Law on Directors' Duties (UK) - s171 Companies Act 2006

A nice summary of s171 (minus the fun part).
A nice summary of s171 (minus the fun part).

S.171 CA 2006: Duty to act ‘in accordance with the constitution’

"A director of a company must—
(a) act in accordance with the company’s constitution, and
(b) only exercise powers for the purposes for which they are conferred."

Defining 'constitution' - s257, a company's constitution includes:

"(a) any resolution or other decision come to in accordance with the constitution, and
(b) any decision by the members of the company, or a class of members, that is treated by virtue of any enactment or rule of law as equivalent to a decision by the company"

s171 Case List

  • Re Smith and Fawcett [1942]
  • Guiness v Saunders [1990]
  • Punt v Symonds [1930]
  • Hogg v Cramphorn [1967]
  • Bamford v Bamford [1969]
  • Howard Smith v Ampol Petroleum [1974]

The power to veto share-transfer case

The directors were able to deny the transfer of shares.
The directors were able to deny the transfer of shares.

Re Smith and Fawcett [1942]

  • The articles gave directors the power to veto the transfer of shares. That is, the directors could decide who becomes a new shareholder, and this power was not limited in any way by the articles.
  • Such a provision is common in small companies, since they're anxious about who will join the company later (one bad egg will have a huge impact if the company is small, unlike a larger public company).
  • Someone objected to the veto the directors gave. The Court of Appeal looked at the articles, and concluded that the provision was 'drafted in the widest possible terms' so as long as the director acted in accordance with his fiduciary duty (act in the company's interests) then there was no restriction to their veto powers. The directors won.

Unconstitutional Remuneration Case

Visual representation of the director chasing his remuneration.
Visual representation of the director chasing his remuneration.

Guinness v Saunders [1990]

  • A trio of directors were put in charge of dealing with a takeover bid.
  • That trio decided amongst themselves that one of them should receive a hefty fee for his services.
  • The articles in that case (as is the case with the current model articles so this provision is very common) stated that the fixing of remuneration is a matter for the whole board of directors, and so in the absence of delegation of this power the trio had no capacity to decide that one of them should receive any remuneration.
  • The House of Lords decided that the directors were clearly acting outside of their powers and could not claim the remuneration they had decided upon.

Flooding the General Meeting with Like-Minded Shareholders Case

Inviting like-minded individuals to take up shares in a company so that you can pass resolutions you want is a classic corporate tactic.
Inviting like-minded individuals to take up shares in a company so that you can pass resolutions you want is a classic corporate tactic.

Punt v Symonds [1930]

  • The company made a contract to not alter its articles.
  • Later the directors decided they wanted to change the articles.
  • In order to get the 75% majority they needed for a change, they issued shares to like-minded recipients.
  • The other party to the contract objected to the directors doing this, claiming that the sole object of issuing the shares was a collateral purpose and not to raise capital for the company,
  • The judge found that although there are other purposes that issuing shares can be done, he concluded that issuing shares in order to achieve an 'unfair majority' was an improper purpose.
  • This is the sort of issue s171(b) CA 2006 now deals with.

'It's to Help the Employees' Takeover Bid Thwarting Case

Even though the court was convinced the thwarting was done for the benefit of the employees and not just self-interest, issuing shares to thwart a takeover was still found to be an improper purpose.
Even though the court was convinced the thwarting was done for the benefit of the employees and not just self-interest, issuing shares to thwart a takeover was still found to be an improper purpose.

Hogg v Cramphorn [1967]

  • Directors issued shares in order to thwart a takeover bid.
  • They convinced the court that the takeover was a concern for the staff and suppliers of the company, who were worried about the intentions of the takeover bidder.
  • The first instance judge nevertheless followed Punt v Symonds and found the issuing of shares to be an improper purpose.
  • However, he also stated that the general meeting could have authorised the shares, either by ex ante modification or ex post ratification.

Ratification of Fiduciary Duty Breach Case

There was a breach of fiduciary duty, but ratification was possible.
There was a breach of fiduciary duty, but ratification was possible.

Bamford v Bamford [1969]

  • The directors issues shares to thwart a takeover bid.
  • This time, when they realised the issue would be challenged, they convened a general meeting and got the issuing of the shares ratified.
  • The Court of Appeal held that the directors issued the shares primarily to prevent the takeover and not for the benefit of the company, and so were in breach of their fiduciary duty to act for proper purposes.
  • However, they accepted that the breach could be, and in this case was, ratified by the general meeting so that the directors incurred no liability.

Rival Bidders Flooding Case

Flooding is an improper purpose because it interferes with the composition of the general meeting which is the organ the board of directors are accountable to.
Flooding is an improper purpose because it interferes with the composition of the general meeting which is the organ the board of directors are accountable to.

Howard Smith v Ampol Petroluem [1974]

  • Here there were two rival bidders for a company.
  • Ampol was an existing shareholder that wanted to buy more shares. He was at war with the directors.
  • Howard Smith was an outside takeover bidder.
  • The directors issued shares to Howard for allegedly two reasons: gain more share capital and favour Howard's bid over Ampol's. It was the latter reason that the court focused on.
  • Ampol challenged the issue.
  • Just like in Punt v Symonds, the court held that raising capital was not the only proper purpose but neglected to offer any examples of others.
  • The court held that it was not within the purpose of the power to issue shares if it was:

‘simply and solely to dilute the majority voting power.. [it is] Unconstitutional for directors to use their fiduciary powers over shares…purely for the purpose of destroying an existing majority or creating a new majority… to do so is to interfere with that element of the company’s constitution which is separate from and set against their powers’

  • This is to say, since it is the general meeting that is the body to whom the directors are accountable, it is improper for directors to start interfering with the composition of the general meeting. Issuing shares primarily to do so is therefore an improper use of the power to issue shares.The directors lost.

Managerial Power Delegation Case

Unsurprisingly, using a director's power to burn the bridge behind you was found to be an improper use.
Unsurprisingly, using a director's power to burn the bridge behind you was found to be an improper use.

Lee Panavision Ltd v Lee Lighting Ltd (CA) [1991]

  • A few directors were going to be let go.
  • Before they left, they entered into a management agreement which delegated managerial powers to Lee Panasonic.
  • Although this was intra vires (permitted by the articles) it was a fiduciary power. The outgoing directors were found to be trying to hamper the managerial options for new directors.
  • The new directors refused to acknowledge the managerial agreement and so Lee Panasonic sued the company to enforce it.
  • The Court of Appeal refused to enforce the agreement, concluding that it was unconstitutional for the the directors to seek to interfere with the managerial powers of their successors, and so the agreement was not binding on the company due to being made for an improper purpose.

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