loan? If he does not but goes
ahead anyway, will the company be bound? If he hires the instructors are their
employment contracts enforceable?
Is the donation to charity outside the company’s powers or is it just a matter of

whether Ranjid is authorised to do this?
Are there any breach of duty issues?
Question 2 Start with the objects issue – is the borrowing ultra vires?
Apply the facts to the statutory provisions – is the transaction saved in the bank’s
favour?
Are Brian and the other directors in breach of duty by authorising an ultra vires act?
Examine the internal authority issues – Brian’s appointment. Apply Freeman & Lockyer v
Buckhurst Park Properties Ltd [1964] 2 QB 480.
Is the signing of the debenture by Brian and Bernice enough to comply with Part (b) of
the objects clause?
Reflect and review

Ready to move on = I am satisfied that I have sufficient understanding of the principles

outlined in this chapter to enable me to go on to the next chapter.

first again
I can explain why the objects clause issue has caused
such difficulty.   
I can describe the effect of the legislative reform

process on the ultra vires issue.   
I can discuss the recommendations of the CLRSG and

the reforms in the Companies Act 2006 as they impact   
on ultra vires issues.
I can explain why attribution in other areas was and is

similarly problematic.   
revise?
Must Revision
revise done
13.1 The objects clause problem  
13.2 Reforming ultra vires  
13.3 Other attribution issues  

14 The management of the company
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 152
14.1 Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153
14.2 Categories of director . . . . . . . . . . . . . . . . . . . . . . . . . . 156
14.3 Disqualification of directors . . . . . . . . . . . . . . . . . . . . . . 158

Introduction
The first part of this chapter considers the relationship between the board of
directors and the general meeting. It then goes on to outline the various categories
of director, their appointment and removal. It also discusses the Company Directors
Disqualification Act 1986 (CDDA 1986) relating to the disqualification of ‘unfit’
directors.
Learning outcomes
u define the term ‘director’
u explain the role of the board of directors and its relationship with the general
meeting
u describe the various categories of director
u explain the process for awarding remuneration
u describe how the general meeting can remove a director from the board
u explain how directors can be disqualified from holding office.
Core text
¢ Dignam and Lowry, Chapter 13: ‘Corporate management’.
Cases
¢ Automatic Self-Cleansing Filter Syndicate Co Ltd v Cunninghame [1906] 2 Ch 34
¢ Secretary of State for Trade and Industry v Tjolle [1998] BCC 282
¢ Secretary of State for Trade and Industry v Hollier [2006] EWHC 1804 (Ch)
¢ Re Kaytech International plc [1999] BCC 390
¢ Re Hydrodam (Corby) Ltd [1994] BCC 161
¢ Bushell v Faith [1970] AC 1099
¢ Re Cannonquest, Official Receiver v Hannan [1997] BCC 644
¢ Re Sevenoaks Stationers (Retail) Ltd [1991] Ch 164
¢ Re Polly Peck International plc (No.2) [1994] 1 BCLC 574
¢ Re Grayan Building Services Ltd [1995] Ch 241
¢ Re Lo-Line Electric Motors Ltd [1988] Ch 477.
Additional cases
¢ John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113
¢ Barron v Potter [1914] 1 Ch 895
¢ Unisoft Group Ltd (No.2) [1993] BCLC 532
¢ Re Gemma Ltd (in liquidation) [2008] BCC 812
¢ Re AG (Manchester) Ltd (in liquidation) [2008] EWHC 64 (Ch)
¢ Official Receiver v Watson [2008] 1 BCLC 321
¢ HM Revenue & Customs v Holland [2010] UKSC 51
¢ Popely v Popely [2019] EWHC 1507 (Ch)
¢ Re Noble Vintners Ltd [2019) EWHC 2806 (Ch)
¢ Standish v Royal Bank of Scotland plc [2019] EWHC 3116

Company Law 14 The management of the company page 153
14.1 Directors
14.1.1 Defining the term ‘director’

As we saw in Chapter 3, companies are artificial legal entities and as such they must
operate through their human organs. The management of the company is vested in
the board of directors, who are expected to act on a collective basis, although the
articles may – and in large companies generally do – provide for delegation of powers
to smaller committees of the board or to individual directors. It should be borne in
mind that in small private companies the same individuals may wear a number of hats:
as directors, workers and shareholders. In large companies, however, there is generally
a clear division between the board and the shareholders (although it should be borne
in mind that even here directors will often receive shares as part of their remuneration
package).
The Companies Act 2006 (CA 2006) does not define the term ‘director’ beyond
stating in s.250 that the term ‘includes any person occupying the position of director,
by whatever name called’. Thus, whatever title the articles adopt to describe the
members of the company’s board (for example, ‘governors’), the law will nevertheless
view them as directors. Section 154 lays down the minimum number of directors that
companies must have: two for public companies and one for private companies. The
Small Business, Enterprise and Employment Act 2015 inserted a new s.156A into the CA
2006. This requires all those appointed as directors to be natural persons. Therefore, it
is no longer possible, for example, for a company to be appointed as a director – what
was known as a ‘corporate director’. Any existing corporate directors will cease to be
directors 12 months after s.156A is brought into force.
14.1.2 The position of the board of directors

The CA 2006 does not attribute specific roles to company directors. The Act is also
silent with respect to the structure and form of corporate management, leaving such
matters to the company’s constitution.
Although it is now accepted that in the modern company the board enjoys a position
of management autonomy this has not always been the case. Until the end of the 19th
century the general meeting of the company had constitutional supremacy: the board
of directors was viewed as its agent and had to act in accordance with decisions of the
general meeting. However, by the early 20th century, with shareholding becoming
more dispersed and directors beginning to be appointed on the basis of professional
merit rather than social standing, articles of association were drafted so as to give
boardrooms greater independence. Consequently, the judicial response was that the
board should no longer be viewed as the agent or servant of the general meeting.
In Automatic Self-cleansing Filter Syndicate Co Ltd v Cunninghame [1906] 2 Ch 34 the
question for the Court of Appeal was whether the directors were bound to give effect
to an ordinary resolution of the general meeting requiring them to sell the company’s
undertaking to a new company incorporated for the purpose. The company’s articles
of association, in terms similar to article 3 of the model articles of association for
private and public companies (see below), provided that ‘the management of the
business and the control of the company’ was in the hands of its directors. Collins MR,
having reviewed the relevant article, explained that:
it is not competent for the majority of the shareholders at an ordinary meeting to affect
or alter the mandate originally given to the directors by the articles of association… the
mandate which must be obeyed is not that of the majority – it is that of the whole entity
made up of all the shareholders.
See also Gramophone and Typewriter Ltd v Stanley [1908] 2 KB 89; and John Shaw & Sons
(Salford) Ltd v Shaw [1935] 2 KB 113.
This ‘balance of power’ between the shareholders and the directors is now confirmed
by article 3 (directors’ general authority) of the model articles of association for both
private and public companies the equivalent provision of the 1985 Table A, namely
article 70, was also drafted in very similar terms). Article 3 confers on the board virtual
managerial autonomy. Article 3 provides:
Directors’ general authority
Subject to the articles, the directors are responsible for the management of the
company’s business, for which purpose they may exercise all the powers of the company.
However, even though directors are, by virtue of article 3, given the power to manage
the company, this does not mean that shareholders are denied any say within the
company. First, article 4 of the model articles for both private and public companies
allows shareholders to ‘give directions’ to the board. Article 4 provides that:
Shareholders’ reserve power: ‘The shareholders may, by special resolution, direct the
directors to take, or refrain from taking, specified action.
Thus, shareholders can instruct the board how to act, but crucially, for such an
instruction to be binding on the directors, it must be passed as a special resolution
(which requires a 75 per cent majority). The CA 2006 also empowers the shareholders
to take a number of decisions within the company, for example dealing with alterations
to the articles (s.21); share capital (ss.617 and 641); and the allotment of shares (ss.549
and 551). If shareholders disapprove of a director they can remove him from office by
ordinary resolution (s.168 CA 2006, see Section 14.1.5). Moreover, executive power will
revert to the general meeting where the board of directors is deadlocked so that it is
incapable of managing the company (Barron v Potter [1914] 1 Ch 895).
Summary
Directors are not mere delegates or agents of the general meeting but are under a
duty to act bona fide in the interests of the company as a whole (see Chapter 15). Article
3 confers extensive managerial powers on directors, who can thus pursue a course of
action different from that prescribed by a bare majority of shareholders. However, the
general meeting can remove a director by ordinary resolution (s.168 CA 2006).
Activity 14.1
Read Gramophone and Typewriter Ltd v Stanley [1908] 2 KB 89.
To what extent can a controlling shareholder dictate how directors should act?
14.1.3 Appointment of directors

Subject to certain statutory provisions, the appointment of directors is left to the
articles of association. Section 16(6) CA 2006 provides that the persons named in the
statement of proposed officers are, on the company’s incorporation, deemed to be its
first directors and secretary. We have seen above that s.154 stipulates the minimum
number of directors for companies. Section 160 goes on to provide that for public
companies the appointment of directors shall be voted on individually. Section 157 lays
down the minimum age of 16 for appointment as a director. Beyond these particular
statutory provisions the CA 2006 is silent on boardroom appointments, leaving the
issue to the articles of association.
Although first directors are appointed in accordance with s.12 CA 2006 their successors
are elected by the shareholders in a general meeting. Article 20 of the model articles
of association for public companies (the 1985 Table A, article 73) provides that at the
first annual general meeting (AGM) all the directors shall retire from office and at every
subsequent AGM any directors who have been appointed by the directors since the
last AGM or who were not appointed at one of the preceding two AGMs, must retire
from office. It should be noted that this requirement does not appear in the model
articles for private companies.
Summary
Sections 154–167 CA 2006 govern the appointment and registration of directors. The
principal requirements for appointment are:
u every private company is to have at least one director, and every public company
to have at least two (s.154)
u 16 is set as the minimum age (as in Scotland) for a director to be appointed (s.157)
u 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)
u the acts of a person acting as a director are valid notwithstanding that it is

afterwards discovered that there was a defect in his appointment, that he was
disqualified from holding office, that he has ceased to hold office, or that he was
not entitled to vote on the matter in question (s.161, replacing s.285 of the CA 1985).
(See the construction given to the provision in Morris v Kanssen [1946] AC 459, Lord
Simonds.)
14.1.4 Directors’ remuneration

As with trustees, directors are not entitled as of right to be paid for their services
unless the articles of association or a service contract between them and the company
provide otherwise (Re George Newman & Co [1895] 1 Ch 674). Article 18 (model articles
of association for private companies) and article 22 (model articles of association for
public companies) provide that the directors shall be entitled to such remuneration as
they determine.
Given the power of directors to set their own remuneration, issues of transparency
and accountability obviously arise. The temptation for directors to vote themselves
‘fat cat’ awards has generated much debate over the past 20 years or so and this is
considered in the corporate governance section of this chapter. For the present it
should be noted that the BIS (formerly the DTI) published a number of proposals
for reinforcing the accountability of directors to shareholders over boardroom pay
awards (see the DTI consultative documents, Directors’ Remuneration (URN 99/923)
(London, DTI, 1999) and (URN 01/1400) (London DTI, 2001)). A significant proposal
was that there should be a mandatory requirement for the company’s annual report
to contain a statement of remuneration policy and details of the remuneration of
each director. This was first implemented for all quoted companies for financial
years ending on or after 31 December 2002 by statutory instrument (the Directors’
Remuneration Report Regulations 2002 (SI 2002/1986)), which came into force on 1
August 2002, and is now incorporated into the ss.420–422 CA 2006.
The remuneration 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)). Besides
requiring companies to supply shareholders with more information through the
remuneration report, the 2002 Regulations also required the report to be put before
the shareholders, and voted on by them. Initially, this vote was only ‘advisory’, so that
boards might lawfully choose to ignore a negative vote by shareholders. However,
s.439 CA 2006 (which was introduced by s.79 Enterprise and Regulatory Reform Act
2013) makes the shareholders’ vote binding as to the company’s remuneration ‘policy’.
To explain: each quoted company must have its policy on executive remuneration
approved by shareholders every three years, and the company can only then pay its
executive directors in accordance with the approved remuneration policy.
Section 412 of the CA 2006 requires disclosure in the annual accounts of directors’
emoluments, including present and past directors’ pensions and compensation for
loss of office. Sections 228–330 provide that the terms of a director’s service contract
must be made available for inspection either at its registered office or the place
where its register of members is kept if other than its registered office. Breach of this
requirement may result in a fine on conviction.
Activity 14.2
Read Guinness plc v Saunders [1990] 2 AC 663.
a. What were the material terms of the company’s articles of association?
b. Why did the House of Lords order Mr Ward to repay the company the £5.2m
awarded him by way of remuneration?
14.1.5 Removal of directors

Section 168(1) of the CA 2006 provides that a company may by ordinary resolution
remove a director before the expiration of his period of office, notwithstanding
anything in the articles or in any agreement between him and the company. Special
notice must be given of the resolution (i.e. at least 28 days’ notice must be given
before the meeting at which the resolution is to be moved (ss.168(2) and 312)).
The 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 providing they are of a reasonable length
(s.169(4)).
While the power contained in s.168 cannot be removed by the articles, it is possible
for a director 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 Bushell v Faith [1970]
AC 1099 the articles provided that on a resolution to remove a particular director, his
shares would carry the right to three votes per share. This meant that he was able to
outvote the other shareholders who held 200 votes between them. In other words,
the ordinary resolution could be blocked by him. 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 fit.’ He
went on to state that in framing s.168 (s.303 CA 1985) all that Parliament was seeking to
do was to make an ordinary resolution sufficient 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 voting clauses are commonly encountered in private companies of a quasi-
partnership nature, they are expressly prohibited by the LSE Listing Rules.
14.2 Categories of director
14.2.1 Executive and non-executive directors

Executive directors are full-time officers who generally have a service contract with
the company. The articles will normally provide for the appointment of a managing
director, sometimes called a chief executive, who has overall responsibility for the
running of the company. Non-executive directors are normally appointed to the
boards of larger companies to act as monitors of the executive management. They are
typically part-time appointments. For the role of non-executive directors see Section
14.4 of this chapter.
14.2.2 De facto directors

A de facto director is one who has not been formally appointed but has nevertheless
acted as a director (Re Kaytech International plc [1999] BCC 390, CA). The issue of
whether or not an individual is a de facto director generally arises in relation to
disqualification orders under the Company Directors Disqualification Act (CDDA) 1986
(see below). The courts have formulated guidelines for determining the issue. In Re
Richborough Furniture Ltd [1996] BCC 155, Lloyd J stated that emphasis should be given
to the functions performed by the individual concerned (see also Secretary for State
for Trade and Industry v Jones [1999] BCC 336). In Secretary of State for Trade and Industry
v Tjolle [1998] BCC 282 Jacob J stated that the essential test is whether the person in
question was ‘part of the corporate governing structure’. This was approved by the
Court of Appeal in Re Kaytech International plc.
In Secretary of State for Trade and Industry v Hollier [2006] EWHC 1804 (Ch), Etherton
J, having made the point that no one can simultaneously be a de facto and a shadow
director, went on to state that although various tests have been laid down for
determining who may be a de facto director there is no single touchstone. The
key test is whether someone is part of the governing structure of a company and
participates, or is entitled to participate in, collective decisions on corporate policy
and strategy and its implementation. In Re Gemma Ltd (in liquidation) [2008] BCC 812
it was emphasised that what mattered was what the director did (and in particular
whether they were part of the governing structure of the company), not the label that
was attached to them. See also HM Revenue & Customs v Holland [2010] UKSC 51. Since a
de facto director falls within the definition of a ‘director’ in s.250 CA 2006 (see above),
then all provisions in CA 2006 which apply to ‘directors’ (such as the general duties
found in ss.171–77 CA 2006) apply equally to de facto directors.
14.2.3 Shadow directors

In order to evade the duties to which directors are subject a shareholder might avoid
formal appointment as such yet nevertheless direct the board’s decision making. In
this case the shareholder may be classified as a ‘shadow director’.
Section 251(1) of the CA 2006 defines a ‘shadow director’ as a person in accordance

with whose directions or instructions the directors are accustomed to act (see also
s.22(5) CDDA 1986). Those who provide professional advice are expressly excluded.
But a professional person may be held to be a shadow director if his or her conduct
amounts to effectively controlling the company’s affairs (Re Tasbian Ltd (No.3) [1993]
BCLC 297). In Re Hydrodam (Corby) Ltd [1994] BCC 161, Millett J, considering the definition
contained in s.741(2) CA 1985, took the view that in determining whether or not an
individual is a shadow director four factors are relevant, namely that:
u the de jure and de facto directors of the company must be identifiable
u the person in question directed those directors on how to act in relation to the
company’s affairs or that he was one of the persons who did
u the directors did act in accordance with his instructions
u they were accustomed so to act.
Millet J explained that a pattern of behaviour must be shown ‘in which the board did
not exercise any discretion or judgment of its own but acted in accordance with the
directions of others’. However, merely controlling one director is not sufficient; the
shadow director must exercise control over the whole board or at least a governing
majority of it (Re Lo-line Electric Motors Ltd [1988] Ch 477; Unisoft Group Ltd (No.2) [1993]
BCLC 532).
We noted above that all the statutory provisions (such as directors’ duties) that apply
to ‘directors’ apply equally to de facto directors. Is the same true of shadow directors?
The position here is a little more complex. Some provisions of CA 2006, and of the
Insolvency Act 1986, expressly apply to shadow directors too. So, for example, under
s.214(7) Insolvency Act 1986, a shadow director may be held liable for wrongful trading
(see Chapter 4). However, the position with regard to the general duties on directors
(found in ss.171–77) is less certain. Section 170(5) CA 2006 (which was inserted by the
Small Business, Enterprise and Employment Act 2015) now provides that ‘The general
duties apply to a shadow director of a company where and to the extent that they are
capable of so applying’. In Standish v Royal Bank of Scotland plc [2019] EWHC 3116 the
court held that the duties owed by the shadow would depend on the instructions they
gave. A shadow director could not be held liable for conduct that was unconnected
with the instructions being given to the directors. Note that in Popely v Popely [2019]
EWHC 1507 (Ch) the court held that a person might be simultaneously both a de facto
and a shadow director.
Activity 14.3
Read Secretary of State for Trade and Industry v Deverell [2001] Ch 340.
What was the court’s approach to the determination of whether or not the
respondent was a shadow director?
14.3 Disqualification of directors

The CDDA 1986 seeks to protect the general public against abuses of the corporate
form. The effect of a disqualification 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 manager of a company’s property or, in any way, whether directly
or indirectly, be concerned or take part in the promotion, formation or management
of a company, for a specified period beginning with the date of the order’ (s.1(1)). A
disqualified person cannot, therefore, act in any of the alternative capacities listed and
so, for example, a disqualified director cannot participate in the promotion of a new
company during the disqualification period (Re Cannonquest, Official Receiver v Hannan
[1997] BCC 644). Nor can he or she be ‘concerned’ or ‘take part in’ the management
of a company by virtue of acting in some other capacity, for example a management
consultant (R v Campbell [1984] BCLC 83).
14.3.1 Discretionary orders
Conviction of an offence
Section 2 CDDA 1986 provides that the court may, at its discretion, issue a
disqualification order against a person convicted of an indictable offence (whether on
indictment or summarily) in connection with the promotion, formation, management,
liquidation or striking off of a company, or with the receivership or management of a
company’s property. The offence does not have to relate to the actual management
of the company provided it was committed in ‘connection’ with its management. The
maximum period of disqualification is five years where the order is made by a court of
summary jurisdiction, and 15 years in any other case (s.2(3)).
Persistent breaches of the companies legislation

The court may disqualify a director where it appears that he or she has been
‘persistently in default’ in complying with statutory requirements relating to any
return, account or other document to be filed with, delivered or sent, or notice of
any matter to be given, to the Registrar (s.3(1)). Persistent default will be presumed
by showing that in the five 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)). Section 5 goes on to provide that a disqualification 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 offence relating to the filing of returns, etc.
Fraud
The court may make a disqualification 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 CA 2006 (fraudulent trading), or
b. has otherwise been guilty, while an officer 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 officer, liquidator, receiver or manager (s.4).
The maximum period for disqualification 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 of this guide), the CDDA 1986
gives the court a discretion to disqualify such person for a period of up to 10 years.
Disqualification after investigation of the company

Section 8 CDDA 1986 provides that if it appears to the Secretary of State from a
report following a DTI investigation that it is expedient in the public interest that
a disqualification 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
disqualification order. The court can disqualify such a person for up to 15 years if it is
satisfied that his conduct in relation to the company makes him unfit to be concerned
in the management of a company. This power has been used where, following a DTI
investigation, it was apparent that a director had abused his or her power to allot
shares in order to retain control of the company (Re Looe Fish Ltd [1993] BCC 348).
14.3.2 Mandatory disqualification orders for unfitness

Section 6(1) CDDA 1986 provides that the court shall make a disqualification order
against a person in any case where it is satisfied:
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 unfit to be concerned in the management of a company.
The minimum period of disqualification is two years and the maximum period is 15
years (s.6(4)). In contrast with the other grounds for disqualification noted above, s.6 is
restricted to directors or shadow directors, including de facto directors.
The policy underlying s.6 was explained by Dillon LJ in Re Sevenoaks Stationers (Retail)
Ltd [1991] Ch 164 as being ‘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 unfit to be concerned in the management of
a company’.
An insolvent company is defined as including a company which goes into liquidation

at a time when its assets are insufficient to meet the payment of its debts, liabilities
and liquidation expenses (s.6(2)). An application under s.6 must be brought by the
Secretary of State or, if the company is in compulsory liquidation, by the Official
Receiver, if it appears to him that it is expedient in the public interest that a
disqualification order should be made against any person (s.7(1)).
The meaning of ‘unfitness’

Section 6 CDDA 1986 provides that the court must be satisfied that the director’s
conduct ‘makes him unfit to be concerned in the management of a company’. This has
been construed as meaning ‘unfit to manage companies generally’ rather than unfit to
manage a particular company or type of company (Re Polly Peck International plc (No.2)
[1994] 1 BCLC 574; see also Re Grayan Building Services Ltd [1995] Ch 241).
In determining whether a person’s conduct renders him unfit to be a director, s.9

CDDA 1986 directs the court to take into account the matters listed in Schedule 1,
although those matters are not exhaustive. The list is divided into those matters which
are generally applicable and those that are applicable only where the company has
become insolvent. The first category comprises:
u misfeasance or breach of any fiduciary or other duty by the director (para 1)
u the degree of the director’s culpability in concluding a transaction which is liable

to be set aside as a fraud on the creditors (paras 2 and 3)
u the extent of the director’s responsibility for any failure by the company to comply
with the numerous accounting and publicity requirements of the CA 2006 (paras 4
and 5).
Those matters to which regard is to be had when the company is insolvent are listed in
Part II of Schedule 1 and include:
u the extent of the director’s responsibility for the causes of the company becoming
insolvent (para 6)
u the extent of the director’s 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 Re Lo-Line Electric Motors Ltd [1988] Ch 477 Sir Nicholas Browne-Wilkinson V-C said
that while ordinary commercial misjudgment is not in itself sufficient to establish
unfitness, conduct which displays ‘a lack of commercial probity’ or conduct which
is grossly negligent or displays ‘total incompetence’ would be sufficient to justify
disqualification (see also Re Dawson Print Group Ltd [1987] BCLC 601; Secretary of State
for Trade and Industry v Ettinger, Re Swift 736 Ltd [1993] BCLC 896; Re AG (Manchester) Ltd
(in liquidation); Official Receiver v Watson [2008] 1 BCLC 32).
In Secretary of State for Trade and Industry v Swan (No.2) [2005] EWHC 603, Etherton
J subjected the responsibilities of a non-executive director, against whom an
application for disqualification under s.6 had been brought, to detailed consideration.
N, a senior non-executive director and deputy chairman of the board and chairman of
the audit and remuneration committees of Finelist plc, together with S, the company’s
CEO, were disqualified for three and four years respectively. N’s reaction upon being
informed by a whistle-blower of financial irregularities (‘cheque kiting’) going on
within the group was held to be entirely inappropriate. He failed to investigate the
allegations properly. Nor did he bring them to the attention of his fellow non-
executive directors or to the auditors. The judge held that N’s conduct fell below the
level of competence to be expected of a director in his position and he was, therefore,
‘unfit’ to be concerned in the management of a company.
Activity 14.4
Read Secretary of State for Trade and Industry v TC Stephenson [2000] 2 BCLC 614.
What were the allegations made against the director by the Secretary of State?
What was the decision of the court?
Summary
The courts will look for abuses of the privilege of limited liability as evidenced
by capricious disregard of creditors’ interests or culpable commercial behaviour
amounting to gross negligence. Non-executive directors who lack corporate financial
experience may rely on the advice and assurances provided by the company’s
accountants although they should be vigilant and raise objections whenever they have
concerns about the financial operation of the company.
14.3.3 Disqualification undertakings

The Insolvency Act 2000 amends the CDDA 1986 by introducing a procedure whereby
in the circumstances specified in ss.7 and 8 of the 1986 Act, the Secretary of State may
accept a disqualification undertaking by any person that, for a period specified 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). In determining
whether to accept a disqualification undertaking by any person, the Secretary of State
may take account of matters other than criminal convictions, notwithstanding that
the person may be criminally liable in respect of those matters.
It is further provided that if it appears to the Secretary of State that the conditions
mentioned in s.6(1) are satisfied with respect to any person who has offered to give
him a disqualification 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 applying or
proceeding with an application for a disqualification order) (s.6(3) of the 2000 Act,
inserting s.7(2A) into the CDDA 1986).
Section 8 of the CDDA 1986 is amended by IA 2000 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 offered to give him a disqualification undertaking, (a) the conduct of the
person in relation to a company of which the person is or has been a director or
shadow director makes him unfit 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 disqualification order),
he may accept the undertaking (s.6(4) of the 2000 Act, inserting s.8(2A) into the CDDA
1986). Section 8A of the CDDA 1986 provides that, on the application of a person who is
subject to a disqualification undertaking, the court may:
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) IA 2000).
These reforms are designed to save court time so that in the specified circumstances,
disqualification can be achieved administratively without the need to obtain a court
order.
Competition disqualification orders

Directors who have breached competition law may also be disqualified by virtue of
s.204 of the Enterprise Act 2002 which inserts ss.9A–9E into the CDDA 1986 with effect
from June 2003. Section 9A places the court under a duty to make a disqualification
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 unfit to be
concerned in the management of a company. The maximum period for disqualification
is 15 years. Application for a disqualification order on this ground may be made by the
Office of Fair Trading (OFT) and certain other specified regulators (including, among
others, the Director General of Telecommunications, the Gas and Electricity Markets
Authority, and the Rail Regulator). The 2002 Act also introduces a parallel scheme for
competition disqualification undertakings under s.9B to the one for disqualification
undertakings introduced by the Insolvency Act 2000. The OFT or a specified regulator
may accept a disqualification undertaking for up to 15 years from a director instead of
applying for a court order. Section 9C provides that if the OFT (or specified 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 disqualification order.
Compensation orders
Although disqualification might prevent a person from acting, and therefore
misbehaving, as a director in the future, it does not redress any harm their past
misbehaviour has already caused to others. Section 15A CDDA 1986, which was
introduced by the Small Business, Enterprise and Employment Act 2015, seeks to
address this. It now allows the court to make a ‘compensation order’ against a person
who has been disqualified as a director.
According to s.15A(3)(b) CDDA 1986, a compensation order can only be made if ‘the
conduct for which the person is subject to the [disqualification] order or undertaking
has caused loss to one or more creditors of an insolvent company of which the person
has at any time been a director.’ The money will either be paid to the Secretary of
State, for the benefit of all or some creditors, or else will be paid as a contribution to
the assets of the company.
Re Noble Vintners Ltd [2019] EWHC 2806 (Ch) is the first case in which the court has used
its new powers, found in ss.15A and 15B of the Company Directors Disqualification Act
1986, to order a disqualified director to compensate creditors of the company who
have been harmed by the director’s misbehaviour. The court found that the amount
of compensation payable should depend upon the loss suffered by the creditor, the
nature of the director’s misbehaviour and whether the director had already made any
other payments in respect of her misbehaviour (for example, to the company under
the wrongful trading regime found in s.214 Insolvency Act 1986).
Further reading
¢ Axworthy, C.S. ‘Corporate directors – who needs them?’ (1988) 51 MLR 273.
¢ Bradley, C. ‘Enterprise and entrepreneurship: the impact of director

disqualification’ (2001) JCLS 53.
¢ Davies and Worthington, Chapter 10: ‘Disqualification of directors’ and Chapter

14: ‘The board’.
¢ Finch, V. ‘Disqualification of directors: a plea for competence’ (1990) MLR 385.
¢ Hicks, A. ‘Disqualification of directors – 40 years on’ (1988) JBL 27.
¢ Lowry, J. ‘The whistle-blower and the non-executive director’ (2006) Journal of

Corporate Law Studies 249.
¢ Milman, D. ‘Personal liability and disqualification of company directors:

something old, something new’ (1992) NILQ 1.
¢ Sullivan, G.R. ‘The relationship between the board of directors and the general
meeting in limited companies’ (1977) 93 LQR 569.

Freedom Publishers Ltd (‘the company’) is a private limited company with model
articles for private companies limited by shares, but with the addition of the
following clause:
‘In the event of there being a resolution before a general meeting to dismiss a
director, that director’s shares shall carry five times the normal number of votes.’
The company has issued 10,000 shares, which are held as to 2,000 each by the three
directors, Karl, Fred and Rosa. The remaining 4,000 are distributed among 10 or so
shareholders. Karl and Fred have become disturbed by the fact that recently Rosa
has taken up with a new boyfriend who is a member of an extremist political party
and they feel that Rosa might not be able to continue to support the progressive
publishing policies of the company. They consult you to consider whether Rosa
could be dismissed as a director, telling you that they are likely to be able to
command the support of all the other shareholders (apart, obviously, from Rosa).
Advise Karl and Fred as to what course or courses of action they should follow.

This is a wide-ranging question requiring you to address a number of issues. It is
important to organise and structure your answer clearly. The following points should
be looked at.
Discuss s.168 CA 2006 and weighted voting. You will need to explain the House of Lords
decision in Bushell v Faith.
A means of defeating Rosa’s voting power on a resolution to remove her is for the
company to alter its articles by special resolution under s.21 CA 2006 (see Chapter 10 of
this guide).
Alternatively, the company might choose to issue additional shares in order to defeat
Rosa’s voting power (ss.549–551 CA 2006). However, she may be able to challenge
such an allotment on the basis that it is for an improper purpose (see Chapter 15 of
this guide, particularly Howard Smith Ltd v Ampol Petroleum [1974] AC 821 and Hogg
v Cramphorn [1967] Ch 254). In any case, if Rosa exercises pre-emption rights (see
ss.561–572 CA 2006) this will frustrate the scheme to defeat her weighted voting rights.
Reflect and review



first again
I can define the term ‘director’.   
I can explain the role of the board of directors and its
relationship with the general meeting.   
I can describe the various categories of director.   
I can explain the process for awarding remuneration.   
I can describe how the general meeting can remove a

director from the board.   
I can explain how directors can be disqualified from

holding office.   
revise?
Must Revision
revise done
14.1 Directors  
14.2 Categories of directors  
14.3 Disqualification of directors  

15 Directors’ duties
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 166
15.1 Directors’ duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167
15.2 The restatement of directors’ duties: Part 10 of the CA 2006 . . . . . . . 169
15.3 Relief from liability . . . . . . . . . . . . . . . . . . . . . . . . . . . 184
15.4 Specific statutory duties . . . . . . . . . . . . . . . . . . . . . . . . 185

Introduction
In this chapter we consider the duties of directors and Part 10 of the CA 2006, which
sets out the equitable and common law duties of directors by way of statutory
restatement. In addition, we will consider certain other statutory duties of directors
aimed at addressing specific types of abuses. We will also examine the scope of the
court’s discretion to relieve directors from liability for breaches of duty. In considering
the fiduciary duties of directors you should bear in mind the work you did for the Law
of trusts in Part I of the LLB (see in particular Chapter 17, ‘Breach of fiduciary duty’, of
that module guide).
Learning outcomes
u discuss the fiduciary position of directors
u discuss the content and scope of the duties of directors restated in Part 10 of the
CA 2006
u explain the authorisation process
u describe the principal transactions with directors that require the approval of
members
u explain the court’s discretion to relieve directors from liability
u describe the specific statutory duties of directors.
Core text
¢ Dignam and Lowry, Chapter 14: ‘Directors’ duties’.
Cases
¢ Percival v Wright [1902] 2 Ch 421
¢ Allen v Hyatt (1914) 30 TLR 444
¢ Gething v Kilner [1972] 1 WLR 337
¢ Peskin v Anderson [2001] 1 BCLC 372
¢ Multinational Gas and Petrochemical Co Ltd v Multinational Gas and Petrochemical

Services Ltd [1983] Ch 258
¢ Re Smith & Fawcett Ltd [1942] Ch 304
¢ Fulham Football Club Ltd v Cabra Estates plc [1994] 1 BCLC 363
¢ Extrasure Travel Insurances Ltd v Scattergood [2002] All ER (D) 307 (Jul) (Ch D)
¢ Item Software (UK) Ltd v Fassihi [2004] EWCA Civ 1244
¢ Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821
¢ Teck Corporation Ltd v Millar [1972] 33 DLR (3d) 288
¢ Regal (Hastings) Ltd v Gulliver [1942] 1 All ER 378, [1967] 2 AC 134n
¢ Cook v Deeks [1916] 1 AC 554
¢ Industrial Development Consultants Ltd v Cooley [1972] 1 WLR 443
¢ Bhullar v Bhullar [2003] EWCA Civ 424
¢ Foster Bryant Surveying Ltd v Bryant [2007] EWCA Civ 200
¢ Guinness plc v Saunders [1990] 2 AC 663
¢ Neptune (Vehicle Washing Equipment) Ltd v Fitzgerald (No.2) [1995] BCC 1000
¢ Re D’Jan of London Ltd [1993] BCC 646
¢ Re Duckwari plc [1997] 2 BCLC 713
¢ Re Duckwari plc (No.2) [1999] Ch 268

Company Law 15 Directors’ duties page 167
¢ Re Duckwari plc (No.3) [1999] 1 BCLC 168
¢ GHLM Trading Ltd v Maroo [2012] EWHC 61 (Ch)
¢ Lexi Holdings plc (in admin) v Luqman [2009] EWCA Civ 117
¢ O’Donnell v Shanahan [2009] EWCA Civ 751.
Additional cases
¢ Colin Gwyer and Associates Ltd v London Wharf (Limehouse) Ltd [2003] 2 BCLC 153, Ch D
¢ Thorby v Goldberg (1964) 112 CLR 597
¢ Gwembe Valley Development Co Ltd v Koshy [2003] EWCA Civ 1478
¢ Norman v Theodore Goddard [1991] BCLC 1028
¢ Bairstow v Queens Moat Houses plc [2000] 1 BCLC 549
¢ Tito v Waddell (No.2) [1977] Ch 106
¢ West Coast Capital (Lios) Limited [2008] CSOH 72
¢ Eclairs Group Ltd v JKX Oil and Gas plc [2015] UKSC 71
¢ Re Southern Counties Fresh Foods Ltd [2009] EWHC 1362 (Ch)
¢ R (on the application of People & Planet) v HM Treasury [2009] EWHC 3020 (Admin)
¢ Re HLC Environmental Projects Ltd [2013] EWHC 2876 (Ch)
¢ British Midland Tool v Midland International Tooling [2003] EWHC 466
¢ Thermascan Ltd v Norman [2011] BCC 535
¢ Towers v Premier Waste Management Ltd [2012] BCC 72
¢ Hedger v Adams [2015] EWHC 2540 (Ch)
¢ Dickinson v NAL Realisations (Staffordshire) Ltd [2017] EWHC 28 (Ch)
¢ Raithatha v Baig [2017] EWHC 2059 (Ch).
¢ Wessely v White [2018] EWHC 1499 (Ch)
¢ Instant Access Properties Ltd v Rosser [2018] EWHC 756 (Ch).
15.1 Directors’ duties

Directors, being the principal management organ of the company, must act for its
benefit and they therefore occupy a fiduciary position. Their fiduciary status can be
traced to the origins of the modern company when companies were established by
a deed of settlement that generally declared the directors to be trustees of the funds
and assets of the business venture. The courts thus had a ready-made template in the
form of trustee liability that was harnessed in order to frame the fiduciary duties of
directors. The common law also constructed the duties of care and skill of directors
and the legislature has added to the obligations of directors, generally as reactive
measures to specific abuses. We will consider the three sources of directors’ duties in
turn: equity, common law and statute (and particularly, Part 10 of the CA 2006).
15.1.1 The origins of Part 10 CA 2006

In July 1999 the Law Commission and the Scottish Law Commission issued a joint
report, Company Directors: Regulating Conflicts of Interests and Formulating a Statement
of Duties (Nos 261 and 173, respectively). The Law Commissions’ examination of
directors’ duties and Part X of the Companies Act 1985 was already underway at the
time of the DTI’s (now BIS) announcement in March 1998 of the company law review.
As part of this wider project the Law Commissions undertook to place their final
report before the CLRSG. The DTI had charged the Commissions with the objective of
determining whether or not the relevant statutory provisions could be ‘reformed,
made more simple or dispensed with altogether’ (the Law Commissions Consultation
Paper No.153 (LCCP), para 1.7). The aim was to examine the presentation of the law
governing directors’ duties rather than its reform. The report was lodged with the
CLRSG in July 1999. The Law Commissions’ recommendations, and the DTI’s response
(see below), are wide ranging.
The Law Commissions examined the case for restating directors’ duties in statute.
Arguments against this were founded on loss of flexibility, while those in favour saw
advantages in terms of certainty and accessibility. The Commissions’ conclusion
was that the case for legislative restatement was made out and that the issue of
inflexibility could be addressed by:
u ensuring the restatement was at a high level of generality by way of a statement of

principles; and by
u providing that it was not exhaustive (i.e. while it would be a comprehensive and
binding statement of the law in the field covered, it would not prevent the courts
inventing new general principles outside the field).
The hallmark of the Law Commissions’ approach was their regard for 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 efficiently, promoting
prosperity (LCCP para 2.8). More particularly, it is recommended that the law ‘should
move towards a general principle of meaningful disclosure, and that approval rules
should be seen as the exception’ (Law Com No.261 and 173, para 3.72).
The CLRSG proposed that the duties of directors should be restated and to this end the
general duties owed by a director of a company to the company are set out in Part 10
CA 2006. We will examine each restated duty in turn.
The Final Report of the CLRSG accepted the case for codification for two principal
reasons.
u First, directors should know what is expected of them and therefore such a
statement will further the CLR’s objectives of reforming the law so as to achieve
clarity and accessibility.
u Second, the process of formulating such a statement would enable defects in the
present law to be corrected ‘in important areas where it no longer corresponds to
accepted norms of modern business practice’.
The CLR thought that this was particularly so with respect to the duties of conflicted
directors.
Before we begin our examination of directors’ duties, we first consider the important
question of to whom are the duties owed?
15.1.2 To whom are the duties owed?

The orthodox answer to this question is now contained in s.170 CA 2006. It states
that directors’ duties are owed to the company and not to shareholders individually
(although note the corporate governance debate considered in Chapter 16 of this guide).
Consequently, a breach of duty is a wrong done to the company and the proper claimant
in proceedings in respect of the breach is the company itself (see Chapter 11 of this guide).
The classic case which is now given the force of statute by s.170 is Percival v Wright
[1902] 2 Ch 421. The directors offered to buy the shares held by the company’s members
without disclosing that at the time of the purchase they were negotiating with an
outsider for the sale of the company at a higher price. The shareholders claimed that
the directors were in breach of their fiduciary duty to them and that the sale ought to
be set aside for non-disclosure. The court rejected their claim. The duty was owed to the
company and, in any case, there was no unfair dealing by the directors. The shareholders
had initially approached the directors asking them to purchase their shares.
The decision in Percival v Wright leaves the critical question unanswered; namely, what
is the company? Some assistance in solving this issue can be gleaned from the Report
of the Second Savoy Hotel Investigation (The Savoy Hotel Ltd, and the Berkeley Hotel Co
Ltd, Report of an Investigation under s.165 (6) of the Companies Act 1948, (HM Stationery
Office, 1954)). The Report concluded that it was not enough for directors to act in the
short-term interests of the company alone (see Greenhalgh v Arderne Cinemas Ltd [1951]
Ch 286, on the meaning of ‘the company as a whole’), but that regard must be taken of
the long-term interests of the company. In other words, the duty is not confined to the
existing body of shareholders, but extends to future shareholders. Some assistance in
addressing this issue is also given in s.172 CA 2006 (see Section 15.2.2).
It is noteworthy that subsections (3) and (4) of s.170, taken together, direct the courts
to have regard to the pre-existing case law when interpreting the statutory statement.
The relevance of the existing jurisprudence is, therefore, put beyond doubt.
In this regard, it is noteworthy that the courts have been able to distinguish Percival
v Wright on its facts and have held that fiduciary duties, carrying a duty of disclosure,
can be owed to shareholders. For example, when recommending whether a
takeover offer should be accepted it has been held that directors owe a duty to the
shareholders which includes a duty to be honest and not to mislead (see Allen v Hyatt
(1914) 30 TLR 444; Gething v Kilner [1972] 1 WLR 337; Heron International Ltd v Lord Grade
[1983] BCLC 244; Coleman v Myers [1977] 2 NZLR 225; Multinational Gas and Petrochemical
Co Ltd v Multinational Gas and Petrochemical Services Ltd [1983] Ch 258; Peskin v Anderson
[2000] 2 BCLC 1, affirmed [2001] BCLC 372).
Activity 15.1
Read Coleman v Myers [1977] 2 NZLR 225.
What were the special circumstances that led the court to distinguish Percival v
Wright and hold that the directors owed fiduciary obligations to the shareholders?
15.1.3 Other points to note about s.170

Section 170(2) CA 2006 codifies the common law position that resignation is no
defence to an action for breach of the no-conflict rule (s.175, see 15.2.5 below) or to
an action where a director has accepted a benefit from a third party (s.176, see 15.2.6
below). (See also: IDC v Cooley [1972] 1 WLR 443; Canadian Aero Service Ltd v O’Malley
(1973) 40 DLR (3d) 371; CMS Dolphin Ltd v Simonet [2001] 2 BCLC 704, discussed below.)
Summary
The general principle at common law, and now carried forward by s.170 CA 2006, is
that directors owe their duties to the company and not to the shareholders.
15.2 The restatement of directors’ duties: Part 10 of the CA 2006

Part 10 of the 2006 Act restates seven duties for directors. These are:
u the duty to act within powers (s.171)
u the duty to promote the success of the company (s.172)
u the duty to exercise independent judgment (s.173)
u the duty to exercise reasonable care, skill and diligence (s.174)
u the duty to avoid conflicts of interest (s.175)
u the duty not to accept benefits from third parties (s.176)
u the duty to declare interest in proposed transactions or arrangement (s.177).
The duty to declare interest in an existing transactions or arrangements is laid down

by s.182. You should read each of these sections of the Act in full.
15.2.1 Duty to act within powers, s.171

Section 171 provides that:
A director of a company must—
act in accordance with the company’s constitution, and
only exercise powers for the purposes for which they are conferred.
This section restates the duty requiring a director to exercise his powers in accordance
with the terms upon which they were granted (i.e. to comply with the company’s
constitution), and do so for a proper purpose (i.e. a purpose for which power was
conferred).
For the purpose of paragraph (a), the company’s constitution is defined in s.17 CA
2006 as including the company’s articles of association, decisions taken in accordance
with the articles and other decisions taken by the members, or a class of them, if
they can be regarded as decisions of the company. The importance of directors
appreciating the purposes of the company as detailed in the constitution is critical if
they are to fulfil the duty laid down by s.172 to promote the success of the company
(see Section 15.2.2).
The articles of association may increase the burden of the duties by, for example,
requiring directors to obtain shareholder authorisation for their remuneration
packages. However, the articles may not dilute the duties except to the extent
expressly provided for in the relevant provisions. In this regard, s.173 (duty to exercise
independent judgment (see 15.2.3 below)) provides that a director will not be in
breach if he has acted in accordance with the constitution. As we will see, s.175 (duty
to avoid conflicts of interest (see 15.2.5 below)) provides that a director will not be
in breach where, subject to the constitution, the matter has been authorised by
independent directors.
Paragraph (b) of s.171 codifies the proper purposes doctrine formulated by Lord
Greene MR in Re Smith & Fawcett Ltd [1942] Ch 304, where he stated that directors must
not exercise their powers for any ‘collateral purpose’.
The facts of Extrasure Travel Insurances Ltd v Scattergood [2002] All ER (D) 307 (Jul) (ChD)
afford a clear illustration of a power (the power to deal with corporate assets) being
exercised for an improper purpose. More generally, however, the issue of whether
directors have used a power for a proper purpose arises in relation to their authority
to issue shares. If shares are allotted in exchange for cash where the company is in
need of additional capital the duty will not be broken. But where directors issue shares
in order to dilute the voting rights of an existing majority shareholder because he or
she is blocking a resolution supporting, for example, a takeover bid, then the duty will
be breached (see Hogg v Cramphorn [1967] Ch 254). In Piercy v S Mills & Co Ltd [1920] 1 Ch
77 the court set aside a share issue on the basis that this was done ‘simply and solely
for the purpose of retaining control in the hands of the existing directors’.
The Privy Council in Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821 subjected
the content of the duty to thorough scrutiny. The directors allotted shares to a
company which had made a takeover bid. The effect of the share issue was to reduce
the majority holding of two other shareholders, who had made a rival bid, from 55 to
36 per cent. The two shareholders sought a declaration that the share allotment was
invalid as being an improper exercise of power. The directors argued, however, that
the allotment was made primarily in order to obtain much needed capital for the
company. It was held that the directors had improperly exercised their powers:
it must be unconstitutional for directors to use their fiduciary powers over the shares in
the company purely for the purpose 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
company’s constitution which is separate from and set against their powers.
Lord Wilberforce stressed that the court must examine the substantial purpose for
which a power is exercised and must reach a conclusion as to whether that purpose
was proper or not (see also Extrasure Travel Insurances Ltd v Scattergood; Criterion
Properties plc v Stratford UK Properties LLC [2003] BCC 50).
The power to issue shares may be exercised for reasons other than the raising of
capital provided ‘those reasons relate to a purpose benefiting 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’ (Harlowe’s Nominees
Pty Ltd v Woodside (Lake Entrance) Oil Co (1968) CLR 483). Further, it has been held that
it may be in the company’s interest for directors to forestall a resolution accepting
a takeover offer by issuing shares. In Teck Corporation Ltd v Millar [1972] 33 DLR (3d)
288 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 stressed that, provided the
directors act in good faith, they are entitled to consider the reputation, experience
and policies of anyone seeking to take over the company and to use their power to
protect the company if they decide, on reasonable grounds, that a takeover will cause
substantial damage to the company.
See further, Criterion Properties plc v Stratford UK Properties LLC [2004] UKHL 28; West
Coast Capital (Lios) Limited [2008] CSOH 72; Eclairs Group Ltd v JKX Oil and Gas plc [2013]
EWCA Civ 640.
Activity 15.2
Read Lord Wilberforce’s opinion delivered in Howard Smith Ltd v Ampol Petroleum
Ltd [1974] AC 821.
What steps should the court go through when determining whether or not an
exercise of power by directors was for an improper purpose?
Summary
The proper purposes doctrine restated in s.171 is an incident of the central fiduciary
duty of directors to promote the success of the company (s.172, see Section 15.2.2).
The power of directors to issue shares (ss.549-551 CA 2006), may be exercised for
reasons other than the raising of capital provided those reasons relate to a purpose
benefiting the company as a whole.
15.2.2 Duty to promote the success of the company, s.172

Section 172 reasserts the notion of the primacy of shareholders while recognising that
well-managed companies operate on the basis of ‘enlightened shareholder value’
(see Developing the Framework (URN 00/656, Department of Trade and Industry (DTI),
2000), paras 2.19–2.22; and Completing the Structure (URN 00/1335, DTI, 2000), para
3.5). According to this approach, directors, while ultimately required to promote
shareholder interests, must take account of the factors affecting the company’s
relationships and performance.
This duty has two elements. First, a director must act in the way he or she considers,
in good faith, would be most likely to promote the success of the company for the
benefit of its members as a whole. Secondly, in doing so, the director should have †
This non-interventionist
regard (among other matters) to the factors listed in s.172(1). This list is not exhaustive,
policy (the internal
but highlights areas of particular importance which reflect wider expectations of
management rule) was
responsible business behaviour.
explained by Lord Eldon
The question of what will promote the success of the company is one for the director’s LC in Carlen v Drury (1812)
good faith judgment. This aligns the duty with the position long taken by the courts 1 Ves & B 154, who said:
that, as a general rule, their role is not to interfere in the internal management of ‘This Court is not required
companies. The orthodoxy here is that the management of companies is best left to on every Occasion to take
the judgment of their directors, subject to the good faith requirement.† In discharging the Management of every
Playhouse and Brewhouse in
the Kingdom.’
this duty and, more particularly, in taking account of the factors listed in subsection
(1), directors are bound to exercise reasonable care, skill, and diligence (s.174, see 15.2.4
below).
A director will, therefore, need to demonstrate that the stakeholder interests listed
informed his or her deliberations. In this regard, it is noteworthy that the requirement
for a ‘strategic report’ set out in s.414A CA 2006 (though not applying to small
companies) specifies, in s.414C, that its purpose ‘is to inform members of the company
and help them assess how the directors have performed their duty under section
172…’.
Section 172(1) restates Lord Greene MR’s formulation of the duty in Re Smith & Fawcett
Ltd:
directors must exercise their discretion bona fide in what they consider – not what a court
may consider – is in the interests of the company…
In Item Software (UK) Ltd v Fassihi [2005] 2 BCLC 91, Arden LJ, having noted that ‘the
fundamental duty [of a director]… is the duty to act in what he in good faith considers
to be the best interests of his company’, concluded that this duty of loyalty is the
‘time-honoured’ rule (citing Goulding J in Mutual Life Insurance Co of New York v Rank
Organisation Ltd [1985] BCLC 11).
The determination of good faith is partly subjective in that the court will not substitute
its own view about a director’s conduct in place of the board’s own judgment. In
Regentcrest plc v Cohen [2001] 2 BCLC 80, Jonathan Parker J observed ‘the question is
whether the director honestly believed that his act or omission was in the interests
of the company. The issue, therefore, relates to the director’s state of mind’ (see
also, Extrasure Travel Insurances Ltd v Scattergood (above)). However, in determining
whether the duty has been discharged an objective assessment is also made. In
Charterbridge Corporation Ltd v Lloyd’s Bank Ltd [1970] Ch 62, 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 company concerned,
could, in the whole of the existing circumstances, have reasonably believed that the
transactions were for the benefit of the company.’ Thus, in Neptune (Vehicle Washing
Equipment) Ltd v Fitzgerald (No.2) [1995] BCC 1000, the company’s sole director resolved
at a board meeting in which he and the company secretary were the only attendees,
that his service contract should be terminated and that £100,892 be paid to him as
compensation. It was held that he was not acting in what he honestly and genuinely
considered to be in the best interests of the company but rather was acting exclusively
to further his own personal interests.
(See also Knight v Frost [1999] 1 BCLC 364; Ball v Eden Project Ltd [2002] 1 BCLC 313, Laddie
J; Item Software (UK) Ltd v Fassihi [2004] EWCA Civ 1244; Re Southern Counties Fresh Foods
Ltd [2009] EWHC 1362 (Ch) and R (on the application of People & Planet) v HM Treasury
[2009] EWHC 3020 (Admin).)
Sections 172 and 414A–D CA 2006: the strategic report

Directors are now required, for each financial year of the company, to prepare a ‘strategic
report’ of the company’s business and operations: see s.414A–D CA 2006. It replaces the
‘business review’, which was previously required under s.417. The strategic report is a
narrative report of the company’s business activities designed to flesh out the figures
contained in the accounts. It must contain ‘a fair review of the company’s business’ and
‘a description of the principal risks and uncertainties facing the company’. It must also
include information about ‘environmental matters, the company’s employees, social,
community and human rights issues and information about the policies of the company
in relation to these matters and the effectiveness of those policies’.
The statutory objective of the strategic report is laid down in s.414C. It provides that:
The purpose of the strategic report is to inform members of the company and help them
assess how the directors have performed their duty under section 172.
It is therefore made clear that the review is an integral part of the duty of loyalty.
In informing the members about the directors’ performance of this duty, s.414C
states that the review must give a balanced and comprehensive analysis using key
performance indicators (KPIs) relating to financial, environmental and employee
matters. Although the particular KPIs used are left to the discretion of the directors,
they must be effective in measuring the development, performance or position of the
business. Moreover, s.414CZA now requires the strategic report to include a statement
that ‘describes how the directors have had regard to the matters set out in section
172(1)(a) to (f) when performing their duty under section 172’.
Insolvency and creditors – s.172(3)

Note that s.172(3) states that the duty to promote the success of the company has
effect subject to any rule of law requiring directors to act in the interests of creditors.
In this respect English and Australian courts have reasoned that where a company is
insolvent directors must have regard to the interests of the creditors. In West Mercia
Safetywear Ltd v Dodd [1988] BCLC 250 the Court of Appeal, citing with approval the
decision of the New South Wales Court of Appeal in Kinsela v Russell Kinsela Pty Ltd
(1986) 10 ACLR 395, held that shareholders cannot absolve directors from a breach of
duty to creditors so as to bar the liquidator’s claim. In Dillon LJ’s view the following
passage from Street CJ’s judgment in Kinsela was of particular note.
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 liquidation, to displace the
power of the shareholders and directors to deal with the company’s 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...
The recognition of the existence of directors’ duties to creditors has received the
endorsement of the House of Lords. In Winkworth v Edward Baron Development Co Ltd
[1986] 1 WLR 1512, Lord Templeman explained that directors owe a fiduciary duty to the
company and its creditors, present and future, to ensure that its affairs are properly
administered and to keep the company’s ‘property inviolate and available for the
repayment of its debts’ (see also, Lonhro Ltd v Shell Petroleum Co Ltd [1980] 1 WLR 627 HL,
at 634 per Lord Diplock).
The duty is to consider the interests of creditors as a general class; it is not to consider
the interests of any specific creditor above others: see GHLM Trading Ltd v Maroo [2012]
EWHC 61 (Ch). See also Re HLC Environmental Projects Ltd [2013] EWHC 2876 (Ch).
One remaining uncertainty is when exactly directors are obliged, under s.172, to
consider, or even prioritise, the interests of creditors. In Dickinson v NAL Realisations
(Staffordshire) Ltd [2017] EWHC 28 (Ch), the High Court refused to say precisely when
this obligation starts, but noted that it did not arise merely because ‘there is a
recognised risk of adverse events that would lead to insolvency’.
In Wessely v White [2018] EWHC 1499 (Ch), the court accepted that the duty to prioritise
the interests of creditors was still a ‘subjective one’. If a director does what she
concludes is best for creditors then she will not be in breach of s.172, even if she is
negligent in reaching that conclusion (although that negligence may mean she is
liable for breach of her duty of care and skill under s.174).
Standing to sue
The question of standing to sue to enforce this duty (locus standi) arose in Yukong Line
Ltd of Korea v Rendsburg Investment Corpn of Liberia (No.2) [1998] 2 BCLC 485 in which it
was pointed out that creditors have no standing, individually or collectively, to bring
an action in respect of any such duty. Toulson J held that a director of an insolvent
company who, in breach of duty to the company, transferred assets beyond the reach
of its creditors owed no corresponding fiduciary duty to an individual creditor of the
company. The appropriate means of redress was for the liquidator to bring an action
for misfeasance (s.212 Insolvency Act 1986).
Notwithstanding the logistical issue of locus standi raised by Toulson J, the question of
directors’ duties to creditors again emerged in two recent decisions of the Companies
Court. In Re Pantone 485 Ltd [2002] 1 BCLC 266, 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 company for
the purposes of the directors’ fiduciary duties is the company’s creditors as a whole, i.e. its
general creditors. It follows that if the directors act consistently with the interests of the
general creditors but inconsistently with the interest 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.
Again, in Colin Gwyer and Associates Ltd v London Wharf (Limehouse) Ltd [2003] 2 BCLC
153, 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 resolution.
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 company’s interests,
must have regard to the interests of the creditors. The court was required to test the
directors’ conduct by reference to the Charterbridge Corp Ltd v Lloyd’s Bank Ltd [1970]
Ch 62 test (i.e. ‘could an honest and intelligent man, in the position of the directors, in
all the circumstances, reasonably have believed that the decision was for the benefit
of the company’). In the case of insolvent companies the test is to be applied with the
benefit of the creditors substituted for the benefit of the company.
Section 172(3) also makes express reference to ‘any enactment’. In this respect, it
should be noted that Section 214 of the Insolvency Act 1986 provides that a liquidator
of a company in insolvent liquidation can apply to the court to have a person who
is or has been a director of the company declared personally liable to make such
contribution to the company’s assets as the court thinks proper for the benefit of the
unsecured creditors. The liquidator must prove that the director in question allowed
the company to continue to trade, at some time before the commencement of its
winding up, when he knew or ought to have concluded that there was no reasonable
prospect that the company would avoid going into insolvent liquidation.
Activity 15.3
Read Extrasure Travel Insurances Ltd v Scattergood [2002] All ER (D) 307 (Jul), Ch D.
Where a company is a member of a group, in whose interests should the directors act?
15.2.3 Duty to exercise independent judgment, s.173

Section 173 provides the following.
(1) A director of a company must exercise independent judgment.
(2) This duty is not infringed by his acting—
(a) in accordance with an agreement duly entered into by the company that restricts
the future exercise of discretion by its directors, or
(b) in a way authorised by the company’s constitution.
This provision restates the principle developed in the case law that directors must
exercise their powers independently and not subordinate their powers to the control
of others by, for example, contracting with a third party as to how a particular discretion
conferred by the articles will be exercised. This is a facet of the duty to promote the
success of the company laid down in Section 172. Directors are not permitted to delegate
their powers unless the company’s constitution provides otherwise.
The duty operates so as to prohibit directors fettering their discretion by contracting

with an outsider as to how a particular discretion conferred by the articles will be
exercised except, possibly, where this is to the company’s commercial benefit.
In Fulham Football Club Ltd v Cabra Estates plc [1994] BCLC 363, four directors of Fulham
football club agreed with Cabra, the club’s landlords, that they would support Cabra’s
planning application for the future development of the club’s ground rather than the
plan put forward by the local authority. In return for this undertaking, Cabra paid the
football club a substantial fee. The directors subsequently decided to renege on this
promise and wanted to give evidence to a planning enquiry opposing the development.
They argued that their agreement with Cabra was an unlawful fetter on their powers to
act in the best interests of the company. The Court of Appeal rejected this argument.
It was held that:
u the agreement with the landlords was part of a contract that conferred significant
benefits on the company
u the directors, in giving their undertaking to Cabra, had not improperly fettered the
future exercise of their discretion.
In fact, it was not a case of directors fettering their discretion because they had exercised
it at the time they gave their undertaking. The Court drew a distinction between:
u directors fettering their discretion, which is a clear breach of duty
u directors exercising their discretion in a manner which restricts their future

conduct; this is not a breach of duty.
Neil LJ endorsed the view of Kitto J in the Australian case Thornby v Goldberg (1964) 112
CLR 597 stating:
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 fide of opinion that it
is in the interests of the company that the transaction should be entered into and carried
into effect I see no reason in law why they should not bind themselves.
15.2.4 Duty to exercise reasonable care, skill and diligence, s.174

Section 174 gives statutory effect to the modern judicial stance taken towards the
determination of the standard of care expected of directors. It provides the following.
A director of a company must exercise reasonable care, skill and diligence.
This means the care, skill and diligence that would be exercised by a reasonably diligent
person with—
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
the general knowledge, skill and experience that the director has.
In Re D’Jan of London Ltd [1993] BCC 646, Hoffmann LJ, applying s.214(4) of the Insolvency
Act 1986, held the director negligent and prima facie liable to the company for losses
caused as a result of its insurers repudiating a fire policy for non-disclosure. The
director had signed the inaccurate proposal form without first reading it.
The effect of s.174 is that a director’s actions will be measured against the conduct
expected of a reasonably diligent person. This is therefore an objective test. However,
subjective considerations will also apply according to the level of any special skills the
particular director may possess.
The focus on objective assessment can also be seen in cases brought under the
Company Directors Disqualification Act 1986 (see Chapter 14, above), particularly in
relation to where directors delegate their powers. Inactivity on the part of directors is
no longer acceptable. Therefore little weight is given to any contention to the effect
that the director was unaware of a state of affairs because he had trusted others to
manage the company (see Re Landhurst Leasing plc [1999] 1 BCLC 286).
Thus, a director cannot take a passive role in the management of the company.
This is also the case in small private owner-managed companies (termed quasi-
partnerships) where a spouse or son or daughter may assume the role of director
without ever expecting to play a proactive part in the affairs of the company. In Re
Brian D Pierson (Contractors) Ltd [2001] 1 BCLC 275 the court refused to countenance
such symbolic roles:
The office of director has certain minimum responsibilities and functions, which are
not simply discharged by leaving all management functions, and consideration of the
company’s affairs to another director without question, even in the case of a family
company… One cannot be a ‘sleeping’ director; the function of ‘directing’ on its own
requires some consideration of the company’s affairs to be exercised.
Further, in Re Westmid Packing Services Ltd, Secretary of State for Trade and Industry v
Griffiths [1998] 2 BCLC 646, Lord Woolf stated that:
The collegiate or collective responsibility of the board of directors of a company is of

fundamental importance to corporate governance under English company law. That
collegiate or collective responsibility must however be based on individual responsibility.
Each individual director owes duties to the company to inform himself about its affairs
and to join with his co-directors in supervising or controlling them.
Similar observations about this ‘core’ responsibility of directors to play a role in

overseeing the management of the company were also expressed in Dorchester
Finance Co Ltd v Stebbing [1989] BCLC 498, Lexi Holdings plc (in administration) v Luqman
[2009] EWCA Civ 117 and again in Raithatha v Baig [2017] EWHC 2059 (Ch).
Activity 15.4
Read Foster J’s judgment in Dorchester Finance v Stebbing [1989] BCLC 498. Were the
non-executive directors (NEDs) held liable for signing blank cheques and leaving
them with Stebbings, the executive director? Was a lower standard of care required
of two of the defendants because they were NEDs? Was the fact that they were
qualified accountants material?
15.2.5 Duty to avoid conflicts of interest, s.175

Section 175 replaces the equitable obligation to avoid conflicts of interest whereby
directors are liable to account for any profit made personally in circumstances where
their interests may conflict with their duty owed to the company.
The substance of this duty is strict. This is reflected in the language of s.175(1), in that it
is framed in terms of the possibility of conflict rather than actual conflicts of interest.
A director of a company must avoid a situation in which he has or can have, a direct or
indirect interest that conflicts, or possibly may conflict, with the interests of the company.
This encompasses the significant body of case law spanning over a century or so
which the provision codifies. See Re Lands Allotment Co [1894] 1 Ch 616 and JJ Harrison
(Properties) Ltd v Harrison [2002] 1 BCLC 162, confirming that a director holds the
proceeds made from a breach of fiduciary duty as a constructive trustee.
The fundamental objective of the duty to avoid conflicts of interest is aimed at curbing
any temptation directors may succumb to when faced with the opportunity of
preferring their own interests over and above those of the company’s. As explained by
Lord Herschell in Bray v Ford [1896] AC 44:
It is an inflexible rule of a court of equity that a person in a fiduciary position… is not,

unless otherwise expressly provided,… allowed to put himself in a position where his
interest and duty conflict. It does not appear to me that this rule is… founded upon
principles of morality. I regard it rather as based on the consideration that, human nature
being what it is, there is a danger, in such circumstances, of the person holding a fiduciary
position being swayed by interest rather than by duty, and thus prejudicing those whom
he was bound to protect.
A modern formulation of this duty was delivered by Millett LJ in Bristol and West
Building Society v Mothew [1998] Ch 1:
The distinguishing obligation of a fiduciary is the obligation of loyalty. The principal is

entitled to the single-minded loyalty of his beneficiary. This core liability has several
facets. A fiduciary must act in good faith; he must not make a profit out of his trust; he
must not place himself in a position where his duty and his interest may conflict...
The classic decision on this aspect of the fiduciary obligation is Regal (Hastings) Ltd v
Gulliver [1942] 1 All ER 378, [1967] 2 AC 134n. Regal owned a cinema and its directors wished
to acquire two additional local cinemas and sell the whole undertaking as a going
concern. They formed a subsidiary company in order to take a lease of the other two
cinemas but the landlord was not prepared to grant the subsidiary a lease on these two
cinemas unless the subsidiary’s paid-up capital was £5,000. The company was unable to
inject more than £2,000 in cash for 2,000 shares and so the original arrangement 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
business was sold by way of takeover and the directors made a profit. The purchasers of
Regal installed a new board of directors and the company successfully brought an action
against its former directors claiming that they should account for the profit they had
made on the sale of their shares in the subsidiary.
Lord Russell of Killowen stated that the opportunity and special knowledge to obtain
the shares had come to the directors qua fiduciaries ‘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 office, are accountable for the profits which they have made out of
them.’ Lord Russell went on to add that:
the rule of equity which insists on those, who by use of a fiduciary position make a
profit, being liable to account for that profit, in no way depends on fraud, or absence of
bona fides; or upon such questions or considerations as whether profit would or should
otherwise have gone to the plaintiff…
The liability arises from the mere fact of a profit having, in the stated circumstances,
been made.
Corporate opportunities
An incident of the duty to avoid a conflict of interests is the so-called corporate
opportunity doctrine. This ‘makes it a breach of fiduciary duty by a director to
appropriate for his own benefit an economic opportunity which is considered to
belong rightly to the company which he serves’ (Prentice, [1974] MLR 464).
A corporate opportunity is viewed as an asset of the company which may not

therefore be misappropriated by the directors. In Cook v Deeks [1916] 1 AC 554, three of
the four directors diverted to their own personal benefit certain railway construction
contracts which were offered to the company. Notwithstanding that their conduct
was ratified by the company, the directors were held accountable. Lord Buckmaster
said that the directors, ‘while entrusted with the conduct of the affairs of the company
[had] deliberately designed to exclude, and used their influence and position to
exclude, the company whose interest it was their first duty to protect.’
The distinction between Regal (Hastings) where ratification was a possibility and Cook
v Deeks in which the Privy Council ruled out the question of ratification as a means of
avoiding liability is not easy to discern. The answer probably lies in the fact that in the
decision for Cook v Deeks the directors were fraudulent. In Regal (Hastings) the House
of Lords accepted that the directors acted in good faith.
In Industrial Development Consultants Ltd v Cooley [1972] 1 WLR 443, 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. The 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 offer to the company. However, he
promptly resigned his office so that he could take up the contract after deceiving the
company into thinking he was suffering from ill health.
Roskill J held that he was accountable to the company for all of the profits he received
under the contract. Information which came to Cooley while he was managing
director and which was of concern to the plaintiffs and relevant for the plaintiffs
to know, was information which it was his duty to pass on to the plaintiffs. 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 profit as a result of
having deliberately put himself into a position in which his duty to the plaintiffs who were
employing him and his personal interests conflicted.
See also Bhullar v Bhullar, Re Bhullar Bros Ltd [2003] EWCA 424; Gwembe Valley
Development Co Ltd v Koshy [2003] EWCA Civ 1478.
One issue that arises is whether a director is only liable if the opportunity that they
take for their own benefit falls within the ‘existing scope’ of the company’s own
business. The case of O’Donnell v Shanahan [2009] EWCA Civ 751 suggests that it does
not need to do so. A director was liable when he made a personal profit from pursuing
an opportunity that he learned about as a director, to acquire certain property. The
company had not engaged in property acquisition (its business being restricted to
providing advice and assistance to others). The director was nevertheless held liable.
On post-resignation breaches (s.175(4)) see Foster Bryant Surveying Ltd v Bryant [2007]
EWCA Civ 200. In this regard in Peso Silver Mines v Cropper [1966] 58 DLR (2d) 1, the board
of Peso was offered the opportunity to buy a number of mining claims. Some of these
were located on land which adjoined the company’s own mining territories. The board
bona fide declined the offer because:
u of the then financial state of the company
u there was some doubt over the value of the claims.
Later, the company’s geologist formed a syndicate with the defendant and two other
Peso directors to purchase and work the claims. When the company was taken over,
the new board (as in Regal (Hastings)) brought an action claiming that the defendant
held his shares on constructive trust for the company. The claim was unsuccessful. It
was held that the decision of the directors to reject the opportunity had been made in
good faith and for sound commercial reasons in the interests of the company.
See also, Laskin J’s approach towards the issue of determining liability in Canadian Aero
Service Ltd v O’Malley [1973] 40 DLR (3d) 371.
Recent decisions have made it clear that the general fiduciary obligations of a director
do not prevent him from:
u making the decision, while still a director, to set up in a competing business after
his directorship has ceased
u taking some preliminary steps to investigate or forward that intention provided he

did not engage in any competitive activity while his directorship continued.
In this regard, see:
u Island Export Finance Ltd v Umunna [1986] BCLC 460
u Balston Ltd v Headline Filters Ltd [1990] FSR 385
u Framlington Group plc v Anderson [1995] 1 BCLC 475
u Coleman Taymar Ltd v Oakes [2001] 2 BCLC 749
u British Midland Tool v Midland International Tooling [2003] EWHC 466.
A director may utilise confidential information or ‘know-how’ acquired while working

for the company after he departs but not ‘trade secrets’ (see Dranez Anstalt v Hayek
[2002] 1 BCLC 693; CMS Dolphin Ltd v Simonet [2001] 2 BCLC 704). They may also use the
‘general fund of skill and knowledge’ they have developed in the role of director: see
Thermascan Ltd v Norman [2011] BCC 535.
It is worth noting that s.175(4)(a) recognises that unexpected situations can arise where
a conflict exists, but that conflict alone does not necessarily constitute a breach by
directors. As explained by Lord Goldsmith (see Official Report, 6/2/2006; coll GC289):
Once you know that you are now in a situation of conflict, you will have to do something
about it, but you are not in breach simply because it happened when, as is set out in
subsection (4)(a), it could not, ‘reasonably be regarded as likely to give rise to’ the conflict.
Competing directorships: conflicts of interest and duty and conflicts of duties
Section 175(7) states that ‘any reference in this section to a conflict of interest includes
a conflict of interest and duty and a conflict of duties.’ This 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 and Mashonaland Co Ltd v
New Mashonaland Exploration Co Ltd [1891] WN 165 in which it was held that no breach of
duty arose where a director held office with two or more competing companies.
The modern courts have adopted a stricter stance in viewing competing directors as
giving rise to an irreconcilable conflict of interest and duty. See SCWS v Meyer [1959] AC
324, where Lord Denning said that such directors walk a very fine line, and Plus Group
Ltd v Pyke [2002] EWCA Civ 370. See also Bell v Lever Bros Ltd [1932] AC 161, HL; Hivac Ltd v
Park Royal Scientific Instruments Ltd [1946] Ch 169.
Thus, s.175(7) brings competing directorships into the general prohibition of conflicts
of duty.
Avoiding liability for conflicts of duty: authorisation by the directors – s.175(5)

A major concern expressed by the Company Law Review was that the case law on
conflicts of duty holds the potential to ‘fetter entrepreneurial and business 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’ (Completing the Structure). The 2005 White Paper echoes this concern by stating that it
is important that the duties do not impose impractical and onerous requirements which
stifle entrepreneurial activity (at para 3.26). Section 175(5)(a) therefore implements the
CLRSG’s recommendation that conflicts may be authorised by independent directors
unless, in the case of a private company, its constitution otherwise provides. For a public
company the directors will only be able to authorise such conflicts if its constitution
expressly permits (s.175(5)(b)). Further, s.175(6) provides that board authorisation
is effective only if the conflicted directors have not participated in the taking of the
decision or if the decision would have been valid even without the participation of the
conflicted directors. The votes of the conflicted directors in favour of the decision will be
ignored and the conflicted directors are not counted in the quorum.
Self-dealing directors: ss.175(3) and 177 CA 2006

The underlying rationale of the self-dealing rule, which prohibits a director from being
interested in a transaction to which the company was a party, was explained by the
House of Lords in Aberdeen Rly Co v Blaikie Bros (1854) 1 Macq 461. The company had
contracted with John Blaikie for the supply of iron chairs. At the time of the contract
John Blaikie was both a director of Aberdeen Railway and a partner of Blaikie Bros. Lord
Cranworth LC, having stated that ‘no-one, having [fiduciary] duties to discharge, shall
be allowed to enter into engagements in which he has, or can have, a personal interest
conflicting, or which possibly may conflict, with the interests of those whom he is
bound to protect’, went on to stress that:
his duty to the company imposed on him the obligation of obtaining these iron chairs
at the lowest possible price. His personal interest would lead him in an entirely opposite
direction, would induce him to fix the price as high as possible. This is the very evil against
which the rule in question is directed.
In a similar vein Megarry VC observed in Tito v Waddell (No.2) [1977] Ch 106:
The self-dealing rule is (to put it very shortly) that if a trustee sells the trust property
to himself, the sale is voidable by any beneficiary ex debito justitiae, however fair the
transaction.... [E]quity is astute to prevent a trustee from abusing his position or profiting
from his trust: the shepherd must not become a wolf.
See also, the joint judgment of Rich, Dixon and Evatt JJ in Furs Ltd v Tomkies (1936) 54
CLR 583.
It is noteworthy that the statutory statement of directors’ duties does not follow the
common law position. Self-dealing is removed from the realms of directors’ fiduciary
duties and replaced with a statutory obligation to disclose an interest. Section 175(3)
makes it clear that the duty to avoid conflicts of interest contained in s.175(1) ‘does not
apply to a conflict of interest arising in relation to a transaction or arrangement with
the company.’ Rather, ‘self-dealing’ falls within s.177(1). This provides that: ‘[i]f a director
is in any way, directly or indirectly, interested in a proposed transaction or arrangement
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 after it ‘has been entered into by the company.’ The provisions do not apply
to substantial property transactions, loans, quasi-loans and credit transactions which
require the approval of the company’s members (ss.190–203, see Section 15.3).
Sections 177 and 182 reflect the common practice that companies’ articles of
association generally permitted directors to have interests in conflict transactions
provided they were declared to the board. The reason why the common law tolerated
such relaxation of the rule was explained by Upjohn LJ in Boulting v Association of
Cinematograph Television and Allied Technicians [1963] 2 QB 606:
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 interested on the other
side of the fence. Directors... may sometimes be placed in such a position that though
their interest and duty conflict, 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
benefit 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.
The 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 criminal sanctions
(s.183). More particularly, s.178 states that the consequences of breach (or threatened
breach) of ss.171–177 are the same as would apply if the corresponding common law
rule or equitable principle applied. This is subject to the proviso introduced by s.180(1)
that, subject to any provision to the contrary in the company’s 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.
The question has arisen as to whether disclosure has to be made at a formal meeting
of the board. In Lee Panavision Ltd v Lee Lighting Ltd [1992] BCLC 22 and Runciman v Walter
Runciman plc [1992] BCLC 1084 it was held that informal disclosure to all members of the
board would suffice. In MacPherson v European Strategic Bureau Ltd [1999] 2 BCLC 203 each
of the shareholders and the directors knew the precise nature of other’s interest so that
there was, in effect, unanimous approval of the agreement. The court therefore held that:
[n]o amount of formal disclosure by each other to the other would have increased the
other’s relevant knowledge.
However it should be noted that the board has to be given precise information about
the transaction in question (Gwembe Valley Development Co Ltd v Koshy [2000] BCC 1127),
affirmed by the Court of Appeal [2003] EWCA Civ 1478.
15.2.6 Duty not to accept benefits from third parties, s.176

Section 176(1) provides that a director must not accept a benefit from a third party
conferred by reason of:
a. his being a director, or
b. his doing (or not doing) anything as director.
This duty is an element of the wider no-conflict duty laid down in s.175 and it too will
not be infringed if acceptance of the benefit cannot reasonably be regarded as likely
to give rise to a conflict of interest. It should be noted that it applies only to benefits
conferred because the director is a director of the company or because of something
that the director does or does not do as director.
The word ‘benefit’, for the purpose of this section, is not defined in the Act although
during the Parliamentary debates on the Bill it was made clear that it includes benefits
of any description, including non-financial benefits (Official Report, 9/2/2006; coll GC330
(Lord Goldsmith)). While s.175(5) provides for board authorisation in respect of conflicts
of interest, this is not the case with this particular duty. However, the company may
authorise the acceptance of benefits by virtue of s.180(4). Section 176(2) defines a ‘third
party’ as a person other than the company or its holding company or its subsidiaries and
thus s.176(3) provides that benefits provided by the company fall outside the prohibition.
15.2.7 Remedies for breach of duties

Section 178 CA 2006 preserves the existing civil consequences of breach (or threatened
breach) of any of the general duties. Although an attempt was made to codify the
remedies available for breach of directors’ duties, this proved to be a very difficult
exercise and eventually it became ‘too difficult to pursue’. It provides:
1. the consequences of breach (or threatened breach) of Sections 171 to 177 are the
same as would apply if the corresponding common law rule or equitable principle
applied
2. the duties in those sections (with the exception of Section 174 (duty to exercise
reasonable care, skill and diligence)) are, accordingly, enforceable in the same way
as any other fiduciary duty owed to a company by its directors.
In the case of fiduciary duties the consequences of breach may include:
u damages or compensation where the company has suffered loss (see Re Lands
Allotment Co [1894] 1 Ch 616, CA; Joint Stock Discount Co v Brown (1869) LR 8 Eq 381)
u restoration of the company’s property (see Re Forest of Dean Coal Co (1879) 10 Ch D

450; JJ Harrison (Properties) Ltd v Harrison [2002] 1 BCLC 162, CA)
u an account of profits made by the director (see Regal (Hastings) Ltd v Gulliver)
u injunction or declaration (see Cranleigh Precision Engineering Ltd v Bryant [1965] 1

WLR 1293)
u rescission of a contract where the director failed to disclose an interest (see Transvaal
Lands Co v New Belgium (Transvaal) Land & Development Co [1914] 2 Ch 488, CA).
Presumably the rules developed for establishing the liability of accessories (for
example, in the case of receipt of property pursuant to a breach of fiduciary duty, or
dishonest assistance of such a breach) will be applied notwithstanding that the breach
may be of a duty which is now statutorily defined and imposed.
The liability to account arises even where the director acted honestly and where the
company could not otherwise have obtained the benefit (Regal (Hastings) Ltd v Gulliver;
IDC v Cooley). In Murad v Al-Saraj [2005] EWCA Civ 959, 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 fiduciary 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 beneficial ownership and control and the shareholders (who may be
numerous and only have small numbers of shares) or beneficial 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 efficiency and to provide an incentive to fiduciaries to
resist the temptation to misconduct themselves, the law imposes exacting standards on
fiduciaries and an extensive liability to account.
In Coleman Taymar Ltd v Oakes [2001] 2 BCLC 749, Robert Reid QC, sitting as a Deputy
Judge of the High Court, stated that a company is entitled to elect whether to claim
u damages (equitable compensation)
u or an account of profits against a director who, in breach of duty, makes a secret

profit.
However, even though the profit may arise out of the use of position as opposed to
the use of trust property, the judges more typically resort to the language of the
‘constructive trust’ as the means for fashioning a remedy (see Boardman v Phipps [1967]
2 AC 46, although, Lord Guest excepted, all of their Lordships spoke of the defendant’s
liability to account).
In A-G for Hong Kong v Reid [1994] 1 AC 324, Lord Templeman explained that Boardman
‘demonstrates the strictness with which equity regards the conduct of a fiduciary
and the extent to which equity is willing to impose a constructive trust on property
obtained by a fiduciary by virtue of his office.’ In JJ Harrison (Properties) Ltd v Harrison
[2002] 1 BCLC 162, CA, a director usurped a corporate opportunity by acquiring for his
own benefit development land owned by the company. At the time of valuation he
failed to disclose that planning permission was forthcoming which, once granted,
would greatly inflate its value. The company, having unsuccessfully applied for
planning permission a couple of years earlier, was unaware that local authority policy
in this respect had changed. The 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 company’s resources, he then resold part of it for £110,300 in 1988 and the
rest in 1992 for £122,500. The director resigned and the company sought to hold him
liable as a constructive trustee. Chadwick LJ, citing Millett LJ in Paragon Finance plc v DB
Thakerar & Co (1999), said:
It follows… from the principle that directors who dispose of the company’s property in
breach of their fiduciary 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.
In the CMS Dolphin Ltd v Simonet, Lawrence Collins J subjected the issue of remedies
for diverting a corporate opportunity to detailed analysis. He held that S was a
constructive trustee of the profits referable to exploiting the corporate opportunity
and, in general, it made no difference whether the opportunity is first 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 v Deeks would have been in
any way different 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 benefit of the
contract to a new company.
The basis of a director’s liability in this situation is that, as seen in Cook v Deeks, the
opportunity in question is treated as if it were an asset of the company in relation to
which the director had fiduciary duties. He thus becomes a constructive trustee ‘of
the fruits of his abuse of the company’s property’ (per Lawrence Collins J, above).
Activity 15.5
Read Regal (Hastings) Ltd v Gulliver [1942] 1 All ER 378, [1967] 2 AC 134n.
What is the basis of the liability of the directors in this case? Who brought the claim?
15.2.8 Consent, approval or authorisation by members

Certain transactions require the approval of the members of the company. These are
contained in Part 10, Chapter 4 of the CA 2006 and include:
u long-term service contracts (s.188)
u substantial property transactions (s.190)
u loans, quasi-loans and credit transactions (ss.197–214)
u payments for loss of office (ss.215–222).
The policy underlying the requirement of shareholder approval of these specified

transactions was explained by Carnwath J in British Racing Drivers’ Club Ltd v Hextall
Erskine & Co [1997] 1 BCLC 182. He stressed that the possibility of conflicts of interests
in these circumstances is such that there is a danger that the judgment of directors
may be distorted and so it ensures that ‘the matter will be... widely ventilated, and a
more objective decision reached.’ Section 180 thus sets out, in part, the relationship
between the general duties of directors and these more specific provisions contained
in Part 10, Chapter 4 of the Act.
Section 180(1) provides that if the requirement of authorisation is complied with for
the purposes of s.175 (see s.175(4) and (5), above), or if the director has declared to the
other directors his interest in a proposed transaction with the company under s.177,
these processes replace the equitable rule that required the members to authorise
such breaches of duty. This is made subject to any enactment (for example, the above
transactions contained in Chapter 4 of Part 10) or any provision in the company’s
articles which require the authorisation or approval of members.
Thus, the company’s constitution can reverse the statutory 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 approach – and therefore a change of approach to
the appropriate consequence of there not being members’ approval in particular cases
because it would no longer be required (see Official 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 CA 2006.
Further, s.180(2) provides that the general duties apply even though the transaction
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. Thus, 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 remuneration of the directors). It also
makes it clear that the company’s articles may not dilute the general duties except to
the extent that this is explicitly permitted. The effect of this provision seems to be that
interested members can vote on a resolution to approve a prospective breach of the
statutory duties, but cannot do so to ratify a breach after the event (s.239).
15.2.9 Ratification by members of a director’s breach of duty

Under the common law a director could avoid liability for breach of duty by disclosing
the breach to, and obtaining the consent of, by ordinary resolution, the company
in general meeting (see Regal Ltd v Gulliver [1967] 2 AC 134; and Gwembe Valley
Development Co Ltd v Koshy [2004] 1 BCLC 131). The Companies Act 2006 maintains
this rule, albeit subject to one major change. Section 239(1) states that the provision
applies to the ratification by a company of conduct by a director ‘amounting to
negligence, default, breach of duty or breach of trust in relation to the company.’
It thus extends the ratification process to all breaches of the duties set out in the
statutory restatement in Part 10 of the Act. The common law is modified by s.239(3)
and (4) which provide that the ratification is effective only if the votes of the director
in breach (and any member connected with him) are disregarded. The effect therefore
is to disenfranchise the defaulting director.
In North-West Transportation Co Ltd v Beatty (1887)) 12 App Cas 589 PC, it had been held
that the director could vote, qua shareholder, in favour of the resolution ratifying his
breach of duty. The reform follows the recommendation of the CLRSG which took the
view that the question of the validity of a decision by the members of the company
to ratify a wrong on the company by the directors (whether or not a fraud) should
depend on whether the necessary majority had been reached without the need to
rely upon the votes of the wrongdoers, or of those who were substantially under
their influence, or who had a personal interest in the condoning of the wrong. See DTI
Consultation Document (November 2000) Completing the structure para.5.85.
Section 239(6)(a) goes on to provide that nothing in the section affects the validity of a
decision taken by the unanimous consent of the members of the company. This
appears to mean that the restrictions on who may vote on a resolution, contained in
s.239(3)–(4), will not apply when every member, including the director qua
shareholder, agrees to condone the breach of duty. This places on a statutory footing
the common law principle that a breach of duty is ratifiable by obtaining the informal
†
approval of every member who has a right to vote on such a resolution.† See Re Duomatic Ltd [1969]
2 Ch 365; Parker & Cooper Ltd
15.2.10 Cases within more than one of the general duties v Reading [1926] Ch 975; EIC
Services Ltd v Phipps [2003]
The way in which the duties are framed results in an overlap between them. Section 1 WLR 2360; Euro Brokers
179 serves to emphasise that the effect of the duties is cumulative: Holdings Ltd v Monecor
(London) Ltd [2003] 1 BCLC
Except as otherwise provided, more than one of the general duties may apply in any given
506, CA.
case.
It is therefore necessary for directors to comply with every duty that may be triggered in
any given situation. For example, the duty to promote the success of the company (s.172)
will not authorise the director to breach his duty to act within his powers (s.171), even if
he considers that it would be most likely to promote the success of the company.
15.3 Relief from liability

Section 1157 CA 2006, replacing s.727 CA 1985, confers on the court the discretion to
relieve, in whole or in part, an officer of the company from liability for:
u negligence
u default
u breach of duty
u breach of trust.
This can occur in cases where it appears to the court that:
u the officer has acted honestly and reasonably
u having regard to all the circumstances of the case, he ought fairly to be excused on
such terms as the court thinks fit.
A classic illustration of the way the provision might be used is Re Welfab Engineers Ltd
[1990] BCLC 833. The directors of a company which had been trading at a loss sold its
main asset for the lower of two competing bids on the understanding that the company
would continue to be run as a going concern. Shortly afterwards the company went into
liquidation. 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 offer but,
even if they had, it was a case in which relief would be granted under s.1157. Hoffmann J
took the view that the directors were motivated by an honest and reasonable desire to
save the business and the jobs of the company’s employees.
Another example is Re D’Jan of London Ltd. You will recall that the director in
question incorrectly completed a proposal form for property insurance. The insurers
subsequently repudiated liability on the policy when the company claimed for fire
damage. The director had signed the proposal without reading it. Hoffmann 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 noted that he held 99 of the company’s
shares (his wife held the other). Therefore the economic reality was that the interests
the director had put at risk were those of himself and his wife. The judge observed
that 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. It
follows that conduct may be reasonable for the purposes of s.1157, despite amounting
to lack of reasonable care at common law.’
A final example where relief was granted is given by Hedger v Adams [2015] EWHC 2540
(Ch).
More often, however, the courts have been reluctant to give relief under s.1157.
In Re Duckwari plc (No.2) (above), the point was made obiter that a director who intends
to profit 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.
For a further illustration of the courts’ reluctance to give relief under s.1157, see
Towers v Premier Waste Management Ltd [2012] BCC 72. And see also: Re Brian D Pierson
(Contractors) Ltd [1999] BCC 26; Re Simmon Box (Diamonds) Ltd [2000] BCC 275; Bairstow
v Queens Moat Houses plc [2000] 1 BCLC 549.
Can a shadow director rely on s.1157? Instant Access Properties Ltd v Rosser [2018] EWHC
756 (Ch) suggests that, in a roundabout way, such a director can. The court held that a
shadow director ought not to be found to be in breach of duty in the first place where,
had she been a de jure or de facto director, she would have been relieved of liability
under s.1157.
15.4 Specific statutory duties

The CA 2006 carries over from the CA 1985 certain statutory duties originally designed
to deal with an increasing number of cases involving fraudulent asset stripping by
directors (HC Official Report, SC A, 2 July 1981, col 425).
15.4.1 Substantial property transactions

Sections 190–196, which replace ss.320–322 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 company’s members. A ‘substantial property transaction’
is defined as arising where the market value of the asset exceeds the lower of
£100,000 or 10 per cent of the company’s net asset value, if more than £5,000 (s.191).
The principal features of the regime are the following.
u It permits a company to enter into a contract which is conditional on member

approval. This implements a recommendation of the Law Commissions (s.190).
The company is not to be liable under the contract if member approval is not
forthcoming (s.190(3)).
u It provides for the aggregation of non-cash assets forming part of an arrangement

or series of arrangements for the purpose of determining whether the financial
thresholds have been exceeded so that member approval is required (s.190(5)).
u It excludes payments under directors’ service contracts and payments for loss
of office from the requirements of these clauses (s.190(6)). This implements a
recommendation of the Law Commissions.
u It provides an exception for companies in administration or those being wound up

(s.193).
In Re Duckwari plc [1997] 2 BCLC 713, the company had acquired a non-cash asset from
a person connected with one of its directors for £495,000. Four years later in 1993,
following the collapse of the property market, the property was valued for the purpose
of the proceedings at £90,000. It was no longer possible to avoid the transaction and
so the company sought an indemnity for its losses. It was held that irrespective of
whether the transaction is or can be avoided, the director or connected person and
any other director who authorised the transaction will be liable to account to the
company for any profit or loss sustained as a result of the breach of s.190 CA 2006 (see
Re Duckwari plc (No.2) [1999] Ch 253 and Re Duckwari plc (No.3) [1999] 1 BCLC 168).
15.4.2 Loans and guarantees

The regulation of loans by companies to their directors dates back to the Companies
Act 1948. It was severely tightened in the CA 1980 in order to address the growing
problem identified in a series of DTI investigations of directors secretly directing
money to themselves under the guise of loans from their companies on highly
favourable terms (see the White Paper, The Conduct of Company Directors (Cmnd
7037, 1977)). In contrast to the CA 1985, ss.197–214 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 transactions subject to the approval of the
company’s 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 affirmation. The requirement for members’
approval of loans applies to all UK registered companies with the exception of
‘wholly-owned’ subsidiaries (s.195(7)). The provisions relating to quasi-loans and credit
transactions apply only to public companies and associated companies (ss.198–203).
There are a number of exceptions to the requirement for members’ approval which
have been consolidated (see ss.204–209). These 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 transactions (s.208);
expenditure for money-lending companies (s.209).
The effect 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, regardless
of whether the company has elected to avoid the transaction, an arrangement or
transaction entered into in contravention of the provision renders the director
(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 transaction with a
person connected with him has a defence if he can show that he took all reasonable
steps to secure the company’s compliance with ss.200, 201 or 203.
The Act does not define ‘loan’, although s.199 does define the term ‘quasi-loan’ and
related expressions (see s.199).
Further reading
¢ Ahern, D. ‘Directors’ duties, dry ink and the accessibility agenda’ (2012) LQR 114.
¢ Ahern, D. ‘Nominee directors’ duty to promote the success of the company:

commercial pragmatism and legal orthodoxy’ (2011) 127 LQR 118.
¢ Conaglen, M. ‘The nature and function of fiduciary loyalty’ (2005) LQR 452.
¢ Davies, P. and J. Rickford ‘An introduction to the new UK Companies Act’ (2008)
ECFR 48.
¢ Davies and Worthington, Chapter 16: ‘Directors’ duties’ and Chapter 17: ‘The
derivative claim and personal actions against directors’.
¢ Developing Directors’ Duties (1999) CfiLR (special edition devoted to the Law
Commission’s report on directors’ duties (Nos 261 and 173) and the DTI’s
fundamental review of core company law).
¢ Edmunds, R. and J. Lowry ‘The continuing value of relief for directors’ breach of
duty’ (2003) MLR 195.
¢ Finch, V. ‘Creditor interests and director’s obligations’ in Sheikh, S. and W.

Rees Corporate governance & corporate control. (London: Cavendish, 1995)
[ISBN 9781874241485].
¢ Finch, V. ‘Company directors: who cares about skill and care?’ (1992) MLR 179.
¢ Grantham, R. ‘The unanimous consent rule in company law’ (1993) CLJ 245.
¢ Keay, A. ‘The duty of directors to take account of creditors’ interests: has it any
role to play?’ (2002) JBL 379.
¢ Keay, A. ‘The authorising of directors’ conflicts of interest: getting a balance?’

(2012) 12 J of Corp Law Studies 129.
¢ Law Commission and the Scottish Law Commission, Company Directors:

Regulating Conflicts of Interests And Formulating A Statement Of Duties (Nos 261
and 173, respectively).
¢ Lowry, J. ‘The irreducible core of the duty of care, skill and diligence of company
directors: Australian Securities and Investments Commission v Healey’ (2012) 79
MLR 249.
¢ Lowry, J. ‘Regal (Hastings) fifty years on: breaking the bonds of the ancien régime’
(1994) NILQ 1.
¢ Lowry, J. and R. Edmunds ‘The corporate opportunity doctrine: the shifting

boundaries of the duty and its remedies’ (1998) MLR 515.
¢ Lowry, J. ‘Self-dealing directors – constructing a regime of accountability’ (1997)

NILQ 211.
¢ Parker, H. ‘Directors’ duties under the Companies Act 2006: clarity or confusion?’
(2013) 13 J of Corporate L Studies 1.
¢ Payne, J. ‘A re-examination of ratification’ (1999) CLJ 604.
¢ Sealy, L. S. ‘“Bona fides” and “proper purposes” in corporate decisions’ (1989)

Monash Univ LR 265.
¢ West, L. ‘Challenging the “golden goodbye”’ (2009) JBL 447.
¢ Worthington, S. ‘Corporate governance: remedying and ratifying directors’

breaches’ (2000) LQR 638.
¢ Worthington, S. ‘Reforming directors’ duties’ (2001) MLR 439.
¢ White Paper: Modern Company Law For a Competitive Economy: Developing the
Framework, (2000) DTI, March.
¢ Yap, J.L. ‘Considering the enlightened shareholder value principle’ (2010) 31

Company Lawyer 35–38.

Arthur, Beatrice and Charles are the directors of Dynamic Development plc, a
company whose main objects are to engage in the business of computer software
development and ‘any other business which, in the opinion of the directors, is in
the interests of the company’.
In November 2016 the company was approached by Fred, a computer games
software designer, who wished to sell one-half of his interest in certain products
which he has designed but not yet launched on the market. At a meeting attended
by all three directors and Fred the possibility of such a joint venture was discussed
but rejected by the company on the grounds that, given the volatile nature of
consumer demand and the fast-changing nature of the computer games market,
the venture was too risky. In January 2017 Fred approached Arthur, Beatrice and
Charles with a view to obtaining their personal involvement in the venture. Arthur
declined but Beatrice and Charles accepted Fred’s invitation. They incorporated
a new company, Zenco Ltd, with Beatrice and Charles each holding one-half of
the issued share capital in the company; they were also its two directors. This
arrangement was not disclosed to Dynamic Development plc.
In April 2017 Dynamic Development plc was taken over by Pro-Computers plc and
Arthur, Beatrice and Charles were replaced by nominees of Pro-Computers. The
new board has now learned of the Zenco Ltd project and that the initial investment
made by Beatrice and Charles has tripled to £250,000.
Advise Dynamic Development plc.

You will need to begin with describing the restatement of the duties of directors in
Part 10 CA 2006 with particular reference to s.175 (duty to avoid conflicts of interests),
s.172 (duty to promote the success of the company), s.188 (remedies) and s.179
(cumulative effect of the restated duties).
The objective of the no-conflict duty was explained by Lord Herschell in Bray v Ford and
by Millett LJ in Bristol and West Building Society v Mothew. You should also state what
the consequences are of a breach of duty (i.e. the director’s liability to account for any
profits obtained (see s.178)). As Millett LJ points out, the core liability has several facets:
a director must not make a profit out of his trust and a director ‘must not place himself
in a position where his duty and his interest may conflict’.
The question requires a detailed analysis of s.175 and particularly Regal (Hastings) Ltd v
Gulliver, IDC v Cooley and Bhullar v Bhullar. In particular you should refer to the reasoning
of Lord Russell in Regal (Hastings) in which he reviews the basis of the directors’ liability
to account. With respect to the January 2017 approach by Fred you should note that in
Cooley the judge stressed that it was irrelevant to the issue of liability that the defendant
director had been approached in his personal capacity. Reference will also, however,
need to be made to Peso Silver Mines v Cropper where, on the particular facts of the case,
liability was avoided because it was held that the company had bona fide declined the
offer to buy the mining claims. You need to discuss whether the decision by Dynamic
Development plc not to join with Fred was reached in accordance with s.172 (duty to
promote the success of the company) or was it made in order to facilitate the defendant
directors pursuing the opportunity themselves. Here you will discuss Cook v Deeks, and
Bhullar v Bhullar. The fact that Arthur was a party to the board’s decision to reject Fred’s
offer, together with the fact that he declined Fred’s personal invitation might point to
the board’s decision being made in accordance with s.172. On the information you are
given it is difficult to reach a firm conclusion in this regard, but it is an issue that must be
addressed. You will also need to discuss s.175(5)(b) as the company is a plc.
You must reach a conclusion on the issue of liability. This shows the examiner that you
have thought about the issues. One final point in this regard: you should mention that
the claim is being brought by Dynamic Development plc because breach of fiduciary
duty is a wrong against the company (see Chapter 11 of the module guide) and the
proper claimant rule therefore applies (see now Part 11 of the CA 2006).
Finally, discuss s.1157 CA 2006. It is a belt and braces provision so that inevitably
defendant directors will argue for relief from liability. Note that the court may relieve
the defendants in whole or in part.
Reflect and review



first again
I can discuss the fiduciary position of directors.   
I can discuss the content and scope of the duties of

directors restated in Part 10 of the CA 2006.   
I can explain the authorisation process.   

I can describe the principal transactions with directors
that require the approval of members.   
I can explain the court’s discretion to relieve directors

from liability.   
I can describe the specific statutory duties of directors.   
revise?
Must Revision
revise done
15.1 Directors’ duties  
15.2 The restatement of directors’ duties: Part 10 of the  

CA 2006
15.3 Relief from liability  
15.4 Specific statutory duties  

16 Corporate governance
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 192
16.1 Introducing corporate governance . . . . . . . . . . . . . . . . . . . 193
16.2 The shareholder–stakeholder debate in the UK . . . . . . . . . . . . . 195
16.3 UK corporate governance developments . . . . . . . . . . . . . . . . 195

Introduction
This chapter examines the corporate governance debate in the UK. It is an extremely
important area. Students are not only expected to be up to date with current
corporate governance issues but are expected to have a detailed knowledge of the
history and theory that informs the corporate governance debate. This chapter
provides an overview but, as with other areas of this course, students need to engage
with the further reading to build up a detailed knowledge of this area.
Learning outcomes
u describe the main historical periods in the development of the modern company
u explain the various corporate theories that influence the corporate governance
debate
u illustrate the current trends in corporate governance writing
u form your own view of what the main purpose of a company should be.
Core text
¢ Dignam and Lowry, Chapter 15: ‘Corporate governance 1: corporate governance
and corporate theory’ and Chapter 16: ‘Corporate governance 2: the UK
corporate governance debate’.
Company Law 16 Corporate governance page 193
16.1 Introducing corporate governance

Corporate governance is a somewhat flexible term. It covers a wide range of academic
literature, from the debate as to who should own and control the corporation
(shareholders or stakeholders such as employees, general public, environmental
concerns etc.) to the more narrow issue of purely the relationship between
shareholders and directors. However if we start with an overview of certain key
developments in the history of corporate theory the general meaning of corporate
governance should become clearer.
16.1.1 The concession or fiction theory

The original charter and statutory companies were in no sense ordinary businesses
but rather they were special ventures which were granted the advantages of
incorporation by state because of the public interest in the success of the business
venture. Rail, telegraph and colonial trade companies are probably the highest profile
example of these companies. For corporate theory purposes the importance of the
state in granting corporate status is central. As a result legal theorists discussed these
companies in terms of what is known as the concession or fiction theory (hereafter,
concession or fiction). This theory describes incorporation as a concession granted or
legal fiction created by the state because of the public good being carried out by the
business. The state is central to the company’s existence and it therefore only exists
and is legitimised because it serves the public good. This theory makes it relatively
easy to justify the imposition of corporate regulations aimed at promoting the public
interest. This theory’s dominance parallels the time when grants of chartered status
were relatively unusual occurrences confined to the privileged few who had both a
public interest venture and the influence to obtain a grant of chartered status.
16.1.2 Corporate realism

This changed, however, with the advent of the registered company in the middle of
the 19th century. Anyone could register such a company for their own private purpose
and the state’s role was correspondingly diminished in the incorporation process. A
second theory, called the corporate realism theory (hereafter, corporate realism), was,
at least partly, better suited to the registered company. It argued that the company
was no fiction but had a real existence. It did not, therefore, depend on its members
or the state for its existence. In essence the members have come together to form
an association which, once formed, has an interest of its own, which is not related
in any way to its individual members’ interests. The 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 corporation. Its high
point followed the advent of large managerial companies with enormous dispersed
shareholdings.
In 1932 Berle and Means, an economist and a lawyer, made two key observations
about the operation of American companies in the 1930s. First, that shareholders
were so numerous (described as dispersed ownership and subsequently as the Berle
and Means corporation) that no individual shareholder had an interest in attempting
to exercise control over management. In their view 65 per cent of the largest two
hundred US companies were controlled entirely by their managers. Second, they
expressed concern that managers were not only unaccountable to shareholders but
exercised enormous economic power which had the potential to harm society.
At the same time Dodd (1932) sought to put flesh onto some of the key remaining
questions posed by corporate realism. Crucially he sought to answer the
question ‘what are the interests of this real person if they are not equated with
the shareholders?’ He argued that, just as other real persons have citizenship
responsibilities that require personal self-sacrifice, a corporation has social
responsibilities which may sometimes be contrary to its economic objectives. In
turn, managers of this citizen corporation are expected to exercise their powers
in a manner which recognises the company’s social responsibility to employees,
consumers and the general public.
16.1.3 The aggregate theory

Berle (1932) responded to Dodd’s article with an opposing argument based on the
aggregate theory (hereafter, aggregate). That theory describes the company as the
central institution formed by the aggregation of private contracting individuals.
That is the members come together to pool their investment on terms they all
agree. The state therefore has little to do with the corporation as a nexus of private
contracting individuals. As such Berle was opposed to Dodd’s solution. He believed
that the Dodd answer was too vague. It would be practically unenforceable and
lead to the furtherance of managerial dominance. Instead he sought to focus the
company’s accountability mechanism on just the shareholders. He argued that the
managers are trustees for the shareholders, not the corporation. Thus, the managers
are accountable to the shareholders and shareholder wealth maximisation is the sole
corporate interest.
Until the late 1960s the tangible success of managerial companies and the ability
of these companies to behave as corporate citizens meant that corporate realism
was the dominant theory. However, by the 1980s a change was occurring in the way
shareholders were behaving. Reform in state pension and health care funding had
pushed enormous amounts of money into the equity markets through institutional
investors (pension finds, investment funds and insurance companies). At the same
time barriers to capital inflows and outflows were removed in many countries which
resulted in international investment funds operating in both the London and New
York markets. In all, the institutional investor emerged as a dominant force in those
markets, holding nearly 80 per cent of the shares in the UK market and 60–70 per
cent of the shares in the US market by the late 1980s. While institutional investors
preferred to remain largely passive investors for the most part, they did favour
market mechanisms in order to promote shareholder wealth maximisation. Thus
share options grew as a percentage of managements’ total salary as this focused
management on share price as a measure of performance and the non-executive
director emerged as a monitoring mechanism on management.
16.1.4 Nexus of contracts theory

Along with this change came a challenge to corporate realism from the work of
economists who provided evidence that managerial self-interest was a dominant
feature of managerial corporations. Aggregate theory, which evolved into the nexus
of contracts theory, with its emphasis on the shareholder as a monitoring mechanism,
was revitalised by economic theory and remains the dominant theory today. While
largely a reformulation of aggregate theory, this provided the additional tools based
around economic efficiency to attack the managerial firm and the pluralism of
corporate realists such as Dodd. In a nexus of contracts analysis the firm is reduced to
contracts and markets and thus the firm is not in any sense a real person. Therefore,
it has no interests of its own into which one can place corporate social responsibility.
Additionally, the allocation of resources by management to social issues would be
inefficient as the monitoring mechanism within the firm in a nexus of contracts
analysis ensures efficiency through a presumption that shareholders maximise their
own self-interest (see Jensen and Meckling (1976)).
The emergence of the Berle and Means corporation has not been universal. Indeed it only
emerged in the UK in the late 1960s. In most of the rest of the world a managerial class
emerged but not accompanied by dispersed ownership. Rather founding families, other
companies and banks held controlling stakes in these companies. Thus, outside the UK
and the US the accountability issue has not formed such a large part of the corporate
governance debate. The differences in the corporate governance systems around the
world has also become a major area of study based around the preconditions necessary
for the emergence of a US/UK corporate governance system (see Coffee (2001)).
Activity 16.1
Provide some examples from your study of company law that illustrate the key
points of the various corporate theories.
16.2 The shareholder–stakeholder debate in the UK

UK company law has traditionally given primacy to the interests of shareholders.
However arguments supporting the status quo within the corporate governance
debate in the UK have not, until recently, been influenced by economic theory (see
Cheffins (1997)). Historically arguments against the primacy UK company law gives to
shareholders have been based on three general points.
u First, corporations are very powerful and therefore have an enormous effect on
society. Thus a narrow accountability to shareholders is insufficient to protect
society’s interests.
u Second, some, like Parkinson (1995), argue that the assumption that shareholders
have a moral claim to primacy by virtue of their property rights is plainly incorrect.
If shareholder primacy is to be justified it must be on other grounds.
u Third, the moral claims of others (stakeholders) either outweigh the shareholders’
claims or at are at least equal to them when it comes to allocating primacy.
However, these moral claims seemed overwhelmed by the efficiency-based arguments

of the government and the private sector in the 1980s. In response, by the early 1990s
a two-fold approach was emerging in the corporate governance literature. First, it was
still morally right to include stakeholders in the decision-making process and, second,
it could be justified on competitive grounds. For example, contented employees
are more productive, the business entity benefits through lower transaction costs
because of higher levels of trust and a greater sense of community, and so ultimately
the economy and society benefits.
16.3 UK corporate governance developments
16.3.1 The UK Corporate Governance Code

As we have seen, the UK has traditionally given primacy to shareholder interests, and
the majority of the corporate governance developments we shall address here reflect
that position. Their aim is to ensure that those running large, quoted, companies, are
more accountable to their investors, rather than to other ‘stakeholders’ within the
company.
Perhaps the most significant instrument that seeks to achieve this accountability is
the UK Corporate Governance Code. This is now issued by the UK’s Financial Reporting
Council (FRC), and the latest version dates from 2018. It began its life, however, in
1992, following the report of the Cadbury Committee (1992) on the Financial Aspects
of Corporate Governance. That Committee was established by the Financial Reporting
Council, the London Stock Exchange and the combined accounting bodies. The
report was an industry attempt to address some of the accountability concerns
expressed about UK listed companies. While fairly narrowly focused the report
succeeded in identifying the lack of managerial accountability at the heart of most
UK listed companies. The key recommendation of the Cadbury Committee was to
introduce non-executive directors to the main board, the idea being that these
non-executive directors would bring some objectivity to board decisions. Cadbury
also recommended that a committee structure should be put in place to improve the
accountability of the appointment of directors, the pay (remuneration) of directors
and the audit process. Therefore a listed company should have three sub-committees
of the board to cover appointments, remuneration and audit. The accountability
process would be ensured by having non-executives on each of the sub-committees.
The remuneration committee in particular was to be made up wholly or mainly of
non-executives and the audit committee should have at least three non-executives.
The London Stock Exchange implemented the Cadbury recommendations on a comply
or explain basis (i.e. if you don’t comply you need to explain why) and subsequently
the Cadbury model has been adopted by stock exchanges around the world.
Accountability issues rumbled on after Cadbury, particularly regarding directors’

pay, and by 1995 the Greenbury Committee (Directors Remuneration, Report of the
Study Group, 1995) was formed to report on directors’ pay. Greenbury identified
that there is an inherent conflict of interest in directors deciding on their own pay
and recommended an enhanced disclosure regime for directors’ pay and a non-
executive only remuneration committee. Unfortunately the open disclosure regime
recommended by the Greenbury committee only succeeded in providing a reference
point for managers to negotiate higher salaries as they could point to higher salaries in
other similar companies to justify higher pay claims.
We shall return to questions of pay below. But sticking with codes of practice, a third
committee called the Hampel Committee reported in 1998 and, while offering nothing
new to the accountability issues, provided an opportunity to combine the Cadbury
and Greenbury recommendations into one single code called the Combined Code.
The Hampel Committee’s importance lies in that fact that its failure to meaningfully
engage in the corporate governance debate antagonised the government into putting
corporate governance firmly on its reform agenda within the ambit of the CLRSG (see
below).
The collapse of the US company Enron in 2002 spurred the government into
announcing a review of the role of non-executive directors in UK companies. The
review was carried out by Derek Higgs, who consulted widely and produced a final
report in January 2003. Its key recommendation was to provide a good definition of
independence for non-executives, which was adopted by the LSE. A non-executive
director will now only be considered independent when the board determines that
the director is independent in character and judgment and there are no relationships
or circumstances which could affect, or appear to affect, the director’s judgment. Such
relationships and circumstances arise where the director:
u is or has been an employee of the company
u has or had a business relationship with the company
u is being paid by the company other than a director’s fee and certain other
payments
u has family ties to the company or its employees
u holds cross-directorships or has significant links with other directors through

involvement in other companies or bodies
u represents a significant shareholder
u has served on the board for 10 years.
The Higgs independence criteria have subsequently been adopted by the London
Stock Exchange.
In 2010, the Combined Code was renamed the UK Corporate Governance Code.
Responsibility for updating its provisions in future years, and for monitoring
compliance with its terms, was taken on by the Financial Reporting Council. It is now
updated every two years.
Despite this change in responsibility, the basic philosophy of the code remains the
same. It continues to focus on the structure, composition and role of the board,
with an emphasis on ensuring a sufficient proportion of independent non-executive
directors who are responsible for monitoring their executive colleagues. Compliance
remains optional, but the companies to which it applies (those with a ‘premium
listing’ on the LSE) must declare whether they do comply with its recommendations
and explain their reasons for any non-compliance. You can access the latest version of
the Code at: www.frc.org.uk/corporate/ukcgcode.cfm
One interesting change that was first introduced in the 2012 version of the Code is a
recommendation that the company’s annual report should ‘include a description of
the board’s policy on diversity, including gender, any measurable objectives that it
has set for implementing the policy, and progress on achieving the objectives’. This
change to the Code followed on from the Review undertaken by Lord Davies into the
proportion of women on company boards, which can be accessed at: www.gov.uk/
government/news/women-on-boards
That review set a goal for the 100 largest quoted companies (known as the ‘FTSE 100’)
to have at least 25 per cent female board members by 2015. This target had been
achieved by October 2015, with a female board membership of 26 per cent.
As noted above, the latest version of the Code dates from 2018 and took effect from
1 January 2019. This new version is rather shorter, and supposedly ‘punchier’, than its
predecessors. There is now a simpler division between the Code’s general ‘Principles’,
and its more specific ‘Provisions’. There are 18 Principles, which are fairly broad,
high-level statements of good practice, which companies are expected to apply, and
to explain how they do so. The 41 Provisions are more detailed and more specific but
companies have more scope for choosing not to follow some of them. Where they
choose not to do so, they must explain why.
16.3.2 The UK Stewardship Code

The UK Corporate Governance Code, as we have seen, focuses primarily on the
contribution which a reformed board of directors can make to good governance. But
some might argue that shareholders, rather than relying on non-executives, should
take more responsibility themselves for improving how their companies are managed.
This sentiment lies behind the Stewardship Code, which was first issued, again by the
FRC, in 2010. Like the UK Corporate Governance Code, its life began rather earlier, but
we can pick up its story in 2009, with the report of the Walker Review.
The Walker Review

Sir David Walker had been appointed to examine corporate governance in, specifically,
the financial services industry, following the global financial crisis of 2008. In
November 2009 he published his report. Much of the report was critical of the
behaviour of directors in financial institutions, including their lack of understanding
about the risks their organisations were running, their failure to exercise proper
control over the banks executives, and the structure of their remuneration awards.
However, criticism was also directed at the shareholders of financial institutions. They
either encouraged, or at least failed to stop, excessive risk taking, and generally failed
to exercise their responsibilities to engage with the banks executives and directors
– their so-called ‘stewardship responsibilities’. The full review can be found at: http://
webarchive.nationalarchives.gov.uk/20130129110402/http://www.hm-treasury.gov.uk/d/
walker_review_261109.pdf
Walker suggested a number of changes to the governance regimes of financial

institutions. Again, many of these focused on boards. But he also recommended that
Institutional shareholders and fund managers should be more engaged with the
companies they invest in. To encourage this they should comply, or explain non-
compliance, with a ‘stewardship code’ overseen by the Financial Reporting Council in
the same manner as the UK Corporate Governance Code.
The Stewardship Code

In response to Walker’s recommendations, the Financial Reporting Council published
the first Stewardship Code in 2010. It was revised in 2012 and again, more extensively,
with effect from 1 January 2020. It applies to ‘institutional investors’ generally. This
group covers not only institutional shareholders themselves (such as pension funds,
or insurance companies) but also those firms of ‘asset managers’, which typically look
after the shareholdings of such institutional shareholders. For these organisations, the
Code sets out nine principles of stewardship, which such organisations are expected
to apply. They must also explain, through an annual reporting requirement, how the
principles have been applied. Furthermore, organisations that act as ‘service providers’
to institutional shareholders (such as organisations that provide proxy voting services)
are also made subject to the 2020 version of the Code. Such service providers are
subject to a shorter list of just seven principles, which they must likewise ‘apply and
explain’.
More information, including a copy of the 2020 Code itself, can be found here:
www.frc.org.uk/investors/uk-stewardship-code
16.3.3 Executive remuneration

We have noted already the controversy that executive pay has generated in the UK.
You can read more about the arguments around this topic (written from a critical
perspective) at http://highpaycentre.org/
Also, have a look back at this topic in Chapter 14, and note how, in quoted companies,
‘Remuneration Reports’ must be prepared, and these must be voted on by
shareholders. As a result of changes introduced in 2013, the shareholders’ vote is now
binding (as to the company’s remuneration policy).
In August 2016, the Government launched its project called Corporate Governance
Reform, which was a general review of corporate governance arrangements in the UK;
see www.gov.uk/government/consultations/corporate-governance-reform
One aspect of that review concerned executive remuneration, and especially the
growing gap within many companies between the pay of the company’s executives
and the pay of the company’s other workers. As a result, the Companies (Miscellaneous
Reporting) Regulations 2018 have now been introduced, requiring quoted companies
to reveal the ratio between the pay of their CEO and the average pay of the company’s
UK workforce.
16.3.4 Long-termism
In October 2010 ‘BIS’ (a government department) launched a review of ‘corporate
governance and economic short-termism’; see: www.bis.gov.uk/Consultations/a-long-
term-focus-for-corporate-britain?cat=open. One major concern was whether UK
equity markets in particular contributed towards the alleged ‘short-termism’ of UK
companies. To explore this issue further, Professor John Kay was appointed to examine
key issues related to investment in UK equity markets and its impact on the long-term
performance and governance of UK quoted companies. In February 2012, Kay and his
colleagues produced an interim review, which provided a wide range of evidence that
British companies were indeed subject to damaging short-term pressures, particularly
from shareholders.
Kay’s final report appeared in July 2012. See: www.bis.gov.uk/kayreview
It listed 17 specific recommendations for addressing these short term pressures.

The bulk of these focused on investors (both shareholders and asset managers) and
included:
u developing the Stewardship Code to ‘incorporate a more “expansive” form of

stewardship, focussing on strategic issues as well as questions of corporate
governance’
u establishing an ‘investors forum’ to facilitate collective engagement by investors
u providing that those involved in the investment chain who had discretion over
the investments of others (e.g. asset managers) or who gave investment advice to
others, should be subject to fiduciary standards
u increasing transparency over the costs charged by asset managers
u ensuring that the structure of asset managers’ pay encouraged long termism.
Other recommendations focused on companies themselves, and included:
u ensuring companies engaged more with long-term investors over major board
appointments
u ensuring the structure of directors’ remuneration rewarded long-term performance

u discouraging companies from trying to manage shareholders’ ‘short-term earnings
expectations’.
To support some of the above recommendations, Kay also proposed a set of three
‘Good Practice Statements’, aimed at directors of companies, asset managers and
institutional shareholders. These statements would highlight the responsibilities of
these different actors for encouraging more stewardship and more long-term decision
making.
In November 2012 BIS released its response to the Kay Review. This can be viewed at
www.bis.gov.uk/kayreview
BIS largely accepted Kay’s analysis of the role which equity markets played in
encouraging short-termism, and also agreed with almost all of Kay’s specific
recommendations. Of course, many of the recommendations were aimed at investors,
or companies, rather than government. But one practical response BIS made
immediately was to publish Kay’s three proposed ‘Practice Statements’ for directors,
asset managers and shareholders. These statements can be found in Annexes A–C of the
BIS response. However, these practice statements are not legally binding on directors,
shareholders or asset managers, and no additional mechanisms have been developed
to ensure that those to whom they are addressed follow them. It remains to be seen,
then, whether they will have any impact on the behaviour of their addressees.
16.3.5 Stakeholder initiatives

So far, we have been concentrating on initiatives designed, primarily, to make
companies more accountable to their shareholders. We have noted already that UK
company law and corporate governance has, historically, tended to ally itself with
shareholder primacy.
However, when a politically more left-leaning government was elected in the UK in

1997, there was an expectation by some that this might result in greater attention
being given to stakeholder interests. The Government’s decision to embark on the
‘modernisation’ of company law, under the leadership of the CLRSG, which would
eventually lead to the CA 2006, increased this expectation. We can note two areas of
company law where the tension between a commitment to shareholder primacy, and
reforms aimed at increasing the weight given to stakeholder interests, were played
out.
Section 172 Companies Act 2006

The first area is in respect of directors’ duties, and in particular the duty that became
s.172 CA 2006. After a long exploratory process the CLRSG focused on including, in
a simplified reform of directors’ duty, obligations to stakeholder groups. The CLRSG
recommended that directors’ duties should be expanded to include stakeholder
constituencies and its recommendations were adopted by the CA 2006 in s.172.
Remember that s.172 says that:
(1) A director of a company must act in the way he considers, in good faith, would be
most likely to promote the success of the company for the benefit of its members as a
whole, and in doing so have regard (amongst other matters) to—
(a) the likely consequences of any decision in the long term,
(b) the interests of the company’s employees,
(c) the need to foster the company’s business relationships with suppliers, customers
and others,
(d) the impact of the company’s operations on the community and the environment,
(e) the desirability of the company maintaining a reputation for high standards of
business conduct, and
(f) the need to act fairly as between members of the company.

We have considered already the rather curious way this section is expressed. It does
at least give an express recognition of stakeholder interests, and tries to encourage
or legitimise ‘enlightened’ directors considering the interests of ‘stakeholders’ in their
decision-making process. However, most commentators accept that it still retains the
primacy of the shareholders’ interests, albeit while perhaps gently nudging directors
to think about stakeholders.
Social reporting
The other area where efforts have been made to address stakeholder interests is in
respect of the reporting obligations of companies. Even if companies, or their directors,
are not compelled to give more weight to stakeholder interests, requiring companies to
disclose how well – or badly – they treat their stakeholders may encourage companies to
improve their behaviour. If companies must disclose their employment and supply chain
practices, their record on environmental impact, how much tax they pay, and so on, fear
of adverse publicity may provide a strong incentive against misbehaviour.
Traditionally, of course, company law in the UK has focused on the release of financial
information, aimed at letting shareholders and creditors know how well the company
is performing. However, the White Paper published by the UK Government prior to
the introduction of the Companies Bill 2005 (http://webarchive.nationalarchives.gov.
uk/20090609003228/http://www.berr.gov.uk/files/file25406.pdf at p.10) recommended
the introduction of an Operating and Financial Review (OFR) which would provide
a narrative statement on the company’s activities as they affect stakeholder
constituencies. The justification for this was that directors would have to give more
credence to stakeholders if they had to write a report on the effect of the company’s
activities on those stakeholders.
Without waiting for the enactment of the CA 2006, the Government acted on this
White Paper proposal. It drafted the Companies Act 1985 (Operating and Financial
Review and Directors’ Report etc.) Regulations, and these were enacted in March 2005.
Almost immediately, however, the Regulations became mired in controversy.

Directors were afraid that they might face increased personal liability if there were
errors in the more forward-looking information they were now being required to
provide. In response, somewhat remarkably, the then Chancellor, Gordon Brown,
announced on 28 November 2005 that the OFR would be repealed from 12 January
2006. (See the Companies Act 1985 (Operating and Financial Review) (Repeal)
Regulations 2005, SI 2005/3442.)
But this ill-thought out repeal was complicated further by the fact that European
legislation, in the form of the European Accounts Modernisation Directive (Directive
2003/51/EC), itself required a ‘fair business review’ (FBR) to take place. And the FBR
sounded similar to what the OFR had required, before it was so hastily repealed. As a
result, the CA 2006, in s.417, then reinstated a requirement for companies to include,
as part of the directors’ annual report, a ‘business review’. Finally, in 2013, s.417 was
itself repealed, and the need for a business review was replaced with a requirement
that companies prepare a ‘strategic report’ (see s.414A–D CA 2006). We have already
examined that requirement in Chapter 15.
This rather complicated and messy process of false starts and half measures does not
reflect terribly well on the reform of UK company law. The amount of stakeholder-
relevant information that must be given remains quite modest. But it is at least an
acknowledgement that groups other than shareholders also have an interest in how
companies are performing. As noted already above, in 2016 the Government launched
its review of UK corporate governance arrangements, entitled Corporate Governance
Reform. One recommendation from the Corporate Governance Reform project was that
companies should be required to give out more information about how their directors
implement the obligation, in s.172, to take account of the interests of a variety of
stakeholders. This has now been achieved through amendments to the strategic
report requirement in s.414, which was considered above.
Moreover, and going beyond mere ‘social reporting’, the Government also decided
to direct the FRC to amend the UK Corporate Governance Code to require companies
that are subject to the Code to improve their engagement with stakeholders. This has
now been achieved in the new, shorter, version of the Code that was issued in 2018.
It now contains two new Principles focusing on stakeholder engagement. Principle D
states that ‘[in] order for the company to meet its responsibilities to shareholders and
stakeholders, the board should ensure effective engagement with, and encourage
participation from, these parties.’ Principle E declares that ‘[t]he board should ensure
that workforce policies and practices are consistent with the company’s values and
support its long-term sustainable success. The workforce should be able to raise
any matters of concern.’ Finally, there is a new Provision 5, which states that ‘[f]or
engagement with the workforce, one or a combination of the following methods
should be used:
u a director appointed from the workforce;
u a formal workforce advisory panel;
u a designated non-executive director.’
Activity 16.2
Read Dignam and Lowry Chapters 15 and 16 and then consider the following.
‘The committees on corporate governance have been an amazing success. We know
this not only because of the domestic improvements in corporate governance
they have brought about but because similar systems have been adopted by
international agencies and other jurisdictions around the world.’
Do you agree with the above statement? Explain your views.
Further reading
¢ Berle, A. ‘For whom corporate managers are trustees: a note’ (1932) Harvard Law
Review 1365.
¢ Berle, A. and G. Means The modern corporation and private property. (New
Brunswick, NJ; London: Transaction Publishers, paperback edition 1991) [ISBN
9780887388873].
¢ Coffee, J. ‘The rise of dispersed ownership: the roles of law and the state in the
separation of ownership and control’ (2001) 1 Yale LJ 25–29.
¢ Deakin, S. ‘The coming transformation of shareholder value’ (2005) 13 Corporate

Governance: An International Review 11.
¢ Dignam, A. ‘A principled approach to self-regulation? The report of the Hampel

Committee on Corporate Governance’ (1998) Company Lawyer 140.
¢ Dignam, A. and M. Galanis ‘Australia inside/out: the corporate governance

system of the Australian listed market’ (2004) 3 Melbourne University Law Review
623–53.
¢ Dignam, A. and M. Galanis The globalization of corporate governance. (Farnham:

Ashgate, 2009) [ISBN 9780754646259].
¢ Dodd, E. ‘For whom are corporate managers trustees?’ (1932) Harvard Law
Review 1145.
¢ Finegold, D., G.S. Benson and D. Hecht ‘Corporate boards and company
performance: review of research in light of recent reforms’ (2007) 15 Corp Gov
865.
¢ Keay, A. ‘Ascertaining the corporate objective: an entity maximisation and

sustainability model’ (2008) 71 Mod Law Rev 663.
¢ Moore, M. ‘Whispering sweet nothings: the limitations of the informal

conformance in UK corporate governance’ (2009) 9 Journal of Corporate Law
Studies 95.
¢ Parkinson, J.E. Corporate power and responsibility: issues in the theory of company
law. (Oxford: Oxford University Clarendon Press, 1995) [ISBN 9780198259893].
¢ Pettet, B. ‘Towards a competitive company law’ (1998) Company Lawyer 134.
¢ Reisberg, A. ‘The UK Stewardship Code: on the road to nowhere’ (2015) Journal of

Corporate Law Studies 217.
¢ Riley, C.A. ‘Controlling corporate management: UK and US initiatives’. (1994) LS

244.
¢ Wedderburn, K.W. ‘The social responsibilities of companies’ (1982) Melbourne

University LR 1.

‘[t]here should be no confusion (of which there is evidence) of the duties which
Mr. Ford conceives that he and the stockholders owe to the general public and
the duties which in law he and his co-directors owe to protesting, minority
stockholders. A business corporation is organised and carried on primarily for the
profit of the stockholders. The powers of the directors are to be employed for that
end. The discretion of directors is to be exercised in the choice of means to attain
the end and does not extend to a change in the end itself, to the reduction of profits
or to the nondistribution of profits among stockholders in order to devote them to
other purposes.’
Dodge v Ford Motor Company (1919) 204 Mich 459; 170 NW 668.
If this statement is applied to the UK, would it remain true?

Establish that traditionally UK company law has been focused on the shareholders. You
could also qualify this by stating that the courts have also allowed directors quite a lot
of discretion which indirectly allows stakeholders to benefit.
Discuss the stakeholder debate generally.
Discuss the CLRSG’s report on corporate governance matters, the reformulation of

directors’ duties in the CA 2006 and the controversy surrounding the introduction and
repeal of OFR.
Remember to apply your findings to the question you have been asked.
Reflect and review



first again
I can describe the main historical periods in the
development of the modern company.   
I can explain the various corporate theories that

influence the corporate governance debate.   
I can illustrate the current trends in corporate

governance writing.   
I can form my own view of what the main purpose of a

company should be.   
revise?
Must Revision
revise done
16.1 Introducing corporate governance  
16.2 The shareholder–stakeholder debate in the UK  
16.3 UK corporate governance developments  

17 Liquidating the company
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206
17.1 Liquidating the company . . . . . . . . . . . . . . . . . . . . . . . . 207
17.2 The liquidator . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209
17.3 Directors of insolvent companies . . . . . . . . . . . . . . . . . . . . 211
17.4 Reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 211

Introduction
In this chapter we consider the various ways in which a company can be wound up.
A principal anxiety of the law is to ensure the most equitable treatment possible of
all the creditors. You will have noted from previous chapters that many key issues
of company law come to the fore during the liquidation process. You should revise
Chapter 7: ‘Raising capital: debentures’ and Chapter 15: ‘Directors’ duties’ before
embarking on the material below.
Learning outcomes
u explain the ways in which a company may be wound up
u describe the powers and duties of the liquidator
u describe the order in which creditors are paid
u discuss the liabilities of directors of insolvent companies.
Core text
¢ Dignam and Lowry, Chapter 17: ‘Corporate rescue and liquidations in outline’.
Cases
¢ Re London and Paris Banking Corp (1874) LR 19 Eq 444
¢ Measures Bros Ltd v Measures [1910] 1 Ch 336
¢ Silkstone and Haigh Moore Coal Co v Edey [1900] 1 Ch 167
¢ Stead, Hazel & Co v Cooper [1933] 1 KB 840
¢ Coutts & Co v Stock [2000] 1 BCLC 183
¢ Re J Leslie Engineers Co Ltd [1976] 1 WLR 292
¢ Re Produce Marketing Consortium Ltd [1989] BCLC 520
¢ Brooks v Armstrong [2015] EWHC 2289 (Ch)
¢ BNY Corporate Trustee Services Ltd v Eurosail-UK 2007-3BL plc [2013] UKSC 28.
Company Law 17 Liquidating the company page 207
17.1 Liquidating the company

The Insolvency Act 1986 (IA 1986) is the principal statute we are concerned with in
relation to liquidations.
There are three principal ways in which a company’s existence can be brought to an
end (i.e. dissolved).
u The members may decide to wind up the company – this is termed voluntary
winding up.
u The creditors may force the dissolution of a company where it is insolvent (i.e. it
cannot pay its debts) – this is termed compulsory winding up.
u It is in the public interest to wind up a company.
17.1.1 Voluntary winding up

The members of the company may decide to wind it up. They may do this even though
it is solvent – because, for example, they wish to retire or its original purpose has come
to an end. Or they may choose to wind it up because it is in fact insolvent, and the
members do not wish to wait until creditors force the company into a compulsory
winding up. Section 84(1) of the IA 1986 provides for two situations in which the
company may be voluntarily wound up.
1. When the period, if any, fixed for the duration of the company by the articles
expires, or the event, if any, occurs which the articles provide will result in the
company being dissolved, and the general meeting has passed a resolution
requiring it to be wound up voluntarily (this category is rare nowadays).
2. If the company resolves by special resolution that it be wound up voluntarily.
In practice, it is the second of these two situations (members passing a special

resolution) which most often leads to a voluntary winding up. A voluntary winding up
can still proceed in two very different ways. First, if the directors of the company are
prepared to make a ‘statutory declaration of solvency’ under s.89 of the IA 1986, then
the winding up will proceed as a ‘members’ voluntary winding up’. In that situation,
the members will have a great deal more control over the winding up process (such as
the choice of liquidator). This degree of member-control is seen as appropriate given
that creditors are likely to be paid in full (because the company is solvent). Secondly, if
the directors are not prepared to make the declaration of solvency, then a ‘creditors’
voluntary winding up’ will ensue.
In either case, a copy of the winding up resolution must be sent to the Registrar
of Companies within 15 days (s.84(3) IA 1986 and s.30 CA 2006). It is the task of the
liquidator to take control of the company for the purpose of realising its assets,
meeting its liabilities and distributing any surplus left over to the shareholders (ss.91
and 107 IA 1986). Once the liquidator has completed this task and has sent to the
Registrar of Companies his final account and return under s.94 (members’ voluntary
winding up) or s.106 (creditors’ voluntary winding up), the Registrar shall then register
them. Three months after the registration of the return the company is deemed to be
dissolved (s.201).
17.1.2 Compulsory winding up

A compulsory winding up normally occurs where a creditor petitions to have the
company wound up because it is unable to pay its debts (s.122(1)(f) IA 1986). There
are other grounds for a compulsory winding up but the vast majority fall under this
category and so we concentrate on it here. Section 123(1) provides that a company will
be deemed to be insolvent:
u if a creditor, to whom a sum exceeding £750 is owed, has served on the company
at its registered office a written demand, in the prescribed form, requiring
the company to pay the debt and the company has for three weeks thereafter
neglected to pay; or
u if an execution or other process issued on judgment in favour of a creditor of the

company is returned unsatisfied in whole or in part; or
u if the court is satisfied that the company is unable to pay its debts as they fall due.
It should be noted in relation to the third category that a company will be deemed
to be insolvent where the value of the company’s assets is less than the amount of
its liabilities (s.123(2) IA 1986). On the meaning of ‘unable to pay its debts’, see BNY
Corporate Trustee Services Ltd v Eurosail-UK 2007-3BL plc [2013] UKSC 28.
However, if the debt is disputed on bona fide grounds the court will not allow the
petition to proceed. Thus, if a creditor presents a petition in order to pressurise the
company into paying a debt, the amount of which is genuinely disputed as being
excessive, the court may dismiss the petition with costs (Re London and Paris Banking
Corp (1874) LR 19 Eq 444).
However, if the petition proceeds a creditor who is owed £750 or more will be entitled
to a winding up order although the court may refuse to make an order if the petition
is not supported by the majority of creditors (s.195). If the court does make an order to
wind up the company it is made in favour of all the creditors, not just the petitioner,
and the Official Receiver is appointed as liquidator. At this point, if the Official
Receiver finds that the realisable assets of the company are insufficient to cover
the expenses of the winding up and that the affairs of the company do not require
further investigation, he or she may apply to the Registrar of Companies for the early
dissolution of the company. Such an application is then registered by the Registrar and
three months after the date of the registration of the notice the company is dissolved.
But, if there are sufficient funds to cover the expenses of the liquidation the Official
Receiver has the power to summon separate meetings of the company’s creditors and
contributories for the purpose of choosing a person to be liquidator of the company in
his or her place (s.136(4)). Once the liquidator has completed his function (see below),
s.205 provides that when he has filed his final returns or the Official Receiver has
filed a notice stating that he considers the winding up to be complete, the Registrar
of Companies shall register those returns or the notice forthwith. At the end of the
period of three months beginning with the day of that registration the company is
dissolved (s.205(2)).
17.1.3 Public interest winding up

Under s.124A of the IA 1986 the Secretary of State may present a petition to wind
up a company in the public interest if, after a BEIS (originally DTI) investigation or
other official enquiry, it appears ‘that it is expedient in the public interest that a
company should be wound up if the court thinks it just and equitable for it to be so’
(see Re Drivertime Recruitment Ltd [2005] 1 BCLC 305). Insolvency is not a requirement
and more usually the company will have been used as a vehicle for defrauding the
general public. For example, in Re UK-Euro Group plc [2006] All ER (D) 394 (Jul), ChD, the
court granted a petition for the winding up of the company on the ground of public
interest under s.124A IA 1986 on the basis that the company’s affairs were conducted
fraudulently and with a complete lack of commercial probity.
Activity 17.1
Read British Eagle International Airlines Ltd v Compagnie Nationale Air France [1975] 1
WLR 758.
What emerges from the British Eagle decision as the overarching purpose of
liquidation?
Activity 17.2
Read Finch, V. and D. Milman Corporate insolvency law: perspectives and principles.
(Cambridge: Cambridge University Press, 2017) third edition [ISBN 9781107039919],
Chapter 2: ‘Aims, objectives and benchmarks’ (available on the VLE).
What are the objectives of the liquidation regime?
17.2 The liquidator
17.2.1 The liquidator’s role and powers

The winding up order terminates the management powers of the company’s directors
(Measures Bros Ltd v Measures (1910) 1 Ch 336). Their powers are transferred to the
liquidator, together with their fiduciary duties, and so a liquidator must act in good
faith, avoid a conflict of interests and not make a secret profit (Silkstone and Haigh
Moore Coal Co v Edey (1900) 1 Ch 167). Section 230(3) of the IA 1986 provides that a
liquidator must be a qualified insolvency practitioner. He or she acts in the name of
the company and will not, therefore, be liable on contracts entered into on behalf of
the company (Stead, Hazel & Co v Cooper [1933] 1 KB 840).
The liquidator takes control of the company for the purposes of realising the company’s
assets and distributing them among the claimants according to their priority. For
example, corporate property, which is subject to a fixed charge, must be used first to
redeem the secured loan to which the charge relates. Similarly, where a supplier of goods
has reserved title until payment, ownership will not have passed to the company and so
the liquidator cannot incorporate these goods into the common pool of assets. If there
are insufficient assets left over after taking account of any fixed charges together with the
preferential debts to satisfy the unsecured creditors, their debts abate equally. The order
in which debts are to be satisfied in a liquidation is as follows.
1. All expenses properly incurred in the winding up, including the remuneration of
the liquidator.
2. Preferential debts as identified in ss.107, 115, 143 and 156 (e.g. unpaid employees’
wages).
3. Ordinary debts.
4. Deferred and subordinated debts.
(See ss.107 and 115 (voluntary liquidations) and ss.143 and 156 (compulsory
liquidations); see also s.175 which is of general application.)
Any balance remaining is distributed to members in accordance with their

entitlements under the company’s memorandum and articles.
Prior to the Enterprise Act 2002, preferential debts were defined by s.386 IA 1986
as debts listed in Schedule 6. These included: debts owed to the Inland Revenue in
respect of PAYE deductions during the previous 12 months but not remitted to the
Revenue; debts due to Customs and Excise in respect of six months’ VAT; debts owed
to the Department of Health and Social Security in respect of employers’ National
Insurance contributions; debts owed by way of unpaid wages to employees and
former employees for the four-month period before the commencement of the
winding up (maximum of £800) together with unpaid holiday pay and outstanding
contributions to pension schemes. Corporation tax liabilities which accrue after the
commencement of a winding up are a ‘necessary disbursement’ of the liquidator
and are therefore expenses of the winding up payable before preferential debts (Re
Toshoku Finance (UK) plc, Kahn v Inland Revenue (2002)). Section 251 of the Enterprise
Act 2002 amends s.386 and Schedule 6 to the IA 1986 by abolishing Crown preferential
debts (i.e. debts due to the Inland Revenue, Customs and Excise and social security
contributions) and adds contributions to occupational pension schemes to the list in
Schedule 6 (see above). Section 252 of the Enterprise Act 2002 inserts a new s.176A into
the IA 1986, which requires, for the benefit of unsecured creditors, a ring-fenced fund
to be created out of the realisations of floating charges. The amount to be transferred
to the prescribed fund for transmission to unsecured creditors is calculated according
to the following: 50 per cent of the first £10,000 plus 20 per cent of available funds
above £10,000 up to a maximum of £600,000. The prescribed fund only applies to
floating charges created after 15 September 2003.
The liquidator is given extensive powers to deal with the company and its property, in
order to wind it up. These powers are contained in s.167 of the IA 1986, and Parts 1 to
3 of Schedule 4 of the IA 1986. Previously, the liquidator could only exercise some of
these powers with the sanction of either the court or the liquidation committee, but
this is no longer the case. No such prior approval is now required. If creditors, say, were
dissatisfied with actions taken by the liquidator, they would have to challenge the
liquidator after she had already acted.
Although, as we have seen, the liquidator’s main role is to secure that the company’s
assets are got in and distributed to the creditors (s.143), he also, along with the court,
polices the end of the company to ensure insiders do not take advantage of the
company’s genuine creditors. As such the liquidator is empowered by s.238 IA 1986 to
apply to court to set aside any transactions at an undervalue which may have occurred
in the two years preceding the winding up.
Sometimes in the lead-up to liquidation the company will attempt to put certain
creditors in preferred positions to ensure that they get paid (often the creditors in
question are in fact directors of the company who may have personally guaranteed a
loan to the company). Section 239 allows the liquidator to apply to court to have such
a preferment set aside. Insiders may also enter into extortionate credit arrangements
which bind the company. If this occurs within three years of the winding up, s.244
again provides for the liquidator to apply to the court to set the transaction aside.
The liquidator in a voluntary solvent liquidation, while he has the same duties of
good faith as a liquidator in a compulsory liquidation, has a very different role. In a
voluntary solvent liquidation the liquidator simply gathers together the assets, pays
the liabilities and distributes any surplus to the members. In a compulsory liquidation
the liquidator will also carry out this function but usually without any chance that
the asset value will exceed the company’s liabilities. Thus the liquidator’s main
function will be to determine the priority in which creditors will receive payment. The
liquidator will also police the years immediately before the insolvency for any irregular
transactions that might be challengeable.
17.2.2 Post-winding up dispositions of company property

Section 129(2) IA 1986 provides that the winding up of a company by the court is
deemed to commence at the time of the presentation of the petition for winding
up. Where the company is already in voluntary liquidation, winding up is deemed to
commence at the time of the passing of the resolution (s.129(1)). These provisions
therefore mean that a winding up order has retroactive effect. The date of the winding
up order can become critical in relation to any disposition of company property.
This is because s.127 provides that, in a winding up by the court, any disposition of
the company’s property and any transfer of shares or alteration in the status of the
company’s members made after the commencement of the winding up is void, unless
the court otherwise orders. It is not necessary to apply for a court order because the
sanction is applied automatically. Section 127 is aimed at preserving corporate assets
for the benefit of the general body of creditors by giving the liquidator power to ‘claw
back’ company property which has been transferred by directors after a petition has
been presented and liquidation is imminent (see Coutts & Co v Stock [2000] 1 BCLC 183,
Lightman J). Thus, a third party dealing with a company in this situation should apply
to the court for a validation order. Otherwise they run the risk that the court will refuse
to validate the transaction and will order the property to be transferred back to the
company unless the third party acquired it as a bona fide purchaser for value without
notice (Re J Leslie Engineers Co Ltd [1976] 1 WLR 292). The court’s power to grant its
consent to a disposition of property is discretionary.
Activity 17.3
Read Re Gray’s Inn Construction Co Ltd [1980] 1 WLR 711.
What factors should be taken into account by the court when deciding whether to
validate a post-winding up disposition of property?
17.3 Directors of insolvent companies

As a safeguard against possible abuses of power, directors of failed companies face
certain restrictions on their activities in the immediate aftermath of an insolvency.
Sections 216 and 217 of the IA 1986 prohibit a director of a company that has gone
into insolvent liquidation from being involved for five years in the management of a
company using either the same name as the insolvent company or a name that is so
similar as to suggest an association with it. The objective of this provision is to prevent
a director simply registering a new company with a similar name and continuing to
trade. (See Re Produce Marketing Consortium Ltd (1989) BCLC 520 in which it was held
that the directors’ failure to keep proper accounts was no defence when determining
whether they knew, or ought to have known, that the company was insolvent.)
Additionally, directors face the real threat that they may become personally liable
for the debts of the company should the civil or criminal penalties for fraudulent and
wrongful trading apply.
Fraudulent trading under s.213 IA 1986 occurs where any business of the company has
been carried on with intent to defraud creditors of the company or creditors of any other
person, or for any fraudulent purpose. The possibility of criminal liability for fraudulent
trading also arises under s.993 of the CA 2006, the wording of which is virtually identical
to s.213 IA. As a result of the linkage between the two sections the courts have set the
standard of proof for s.213 very high. This led to the introduction of the easier-to-prove
offence of wrongful trading in s.214. This provides that the liquidator must prove that,
at some time before the commencement of its winding up, a person was a director of
the company and he or she either knew, or ought to have concluded, that there was no
reasonable prospect that the company would avoid going into insolvent liquidation. The
director is then liable to contribute to the assets of the insolvent company, unless the
director, from the moment she knew (or ought to have concluded) that insolvency was
inevitable, took all the steps she ought to have taken to minimise the loss to creditors.
The onus of proving that the director took all the steps he or she ought to have taken is
on the director: Brooks v Armstrong [2015] EWHC 2289 (Ch).
Liquidators have often proved unwilling to bring claims under ss.213 and 214 IA 1986.
Now, s.246ZD IA1986 (introduced by the Small Business, Enterprise and Employment
Act 2015) permits liquidators to assign (and therefore, effectively, to sell) such causes
of action. Thus, a liquidator, who decides that they do not want to bring an action
against, say, a director of the company for wrongful trading, might nevertheless
choose to sell (and, thus, assign) the action to a third party, who would then be able
to bring the action instead. In this way, the liquidator gets at least some money for the
benefit of the creditors, and the risks associated with bringing the claim fall on the
purchasing third party. However, if the action is successful, the benefit will go to the
third party (rather than to the insolvent company for the benefit of all the creditors).
17.4 Reform
In Chapter 15 we considered the state of the case law suggesting that directors may
owe duties to creditors where the company is insolvent. In this regard you should note
s.172(3) of the CA 2006.
Activity 17.4
a. What are the three ways of bringing a company’s existence to an end?
b. Where a company is wound up voluntarily, can the creditors appoint a liquidator?
c. What are the three grounds given in s.123(1) of the Insolvency Act 1986 for
deeming a company to be insolvent?
d. In an insolvent liquidation, which creditors are given preference over ordinary

debts?
e. In a voluntary liquidation, what happens to any surplus assets?
Further reading
¢ Cooke, T.E. and A. Hicks ‘Wrongful trading – predicting insolvency’ (1993) JBL 338.
¢ Finch, V. and D. Milman Corporate insolvency law: perspectives and

principles. (Cambridge: Cambridge University Press, 2017) third edition
[ISBN 9781107039919].
¢ Nolan, R. ‘Less equal than others – Maxwell and subordinated unsecured

obligations’ (1995) JBL 485.
¢ Oditah, F. ‘Wrongful trading’ [1990] LMCLQ 205.
¢ Oditah, F. ‘Assets and the treatment of claims in insolvency’ (1992) LQR 459.
¢ Report of the Review Committee on insolvency law and practice (Cork Committee
Report), Cmnd 8558.
¢ Van Zwieten, K. Goode on principles of corporate insolvency law. (London: Sweet &
Maxwell, 2018) fifth edition [ISBN 9780414066014].
¢ Wheeler, S. ‘Swelling the assets for distribution in corporate insolvency’ (1993)

JBL 256.

In 1996, Helen, then aged 24, qualified as a chartered accountant. In 1997 she
formed Pear Ltd and its wholly‑owned subsidiary, Sub Ltd. Helen holds all the shares
in Pear except one, which is held by a nominee for her. Pear Ltd holds all the shares
in Sub Ltd, except one, which is similarly held by a nominee for Pear Ltd. Helen is the
only director of both companies and neither company has filed any accounts with
the Registrar for the last three years. Other than her shares in Pear Ltd, Helen has
virtually no assets.
Since 1997 Pear Ltd has made telephone answering machines and has flourished so
that it now has assets of over £1 million and employs 40 people. Sub Ltd however,
is mainly engaged in supplying Pear Ltd with components and is not run primarily
with a view to making a profit on its own, although for the first two years, 1998 and
1999, Sub Ltd made profits of £8,000 and £3,000 respectively. However in 2000 it
made a loss of £38,000; in 2001 a loss of £23,000 and in 2002 a loss of £11,000.
In September 2001 Big Bank plc was pressing for a reduction of Sub Ltd’s overdraft
of £40,000. Helen then paid £20,000 of her own money into the account, taking in
return a debenture from Sub Ltd for £20,000 and a floating charge to secure both
that £20,000 and an earlier loan by her to the company of £15,000.
On 2 April 2003 a creditor presented a petition for the winding up of Sub Ltd and a
winding up order was made on 14 May 2003. The assets of Sub Ltd fall short of its
liabilities by £60,000.
Advise Helen as to her potential liabilities, if any, and her position generally.

You will need to address the following issues.
u Section 245 IA 1986, whereby the liquidator of an insolvent company can avoid
floating charges (see Chapter 7 of this guide).
u Whether or not Helen is liable for wrongful trading – see IA 1985, s.214. Particular
reference should be made to Re Produce Marketing Consortium (No.2).
u You will need to discuss Salomon v Salomon [1897] AC 22 and Adams v Cape Industries
plc [1990] 2 WLR 657 (see Chapters 3 and 4) in order to explain that a parent
company (Pear Ltd) is not liable for the debts of its subsidiary (Sub Ltd). However,
if Pear Ltd is a shadow director of Sub Ltd (see Chapter 14 of this guide and
particularly Secretary of State for Trade and Industry v Deverall [2001] Ch 340), the
assets of Pear Ltd may be liquidated to meet the claims against Sub Ltd.
u Whether Helen can be disqualified as a director under the Company Directors

Disqualification Act 1986 (see Chapter 14). Particular reference should be made
to the degree of culpability required before the court will disqualify a director. In
Re Lo-Line Electric Motors Ltd [1988] Ch 477 Sir Nicholas Browne-Wilkinson V-C said
that while ordinary commercial misjudgment is not in itself sufficient to establish
unfitness, conduct which displays ‘a lack of commercial probity’ or conduct which
is grossly negligent or displays ‘total incompetence’ would be sufficient to justify
disqualification.
Reflect and review

Are you ready to start revising this guide?

principles outlined in this chapter to enable me to go on to revise the whole subject.
Need to revise first = There are one or two areas in this chapter I am unsure about and
need to revise before I go on to wider revision.

first again
I can explain the ways in which a company may be
wound up.   
I can describe the powers and duties of the liquidator.   
I can describe the order in which creditors are paid.   
I can discuss the liabilities of directors of insolvent

companies.   
revise?
Must Revision
revise done
17.1 Liquidating the company  
17.2 The liquidator  
17.3 Directors of insolvent companies  
17.4 Reform  
Feedback to activities
Contents
Chapter 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217
Chapter 3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217
Chapter 4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 218
Chapter 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 218
Chapter 6 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 219
Chapter 7 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 220
Chapter 8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 221
Chapter 9 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 221
Chapter 10 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 222
Chapter 11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 223
Chapter 12 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 223
Chapter 13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224
Chapter 14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 225
Chapter 15 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 226
Chapter 16 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 228
Chapter 17 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 228
Company Law Feedback to activities page 217
Chapter 2
Activity 2.1
Activity 2.2
Activity 2.3
Activity 2.4
Activity 2.5
Small businesses seem to have been particularly ill-served by the corporate form. At
the heart of this has been the difference between company law’s presumption that
the shareholders do not exercise day-to-day control of the business and the reality in
a small business that shareholders often do exercise day-to-day control. The elective
regime in the CA 1985 and Table A did try to simplify matters, but from the 1994
Freedman study we know that the only real advantage perceived by small businesses
from forming a company was the legitimacy it conferred on the business. The reform
process leading to the Companies Act 2006 identified this as a significant problem and
the 2006 Act attempts to redress this imbalance by removing the presumption that
ownership is separated from control in order to make the corporate form a better
model for small businesses.
Chapter 3
Activity 3.1
a. Mr Salomon’s personal liability for the debts of the business had changed
completely from unlimited liability as a sole trader to limited liability as a
shareholder in the company. Not only was Mr Salomon not liable for the debts
of the company but he had also, as managing director of the company granted
himself a secured charge over all the company’s assets. As a result if the company
failed not only would Mr Salomon have no liability for the debts of the company
but whatever assets were left would be claimed by him to pay off the company’s
debt to him.
b. There is really one central principle we can draw and two minor ones. The central
principle is that the company is a separate legal personality from its members and
therefore legally liable for its debts. This brings us to the minor principles. The first
being that once the technicalities of the Companies Act are complied with, a one-
person company can have the benefits of corporate legal personality and limited
liability. The second is that debentures can be used effectively to further shield
investors from losses.
c. This is really a matter of your own personal opinion. It is useful, however, to work
out what you think about this issue as it will help you deal with other areas of
company law where the Salomon decision has implications.
Activity 3.2
The key point here for your further understanding is that a share is in no way a
representation of the fractional value of the company’s property. The company as a
separate legal entity owns its own property and there is no legal connection between
a share in the company and the company’s property. That is the case even where
(as in Macaura and Lee) the shareholder owns all the shares. Shareholders generally
benefit from this (although not Mr Macaura) because it facilitates limited liability as
the company also owns its own debts (see also Woolfson v Strathclyde Regional Council
[1978] SC 90).
Chapter 4
Activity 4.1
Activity 4.2
You will have noted from your reading that from the 1960s until the 1990s there was
little consistency in the way the senior judiciary approached difficult cases where veil
lifting was an option. In 1985 the Court of Appeal in Re a Company [1985] BCLC 37, Ch.D
could draw on cases such as Wallersteiner v Moir [1974] 1 WLR 991 to argue that the
court can use its power to lift the corporate veil if it is necessary to achieve justice,
irrespective of the legal efficacy of the corporate structure under consideration.
Equally, four years later the Court of Appeal in National Dock Labour Board v Pinn &
Wheeler Ltd [1989] BCLC 647 could draw on cases such as Woolfson v Strathclyde RC
[1978] SLT 159 to argue for a strict interpretation of the Salomon principle. In short
there was little consistency or certainty in a very important area of company law.
This, it seems, is what the Court of Appeal seeks to address in Adams by narrowing the
categories of veil lifting and eliminating any concept of veil lifting in the interests of
justice. Instead, narrow categories have been created which are somewhat elusive.
It does indeed seem an overly cautious approach which does little to serve the
interests of justice. It is true that there have, since Adams, been cases – such as Ratiu v
Conway (2006) 1 All ER 571 – which suggested that the courts might be prepared to be
a bit more flexible in their interpretation of veil lifting issues. However, more recent
decisions, such as VTB Capital plc v Nutritek International Corp [2013] UKSC 5 and Petrodel
Resources Ltd v Prest [2013] UKSC 34 indicate the courts are following the hardline
approach of Adams.
Activity 4.3
Involuntary creditors (generally, in this context, the victims of personal injury by the
company) are in a vulnerable position when it comes to the application of the Salomon
principle. Normal creditors have at least a way of calculating the business risk and
charging more or monitoring in order to protect themselves. Involuntary creditors
cannot do so and so if, for example, a parent company remains protected from the
tortious activities of its subsidiary by the Salomon principle, involuntary creditors can
suffer badly.
Thankfully the courts seem to realise this and draw a subtle distinction between
commercial torts (negligent misstatement) where Salomon is strictly applied and
personal injury actions where a more flexible approach has been taken (see Chandler v
Cape plc [2012] EWCA Civ 525).
Chapter 5
Activity 5.1
The House of Lords reasoned that Erlanger, as representing the syndicate, had
undertaken to act on behalf of the yet unformed company. We saw from the brief
extract taken from Lord Cairns LC’s speech (para 4.2), that promoters possess
considerable power in determining the shape of a new company’s management and
supervision. Given the vulnerability of companies to abuse by their promoters, the
law has responded by holding them subject to the rigour of the core fiduciary duty
of loyalty. In effect, this prohibits promoters from placing themselves in a position
where their personal interests might conflict with those of the putative company.
Thus, although promoters are not prohibited from selling their own property to the
company, they can only do so having made full disclosure to an independent board of
directors.
The House noted that there is nothing illegal in promoters selling their own property
to the company. However, it was stressed that the privilege of promoting a company
carries with it certain obligations. Promoters must appoint directors independent of
themselves who will be guardians of the company’s interests and who will protect the
shareholders. It need not be shown that the promoters were activated by fraudulent
motives – the fiduciary obligation will be broken even if there was ‘no intention to do
injustice’.
Activity 5.2
It is important to note that on the facts the promoters did not disclose to an
independent board of directors the profit they made on selling property owned by
them to the company. Lord Macnaghten, examining the conduct of Gluckstein, against
whom the action was brought, stressed that where a person who plays many parts
(i.e. being a promoter and then subsequently a director of the company) announces
to himself in one character what he has done in another character, this cannot be
described as disclosure in its proper sense. Indeed, there was no disclosure to the
intended shareholders at all; they were thus victims of a deception. Consequently,
where promoters make a secret profit during the promotion process they will be
jointly and severally liable to account for that profit to the company.
Activity 5.3
The policy underlying s.51 is to protect third parties who contracted in the belief that
they were dealing with registered companies. It makes pre-incorporation contracts
legally enforceable as personal contracts with promoters unless their personal liability
has been unequivocally excluded. The question of whether the promoter could enforce
the contract he is personally liable on has now been resolved by the Court of Appeal.
Chapter 6
Activity 6.1
Activity 6.2
Activity 6.3
By emphasising continual disclosure by listed companies, before and after listing, the
FCA and the LSE wish to achieve a number of aims.
u Where the company is listing for the first time disclosure provides the potential
investor with enough information to decide whether to invest or not.
u Where the company is already listed the disclosure regime is designed to ensure
that information is fairly distributed. If this was not the case large shareholders
would have greater access to information than small ones.
Continuous disclosure also minimises the risk of insider dealing.
Activity 6.4
The answer to this question is not as straightforward as it may seem. There are those
who believe that insider dealing should be allowed as it enables insiders to send
signals about impending actions by companies much quicker than the disclosure
regime (see McVea (1995)). However, the prevailing view on why it is illegal is that
it is morally reprehensible and has very damaging effects on the investing public’s
confidence in the marketplace (see Campbell (1996) on why insider dealing is
outlawed).
Chapter 7
Activity 7.1
A floating charge is a creature of equity. It attaches to assets for the time being. The
hallmark of a floating charge is that the company can continue to deal with the
charged assets in the ordinary way without obtaining the chargee’s consent (Re
Yorkshire Woolcombers Association, Romer LJ). As its name suggests, it floats over the
class of assets charged and it will only attach as a fixed charge upon a crystallising
event such as a default in making a loan repayment.
A fixed charge is a mortgage (legal or equitable) that is generally granted over

identifiable assets not commonly traded in the day-to-day operations of the company
– it attaches to specific assets of the company, for example, land. The holder of a fixed
charge will have rights in rem over the assets (see Agnew v Commissioner of Inland
Revenue).
Fixed chargees rank above floating chargees in respect of their priority in a liquidation
(see Chapter 17 of this module guide).
Floating charges may be challenged under the Insolvency Act 1986, s.245 (see Section
7.4 of this guide).
Activity 7.2
In Agnew Lord Millett explained that, unlike a floating charge where the company
continues to have the freedom to deal with the assets subject to the charge, a fixed
charge creates an immediate proprietary interest in the assets in favour of the holder
and therefore the company cannot deal with its assets without committing a breach
of the terms of the charge. He stressed that the classification of a security as a fixed
or floating charge was a matter of substance rather than drafting. If the chargor was
free to deal with the charged assets and could withdraw them from the ambit of the
charge without the consent of the chargee, then the charge must be viewed as a
floating charge. From the chargee’s perspective, if the charged assets were not under
its control, whereby it could prevent their dissipation without its consent, then the
charge cannot be viewed as a fixed charge. The critical test was whether the company
could continue receiving the book debts and to use them in its business and whether
it had the unrestricted right to deal with the proceeds of book debts paid into its
bank account. Note that Lord Millett states that Re New Bullas was wrongly decided
because the company was left in control of the process by which the book debts were
extinguished and replaced by different assets that were not the subject of a fixed
charge and were at the free disposal of the company. That was clearly inconsistent
with the nature of a fixed charge.
Activity 7.3
Section 874 of the CA 2006 states that certain charges will be void if not registered
within 21 days of their creation. Once registered the charge is valid from the date of
its creation. This gives rise to a 21-day invisibility period because whenever a person
checks the register it cannot be assumed that it is comprehensive because there may
be a charge for which the 21-day period is still running. Under the reform proposals
put forward by the CLRSG and the Law Commission the 21-day registration rule
would be dispensed with altogether. The period between creation and registration
would therefore cease to be relevant and, consequently, there would be no period of
invisibility. If adopted by the government, registration will no longer be a perfection
requirement but becomes a priority point as between competing chargees.
Chapter 8
Activity 8.1
Lindley LJ stressed that notwithstanding Ooregum, there is no rule preventing a private
company purchasing property or services at any price it thinks proper. Thus, provided
a company acts honestly, a contract that provides for it to pay for goods or services by
fully paid-up shares is valid and binding both on the company and its creditors. Unless
the transaction can be attacked on the basis of, for example, fraud, the value of the
consideration received by the company in return for its shares cannot be enquired
into.
Activity 8.2
Lord Oliver rejected both the trial judge’s and the Court of Appeal’s view that larger
purpose could embrace avoiding liquidation and preserving the company’s goodwill
and the advantages of an established business. He noted that ‘purpose’ is in some
contexts a word of wide content and in attaching meaning to it for the purposes of
s.153 CA 1985 (now ss.678–682) the mischief against which s.151 (now s.678) seeks
to address must be borne in mind. It is therefore necessary to distinguish between
a purpose and the reason why a purpose is formed. ‘Larger’ does not mean more
important and ‘reason’ is not the same as ‘purpose’. On the facts of the case, Lord
Oliver concluded that the scheme was framed for the best of reasons ‘but to say that
the “larger purpose” of Brady’s financial assistance is to be found in the scheme of
reorganisation itself is to say only that the larger purpose was the acquisition of the
Brady shares on their behalf’. Larger purpose cannot be found in the benefits likely
to flow from the financial assistance and therefore the acquisition was not a mere
incident of the scheme devised to break the deadlock – it was ‘the essence of the
scheme itself’.
Chapter 9
Activity 9.1
a. No feedback provided.
b. The articles have historically assumed a situation where there are potentially
large numbers of people involved in a business venture. As such it provides a
very clear set of rules designed to allocate power between the board and the
general meeting, the board having responsibility for the day-to-day running of
the company and the general meeting having a supervisory function. This has
historically been both a strength and a weakness: a strength in that companies
that match the statutory presumption of large numbers of participants can
function effectively according to its division of powers; a weakness in that small
companies with few participants find its formal division of power inappropriate.
The supervisory role of the general meeting has also been diminished in very
large companies by shareholder apathy. The separating out of private and public
company articles, thus providing appropriate rules, should go some way to
resolving this weakness.
Activity 9.2
The s.33 contract is an unusual one but that alone does not explain why enforcing it
has been such a complex issue. It seems that all the enforcement issues touch upon a
central question in company law. That is, when can an individual member sue in the
context of a corporate activity? As we will see in Chapter 11 the general rule in Foss v
Harbottle (1843) 2 Hare 461 states that only the company itself can sue to right a wrong
to the company. When the judiciary have been deciding on s.33 issues this general
principle seems to loom large in their thoughts. As a result, some of the judiciary hold
firm to the belief that only the company’s organs can enforce the constitution. Others
have taken the view that to apply the general rule in Foss v Harbottle is inappropriate in
the context of s.33 as it would allow the majority to defeat the intention of the section,
which is to ensure the constitution is enforceable. Thus the individual shareholders
must be allowed to sue to enforce the constitution. While the CLRSG has recognised
that shareholders should be able to do so in its recommendations the CA 2006 has
done little to change the confusion.
Activity 9.3
a. The key advantage of a shareholders’ agreement is the certainty of enforcement
against the other parties to the agreement. The courts have continually shown that
they will enforce such agreements. A shareholder can also identify who he wishes
to contract with. For example, if he wishes to contract for other shareholders’ votes
he can identify a shareholder with the right percentage of votes and then enter
into an agreement with the other shareholder to exercise his votes in a particular
way. It is also private. The disadvantage of a shareholders’ agreement is that
once a party to a shareholders’ agreement sells his shares, the new owner has no
obligations under the shareholders’ agreement. This is in contrast to the way the
s.33 contract operates to bind future shareholders to the company’s constitution.
Adding the company to the shareholders’ agreement may also be a disadvantage
as there are statutory restrictions on its ability to contract.
b. As we have discussed above there are certain restrictions on the shareholders’

ability to vote. First, alterations of the articles cannot conflict with any statutory
provisions. Second, sometimes the courts (particularly where minority
shareholders are disadvantaged) will impose equitable restriction on the majority
shareholders’ votes.
Chapter 10
Activity 10.1
A share represents the member’s financial stake in the company as an association and
delimits the extent of the shareholder’s liability to the company. If the share is partly
paid the shareholder owes the company the difference between the price actually
paid and its nominal or par value plus any premium (see Chapter 8). In fact, nowadays
most shares are fully paid and so the holder has no further liability to contribute
to the company’s capital in the event of it becoming insolvent. Unlike partners in a
partnership, shareholders do not own corporate assets but rather ownership is vested
in the company itself: Macaura v Northern Assurance Co Ltd [1925] AC 619.
Activity 10.2
Where rights are annexed to particular shares, such as the right to receive dividends
at a specified rate or to receive a return of capital on winding up, they are class rights.
Obviously, if a company has issued only one class of shares – ordinary shares – there
are no class rights as such, only shareholder rights. In Cumbrian Newspapers Group Ltd
v Cumberland and Westmoreland Herald Newspapers and Printing Co Ltd [1987] Ch 1, Scott
J explained that where a company’s articles confer special rights on one or more of its
members in the capacity of member or shareholder the rights are class rights.
Activity 10.3
The significance of identifying a right as a ‘class right’ is that it cannot be varied by the
company without going through the procedure laid down in ss.630–634 CA 2006. A
proposal to vary class rights requires the consent of the class concerned. Class rights
therefore have greater protection than a right conferred just by the articles, because
the articles of association can be altered by a special resolution of the company (s.21
CA 2006).
Chapter 11
Activity 11.1
Activity 11.2
The judge explained that if the substance of a complaint relates to something that
the majority of the company are entitled to do, or if the complaint concerns some
irregularity which the majority can legitimately do regularly – then there is no point in
suing, because ultimately a general meeting will be called at which the majority will
get its own way. Mellish LJ went on to add, however, that if the majority abuse their
powers and deprive the minority of their membership rights then the minority can sue
(see Chapter 9 of this guide and s.33 CA 2006, the statutory contract).
Activity 11.3
Activity 11.4
Briefly, the facts were that the company was insolvent due to a former director’s
breach of certain fiduciary duties not to compete or misuse confidential 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 director applied for a security of costs order (i.e. a court order requiring the
company to demonstrate its ability to comply with the court’s decision on costs). In
effect, the defendant had, by his breach of duty, rendered the company incapable of
seeking legal redress against him because it lacked the means to fund the litigation.
The claimant sought to recover losses to the value of his shareholding, loss of
remuneration and loss of the value of loan stock. The issue for the court was whether
these were recoverable by him given the decision in Johnson v Gore Wood & Co. The
Court of Appeal, in placing considerable emphasis on the fact that the defendant’s
own wrongdoing had, in effect, disabled the company from suing him for damages,
found that this situation had not confronted the House of Lords in Johnson. Given that
the duties in question were expressly provided for in the shareholders’ 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. The 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 reflective losses.
In summary, the decision means that if a company is rendered incapable of suing a

wrongdoer by the wrongdoing in question, a shareholder who also has a claim may
bring proceedings for his own losses, including losses (termed reflective losses)
attributable to the diminution in value of his shares.
Chapter 12
Activity 12.1
The petitioners argued that the majority shareholders who were also the directors
had run three companies for their own benefit in that they claimed excessive
remuneration while paying low dividends to non-director shareholders. On the facts
the court considered that the petitioners had an arguable claim for relief under s.994
and that an order requiring the respondents to purchase the petitioners’ shares at a
fair price to be determined by the court would be more appropriate than destroying
the company by ordering its winding up.
Activity 12.2
The Court of Appeal held that the petitioner was not acting unreasonably in refusing to
accept a valuation of his shares by the company’s auditor, as provided in the articles,
given that his shares might be discounted in circumstances where a discount was
inappropriate. Balcombe LJ took the view that it would be just and equitable to ignore
the articles of association and allow the petition to proceed.
The converse of the decision in Virdi is that if an offer to purchase a petitioner’s shares
is fair, the petitioner will be acting unreasonably in seeking a winding up order rather
than seeking relief under s.994 CA 2006.
Activity 12.3
a. The evidence of the events giving rise to the claim spans a period of some 40
years. The petitions were brought against two associated companies, Macro
(Ipswich) Ltd and Earliba Finance Co Ltd. The petitioners alleged that the conduct
of the companies’ sole director, Mr. Thompson, (T), amounted to mismanagement
which unfairly prejudiced their interests as members. At the time of the petition
T was 83 years of age. He was described as a ‘patriarchal figure’ and engaged in
serious disagreements with the petitioners. It is noteworthy that of the three
petitioners, one was T’s son and the other two were his nephews. Central to
the mismanagement allegation was the complaint that T’s laissez faire style of
management left the companies vulnerable to the dishonesty and neglect of his
employees at Thompsons, an estate agency business which managed a substantial
number of rental properties owned by the company. The petitioners alleged that
Thompsons’ employees received secret commissions from builders, the costs of
which were passed on to the companies, and that they took ‘key’ money from new
tenants. It was successfully argued that the substantial financial losses suffered
were due to T’s mismanagement which unfairly prejudiced the petitioners.
b. Arden J stated that the question of whether any conduct was ‘unfairly prejudicial’
to the interests of the members has to be judged on an objective basis. First it has
to be determined whether the action of which the complaint is made is prejudicial
to members’ interests and, second, whether it is unfairly so.
c. In granting relief, the court took the view that rather than appoint the petitioners
to the board, which they had contended had been their expectation, T would be
ordered to purchase his son’s shares in Macro and Earliba.
Chapter 13
Activity 13.1
a. This case probably represents the harshest interpretation of the ultra vires doctrine
and perhaps illustrates best the danger ultra vires posed to companies. In this case
the company’s object was to acquire and develop a German patent for producing
coffee from dates. The company failed to get the German patent but obtained a
Swedish one instead. Despite the fact the company had a thriving business based
on the Swedish patent it was wound up by the court because it could not achieve
its strictly stated object.
b. Re Jon Beauforte and Re Introductions Ltd are further good examples of the problems
thrown up by the ultra vires issue and the need for legislative intervention.
Activity 13.2
The statutory reforms have the combined effect of making it easier for companies to
change their objects and of providing saving provisions for outsiders. This means that
there are very few remaining ultra vires problems. Most of the criticism of the reforms
has focused on the complexity of the solutions provided for what seems a relatively
simple problem. The CLRSG in its Final Report (July 2001) (para 9.10) recognised this
and recommended that any company formed under a new companies act should have
unlimited capacity whether or not it chooses to have an objects clause. This was partly
implemented in the CA 2006.
Activity 13.3
Activity 13.4
Lord Hoffmann viewed the organic theory of the company as largely unhelpful. Instead
he considered that if a rule of law requires the court to determine the act or a state
of mind of a person, and that rule was intended to apply to companies as well, the
court can construct a special rule to test whether something can be attributed to
the company. For example the court may not be limited to looking at the directing
mind and will of the company but rather could also examine the state of mind of the
individual responsible for the matter at hand, no matter what level they were at in the
company.
Chapter 14
Activity 14.1
Buckley LJ explained that a person who holds all of the shares in a company is not
entitled to control its business. Directors are not the servants of shareholders and so
they are not bound to obey their directions given as individuals. Nor are directors the
agents of shareholders, bound to follow orders given by their principals. But where the
articles of association entrust directors with control of the company, such control can
only be removed by amending the articles in accordance with the statutory procedure
laid down by s.21 CA 2006 which requires a special resolution.
Activity 14.2
a. Article 90 provided that the board shall fix the annual remuneration of the
directors subject to the proviso that without the consent of the general meeting
such remuneration shall not exceed £100,000. Article 91 went on to confer on
the board the power to grant special remuneration, in addition to ordinary
remuneration, to any director who serves on any committee or who gives special
attention to the business of the company.
b. Mr Ward was a member of a committee set up by Guinness’s board of directors

to guide the company through a takeover bid it had made for another company,
Distillers. He had been paid a fee of £5.2m for his services which had been agreed
by the committee. Lord Templeman, construing the language of the articles
of association, found that they did not confer on the committee the power to
pay remuneration to one of its own members. He said that ‘Article 91 draws a
contrast between the board and a committee of the board. The board is expressly
authorised to grant special remuneration to any director who serves on any
committee. It cannot have been intended that any committee should be able to
grant special remuneration to any director, whether a member of the committee
or not.’
Activity 14.3
In reversing the trial judge’s finding that the respondents were not shadow directors
within the statutory definition, Morritt LJ, having reviewed the case law, laid down five
propositions.
i. The definition of a shadow director is not to be too narrowly construed given that
the purpose of the CDDA 1986 is to protect the public.
ii. Although the purpose of the legislation is to identify those, other than professional
advisers, with real influence in the corporate affairs of the company, it is not
necessary that such influence should be exercised over the whole field of its
corporate activities.
iii. Whether any particular communication (by words or conduct) from the alleged
shadow director is to be classified as a direction or instruction must be objectively
ascertained by the court in the light of all the evidence.
iv. Non-professional advice may come within the statutory description: the proviso
excepting advice given in a professional capacity assumes that advice generally is
or may be included. The concepts of ‘direction’ and ‘instruction’ do not exclude the
concept of ‘advice’ because all three share the common feature of ‘guidance’. The
critical factor is whether the person has real influence over the company’s affairs.
v. Although it is sufficient to show that in the face of ‘directions or instructions’ from

the alleged shadow director the properly appointed directors (or some of them)
cast themselves in a subservient role or surrendered their respective discretions,
this is not necessary in all cases. Such a requirement would be to put a gloss on the
statutory requirement that the board are ‘accustomed to act’ ‘in accordance with’
such directions or instructions.
Activity 14.4
H, as a non-executive director of the company, was signatory to the company’s cheque
account. The company’s accounts, which H looked to when assessing the company’s
financial position, were prepared by professional accountants. The company went into
liquidation and the Secretary of State applied for an order under s.6 CDDA 1986 on the
†
basis that H had caused the company to operate a policy of not paying Crown monies † ‘Crown monies’: National
and had failed to keep himself properly informed of the company’s financial position. Insurance, PAYE (employees’
The grounds of the application were that beginning in June 1995 the company had income tax) and VAT (sales
ceased making National Insurance and PAYE payments. Also, the fact that the company tax) are all collected by
was in arrears of VAT was apparent in the management accounts for February and April companies on behalf of the
1995. It was alleged by the Secretary of State that H either knew the payments were government and paid over at
not being made or ought to have realised they were not being paid because he had set intervals.
not been requested to sign any cheques in respect of such payments. Further, H had
signed a number of cheques to pay another director’s son’s school fees thereby
allowing that director to breach his fiduciary duties by misusing company funds for his
own personal use. H had questioned the propriety of these payments but had been
assured by the accountants that they would be treated as part of that director’s
remuneration and would be properly reflected in the accounts as such.
Notwithstanding the accountant’s advice H had refused to sign additional cheques for
school fees and he had reported these payments to the board.
The Secretary of State’s allegation that H had failed to keep himself properly informed
of the company’s financial health was rejected. Merely being a signatory to the
company’s cheques was not sufficient to make the director personally responsible for
any policy of not paying Crown monies. H was entitled to rely on the assurances of the
accountant that the finances of the company were being properly managed. The court
held, taking H’s lack of experience in operating corporate finances together with his
non-executive status, that he was entitled to rely on the accountants to prepare the
accounts and on their assurances that the finances were being properly run. A cheque
signatory is not a Finance 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.
Chapter 15
Activity 15.1
In Coleman v Myers the board of a family company had recommended to the
shareholders a takeover offer by a company controlled by one of the defendant
directors. The court held that in a small private company where the minority
shareholders habitually looked to the directors for advice on matters affecting
their interests, a duty of disclosure arose which placed the directors in a fiduciary
relationship with the shareholders. Woodhouse J stated that while it is impossible
to lay down a general test as to when the fiduciary duty will arise, the following
factors will be material to the court’s determination: ‘dependence upon information
and advice, the existence of a relationship of confidence, the significance of some
particular transaction for the parties and… the extent of any positive action taken by
or on behalf of the director or directors to promote it’.
Activity 15.2
Lord Wilberforce stated that the court should:
i. consider the nature and scope of the power whose exercise is in question (in this
case, a power to issue shares)
ii. identify the limits within which it may properly be exercised
iii. identify the substantial purpose for which it was actually exercised
iv. having given credit to the bona fide opinion of the directors and accepting their
judgment as to matters of management, determine whether the substantial
purpose (point iii, above) fell within a legitimate purpose determined according to
point ii, above.
If the substantial purpose is proper, the exercise of the power will not be set aside
because some other improper, but merely incidental, purpose was also achieved.
Activity 15.3
In Extrasure the directors had transferred company funds to another company in the
group 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. The decision clearly illustrates that where the company is
one of a number in a group structure the directors must act bona fide in the interests of
that company. This is, after all, a straightforward application of the decision in Salomon
(see Chapter 3 of this guide) – that each company is a separate legal entity. There 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 financial difficulty 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 affected by the liquidation of the parent company (see Nicholas v
Soundcraft Electronics Ltd [1993] BCLC 360).
Activity 15.4
All three of the directors (the executive and the two NEDs) were held liable to make
good the company’s losses and, while the judge noted the accountancy experience of
the NEDs, their professional qualifications were not material to his finding. The court
found the NEDs negligent in allowing Stebbings ‘to do as he pleased’. You should note
Foster J’s finding that the NEDs not only failed to exhibit the necessary skill and care in
the performance of their duties as directors, but that they failed to perform any duty
at all.
Activity 15.5
The directors were liable notwithstanding that:
u the company was financially incapable of purchasing the necessary shares
u they had used their own money
u they had acted honestly.
As Lord Russell pointed out, the liability to account for any profit does not depend
upon fraud or absence of bona fides, ‘the liability arises from the mere fact of a
profit having, in the stated circumstances, been made’. The fact that the purchasers
of the company in effect got a reduction on the purchase price they had agreed
was irrelevant to the issue of liability. The decision illustrates that the liability of
directors in this respect is founded upon their trustee-like status – thus, like trustees,
directors will hold any secret profit (i.e. a profit not disclosed to and ratified by the
shareholders) on constructive trust.
The new board caused the company to bring the claim against its former directors.
As we saw in Chapter 11, the proper claimant rule requires the company to bring
proceedings for redress when a wrong has been committed against it.
Chapter 16
Activity 16.1
This is a good way for you to bring company law to life a bit more by thinking
about how various aspects of company law can be categorised. As a general guide,
mandatory company law rules, such as minimum capital requirements which override
any private agreements between contracting parties, sit easier with concession theory,
where state interference is more easily justifiable. Default rules, such as the articles of
association which apply in the absence of any agreement to the contrary, and enabling
rules, such as the company registration procedure, which provide a framework
for private parties to carry out certain functions sit easier with aggregate theory.
Additionally the common law’s protection of managerial discretion seems to have
some resonance with corporate realism. Company law, as you will note, is not in reality
dominated by any one theory but is a mix of all three.
Activity 16.2
This is a provocative statement and you must agree or disagree with it. Do not ‘sit
on the fence’ as a strong argument on one side or the other is the only way to deal
with it. The statement is interesting given that until recently it was generally agreed
that corporate governance had improved. Given the collapse of the financial services
sector in the UK and US over the course of 2008–9 corporate governance failure is once
more at the top of the reform agenda. While it is true that the committees have been
a great export success, with many countries adopting their recommendations, this
may not be the success it might have seemed. It now seems that the reason why these
recommendations are particularly palatable for the global business community is
that they are not particularly onerous. If you have not already read Dignam and Lowry,
Chapter 15, please do so now.
Chapter 17
Activity 17.1
The primary purpose of liquidation is to ensure, as far as possible, that all creditors
receive fair treatment, so if there is any scheme put in place which prevents this the
court will set it aside. Thus, the House of Lords held that the pari passu principle of
distribution (by which is meant that the free assets of the company are distributed pro
rata among unsecured creditors) is mandatory to the extent that a creditor cannot, by
contract, obtain a better position than that which the pari passu principle permits.
Activity 17.2
The objectives of the IA 1986, which implements the recommendations of the Report
of the Review Committee on Insolvency Law and Practice (Cork Committee Report,
1982 (Cmnd 8558)), are:
u to maximise the return to creditors where the company cannot be saved
u to establish a fair system for the ranking of competing claims by creditors
u to provide a mechanism by which the causes of the company’s failure can be

identified and those guilty of mismanagement can be made answerable.
The compulsory winding up procedures and the powers of a liquidator and the court
to police the winding up seek to achieve these objectives.
Company law Feedback to activities page 229
Activity 17.3
Buckley LJ explained that there may be circumstances where it is beneficial, both to
the company and to the unsecured creditors, that the company be allowed to dispose
of some of its property after the petition has been presented. However, he stressed
that in considering whether to make a validating order the court should ensure that
the interests of the unsecured creditors are not prejudiced. Where an application is
made in respect of a specific transaction this may be susceptible of positive proof. But,
whether or not the company should be permitted to carry on business generally is
more speculative and will depend on whether a sale of the business as a going concern
will be more beneficial than a break-up realisation of the assets. Buckley LJ concluded
by saying that, although the court will be disinclined to consent to any transaction
which has the effect of preferring a pre-liquidation creditor, nevertheless ‘the court
would be inclined to validate a transaction which would increase, or has increased, the
value of the company’s assets, or which would preserve, or has preserved, the value
of the company’s assets from harm which would result from the company’s business
being paralysed…’
Activity 17.4
Notes

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What are the main forms of business organization discussed in the text?

What are the main forms of business organization discussed in the text?

What is the principle established in Salomon v Salomon & Co?

What is the principle established in Salomon v Salomon & Co?

Company law

Published by: University of London

2 Forms of business organisation . . . . . . . . . . . . . . . . . . . . . . 7

3 The nature of legal personality . . . . . . . . . . . . . . . . . . . . . 19

4 Lifting the veil of incorporation . . . . . . . . . . . . . . . . . . . . . 27

5 Company formation, promoters and pre-incorporation contracts . . . 39

6 Raising capital: equity . . . . . . . . . . . . . . . . . . . . . . . . . . 49

7 Raising capital: debentures . . . . . . . . . . . . . . . . . . . . . . . 61

9 Dealing with insiders: the articles of association and shareholders’

11 Majority rule and wrongs against the company . . . . . . . . . . . . 109

12 Statutory minority protection . . . . . . . . . . . . . . . . . . . . . 125

14 The management of the company . . . . . . . . . . . . . . . . . . . 151

15 Directors’ duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165

16 Corporate governance . . . . . . . . . . . . . . . . . . . . . . . . . 191

17 Liquidating the company . . . . . . . . . . . . . . . . . . . . . . . . 205

Feedback to activities . . . . . . . . . . . . . . . . . . . . . . . . . . . 215

Courses on which this module is offered

Notional study time

MODULE PURPOSE AND OVERVIEW

LEARNING OUTCOMES: KNOWLEDGE

LEARNING OUTCOMES: SKILLS

5. Identify the legal issues raised by complex hypothetical ‘problem question’

BENCHMARK FOR LEARNING OUTCOMES

(e) Management of the company. Directors and other officers. Appointment.

(h) Corporate governance. Corporate accountability (stakeholder v shareholder

LEARNING AND TEACHING

The Laws Virtual Learning Environment

u a complete version of the module guides;

u past examination papers and reports;

u Computer Marked Assessments – multiple choice questions with feedback

The Online Library

u the professional legal databases LexisLibrary and Westlaw;

u cases and up-to-date statutes;

u key academic law journals;

u links to important websites.

Summative assessment is through a three hour and fifteen minute unseen

¢ Core statutes on company law 2020–21 (Palgrave Macmillan).

1.1 Company law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

1.2 Approaching your study . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Company law requires students to develop their existing understanding of tort,

1.1 Company law

1.1.1 Reforming company law

¢ Goddard, R. ‘Modernising Company Law: the Government’s White Paper’ (2003)

1.2 Approaching your study

This is a very comprehensive and authoritative textbook. It is very detailed, but it is a

¢ Reisburg, A. and A. Donovan Pettet, Lowry and Reisburg’s company law:

¢ Kershaw, D. Company law in context: text and materials. (Oxford: Oxford

¢ Dignam, A. and Galanis, M. The globalization of corporate governance. (Farnham:

¢ Core statutes on company law 2020–21 (Palgrave Macmillan).

¢ Modern Law Review (MLR)

¢ Oxford Journal of Legal Studies (OJLS)

¢ Journal of Law and Society (JLS)

¢ Law Quarterly Review (LQR)

¢ Cambridge Law Journal (CLJ).

However, we do not live in an ideal world, so a good compromise is to buy or read in