Owner Managed Businesses.

Director Shareholder Conflicts.

A recent case in the High Court, featuring a conflict between a shareholders’ agreement and articles of association, analyses the position of parties to a shareholders’ agreement who are also directors of the company and therefore subject to fiduciary and other duties owed to the company.

The case is of general interest because it is not unusual for one person to act in different capacities in connection with the same company: as well as being a director he might be a shareholder or an officer or representative of a shareholder. As shareholder he might advocate one course of action and the opposite course as director, so that in one role or the other he may appear to act purely formalistically.

In the case, however, the court refused to let the same persons do as directors what they had agreed as owners to prevent.

Shareholder & Director Decision-Making

In joint ventures, private equity and other forms of investment shareholders often agree to use their voting powers as shareholders in certain ways – for example, to maintain each other’s appointees in office as directors of the company. Shareholders are normally free to vote in their own interests or to bind themselves contractually to vote in a particular way.

It is very different with director decision-making. Directors of English and Welsh companies are subject to various duties under the Companies Act 2006, including duties to promote the success of the company for the benefit of its members, to exercise reasonable care, skill, and diligence, to exercise independent judgement and to act in accordance with the company’s constitution.

Although a director may owe his seat on the board to the appointing shareholder, the law is clear that he must comply with these duties and put the company first, even if that is disadvantageous to the appointor or more favourable to another shareholder. The appointor cannot legitimately expect the director to agree that he will vote in a particular way if that is not the way he would have voted in good conscience anyway.

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The Facts

The case concerned three individual founders of a Guernsey company, who together owned a Cayman company that held all the voting shares. One of them, the claimant, fell out with the other, who controlled the Cayman company. The shareholders’ agreement represented the compromise between them and provided that the claimant would be appointed by the Cayman company as a director of the Guernsey company at the 2008 annual general meeting, and then re-appointed at successive AGMs. The other founders were parties to the agreement and were also directors.

The Guernsey company’s articles provided that a director’s office would be vacated if all the other directors so resolved. Although this is not unusual, it is not a standard provision, and it was perhaps retained by oversight. After the claimant was re-appointed by the Cayman company at the 2010 AGM the other founders, as directors, joined in a resolution to remove him pursuant to the articles. They said that, as they considered him unsuitable, their fiduciary duty required this; Directors’ duties under Guernsey law are like the general duties under the Companies Act 2006. Despite the agreement, the Cayman company refused to re-appoint the claimant at the 2011 AGM on the grounds that it would be futile, as he would inevitably be removed by the directors.

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Judgment

The court ruled that it was an implied term of the shareholders’ agreement that the other founders were not entitled to vote as directors to remove the claimant under the articles. A contracting party is entitled to assume that the other parties will do nothing voluntarily to render the agreement inoperative.

It was argued on behalf of the other founds that they had not acted voluntarily: they had had no choice but to comply with their fiduciary duties. The judge indeed acknowledged that it would be problematic to uphold an agreement that constrained directors from acting in accordance with their perception of their fiduciary duty.

But there is a principle that, if an obligation can be performed – within the framework of what has been agreed – in alternative ways, one of which is lawful and the other not, performance by the lawful way can be ordered. The other founds could have avoided their fiduciary difficulties by getting the Cayman company to sanction the breach, or to change articles or give a direction to the board not to remove the claimant.

These were the sort of steps that they were obliged to take under a further assurance clause in the agreement, under which the parties agreed to take such actions as might be reasonably required to give effect to the agreement. The court was therefore reached to declare that they must not remove the claimant under the articles and – if they insisted that this put them in breach of duty – they had their choice as to the steps that could be taken to remove the problem.

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Comment

The case highlights the rule of contract law that it is a breach of contract to do something voluntarily that will make performance of the contract impossible or futile. It is this rule that enables contracts to be written sensibly, setting out clear positive obligations without having to specify that this means the party must not do other things that would make the positive obligation pointless.

Here, the individuals contracted as founders, not as directors, but the distinction was artificial. It might be tempting for a shareholder who is also a director of the company to think of himself as having separate identifies according to the particular hat he is wearing. He may think that in this way he can comply to the letter with the shareholders’ agreement but then be free of his contractual obligations when he acts as a director. But that will not be the case unless there is a carve-out to that effect in the agreement.

There are problems where a person binds himself to act in a way that is inconsistent with a fiduciary duty to which he is subject. If the shareholders’ agreement had not contained a further assurance clause under which the parties agreed to take additional steps it might not have been possible for the agreement to work lawfully, and the court might have held the agreement to be unenforceable. On the other hand, perhaps the court would have found that it was an implied term of the agreement that the necessary steps be taken to stop a breach of duty arising.

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