Directors Behaving Badly

Q Who has control: directors or shareholders?

AAs a general rule, directors have complete control of their companies. They have the last word and they do not have to get shareholders’ approval in advance of their decisions unless there is a written agreement reserving decisions about certain things to the shareholders. And then they only have to seek approval for those reserved matters.

Q Is there anything that shareholders have to have their say about first?

AThere are a few significant exceptions that apply automatically by law even if there is no agreement about it with shareholders. Directors must seek advance shareholder approval about

• Long-term service contracts

• Substantial property transactions;

• Loans, quasi-loans and credit transactions

• Payments for loss of office.

Long-term service contracts and payments for loss of office are examples of benefits that one director might give to another at the company’s expense in the expectation that they will receive similar benefits from the other directors then or at a later date.

Q Okay, but what is ‘substantial property transaction’?

AA transaction will be a substantial property transaction if it transfers a “non-cash asset” from or to any of the following:

• A director of the company

• A director of its holding company

• A person connected with a director of the company

• A person connected with a director of its holding company.

The consequences of getting this wrong can be severe. Any long-term service contract is void -– that is, the company is not bound by the agreement and, potentially, any payments made might be claimed back. And a substantial property transaction might be set aside with the directors who approved it without authority being personally obliged to indemnify the company for any loss it may have suffered.

AQAre the directors completely safe from any comebacks if shareholders have approved?

It is not enough just to ask for the shareholders’ permission. The shareholders need to have had enough information to make an informed decision. The case of Stubbins Marketing Ltd v Stubbins Food Partnerships Ltd – a case that Longmores were directly involved in –illustrates the point very well.

The shareholders gave written consent to a management buyout and other plans by the directors but the court later found that the shareholders had not given fully informed consent to the transaction. This was because they had not been given an adequate explanation of the details including how the price for all of the assets transferred had been calculated. It ordered the directors who had carried out the transactions to pay back millions of pounds, resulting in some of the directors having to declare personal bankruptcy.

Those directors had also awarded each other service contracts with very substantial payments for loss of office. When the shareholders fired the directors they claimed large sums from the company under their contracts. The shareholders had not been consulted about those contracts. The court set those agreements aside.