Ownership and Control in Companies

The Berle-Means thesis was stated in the essay “The Modern Corporation and Private Property”; the thesis is that where the ownership and control in a limited company is separated, the owners depend on the board of directors to represent their interests but over time the supervisory role of the shareholders is diluted and rendered ineffective leaving the directors with the final say. This essay critically evaluates this statement with reference to the means applied by the shareholders to exercise supervisory powers over a board of directors; and the extent to which the statutory duties of the director under Sections 171, 172 and 174 of the Companies Act 2006 aids shareholders in exercising power and control over the board of directors.

There is a separation of ownership and control in companies because although the shareholders are the owners of the company, they leave the management of the company to directors (usually professionally trained executives), which effectively means that the control of the company is with the directors and not the shareholders. Paul Davies notes that in most companies in the UK, the “function of managing the company has become to some degree specialised and separated from that of providing risk capital to the company.” The task of managing the company is legally vested in the board of directors of the company. As management gets centralised, the shareholders may lose control over the company as noted by the Berle-Means thesis.

It is the directors that take many of the decisions for the company. The Berle-Means thesis is correct to an extent when considered how the separation of ownership and control works in most limited companies. However, shareholders do exercise supervisory powers over a board of directors under certain circumstances. First, shareholders have powers to dismiss or replace directors through a simple majority of votes. There is no specific reason that needs to be given by the shareholders for removing directors from their positions; as long as more than 50% of the shareholders vote at a general meeting to remove the director or directors, the decision can be taken.

Shareholders can also alter the Articles of Association, which means that they can authorise actions as well as take away existing powers of the directors. Shareholders retain control over the directors of the company through their power to alter the articles of association. Powers of the board can be expanded or reduced by the shareholders’ resolution. Shareholders’ decisions are made through resolutions of the shareholders. Some of the decisions of the company have to be approved by the shareholders’ meetings for which the directors also have the duty to inform the shareholders of facts and information that is needed for the making of the decision by the shareholders. Directors are under a duty to inform the shareholders about what would be in the interests of the shareholders. The shareholders have the right to expect that the information is fairly presented and is accurate. There are other ways in which shareholders exercise control over the directors. For instance, shareholders can pass a resolution for the winding up of the company.

Shareholders also exercise control over the directors through the disclosure regime, under which the directors are under a duty to disclose certain categories of information to the shareholders. As investors in the company, disclosures to the shareholders are necessitated for ensuring the principle of shareholders’ primacy. Directors are duty bound to disclose all relevant information to the shareholders for the latter to take informed decisions in Shareholders’ meetings. The company is governed indirectly by the shareholders because they decide upon many important decisions as per the majoritarian rule. In Re Chez Nico (Restaurants) Ltd, Browne-Wilkinson VC observed that “in certain special circumstances fiduciary duties, carrying with them a duty of disclosure may arise which place the directors in a fiduciary capacity vis-a-vis the shareholders.” Shareholders can also control the directors of the company through the control over directors’ remuneration through linking it with their performance. Section 420 (1) and (2) of the Companies Act 2006 requires that directors of quoted companies prepare a directors’ remuneration report, which provides a statement of the company’s policies in regard to the remuneration for directors.

Despite the many provisions related to the control of directors by the shareholders, it must be noted that minority shareholders may not be similarly able to exert such control, thus marking a distinction between minority and majority shareholders. However, there are some ways in which minority shareholders can get some remedy against oppressive policies or actions. One of the statutory provisions under which minority shareholders can seek to take back some control from the directors is through take derivative actions against the directors of the company; this is allowed under Companies Act 2006, part 11. Section 260 (1) allows derivative claims where the cause of action is vested in the company, and there is an allegation that the director’s actual or proposed act or omission involves negligence, default, breach of duty or breach of trust. Section 260 (1) differs from the common law derivative action, because common law actions can be taken when the director’s action falls within Foss exceptions, and Section 260 (1) requires the shareholder to take permission from the court to continue with the action. Minority shareholders may still not be able to take action however where the offending action of the director has been ratified by the majority shareholders. Although in such situations, minority shareholders may not be able to control the directors, the point remains that the majority shareholders do control the directors and they have the power to ratify the actions of the directors. In any case, the derivative actions are also related to the general duties of the directors, which provide the basis for cause of action by the company.

The duties of the directors, which are now codified in the Companies Act 2006, also arise from the common law. In Re Chez Nico (Restaurants) Ltd, the court held that the directors may even owe fiduciary duties to individual shareholders in certain circumstances. In the common law, and now under statutory provisions, there are some duties of the directors that can be used by the shareholders to exercise control over the actions and decisions of the directors of the company. For instance, the duty to take care, and exercise skill and diligence, has been used by shareholders to ensure directors’ accountability and responsibility for actions that lead to any loss to the company and the interests of the directors.

Section 171 Companies Act 2006 contains the duty to exercise the powers for the purpose for which it was conferred. These powers and purpose are contained in the Articles of Association. In Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd, if articles allowed delegation of powers to director, then the exercise of these powers is permitted; conversely powers not given under the articles or not exercised for the purpose given are ultra vires. It is noteworthy that under the statute, the test of whether the director has exercised his powers to the purpose for which these were given, is an objective test. This was held by the court in Extrasure Travel Insurances, in which the court held that the court must apply the test under Section 171 to consider four points: the power in question; proper purpose for delegation of power; substantial purpose for exercise of power; and whether the exercise was proper.

A shareholder is the only person in the company who is directly interested in its financial affairs and for that reason, the interest of the shareholders is an important consideration that is ensured through making it incumbent on the directors to have regard to the interests of the shareholders under Section 172 of the Companies Act 2006. Section 172 has been referred to as the ‘enlightened shareholder value provision’ although there is some criticism of this characterisation of Section 172, as pointed out by Keay who argues that the wording of the provision is vague and amorphous. Nevertheless, Section 172 requires that the director must have regard to the long term consequences of any act on the interests of the shareholders. This is due to the wording of Section 172, which provides that director “must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole.”

Indeed, there are other aspects of this provision, in that, the director is required to consider the interests of company employees, and also consider the impact of its operations on the community and the environment. To a great extent, the inclusion of these duties of the directors in Section 172 is to the purpose of ensuring that there is compliance with the Corporate Governance Code. Corporate governance is being developed to ensure that the directors are not able to control the company in a way that dilutes their accountability. Tricker explains this by saying that “if management is about running business; governance is about seeing that it is run properly.” Accountability to shareholders is linked to the fiduciary position of the director vis a vis the company and shareholders; the personal interests of the directors and duties towards the shareholders are not to conflict.

Section 172 is related to corporate governance and directors’ accountability. Shareholders are not the only stakeholders under Section 172, as this provision also mentions employees’ interests and the interests of the environment. Nevertheless, the interest of the shareholder as per the shareholder interest primacy is prioritised under Section 172. This means that the duties of the directors are more focused on shareholders’ interest and may sometimes require the directors to ignore the interests of other stakeholders. Sales J has specifically noted that the shareholders’ primacy is the core consideration for directors, which is not to be subordinated to any other stakeholders’ concern.

Section 174 contains the duty of the directors to exercise care and skill in the performance of their functions and exercise of their powers. The duty to exercise care and skill is relevant under different situations. The director has the duty to exercise care, skill and diligence as per the general knowledge, skill and experience that can be expected from him in his position, else his actions can be held to be negligent. Indeed, the duty is not exercisable only from the perspective of the shareholders’ interests; at times, the duty becomes exercisable for protecting the interests of the creditors as against the shareholders. This is illustrated in Re Loquitor, wherein the directors recommended the payment of dividends without considering the financial health of the company; the court held that this was done in negligence.

A number of independent reports have also considered the issue of directors’ duties and linked it to the interests of the shareholders: Jenkins Committee emphasised on duties of directors; Cadbury Committee was concerned with the responsibility of the directors’ responsibility towards governance; and Hampel Report emphasised directors’ accountability to shareholders.

To conclude, although there is separation between ownership and control in listed companies, which means that for the greater part management is controlled by the directors, there is still control exerted by shareholders over the directors. It would be wrong to say that shareholders in British companies completely lose control over a period of time. Shareholders can remove directors and also alter Articles of Association. Both of these allow them to control the directors of the company. Additionally, directors of the company also have some duties towards the shareholders which means that they can be held to account for breach of these duties. This is another way in which directors’ actions can be made responsible to the interest of the shareholders.

Cases

Bray v Ford [1896] AC 44.

Extrasure Travel Insurances Ltd v Scattergood [2003] 1 BCLC 598.

Foss v Harbottle [1843] 67 ER 189.

Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480.

Goldex Mines Ltd v Revill (1974) 54 DLR (3d) 672.

Johnson v Gorewood & Co [2001] 2 WLR 72

R (on the application of People & Planet) v HM Treasury [2009] EWHC 3020 Admin.

Rackam v Peek Foods Ltd (1990) BCLC 895.

Re Chez Nico (Restaurants) Ltd [1992] BCLC 192.

Re City Equitable Fire Insurance [1925] Ch 407.

Re Loquitor Ltd, IRC v Richmond [2003] 2 BCLC 442.

Books

Berle AA and Means GC, The Modern Corporation and Private Property (2nd edn Harcourt, 1967).

Davies P, Introduction to Company Law (Oxford University Press 2010).

Dignam AJ, Andrew Hicks and SH Goo, Hicks and Goo’s Cases and Materials on Company Law (7th edn, Oxford University Press 2011).

French D, Ryan C & Mayson S, Mayson, French & Ryan on Company Law (Oxford: Oxford University Press 2016).

Kershaw D, Company Law in Context: Text and Materials (2nd edn, Oxford University Press 2012).Tricker B, Corporate Governance: Practices, Procedures, and Powers in British Companies and their Boards of Directors (Gower Publishing 1984).

Journals

Cheffins BR, ‘Does law matter? The separation of ownership and control in the United Kingdom’ (2001) 30 (1) The Journal of Legal Studies 459.

Keay A, ‘Tackling the Issue of the Corporate Objective: An Analysis of the United Kingdom’s “Enlightened Shareholder Value Approach”’ (2007) 29 Sydney L. Rev. 577.

Mance J, ‘Ex Turpi Causa – When Latin Avoids Liability’ (2014) 18(2) Edinburgh L. Rev. 175.

Oraee-Mirzamani N and Makush Z, ‘Corporate Environmental Disclosure Law, Fiduciary Duties, and the Aarhus Convention’ (2011) 18 European Energy and Environmental Law Review 18.

Tomasic R, ‘Company Law Modernisation and Corporate Governance in the UK— Some Recent Issues and Debates’ (2011) 1 Victoria law School Journal 43.

Wooldridge F and Davies L, ‘Derivative claims under UK company law and some related provisions of German law’ (2012) 90 Amicus Curiae 5.

Reports

Cadbury A, Report of the Committee on the Financial Aspects of Corporate Governance (London: Gee & Co. Ltd 1992).

Hampel, Committee on Corporate Governance, Final Report (London 1998).

Jenkins Committee (1962) Cmnd 1749.