In this issue we take a look at a case in which the courts reexamined the Duomatic principle, as well as touching on recent guidance from the FRC for companies preparing their 2016 annual reports.

Testing the limits of the Duomatic principle

The High Court has held, in Randhawa and others v Turpin and another, that certain acts by a company's sole director were valid because they were done with the consent of its shareholder and beneficial owners, even though he did not comply with the company's articles.

Background

The case concerned BW Estates Limited ("BWE"), which from 2009 had only one director Mr David Williams following the disqualification of its other director, Mr Robert Williams (David's father).

David was BWE's main shareholder, holding 75 per cent of its shares on bare trust for his father. The other registered shareholder was an Isle of Man company ("Belvedere"), which had previously held the other 25 per cent on bare trust for Robert but which was dissolved in October 1996.

BWE's articles of association contained a fairly standard clause stating that, while it had only one director, that director's powers were limited to convening a general meeting to appoint an additional director. For any other decision, the quorum for a board meeting was two.

In September 2013, David, acting alone, resolved to place BWE into administration. Robert attended the meeting with David in which the decision was made and acquiesced in the decision.

In 2015, one of BWE's creditors applied for a declaration that the administrators' appointment was invalid, since the board meeting at which David resolved to make the appointment was inquorate.

Robert and David argued in response that Robert, although not recorded as such, was in reality a de facto director all along, and so the board meeting was in fact quorate. Alternatively, they argued that the administrators' appointment was valid under the Duomatic principle.

Legal context

If all the shareholders of a company who can vote at general meetings agree to a matter that could be approved at a general meeting, that matter is binding as if a resolution had been passed in general meeting to that effect. This is usually called the principle of informal unanimous consent, or the Duomatic principle, after the case in which it was established. Essentially, with exceptions, where all shareholders agree, a company can bypass a formal meeting.

A long line of cases has established that the Duomatic principle can operate to amend a company's articles of association.

Most recently, in the high-profile case of Sherlock Holmes International Society Ltd v Aidiniantz, the court found that articles can be amended even if the shareholders do not formally agree the amendment, provided they conduct themselves as though it had been made.

A de facto director is a person who acts as a director but has not been validly appointed as such.

Decision

The court dismissed the claim because it thought it was an abuse of process. However, it also found that Duomatic did indeed apply. Both David and Robert had conducted themselves at all times as if the articles had stated a quorum of one for board meetings, and the articles were amended to that effect.

In reaching this conclusion, the court made some interesting and striking findings:

De facto director. The judge could not find that Robert was a de facto director, because he was subject to a disqualification order. He was incapable in law of acting as a director. The quorum of two could not be interpreted as extending to a person who was disqualified from being a director.

Dissolved shareholder. Normally, Duomatic requires assent from all shareholders entitled to vote. However, here, one shareholder no longer existed, and BWE's articles did not provide for its shares to pass to anyone else. The shares in question could not be voted and so were ignored. David's assent, as the only other shareholder, was enough to invoke the Duomatic principle.

Beneficial owner. The judge found that Robert had assented to the administrators' appointment. Although it did not need to decide this point, the court held that, as Robert was the beneficial owner of the shares held on bare trust by David and formerly held on bare trust by Belvedere, Robert's assent was also sufficient to invoke the Duomatic principle.

Practical implications

Procedural defects are not uncommon when companies make decisions, and this is not the first time a company has had fewer directors than its articles require. Often, Duomatic can be used after the event to "cure" these defects (although it is important to note that there are limits to the principle).

The decision that Duomatic applied even though one of the shareholders did not assent is pragmatic and sensible, given that the shareholder in question had been dissolved and so could not vote.

What is striking is the finding that Duomatic can be invoked by a company's beneficial owners. This has been alluded to before but not taken further.

Randhawa appears to expand the Duomatic principle to beneficial owners in two specific scenarios: (i) where the registered holder holds the shares on bare trust and acts under the beneficiary's directions; and (ii) where a "disqualifying feature" affects the registered holder (such as the registered holder ceasing to exist). However, it is not abundantly clear that this is where the principle now ends.

While this may seem fair on the facts, it is not ideal for companies, which are not required to take notice of trusts over their shares.

Rather, companies can generally treat their registered shareholders as the only persons entitled to vote and receive dividends. This makes sense. Companies now have powers under the PSC regime to investigate their beneficial owners, but they may still be unaware of trusts over their shares. The burden on a company to investigate the "true" owners of its shares would be significant.

If correct, the decision in Randhawa could result in constitutional changes affecting a company without the company, or even its registered shareholders, being aware. To guard against this, companies may need to consider taking further steps, including using their statutory powers under the PSC regime, to discover the identity of their "true owners".

OTHER ITEMS

FRC publishes advice on annual reports

The Financial Reporting Council (FRC) has written to audit committee chairs and finance directors of listed companies with suggestions for preparing their 2016 annual reports. Recommendations include:

  • making the strategic reports clearer and more userfriendly (particularly smaller companies) and making sure alternative performance measures do not obscure IFRS / UK GAAP information;
  • making specific disclosures arising from the EU referendum as its effects become clearer;
  • more detailed explanations of where tax is paid, whether the company's tax strategies are sustainable, how its dividend policy operates in practice, and actions taken by its audit committee; and
  • more clarity and brevity in reporting on directors' remuneration.

A copy of the letter can be found here.