COURSE OBJECTIVES
1. To expose the legal status
of the company. Though an artificial person functions through its “Alter ego” or mind i.e. its officers.
2. To discuss rules and
regulations governing the operations of companies in particular the Companies
Act.
3. To prepare to overcome the
challenges facing the ever dynamic corporate world and direct us to apply the
rules and regulations in dealing with those challenges e.g. the powers of the
Board of Directors vis-a-vis the general meeting for private and public
companies and the minister for statutory companies e.g. CCK
4. To make a case for reform
of company law in Kenya.
MEANING, NATURE AND IMPORTANCE OF A COMPANY
Definition was considered
in the English case of Re Stanley (1906) 1 ch 131 in which
Buckley J noted that the term ‘company’ has neither a legal nor technical
definition.
Company therefore has to be
defined from a commercial perspective and this is why even the Companies Act
both of the U.K and Kenya do not give a clear definition of a company.
Section 2 (1) Companies Act
says a company means under the Act or an existing company.
A company is an association
of persons with similar objectives as stated in its constitution. It must not
be a business entity.
This is because some
companies have limited guarantee and may engage in charitable rather than
profitable activities.
Even statutory companies
are not business oriented e.g. KBC, NSSF, TELCOM etc
At another level a company
is an artificial legal person separate and distinct from its members
(shareholders), directors, company officers and promoters.
The difficulty of defining
a company is well captured by Frank Evans “what is a company?
Private company
Under section 30 the
private company limits the transfer of its shares from one member to another
Secondly, it does not issue
its shares/equity and securities to the public debentures
A private company can be
converted to a public company by approval of majority of members
Chartered
It gave the company the
exclusive right to exploit specified business in an area without rivalry.
Created by Queen of England
by letters of patent for example, Imperial British East Africa Company
Charter was granted on
grounds of certain conditions or else the crown would withdraw the charter.
HISTORICAL BACKGROUND OF COMPANIES
In Medieval law, a
primitive form of incorporation existed in relation to ecclesiastical and
public bodies which received corporate personality through a royal charter
Then, the mercantile era
which entailed maritime trade and organizations of traders necessitated the
extension of the corporate personality to these organizations, the traders were
then known as the guild merchants
A good example is the East
India Company which had a monopoly of trade with Indies
Bubble act
The first attempt at a
unified law on companies was the Bubble Act of 1825 which governed joint stock
companies and was preceded by the Bubble Act of 1720.
These two Acts put many
obstacles on the path of incorporation of companies by putting tough conditions
regarding the deed of settlement
In 1837, there were the
chartered companies Act which provided for the liability of the members of the
chartered companies.
In 1844, Joint stock
Companies Act which formed the basis for modern principles of company law.
1862 Companies Act which
prohibited any alteration of the objects clause and established companies
limited by guarantee and unlimited companies.
It had elaborate provisions
on winding up but was later improved in 1867 Companies Act
1929 Companies Act which
contributed towards the modernization of company law by establishing disclosure
threshold for holding companies. This Act also allowed the admission of
redeemable preference shares
The Act also offered more
protection for minority shareholders, simplified the procedure for passing
special resolutions and the procedure of winding up.
1948 companies Act upon
which the Kenyan Act is based whose main concern was the public accountability
of the company and introduced public disclosure for all companies except the
exempt ‘private companies’.
These requirements included
audit by professional auditors, group accounts for interconnected companies,
publication of balance sheets, minority protection, investigation of company
affairs (section 164 see and compare investigation by registrar ) 165 in
Companies Act of Kenya
1948 Act amended in 1962 to
give rise to the 1962 Companies Act which abolished the exempt private company
and improved on the provisions of the 1948 Act
NB: the Kenyan Act
commenced on 1st January 1962 borrowed from the English Act of 1948,
therefore the challenge for the reformer’s of company law is that while the
English Act of 1948, therefore the challenge for the reformers of company law
is that while the English act has been severally amended including in 1985 and
the fact that the UK has come up with an insolvency law, the Kenyan law has
largely remained static ignoring modern developments in company law.
Derivative action
Evasion of ultra vires rule
Entrepreneurs will opt for one or more
commercial vehicles that are most suited to their economic interest.
They are always on a
dilemma to choose between forming a sole proprietorship, partnership or Sacco.
Comparative Advantages
|
Companies
|
Sole proprietorship
|
Partnership
|
Sacco
|
|
Companies Act
Incorporation
Separate legal persons
Profit driven
Winding up
Regulated by registrar
Documents Memorandum of
Association and Articles
Perpetual succession
Management is by a board
of directors
|
Registration of business
names (cap 499)
Registration
Personal liability
Profit driven
Registrar of business
names/local authority
Certificate
Death of owner
Succession dies with the
owner
Management is by the
proprietor
|
Partnership Act
Registration
Personal liability
section 28
Profit driven
Wound up in various ways
section 36-39
Regulated by registrar of
business names
Governed by partnership,
articles and deed
Succession dies
Managed by partners
|
Cooperatives Societies
Act
Registration
Separate legal
personality
Welfare of society
Order of commissioner of
cooperatives
Governed by the
constitution
Perpetual succession
Central management
committee
|
The distinction between a
company and a partnership was laid bare in the case Fort Hall Bakery Supply Company v Wangoe 1959 the plaintiff sued
the defendant for a business debt. During the hearing it emerged that the
plaintiff was a business carried on by 45 people yet it had not been registered
under the company’s act. The question that arose was whether the plaintiff was
a legal entity within the meaning of section 389. It was held that the
plaintiff could not be recognized as having any legal existence and were
therefore incapable of maintaining any legal action.
PROMOTERS AND PROSPECTUS
Promoters are the initial
founders of the company. They invented the business idea of the company and
conceive the same in a prospectus therefore promoters and prospectus are
pre-incorporation entities. However, a recent
practice has emerged where companies use the prospectus after incorporation
when inviting for share subscriptions from members of public.
It is the duty of the
promoters to look for business opportunities for the company. Furthermore
logistical issues like the registered address of the company are decided on by
the promoters.
A question arises as to the
extent to which promoters can bind the company especially if they make a
misrepresentation in the initial prospectus of the company. This is the
situation which arose in the case of
Derry v Peek.
In the case a bus company
had the power to operate buses which were driven by horses. If the company
obtained board of trade content then they could operate mechanically driven
buses in a prospectus asking for subscribers the company represented that they
had the right to operate mechanized buses. They assumed that the board of trade
would grant permission. Derry bought shares in the company but the board later
refused permission and the company wound up.
The question that arose in
the court was whether the company was guilty of fraudulent misrepresentation?
Held: the court held that
the promoters had not acted recklessly and were not guilty of fraudulent
misrepresentation.
Hedley Byrne and Company limited v Heller and partners
limited (1963) 2 ALL ER 575
A bank gave an opinion that
a company easy power was financially stable. The bank’s evaluation was later on
held to be negligent. The opinion was given to a customer.
Hedley Byrne contacted A’s
bankers, Heller and partners (defendants) for references Heller and partners
gave a favorable report of A’s credit worthiness. Heller and partners headed
the document ‘Without Responsibility’ Hedley Byrne acted on the misleading
report, gave substantial credit and suffered heavy loss when A went into
liquidation shortly after. Hedley Byrne sued Heller and Partnership in
negligence House of lords held that the defendant banker Heller and partnership
would have been liable in negligence had they not expressly disclaimed
liability ‘where in a sphere in which a person is so placed that others could
reasonably rely on his judgment or his skill on his ability to make careful
inquiry, a person takes it on himself to give information or advice to, or
allows his information or advice to be passed on to, another, who as he knows
or should know, will place reliance on it, then a duty of care will arise.
The company has the
following remedies
1. Rescind the contract and
recover the purchaser money this is what happened in the above case
2. Compel the promoter to account
for the profit
3. To sue the promoter for
damages of breach of fiduciary duties
A syndicate headed by
Erlanger purchased an island in the West Indies said to contain valuable mines
of phosphate. The purchase price was 55000 pounds. E formed a company to buy
the island and a contract was made between X who was a nominee of the syndicate
and the company at a purchase price of 110,000 pounds. The court held that
since there was no disclosure by the promoters of the profit they were making
the company was entitled to rescind that contract and recover the purchase
money from the syndicate Erlanger included (as he was a member of the syndicate
Section 45 (1) of the
Companies Act the promoter is personally liable to pay compensation to
shareholders who have been misled by the prospectus. If the same was issued
with their knowledge and consent
NB: A preliminary contract
is a term given to contracts entered in to before incorporation and normally
they are signed by the promoters.
PROCEDURE FOR INCORPORATION
1. Search for suitable name of
the company
2. Prepare the company’s
constitution memorandum of association together with the requisite forms
Caution should be taken on
clause 3 of the memo which is the objects clause for purposes of the ultra vires rule
3. Assessment of documents and
presentation for stamp duty
Consequences
1. Once incorporated or
registered the company from the date of incorporation mentioned in the
certificate becomes an artificial legal person or body corporate capable of the
following
a) Having separate legal
personality
b) Having limited liability
c) Owning or holding property
on its own
d) Having locus standi (capacity to sue and be sued) in its own name
e) Having perpetual succession
f) Transfer and
transferability of shares though limited for limited liability company’s and
private companies section 30
g) Borrowing in its own name
on the security of its own assets
h) Having the power to trade
in its own name and issue financial products e.g. Debentures, shares,
derivatives, fixtures, forwards, currency sways, options
A) Separate legal entity
A company is a legal person
distinct from its members this was affirmed in the case Salomon v Salomon and
company limited 1892. Salomon promoted the company which he called Salomon and
company. He was also the managing director of the company. His co-shareholders
were his wife and five children. The company purchased Salomon’s existing
business for 39000 pounds. The purchase was paid for using 10’000 pounds in
debentures creating floating securities of 20,000 pounds. The company went in
to liquidation and a receiver was appointed by the debenture holder. The
unsecured creditors were not paid and they sued Salomon arguing that the
company was merely a nominee and agent of Salomon and that Salomon was
therefore liable to personally indemnify the receiver against the unsecured
debts of the company. Court of Appeal agreed with the receiver and Salomon
appealed to the House of Lords. The company is a distinct person from its
subscribers or members. The company cannot be an agent of the subscribers
therefore the debentures were perfectly valid (McNaughton) HL Holding
A company can be guilty of a crime on its own and can be
charged with a criminal offence, tax evasion, section 23 penal code and is
generally referred to as the organic theory of company law.
The net effect of separate legal personality is that even the
largest shareholder has no insurable interest in the property of the company
Macaura v northern Assurance Company limited (1925) ALL ER 51
The managing director, even if he owns 99.9% of the shares
cannot lawfully pay cheques belonging to the company into his own bank account
or draw cheques for his own purposes from the company’s account. (Al Underwood
v Bank of Liverpool and Marine Limited)
A company’s money is not members’ money and any member who
uses company’s money to discharge personal obligation is liable to the company
for conversion
B)
Limited Liability
This forms the distinction between a company and a
partnership and it protects the personal assets of the members from intrusion
by creditors. This is especially so far limited liability companies bur for
companies limited by guarantee and unlimited company’s their personal assets
could be attached by the creditors should the company’s assets be exhausted.
C)
Ownership
Property of a company is
distinct from that of its members and this is what makes it to create its own
securities over its assets e.g. debentures, mortgages, charges etc hence a
company can sue to recover or protect its property.
D) Locus standi
A company can
only sue and be sued in its own name and the members can only sue the company
through their own names.
E) Perpetual succession
A company cannot die naturally but can only die legally
but the company does not even have allocated life span like a lease or human
beings have life expectations. This was affirmed in Re Noel Ted man holding
property limited where the company survived the death of its only two members
through a road accident
F) Transfer and
transferability of shares
Incorporation makes the transfer and transferability of
shares physically and legally feasible and easy at the stock exchange.
A shareholder does not need to seek anyone’s permission
in order to sell his or her shares.
Section 32 a capital markets Act
Section 30 Companies Act (limitation on private companies)
Two documents are important
in the transfer of shares assuming that the share holder posses a share
certificate which is the evidence of share ownership in a company.
1. Certificate of transfer
which signifies the shareholders voluntary assignment or sale of his or her
shares or pursuant to a court order.
2. Transfer from which
signifies that the shares are negotiable instruments capable of being
transferred to the buyer.
THE LAW OF BUSINESS ASSOCIATIONS
Section 2 (1) of the Companies
Act states what company means as 'a
company formed and registered under this Act or an existing company. This is a very vague definition, in the
statute the word company is not a legal term hence the vagueness of the
definition. The legal attributes of the
word company will depend upon a particular legal system.
In legal theory company
denotes an association of a number of persons for some common object or objects
in ordinary usage it is associated with economic purposes or gain. A company can be defined as an association of
several persons who contribute money or money’s worth into a common stock and
who employ it for some common purpose.
Our legal system provides for three types of associations namely
1.
Companies
2.
Partnerships.
3.
Upcoming is the cooperative society.
The law treats companies in
company law distinctly from partnerships in partnership law. Basically company law consists partly of
ordinary rules of Common law and equity and partly of statutory rules. The common law rules are embodied in
cases. The statutory rules are to be
found in the Companies Act which is the current Cap 486 Laws of Kenya. It should denote that the Kenya Companies Act
is not a self contained Act of legal rules of company law because it was
borrowed from the English Companies Act of 1948 which was itself not a
codifying Act but rather a consolidating Act.
Exceptions to the Rules are
stated in the Act but not the rules themselves. Therefore fundamental
principles have to be extracted from study of numerous decided cases some of
which are irreconcilable. The true meaning
of company law can only be understood against the background of the common law.
There are two fundamental
legal concepts
1.
The concept of legal personality; (corporate personality) by
which a company is treated in law as a separate entity from the members.
2.
The concept of limited liability;
(I)
A legal person
is not always human, it can be described as any person human or otherwise who
has rights and duties at law; whereas all human persons are legal persons not
all legal persons are human persons. The
non-human legal persons are called corporations. The word corporation is derived from the
Latin word Corpus which inter-alia
also means body. A corporation is
therefore a legal person brought into existence by a process of law and not by
natural birth. Owing to these artificial
processes they are sometimes referred to as artificial persons not fictitious
persons.
Basically liability means
the extent to which a person can be made to account by law. He can be made to be accountable either for
the full amount of his debts or else pay towards that debt only to a certain
limit and not beyond it. In the context
of company law liability may be limited either by shares or by guarantee.
Under Section (2) (a) of
the Companies Act, in a company limited by shares the members liability to
contribute to the company’s assets is limited to the amount if any paid on
their shares.
Under Section 4 (2) (b) of
the Companies Act in a company limited by guarantee the members undertake to
contribute a certain amount to the assets of the company in the event of the
company being wound up. Note that it is the members’ liability and not the
companies’ liability which is limited.
As long as there are adequate assets, the company is liable to pay all
its debts without any limitation of liability.
If the assets are not adequate, then the company can only be wound up as
a human being who fails to pay his debts.
Note that in England the Insolvency Act has consolidated the
relationships relating to …. That does
not apply here.
Nearly all statutory rules
in the Companies Act are intended for one or two objects namely
1.
The protection of the company’s creditors;
2.
The protection of the investors in this instance being the
members.
These underlie the very
foundation of company law.
FORMATION OF A LIMITED COMPANY
This is by registration
under the Companies Act
In order to incorporate them
into a company, those people wishing to trade through the medium of a limited
liability company must first prepare and register certain documents. These are as follows
a.
Memorandum of Association: this is the document in which they express
inter alia their desire to be formed into a company with a specific name and
objects. The Memorandum of Association
of a company is its primary document which sets up its constitution and
objects;
b.
Articles of Association; whereas the memorandum of
association of a company sets out its objectives and constitution the articles
of association contain the rules and regulations by which its internal affairs
are governed dealing with such matters as shares, share capital, company’s
meetings and directors among others;
Both the
Memorandum and Articles of Associations must each be signed by seven persons in
the case of a public company or two persons if it is intended to form a private
company. These signatures must be
attested by a witness. If the company
has a share capital each subscriber to the share capital must write opposite
his name the number of shares he takes and he must not take less than one
share.
c.
Statement of Nominal
Capital –
this is only required if the company has a share capital. It simply states that the company’s nominal
capital shall be xxx amount of shillings. The fees that one pays on
registration will be determined by the share capital that the company has
stated. The higher the share capital, the more that the company will pay in
terms of stamp duty.
d.
Declaration of Compliance: this is a statutory declaration made either
by the advocates engaged in the formation of the company or by the person named
in the articles as the director or secretary to the effect that all the
requirements of the companies Act have been complied with. Where it is intended
to register a public company, Section
184 (4) of the Companies Act also requires the registration of a list of
persons who have agreed to become directors and Section 182 (1) requires the
written consents of the Directors.
These are the only
documents which must be registered in order to secure the incorporation of the
company. In practice however two other
documents which would be filed within a short time of incorporation are also handed
in at the same time. These are:
1.
Notice of the situation of the Registered Office which under
Section 108(1) of the statute should be filed within 14 days of incorporation;
2.
Particulars of Directors and Secretary which under Section
201 of the statute are normally required within 14 days of the appointment of
the directors and secretary.
The documents are then
lodged with the registrar of companies and if they are in order then they are
registered and the registrar thereupon grants a certificate of incorporation
and the company is thereby formed. Section
16(2) of the Act provides that from the dates mentioned in a certificate of
incorporation the subscribers to the Memorandum of Association become a body
corporate by the name mentioned in the Memorandum capable of exercising all the
functions of an incorporated company. It
should be noted that the registered company is the most important
corporation.
The difference between a
statutory corporation (and parastatal) and a company registered under the
companies Act is that a statutory corporation is created directly by an Act of
Parliament. The Companies Act does not
create any corporations at all. It only
lays down a procedure by which any two or more persons who so desire can
themselves create a corporation by complying with the rules for registration
which the Act prescribes.
Before registering a
company the promoters must make up their minds as to which of the various types
of registered companies they wish to form.
1.
They must choose between a limited and unlimited company;
Section 4 (2) (c) of the Companies Act states that ‘a company not having the
liability of members limited in any way is termed as an unlimited company. The disadvantage of an unlimited company is
that its members will be personally liable for the company’s debts. It is unlikely that promoters will wish to
form an unlimited liability company if the company is intended to trade. But if the company is merely for holding land
or other investments the absence of limited liability would not matter.
2.
If they decide upon a limited company, they must make up
their minds whether it is to be limited by shares or by guarantee. This will depend upon the purpose for which
it is formed. If it is to be a
non-profit concern, then a guarantee company is the most suitable, but if it is
intended to form a profit making company, then a company limited by shares is
preferable.
3.
They have to choose between a private company and a public
company. Section 30 of the Companies Act
defines a private company as one which by its articles restricts
(i)
the rights to transfer shares;
(ii)
restricts the number of its members to fifty (50);
(iii)
Prohibits the invitation of members of the public to
subscribe for any shares or debentures of the company.
A company which does not fall under this
definition is described as a public company.
In order to form a public
company, there must be at least seven (7) subscribers signing the Memorandum of
Association whereas only two (2) persons need to sign the Memorandum of
Association in the case of a private company.
A corporation is a legal
entity distinct from its members, capable of enjoying rights being subject to
duties which are not the same as those enjoyed or borne by the members.
The full implications of
corporate personality were not fully understood till 1897 in the case of
Facts of the case
Salomon
was a prosperous lender/merchant. He
sold his business to Salomon and Co. Limited which he formed for the purpose at
the price of £39,000 satisfied by £1000 in cash, £10,000 in debentures
conferring a charge on the company’s assets and £20,000 in fully paid up £1
shares. Salomon was both a creditor
because he held a debenture and also a shareholder because he held shares in
the company. Seven shares were then
subscribed for in cash by Salomon, his wife and daughter and each of his 4
sons. Salomon therefore had 20,101
shares in the company and each member of the family had 1 share as Salomon‘s
nominees. Within one year of
incorporation the company ran into financial problems and consequently it was
wound up. Its assets were not enough to
satisfy the debenture holder (Salomon) and having done so there was nothing
left for the unsecured creditors. The
court of first instance and the court of appeal held that the company was a
mere sham an alias, agents or nominees of Salomon and that Mr. Salomon should
therefore indemnify the company against its trade loss.
The House of Lords
unanimously reversed this decision. In
the words of Lord Halsbury “Either the limited company was a legal
entity or it was not. If it was, the
business belonged to it and not to Salomon.
If it was not, there was no person and no thing at all and it is
impossible to say at the same time that there is the company and there is not”
In the words of Lord McNaughton
“the company is at a law a different
person altogether from the subscribers and though it may be that after
incorporation the business is precisely the same as it was before, and the same
persons are managers, and the same hands receive the profits, the company is
not in law the agent of the subscribers or trustee for them nor are the
subscribers as members liable in any shape or form except to the extent and
manner prescribed by the Act. … in
order to form a company limited by shares the Act requires that a Memorandum of
Association should be signed by seven (7) persons who are each to take one
share at least. If those conditions are
satisfied, what can it matter, whether the signatories are relations or
strangers. There is nothing in the Act
requiring that the subscribers to the Memorandum should be independent or
unconnected or that they or anyone of them should take a substantial interest
in the undertaking or that they should have a mind and will of their own. When the Memorandum is duly signed and
registered though there be only seven (7) shares taken the subscribers are a
body corporate capable forthwith of exercising all the functions of an
incorporated company.
… The company attains maturity on its birth. There is no period of minority and no
interval of incapacity. A body corporate
thus made capable by statutes cannot lose its individuality by issuing the bulk
of its capital to one person whether he be a subscriber to the Memorandum or
not.”
There were several other
Law Lords who decided business in the House.
1.
The decision established the legality of the so called one
man company;
2.
It showed that incorporation was as readily available to the
small private partnership and sole traders as to the large private company.
3.
It also revealed that it is possible for a trader not merely
to limit his liability to the money invested in his enterprise but even to
avoid any serious risk to that capital by subscribing for debentures rather
than shares.
Since the
decision in Salomon’s case the complete separation of the company and its
members has never been doubted.
The Appellant
owner of a timber estate assigned the whole of the timber to a company known as
Irish Canadian Sawmills Company Limited for a consideration of £42,000. Payment was effected by the allotment to the
Appellant of 42,000 shares fully paid up in £1 shares in the company. No other
shares were ever issued. The company
proceeded with the cutting of the timber.
In the course of these operations, the Appellant lent the company some
£19,000. Apart from this the company’s
debts were minimal. The Appellant then
insured the timber against fire by policies effected in his own name. Then the timber was destroyed by fire. The insurance company refused to pay any
indemnity to the appellant on the ground that he had no insurable interest in
the timber at the time of effecting the policy.
The courts held
that it was clear that the Appellant had no insurable interest in the timber
and though he owned almost all the shares in the company and the company owed
him a good deal of money, nevertheless, neither as creditor or shareholder
could he insure the company’s assets. So
he lost the Company.
Lee’s company
was formed with capital of £3000 divided into 3000 £1 shares. Of these shares Mr. Lee held 2,999 and the
remaining one share was held by a third party as his nominee. In his capacity as controlling shareholder,
Lee voted himself as company director and Chief Pilot. In the course of his duty as a pilot he was
involved in a crash in which he died.
His widow brought an action for compensation under the Workman’s
Compensation Act and in this Act workman was defined as “A person employed under a contract of service” so the issue was
whether Mr. Lee was a workman under the Act?
The House of Lords Held:
“That it was the logical consequence of the
decision in Salomon’s case that Lee and the company were two separate entities
capable of entering into contractual relations and the widow was therefore
entitled to compensation.”
The Respondent sued the
Petitioner for the recovery of certain sums of money allegedly due to the
Ankore African Commercial Society Ltd in which the petitioner was a Director
and also the deputy chairman. The Respondent
conceded that in filing the action he was acting entirely on behalf of the
society which was therefore the proper Plaintiff. The action was filed in the Central Native
Court. Under the Relevant Native Court
Ordinance the Central Native Court had jurisdiction in civil cases in which all
parties were natives. The issue was
whether the Ankore African Commercial Society Ltd of whom all the shareholders
were natives was also a native.
The court held
that a limited liability company is a corporation and as such it has existence which
is distinct from that of the shareholders who own it. Being a distinct legal entity and abstract in
nature, it was not capable of having racial attributes.
1. Since a corporation is a
separate person from the members, its members are not liable for its
debts. In the absence of any provisions
to the contrary the members are completely free from any personal liability. In a company limited by shares the members’
liability is limited to the amount unpaid on the shares whereas in a company
limited by guarantee the members’ liability is limited to the amount they
guaranteed to pay. The relevant
statutory provision is Section 213 of the Companies Act.
2. Corporate personality
enables the property of the association to be distinguishable from that of the
members. In an incorporated association,
the property of the association is the joint property of all the members although
their rights therein may differ from their rights to separate property because
the joint property must be dealt with according to the rules of the society and
no individual member can claim any particular asset to that property.
Suing and Being Sued:
3. As a legal person, a company can take action
in it’s own name to enforce its legal rights.
Conversely it may be sued for breach of its legal duties. The only restriction on a company’s right to
sue is that it must always be represented by a lawyer in all its actions.
In East
Africa Roofing Co. Ltd v Pandit (1954) 27 KLR 86
Here the
Plaintiff a limited liability company filed a suit against the defendant
claiming certain sums of money. The
defendant entered appearance and filed a defense admitting liability but
praying for payment by installments. The
company secretary set down the date on the suit for hearing ex parte and
without notice to the defendant. This
was contrary to the rules because a defense had been filed. On the hearing day the suit was called in
court but no appearance was made by either party and the court therefore
ordered the action to be dismissed. The
company thereafter applied to have the dismissal set aside. At the hearing of that application, it was
duly represented by an advocate. The
only ground on which the company relied was that it had intended all along to
be represented at the hearing by its manager and that the manager in fact went
to the law courts but ended in the wrong court.
It was held that a corporation such as a limited liability company
cannot appear in person as a legal entity without any visible person and having
no physical existence it cannot at common law appear by its agent but only by
its lawyer. The Kenya Companies Act does
not change this common law rule so as to enable a limited company to appear in
court by any of its officers.
4. As an artificial person,
the company has neither body mind nor soul.
It has been said that a company is therefore invisible immortal and thus
exists only intendment consideration of the law. It can only cease to exist by the same
process of law which brought it into existence otherwise; it is not subject to
the death of the natural body. Even though the members may come and go, the
company continues to exist.
5. Section 75 of the Companies
Act states as follows “The Shares or any
other interests of a member in a company shall be moveable property
transferable in the manner provided by the Articles of Association of the
Company.” In a company therefore
shares are really transferable and upon a transfer the assignee steps into the
shoes of the assignor as a member of the company with full rights as a
member. Note however that this
transferability only relates to public companies and not private companies.
6. In practice companies can
raise their capital by borrowing much more easily than the sole trader or
partnership. This is enabled by the
device of the ‘floating charge’ a floating charge has been defined as a charge
which floats like a cloud over all the assets from time to time falling within
a certain description but without preventing the company from disposing of
these assets in the ordinary course of its business until something happens to
cause the charge to become crystallized or fixed. The ease with which this is done is
facilitated by the Chattels Transfer Act which exempts companies from compiling
an inventory on the particulars of such charges and also by the bankruptcy Act
which exempts companies from the application of the reputed ownership clause. As far as companies are concerned the goods
in the possession of the company do not fall within the reputed ownership
clause.
(i)
Too many formalities required in the formation of the company
(ii)
There is maximum publicity of the company’s affairs;
(iii)
There is expense incurred in the formation and in the
management of a company.
In order to form a company,
certain documents must be prepared whereas no such documents need to be
prepared to establish business as a sole proprietor or partnership and
throughout its life a company is required to file such documents as balance
sheets and profits and loss accounts on dissolution of the company it is
required to follow a certain stipulated procedure which does not apply to sole
traders and partnerships.
Although Salomon’s case
finally established that a company is a separate and distinct entity from the
members, there are circumstances in which these principle of corporate
personality is itself disregarded. These
situations must however be regarded as exceptions because the Salomon decision
still obtains as the general principle
Although a company is
liable for its own debt which will be the logical consequence of the Salomon
rule, the members themselves are held liable which is therefore a departure
from principle. The rights of creditors under
this section are subject to certain limitations namely (under statutory provision)
(i)
REDUCTION
IN THE NUMBER OF MEMBERS - Section 33 refers to membership that has fallen below the
statutory minimum in a public company.
The Act provides that only those members who remain after the six month
during which the company has fallen below the provided minimum period can be
sued; even these members are liable if they have knowledge of the fact and only
in respect of debts contracted after the expiration of the six months. Moreover
the Section is worded in such a way as to suggest that the remaining members
will be liable only in respect of liquidated contractual obligations.
(ii)
Of the Companies Act come into operation here. It is provided that if in the course of the
winding up of the company it appears that any business has been carried on with
the intent to defraud the creditors, or for any fraudulent purpose, the courts
on the application of the official receiver, the liquidator or member may
declare that any persons who are knowingly parties to the fraud shall be
personally responsible without any limitation on liability for all or any of
the debts or other liabilities of the company to the extent that the court
might direct the liability. This Section
does not define the term fraud nor have the courts defined it. However, in
The company was
incorporated to acquire William’s business as a furniture manufacturer. The directors of the company were William and
his wife and they appointed William as the Managing Director at a Salary of
£1000 per annum. Within the period of
one month, the company was debited with an amount which was £500 more than what
was actually due to William. By that
time the company had made a loss of £2500.
Within 2 years of formation, and while the company was still in
financial problems, the directors paid to themselves the dividends of
£250. By the end of the 3rd
year since incorporation the company was in such serious difficulties such that
it could not pay debts as they fell due.
In spite of this William ordered goods worth £6000 which became subject
to a charge contained in a debenture held by them. At the same time he continued to repay
himself a loan of £600 (six hundred pounds) which he had lent to the company at
the beginning of the 4th year the company with the knowledge of
William owed £6500 for goods supplied.
In the winding up of the company the official receiver applied for a
declaration that in no circumstances William had carried on the company’s
business with intent to defraud and therefore should be held responsible for
the repayment of the company’s debts. It
was held that since that company continued to carry on business at a time when
William knew that the company could not comfortably pay its debts, then this
was fraudulent trading within the meaning of Section 323 and William should be
responsible for repaying the debts.
These are the words of Justice Maugham J. “if a company continues to carry on business and to incur debts at a
time when there is to the knowledge of the directors no reasonable prospects of
the creditors ever receiving payments of those debts, it is in general a proper
inference that the company is carrying on business with intent to defraud.”
The test is both subjective
and objective. In the Case of
On facts which were similar
to the Williams case, the same Judge Maugham J. said as follows: “the
words fraud and fraudulent purpose where they appear in the Section in question
are words which connote actual dishonesty involving according to the current
notions of fair trading among commercial men real moral blame. No judge has
ever been willing to define fraud and I am attempting no definition.”
The statutes are not clear
as to the meaning of fraud the question arises that once the money has been
recovered from the fraudulent director, is it to be laid as part of the
company’s general assets available to all creditors or should it go back to those
creditors who are actually defrauded.
In the case of Re William
Justice Eve J. stated that such money should form part of the company’s general
assets and should not be refunded to the defrauded creditors.
In the case of
The Court of Appeal ruled that if the application under
Section 323 is made by the debtor then the money recovered should form part of
the company’s general assets but where the application is made by a creditor
himself, then that creditor is entitled to retain the money in the discharge of
the debts due to him.
One of the most important
limitations imposed by the Companies Act on the recognition of the separate
personality of each individual company is in connection with associated
companies within the same group enterprise.
In practice it is common for a company to create an organization of
inter-related companies each of which is theoretically a separate entity but in
reality part of one concern represented by the group as a whole. Such is particularly the case when one
company is the parent or holding company and the rest are its subsidiaries.
Under Section 154 of the
Companies Act Cap 486 a company is deemed to be a subsidiary of another if but
only if
(a)
That other company either
(i)
is a member of it and controls the composition of its board
of directors or
(ii)
Holds more than half in nominal value of its equity share
capital or
(b) The first mentioned
company is a subsidiary of any company which is that other’s subsidiary.
Under Section 150 (1) where
at the end of the financial year a company has subsidiaries, the accounts
dealing with the profit and loss of the company and subsidiaries should be laid
before the company in general meeting when the company’s own balance sheet and
profit and loss account are also laid.
This means that group accounts must be laid before the general
meeting.
The group accounts should
consist of a consolidated balance sheet for the company and subsidiary and also
of a consolidated profit and loss account dealing with the profit and loss
account of a company.
Section 151(2) – it may be
observed that the treatment of these accounts in a consolidated form qualify an
old rule that each company constitutes a separate legal entity. The statute here recognizes enterprise entity
rather than corporate entity i.e. the veil of incorporation will be lifted so
that they will not be regarded as separate legal entities but will be treated
as a group.
Under Section 109 of the
Companies Act it requires that a company’s name should appear whenever it does
business on its Seal and on all business documents. Under paragraph 4 of this Section, if an
officer of a company or any person who on its behalf signs or authorizes to be
signed on behalf of the company any Bill of Exchange, Promissory Note, Cheque
or Order for Goods wherein the Company’s name is not mentioned as required by
the Section, such officer shall be liable to a fine and shall also be personally
made liable to the holder of a Bill of Exchange Promissory Notes, Cheque or
order for the goods for the amount thereof unless it is paid by the
company. The effect of this section is
that it makes a company’s officer incur personal liability even though they
might be contracting as the company’s agents.
Liability under this Section normally arises in connection with cheques
and company officers have been held liable where for instance the word limited
has been omitted or where the company has been described by a wrong name.
Generally there is no
reason why a company may not be an agent of its share holders. The decision in Salomon’s case shows how
difficult it is to convince the courts that a company is an agent of its
members. In spite of this there have
been occasions in which the courts have held that registered companies were not
carrying on in their own right but rather were carrying on business as agents
of their holding companies. Reference
may be made to the case of
Smith Stone & Knight v. Birmingham Corporation
(1939) 4 All E.R. 116
In this case the Plaintiffs
were paper manufacturers in Birmingham City.
In the same city there was a partnership called Birmingham Waste
Company. This partnership did business
as merchants and dealers in waste paper.
The plaintiffs bought the partnership as a going concern and the
partnership business became part of the company’s property. The plaintiffs then
caused the partnership to be registered as a company in the name of Birmingham
Waste Company Limited. Its subscribed
capital was 502 pounds divided into 502 shares.
The Plaintiff holding 497 shares in their own name and the remaining
shares being registered in the name of each of the Directors. Thereafter the Directors executed a
declaration of trust stating that their shares were held by them on trust for
the Plaintiff Company. The new company
had its name placed upon the premises and on the note paper invoices etc. as
though it was still the old partnership carrying on business. There was no agreement of any sort between
the two companies and the business carried on by the new company was never
assigned to it. The manager was
appointed but there were no other staff.
The books and accounts of the new company were all kept by the plaintiff
company and the manager of this company did not know what was contained therein
and had no access to those books. There
was no doubt that the Plaintiff Company had complete control over the waste
company. There was no tenancy agreement
between them and the waste company never paid any rent. Apart from the name, it was as if the manager
was managing a department of the plaintiff company.
The Birmingham Corporation
compulsorily acquired the premises upon which the subsidiary company was
carrying on business and the Plaintiff Company claimed compensation for removal
and disturbance. Birmingham Corporation
replied that the proper claimants were the subsidiary company and not the
holding company since the subsidiary company was a separate legal entity.
If this contention was
correct the Birmingham Corporation would have escaped liability for paying
compensation by virtue of a local Act which empowered them to give tenants
notice to terminate the tenancy.
The court held that
occupation of the premises by a separate legal entity was not conclusive on a
question of a right to claim and as a subsidiary company it was not operating
on its own behalf but on behalf of the parent company. The subsidiary company was an agent. Lord Atkinson had the following to say
“It is well settled that the mere fact that a man holds all the shares
in a company does not mean the business carried on by the company is his
business nor does it make the company his agent, for the carrying on of that
business. However, it is also well
settled that there maybe such an arrangement between the shareholders and the
company as will constitute the
company. The shareholders agents for the
purpose of carrying on the business and make the business that of the
shareholders. It seems to be a question
of fact in each case and the question is whether the subsidiary is carrying on
the business as the parents business or as its own. In other word, who is really carrying on the business?
His Lordship then stated
that in order to answer the question six points must be taken into
account.
1.
Are the profits treated as
the profits of the parent company?
2.
Are the persons conducting
the business appointed by the parent company?
3.
Is the parent company the
head and brain of the trading venture?
4.
Does the parent company
govern the venture decide what should be done and what capital should be
embarked on in the venture?
5.
Does the company make the
profits by its skill and direction?
6.
Is the company in effectual
and constant control?
If the answers are in the affirmative, then the subsidiary
company is an agent of the parent company.
Reference may also be made
to the case of
Here a British company was
formed with a capital of 100 pounds of which 90 pounds was contributed by the
president of an American Film Company.
There were 3 directors, the American and 2 Britons. By arrangement between the two companies, a
film was shot in India nominally by the British Company but all the finances
and other facilities were provided by the American Company. The British Board of Trade refused to
recognize the Film as having been made by a British company and therefore
refused to register it as a British film.
The court held that insofar
as the British company had acted at all it had done so as an agent or nominee
of the American company which was the true maker of the film.
Again in this case an
American company had an arrangement with its distributors on the European
continent whereby the distributors obtained the supplies from the English
manufacturers who were a wholly owned subsidiary of an American company. The English subsidiary credited the American
company with a price received after deducting costs and a certain
percentage. It was agreed that the
distributors will not obtain their supplies from anyone else. The issue was whether the subsidiary company
in Britain was selling its own goods or whether it was selling goods of an
American company.
The court held that the
substance of the arrangement was that the American company traded in England
through the subsidiary as its agent and that the sales by their subsidiary were
a means of furthering the American company’s European interests.
There have been cases where
Salomon’s case has been upheld that a company is a legal entity.
Lord Justice Cohen L.J “Under
the ordinary rules of law, a parent company and a subsidiary company even when
a hundred percent subsidiary are distinct legal entities and in the absence of
an agency contract between the two companies,
one cannot be said to be an agent of the other.”
2. FRAUD & IMPROPER CONDUCT
Where there is fraud or
improper conduct, the courts will immediately disregard the corporate entity of
the company. Examples are found in those
situations in which a company is formed for a fraudulent purpose or to
facilitate the evasion of legal obligations.
Re Bugle Press Limited [1961] Ch. 270
This was based on Section
210 of the Companies Act where an offer was made to purchase out a company if
90% of shareholders agreed. There were 3
shareholders in the company A, B and C.
A held 45% of the shares, B
also held 45% of the shares and C held the remaining 10% of the shares. A and B
persuaded C to sell his shares to them but he declined. Consequently A and B formed a new company
call it AB Limited, which made an offer to ABC Limited to buy their shares in
the old company. A and B accepted the
offer, but C refused. A and B sought to
use provisions of Section 210 in order to acquire C’s shares compulsorily.
The court held that this
was a bare faced attempt to evade the fundamental principle of company law
which forbids the majority unless the articles provide to expropriate the
minority shareholders.
Lord Justice Cohen said “the company was nothing but a legal hut.
Built round the majority shareholders and the whole scheme was nothing but a
hollow shallow.” All the minority
shareholder had to do was shout and the walls of Jericho came tumbling down.
Here the Defendant was a
former employee of the plaintiff company and had covenanted not to solicit the
plaintiff’s customers. He formed a company to run a competing business. The company did the solicitation. The defendant argued that he had not breached
his agreement with the plaintiffs because the solicitation was undertaken by a
company which was a separate legal entity from him.
The court held that the
defendant’s company was a mere cloak or sham and that it was the defendant
himself through this device who was soliciting the plaintiff’s customers. An injunction was granted against the both
the defendant and the company not to solicit the plaintiff’s customers.
This case the Defendant
entered into a contract for the sale of some property to the plaintiff. Subsequently he refused to convey the
property to the plaintiff and formed a company for the purpose of acquiring
that property and actually transferred the property to the company. In an action for specific performance the
Defendant argued that he could not convey the property to the Plaintiff as it
was already vested in a third party.
Justice Russell J. observed
as follows
“The Defendant Company was merely a device and a sham a mask which he
holds before his face in an attempt to avoid recognition by the eye of equity”
GROUP ENTERPRISE
In exercise of their
original jurisdiction, the courts have displayed a tendency to ignore the
separate legal entities of various companies in a group. By so doing, the courts give regard to the
economic entity of the group as a whole.
Authority is the case of Holsworth & Co.
v. Caddies [1955]1W.L.R. 352
The Defendant Company had
employed Mr. Caddies as their Managing Director for 5 years. At the time of that contract the company had
two subsidiaries and Caddies was appointed Managing Director of one of those
subsidiaries. He fell out of favour with
the other Directors consequent upon which the board of directors stated that
Caddies should confine his attention to the affairs of the subsidiary company
only. He treated this as a breach of
contract and sued the company for damages.
It was held that since all the companies form but one group, there was
no breach of contract in directing Caddies to confine his attention to the
activities of the subsidiary company.
Lord Lorenburn said “in
applying the conception of residence to a company, we ought to proceed as
nearly as possible on the analogy of an individual. A company cannot eat or sleep but it can keep
house or do business. A company resides
for purposes of Income Tax where its real business is carried on. The real business is carried on where the
central management and control actually abides.”
The courts also look behind
the façade of the company and its place of registration in order to determine
its residence.
THE DOCTRINE OF ULTRA VIRES
A Company which is
registered under the Company’s Act cannot effectively do anything beyond the
powers which are either expressly or by implication conferred upon in its
Memorandum of Association. Any purported
activity in excess of those powers will be ineffective even if agreed to by the
members unanimously. This is the
doctrine of ultra vires in company law.
The purpose of this
doctrine is said to be twofold
1.
It is said to be intended for the protection of the investors
who thereby know the objects in which their money is to be applied. It is also said to be intended for the
protection of the creditors by ensuring that the Company’s assets to which the
creditors look for repayment of their debt are not wasted in unauthorized
activities. The doctrine was first
clearly articulated in 1875 in the case of Ashbury
Railway Carriage v. Riche (1875) L.R. CH.L.) 653
In this case the Company’s
Memorandum of Association gave it powers in its objects clause
1.
To make sell or lend on hire railway carriages and wagons.
2.
To carry on the business of mechanical engineers and general
contractors
3.
to purchase, lease work and sell mines, minerals, land and
realty.
The directors entered into
a contract to purchase a concession for constructing a railway in Belgium. The issue was whether this contract was valid
and if not whether it could be ratified by the shareholders.
The court held that the
contract was ultra vires the company and void so that not even the subsequent
consent of the whole body of shareholders could ratify it. Lord Cairns stated as follows:
“The words general contractors referred to
the words which went immediately before and indicated such a contract as
mechanical engineers make for the purpose of carrying on a business. This contract was entirely beyond the objects
in the Memorandum of Association. If so,
it was thereby placed beyond the powers of the company to make the
contract. If so, it was not a question
whether the contract was ever ratified or not ratified. If the contract was going at its beginning it
was going because the company could not make it and by purporting to ratify it
the shareholders were attempting to do the very thing which by the act of
parliament they were prohibited from doing.”
The courts construed the
object clause very strictly and failed to give any regard to that part of the
Objects clause which empowered the company to do business as general
contractors. This construction gave the
doctrine of ultra vires a rigidity which the times have not been able to
uphold. At the present day, the doctrine
is not as rigid as in Ashbury’s case and consequently it has been eroded.
The first inroad into the
doctrine was made five years later in the case of
Lord Selbourne stated as
follows:
“the doctrine
of ultra vires as it was explained in Ashbury’s case should … but this doctrine
ought to be reasonably and not unreasonably understood and applied and whatever
may fairly be regarded as incidental to or consequential upon those things that
the legislature has authorized ought not to be held by judicial construction to
be ultra vires.”
An act of the company
therefore will be regarded as intra vires not only when it is expressly stated
in the object’s clause but also when it can be interpreted as reasonably
incidental to the specified objects. As
a result of this decision, there is now a considerable body of case law
deciding what powers will be implied in a case of particular types of
enterprise and what activities will be regarded as reasonably incidental to the
act.
However businessmen did not
wish to leave matters for implication. They preferred to set up in the
Memorandum of Association not only the objects for which the company was
establish but also the ancillary powers which they thought the company would
need. Furthermore instead of confining
themselves to the business which the company was initially intended to follow,
they would also include all other businesses which they might want the company
to turn to in the future. The original
intention of parliament was that the companies object should be set out in
short paragraphs in the Memorandum of Association. But with a practice of setting out not only
the present business but also any business which the promoters would want the
company to turn to, the result is that a company’s object’s clause could
contain about 30 or 40 different clauses covering every conceivable business
and all that incidental powers which might be needed to accomplish them.
In practice therefore the
objects laws of practically every company does not share the simplicity
originally intended in favor of these practice it may be argued that the wider
the objects the greater is the security of the creditors since it will not be
easy for the company to enter into ultra vires transactions because every
possible act will probably be covered by some paragraph in the Objects clause.
Unfortunately this does not
ensure preservation of the Companies assets or any adequate control over the
director’s activities thus the original protection intended vanishes, the
highpoint of this development came in 1966 in the case of Bellhouse v. City
Wall Properties (1966) 2 Q.B 656
In this case the Plaintiff Company’s
business was requisitioned for vacant land and the erection thereon of Housing
Estates. Its objects as set up in the
Memorandum of Association contained the Clause authorizing the company to
“carry on any other trade or business whatsoever which can in the opinion of
the Board of Directors be advantageously carried on by the company in
connection with or as ancillary to any of the above businesses or a general
business of the company”.
In connection with its
various development skills the company’s managing director met an agent of the
Defendants who required some finance to the tune of about 1 million
pounds. The Plaintiff’s Managing
Director intimated to the Defendant’s agent that he knew of a source from which
the Defendant could obtain finance and accordingly referred them to a Swiss
syndicate of financiers. In this action
the Plaintiffs alleged that for that service, the Defendants had agreed to pay
a commission of 20,000 pounds and in the alternative they claimed 20,000 pounds
for breach of contract. The Defendants
argued that there was no contract between the parties. In the alternative they argued that even if
there was a contract such contract was in effect one whereby the Plaintiffs
undertook to act as money-brokers which activity was beyond the objects of the
plaintiff company and which was therefore ultra
vires.
The issues were
1.
Whether the contracts were ultra vires
2.
Whether it was open to the defendant to raise this point;
The court of first instance
decided that the company was ultra vires and it was open to the defendant to
raise the defense of ultra vires.
However a unanimous court of appeal reversed the decision and hailed
that the words stated must be given their natural meaning and the natural
meaning of those words was such that the company could carry on any business in
connection with or ancillary to its main business provided that the directors
thought that could be advantageous to the company.
Lord Justice Salomon L.J
stated as follows:
“It may be that the Directors take the wrong
view and in fact the business in question cannot be carried on as they believe
but it matters not how mistaken they might be provided that they formed their
view honestly then the business is within the plaintiff’s company’s objects and
powers.”
The courts have introduced
2 methods of curbing the evasion of the ultra vires doctrine.
1.
Is also referred to as the main objects rule of
construction. Here a Memorandum of
Association expresses the objects of a company in a series of paragraphs and
one paragraph or the first 2 or 3 paragraphs appear to embody the main object
of the company all the other paragraphs are treated as merely ancillary to this
main object and as limited or controlled thereby. Business persons evaded this method by use of
the independent objects clause. The
objects clause will contain a paragraph to the effect that each of the
preceding sub-paragraphs shall be construed independently and shall not in any
way be limited by reference to any other sub-clause and that the objects set
out in each sub-clause shall be independent objects of the company. Reference may be made to the case of
In this case
the objects clause of the company contained 30 sub-clauses. The first sub-clause authorized the company
to develop rubber plantations and the fourth clause empowered the company to
deal in any shares of any company. The
objects clause concluded with a declaration that each of the sub clauses was to
be construed independently as independent objects of the company. The company underwrote and had allotted to it
shares in an oil company. The question
that arose was whether this was intra vires the company’s objects. The court held that the effect of the
independent objects clause was to constitute each of the 30 objects of the
company as independent objects.
Therefore the dealing of shares in an oil company was within the objects
and thus intra vires. However the power
to borrow money cannot be construed as an independent object of the company in
spite of this decision.
In this case
the company was formed to provide accommodation and services to those overseas
visitors going to a festival in Britain.
The company did this during the first few years of existence. Later the company switched over to pig
breeding as its sole business. While so
engaged it borrowed money from a bank on a security of debentures. The bank was given a copy of the company’s
Memorandum of Association and at the material time knew that the company’s sole
business was that of pig breeding. The
issue was, whether the loan and debentures were valid in view of the fact one
of the sub clauses empowered the company to borrow money and the last sub
clause was an independent object clause.
The court held
that borrowing was a power and not an object.
The power to borrow existed only for furthering intra vires objects of
the company and was not an object in itself.
Therefore
1. The exercise of powers
which will be intra vires is exercised for the objects of the company and is
ultra vires only if used for the objects not covered by the company’s
Memorandum of Association.
2. Even an independent object
clause cannot convert what are in fact powers into objects.
Where the main object of a
company has failed, a petitioner will be granted an order for the winding up of
a company. Such a petitioner must
however be a member or shareholder in the company.
The object of the ultra
vires rule is to make the members know how and to what their money is being
applied. This is the rationale of
members’ protection.
In this case the major
object of the company was to acquire a German Patent for manufacturing coffee
from dates. The German patent was never
granted but the company acquired a Swedish Patent for the same purpose. The company was solvent and the majority of
the members wished to continue in business.
However, two of the shareholders petitioned for winding up of the
company on the grounds that the company’s object had entirely failed.
The court held that upon
the failure to acquire the German patent, it was impossible to carry out the
objects for which the company was formed.
Therefore the sub stratum had disappeared and therefore it was just inevitable
that the company should be wound up.
Kay J. stated “where
a company is formed for a primary purpose, then although the Memorandum may
contain other general words which include the doing of other objects, those
general words must be read as being ancillary to that which the Memorandum
shows to be the main purpose and if the main purpose fails and fails
altogether, then the sub-stratum of the association fails.”
This substratum rule is too
narrow and cannot sufficiently uphold the ultra vires rule. Questions are, are members or shareholders
really protected? Do they know what the
objects are? The Directors may choose
any amongst the many.
Secondly a member has to
petition first and the court has to decide
A company was authorised by
its Memorandum of Association to carry on the business of costumiers, gown
makers and other activities ejusdem generis.
The company decided to undertake the business of making veneered panels
which were admittedly ultra vires and for this purpose, it constructed a
factory at Bristol. The company later
went into compulsory liquidation.
Several proofs of debts were lodged with the liquidator which he
rejected on the ground that the contracts which they related to were ultra vires.
Applications by way of
Appeal were lodged by the 3 creditors one of whom had actual knowledge that the
veneer business was ultra vires. The 3
creditors were a firm of builders who built the factory, a firm which supplied
the veneers to the company and a firm which had contractual debts with the
company.
The courts held dismissing
the applications that no judgment founded on an ultra vires contract could be
sustained unless it embodied a decision of the court on the issue of ultra
vires or a compromise on that issue. The
contracts being founded on an ultra vires transaction were void.
Can a company validly make
a gift out of corporate property or asset?
The law is that a company has no power to make such payments unless the
particular payment is reasonably incidental to the carrying out of a company’s
business and is meant for the benefit and to promote the property of the
company.
This issue was first
decided in the case of
A company sold its assets
and continued in business only for the purpose of winding up. While it was awaiting winding up, a
resolution was passed in the company’s general meeting authorizing the payments
of a gratuity to the directors and dismissed employees.
The
court held that as the company was no longer a going concern such a payment
could not be reasonably incidental to the business of the company and therefore
the resolution was invalid. In the words
of the Lord Justice Bowen said
“The
law does not say that there are not to be cakes and ale but there are to be no
cakes and ale except such as is required for the benefit of the company”
The question is, suppose
there is a clause in the Memorandum of Association that such payments shall be
made, is payment ultra vires? The
authority that dealt with this position was the case of
The object clause of the
company contained an express power to provide for the welfare of employees and
ex employees and also their widows, children and other dependants by the grant
of money as well as pensions. Three
years before the company was wound up, the Board of Directors decided that the
company should undertake to pay a pension to the widow of a former managing
director but after the winding up the liquidator rejected her claim to the
pension.
The court held that the
transaction whereby the company covenanted to pay the widow a pension was not
for the benefit of the company or reasonably incidental to its business and was
therefore ultra vires and hence null and void.
Justice Eve stated as
follows
Whether they reneged an express or implied power, all such
grants involved an expenditure of the company’s money and that money can only
be spent for purposes reasonably incidental
to the carrying on of the company’s business and the validity of such
grants can be tested by the answers to three questions:
(i)
Is the transaction
reasonably incidental to the carrying on of the company’s business?
(ii)
Is it a bona fide
transaction?
(iii)
Is it done for the benefit
and to promote the prosperity of the company?
These questions must be answered in the affirmative. The question may be posed as to whether these
tests apply where there is an express power by the objects. This is one area where the courts are still
insistent that creditors’ security must be reserved.
Sometimes ultra vires can
be excluded by good and clever draftsmanship
In this case the company
transferred the major portion of its assets and proposed to distribute the
purchase price to those employees who are going to become redundant after
reduction in the stock of the company of the company’s business. The company was not legally bound to make any
payments by way of compensation. One
shareholder claimed that the proposed payment was ultra vires.
The court held that the
proposed payment was motivated by a desire to treat the ex-employees generously
and was not taken in the interest of the company as it was going to remain and
that therefore it was ultra vires.
The Court observed as
follows “the defendants were prompted by
motives which however laudable and however enlightened from the point of view
of industrial relations were such as the law does not recognize as sufficient
justification. The essence of the matter
was that the Directors were proposing that a very large part of its assets
should be given to its employees in order to benefit those employees rather
than the company and that is an application of the company’s funds which the
law will not allow.”
The company carried on the
business of chemical manufacturers. Its
object clause contained a power to do all such things as maybe incidental or
conducive to the attainment of its objects.
The company distributed some money to some universities and scientific
institutions, which was meant to encourage scientific education and
research. The company thereby hoped to
create a reservoir of qualified scientists from which the company could recruit
its staff.
The court held that even
though the payment was not under an express power, it was reasonably incidental
to the company’s business and therefore valid.
This is one of the few
cases where payment was recognized as being valid.
These are remedies
Whether or not a contract
is ultra vires depends on the knowledge of the party’s dealing with that
company. Such is the case as regards
borrowing contracts. Consider the case of
X was a director of company
B and at the same time had some interests in company A. He learnt that company B wished to borrow
some money which it intended to apply to unauthorised activities. He urged company A to lend the money on the
security of debentures. The issues were
(a) Whether the debentures were valid security;
(b) Whether the
knowledge of X as to the intended application of the money could be imputed to
the company.
The court held that X was
not company A’s agent for obtaining such information and therefore his
knowledge was not the company’s knowledge and consequently the debentures were
valid security.
This loophole however will
be applied very rarely because everybody is presumed to know the contents of a
company’s public documents. Where a
contract with that company is ultra vires, generally speaking the party dealing
with that company has no rights under the contract. The transaction being null and void cannot
confer rights on the 3rd party nor can it impose any obligation on
the company.
In many instances however,
property will be transferred under an ultra vires transaction. Such transaction
cannot vest rights in the transferee and cannot divest the transferor of his
rights.
1. At common law therefore, the first remedy of a
person who parts with property under an ultra vires transaction is that he has
a right to trace and recover that property from the company as long as he can
identify it.
This principle also applies
to money lent to the company on an ultra vires borrowing so long as the money
can be traced either in law or in equity.
The basis of this principle is that the company is deemed to hold the
money or the property as a trustee for the person from whom it was obtained.
Therefore, if the money
received is paid into a separate account, or is sufficiently earmarked e.g. by
the purchase of some particular items, it can be followed and claimed by the
lender. Where tracing is impossible,
because the money has become mixed with other money, the lender is entitled in
equity to a charge on the mixed fund together with the other creditors
according to the respective amounts otherwise money obtained on ultra vires
transaction generally cannot be followed once it has been spent. But if such money has been spent by
discharging the company’s intra vires debts then the lender is entitled to rank
as a creditor to the extent to which the money has been so applied. Since the company’s liabilities are not
increased but in fact decreased, equity treats the borrowing as valid to the
extent of the legal application of such money.
2. The 3rd party
has a personal right against the directors or other agents with whom he has
dealt. The rationale is that such
directors or other agents are treated as quasi trustees from whom it follows
that a 3rd party is entitled to a claim against them for
restitution.
The intra vires creditor does not have the locus standi to prohibit ultra
vires actions. Again there is the
presumption of knowledge of a company’s documents and activities. In spite of the fact that the doctrine of ultra vires is over due for reform, it
has not undergone any reform in Kenya unlike in the United Kingdom where it has
been severely eroded.
All the company can do is
to alter its objects under the power conferred by Section 8 of the Companies
Act. The effect of the Section is
that a company may by special resolution alter the provisions in its Memorandum
with respect to the objects of the company.
Section 141 defines Special Resolution
as a resolution which is passed by a majority of not less than three quarters
of those members voting at a company’s general meeting either in person or by
proxy and of which notice has been given of the intention to propose it as a
special resolution.
Within 30 days of the date
on which the resolution altering the objects is passed, an application for the
cancellation of the Resolution may be made to Court by or on behalf of the
holders who have not voted in favor of the Resolution, of not less than 15% of
the nominal value of the issued share capital of any class and if the company
does not have a share capital, the application can be made by at least 15% of
the members of the company.
If such an application is
made, the alteration will not be effective except to the extent that it is
confirmed by a court. Normally a court
has an absolute discretion to confer, reject or modify the alteration.
In this case, it was held
that the registrar of companies is entitled to receive a notice of any such
application and to appear and be heard at the hearing of the Application on the
ground that such matters affect his record.
Under Section 8 (9) of
the Companies Act Cap 486 if no application is made to the court, within 30
days the alteration cannot subsequently be challenged. The effect of this provision is that as long
as an alteration is supported by more than 85% of the shareholders or so long
as no one applies to the court within 30 days of the resolution, companies have
complete freedom to alter their objects.
Note however, that such
alterations do not operate retrospectively.
Their effect relates only to the future.
A Company’s constitution is
composed of two documents namely the Memorandum of Association and the Articles
of Association. The Articles of
Association are the more important of the two documents in as much as most court
cases in Company Law deal with the interpretation of the Articles.
Section 9 of the Companies
Act
provides that a Company limited by guarantee or an unlimited company must
register with a Memorandum of Association Articles of Association describing
regulations for the company. A company
limited by shares may or may not register articles of Association. A Company’s Articles of Association may adopt
any of the provisions which are set out in Schedule 1 Table A of the Companies
Act Cap 486.
Table A is the model form
of Articles of Association of a Company Limited by Shares. It is divided into two parts designed for
public companies in part A and for private companies in part B (II) thus a
company has three options. It may either
(a)
Adopt Table A in full; or
(b)
Adopt Table A subject to modification or
(c)
Register its own set of Articles and thereby exclude Table A
altogether.
In the case of a company
limited by shares, if no articles are registered or if articles are registered
insofar as they do not modify or exclude Table A the regulations in Table A
automatically become the Company’s Articles of Association.
Section 12 of the Companies
Act
requires that the Articles must be in the English language printed, divided
into paragraphs numbered consecutively dated and signed by each subscriber to
the Memorandum of Association in the presence of at least one attesting
witness.
As between the Memorandum
and the Articles the Memorandum of Association is the dominant instrument so
that if there is any conflict between the provisions in the Memorandum and
those in the Articles the Memorandum provisions prevail. However if there is any ambiguity in the
Memorandum one may always refer to the Articles for clarification but this does
not apply to those provisions which the Companies Act requires to be set out in
the Memorandum as for instance the Objects of the Company.
Whereas the Memorandum
confers powers for the company, the Articles determine how such powers should
be exercised.
Articles regulate the
manner in which the Company’s affairs are to be managed. They deal with inter alia the issue of
shares, the alteration of share capital, general meetings, voting rights,
appointment of directors, powers of directors, payment of dividends, accounts,
winding up etc.
They further provide a
dividing line between the powers of share holders and those of the directors.
Under Section 22 of the
Companies Act it is provided that subject to the provisions of the Act, when the
Memorandum and Articles are registered, they bind the company and the members
as if they had been signed and sealed by each member and contained covenants
for the part of each member to observe all their provisions. This Section has been interpreted by the
courts to mean that the Memorandum gives rise to a contract between the Company
and each Member.
Reference may be made to
the case of
Here the Articles of the
Company provided that any dispute between any member and the company should be
referred to arbitration. A dispute arose
between Hickman and the company and instead of referring the same to arbitration;
he filed an action against the company.
The company applied for the action to be stayed pending reference to
arbitration in accordance with the company’s articles of association.
The court held that the
company was entitled to have the action stayed since the articles amount to a
contract between the company and the Plaintiff one of the terms of which was to
refer such matters to arbitration.
Justice Ashbury had the
following to say: “That the law was clear
and could be reduced to 3 propositions
1.
That no Article can
constitute a contract between the company and a third party;
2.
No right merely purporting
to be conferred by an article to any person whether a member or not in a
capacity other than that of a member for example solicitor, promoter or
director can be enforced against the company.
3.
Articles regulating the
right and obligation of the members generally as such do not create rights and
obligations between members and the company”.
In this case, the company’s
articles provided that Eley should become the company Solicitor and should
transact all legal affairs of the company for mutual fees and charges. He bought shares in the company and thereupon
became a member and continued to act as the company’s solicitor for some
time. Ultimately the company ceased to
employ him. He filed an action against
the company alleging breach of contract.
The court held: that the
articles constitute a contract between the company and the members in their
capacity as members and as a solicitor Eley was therefore a third party to the
contract and could not enforce it. The
contract relates to members in their capacity as members and the company so it’s
only a contract between the company and members of that company and not in any
other capacity such as solicitor. But
note that there can be an intra member contract.
Here the Plaintiff who was
a member of the company petitioned the court to stay the implementation of a
resolution not to pay dividends but issue debentures instead. Holding that a member was entitled to the
stay of the implementation of the Resolution Sterling J. had the following to
say: “the article of association constitutes a contract not merely between
shareholders and the company but also between the individual shareholders and
every other.”
This case was followed in
Here the company’s articles
provided that every member who intends to transfer his shares shall inform the
directors who will take those shares between them equally at a fair value. The
Plaintiff called upon the directors to take his shares but they refused. The issue was did the articles give rise to a
contract between the Plaintiff and the directors. In their capacity as directors they were not
bound.
The court here held that
the Articles related to the relationship between the Plaintiff as a member and
the Defendants not as directors but as members of the company. Therefore the Defendants were bound to buy
the Plaintiff shares in accordance with the relevant article.
Section 13 of the Companies
Act gives
the company power to alter the articles by special resolution. This is a statutory power and a company
cannot deprive itself of its exercise. Reference may be made to the case of
The issue herein was
whether a company which under its Memorandum and Articles had no power to issue
preference shares could alter its articles so as to authorise the issue of
preference shares by way of increased capital
The court held that as long
as the Constitution of a Company depends on the articles, it is clearly
alterable by special resolution under the powers conferred by the Act.
Therefore it was proper for the company to alter those articles and issue
preference shares. Any regulation or
article which purports to deprive the company of this power is therefore
invalid, on the ground that such an article or regulation will be contrary to
the statute. The only limitation on a
company’s power to alter articles is that the alteration must be made in good
faith and for the benefit of the company as a whole.
In this case the company
had a lien on all debts by members who had not truly paid up for their
shares. The Articles were altered to
extend the Company’s lien to those shares which were fully paid up.
The court held that since
the power to alter the Articles is statutory, the extension of the lien to
fully pay up shares was valid. These
were the words of Lindley L.J.
“Wide however as the language of Section 13 mainly the power conferred
by it must be exercised subject to the general principles of law and equity
which are applicable to all powers conferred on majorities and 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.”
Further reference may be
made to the case of
Here the Articles of the
Company provided that the Plaintiff and 4 others should be the first directors
of the company. Further each one of them
should hold office for life unless he should be disqualified on any one of some
six specified grounds, bankruptcy, insanity etc. The Plaintiff failed to account to the
company for certain money he had received on its behalf. Under a general meeting of the company a
special resolution was passed that the articles be altered by adding a seventh
ground for disqualification of a director which was a request in writing by his
co-directors that he should resign. Such
request was duly given to the Plaintiff and there was no evidence of bad faith
on the part of shareholders in altering the articles.
The Plaintiff sued the
company for breach of an alleged contract contained in their original articles
that he should be a permanent director and for a declaration that he was still
a director.
The court held that the
contract if any between the Plaintiff and the company contained in the original
articles in their original form was subject to the statutory power of
alteration and if the alteration was bona fide for the benefit of the company,
it was valid and there was no breach of contract. Lord Justice Bankes observed as follows
“In
this case, the contract derives its force and effect from the Articles
themselves which may be altered. It is
not an absolute contract but only a conditional contract.”
The question here is who
determines what is for the benefit of the company? Is it the shareholders or the Courts?
Scrutton L.J. had the
following to say
“To
adopt such a view that a court should decide will be to make the court the
manager of the affairs of innumerable companies instead of shareholders
themselves. It is not the business of
the court to manage the affairs of the company.
That is for the shareholders and the directors.”
Director controlled share
company had a minority shareholder who was interested in some competing
business. The company passed a special
resolution empowering the directors to require any shareholder who competed
with the company to transfer his shares at their fair value to nominees of the
directors. The Plaintiff was duly served
with such a notice to transfer his shares. He thereupon filed an action against
the company challenging the validity of that article.
The court held that the
company had a power to re-introduce into its articles anything that could have
been validly included in the original articles provided the alteration was made
in good faith and for the benefit of the company as a whole and since the
members considered it beneficial to the company to get rid of competitors, the
alteration was valid..
Contrast this case with
that of
Here a public company was
in urgent need of further capital which the majority of the members who held
98% of the shares were willing to supply if they could buy out the
minority. They tried persuasion of the
minority to sell shares to them but the minority refused. They therefore proposed to pass a Special
Resolution adding to the Articles a clause whereby any shareholder was bound to
transfer his shares upon a request in writing of the holders of 98% of the
issued capital.
The court held that this
was an attempt to add a clause which will enable the majority to expropriate
the shares of the minority who had bought them when there was no such
power. Such an attempt was not for the
benefit of the company as a whole but for the majority. An injunction was therefore granted to
restrain the company from passing the proposed resolution.
Sometimes the Articles may
be altered in such a way that the implementation of those articles in the
altered form would give rise to breach of an existing contract between the
company and a third party and particularly so as regards contracts between companies
and their directors.
A director may hold office
either
1.
Under the Articles without a service contract;
2.
Under a contract of service which is entirely independent of
the articles; or
3.
Under a service contract which expressly or by implication
embodies the relevant provisions in the Articles.
Where a director holds
office under the Articles without a contract of service, then his appointment
is conditional on the footing that the articles may be altered at any time in
exercise of statutory power.
If however, a director’s
appointment is entirely independent of the articles then any alterations which
affects his contract with the company will constitute a breach of contract for
which the company will be liable in damages.
The Plaintiff by a written
contract was appointed the company’s Managing Director for 10 years. The
agreement was not expressed to be subject to the Articles in any way. The Articles provided various grounds for the
removal of a director from office subject to the terms of any subsisting
agreement. The Articles further provided
that if the Managing Director ceased to be a director, he would ipso facto
cease to be Managing Director. The
Company’s Articles were subsequently changed to give the Directors power to
remove a fellow director from office by notice.
Such notice was given to the Plaintiff who thereupon filed an action
claiming damages from the company for breach of contract.
It was held that since his
appointment was not subject to the articles, he could only be removed from
office in accordance with the terms of his appointment and not by way of
alteration of the articles. Damages were
therefore payable.
Lord Atkins said “if a party enters into an arrangement which
can only take effect by the continuance of an existing state of circumstances
there is an implied undertaking on his part that he shall be done of his own
motion to put an end to that state of circumstances which alone the arrangement
can be operative.”
If a director is appointed
in very general terms and without limitation of time, then the provisions in
the Articles are deemed to be incorporated in the appointment and in the
absence of any provision in the articles to the contrary, the company may dismiss
him at any time and even without notice.
A Company’s Articles
provided that the appointment of a Managing Director shall be subject to
termination if he ceases for any reason to be a director or if the company in
general meeting resolved that his tenure of office as managing director be
terminated. The Plaintiff was appointed
as the company’s Managing Director 17 years later the directors decided to
relieve him of his duties as Managing Director.
The decision was subsequently ratified by the company in general
meeting. He claimed damages for wrongful
dismissal.
The court held that on a
true construction of the company’s articles the Plaintiff’s appointment was
immediately and automatically terminated on passing of the Resolution at the
general meeting since the company had expressly reserved to itself the power to
dismiss the Managing Director.
7The question is, can a
company be restrained by injunction from altering its articles if the
alteration is likely to give rise to a breach of contract?
Part of the answer to this
question was given in the case of
-
By an agreement binding on
the Defendant Company it was provided that so long as the operative syndicate
should hold over 5000 shares in the Defendant’s company, the Plaintiff’s
syndicate should have the right of nominating two directors on the Board of the
Defendant Company. A clause to the same
effect was contained in Article 88 of the Defendant Company’s Articles of
Association.
Another Article provided
that the number of directors should not be less than 3 nor more than 7. The
Plaintiff syndicate had recently nominated 2 persons as directors. The Defendant Company objected to these two
persons as directors and refused to accept the nomination and a meeting of
shareholders was called for the purpose of passing a special resolution under
Section 13 of the Companies Act cancelling the article.
The court held that the
defendant company had no power to alter its articles of association for the
purpose of committing a breach of contract and that an injunction ought to be
granted to restrain the holding of the meeting for that purpose.
This case had words to the
effect that the company cannot be restrained but this was overruled in the case
of
In this case an article was
altered in such a way as to prejudice one shareholder. The article gave a lien on partly-paid shares
for debts of members. Zuccani owed money
in respect of unpaid calls on partly-paid shares but was the only holder of
fully paid shares as well. The court
held that it was for the benefit of the company to recover moneys due to it and
the alteration in its terms related to all holders of fully-paid shares. The fact that Zuccani was the only member of
that class at that moment did not invalidate it.
Although the Companies Act recognizes
the existence of class of shareholders, it does not define the term ‘class’ the
best definition is found in the case of
In that case Bowen L.J.
stated as follows: “The word Class is vague it must be confined to those persons whose
rights are not dissimilar as to make it impossible for them to concert together
with a view to their common interest.”
Under Article 4 of Table
A where the Share Capital is divided into different classes of Shares, the
rights attached to any class may be varied only with a consent in writing of
the holders of three quarters of the issued share of that class or with
assumption of a special resolution passed at a separate meeting of the holders
of the shares of that class.
However, under Section
25 (2) if the rights are contained in the Memorandum of Association and if
the Memorandum prohibits alteration of those rights, then class rights cannot
be varied
Since a company is an
artificial person, it can only act through an agency of a human person. For this purpose, a company has two primary
organs.
1.
The general Meeting;
2.
The Board of Directors.
The authority to exercise a
company’s powers is normally delegated neither to the members nor individual
directors but only to the directors as a Board.
The directors may however delegate powers to an individual Managing
Director.
Section 177 of the
Companies Act requires every public company to have at least two directors and every
private company at least one director.
The Act does not provide for the means of appointing Directors but in
practice the Articles of Association provide for initial appointments by
subscribers to the Memorandum of Association and thereafter to annual
retirement of a certain number of directors and the filling of vacancies at the
annual general meeting.
Under Section 184 (1) of
the Companies Act every appointment must be voted on individually except in
the case of private companies or unless the meeting unanimously agrees to
include two or more appointments in the same resolution. The appointment is usually effected by an
ordinary resolution. However, no matter how a director is appointed, under
Section 185 of the Companies Act he can always be removed from office by
an ordinary resolution in addition to any other means of removal which may be
embodied in the articles.
Unless the Articles so
provide Directors need not be members of a company, but if the articles require
a share qualification, then the shares must be taken up within two months
otherwise the office will be vacated. Undischarged
Bankrupts are not allowed to act as directors without leave of the court. A director need not be a natural person. A company may be appointed a director of
another. The disqualifications of
directors are set out in article 88 of Table A. The division of powers between the general
meeting and the Board of Directors depends entirely on the construction of the
Articles of Association and generally where powers of management are vested in
the Board of Directors, the general meeting cannot interfere with the exercise
of those powers.
The company’s articles
provided that subject to such regulations as might be made by extra ordinary
resolution, the Management of the company’s affairs should be vested in the
Directors who might exercise all the powers of the company which were not by statute
or articles expressly required to be exercised by the company in general
meeting. In particular the articles gave the directors power to sell and deal
with any property of the company on such terms as they must deem fit. At a general meeting of the company, a
Resolution was passed by a simple majority of the members for the sale of the
company’s assets on certain terms and instructing the directors to carry the
sale into effect. The Directors were of
the opinion that a sale on those terms was not of any benefit to the company
and therefore refused to carry it into effect.
The issue was, whether the directors were under an obligation to act in
accordance with the directives.
The court held that the
Articles constituted a contract by which the members had agreed that the
Directors alone should manage the affairs of the company unless and until the
powers vested in the Directors was taken away by an alteration in the Articles they
could ignore the general meeting directives on matters of management. They were therefore entitled to refuse to
execute the sale.
The division of the power to manage the
company’s affairs is embodied in Article 80 of Table A which states that
the business of the company shall be managed by the directors who may exercise
all such powers of a company as are not by the Act or by these regulations
required to be exercised by the company in general meeting. Where this article is adopted as it is
invariably done in practice the general meeting cannot interfere with a
decision of the directors unless they are acting contrary to the provisions of
the Companies Act or the particular company’s articles of association.
Shaw & Sons Ltd v. Shaw (1935) 2 KB 113
Here the Directors were
empowered to manage the company’s affairs.
They commenced an action for and on behalf of the company and in the
company’s name, in order to recover some money owed to the company. The general meeting thereafter passed a
resolution disapproving the commencement of the suit and instructing the
Directors to withdraw it
It was held that the
resolution of the general meeting was a nullity Greer L.J. stated
“A company is an entity distinct from its
shareholders and its directors. Some of
its powers may be according to its articles exercised by the Directors and
certain other powers may be reserved for shareholders in general meeting. If
powers of management are vested in the Directors, they and they alone can
exercise these powers. The only way in
which the general body of the shareholders can control the exercise of the
powers vested by the articles in the directors is by altering the articles or
if opportunity arises under the articles by refusing to re-elect the directors
or whose actions they disapprove. They
cannot themselves reserve the powers which by themselves are vested in the
Directors any more than the directors can reserve to themselves the powers
vested by the articles in the general body of shareholders.”
To this there are two
exceptions
1.
In relation to litigation – here a general meeting can
institute proceedings on behalf of the company if the board of directors
refuses or neglects to do so.
2.
When there is a deadlock in the Board of Directors as for
instance in the case of
The articles of association
vested the power to appoint additional directors in the Board of
Directors. There were only two directors
namely, Barron and Porter and the conduct of the company’s business was at a
standstill as Barron refused to attend any Board meeting with Porter.
The court held that it was
competent for the general meeting to appoint additional directors even if the
power to do so was by articles vested in the Board of Directors.
There are certain
situations in which the law does not recognize vicarious liability but insists
on personal fault as a prelude to liability.
In such cases a company could never be liable if the courts applied
rigidly the rule that a company is an artificial person and therefore can only
act through the directors. In practice
and for certain purposes the courts have elected to treat the acts of certain
officers as those of the company itself.
This is sometimes referred to as THE ORGANIC THEORY OF COMPANY
LAW.
The theory sprung from the
case of:
In this case a ship and her
cargo were lost owing to unseaworthiness.
The owners of the ship were a limited company. The managers of the company were another
limited company whose managing director a Mr. Lennard managed the ship on
behalf of the owners. He knew or ought
to have known of the Ship’s unseaworthiness but took no steps to prevent the
ship from going to sea. Under the
relevant shipping Act the owner of a sea going ship was not liable to make good
any loss or damage happening without his fault.
The issue was whether Lennard’s knowledge was also the company’s
knowledge that the ship was unseaworthy.
The court held that Lennard
was the Directing mind and will of the company his knowledge was the knowledge
of the company, his fault the fault of the company and since he knew that the
ship was unseaworthy, his fault was also the company’s fault and therefore the
company was liable. As per Viscount
Haldane
“My Lords a corporation is an
abstraction. It has no mind of its own
anymore 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.
Here the Plaintiffs who were tenants in
certain business premises were entitled to a renewal of their tenancy unless
the landlords who were a limited company intended to occupy the premises
themselves for their business purposes.
The issue was whether the Defendant Company had effectively formed this
intention. There had been no formal
general meeting or Board of Directors meeting held to consider the question but
the managing director’s clearly manifested the intention to occupy the premises
for the company’s business.
The court held that the
intention manifested by the Directors was the company’s intention and therefore
the tenants were not entitled to a renewal of the tenancy.
Denning L.J. As he then was stated as follows:
“A company may
in many ways be likened to a human being.
It has a brain and nerve centre which controls what it does. It also has hands which hold the tools and
act in accordance with the directions from the centre. Some of the people in the company are mere
servants and agents who are nothing more than hands to do the work and cannot
be said to represent the mind and will of the company. Others are directors and managers who
represent the directing mind and will of the company and control what it does. The state of mind of these managers is the
state of mind of the company and is treated by the law as such. Whether their intention is the company’s
intention depends on the nature of the matter under consideration, the relative
position of the officer or agent and other relevant facts and circumstances of
the case”
Crossly connected with this
aspect is the so called rule in Turquand’s case:
This rule deals with a
company’s liability for acts of its officers.
The question as to whether or not the company is bound or not depends on
the normal agency principles: If a
company’s officer or a company’s organ does an act within the scope of its
authority, the company will be bound.
The problem which might arise is that even if the Act in question is
within the scope of the organs or officers authority, there might be some
irregularity in the action of the organ concerned and consequently in the exercise
of authority. For example, if a
particular act can only be valued if done by the Board of Directors or the
general meeting, the meeting might have been convened on improper notice or the
resolution may not have been properly carried.
In the case of the Directors, they may not have been properly
appointed. In these circumstances can
the company disclaim an act which was so done by arguing that the meeting was
irregular? Must a third party dealing with the company always ascertain that
the company’s internal regulations have been complied with before holding the
company liable?
The answer to this question
was given in the negative in the case of
Here under the Company’s
constitution the directors were given power to borrow on bond such sums of
money as from time to time by a general resolution be authorized to be
borrowed. Without any such resolution
having been passed, the directors borrowed a certain sum of money from the
Plaintiff’s bank. Upon the company’s
liquidation the bank sought to recover from the liquidator who argued that the
Bank was not bound to recover it as it was borrowed without authority from the
general meeting.
The court held that even
though no resolution had been passed, the company was nevertheless bound by the
act of the directors and therefore was bound to repay the money.
The words of Jarvis C.J.
were as follows:
“A party dealing with a company is bound to
read the company’s deed of settlement (Memorandum of Association) but he is not
bound to do more. In this case a third
party reading a company’s documents will find not a prohibition from borrowing
but permission to do so on certain conditions.
Finding that the authority might be made complete by resolution, he
would have had a right to infer the fact of a resolution authorizing that which
on the face of the document appeared to be legitimately done.”
This is the rule in
Turquand’s Case which is often referred to as the rule as to indoor management.
This rule is based not on
logic but on business convenience.
1.
A third party dealing with a company has no access to the
company’s indoor activities;
2.
It would be very difficult to run business if everyone who
had dealings with the company had first to examine the company’s internal
operations before engaging in any business with the company;
3.
It would be very unfair to the company’s creditors if the
company could escape liability on the ground that its officials acted
irregularly.
But should the company
always be held liable for the act of any people purporting to act on the
company’s behalf? Suppose these persons are impostors, what happens?
In order to avoid this some
limitations have been imposed on the rule.
Later cases have refined the rule to a point where the position appears
to that ordinary agency principles will always apply
Anybody dealing with a
company is deemed to have notice of the contents of the company’s public
documents. Therefore any act which is
contrary to those provisions will not bind the company unless it is
subsequently ratified by the company acting through its appropriate organ. The term public document is not defined in
the companies Act but so far as registered companies are concerned, the
expression is not restricted to the Memorandum and Articles but it also
includes some of those documents filed at the companies’ registry. These
include special resolutions, particulars of directors and secretary, charges
etc. provided that everything appears to
be regular, so far as can be checked from the public documents, a third party
dealing with a company is entitled to assume that all internal regulations of
the company have been complied with unless he has knowledge to the contrary or
there are suspicious circumstances putting him on inquiry. Reference is made to the case of
Here a mining company was
founded by W and his friends and relatives.
Subscriptions were obtained from applicants for shares. These monies were paid into the bank which
had been described in the prospectus as the company’s bank. The communication of the letter was sent to
the Bank by a person describing himself as the Company’s secretary to the
effect that in accordance with a resolution passed on that day, the bank was to
pay out cheques signed by either two of the three named directors whose
signatures were attached and countersigned by the Secretary. The bank thereafter honored cheques so
signed. When the company’s funds were
almost exhausted, the company was ordered to be wound up. It was then discovered that no meeting of the
Shareholders had been held, and no appointment of Directors and Secretary met
but that with his friends and relatives, W had held themselves to be secretary
and directors and had appropriated the subscription money. The issue was whether the Bank was liable to
refund the money it had paid back to the borrower.
The court held that the
bank was not liable to refund any money to the company as it had honored the
company’s cheques in reliance on a letter received and in good faith.
Lord Hatherly stated
“When there are persons conducting the affairs of a company in a manner
which appears to be perfectly consonant with the articles of association, then
those dealing with them externally are not to be affected by any irregularities
which may take place in the internal management of the company.”
Directors will not
necessarily and for all purposes be insiders.
The test appears to be whether the acts done by them are so closely
related to their position as directors as to make it impossible for them not to
be treated as knowing the limitations on the powers of the officers of the
company with whom they have dealt.
Otherwise a third party dealing with a company through an officer who is
or is held out by the company as a particular type of officer e.g. a Managing
Director and who purports to exercise a power which that sort of officer will
usually have is entitled to hold the company liable for the officer’s acts even
though the officer has not been so appointed or is in fact exceeding his
authority as long as the third party does not know that the company’s officer
has not been so appointed or has no actual authority.
A third party however, will
not be protected if the circumstances are such as to put him on inquiry. He will also lose protection if the public
documents make it clear that the officer has no actual authority or could not
have authority unless a resolution had been passed which requires filing in the
Companies Registry and no such resolution had been filed. These are normal agency principles.
In this case Kapool &
Hoon formed a private company which purchased Buckhurst Park Estate. The Board of Directors consisted of Kapool,
Hoon and two others. The Articles of the
company contained a power to appoint a Managing Director but none was
appointed. Though never appointed as
such, Kapool acted as Managing Director.
In that capacity he engaged the Plaintiffs who were a firm of Architects
to do certain work for the company which was duly done. When the Plaintiff’s claimed remuneration,
according to the agreement, the company replied that it was not liable because
Kapool had no authority to engage them.
The Court held that the act
of engaging Architects was within the ordinary ambit of the authority of a
Managing Director of a property company and the Plaintiffs did not have to
inquire whether a person with whom they were dealing with was properly appointed. It was sufficient for them that under the
Articles, the Board of Directors had the power to appoint him and had in fact
allowed him to act as Managing Director.
Four conditions must however be fulfilled in order to entitle a third
party to enforce a contract entered to on behalf of the company by a person who
has no actual authority.
1.
It must be shown that there was a representation that the
agent had authority to enter into a contract of the kind sought to be enforced;
2.
Such representation must be made by a person or persons who
had actual authority to manage the company’s business either generally or in
respect of those matters to which the contract relates;
3.
It must be shown that the contract was induced by such
representation;
4.
It must be shown that neither in its Memorandum or under its
Articles was the company deprived of the capacity either to enter into a
contract of the kind sought to be enforced or to delegate authority to do so to
the agent.
Emco Plastica International vs. Freeberne (1971) E.A.
432
Here by a resolution of the
company at a meeting of the Board of Directors, the Respondent was appointed as
the company’s secretary. Nothing was
decided at the meeting as regards his remuneration or other terms of service. The terms of his appointment were contained
in a letter signed on behalf of the company by its Managing Director which
provided that the appointment was for a maximum period of 5 years. The Managing Director dealt with the day to
day affairs of the company but had no express authority to appoint a Secretary
or to offer such unusually generous terms as contained in the letter. After two years service the company purported
to dismiss the Respondent by five days notice.
The Secretary sued for benefits under the Contract. The Company contended that the Managing
Director had no authority from the Company to offer the terms of the contract. There being no resolution of the board to
support it and nothing in the company’s articles conferring any such powers on
a Managing Director.
The court held that as a
chairman he performed the functions of the Managing Director with a full
knowledge of the Board of Directors and that a contract of service as the one
entered into with the Secretary was one which a person performing the duties of
a Managing Director would have power to enter into on behalf of the
company. Therefore, the contract was
genuine, valid and enforceable. If
however, the officer is purporting to exercise some authority which that sort
of officer would not normally have, a third party will not be protected if the
officer exceeds his actual authority unless the company has held him out as
having authority to act in the matter and the third party has relied thereof
i.e. unless the company is estopped.
However, a provision in the Memorandum or Articles or other public
document cannot create an estoppel unless the third party knew of the provision
and has relied on it. For this purpose,
regulations at the Companies Registry do not constitute notice because the
doctrine of constructive notice operates negatively and not positive. If a document purporting to be received by or
signed on behalf of the company is proved to be a forgery, it does not bind the
company. However, the company may be
estopped from claiming the document as a forgery if it has been put forward as
genuine by an officer acting within his usual or ostensible authority.
PROMOTERS
The Companies Act does not
define the term promoter but Section 45(5) says
“A promoter is
a promoter who was a party to the preparation of the prospectus. Apart from the
fact that this definition does not speak much, it nevertheless shows that the
definition is only given for the purposes of that section.
At common law the best
definition is that by Chief Justice Cockburn in the case of
Twyfords – v – Grant (1877) 2C.P.D. 469
Cockburn says “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.”
The term is also used to
cover any individual undertaking to become a director of a company to be
formed. Similarly it covers anyone who
negotiates preliminary agreements on behalf of a proposed company. But those who act in a purely professional
capacity e.g. advocates will not qualify as promoters because they are simply
performing their normal professional duties.
But they can also become promoters or find others who will. Whether a person is a promoter or not
therefore, is a question of fact. The reason
is that Promoter of is not a term of law but of business summing up in a single
word the number of business associations familiar to the commercial world by
which a company is born.
It may therefore be said
that the promoters of a company are those responsible for its formation. They decide the scope of its business
activities, they negotiate for the purchase of an existing business if necessary,
they instruct advocates to prepare the necessary documents, they secure the
services of directors, they provide registration fees and they carry out all
other duties involved in company formation.
They also take responsibility in case of a company in respect of which a
prospectus is to be issued before incorporation and a report of those whose
report must accompany the prospectus.
DUTIES OF A PROMOTER
His duty is to act bona
fide towards the company. Though he may not strictly be an agent, or trustee
for a company, anyone who can be properly regarded as a promoter stands in a
fiduciary relationship vis-Ã -vis the company.
This carries the duties of disclosure and proper accounting particularly
a promoter must not make any profit out of promotion without disclosing to the
company the nature and extent of such a Promotion. Failure to do so may lead to the recovery of
the profits by the company.
The question which arises
is – Since the company is a separate legal entity from members, how is this
disclosure effected?
Erlanger v New Sombrero Phosphates Co. (1878) 3 A.C. 1218
The facts were as follows
The promoters of a company
sold a lease to the company at twice the price paid for it without disclosing
this fact to the company. It was held
that the promoters breached their duties and that they should have disclosed
this fact to the company’s board of directors.
As Lord Cairns said
“the owner of the property who promotes and
forms that company to which he sells his property is bound to take care that he
sells it to the company through the medium of a Board of Directors who can
exercise an independent judgment on the transaction and who are not left under
belief that the property belongs not to the promoters and not to another
person.”
Since the decision in
Salomon’s case it has never been doubted that a disclosure to the members
themselves will be equally effective. It
would appear that disclosure must be made to the company either by making it to
an independent Board of Directors or to the existing and potential
members. If to the former the promoter’s
duty to the company is duly discharged, thereafter, it is upon the directors to
disclose to the subscribers and if made to the members, it must appear in the
Prospectus and the Articles so that those who become members can have full
information regarding it.
Since a promoter owes his
duty to a company, in the event of any non-disclosure, the primary remedy is
for the company to bring proceedings for
1.
Either rescission of
any contract with the promoter or
2.
Recovery of any profits from the promoter.
As regards Rescission, this
must be exercised with keeping in normal principles of the contract.
1. The company should not have done anything to
ratify the action
2. There must be restitution in inter-gram (restore
the parties to their original position),
REMUNERATION OF PROMOTERS
A promoter is not entitled
to any remuneration for services rendered for the company unless there is a
contract so enabling him. In the absence
of such a contract, a promoter has no right to even his preliminary expenses or
even the refund of the registration fees for the company. He is therefore under
the mercy of the Directors. But before a
company is formed, it cannot enter into any contract and therefore a promoter
has to spend his money with no guarantee that he will be reimbursed.
But in practice the
articles will usually have provision authorizing directors to pay the
promoters. Although such provision does
not amount to a contract, it nevertheless constitutes adequate authority for
directors to pay the promoter.
PRELIMINARY CONTRACTS BY PROMOTERS
Until a company is formed,
it is legally non-existent and therefore cannot enter into any contract or even
do any other acts in law. Once
incorporated, it cannot be liable on any contract nor can it be entitled under
any contract purported to have made on its behalf before incorporation.
Ratification is not
possible when the ostensible principle is non-existent in law when the contract
was entered into.
Price v. Kelsall
(1957) E.A. 752
One of the issues in this
case was whether or not a company could ratify a contract entered into on its
behalf before incorporation. The alleged
contract was that the Respondent had undertaken to sell some property to a
company which was proposed to be formed between him and the Appellant. In holding that a company cannot ratify such
an agreement, the Eastern Africa Court of Appeal as then constituted O’Connor
President said as follows:
“A company
cannot ratify a contract purporting to be made by someone on its behalf before
its incorporation but there may be circumstances from which it may be inferred
that the company after its incorporation has made a new contract to the effect
of the old agreement. The mere
confirmation and adoption by Directors of a contract made before the formation
of the company by persons purporting to act on behalf of the company creates no
contractual relations whatsoever between the company and the other party to the
contract.”
However, acts may be done
by a company after its formation which gives rise to an inference of a new
contract on the same terms as the old one.
The question whether there
is a new contract or contracts is always a question of facts which depends on
the circumstances of each individual case.
Mawagola Farmers
& Growers Ltd. V Kanyanja (1971) E.A. 272
Here, prior to the
incorporation of a company the promoters held public meetings at which members
of the public were asked to purchase shares in a proposed company. The Respondents paid for the shares both
before and after incorporation of the company but the company did not allot any
shares to them. Instead after
incorporation, it allotted shares to other people.
The Respondents filed
actions praying for orders that the shares they paid for be allotted to them
and the company’s registered members be rectified accordingly.
The Company argued that as
the Respondents had paid money for the purchase of their shares before
incorporation, their claim could only be directed against promoters because no
pre incorporation agreement could bind the company and the company could not even
after incorporation ratify or adopt any such contract.
Mustafa J.A. replied as
follows:
“In order that the company
may be bound by agreements entered into before incorporation, there must be a
new contract to the same effect as the old agreements. This contract may however be inferred from
the acts of the company when incorporated.”
The allotment of shares to
the Respondents after the incorporation was held to be sufficient evidence of a
new contract between the company and the Respondents. Therefore the Respondents were entitled to be
allotted the shares agreed upon.
If any preliminary
arrangements are made, these must therefore be left to mere gentlemen’s
agreements or otherwise the promoters might have to undertake personal
liability.
Although the principle is
clear, those engaged in the formation of companies often cause contracts to be
entered into on behalf of their proposed companies.
As to whether the promoters
will be personally liable on such contracts of naught might depend on the
terminology employed. In the case of
Kelner v. Baxter
(1886) L.R. 2 C.P. 174
In this case, A, B and C
entered into a contract with the Plaintiff to purchase goods “on behalf of the
proposed Gravesand Royal Alexandra Hotel Company” the goods were duly supplied
and consumed. Shortly after incorporation
the company in question collapsed and the Plaintiff sued A B and C for the
price of the goods supplied.
It was held that A B and C
were liable. Chief Justice Erne stated
as follows:
“Where a
contract is signed by one who professes to be signing as agent but who has no
principal existence at the time, then the contract will hold together the
inoperative unless binding against the person who signed it. He is bound thereby and a stranger cannot by
subsequent ratification relieve him from that responsibility. When the company came afterwards into
existence, it had rights and obligations from that time but no rights or
obligations by reason of anything which might have been done before.”
Contrast this case with the
case of Newborn v. Sensolid (G.B Ltd) (1954) 1 Q.B. 45
Here a contract was entered
into between Leopold Newborn London Ltd and the Defendant for purchase of goods
by the latter. The defendant
subsequently refused to take delivery of the goods and an action was commenced
by Leopold Newborn Ltd.
It was discovered that at
the time the contract was entered into, the company had not been
incorporated. Leopold Newborn thereupon
sought personally to enforce the contract.
It was held that the
signature on the document was the company’s signature and as the company was
not in existence when the contract was signed, there never was a contract and
Mr. Newborn could not come forward and say that it was his contract. The fact was that he made a contract for a
company which did not exist.
PROSPECTUSES
Basically when the public
is asked to subscribe for shares or debentures in a company the invitation
involves the issue of documents which set out the advantages to accrue from an
investment in the company. This document
is called a prospectus and may be issued either by the company itself or by a
promoter. It is only in the case of a
public company that a prospectus may be issued.
A private company must
always raise its capital privately as required by Section 13 of the
Companies Act Cap 486.
Section 20 of the Statute
defines Prospectus as “any prospectus notice circular advertisement or other
invitation offering to the public for subscription or purchase of any shares or
debentures in the company.”
The word invitation and
offering in that definition are loosely used because when a company issues a
prospectus it does not offer to sell any shares but rather invites offers from
members of the public. A prospectus is
therefore not an offer but an invitation to treat.
The word prospectus is thus
a vague and uncertain term. Whether an
invitation is made to members of the public is always a question of fact. The question “public” is not restricted to a
certain section of the public but includes any members of the general
public.
A newly formed company
issued 3000 copies of a document which offered for subscription shares in a
company and which was headed “for private circulation only”. These copies were then circulated to the
shareholders of a number of gas companies and the question arose Was this a
prospectus?
The court held that this
was an offer to the public and therefore constituted a prospectus.
CONTENTS OF A PROSPECTUS
The object of the Companies
Act is to compel a company to disclose in a prospectus all the necessary
information which will enable a potential investor in deciding whether or not
to subscribe for a company shares or debentures. Therefore Section 40 requires that every
Prospectus shall state the matter specified in Article 1 of the 3rd
Schedule to the Act and that it will also set out the report specified in Part
II of that Schedule. The provisions in
that Schedule are designed mainly to provide information about the following
matters:
1.
Who the directors are; and What benefits they will get from
the Directorship;
2.
In the case of a new company, what profits are being made by
the promoters;
3.
the amount of capital required by the company to be
subscribed, the amount actually received or to be received, the precise nature
of the consideration which is not paid in cash;
4.
In the case of an existing company, what the company’s
financial records have been in the past.
5.
the company’s obligations under any contracts it has entered
into;
6.
the voting and dividend rights of each class of shares;
7.
If a Prospectus includes any statement by an expert, then the
expert must have given his written consent to the inclusion of the statement
and the prospectus must state that he has done so as per Section 42 of the
Companies Act.
Contravention of these
requirements renders the company and every person who was knowingly a party to
the issue of the prospectus to a fine not exceeding 10,000/-
Section 42 defines Expert as
including “Engineer, Valuer, Accountant or any other person whose profession
gives authority to the statement made by him.”
In addition to these
requirements the prospectuses must also be dated and the date stated therein is
taken to be the date of publication of the prospectus. However, there are two instances when a
prospectus need not contain the matter set out in Schedule III namely
1.
When the prospectus is issued to existing members or
shareholders of the company;
2.
When the prospectus relates to shares or debentures uniform
with previously issued shares or debentures.
LIABILITY IN RESPECT OF PROSPECTUS
If a prospectus contains
untrue statements, the Companies Act prescribes both penalty at Criminal Law
and also Civil Liability for payment of damages. As concerns Criminal Liability, under Section
46 where a prospectus includes any untrue statement, any person who authorized
the issue of the prospectus is guilty of an offence and liable to imprisonment
of a term not exceeding two years or a fine not exceeding 10,000/- or both such
a fine and imprisonment unless he proves either that the statement was immaterial
or that he had reasonable grounds to believe and did up to the time of issue of
the prospectus that the statement was true.
A statement is deemed to be
untrue if it is misleading in the form and context in which it is included.
R. v. Kylsant
(1932) 1 K.B. 442
In this case the company
had sustained continuous loses for over 6 years from 1921 to 1927. The company issued a prospectus which in all
material facts was correct. It further specified that the dividends being paid
were high. But these dividends were
being paid out of abnormal profits made after World War 1. Therefore the Prospectus was misleading in
its context.
CIVIL REMEDIES
There are two primary
remedies for those who subscribe for shares in a company as a result of a
misrepresentation in a prospectus
(a)
Damages;
(b)
Rescission of any resulting contract.
DAMAGES
Section 45 provides for compensation
to all persons who subscribe for any shares or debentures on the faith of the
Prospectus for loss or damage they may have sustained by reason of untrue
statements included therein. If the statement
is false to the knowledge of those who made it, then this amounts to fraud and
damages will be recoverable from all those who made the statement intending it
to be acted upon. Refer to the case of
Derry v Peek (1889) 14 A.C. 337
Herein a company had power
to construct tramways to be moved by animal power and with the consent of the
British Board of Trade by steam or mechanical power. The Directors issued a prospectus stating
that the company had power to use steam or mechanical power.
In reliance on this
misrepresentation, the Plaintiff bought shares in the company. Subsequently the Board of Trade refused to
give consent to the use of Steam or mechanical power and as a result the
company was wound up. The Plaintiff
brought an action for deceit alleging fraudulent misrepresentation.
The Court held that the
Defendants were not liable as they had made the incorrect statement in the
honest belief that it was true. Lord
Herschell said “the authorities establish two major propositions.
(i)
In order to sustain an action of Deceit, there must be proof
of fraud and nothing short of that will suffice;
(ii)
Fraud is proved when it is shown that a false representation
has been made either;
(a)
Knowingly or
(b)
Without belief in its truth; or
(c)
Recklessly not caring whether it is true or false.
In order to succeed in an
action for damages for fraud the plaintiff must show that the Misrepresentation
was made to him or that he was one of a class of persons who were intended to
act upon it. The ordinary purpose of a
prospectus is to invite members of the public to become allottees of shares in
a company. Once the shares have been
allotted therefore the prospectus will have served its purpose and thereafter
it cannot be used as a ground for filing an action for fraud in respect of
shares bought at a later date from another source. Reference made to the case of
Peek v. Gurney (1873) L.R. 377
The allotment of shares in
the company began on July 24th and was completed on 28th
July. In October, the Plaintiff bought
shares on the stock exchange. He
subsequently found that the prospectus issued in July contained some untrue
statements and therefore brought an action in respect thereof.
The issue was could he sue?
The court held that the
Plaintiff could not base his action on the prospectus which was intended to be
addressed only to the original company subscribers to the company shares. The Directors of a company are not liable
after the full original allotment of shares for all the subsequent dealings
which may take place with regard to those shares on the stock exchange.
However, the rule in Peek v. Gurney will not apply where a
prospectus is intended to induce not only the original subscribers for the
company shares but also to influence the subsequent purchase of those shares
Andrews v. Mockford (1896) 1 QB 372
Here the Plaintiff alleged
that the Defendant sent him a prospectus inviting him to buy shares in the
company which they knew would be a sham but the Plaintiff did not subscribe for
the shares. The prospectus eventually
produced a very scanty subscription and the Defendant caused a telegram to be
published in the local Newspaper to the effect that they had struck a vain of
Gold. And this they alleged had
confirmed the statistics in the prospectus.
The Plaintiff immediately
bought shares on this basis. The company
was wound up. The question arose, had the
Prospectus served its purpose?
The court held that the
prospectus was intended to induce the Plaintiff both to subscribe for shares
initially and also to buy them in the Market thereafter. The telegram was part of the prospectus.
Lord Justice Smith stated
as follows
“there was proved against the Defendant a
continuous fraud on their part commencing with ascending of the prospectus to
the Plaintiff and culminating in the direct lie told in a telegram which was
intended by the defendant to operate upon the Plaintiff’s mind and minds of
others and did so operate to his prejudice and the advantage of the
Defendant. In this case the function of
the prospectus was not exhausted and a false telegram was brought in to play by
the Defendant to reflect back upon and countenance the false statements in the
prospectus.”
The purchaser of shares
induced to buy shares by the misstatement in the prospectus has an action for
damages in negligence. He has also an
action for negligent misstatement.
All these actions are directed to the Directors personally.
RESCISSION
As against the company a
person induced to buy shares by a misrepresentation in the prospectus may
rescind the contract. On buying shares
ones contract is with a company itself.
The remedy is available only against the company. To be entitled to this remedy, it is not
necessary for the purchaser of the shares to show that the statement was
fraudulent or negligent. Even if the
misrepresentation was innocent, rescission lies. However, the rights to rescind is subject to
two limitations
1.
The allotee loses the right to rescind if he shows any
election to affirm the contract; e.g. by attending and voting at the company’s
meetings or by accepting dividends or by selling or attempting to sell the
shares.
2.
If the allotee does not rescind the contract before the
company is wound up, he loses the right to do so as from the moment the winding
up proceedings commenced. The rationale
is the protection of the other company’s creditors.
DIRECTORS’ DUTIES
First, three preliminary
observations
1.
Whereas the Directors’ authority to bind the company depends
on their acting collectively as a Board, their duties to the company are owed
by each Director individually. These
duties are owed to the company and the company alone and not to individual
shareholders.
Percival v. Wright (1902) 2 Ch. 421
Certain Shareholders wrote
to the Company’s Secretary asking if he knew anyone willing to buy their
shares. Negotiations took place and
eventually the company chairman and two other directors bought the Plaintiff Shares
at £12 10s per share. The Plaintiff
subsequently discovered that prior to and during their own negotiations for
sale, the Chairman and the Board of Directors had been approached by 3rd
Party with a view to the purchase of the entire company’s assets at more than
the price of 12 pounds 10 shillings per share.
The Plaintiff brought an
action to set aside the share sales on the ground that the directors owed them
a duty to disclose the negotiations with the 3rd Party.
It was held that the
Directors were not agents for the individual shareholders and did not owe them
any duty to disclose. Therefore the sale
was proper and could not be set aside.
However, if the Directors are authorized by the members to negotiate on
their behalf e.g. with a potential purchaser then the Directors will be in a
position of agents for such members and will owe them a duty accordingly.
Allen v Hyatt (1914) 30 T.L.R. 444
These duties except where
expressly stipulated in the Companies Act are not restricted to directors alone
but apply equally to any officials of the company who are authorized to act as
agents of the company and in particular to those acting in a managerial
capacity. This is particularly so as
regards fiduciary duties.
These fall into two broad
categories
1.
duties of care and skill in the conduct of the company’s
affairs; and
2.
Fiduciary duties of loyalty and good faith.
Duties of care and skill
were summed up by Romer J. In the case
of
Here the Directors of an
insurance company left the management of the company’s affairs almost entirely
to the Managing Director. Owing to the
managing Director’s fraud, a large amount of the company’s funds disappeared. Certain items appeared in the balance sheet
under the heading “loans at call or short notice and “Cash in Bank or in
Hand”. The Directors did not inquire how
these items were made up. If they had
inquired they would have found that the loans were chiefly to the Managing
Director himself and to the Company’s General Manager and the cash at Bank or
in hand included some £13,000 in the hands of a firm of stockbrokers at which
the managing director was a partner.
On the company’s winding
up, an investigation of its affairs disclosed a shortage in its funds of more
than £1.2 million incurred mainly due to the delinquent fraud of the Managing
Director for which he was convicted and sentenced. The other Directors had all
along acted in good faith and honestly but the liquidator sought to make them
liable for the damages.
It was held that the
Directors were negligent. Justice Romer
reduced the Directors duties of care and skill as follows
“A Director
need not exhibit in the performance of his duties a greater degree of skill
than may reasonably be expected from a person of his knowledge and experience.”
This proposition prescribes
the standard of skill to be exhibited in actions undertaken by directors. The test is partly objective and also partly
subjective because a reasonable man would be expected to have the knowledge of
a director with his experience. Refer to
Re Brazilian Rubber & Plantations Estates Ltd. (1911) 1
Ch. 405
In this case a company had
five directors and one of them confessed that he was absolutely ignorant of
business. A second one was 75 years old
and very deaf. A third one said he only
agreed to become a director because he saw one of his friends names on the list
of directors. The other two were fairly
able businessmen. The directors caused a
contract to be entered into between the company and a certain syndicate for
purchase by that company of some rubber plantation in Brazil. The prospectus issued by the company
contained false statements about the acreage of the Plantation, the types of
trees and so forth. The information
given therein was given to the Directors by a person who had an original option
to purchase that property. He had never
been to Brazil and the data was based on his own imagination. The Directors caused the company to purchase
the property. The question arose, were
they negligent in so doing?
The court held that their
conduct did not amount to gross negligence.
Neville J. had the following to say:
“It has been laid down that so long as they act
honestly, Directors cannot be made responsible in damages unless they are
guilty of gross negligence. A Director’s
duty requires him to act with such care as is reasonably expected from his
having regard to his knowledge and experience.
He is not bound to bring any special qualifications to his office. He may undertake the Management of a Rubber
Company in complete ignorance of anything connected with Rubber without
incurring responsibility for the mistakes which may result from such
ignorance. While if he is acquainted
with the Rubber business, he must give the company the advantage of his
knowledge when transacting the company’s business. He is not bound to take any definite part in
the conduct of the company’s business but insofar as he undertakes it he must
use reasonable care. Such reasonable
care must be measured by the care an ordinary man might be expected to take in
the same circumstances on his own behalf.”
3.
A director is not bound to give continuous attention to the
affairs of his company. His duties are
of an intermittent nature to be performed at periodical Board Meetings and at
meetings of any committee of the Board on which he is placed. He is not bound to attend all such meetings
though he ought to attend whenever in the circumstances he is reasonably able
to do so.
Refer to the case of Re Denham & Co. Ltd (1883) 2 Ch. D 752.
Here a company was incorporated in 1873.
Under the Articles 3 Directors were appointed namely, Denham, Taylor and
Crook. A fourth Director was appointed
later. The articles conferred on Denham
supreme control of the company’s affairs.
He was given power to override decisions of the general meeting and a
Board of Directors. He was responsible
for declaring dividends and he managed the company’s affairs entirely alone and
without consulting the other directors.
Between 1874 and 1877 a dividend of 15% per annum was recommended and
paid and the total amount paid was some £21,600. In 1880 the company went into liquidation and
an investigation revealed that the money paid as dividends had been paid not
out of profits but out of capital.
Thereafter Denham became bankrupt, Taylor was dead and his estate was
worthless and the third man was a man of straw.
The creditors directed their claims against Crook who had property. Crooks argued that since the formation of the
company, he had never attended Board Meetings and therefore could not be
accountable for fraudulent statements in the Company’s Balance Sheets. He attended one meeting in 1876 where he
formally put forth a Resolution for the payment of a dividend for that year.
The Court held that a
Director is not bound to attend every Board meeting and that he is not liable
for misfeasance committed by his co-directors at Board meetings at which he was
never present.
Marquis of Butes (1892) 2 Ch. 100
Here the Director never
attended any Board meetings for 38 years.
It was held that he was not liable.
3. In respect of all duties which having regard to
all exigencies of business and articles of association may properly be left to
some other official. A Director in the
absence of grounds for suspicion will not be liable in trusting that other
official to perform that other duty honestly.
Dovey v. Cory (1901) A.C. 477
A bank sustained heavy
losses by advances made improperly to customers. The irregular nature of advances was
concealed by means of fraudulent Balance Sheets which were the work of the
General Manager and the Chairman in assenting to the payment of dividends out
of capital and those advances on improper security were done on the advice of
the general manager and chairman.
The court held that the
reliance placed by the co-director on the general manager and chairman was
reasonable. He was not negligent and
therefore was not liable for not having discovered the fraud as he was not in the
absence of circumstances of suspicion bound to examine entries in the Company’s
Books to see that the Balance Sheet was correct.
It may be said that the
duties of care and skill appear to be negative duties. What about fiduciary duties?
FIDUCIARY DUTIES
Basically a Director’s
fiduciary duties are divisible into 4 sub categories
1.
The Directors must always act bona fide in what they consider
and not what the courts may consider to be in the best interest of the
company. In this context, the term
company means the present and future members of the company on the basis that
the company will be continued as a going concern thereby balancing long-term
view against short term interests of existing members.
2.
The directors must always exercise their powers for the
particular purpose for which they were conferred and not for extraneous
purposes even if the latter are considered being in the best interests of the
company. For example the Directors are
invariably empowered to issue capital and this power should be exercised for
only raising more funds when the company requires it. Hence it will be a breach of the Directors’
duties to issue the company shares for the purpose of entrenching themselves in
the control of the company’s affairs.
Refer to the
case of Punt
v. Symons (1903) 2 Ch. 506 in this
case the directors issued shares with the object of creating a sufficient
majority to enable them to pass a special resolution depriving the other
shareholders of some special rights conferred upon them by the company’s
articles. It was held that a power of a
kind exercised by the Directors in this case was a power which must be
exercised for the benefit of the company.
Primarily this power is given to them for the purpose of enabling them
to raise capital for the purposes of the company. Therefore a limited issue of shares to
persons who are obviously meant and intended to secure the necessary statutory
majority in a particular interest was not a fair and bona fide exercise of the
power.
Piercy v. Mills & Co. (1920) 1 Ch. 78
A company had two
directors. They fell out of favor with
the majority of the shareholders who were therefore threatened with the
election of 3 other directors to the Board.
The directors issued shares with the object of creating a sufficient
majority to enable them to resist the election of the 3 additional directors
whose election would have put the two directors in the minority on the Board.
The Court held that the
Directors were not entitled to use their powers of issuing shares merely for
the purpose of maintaining their control or the control of themselves and their
friends over the affairs of the company or even merely for the purpose of
defeating the wishes of the existing majority of shareholders. The Plaintiff and his friends held the
majority of shares in the company and as long as that majority remained, they
were entitled to have their wishes prevail in accordance with a company’s regulations. Therefore it was not open to the directors
for the purpose of converting a minority into a majority and purely for the
purpose of defeating the wishes of the existing majority to issue the shares in
dispute.
In those circumstances
where the directors have breached their duty to exercise their powers for the
proper purpose, the shareholders may forgive them by ratifying their action
Hogg v. Cramphorn Ltd. (1967) Ch. 254
In this case the company
had two classes of shares, ordinary and preference shares. Each share carried 1 vote. The power to issue the company shares was
vested in the Directors. They learnt
that a takeover bid was to be made to the Shareholders. In the Bona fide belief that the acquisition
of control by the prospective take over bidder will not be the interest of the
company or its staff. The Directors
decided to forestall this move. They
therefore attached 10 votes to each of the unissued preference shares and
allotted to a trust which was controlled by the Chairman of the Board of
Directors and one of his partners in the company’s audit department and an
employee of the company. To enable the trustees
to pay for the shares, the directors provided them with an interest free loan
out of the company’s reserve fund.
An action challenged by the
Plaintiff who was an associate of the prospective take-over bidder and
registered holder of 50 ordinary shares in the company was started. After finding that it was improper for the
directors to attach such special voting rights, the Court stood over the action
in order to enable a general meeting to be held and to debate whether or not to
ratify the Director’s actions. The
general meeting ratified the action.
Bamford v. Bamford (1969) 1 All ER 969
There were similar facts as
in the former case but a meeting was held before proceeding to court and that
general meeting ratified the Director’s action.
The question also arose in this case, could a decision of the general
meeting cure the irregularity?
The court held if the
allotment was made in bad faith, it was voidable at the instance of the company
because it was a wrong done to the company and that being so, the company which
has the rights to recall the allotment has also the right to approve it and
forgive the breach of duty.
3.
They must not fetter their displeasure to act for the company
for example, the directors cannot contract either among themselves or with
third parties as to how they will vote at future Board meetings. However, where they have entered into a
contract on behalf of the company they may validly agree to take such further
action at Board meetings as maybe necessary to carry out such a contract.
FIDUCIARIES CONTINUED
4.
As fiduciaries the Directors must not place themselves
without consent of the company in a position in which there is a conflict
between their duties to the company and their personal interests. Good faith must not only be done but it must
also manifestly be seen to be done. The
law will not allow the fiduciary to place himself in a position where he will
have his judgments to be biased and then argue that he was not biased. This principle applies particularly when a
Director enters into a contract with his company or where he makes any secret
profit by being a Director. As far as
contracts are concerned a contract entered into by the Board on behalf of the
company and another Director is governed by the equitable principle which
ordains that a fiduciary relationship between the Director and his company
vitiates such contracts. Such contract
is therefore voidable at the instance of the company. Reference may be made to the case of
Aberdeen Railway v. Blaikie (1854) 1 Macc. 461
The Defendant Company
entered into a contract to purchase a quantity of chairs from the Plaintiff
partnership. At the time that the
contract was entered into a Director of the company was also one of the
partners. The issue was, was the company
entitled to avoid the contract? The
court held that the company was entitled to avoid the contract. The Judge said that as a body corporate can
only act by agents and it is the duty of those agents so to act as best to
promote the interests of the corporation whose affairs they are
conducting. Such an agent has a duty of
a fiduciary nature to discharge towards his principal. It is a rule of universal application that no
one having such duties to discharge shall be allowed to enter into or can have
a personal interest conflicting or which may possibly conflict with the
interests of those whom he is bound to protect.
This principle is strictly applied no question is entertained as to the
fairness or unfairness of the contract so entered into. However, it is possible for such contract to
be given effect by the articles of association.
At their narrowest the Articles might provide that a Director who is
interested in a Company contract should disclose his interests and he will not
be counted to decide that a quorum is raised and his votes will also not be
counted on the issue. At their widest
the articles might allow the director to be counted at Board meeting.
In order to create a
balance between these two extremes and ensure that a minimum standard prevails,
Section 200 was incorporated into the Companies Act. Under this Section it is the duty of a
director who is interested in any contract or proposed contract to disclose the
nature and extent of his interest to the Board of Directors when the contract
comes up for discussion. Failure to do
so renders the defaulting director liable to a fine not exceeding 2000
shillings. In addition the failure also brings in the equitable doctrine
whereby the contract becomes voidable at the option of the company and any
profit made by the director is recoverable by the company.
The shortcoming of the
Section is that the Director has to disclose to the Board of Directors and not
to the general meeting. It is not
sufficient for a Director to say that he is interested. He must specify the nature and extent of his
interests. If the company’s articles
take the form of Article 84 of Table ‘A’ then a Director who is so interested
is required to abstain from voting at the Board meeting and his vote will not
be taken in determining whether or not there is a quorum on the Board. Once the Director has complied with Section
200 and Article 84 then he can escape liability.
In respect of all other
profits which a Director may make are out of his position as a Director the
equitable principle which requires the Directors to account for any such
profits is vigorously enforced. This is
because the Courts have equated Directors to trustees and their duties have
also been equated to those of Trustees.
The question is, are they really trustees?
Re Forest of Dean Coal Mining Company (1879) 10 Ch. D 450
In the latter case, the
directors of a company were seen to be trustees only in respect of the
company’s funds or property which was either in their hands or which came under
their control. But this does not necessarily
make directors trustees. There are two
basic differences between Directors as Trustees and Ordinary Trustees.
(a)
The function of ordinary trustee is to preserve the Trust
Property but the role of a director is to explore possible channels of
investment for the benefit of the company and these necessitates some elements
of having to take a risk even at the expense of the company’s property.
(b)
Whereas trust property is vested in the Trustees, a company’s
property is held by the company itself and is not vested in the trust.
Nevertheless if the
directors make any secret profits out of their positions then the effect is
identical to that of ordinary trustees.
They must account for all such profits and refund the company.
Regal Hastings v. Gulliver (1942) 1 All E.R. 378
Herein the company owned a
cinema and the directors decided to acquire two other cinemas with a view to
the sale of the entire undertaking as a going concern. Therefore they formed a subsidiary company to
invite the capital of 5000 pounds divided into 5000 shares of 1 pound
each. The owners of the two cinemas
offered the directors a lease but required personal guarantees from the
Directors for the payment of rent unless the capital of the subsidiary company
was fully paid up. The directors did not
wish to give personal guarantees. They
made arrangements whereby the holding company subscribed for 2000 shares and
the remaining shares were taken up by the directors and their friends. The holding company was unable to subscribe
for more than 2000 shares. Eventually
the company’s undertakings were sold by selling all the shares in the company
and subsidiary and on each share the Directors made a profit of slightly more
than two pounds. After ownership had
changed the new shareholders brought an action against the directors for the
recovery of profits made by them during the sale.
The court held that the
company as it was then constituted was entitled to recover the profits made by
the Directors. Lord Macmillan had the
following to say:
“The directors will be liable to account if
it can be shown that what they did is so related to the affairs of the company
that it can properly be said to have been done in the course of their
management and in utilization of the opportunities and special knowledge and
what they did resulted in a profit to themselves.”
Phipps v. Boardman (1966) 3 All E.R. 721
In this case Boardman was a
solicitor to the trust of the Phipps family.
The trust held some shares in the company. Boardman and his colleagues were not
satisfied with the company’s accounts and therefore decided to attend the
company’s general meeting as representatives of the Trust. At the meeting they received information
pertaining to the company’s assets and their value. Upon receipt of the information, they decided
to buy shares in the company with a view to acquiring the controlling
interest. Their takeover bid was
successful and they acquired control.
Owing to the fact that Boardman was a man of extraordinary ability, the
company made progress and the profits realized by Boardman and his friends on
the one hand and the trusts on the other were quite extensive. One of the beneficiaries of the Trust brought
an action to recover the profits which were realized by Boardman and his
friends.
The court held that in
acquiring the shares in the company, Boardman and his friends made use of
information obtained on behalf of the trust and since it was the use of that
information which prompted them to acquire the shares, then the shares were
also acquired on behalf of the trust and thus the solicitors became
constructive trustees in respect of those shares and therefore liable to
account for the profits derived there from to the trust.
Peso Silver mines v. Cropper (1966) 58 D.L.R. 1
The Defendant was the
company’s Managing Director. The Board
of Directors was approached by a prospector who offered to sell his claims to
the company. The company’s consulting
geologists advised that it was in order for the company to acquire the
claims. The directors decided that it
was inadvisable for the company to acquire the same mainly because of its
strained financial resources.
Subsequently at the suggestion of the geologists, some of the Directors
agreed to purchase the claims at the price at which they had been offered to
the company. Thereafter they formed a
company which took over the claims and a second company for developing the
resources. After the control of Peso
Silver Mines had changed the new directors brought an action against the
Defendant to account to the company for the shares held by them in the new
companies. But here the court held that
since the company could not have taken over the claims, there was no conflict
of interest between the Directors and the Company and therefore the Defendant
was not liable to account for the shares.
Directors may make use of
opportunities originally offered to the company and thereby make profits
provided that some 4 conditions are satisfied namely
1.
The opportunity must have been rejected by the company;
2.
If the directors acted in connection with that rejection,
they must have acted bona fide in the best interests of the company.
3.
The information about that opportunity should not have been
given to them confidentially on behalf of the company.
4.
Their subsequent use of that information must not relate to
them as directors but as any other ordinary person.
Industrial Development Consultants v Cooley (1972) 2 All E.R.
162
The Defendant who was an
architect was appointed the company’s Managing Director. The company’s business was to offer design
and construction services to industrial enterprises. One of the defendant’s duties was to obtain
new business for the company particularly from the gas companies where he had
worked before joining the Plaintiff.
While the Defendant was still so employed by the Plaintiff a
representative of one Gas Company came to seek his advice on some personal
matters. In the course of their conversation
the Defendant learnt that the gas company in question had various projects all
requiring design and construction services of the type offered by the
Plaintiff. Upon acquiring this
information and without disclosing it to the company, the Defendant feigned
illness as a result of which he was relieved by the company from his
duties. Thereafter, he joined the gas
company and got the contract to do the work.
Two years previously, the Plaintiff had unsuccessfully tried to obtain
that work. After the Defendant acquiring
the contract, the company sued him alleging that he obtained the information as
a fiduciary of the company and he should therefore account to the company for
all the remuneration fees and all dues obtained.
The court held that until
the Defendant left the Plaintiff, he stood in a fiduciary relationship to them
and by failing to disclose the information to the company, his conduct was such
as to put his personal interests as a potential contracting party to the gas
company in conflict with the existing and continuing duty as the Plaintiff’s
Managing Director.
Roskill J.
“It is an
overriding principle of equity that a man must not be allowed to put himself in
a position where his fiduciary duty and interest conflict. It was the defendant’s duty to disclose to
the plaintiff the information he had obtained from the Gas Board and he had to
account to them for the profits he made and will continue to make as a result
of allowing his interests and duty to conflict.
It makes no difference that a profit is one which the company itself
could not have obtained. The question
being not whether the company could have acquired it but whether the defendant
acquired it while acting for the company.”
CONTROLLING SHARE HOLDERS
By controlling share
holders is meant those who hold the majority of the voting rights in the
company. Such share holders can always
ensure control of the company’s business by virtue of their voting power to
ensure that the controlling shareholders do not use their voting power for
exclusively selfish ends; the Law requires that in exercise of their voting
power, these shareholders must not defraud a minority. For example by endeavoring directly or
indirectly to appropriate to themselves any money property or advantage which
either belong to the company or in which the minority shareholders are entitled
to participate.
Menier v Hoopers Telegraphy Works (1874) L.R. Ch. A 350
In the latter case the
company brought action against its former Managing Director for a declaration
that the concessions for laying down a telegraph cable from Portugal to Brazil
was held by that former Director as a trustee for the company. While this action
was still pending, the Defendants who were the majority shareholders in the
company approached that former Managing Director with a view to striking a
compromise. It was agreed between the
parties that if that director surrendered the concessions to the Defendants
then the Defendants would use their voting power to ensure that the action was
discontinued. At a subsequent general
meeting of the company, by virtue of the defendant’s voting power, a resolution
was passed that the company should be wound up.
The court said that the
resolution was invalid since the defendants had used their voting power in such
a way as to appropriate to themselves the concessions which if the earlier action had succeeded should
have belonged to the whole body of shareholders and not merely to the
majority. Lord Justice Mellish stated as
follows:
“Although the shareholders of the company may
vote as they please and for the purpose of their own interest, yet the majority
of the shareholders cannot sell the assets of the company itself and give the
consideration but must allow the minority to have their share of any
consideration which may come to them.”
Cook v. Deeks (1916) 1 A.C. 554
The Toronto Construction
Company carried on business as Railway Construction contractors. The Shares in the company were held equally
among Cook, G S Deeks and G M Deeks. And
another party called Hinds. The company
carried out several large construction contracts for the Canadian Pacific
Railway. When the two Deeks and Hinds
learnt that a new contract was coming up, they obtained this contract in their
own names to the exclusion of the company and then formed a new company to
carry out the work. At a general meeting
of the shareholders of Toronto Construction Company a resolution was passed
owing to the two powers of Deeks and Mr. Hinds declaring that the company was
not interested in the new contract of the Canadian Pacific Railway. Cook brought an action and the court held: that the benefit of the contract belonged
properly to the Company and therefore the Directors could not validly use their
voting power as shareholders to vest it in themselves.
ENFORCEMENT OF DIRECTORS’ DUTIES
As the company is a
distinct entity from the members and since directors owed their duties to the
company and not to individual shareholders, in the event of breach of those
duties any action for remedies should be brought by the company itself and not
by any individual shareholder. The
company and the company alone is the proper Plaintiff. This is generally referred to as the rule in:
Foss V.
Harbottle (1843) 2 Hare 461
In this case the directors
who were also the company’s promoters sold the company’s property at an
undisclosed profit. Two shareholders
brought action against them alleging that in so doing, that the directors had
breached their duties to the company. It
was held that if there was any breach of duty, it was a breach of duty owed to
the company and therefore the Plaintiffs had no locus standi for the company was the proper plaintiff. This rule has two practical advantages
namely:
1.
Insistence on an action by the company avoids multiplicity of
actions;
2.
If the irregularity complained of is one which could have
been effectively ratified by the company in general meeting, then it is
pointless to commence any litigation except with the consent of the general
meeting.
However there are four
exceptions to this rule in which an individual member may bring action against
the directors namely:
(a)
Where it is complained that the company through the directors
is acting or proposing to act ultra
vires;
(b)
Where the act complained of even though not ultra vires, the company can effectively
be done by a special resolution;
(c)
Where it is alleged that the personal rights of the Plaintiff
have been infringed and/or are about to be infringed;
(d)
Where those who control the company are perpetuating the
fraud on the minority;
The problem likely to arise
is that if the directors themselves are also controlling shareholders, the rule
in Foss v. Harbottle if strictly applied in exercise of their voting powers,
the Directors may easily block any attempt to bring an action against
themselves. In such cases a shareholder
will be allowed to bring an action in his own name against the directors even
if the wrong complained of has been done to the company. Such an action is called a derivative action.
In order to be entitled to
commence a Derivative Action, it must be shown that
1.
The wrong complained of was such as to involve a fraud on the
minority which is not ratifiable by the company in general meeting;
2.
It must be shown that the wrong doers hold the controlling
interests
3.
The company must be joined as a nominal defendant;
4.
The action must be brought in a representative capacity on
behalf of the plaintiff and all other shareholders except the Defendant.
The question is, are these
exceptions effective?
There are situations where
the rule does not apply.
Another remedy against
directors for breach is found in Section 324 of the statute which provides as
follows:
“If in the
course of the winding up of the company it appears that any person who has
taken part in the formation or promotion of the company or any past or present
director has misapplied or retained any money or property of the company, or
been guilty of any breach of trust in relation to the company on the
application of the liquidator, a creditor or member or a court may compel such
person to restore the money or property to the company or to pay damages
instead.”
This section is designed to
deal with actual breaches of trust which come to light in the winding up
proceedings or during the winding up proceedings but winding up itself may be
used as a means of ending a course of oppression by those formally in control. Among the grounds for the winding up is one
which is particularly appropriate for such circumstances.
Under Section 219 (f) of
the Companies Act the court may order a company to be wound up if it is of the
opinion that it is “just inequitable” the courts have so ordered when satisfied
that it is essential to protect the members or any of them from oppression in
particular they have done so when the conduct of those in control suggests that
they are trying to make intolerable the position of the minority so as to be
able to acquire the shares held by the minority on terms favorable only to the
majority. But a member cannot petition
under this section if the company is insolvent.
If the company is solvent to wind it up, contrary to the majority wishes
will only be granted where a very strong case against the majority is
established.
Winding up a company merely
to end oppression appears rather awkward as it may not be of any benefit to the
petitioners themselves. Owing to these
shortcomings, Section 211 was incorporated into the Companies Act as an
alternative remedy for the minority of the shareholders. Section 211 provides that any member who
complains that the affairs of a company are being conducted in a manner
oppressive to some part of the members including himself may petition the court
which if satisfied that the facts will justify a winding up order but that this
will unduly prejudice that part of the members, may make such order as it
thinks fit. Such an order may regulate
the conduct of the company’s affairs in the future or may order the purchase of
member shares by others or by the Company itself. This remedy is available only to the
members. An oppressed director or
creditor cannot obtain any remedy under Section 211 of the Companies Act for
this is expressly restricted to oppression of the members even if a director or
creditor also happens to be a member.
Elder V. Elder & Watson (1952) AC 49
The two Plaintiffs were the
company director and secretary and factory manager respectfully. As this was a small family concern, serious
differences arose between the plaintiffs and the beneficial owners of the undertaking. Consequently the Plaintiff brought action
under Section 211 alleging oppression.
It was held that if there was any oppression of the Plaintiffs, it
related to them as directors and the remedy under Section 211 is only available
to members. The suit was dismissed.
WHAT IS OPPRESSION?
This term has been defined
to mean something burdensome, harsh or wrongful.
Scottish Cooperative Wholesale Society v. Meyer (1959) AC 324
Here the Society wished to
enter into the retail business. For this
purpose a subsidiary company was formed in which the two Respondents and 3
Nominees of the Society were the directors.
The society had majority shareholders and the Respondents were the
minority. The Company required 3 things
namely;
1.
Sources of supplies of raw material;
2.
A license from a regulatory organization called cotton
control
3.
Weaving Mills.
The Respondents provided
the first two but weaving Mills belonged to the society. For several years, the business prospered
because of mainly the knowhow provided by the Respondent. The company paid large dividends and
accumulated substantial results. Due to
the prosperity, the society decided to acquire more shares and through its
nominee directors offered to buy some of the shares of the Respondent at their
nominal value which was one pound per share but their worth was actually 6
pounds per share. When the Respondents
declined to sell their shares to the society, the society threatened to cause
the liquidation of the company. About 5
years later, Cotton control was abolished which meant that the society would obtain
the raw materials and weave cloth without a license. It accordingly started to do the same and
also started starving the subsidiary by refusing to manufacture for it except for
an economic crisis. As all the other Mills were fully occupied, the subsidiary
company was being starved to death and when it was nearly dead the Respondent
brought the petition claiming that the affairs of the company were being
conducted in an oppressive manner.
It was held that by
subordinating the interests of the company to those of the society, the nominee
directors of the society had thereby conducted the affairs of the company in a
manner oppressive to the other shareholders.
The fact that they were perhaps guilty of inaction was irrelevant. The affairs of the company can be conducted
oppressively by the Directors doing nothing to protect its interests when they
ought to do so.
Re Hammer (1959) 1 WL.R 6
In this case Mr. Hammer
senior was a Philatelist (stamp collector) dealer and incorporated business in
1947 forming a company with two types of ordinary shares class A shares which
were entitled to a residue of profit and Class B Shares carrying all the votes. He gave out the shares to his two sons and at
the time of the petition each son held 4000 Class A shares and the father owned
1000 shares. Of the Class B Shares, the
father and his wife held nearly 800 to the 100 held by each son. Under the Company’s articles of association,
the father and two sons were appointed directors for life and the father was
further appointed chairman of the Board with a casting vote. The father assumed powers he did not possess
ignored decisions of the Board and even in court, during the hearing asserted
that he had full power to do as he pleased while he had voting control. He dismissed employees using his casting vote
to co-opt self directors; he prohibited board meetings, engaged detectives to
watch the staff and secured payment of his wife’s expenses out of the company’s
funds. He negotiated sales and vetoed
leases all contrary to the decisions and wishes of the other directors.
The sons filed an action
claiming that the father had run the affairs of the company in a manner
oppressive to them. The father was 88
years.
The court held that by
assuming powers which he did not possess and exercising them against the wishes
of those who had the major beneficial interests, Mr. Hammer senior had
conducted the company’s affairs in an oppressive manner.
These two cases are among
the few where an application under Section 211 has succeeded. This is because section 211 has been
subjected to a very restrictive meaning.
To succeed under Section 211, one must establish a case of oppression.
There is no clear
definition of the term and therefore it is not easy to tell when a company’s
affairs are being conducted oppressively.
For example in the case of:
Re Five
Minute Car Wash Ltd (1966) 1 W.L.R. 745
The petitioner alleged
oppression on grounds that the company’s Managing Director was extremely
incompetent. The court ruled that even
though the allegation suggested that the Managing Director was unwise
inefficient and careless in the performance of his duties, this did not mean
that he had at any time acted unscrupulously, unfairly or with any lack of
probity towards the petitioner or to other members of the company. Therefore his conduct was not oppressive.
1.
The conduct which is complained of must relate to the affairs
of the company and must also relate to the petitioner in his capacity as a
member. Personal representatives cannot
petition nor can trustees in bankruptcy petition.
2.
The wording of the section suggests that there must be a
continuous cause of conduct and not merely isolated acts of impropriety.
3.
The conduct must be such as to make it just and equitable to
wind up the company. In other words, the
members must be entitled to a winding up order.
Re Bella Dor Sick Ltd (1965) 1 All E.R. 667
In a small family concern,
there developed two factions among shareholders. Owing to these personal differences the
petitioner filed a petition under Section 211 complaining inter alia that the
distribution of profits had not been fairly made. That he had been excluded from the Board of
Directors and that the affairs of the company were being conducted irregularly.
In particular, he alleged that the company had failed to repay its debts to
another company in which he had some interests.
It was held that the
petitioner had not made a case of oppression and the petition must be
dismissed.
Three reasons were given:
(a)
This petition had been brought for the collateral purpose of
enforcing repayment of debts to some third party;
(b)
The conduct complained of and particularly the removal of the
petitioner from the Board related to him as a director not as a member;
(c)
That the circumstances were not such as to justify a winding
up order at the instance of the petitioner because the company was insolvent
and therefore the shareholders had no tangible interests.
It is an unfortunate
mistake to link up Section 211 with winding up.
The courts are construing the Section very restrictively. Section 211 has therefore failed to live up
to expectations. It is no real remedy.
RAISING AND MAINTENANCE OF CAPITAL
The basis of the whole
concept or a company’s capital was explained by Jessel M.R. in the Flitcrafts
Case 1882 21 Ch. D 519 in this case
for several years the directors had been in the habit of laying before the
meeting of shareholders reports and balance sheets which were substantially
untrue inasmuch as they included among other assets as good debts a number of
debts which they knew to be bad. They
thus made it appear that the business had produced profits whereas in fact it
had produced none. Acting on these
reports, the meetings declared dividends which the directors paid. It was held here that since the directors
knew that the business had not made any profit, they were liable to refund to
the company the monies paid by way of dividends.
Jessel M.R said as follows
“when a person advances money to a company, his debtor is that artificial
entity called the corporation which has no property except the assets of the
business. The creditor therefore gives
credit to that capital or those assets.
He gives credit to the company on the faith of the implied
representation that the capital shall be applied only for the purposes of the
business and he has therefore a right to say that the corporation shall keep
its capital and shall not return it to the shareholders.”
The capital fund is
therefore seen as a substitute for unlimited liability of the members. Courts have developed 3 basic principles for
ensuring that the company’s represented capital is actually what it is and for the
distribution of that capital.
1.
Once the value of the company’s shares has been stated it
cannot subsequently be changed the problem which arises in this respect is that
shares may be issued for non-monetary consideration. For instance for services or property in such
cases the company’s valuation of the consideration is generally accepted as
conclusive. If the property has been
over valued, provided the valuation has been arrived at bona fide, the courts
will not question the adequacy of the consideration but if it appears on the
face of the transaction that the value of the property is less than that of the
shares, then the court will set aside that transaction. For this reason the shares in a company must
be given a definite value. The law tries
to ensure that the company initially receives assets at least equivalent to the
nominal value of the paper capital.
Refer to Section 5 of the Companies Act.
Unfortunately if in the insistence that shares do have a definite fixed
value is not an adequate safeguard because there is no legal minimum as to what
the nominal value of the shares should be.
2.
The Rule in Trevor v. Whitworth [1887] 12 A.C 449
under this rule a company is not allowed to purchase its own shares even if
there is an express power to do so in its Memorandum of Association as this
would amount in a reduction of its capital.
This principle is now supplemented by Section 56 of the Companies Act
which prohibits any direct or indirect provision of any form of assistance in
the purchase of the company shares.
However, there are 3 exceptions to this broad prohibition.
a.
where the lending of money is part of the ordinary business
of the company;
b.
Where the company sets a trust fund for enabling the trustees
to purchase or subscribe for the company shares to be held or for the benefit
of the employees of the company until where the company gives a loan to its
employee other than directors to enable them to purchase shares in the company.
3. Payment of
Dividends: In order to ensure
that the company’s capital is not refunded to the shareholders under the guise
of dividends, the basic principle is that dividends should not be paid
otherwise than out of profits. Refer to
Article 116 of Table A of the Companies Act.
The legal problem in this respect has been the lack of an adequate
definition of what constitutes profits.
To avoid the problem of definition the courts have formulated certain
rules for the payment of dividends.
These are as follows
(i) Before a
company can declare dividends, it must be solvent. Dividends will not be paid if this will
result in the company’s inability to pay its debts as and when they fall due;
(ii)
If the value of the company’s fixed assets has fallen thereby
causing a loss in the value of those assets, the company does not need to make
good that loss before treating revenue profits as available for dividends. It is not legally essential to make provision
for depreciation in the fixed assets.
However Losses of circulating assets in the current accounting period
must be made good before a dividend can be declared. The realized profits on the sale of fixed
assets may be treated as profit available for distribution as a dividend. Unrealized
profits on evaluation of the company’s assets may also be distributed by way of
dividends. Refer to Dimbula Valley
(Ceylon) Tea Co. V. Laurie [1961] Ch. D 353
Losses on circulating assets made in previous accounting periods need
not be made good. The dividend can be
declared provided that there is a profit on the current year’s trading. Each accounting period is treated in
isolation and once a loss has been sustained in one trading year, then it need
not be made good from the profits over subsequent trading periods. Undistributed profits of past years still
remain profit which can be distributed in future years until they are capitalized
by using them to pay a bonus issue.
CORPORATE SECURITIES
Basically securities are a
collective description of the various forms of investment which one can buy for
sale at the stock exchange. A company
can issue two primary classes of securities.
These are shares and debentures.
The basic distinction between a share and a debenture is that a share
constitutes the holder. A member of the
company whereas a debenture holder is a creditor of a company and not a member
of it
The best definition of the
term share is that given by Farwell J. in the case of Borland’s Trustee v.
Steel [1901] Ch. D 279 stated “a share is the interest of a member in a
company measured by a sum of money for the purpose of liability in the first
place and of interest in the second and also consisting of a series of mutual
covenants entered into by all the shareholders among themselves in accordance
with Section 22 of the Companies Act.”
The contract contained in
the Articles of Association is one of the original incidents of a share. A share is therefore not a sum of money but
an abstract interest measured by a sum of money and made up of various rights
contained in a contract of membership.
In contrast a debenture
means a document which either creates or acknowledges a debt and any document
which fulfils either of these conditions is called a debenture. A debenture may take any of 3 forms
1.
It may take the form of a single acknowledgment under seal or
the debts;
2.
It may take the form of an instrument acknowledging the debt
and charging the company’s property with repayment; or
3.
It may take the form of an instrument acknowledging the debt
charging the company’s property with repayment and further restricting the
company from creating any other charge in priority over the charge created by
the debenture.
The indebtedness
acknowledged by a debenture is normally but not necessarily secured by charge
over the company’s property. Such charge
could either be a specific charge or a floating charge. Both were defined by Lord McNaughton in the
case of Illingworth v. Houlsworth [1904]
A.C. 355 AT 358 He stated:
“A specific
charge is one that without more fastens on ascertained and definite property or
property capable of being ascertained and defined. A floating charge on the other hand is
ambulatory and shifting in its nature, hovering over and so to speak floating
with the property which it is intended to affect until some event occurs or
some act is done which causes it to settle and fasten on the subject of the
charge within its reach or grasp.”
A floating charge has 3
basic characteristics.
1.
It must be a charge on a class of a company’s assets both
present and future;
2.
That class must be one which in the ordinary cause of
business of the company keeps changing from time to time;
3.
By the charge it must be contemplated that until future step
is taken by or on behalf of those interested, the company may carry on its
business in the ordinary way as far as concerns the particular class of the
assets charged.
CRYSTALISATION
A floating charge will crystallize
under the following
(a)
Where the company defaults in the payment of any portion of
the principal or interest thereon, when such portion or interest is due and
payable. In that event however, the
debenture holders’ rights will not crystallize automatically. After the expiry of the agreed period for
repayment, the debenture still remained a floating security until the holders
take some step to enforce that security and thereby prevent the company from dealing
with its property;
(b)
Upon the appointment of a receiver in the course of a
company’s winding up;
(c)
Upon commencement of recovery proceedings against the
company;
(d)
If an event occurs upon which by the terms for the debenture
the lender’s security is to attach specifically to the company’s assets
Section 96 of the Companies
Act requires every Charge created by a company and conferring security on the
company’s property to be registered within 42 days. Under this Section what
must be registered are the particulars of the charge and the instrument creating
it. Failure to register renders the
charge void as against the liquidator or any creditor of the company.
Under Section 99 of the
Companies Act the registrar is under a duty to issue a certificate of the
registration of a charge and once issued, that certificate is conclusive
evidence that all the requirements as to registration have been complied with.
SHARES
In a company with a share
capital it is obvious that the company must issue some shares and the initial
presumption of the law is that all the shares so issued confer equal rights and
impose equal liabilities. Normally a
shareholder’s right in a company will fall under 3 heads.
1.
Payment of dividends;
2.
Refund of Capital on winding up;
3.
Attendance and voting at company’s general meetings.
Unless there is indication
to the contract all the shares will confer the same rights under those
heads. In practice companies issue
shares which confer on the holders some preference over the others in respect
of either payment of dividends or capital or both. This is the method by which classes of shares
are created i.e. by giving some of the shareholders preference over others.
In practice therefore most
companies with classes of shares will have ordinary shares and preference
shares. The preference shares being
those that enjoy some preference with reference to voting rights refund of
capital or payment of dividends.
There are certain rules
that courts use to interpret or construe on shares.
(a)
Basically all shares rank equally and therefore if some
shares are to have any priority over the others; there must be provision to
this effect in the regulations under which these shares were issued. Refer to the case of Birch V. Cropper (1889) 14 AC 525 here the company was in voluntary
winding up. The company discharged all
its liabilities and some money remained for distribution to the members. The Articles being silent on the issue, the
question was on what principle should the surplus be distributed among the
preference and ordinary shareholders?
The ordinary shareholders argued that they were entitled to the entire
surplus. Alternatively the division
ought to be made according to the capital subscribed and not the amount paid on
the shares. It was held that once the
capital has been returned to the shareholders, they thereafter become equal and
therefore the distribution of the surplus assets should be made equally between
the ordinary and preference shareholders.
(b)
However if the shares are expressly divided into separate
classes thereby rebutting the presumed equality, it is a question of
construction in each case what the rights of each class are. Hence if nothing is expressly said about the
rights of one class in respect of either dividend, return of capital or
attendance and voting at meetings, then that class has the same rights in that
respect as the other shareholders. The
fact that a preference is given in respect of any of these matters does not
imply that any right to preference in some other respect is given e.g. a
preference as to dividends will not apply a preference as to capital i.e. the
shares enjoy only such preference as may be expressly conferred upon them.
(c)
If however, any rights in respect of any of these matters are
expressly stated, the statement is presumed to be exhaustive so far as that
matter is concerned. For instance the
preference dividend is presumed to be non-participating in regard to other
dividends. Refer to Re Isle of Thanet Electricity Supply Co. (1950) Ch. 1951 where
Justice Wynn Parry stated;
“The effect of
the authorities as now in force is to establish two principles. First that in construing an article which
deals with the rights to share all profits, that is dividend rights and rights
to shares in the company’s property in liquidation, the same principle is
applicable and secondly that principle is that where the articles sets out the
rights attached to a class of shares to participate in profits while the
company is a going concern or to share in the property of a company in
liquidation, prima facie the rights so set out are in each case exhaustive.”
(d)
Where a preferential dividend is provided for it is presumed
to be cumulative for instance if no preferential dividend is declared the
arrears of dividend are carried forward and must be paid before any dividend is
paid on the other shares. But these
presumptions may be rebutted by words tending to show that the shares are not
intended to be cumulative or words indicating that the preferential dividend is
only to be paid out of the profits of each year i.e. if the company sustains
any financial loss during any year, there will be no dividend for that
year. Even then preferential dividends
are payable only if and when declared.
Therefore arrears of cumulative dividends are not payable on winding up
unless the dividend has been declared. This
presumption could be rebutted by any indication to the contrary.
Section 212 of the
Companies Act provides that a company may be wound up as follows
1.
Voluntarily;
2.
Order of the Court;
3.
By supervision of the Court.
The circumstances under
which the company may be voluntarily wound up are outlined in Section 217 of
the Companies Act. Here a company may be
wound up
a.
When the period fixed for its duration by the articles
expires or the event occurs on the occurrence of which the articles provide
that the company is to be dissolved and thus a company passes a resolution in
general meeting that it should be wound up voluntarily;
b.
If it resolves by special resolution that it should be wound
up voluntarily;
c.
If the company resolves by special resolution that it cannot
by reason of its liabilities continue its business and that it be advisable
that it be wound up.
Basically the second
circumstance is the most important because in practice at least the first
circumstance does not arise and in the 3rd circumstance the
creditors themselves will resolve that the company be wound up.
In any winding up those in
need of protection are the creditors and the minority shareholders. Where it is proposed to wind up a company
voluntarily Section 276 of the Companies Act requires the directors to make a declaration
to the effect that they have made a full inquiry in to the affairs of the
company and having so done have found the company will be able to pay its debts
in full within such period not exceeding one year after the commencement of the
winding up as may be specified in the declaration. Such declaration suffices as a guarantee for
the repayment of the creditors. If the
directors are unable to make the declaration, then the creditors will take
charge or the winding up proceedings in which case they may appoint a
liquidator.
WINDING UP BY THE COURT
Winding up after an order
to that effect by the court is the most common method of winding up companies.
Section 218 of the
Companies Act gives the High Court jurisdiction to wind up any company
registered in Kenya. The circumstances
under which a company may be wound up by a court order are spelt out in Section
219 of the Companies Act.
These cover situations in
which
1.
the company has by special resolution resolved that it be
wound up by court;
2.
Where default is made by the company in delivering to the
registrar the statutory report or on holding the statutory meeting;
3.
When the company does not commence business within one year
of incorporation or suspends its business for more than one year;
4.
Where the number of members is reduced in the case of a
private company below 2 or in the case of a public company below 7;
5.
Where the company is unable to pay its debts;
6.
Where the court is of the opinion that it is just and
equitable to wind up the company;
7.
In the case of a company registered outside Kenya and
carrying on business, the court will order the company to be wound up if
winding up proceedings have been instituted against the company in the country
where it is incorporated or in any other country where it has established
business.
Under Section 221 of the
Companies Act an Application for winding up by an order of the court may be
presented either by a creditor or a contributory. However a contributory cannot make the
application unless his name has appeared on the register of members at least 6
months before the date of the application and in any event he can only petition
where the number of members has fallen below the statutory minimum.
In practice the creditors
will petition for a compulsory winding up where the company is unable to pay
its debts. The company’s inability to
pay its debts under Section 220 is deemed in the following circumstances
1.
If a creditor to whom the company is indebted in a sum
exceeding 1000 shillings demands payment from the company and 3 weeks elapse
before the company has paid that sum or secured it to the reasonable
satisfaction of a creditor;
2.
If execution issued on a judgment against the company is
returned unsatisfied;
3.
If it is proved by any other method that a company is unable
to pay its debts.
Before a creditor can
petition it must be shown as a preliminary issue that he is in fact a creditor
or a company creditor. This is a
condition precedent to petitioning and the insolvency of the company is a
condition precedent to a winding up order.
PETITION BY A CONTRIBUTOR
Section 221 of the
Companies Act speaks not of members but of contributories.
Section 214 defines the
term contributory as follows “every person liable to contribute to the assets
of the company in the event of its being wound up”. The persons falling under this category are
defined in section 213 of the Companies Act and include both present and past
members. A past member however, is not
liable to contribute if he ceased to be a member one year or more before the
commencement of the winding up and he is not liable to contribute for any debt
or liability contracted after he ceased to be a member. Even then he is not liable to contribute
unless it appears to the court that the existing members are unable to satisfy
the contributions required.
The most important
limitation on liability of contributories is found in Section 213 (1) (d) of
the Companies Act. Under that clause no
contribution shall be required from any member exceeding the amount unpaid on their
shares in respect of which he is liable as a present or past member.
The petitioning contributor
must establish that on winding up there will be prima facie a surplus for
distribution among the members i.e. he must establish a tangible interest. If therefore the company’s affairs have been
so managed that there would be no assets available for distribution among the
members then a shareholder has no locus standi and will not be allowed to
petition for winding up.
Another possible limitation
is that stated under Section 22(2) of the Act.
Here the court has a discretion not to grant the winding up order where
it is of the opinion that an alternative remedy is available to the petitioners
and that they are acting unreasonably in seeking to have the company wound up
instead of pursuing that other remedy.
WINDING UP ON JUST AND EQUITABLE GROUNDS
It is now established that
the just and equitable clause in Section 219 of the Act confers upon the court
an independent ground of jurisdiction to make an order for the compulsory
winding up of the company. The courts
have exercised their powers under this clause in the following circumstances:
1.
In order to bring to an end a cause of conduct by the
majority of the members which constitutes operation on the minority;
2.
The courts have also exercised this power where the substratum
of the company has disappeared;
3.
The courts have applied the partnership analogy to the small
private companies particularly those of a kind which makes an analogy with
partnerships appropriate.
In case of domestic private
companies, there is normally an understanding between the members that if not
all of them, then the majority of them will participate in the management of
the company’s affairs. Such members
impose mutual trust and confidence in one another just as in the case of
partnerships.
Also usual in such
companies is the restriction of the transfer of a member’s shares without the
consent of all the other members.
If any of these principles
were violated in a partnership, the courts will readily order the partnership
to be dissolved. In the case of a small
private company, the courts have also held that such companies are run on the
same principles as partnerships and therefore if the company was run on such
principles it is just and equitable to wind it up where a partnership would
have been dissolved in similar circumstances.
RE YENIDGE
TOBACCO CO. LTD [1916] 2 Ch. 426
Here W and R who traded
separately as Tobacco and Cigarette manufacturers agreed to amalgamate their
business. In order to do so, they formed
a private company in which they were the only shareholders and the only directors. Under the Articles, both W and R had equal
voting powers. Differences arose between them resulting in a complete deadlock
in the management of the company. The
issue was whether it was just and equitable to wind up the company. Lord Justice Warrington stated as follows
“It is true
that these two people are carrying on business by means of the machinery of the
limited company but in substance they are partners. The litigation in substance
is an action for dissolution of the partnership and we should be unduly bound
by matters of form if we treated the relations between them as other than that
of partners or the litigation as other than an action brought by one for the
dissolution of the partnership against the other.”
The Model
Retreading Co. [1962] E.A. 57
Here the petitioner who was
a shareholder in a small private company petitioned for winding up mainly on
the ground that this was just and equitable.
The Affidavits sworn by the petitioner and his co-shareholders disclosed
that there had been bitter and unresolved quarrelling between the parties going
to the root of the companies business but none of these stated that the
company’s affairs had reached a deadlock.
It was however conceded by all the parties that as a result of the
quarrelling the petitioner had been prevented from participating in the
management of the company’s affairs.
The issue was it just and
equitable to wind up the company? Sir
Ralph Windham C.J. said as follows:
“in these
circumstances the principle which must be applied is that laid down in Re-Yenidge
Tobacco namely that in the case of a small private company which is in
fact more in the nature of a partnership a winding up on the just and equitable
clause will be ordered in such circumstances as those in which an order for
dissolution of the partnership would be made.
In that case the shareholders were two and they had quarreled
irretrievably. In the present case, if
this were a partnership an order for its dissolution ought to be made at the
instance of one of the quarrelling partners.
The material point is not which party is in the right but the very
existence of the quarrel which has made it impossible for the company to be ran
in the manner in which it was designed to be ran or for the parties disputes to
be resolved in any other way than by winding up.”
Mitha Mohamed V. Mitha
Ibrahim [1967] EA 575
4.
Finally the just and equitable clause will also be applied
where there is justifiable loss of confidence in the manner in which the
company’s affairs are being conducted Continuous Cause of Conduct.
CONSEQUENCES OF A WINDING UP ORDER
Once a company goes into
liquidation, all that remains to be done is to collect the company’s assets,
pay its debts and distribute the balance to the members.
Under Section 224 of the
Companies Act, in a winding up by the Court, any dealing with the company’s
property after the commencement of the winding up is void except with the
permission of the court.
The purpose is to freeze
the corporate business in order to ensure that the company’s assets are not
wasted. Once the company has gone into
liquidation, the directors become functus
officio.
Thereafter a liquidator is
appointed whose duty is to collect the assets, pay the debts and distribute the
surplus if any. In so doing, he must
always have regard to the interests of the creditors.
The powers of the
liquidator are set out in Section 241 of the companies Act.
(1910) 26 LQR 259 in his Article Law Quarterly review
Rama Corp v Proved Tin & General Investment (1952) 2 Q.B. 147
Re South of England Natural Gas Co. (1911) 1 Ch. 573
Selanger United Rubber Estates v. Craddock (1968) 1 All E.R. 567
Brown v. British Abrasive Wheel Co. (1919) 1 Ch. 290
National Provincial & Union Bank V. Charmley [1824] 1 KB 431
Re C.L. Nye [1970] 3 AER 1061
