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Shareholders v. Directors
Published online by Cambridge University Press: 12 February 2016
Extract
Two recent English cases bring to the fore the difficulties that controlling shareholders face when they wish to remove incumbent directors. In the case of Bushell v. Faith, the director involved took refuge in an article of association which weighted the voting power of directors for the sole purpose of defeating a removal resolution. Although he held only one third of the outstanding shares, he was able to outvote the controlling shareholders and remain in the saddle. The House of Lords decided that the article in question did not run foul of sec. 184(1) of the 1948 Companies Act, which invalidates articles requiring more than a simple resolution for removal of directors.
The rationale of the Court of Appeal and of the House of Lords was that as long as multiple and restricted voting rights are generally recognized, no different rule can apply to voting rights weighted specifically for blocking a removal resolution. Only Lord Morris of Borth-Y-Gest endorsed the reasoning of Ungoed-Thomas J. at first instance (not reported) who held that the purpose of the article in question was to make a director irremovable and that it was tantamount to a requirement that more than a simple majority be necessary for removal.
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1 [1970] 2 W.L.R. 272, H.L., approving [1969] 2 Ch. 438, C.A.
2 “A company may by ordinary resolution remove a director before the expiration of his period of office not withstanding anything in its articles or in any agreement between it and him”. “Ordinary resolution” is not defined in the Companies Act, but such a resolution is passed by a bare majority of the votes cast, in contrast to special or extraordinary resolutions which need a three-quarters majority. Sec. 184 does not interfere with the contractual rights of the director. Gower, , Modern Company Law (3rd., 1969) 134–36Google Scholar. Removal may be a breach of a service contract. Long-term service contracts are indeed used as defensive measures against removal. Weinberg, , Take Overs and Mergers (3rd ed., 1971) 361–3Google Scholar.
3 Russell L. J. in the Court of Appeal and Lord Reid in the House of Lords stated obiter that voting rights weighted only for defeating an amendment of the articles are also valid; under sec. 10 of the Act a special resolution is required. The other judges did not address themselves to this point. It seems, however, that the principle espoused in Bushell v. Faith, that loading the voting power for a particular resolution is valid, compels this result. The ramifications of Bushell v. Faith are that if the incumbents can succeed in passing two articles, one giving them a veto against their removal and the other safeguarding the first article from any possible amendments (in both cases, by means of Joaded voting rights rather than a merely personal veto), a person who purchases even more than 75% of the shares will have to wait until the term of office of the incumbents expires before he can achieve control. During its term of office, the management has complete control of the company with, perhaps, only nominal ownership, depriving the concept of “shareholders' democracy” of its meaning. This analysis assumes that clauses granting a class vote to a “class” of shareholders to block an amendment to the articles which affects their rights are valid and that directors constitute a class worthy of such a protecting clause. The validity of such protecting clauses had been assumed (e.g., Gower, op. cit., pp. 507–8) until the issue came up recently in Australia. While one case upheld an article conferring a class vote (Crumpton v. Mortine Hall Pty. Ltd. (1965) 82 W.N. (Pt. 1) (N.S.W.) 456, a second did not. (Fischer v. Easthaven Ltd. (1963) 80 W.N. (N.S.W.) 1155). Both cases are discussed in Baxt, , “The Variation of Class Rights” (1968) 41 Aust. L.J. 490.Google Scholar See Prentice, , “Removal of Directors from Office” (1969) 32 Mod. L.R. 693Google Scholar, 696. On the question of blocking amendment of articles, see also Hahlo, , “Restrictions on the Alteration of Articles” (1969) 86 S. Afr. L.J. 349Google Scholar. A voting agreement is another valid device for circumventing sec. 184(1): Stewart v. Schwab (1956) 4 S.A. 791. See Beuthin, , “A Director Firmly in the Saddle” (1969) 86 S. Afr. L.J. 489.Google Scholar
4 [1970] 1 W.L.R. 1167.
5 The story of the takeover, friendly at first and bitterly contested later, made head lines in American and English financial newspapers. The story is summarized in Leasco Data Processing Equipment Corp. v. Maxwell, CCH Fed. Sec. L. Rep. 92, 505 (S.D.N.Y. Sept. 16, 1970). In June 1969, Leasco, an aggressive conglomerate concern, reached an agreement with Maxwell to acquire from him his family interest in Pergamon. Following the agreement, Leasco spent some 22 million dollars to purchase Pergamon stock on the open market. In August 1969, the Leasco-Maxwell courtship turned sour. Leasco charged Maxwell with misleading it as to the financial status of Pergamon and other of Maxwell's companies and also as to the commercial relations between Pergamon and the other companies. Maxwell countercharged Leasco with engaging in a conspiracy to depress Pergamon's market price so as to acquire control of Pergamon at a deflated price. Leasco refused to consummate the June agreement. Trading of the Pergamon stock on the London Stock Exchange was suspended and the Board of Trade instituted an investigation into the affairs of Pergamon. In the battle for control that ensued, Leasco managed to oust the Maxwell management from the English parent corporation but not from the American subsidiary because of the reasons explained in the text. Finally, in November 1970, Leasco called off its bid for Pergamon. Wall Street Journal, Nov. 17, 1970, p. 12, col. 3.
6 Sec. 132 enables shareholders to have an extraordinary general meeting called.
7 The parent could fire neither the directors (being unable to convene a general meeting) nor the president (having on its side only a minority of the directors).
8 The parent argued that Maxwell misused a corporate power (to vote the stock in the subsidiary) to achieve the ulterior purpose of perpetuating his presidency of the subsidiary. It is well settled in England that a misuse of a corporate power to effect a collateral purpose constitutes a breach of fiduciary duty to the corporation. See infra pp. 521–2. Parent contended that the only effective remedy would be to order the ex-director to convene a special meeting of the subsidiary in his capacity as the subsidiary's president.
9 In Pergamon Press Ltd. v. Maxwell [1970] 1 W.L.R. 1167, 1169, the Court observed that in New York the incumbents may stretch their control to upwards of a year from the due date for the next meeting. Examination of the relevant statutory provision, sec. 603 of the N.Y. Business Corporation Law, however, shows that the period is about three and a half months.
10 Sec. 132 of the 1948 Companies Act.
11 Sec. 63 of the Companies Ordinance, 1929 (Drayton, , The Laws of Palestine I, Ch. 22Google Scholar). This Ordinance modelled on the 1929 English Companies Act is still the law in Israel. Three revision committees—the first Zeltner Committee (appointed in 1949 and reporting in 1953), the second Zeltner Committee (appointed in 1962 and reporting in 1965), and the Yadin Committee (appointed in 1962 and reporting in 1963)— and a Companies Draft Bill in 1957 prepared by the Justice Ministry have resulted in very little modification of the law. Only the recommendations of the Yadin Committee led to legislation; the Securities Law, 1968, which implemented only part of the Committee's recommendations, in the form of a separate law.
12 The Act requires the directors to “proceed duly to convene a meeting” within 21 days from the date of request, yet does not fix a deadline for the meeting to be held. The Jenkins Committee recommended a deadline of 28 days from the day on which notice of meeting was sent: Cmnd. 1749, Para. 486(B) (1962). This recommendation, which would ensure that the meeting would be held within 49 days from the day of request, has not yet been implemented.
13 By reduction of their remuneration: sec. 132(5), Companies Act 1948.
14 Sec. 72. The Draft Bill left for determination in a private company's constitution the question of whether an annual general meeting should be held: sec. 166. Sec. 72 was proposed in order to increase the rights of the minority and in light of the fact that an annual meeting is not obligatory in a private company: Explanatory Notes to sec. 72.
15 Sec. 73.
16 The power to call a shareholders' meeting may not always be sufficient for initiating corporate action even if such action needs the shareholders' approval. The corporate statutes leave certain matters to be initiated only by the directors, e.g., a sale of substantially all the assets, MBA (1969 Revised Model Business Corporation Act) sec. 79; voluntary dissolution, MBA sec. 84; and merger, MBA sec. 71. Under the MBA, the shareholders may initiate an amendment of the by-laws if the charter reserves to them the power to amend the by-laws (sec. 27), but they may not initiative an amendment to the charter (sec. 58).
17 A provision like Del. Sec. 228 (a 1969 innovation) that a majority can substitute a resolution obtained by written consent for one passed at a general meeting enables majority insurgents to circumvent this obstacle. See also Hornstein, , “Comparative Company Law: New Perspectives” (1970) 5 Is.L.R. 501–2Google Scholar.
18 The rule that in the absence of a permissive provision (in a statute or in the corporate constitution) directors cannot be removed during their incumbency without cause further perpetuates the board in their collective saddle. If the corporation has a staggered board and it takes more than a simple majority to amend the by-laws, a successful offer for just more than 50% of the shares does not secure control.
19 Sec. 28 of the MBA provides that holders of 10% of voting shares shall have the right to call a special meeting. Accord: Mass. Bus. Corp. Law sec. 34, No. Car. sec. 55–61, & Text. Art. 2.24(c). Other states confer the right only to holders of 20%: Cal. sec. 2202, D.C. Sec. 25, Pa. sec. 501(c). Maryland confers the right upon 25% of the shareholders (sec. 38(c)). Ohio (sec. 1701.40(a)) follows Maryland but allows the corporate constitution to decrease or increase the percentage, provided it does not exceed 50%. Michigan retains the old regime: sec. 450.39 leaves the matter to the by-laws.
20 Sec. 602(c) of the N.Y. Business Corporation Law provides that special meetings “may be called by the board and by such person or persons as may be authorized by the certificate of incorporation or by-laws”. Note that in the Pergamon case once the acquirer succeeded in convening a general meeting of the subsidiary, he would have prevailed. Even if the corporate constitution of the subsidiary did not allow removal without cause, he could have had the general meeting amend the by-laws to include such a provision (such an amendment would be valid under sec. 601, as amended in 1965). Sec. 706(b) states that “if the certificate of incorporation or the by-laws so provide, any or all of the directors may be removed without cause by vote of the shareholders”.
21 [1967] Ch. 254.
22 [1970] Ch. 212, approved in [1970] Ch. 228. See Barak, , “Ratification by the General Meeting” (1970) 5 Is.L.R. 249.CrossRefGoogle Scholar
23 The president of the American subsidiary contended that no unworthy motive was involved in repealing the by-laws, that it was done only as a matter of convenience (the new by-law being common in American corporations) and that the amendments emanated from the company's American lawyers, not from himself. As a practical matter, it is very difficult to prove that an act was motivated by control considerations.
24 (1856) 6 E. & B. This rule allows a third party to assume that all the internal regulation (indoor management) of the corporation regarding exercise of authority by corporate organs have been complied with.
25 Matter of Mansdorf v. Unexcelled, Inc., 28 App. Div. 2d 44, 281 N.Y.S. 2d 173 (1967).
26 In the United States, this is usually done by a statutory provision, e.g., MBA sec. 35. In England and Israel, the statutes are silent, and it is customary for the articles of association to make such provisions: article 80 of Table A to the 1948 English Companies Act. In the three countries, the articles of association may provide for a different allocation of power: MBA sec. 35. This is rarely done in public companies.
27 Automatic Self-Cleansing Filter Syndicate Co. v. Cuninghame [1906] 2 Ch. 34, CA.; Salmon v. Quin & Axtents Ltd. [1909] 1 Ch. 311, C.A., affirmed [1909] A.C. 442, H.L.; Shaw and Sons (Sailford) Ltd. v. Shaw [1935] 2 K.B. 113, CA.; Scott v. Scott [1943] All E.R. 582; Charlestown Boot & Show Co. v. Dunsmore 60 N.H. 85 (1880). This principle has been reinstated lately in the Bamford case, supra n. 22. See generally Slutsky, B., “The Relationship between the Board of Directors and the Shareholders in General Meeting” (1968) 34 B.C.L. Rev. 81.Google Scholar The 1957 Draft Companies Bill of Israel includes a provision empowering a general meeting to instruct the directors to act in a certain way: sec. 108. The section is not a model of clarity. It comes close to contradicting sec. 94 of the Draft which states that the business of the company shall be conducted by the directors. The comment to sec. 108 and the explanation of the chief draftsman. Professor Yadin. at the round table on the draft held in 1958 in Luxemburg, show that the intent was to reverse English case law: see Minutes of the Round Table on the Draft Companies Bill for Israel (Harvard, 1958) pp. 1–6. Professor Yadin indicated that the power of the general meeting to instruct the board would relate to ad hoc decisions and would not extend to dictating future business policy. The Draft also provides that when there are no incumbent directors, the general meeting may elect directors, disregarding the provisions in the corporate constitution regulating election of directors: sec. 98. This section insures that a general meeting which removes directors can elect new ones agreeable to it. The English Act paradoxically does not state that a simple resolution suffices to elect directors, although this is usually the practice: Art. 92, Table A. Gower, op. cit., supra n. 2 at p. 128, n. 17.
28 Lattin, , Corporations (1959) 213–214Google Scholar, emphasizes this point.
29 Ballantine, , Corporations (Rev. ed., 1946), 434Google Scholar, in discussing the principle that, unless a statute or the corporate constitution permits it, directors cannot be removed during incumbency without cause, calls it an “unsound rule” because it impinges upon corporate democracy. The justification for the principle is that directors “unlike ordinary agents, occupy a unique position as top echelon officers of the corporation”. Lattin, loc. cit. It has also been argued that allowing removal of directors is a “double edged sword”. In public corporations, directors usually have effective control over general meetings, and they will utilize the removal power to get rid of nonconformist colleagues: Beuthin, R. C., “A Director Firmly in Saddle” (1969) 86 S. Afr. L.J. 489.Google Scholar
30 Another common provision was that directors could not be removed during office: Bushell v. Faith, [1970] 2 W.L.R. 272, 276, per Lord Upjohn. The practical impact of the two provisions was identical since it took a 3:1 vote to pass an extra ordinary or special resolution and to amend the articles.
31 Cmd. 6659, Para. 124.
32 If written personal notice is sent, the period of the notice is two weeks, if another channel of communication is used, the period is three weeks. See sees. 142 & 133 (2)(b).
33 Sec. 184(3). If the company does not comply, the director has a right to have his circular read at the meeting in addition to his right to address the meeting. It seems to us that the substitution right is useless, since by the time of the meeting, the impeaching faction may very well have obtained sufficient proxies to carry the vote. It is to be hoped that when this matter comes before the courts, they will adjourn the meeting and decree compliance by the company rather than let it redeem itself so cheaply.
34 This is so because sec. 184(2) and (3) refer only to removal resolutions thereunder. Gower, op, cit., supra n. 2 at p. 134, n. 59 Sec. 184(6) specifically preserves more far-reaching removal powers under the corporate constitutions.
35 Gollier, J. G., “Note on Bushell v. Faith” (1970) 28 Cam. L.J. 41Google Scholar, 42. See also comment by Baker, P. V. (1970) 86 L.Q.R. 155.Google Scholar
36 Sec. 99 of the Draft. See supra, n. 27. As in England, neither the corporate constitution nor a contract may restrict the right to remove by simple resolution. If a contract of service is broken, the dismissed director would be entitled to compensation. The drafters indicate that the provision follows the English innovation as well as the laws of other countries such as Sweden and Switzerland. For a description of the law in other European countries, see Cary, , Cases and Materials on Corporations (abridged 4th ed. 1970), p. 129Google Scholar, n. 19.
37 In re Koch, 257 N.Y. 318, 178 N.E. 545; Abberger v. Kulp, 156 Misc. 210, 281 N.Y.S. 373; Matter of Auer v. Dressel, 306 N.Y. 427, 118 N.E. 2d 590 (Ct. of App. N.Y. 1954); Campbell v. Loew's Inc., 134 A 2d 852 (Ch. Del. 1957).
38 See the references in Cary, op. cit. supra n. 36 at 128, n. 7.
39 Sec. 36A.
40 Cal. Sec. 810; No. Car. Sec. 55–27 (f). The provisions prevent circumvention of cumulative voting. If there is cumulative voting, a removal resolution against which sufficient votes to elect the director were cast is invalid. Cumulative voting is “nonexistent in England”. Gower, , “Some Contrasts Between British and American Corporation Law” (1956) 69 Harv. L.R. 1369CrossRefGoogle Scholar, 1390.
41 E.g., N.Y. sec. 706(b).
42 Gower, op. cit., supra n. 40 at 1389.
43 Essex Universal Corporation v. Yates, 305 F. 2d 572 (2d Cir. 1962); In re Caplans' Petition, 20 A.D. 2d 301, 246 N.Y.S. 2d 913 (1964), aff'd. 14 N.Y. 2d 679, 249 N.Y.S. 2d 877 (1964). Sec. 14(f) of the 1968 “Williams Bill” amendment to the Securities Exchange Act, 1934 modifies the common law. If a friendly takeover bid or a private purchase transfers more than 10% (5% since 1970) of the shares of almost any public company, a circular akin to a proxy statement must be sent to shareholders when a majority of the board is replaced through seriatim resignation. This is so even if the acquirer purchased effective control. 15 U.S.C.A. sec. 78n(f) (Supp. 1968). See generally D. L. Ratner, “Section 14(f): A New Approach to Transfers of Corporate Control” (1969) Corporate Counsels' Annual 228–235.
44 Bradshaw, D. S., “Defensive Tactics Employed by Incumbent Managements in Contesting Tender Offers” (1956) 21 Stan. L.R. 1104CrossRefGoogle Scholar; Weinberg, op. cit., supra n. 2 at pp. 342–71.