When setting up a company (whether a joint venture or a wholly owned subsidiary) it will be important to tie down the matters to be decided by the board and the matters to be reserved for shareholder approval.  We look at points for shareholders to consider, including the implications of a recent High Court case, which arose from a dispute about the extent of shareholders' rights and directors' powers when a director was removed from office.

The division of power between the board and shareholders is important, not only because the individuals involved and voting structures may be different at each level, but also because directors will have to make decisions in accordance with their statutory duties (whereas shareholders will generally be free to act in their own interests).  The directors' statutory duties include the duties to promote the success of the company for the benefit of its members as a whole and to exercise independent judgment.  Whilst these duties are usually aligned with the interests of the shareholders, this may not always be the case.

The interrelationship between the rights of the directors and shareholders in a set of corporate documents has recently been considered by the High Court in the case of Jackson v Dear and Anor [2012] EWHC 2060 (Ch).  The case highlights some key points for shareholders to bear in mind.

  • Each director will be bound to act in accordance with his statutory duties.  In the Jackson case, director/shareholders faced a potential conflict between their duties as directors and their contractual commitments under a shareholders' agreement.  To avoid this type of difficulty, appropriate wording can be included in the documents (for example, a carve-out from the relevant commitment to avoid conflicts with directors' duties).  Alternatively, if the shareholders consider any decisions to be critical (such as the sale of a business or dismissal of a senior employee) the best solution will generally be to include provisions reserving these decisions for themselves in the shareholders' agreement or other appropriate document.
  • It will be important to make sure that the provisions in the documents are consistent.  One of the questions in the Jackson case was whether provisions in the company's articles gave the directors leeway to undermine provisions in a shareholders' agreement by the back door.  As a safeguard against conflicts between different documents, it is common to include a prevailing terms clause.  Typically the terms of any shareholders' agreement will prevail over the articles and the shareholders will agree to amend the articles as necessary to eliminate conflicts or ambiguities.
  • Once the company is up and running, there are a number of ways in which shareholders may be able to intervene, if they do not agree with decisions at board level.  Examples highlighted in the case include the shareholders giving a direction to the board as to the management of the company, under the company's articles.  The shareholders may also be in a position to sanction any breach of duty on the part of the directors or to amend the company's articles to limit the directors' powers.  

The case

The Jackson case centred on a dispute which arose when a director, Mr Jackson, was removed from office by his fellow directors under the company's articles of association.  The High Court was asked to consider the interplay between two potentially conflicting provisions:

  • the article setting out the removal provisions, which allowed a director to be removed from office at any time, by notice from all his fellow directors; and
  • a shareholders' agreement setting out the terms on which Mr Jackson should remain in office.  The company's parent and ultimate shareholders agreed that the parent company would use its voting rights so as to procure the appointment of Mr Jackson as a director of the company at its next AGM, and his re-appointment at every AGM after that, unless a "termination event" occurred.  The Court assumed, for the purposes of the hearing, that no termination event had occurred.

Mr Jackson and two other directors of the company were also ultimate shareholders and bound by the agreement.

The Court was asked to consider the exercise of the directors' power of removal under the articles, in light of the shareholders' agreement.  Once Mr Jackson had been removed from office under the articles, the other shareholders had refused to re-appoint him at the next AGM in accordance with the shareholders' agreement, arguing that this would be futile, as Mr Jackson would simply be removed again by the directors under the articles.

The decision

The judge concluded that the parties to the agreement were contractually obliged not to take any steps themselves to remove Mr Jackson from office, unless a termination event had occurred.  This was either on the basis of an implied term in the agreement (very broadly, a term which was necessary to spell out what the agreement actually meant) or because of a general rule that a party to a contract must do nothing of his own motion to render its further performance impossible or futile.

On this interpretation, there was a possibility that the contractual obligation not to take steps to remove Mr Jackson could conflict with the parties' duties as directors which, in some circumstances, might oblige the directors to exercise their power under the articles to remove Mr Jackson.  It was here that a further assurance clause in the agreement came into play.  The judge concluded that under the further assurance clause, the parties were obliged to take any steps available to ensure that the agreement could be implemented without causing the directors to breach their duties suggesting, by way of example, using the shareholders' powers set out at the third bullet point above.

The judge in the Jackson case admitted that the issues were finely balanced.  The case is scheduled for appeal and we will provide further updates on any developments.