·       The four principal business structures under the Companies Act 2015 are: the sole proprietorship; the partnership; the limited liability partnership; and the company

·       Sole proprietorships are the most common business structure and involve little formality, but the liability of a sole proprietor is personaland unlimited

·       Where two or more persons wish to conduct business together, they may form apartnership. Such partnerships are subject to greater regulation than sole proprietorships, but less regulation than limited liability partnerships and companies. The liability of the partners is personaland unlimited

·       Limited liability partnerships (LLP’s)were created largelyto be a suitable businessvehicle for largeprofessional firms, and in many respects, they closely resemble companies

·       Public companies are so called because they can offer to sell their shares to the public at large, while private companies cannotoffer to sell their shares to the public at large. Thereare also other notable differences between public and private companies

·       Both LLP’s and companies are created via a process called incorporation, and are thus known as incorporated business structures or ‘bodies corporate’ – the other two business structures (sole proprietorships and ordinary partnerships) are not created via incorporation and so areknown as unincorporated business structures

·       A person wishing to engage in some form of business activity will need to do so via one of the business structures identified above, with each providing different advantages and disadvantages



·       The simplest and most popular business structure is the sole proprietorship, and a sole proprietor is simply a single natural person carryingon some form of businessactivity on his own account

·       Whilst a sole proprietorwill be carried on by an individualfor that individual’s benefit, sole proprietorships can take on

employees (althoughthe vast majoritydo not)

·       The key points are: the sole proprietorship is not incorporated, and the sole proprietor does not carry on businessin partnership with anyone else

·       Sole proprietorships will come in two forms:

(i)            Sole practitioners this is where the sole proprietor is a professional, e.g. an accountant, an advocate, etc.

(ii)            Sole trader this is where the sole proprietor is not a professional

·       There is no separation between a sole proprietor and his business, and the sole proprietorships do not have corporate personality. Accordingly, the sole proprietor owns all of the assets of the business and is entitled to all the profit that the business generates



·       Commencing a business as a sole proprietor is extremely straightforward and involved much less formalitythan creating an LLP or a company

·       All that an individual needs to do in order to commence business as a sole proprietor is to registerhimself with the Registrar

·       Requirements for registering as a Sole Proprietor in Kenya are:

(i)            Unique business name your business has to be unique and not an imitation of another business name;

(ii)            Nature and businessor company must be stated clearly (and specifically)

(iii)            Having a specificphysical and postaladdress, and contactinformation of the sole proprietor

(iv)            Names of the business owner and all other partners involved in the business, as well as other details such as: nationality, age, gender, location of residence, copy of identification documents, additional business occupation passport photos, copies of KRA PIN Certificates and signed B2N Forms


2.2        FINANCE

·       In terms of raisingfinance, sole proprietorships are at a disadvantage when compared to other businessstructures

·       E.g. partnerships can raise finance by admitting new partners and companies can raise financeby selling shares,however, neither of these optionsis available to a sole proprietor (who wishes to remain as such)

·       To raise finance, sole proprietors must either invest their own money into the business (and risk losing it should the business fail) or obtain a loan

·       However, given that many sole proprietorships are small affairs, banks are ordinarily cautious when lending money and obtaining large amounts of debtcapital or usually impossible


2.3        LIABILITY

·       The principledisadvantage of carrying on business as a sole proprietor is that the liability of the sole proprietorship is

personal and unlimited

·       Whereas partnerships and companies can be limited, it is impossible to create a limited sole proprietorship. Accordingly, the sole proprietor’s assets (including personal assets such as his house, car and bank accounts) can be seized and sold in order to satisfy the debts and liabilities of the sole proprietorship

·       If the sole proprietorship’s debts and liabilities exceed the assets,then the sole proprietor will likely be declared bankrupt


3.       COMPANY

·       Section 3(1) Companies Act 2015 (‘CA 2015’) defines a company as ‘a company formed and registered under this Act or an existing company’

·       Aregistered company is a legal, juristicperson, capable of owning land and other property, and entitled to enter into contracts, sue and be sued, have a bank account in its own name, owe money and be a creditor to others

·       Aregistered company is liable for torts and crimes committedby its servants and agents of the company, and is distinct and separate from its foundersand members

·       In legal theory, a company denotes an association of persons for some common object or objects, who contribute money

or money’sworth into a common stock and who employ it for some common purpose

·       There are three fundamental legal concepts pertinent to companies:

o   The concept of legal personality (i.e. corporate personality);

o   The capacity to create legal binding relations; and

o   The concept of limited liability




·       Legal personality means that the law recognises certainpersons as having certain legal rights and duties which can be enforced through the courts. Apart from human beings,the law also affords this legal personality to corporations

·       A corporation is an artificial person created by law, and once it comes into being it is treated by law as a person in its own right, and is independent from the individual memberswho compose it

·       Corporate personality thus encompasses the capacity of a corporation to have a name of its own, to sue and be sued, to have the right to purchase/sell/lease/mortgage its property in its own name, etc.

·       In addition, property cannot be taken away from a corporation withoutthe due process of the law



·       The validity of a business transaction rests almost entirely on the status of the parties and on their legal capacity to crea tea relationship attended to by legal consequences

·       Accordingly, to attract legal intervention in any case, recognition as a body corporate is vital i.e. to engage in any legal

process as a party to a transaction depends on one’s status and recognition as a legalperson

·       Therefore, legal personality is a fundamental ingredient of capacity,without which a person cannot enter into a binding contract

·       Institutions that enjoy corporate personality, separate from the memberswho formed it, are:

o   Companies registered under the Companies Act (i.e. incorporated entities/corporations)

o   Statutory corporations established by Acts of Parliament

o   Chartered companies

·       Onthe other hand, there are institutions that do not have legal personality and do not attract recognition as legal entitiesdue to the fact that they advanceinterests of a social rather than commercial nature, e.g. societies, guilds,NGOs, etc.

·       Due to the fact that these institutions lack the status of a body corporate, they cannot be liable for contractual debts and obligations incurredby officers on their behalf, whetheror not they purport to act for and on behalf of the members

·       Liability vests in actual officers who act on behalf of members or who have been given express authority by members to carry out certainacts, e.g. in the case of societies: they are an unincorporated association (though registered and regulated by statute), and so do not enjoy recognition as legal entities and are not conferred with corporate personality. Thus, they may transact business in their own name, but the members are jointly and severally liable to account for the society’s debts and obligations without any limitation



·       Liability is the extent to which a person can be made to account by law i.e. he can be made accountable either for the full amountof his debts or else pay towards that debt only to a certainlimit and not beyond it

·       In the context of company law, liability may be limitedeither by shares or by guarantee:

o   Section 6(2) CA 2015: in a company limited by shares, the liability of the members of the company is taken to be limited to anyamount unpaid on the shares held by that member

o   Section 7(1)(b)CA 2015: in a companylimited by guarantee, the liability of the membersis limited to the amountthat they undertake, within the articlesof association, to contribute to the companyin the event of its liquidation

·       Note: nearly all statutory rules embodied in CA 2015 are for the protection of the company’screditors and investors(who

are ordinarily the members)


3.2                     INCORPORATION OF A COMPANY

·       Sole proprietorships and ordinarypartnerships can be brought into existence very easily and with minimalstate involvement

·       Conversely, companies (and LLPs) are brought into existence at the discretion of the state via a formal process known as ‘incorporation’ à the word ‘incorporation’ is used because successful incorporation brings into existence a ‘corporation’ (Section 18, 19CA 2015)

·       There are three principal methods by whicha company can be incorporated:

o   Incorporation by an Act of Parliament;

o   Incorporation by an Executive Order;or

o   Incorporation by registration

·       The provisions of the CA 2015 generally applyonly to companiesincorporated by registration (known as registered companies), although they canbe extended to cover unregistered companies (i.e. state corporations)

·       The vast majority of companies in Kenya, however,are registered



·       Parliament can create a company by passing an Act of Parliament

·       E.g. the Kenya RailwayCorporation Act (Cap. 397) gave rise to the Kenya Railway Corporation



·       A companycan be created by an Executive Order (Section 3 of the State Corporations Act)

·       E.g. in March 2013, the LAPSSETCorridor Development Authority (LCDA) was established through the Presidential Order Kenya GazetteSupplement No. 52, Legal Notice N. 58, The LAPPSETCorridor Development Authority Order 2013

·       This was established to coordinate, plan and manage the implementation of the Lamu Port South Sudan EthiopiaTransport Corridor



·       There are three generally recognised corporate personalities: companies, chartered corporations and statutory companies

·       Although they all have corporate personalities, the procedure in forming them varies

·       The procedurein incorporation of a companyis generally as follows:

(i)       Determine whether you are incorporating a public or a privatecompany

(ii)     Determine whether you will be incorporating a limited or unlimited company

(iii)    If your companyis limited, determine whether your companywill be limitedby shares or by guarantee

(iv)    Choose a name for your company

§  The chosenname must be reserved at the company’s registry

§  This involves writing to the Registrar of Companies asking that a search be run on the name to confirm that a company with the same name does not already exist, and if so, asking that the name be reserved for use as a company name

§  The Registrar checks if the name sought is desirable, and once this is confirmed, the reservation remainsin force for a period of 30 days

§  This period can be extended for a further 30 days, during which time no other company may be registered in that name

(v)     Develop the Memorandum and Articles of Association

§  The MEMARTSare the foundingdocument and providethe basis for the whole corporate structure

§  This is the documentin which the promoters expressinter alia their desire to be formed into a company with a specific name and objects

§  The MEMARTS are the primary document which set up the company constitution and its objects as the founding document, it determines the natureand scope of the company

§  The Articles play a subordinate role to the Memorandum they contain the rules and regulations b which the company’s internal affairs are governed, e.g. how shares and share capital are to be allotted, how companymeetings are to be conducted, how directors are appointed, etc.    PREPARATION OF THE MEMARTS

·       Before preparingthe MEMARTS, the draftsman will need to obtain the following information from the promoters:

(i)       The nature of the business

(ii)     The amount of the nominalcapital and the denomination of the sharesinto which it is to be divided

§  These detailswill need to be statedin the MEMARTS

§  For the articles, the drafter will also requireto know if the shares are all to be of one class, and if not, what special rights are to be attached to each class

(iii)    Any other special requirements which deviate from the normal,as exemplified by the appropriate table

·       The MEMARTSshould be printedin the English language and should providefor the following:

o   The name of the company with ‘limited’ as the last word of the name

o   The registered officeof the company (to be situated in Kenya)

o   The objects of the company

o   The liability of the membersof the company (i.e. unlimited)

o   The share capitalof the company and how the same is divided up)

·       Moreover, the memorandum should be dated and signed by each subscriber. Opposite the signatures of the subscribers, the memorandum should state the subscribers’ full name, his occupation, full address and for furtherclarity it is important to indicate their national identity numbersand PIN numbers

·       The signatures must be witnessed by at least one witness who should state his occupation and postal address à witnessing is best done by an advocate    EFFECT OF THE MEMARTS

·       The MEMARTSform a contract which is binding on members of the company

·       Action to enforce this contract must be broughtin the name of the company, exceptwhere a personalright is infringed

·       The MEMARTS bind the company and each of the members as if they had been signed and sealed by each member and containedcovenants for the part of each member to observe all theirprovisions

·       Hickman v Kent [1950]: the MEMARTS provided that any suit 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 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. JusticeAshbury had the following to say à The law is clear and could be reduced to 3 propositions:

(i)       No Article can constitute a contract betweenthe company and a thirdparty;

(ii)     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, a solicitor, promoteror director) can be enforcedagainst the company

(iii)    Articles regulating the right and obligation of the membersgenerally as such do not create rights and obligations between members and the company




Eley v Positive Government Security Life Assurance Company [1876]

The claimant solicitor drafted the defendant company’s articles, which were duly registered. The articles provided that the claimant would act as the company’s solicitor and could not be removed unless he engaged in some form of misconduct. Soon thereafter, the company ceased to employ the claimant and engaged another firm of solicitors. The claimant held that the company had breached the terms of the articles.

The claimant’s action failed. The company might very well have breached the

articles, but as the claimant was not party to the statutory contract, he could not sue for such a breach




·       The primary advantage, from which many other advantages flow, is that the companyacquires corporate (or separate, or legal) personality à This means that the company is regarded by the law as a person

·       Whereas humans are classified as natural persons, the company is a legal person and can therefore do many things that humans can



·       Since a corporation is a separate person from its members, the members are not liable for its debts – in the absence of 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 shares, whereas in a company limited by shares, the members’ liability is limited to theamount they guaranteed to pay

·       Thus, a corporation is a legal entity, distinct from its members,capable of enjoyingrights and being subject to duties which are not the same asthose enjoyed or borne by the members

·       Limited liability is a powerful incentive to incorporate, but may not provide substantial benefit to smaller companies in practice, e.g. banks will often require that the directors/members of small companies sign personal guarantees, thereby ensuring that they become personally liable should the companydefault on the loan

·       Further, limited liability companies pay for limitedliability in the form of increased regulation, e.g. disclosure requirements

·       Salomon v Salomon [1987] AC 22: The House of Lords held that there is a complete separation of a company and its members, i.e. ‘either the limited company was a limited entity or it was not. If it was, the business belongedto it and not to Salomon. If it was not, there was no person and nothing at all and it is impossible to say at the same time that there is the company and there is not’. The significance of the case is threefold:

(i)            The decision established the legality of the so-calledone-man company;

(ii)            The decision showed that incorporation was as readily available to small private partnerships and sole traders as to the large private company; and

(iii)            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

·       It is noteworthy that while limited liability minimises the risk faced by members and so encourages investment in companies, it weakens the position of the company’s creditors who cannot access the personal assets of the members to offsetany debts of the company.It is therefore argued that limited liability does not so much minimisethe members’ risk, but instead shifts it from them to the company’s creditors



·       As the company is a person, it can enter into contracts with both personsinside and outsidethe company

·       Lee v Lee’s Air Farming Limited [1961] A.C. 12: 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 involvedin 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 relationsand the widow wastherefore entitled to compensation”



·       Corporate personality enables the propertyof the association to be distinguishable from that of the members

·       The property of the incorporated entity must be dealt with according to the rules (i.e. memorandum and articles of association) and no individualmember can claim any particular asset within that pool of property



·       As a legal person, a company can take action in its own name to enforce its legal rights. Conversely, it may be sued for breach of its legal duties (the only restriction being that it must be represented by a lawyer in allthese actions)

·       East Africa Roofing Company v Pandit [1954] 27 KLR 96: the court held that a corporation such as a limited liabilitycompany cannotappear in person as a legal entity without any visible personand having no pshysical existenceit cannot at common law appear by its agent but only by its lawyer (the CA 2015 has not changed this common law rule so as to enable a limited company to appear in court by anyof its officers)



·       A company 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 a natural body

·       Even though the company’s membersmay change over the years,the company continues in existence



·       Section 326 CA 2015: ‘the shares or any other interests of a memberin a company shall be moveable propertytransferable in the manner providedby the Articles of Association’

·       Therefore, shares in a company are transferable and upon a transfer being effected, the assignee steps into the shoes of the assignoras a member of the company with the full attendant rights thereto

·       Note: this transferability does not relate to private companies, which companies often have their own rules regarding transfer and sale of shares (containedin the memorandum and articles of association ‘MEMARTS’)



·       In practice, companies can raise capital by borrowing much more easilythan the sole trader or partnership

·       This borrowing is enabled by the device of the ‘floating charge’ – it is a charge that ‘floats’ over the assets of a company, from time to time with a certaindescription, but withoutpreventing the companyfrom using those assets or disposing off those assets in the ordinary course of its business, until an event which causesthe charge to become crystallised or fixed

·       This is facilitated by the Chattels Transfers Act which exempts companies from compiling an inventory on the particulars of such charges




·       Companies are subject to significantly more formality and regulation than unincorporated businesses

·       Setting up a companyis a more complextask than settingup a sole proprietorship or an ordinarypartnership

·       The increasedformality and regulation extend beyond formation, and complex rulescan apply throughout the company’s

existence (e.g. the rules relatingto the calling and runningof general meetings)

·       Directors are also subjectto a raft of statutory duties that sole proprietors and partners are not subjectto

·       Incorporation also results in a loss of privacyas most companies are required to make certain information (e.g. financial accounts)publicly available throughout their existence



·       If a company has been wronged, it can commence legal proceedings to redressthat wrong. Similarly, if a companycommits a civil wring, it can be sued and made liable to pay compensation

·       In many cases, imposing liability upon the company for civil wrongs of its directors/employees poses no problem, as the company can be made liable via the doctrine of vicarious liability (in the case of tortious liability) or via the law of agen cy (in relation to contractual liability)

·       However, the issue is often more complex as certain civil wrongs require defendants to have a certain level of knowledge that the company, as an entity, will lack for obvious reasons

·       The law’s answer is to use the ‘identification theory’ which states that knowledge of certain persons will be attributed to a company.However, the courts will only attribute to the company the knowledge of persons who constitute the ‘directing willand mind’ of the company (Lennard’s Carrying Companylimited v AsiaticPetroleum Company Limited[1915])

·       In many cases, this will be limited to the directors and senior officers of the company, and to persons in management to whom the directors have delegated managerial functions (Tesco Supermarkets Limitedv Nattrass [1972])



·       Just as a company can be found liable for committing a civil wrong, so too can it be found guilty of committing a crime

·       However, in the case of R v ICR Haulage Limited[1944] it was held that a companycannot be imprisoned, i.e. it cannotbe found guilty of any crime for which the only punishment is imprisonment (e.g. murder)

·       Where the crime is one that requires mens rea, the courts will utilise the identification theory and attributemens rea to those who are the directing will and mind of the company

·       Corporate manslaughter is a relaxation of this rule i.e. courts would only impose liability on the company if the death was the result of the actions and gross negligence of an identifiable member of the directing mind and will of the company



·       The CA 2015 provides for a number of different forms of company,classifiable by reference to certain characteristics:

o   Is the company public or private?

o   Is the liability of the company’smembers to be limited or unlimited? If liabilityis to be unlimited, then the companymust be private.The law does not allow for creation of unlimited public companies (CA 2015, S. 5 & 8)

o   Does the company have share capital or not? Public companies must have a share capital,but private companies

need not. A limited company that does not have a share capital will be a company ‘limitedby guarantee’ (CA 2015,

S. 6 & 7)

·       When creating a company,the promoters are required to state whetherthe company is to be registered as a private company or asa public company

o   Section 10 CA 2015: A publiccompany is a company limitedby shares, or limited by guarantee and having a share capital,whose certificate of incorporation states that it is a public company

o   Section 9 CA 2015: A private company is a company whose MEMARTS restrict a member’srights to transfershares, limit the number of members to 50, and prohibit invitations to the public to subscribe for shares; it is not a company limitedby guarantee; and, its certificate of incorporation states that is it a private company




May offer to sell its shares to the public at large, and to facilitate this end, may list its shares on a stock market. Such companies are known as ‘listed companies’ or

‘quoted companies’

Are not permitted to sell their shares to the public at large, nor can they list their shares on a stock exchange (CA 2015, S. 11)

Required to have an allotted share capital of at least Kshs.

6, 750, 000 (‘minimum authorised capital requirement’

under CA 2015, S. 518)

Can be created with a trivial amount of capital

Can be created with only one member, but must have at

least two directors (CA 2015, S. 128)

Can be created with only one member, and can be formed

with only one director

Required to appoint a Company Secretary

Only required to appoint a Company Secretary if the paid-

up capital is more than Kshs. 5, 000, 000 (but may also do so if they otherwise wish) (CA 2015, S. 243 – 244)

Must add the suffix ‘Plc’ to their name (CA 2015, S. 53)

Must add the suffix ‘Ltd’ to their name (CA 2015, S. 54)


·       The terms‘limited’ and ‘unlimited’ do not refer to the company itself,but to the liability of its members

·       It is not clear whether the liability of a public company must be limited (as is the case in the United Kingdom), however, when the promoters decide to form a private company, they will need to decide whether the liability of the company’s members will be limited or unlimited

·       Limited liability:

o   The vast majorityof companies are limited liability companies as comparedto unlimited companies

o   Where the liability of a company is limited, the form and extent of the limitation will depend upon whether their liability is limited by guarantee or limited by shares

o   Where a company is limited by guarantee, the liability of the members is limited to the amount stated in the statement of guarantee (Insolvency Act 2015, Section 385(3))

o   Where a company is limited by shares, the liability of the company’s members will usually be limited to the amount that is unpaid on their shares (Insolvency Act 2015, Section 385(2)(d)) à members who have fully paid for their shares are generally not liable to contribute any more to the company

·       Unlimited liability:

o   In the UnitedKingdom, for example,only 0.1% of all companies are unlimited

o   The reason why there are so few unlimited companies is because upon winding up, the liability of the members is personal and unlimited, and so their personal assets (e.g. house, car, bank accounts, etc.) can be seized and sold to satisfy the company’s debts

o   The primary reason a company would choose unlimited liability is that such companies are subject to less regulation than limited companies, and so theiraffairs can be conducted with less formality and more privacy

o   It is unlikely that the promoters will wish to form an unlimited company if the company is intended to trade, howeverif the company is merely for holding land or other investments, the absence of limited liability would not matter



·       Persons who wish to create a company may need to undertake various activities in order for the company to be able to commence business (e.g. preparing incorporation documents, hiring or buying business premises, obtaining supplies or operating capital, etc.)

·       Such persons,who usually go on to become the company’s first directors, are known as ‘promoters’ of the company and

their activities are closely regulated by the law

·       Notably, these promoters owe fiduciary and statutory duties to the unformed company notably, e.g. a promoter cannot make a secret profit out of the company’spromotion. In addition, a promoter will usually be personally liable on a contract enteredinto on behalf of a company if that companyhas not been incorporated at the time the contractwas entered into



·       The law has not sought to define preciselywhat a promoter is, as if it did, personswould try take themselves out of the definition in order to avoid regulation

·       However, lack of a definition is problematic, as determining whethera person is a promoteris crucial for several reasons:

o   Promoters owe fiduciary duties to the unformed company;

o   Promoters can be held liablefor acts in engaged in on behalf of the unformed company; and

o   While the word ‘promoter’ only appears once in the CA 2015, the common law imposesa number of obligations

on company promoters (especially those of public companies)

·       Accordingly, the court in Whaley Bridge Calico Printing Co. v Green [1880] described a promoter: ‘the term promoter is a term not of law, but of business, usefully summing up in a single word a number of business operations familiar to the commercial world,by which a company is generally broughtinto existence’

·       Accordingly, the word promoter refers to those persons involved in the formation of the company, but based upon the particular facts of each case

·       However, not all persons involved in the formation of a company will be categorised as promoters, e.g. those involved by virtue of their professional duties (such as advocates or accountants) will not be regarded as promoters (Re Great Wheal PolgoothCo. Limited [1883])


·       A promoter occupies a dominant position in relation to the unformed company and, to prevent that position being abused, the promoter will owe the unformed companya number of duties

·       Two board categories of duties can be identified: fiduciary duties and duties imposedby statute


(i)             Fiduciary duties

·       A promoteroccupies a fiduciaryposition in relationto the unformed company

·       Accordingly, the promoter is not permitted to make a profit out of the company’s promotion, unless the nature of the promoter’s interest and the profit made by the promoter is disclosed

o   Should the promoter fail to disclose the profit, the transaction in question will be voidable and can be rescinded by the companyà Erlanger v new Sombrero Phosphate Co. [1978]: in this case,the promoters of a companysold 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 had breachedtheir duties and that they should have disclosed this fact to the company’sboard of directors. 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 rescission of any contract with the promoter, or, recovery of any profitsfrom the promoter

o   If rescission fails to recover the value of the profit,or if the right to rescind is lost, then the promotercan be made to accountto the company for the value of the profit(Emma Silver Mining Co. v Grant [1897])

·       For example: if, upon incorporation, a promoter sells to the newly formed company an asset that he acquired during the company’s promotion, he will not be permittedto keep the proceeds of sale, unlesshe discloses the nature of the interestand the extent of the profit made. However, disclosure will only be valid if the persons to whom it is made are independent (Erlanger v new Sombrero Phosphate Co. [1978])


(ii)            Duties imposed by statute

·        In addition to the commonlaw fiduciary duty, promoters are also subjectto statutory duties

·       E.g. CA 2015, Section373 states that a non-cashasset cannot be sold to a publiccompany by a person who is a subscriber to the company’s memorandum, unless the non-cash asset has been independently valued and the members have approvedthe same (2-year initial period)



·       Prior to incorporation being completed, the promoters of the unformedcompany will likelyneed to enter into contractual

agreements with third parties in order to cater for the company’s future needs

·       E.g. the promoters may need to contract with creditors to obtain capital, or they may need to contract for supplies or office premises, or take on employees

·       A companydoes not have the capacityto enter into such contracts until it is fully incorporated

·       The validity of these contracts has been (through case law) based on determining the intent of the parties as revealed in the contract a process which provednotoriously difficult and which resultedin a significant confusion in the law (as well as a perception that cases in this area could turn based on complex and technicaldistinctions) – see: Phonogram Ltd v Lane

·       This confusion is shown by contrasting the two followingcases:

o   Kelner v Baxter [1866]: the promoter signed the contract ‘on behalf of’ the unformed company, and it was held that a binding contractexisted between the promoter and thethird party

o   Newborne v Sensolid (Great Britain) ltd [1954]: the promoter signed the contract using the company’s name and added his own signature underneath. It was held that the contractwas between the promoter and the unformedcompany, and, as the company had no legal capacity, no contract existed

·       Under statute, the generalposition is that if, beforea company has acquired legalpersonality, action has been carriedout in its name, and the company does not assume the obligations arising from such an action, the persons who acted shall – without limited– be jointly and severally liabletherefore (unless otherwiseagreed)

·       CA 2015, Section 44: ‘a contract that purports to be made by or on behalf of a company at a time when the company has not been formed has effect, subject to any agreement to the contrary, as a contract made with the person purporting to act for the company or as an agent for it, and the person is personally liable on the contract accordingly’

o   The basic effectof this sectionis to render a promoterpersonally liable for the pe-incorporation contract

o   This clearly benefits third parties who contract with the promoter, as they will be able to sue the promoter should the termsof the pre-incorporation contract be breached

o   However, the section does notindicate whether or not the third party can be liable to the promoterin the event of the third party failing to honour the contract

o   Braymist Ltd v Wise finance Co Ltd [2002]: it was held that a promoter could sue a third party, but the fact that judicial clarification was required demonstrates a flaw in drafting of the section

·       The courts have clearly stated that a company, once incorporated, cannot ratify or adopt a pre-incorporation contract made on its behalf (Re Northumberland Avenue Hotel Co [1886]) à The only way that a company can take advantage of apre-incorporation contract is for the promoter and third party to discharge the pre-incorporation contract and the company then to enter into a new contract with the third party in respect of the same subject matter (Howard v Patent Ivory Manufacturing Co (1888)).This process of substituting one contract with another is known as ‘novation’



·       The imposition of liability under Section 44 is ‘subject to any agreement to the contrary’, which means that a promoter can avoid liabilityif he can show that he and the other party to the contractagreed that, upon incorporation, the promoter would be released from liability and the company would enter into a second contract with the other party on the same terms as the first contract(i.e. an agreement to novate the contract was present)

·       The agreement can be express or implied, but the courts will require clear evidence that such an agreement exists ( Bagot PneumaticTyre Co v Clipper Pneumatic Tyre Co [1902])

·       In the absence of an express agreement, this will likely be difficult for a promoter to prove. Simply acting as a promoter or agent of an unformed company will not be enough to infer the existence of a contrary agreement (Phonogram Ltd v Lane [1982])



·       Upon incorporation, the company becomesa person in its own right and can do many thingsthat a natural person can do

·       Corporate personality was available to unregistered companies, but with the passing of the Joint Stock Companies Act 1844 and the abilityto incorporate a company by registration, corporatepersonality took on a new found importance

·       However, it was not until Salomon v Salomon [1897] that courts appreciated the true significance of corporate personality

o   It recognised that a companycould legitimately be set up to shield its membersand directors from liability;

o   It implicitly recognised the validity of the ‘one-man company’(i.e. a company run by one person,with a number

of dormant nomineemembers) nearly a century beforesingle-person companies could be formallycreated; and

o   The fact that a person holds shares (even all the shares) is not enoughto create a relationship of agency or trusteeship

·       There is no doubt that Salomon is the cornerstone upon which company law is based. However,the ability to set up a company to shield oneself from liability is clearly open to abuse

·       Therefore, both Parliament and the courts have the ability to ignore a court’s corporatepersonality and impose liability upon those behind the company’s corporate personality

·       This is known as ‘piercing’ or ‘lifting’ the ‘corporate veil’ referring to the ‘corporate veil’ that hides the company’s

members and directors from liability


1.       STATUTE

·       Ascompanies are grantedcorporate personality by statute, it follows that statute can set aside corporate personality and impose liability on those behind the veil


SECTION 519, CA 2015

No trading certificate: if a public company carries on business, or exercises any borrowing

powers, prior to being issued with a trading certificate, then the directors can be made personally liable

SECTION     505,                   632,


Fraudulent trading: where, in the course of winding up, it appears that the company has been run with an intent to defraud the creditors (known as fraudulent trading), the court may lift the

veil and impose personal liability on any persons who were knowing parties to such conduct

SECTION                               506,


Wrongful trading: where a company has gone into insolvent liquidation, the directors may be

personally liable if they continued trading when they knew, or ought to have known, that there was no reasonable prospect of the company avoiding liquidation


2.       COMMON LAW

·       Ascorporate personality is bestowed by statute, it follows that the courtsare reluctant to pierce the veil, as case of Adams v Cape Industries Plc [1990] demonstrates:

o   FACTS:The defendant parent company (Cape) was based in England. A subsidiary of Cape was based in South Africa, where it mined asbestos. The asbestos was sold by other subsidiaries, one of which was based in Illinois, USA. The asbestos was sold to a factory in Texas and a number of the factory’s employees developed asbestos- relates medical conditions. A US court ordered that $15 million be paid in damages, but this could only be enforced against Cape in the UK if the claimants could show that Cape was present in the USA. Accordingly, the claimants argued that Cape was present in the USA through its Illinois subsidiary. For this argument to succeed, the separatepersonalities of the variouscompanies would need to be ignored

o   HELD: The court refused to lift the veil and held that the US subsidiary was separateand distinct from its UK parent company. Accordingly, Cape was not present in the USA and the judgement of the US court could not be enforced against it. Salomon allowed a parent to use its subsidiaries to avoid liability in this way, and the Court was of the opinion that, on the facts, there were no ground to avoid following Salomon

·       However, as we shall see below, the courts have developed a string of jurisprudence touching on situations where the corporate veil will be lifted



·       The most straightforward and least problematic situation in which courts could pierce the corporate veil was where the company was being used to perpetuate fraud, or the company was a façade or sham

·       Acommon theme amongstsuch cases is that the company was used to evade some form of existing contractual provision or obligation (i.e. avoiding an existingliability, not a future liability)




Gilford Motor Company Limited v Horne [1933] Ch 935

The defendant was the managing director of the claimant company. His employment contract provided that, should he leave the company, he would not attempt to solicit any of its customers. His employment was terminated, and his wife set up a rival company which competed directly with the claimant. It was clear that this new company was set up at the defendant’s behest and was under the defendant’s control.

The court granted an injunction preventing the defendant (and the new company) from soliciting the claimant’s customers. Lord Hanworth MR stated that the new company was ‘formed as a device, a stratagem, in order to mask the effective

carrying on of a business of [the defendant]’ and to avoid the restrictive covenant.

Jones v Lipman [1962]

Lipman entered into a contract to sell property to Jones. Shortly thereafter, Lipman changed his mind. To avoid selling the property to Jones, Lipman transferred the property to a company he owned and controlled and had set up to hold the property. When Jones decided to sue Lipman, Lipman said he did not own the land anymore as it was owned by the company.

The court found that Lipman created the company only to avoid existing legal obligations and so it lifted the corporate veil – ‘the defendant company is the creature of the first defendant, a device and sham, a mask which he holds before his

face in an attempt to avoid recognition by the eye of equity’.

Antonio Gramsci Shipping Corn v Stepanovs [2011]

The holding developed a number of principles to apply in cases involving companies set up fraudulently:

·       The defendant need not be in sole control of the company in question – where there were a number of wrongdoers, with a common purpose, in control of the company, then liability could be imposed on all, or one, of them

·       The veil would not be pierced simply because the company behaved fraudulently

what must be established is that there was a fraudulent misuse of the company structure

·       The veil will only be pierced when the fraud or wrongdoing in question is within the ordinary business of the company in question

·       A contract entered into by a ‘puppet company’ could be enforced against both

the puppet company and the puppeteer, although the puppeteer would not be permitted to enforce the contract on policy grounds

VTB     Capital     Plc     v     Nutritek International Corp [2013]

VTB Capital plc (VTB) lent US$225 million to Russagroprom LLC (RAP), which RAP intended to use to purchase a number of Russian companies from Nutritek. RAP defaulted on the loan. VTB alleged that it was induced into entering into the loan agreement with RAP based on fraudulent misrepresentations made by Nutritek. VTB alleged that representations were made indicating that RAP and Nutritek were not under common control, whereas both companies were, in reality, controlled by Mr Malofeev, a Russian entrepreneur. VTB commenced proceedings against Nutritek, Malofeev and several other companies that were involved, alleging that they were liable for RAP’s breach of contract. In order for this claim to succeed, the corporate personality of RAP would need to be pierced and VTB argued that the veil should be pierced on the ground that Malofeev and his associated companies were using RAP as a puppet company to orchestrate a fraud against VTB. VTB claimed that once the veil was pierced, the defendants would become party to the original loan agreement between VTB and RAP, and so would be liable on it.

The Supreme Court refused to pierce the corporate veil. Lord Neuberger stated that,

to find the defendants liable on the loan agreement, would involve an extension of



the circumstances in which the veil could be pierced. It would, in effect, result in Malofeev becoming a co-contracting party with RAP under the loan agreement. He refused to do this on the ground that where B and C are the contracting parties and A is not, there is simply no justification for holding A responsible for B’s contractual liabilities to C simply because A controls B and has made misrepresentations about B to induce C to enter into the contract. This could not be said to result in unfairness to C: the law provides redress for C against A, in the form of a cause of action in

negligent or fraudulent misrepresentation

Creasy     v   Breachwood  Motors Limited [1993]

Creasy claimed wrongful dismissal from Breachwood Motors. Breachwood Motors, in response, ceased trading and transferred its assets to BW, leaving nothing with which to compensate Creasy. Creasy sought to lift the corporate veil and bring action against BW, as the directors of BW and Breachwood Motors were the same. The

court lifted the corporate veil to allow for this.

Adams v Cape Industries [1990]

[TO SHOW that avoiding future liability is permissible]:

‘We do not accept that the corporate veil should be lifted simply because the corporate structure has been used so as to ensure that legal liability (if any) in respect of particular future activities of the group (and correspondingly the risk of enforcement of that liability) will fall on another member of the group rather than the defendant company. Whether or not this is desirable, the right to use a

corporate structure in this manner is inherent in our corporate law’



·       It is common for larger companies to carry out their functions via a numberof smaller subsidiary companies

·       Initially, each subsidiary in a group of companies was regarded as its own ‘single economic unit’ à The Albazero [1977]: the court stated that it was ‘long established and now unchallengeable by judicial decision that each company in a group of companies is a separate entity possessed of separate legalrights and liabilities’

·       However, this position was changed by DHN Food Distributors v Tower Hamlets




DHN Food Distributors v Tower hamlets LBC [1976]

DHN was a holding company that included two other wholly owned subsidiaries. One of these subsidiaries owned the land upon which DHN conducted business, with DHN occupying the land as a bare licensee. The land was compulsorily purchased by the defendant, who paid £360,000 compensation to the subsidiary. DHN could not find suitable replacement premises, and went into liquidation. DHN argued that it was entitled to compensation for loss of business, but the law provided that only those with a legal or equitable interest in the land were entitled to such compensation, with a bare license not conferring such an interest.

DHN was awarded compensation for loss of business. Lord Denning MR stated that the subsidiaries were ‘bound hand and foot’ to DHN and that ‘the group is virtually the same as a partnership where all three companies are partners’. Accordingly, the

three companies were treated as one, with DHN regarded as that one.

Adams v Cape Industries [1990]

[HOWEVER, this decision took a different approach:]

Slade LJ held: ‘save in cases which turn on the wording of particular statutes or contracts, the court is not free to disregard the principle of Salomon … merely because it considers that justice so requires. Our law, for better or worse, recognises the creation of subsidiary companies, which though in one sense the creatures of their parent companies, will nevertheless under the general law fall to be treated as separate legal entities with all the rights and liabilities which normally attach to

separate legal entities’.

2.3    AGENCY

·       A relationship of agency usually arises where one person (known as the principal) appoints another person (known as the agent) to acton his behalf

·       Where two parties are involved in an agency relationship, the principal is normally legally responsible for the acts of his agent – in the corporate context, a relationship of agency can arise in two situations:

(i)            The company could be regarded as an agent of a member à i.e. the member, as principal, is responsible forthe acts of the company (i.e. the company’s corporate personality is ignored and the member made liable). However, Salomon emphatically stated that the mere fact of incorporation does not cause a relationship of agency to be created between a company and its members, although an agency relationship can arise betweena member and the companybased on the particular facts of a case (Gramophone & Typewriter Ltd v Stanley)

(ii)            Where two companies are in an agency relationship, the principal (normally the parent or holding company) can be liable for the acts of its agent (normally, a subsidiary company). In effect, the corporate personality of the subsidiary is ignored and the parentcompany is made liablefor the subsidiary’s acts




Smith,     Stone     and     Knight     v Birmingham Corporation

The claimant company purchased a business, and set up a new subsidiary company to run this business. However, the claimant never transferred ownership of the business to the newly created subsidiary. The land upon which the subsidiary conducted business was compulsorily purchased by the defendant, who planned to pay compensation to the subsidiary for loss of business. The claimant contended that it was entitled to the compensation.

The court held that the subsidiary was the agent of the claimant and therefore, the corporate personality of the subsidiary was ignored and the claimant obtained the compensation. The crucial factor was that the newly acquired business and the land

on which it operated still belonged to the claimant.



·       The final ground for lifting of the corporate veil is where justice of the case demands so – however, the courts have consistently held that justice is not a ground to lift the corporate veil

·       This is unfortunate for victims of tort (‘involuntary creditors’), therefore, courts have developed a way to hold companies

accountable for tortiousharm to individuals




Chandler v Cape Plc [2012]

Chandler worked for Cape products, a subsidiary of Cape Industries. He was exposed to asbestos and later he developed asbestosis, however, by the time he was diagnosed the subsidiary had closed down and so there was no one to sue. Chandler therefore elected to sue the parent company, but the parent company said that they were not to blame for any illness faced by the employee due to the actions of the company’s subsidiary (even the insurance did not cover employees of the subsidiaries).

The court agreed later that cape industries was liable, but it only agreed that it was liable on the ground that cape industries had a duty of care to the employees of its subsidiaries à (this is not a veil lifting case, it is a case where the parent company is held accountable on the basis of the duty of care, i.e. the court found an inventive

way to hold the parent company liable)



(i)            To take advantage of integrated finance: assets and liabilities are passed from one company to another in the group, and this obscuresthe true financial position of each company

(ii)            Enhances anonymity of beneficial owners: people who have a lot of money do not like people to know wheretheir money is/where their money comes from, and so they create corporate vehicles which are interconnected in order to obscure the trail of theirmoney

(iii)            For management, avoidance or evasion of tax obligations: “tax heavens” are jurisdictions which have very low regimes of tax, or in some cases no taxes at all

o   Many Multi National Corporations have their holding companies or entities registered in those jurisdictions (it is very difficult to trace money in these jurisdictions)

o   This makes it is possible to manage tax liabilities or reduce tax liabilities by organising your corporate group in such a way which reduces the profitsyou are earningin any particular jurisdiction

(iv)            Regulatory arbitrage: different jurisdictions have different regulations, and sometimes companies will try to avoid jurisdictions which have higher regulations by setting up an officein a country with lower regulatory hurdles/standards

(v)            Avoiding creditors by concealing or shielding assets: for instance if someoneis suing you in jurisdiction X and you realise that you are in trouble then it may be a good idea to move your assets to jurisdiction Y, and this is done by forming a corporateentity in jurisdiction Y

(vi)            Limiting exposure to/avoiding tortious liability: principle that one cannot be liable for the actions of another à if you are going to carry out riskyactivities then you want to do so in a manner that will shieldyou from the damages that may occur in the process. Since each company in a corporate entityis only liable for itself, it may be possible to escape liability

(vii)            Compliance with domestic laws: sometimes corporate groups are enforced upon companies by domestic laws, e.g. in Zimbabweany company that invests in the countrycannot have 100% ownership in the company;the most they can have is 49%, and 51% is to be owned by locals. Thus, you have to formulate mechanisms which would enable you to retain ownership and control in the company (e.g. you may create phantom organisation in Zimbabwe that is owned 51% by locals, but that 51% is controlled by external forces)

(viii)            Facilitating illicit activities such as bribery,corruption or moneylaundering



·       Acompany’s constitution consistsprimarily of the articles of association, agreements, and resolutions affecting the company

·       The CA 2015 has significantly reduced the importance of the Memorandum of Association, and the Articles of Association now form the company’s principal constitutional document

·       The constitution forms a statutory contractbetween the companyand its members, and betweenthe members themselves. However, only those provisions relatingto membership rightswill constitute terms of the statutory contract

·       While ordinarily an act outside the scope of a company’sobjects clause would be ultra vires,companies incorporated under the CA 2015 have unrestricted objects by default(CA 2015, Section 28)

·       A company can alter its articles by passing a specialresolution, however, statute and common law restricta company’s

ability to alter its articles

·       The CA 2015 does not seek to exhaustively regulate the internal affairs of the company, much is left to the companies themselves – accordingly, a company’s constitution aims to set out the powers, rights and obligations of the company’s members and directors, and also to lay down certain processes regardinghow the company is to be run



·       The CA 2015 has altered significantly the form and content of the corporateconstitution:

o   Prior to 2015, a company’sconstitution consisted of the Memorandum of Association & Articles of Association

o   After 2015, a company’s constitution includes the company’s Articles of Association & any resolutions and agreements affectingthe company’s constitution

·       Prior to the CA 2015, the Memorandum was of fundamental importance and formed one of the two principal documents that formed a company’s constitution (however, its importance was reduced to simplify company formation and make it easier to discover the constitutional workingsof a company)

·       Under the CA 2015, the memorandum creates a ‘historical screenshot’ by indicating the company’s state of affairsat the

time it was created. Section12, CA 2015 provides that the memorandum must state that the subscribers:

a.        Wish to form a company under the Act; and

b.       Agree to become members of the company and, in the case of a company with a share capital, to take at least one share each

·       Currently, the company’s Articles of Association (‘articles’) form its principal constitutional document – they tend to regulate the internalworkings of a company and regulate issues such as balance of power between membersand directors, conductof general meetings, issues pertaining to sharesand distribution of assets, etc.

·       Every company must have a set of articles(Section 13, 20, Companies Act 2015) and promoters are free to draft their own articles that suit the needs of their particular business requirements à however, drafting articles is complex and technical, accordingly the CA 2015 has provided a set of model articles that companies may adopt if they so choose

o   Companies incorporated under the repealed CA will not be governed by the new model articles, but can adopt them if they so choose

o   Where promoters of a limitedcompany do not submit their own articlesupon registration, the applicable model

articles will form the company’s articles (Section 20, CA 2015)

o   Even if the promoters do register their own articles,the relevant modelarticles will still form part of the

company’s articles, unlessthe registered articlesmodify or excludethem (Section 21, CA 2015)

·       Should a dispute arise,the courts may be requiredto interpret the provisions of the articlesin order to resolve the dispute

·       Holmes v Keyes [1959]: the articles of association of the company should be regarded as a business document and shouldbe construed so as to give them reasonable business efficacy

·       Thompson v Goblin Hill Hotels Limited[2011]: the words of the articles are not to be given their plan and obviousmeaning if such aninterpretation would produce a commercial absurdity



·       Certain resolutions and agreements form part of, and affect, the company’s constitution (Section 27, CA 2015)

·       However, the list of such resolutions and agreements is much wider than this definition suggests and appearsto go beyond

agreements and resolutions that affect a company’s constitution directly, e.g. special resolutions often form part of the

company’s constitution even though special resolutions ordinarily involve decisions with no bearing on the company’s




·       Re Tavarone MiningCompany (Pitchard’s Case)(1873): the company’s articles form a contractbetween a companyand its

members, and betweenthe members themselves

·       Section 30(1),CA 2015: the provisions of a company’sconstitution bind the company and its membersto the same extent

as if therewere covenants on the part of the company and of each member to observe those provisions

·       Accordingly, the company’s constitution forms the ‘statutory contract’ and imposesobligations upon:

o   The company when dealing with its members;

o   The members when dealing with the company;and

o   The members when dealing with one another

·       This statutory contractdiffers from a standard contractin several importantways and is not subjectto certain standardcontractual rules






binding force from?

The agreement between the parties

From Section 30 of the Companies Act 2015

Alteration of terms against a             party’s


The terms of a standard contract cannot usually be altered against the wishes of the parties

As the articles can be altered by passing a special resolution, the majority can alter the terms of the statutory contract against the wishes of the minority

Enforcement by     a         third


Generally, third parties cannot enforce a standard contract (save for in particular, pre-defined


Third parties cannot enforce the statutory contract,

i.e. privity of contract third parties cannot enforce the provisions of the constitution

Action                   for

breach                     of contract?

If any term of a standard contract is breached, it can give rise to an action for breach of contract

Only those terms of the constitution that relate to membership rights can form the basis for an action for

breach of the statutory contract

Rectification of contract?

The courts may be willing to rectify a standard

contract if it fails to give effect to the parties’

intentions, or if it contains a mistake

The courts will not rectify the statutory contract if it

fails to give effect to the parties’ intentions, or if it

contains a mistake (Scottv Frank F Scott ltd [1940])

Defeasible on certain grounds?

Standard contracts can be defeated on the grounds of mistake, misrepresentation, duress or undue influence

The statutory contract cannot be defeated on the grounds of mistake, misrepresentation, duress or undue influence (Bratton Seymour Service Co Ltd v

Oxborough [1992])



·       Asthe constitution forms a contractbetween the company and its members, it follows that both partiescan enforce compliance with the terms of the constitution against the other





Hickman v Kent or Roney Marsh

Sheepbreeders’ Association [1915]  

The articles of the defendant company provided that any dispute between it and a member should be referred to arbitration before any legal proceedings were initiated. The defendant purported to expel one of its members (the claimant) from its organisation but, instead of referring the dispute to arbitration, the claimant petitioned the High Court for an injunction restraining his expulsion.

Held: the articles formed a contract between the company and its members. The company was therefore permitted to enforce the term of the articles and require disputes to be referred to arbitration. The High Court stayed the legal proceedings

initiated by the claimant, and the claimant was subsequently expelled.


Pender v Lushington [1877]

The company’s articles provided that its members would have one vote for every ten shares, up to a maximum of 100 votes. Consequently, members with over 1,000 shares would not have voting power commensurate to their shares. To avoid this, members with over 1,000 shares transferred some of their excess shares to several nominees (including the claimant), thereby unlocking the votes within them. The company’s chairman (the defendant) refused to accept the nominees’ votes and the claimant alleged that his votes were improperly rejected.

Held: the claimant’s action succeeded. The shares were properly transferred and

registered to the nominees, so refusing to accept their votes constituted a breach of the articles

Bisgood v Henderson’s Transvaal

Estates Ltd [1908]

Held: the purpose of the constitution is to define the position of the shareholder as shareholder, and not to bind him in his capacity as an individual à it follows that only the terms of the constitution that relate to membership rights will form part of

the statutory contract

Beattie v E and F Beattie Ltd [1938]

The company’s articles provided that any disputes between it and its members should be referred to arbitration. A director (who was also a member) was alleged to have improperly drawn a salary without the authorization of the company or its members. The company therefore initiated legal proceedings to recover this payment. The director alleged that, because he was a member, the article provision applied and the dispute should be referred to arbitration. He therefore sought to enforce the provision of the constitution.

Held: the director was relying on the articles in his capacity as a director, not in his capacity as a member. Accordingly, the director could not enforce the relevant provision of the articles and the legal proceedings were permitted to go ahead.

Accordingly, provisions of the constitution that relate to the rights of directors will

not normally form part of the statutory contract



·       Just as the constitution forms a contract between the company and its members, so too does it form a contract amongst the members themselves

·       Accordingly, a breach of the statutory contract by a member can be enforced by another member, providing that the provision breached concerns a membership right





Rayfield v Hands [1960]  

The company’s articles provided that, if a member wished to sell his shares, he should inform the directors, who would then purchase the shares between them. The claimant wishes to sell his shares and so notified the defendant directors, who then refused to purchase the claimant’s shares. The directors were all members, and so the claimant sought an order requiring the directors to purchase his shares.

Held: the directors should purchase the claimant’s shares. As the company was a

quasi-partnership, the article provision affected the directors in their capacity as members and accordingly concerned a membership right



·       As the companyis a legal person, it can enter into contractsin much the same way as naturalpersons can

·       However, historically, the company’s ability to enter into contracts was subject to a significant limitation à Prior to the passing of the CA 2015, all companies were required to state in their Memoranda the objects or purposes for which the company was set up (this is known as the ‘objects clause’). The objects clause serves to limit the contractual capacity of the companyand if a company entered into a contract that was outside the scope of its objectsclause, the companywould be acting ultra vires (‘beyond one’s powers’) and the contract would be void ab initio (Ashbury Railway Carriage and Iron Co Ltd v Riche [1875])

·       This restriction on a company’s capacity was introduced to protect persons who provided a company with capital, on the expectation that the companywould pursue the lines of business for which it was set up and would not expend capitalon frolics outside the company’s stated purposes

·       The problem was that the rules relating to ultra vires were overly complex, technical, and vague and served to harm third parties who had innocently contracted with the company.Accordingly, successive amendments to the CompaniesAct have weakenedthe ultra vires doctrine



·       The requirement of an object’s clause has been abolished by the CA 2015 (although companies can still includean objects clause if they so wish)and such companies will accordingly have unrestricted objects (Section 28, CA 2015)

·       For such companies, the ultra vires doctrine will be of little relevanceas the company’s contractual capacity will not be

limited, and this is the default positionfor companies incorporated under the CA 2015

·       Companies incorporated under previous Companies Acts will still have an objects clause, but the companies can delete the objects clause by passing a special resolution to that effect, and in doing so, acquiring unrestricted capacity (Section 22,CA 2015)



·       The objectsclause and the doctrine of ultra vires arestill relevant in two instances:

(i)            Although companiesincorporated under the CA 2015 do not need to include an objects clause in their articles,they may do so if they wish. It is anticipated that very few companies incorporated under the CA 2015 will include an objects clause

(ii)            Companies incorporated under prior Companies Acts may decide not to, or may neglect to, remove their objects clause. As regards such companies, the objects clause will serve to limit the directors’ authority and the ultra vires doctrine will still be of relevance. Although, it is noteworthy that this doctrine has lost a lot of its force

·       Historically, if a company entered into an ultra vires contract, then that contract would be rendered void ab initio. Unfortunately, this served to harm the innocent third party who contracted with the companyand who often had no idea of the scope of the company’s objects clause

·       This has been remedied by Section 33, CA 2015, which provides that the validity of an act done by a companyshall not be called into question on theground of lack of capacityby reason of anything in the company’s constitution

·       It may be the case that a transaction is within the capacity of the company, but the director who caused the company to enter into the transaction had no authority to do so. In such a case, the issue is not one of corporate capacity, but of directors’ authority. Again, the Act seeks to protect third parties, with Section 34(1), CA 2015 stating that, ‘in favour of a person dealing with a company in good faith, the power of the directors to bind the company, or authorize others to do so, is deemed to be free of any limitation under the company’s constitution’

·       The resultant effect of Section 33 and 34(1), CA 2015 is that if a company or director enters into an ultra vires contract with a thirdparty, then the contract cannot be attackedon the ground that it is ultra vires à Therefore, from the point of viewof a third party, the ultra vires doctrine is of littlerelevance, which is why it is often stated that the CA 2015 abolishesultra vires externally, because it is of little concern to external third parties.

·       However, whilst the CA 2015 may have rendered the ultra vires doctrine largelyirrelevant to personsoutside the company,it remains relevantto persons insidethe company for two reasons:

(i)            If a member of a company discovers that the company is about to enter into an ultra vires transaction, the member has a personalright to petition the court for an order preventing the company from entering into the transaction (this right arises from the statutory contract that exists between a company and its members. However, this right only arises if a legal obligation has yet to arise (Section 34(4), CA 2015) – the right is lost once the company has entered into the contract. In practice, most members will only become aware of a contractonce the company has enteredinto it, and so thisright will be oflittle use

(ii)            Where the directors of a company cause the company to enter into an ultra vires transaction, or where the directors exceed the authority bestowed upon them by the constitution, then they will likely be in breach of the statutory duty to act in accordance with the company’s constitution (Section 142(a), CA 2015 – ‘Duty to act within the company’s powers’)

·       NOTE:

o   As the constitution forms a contractbetween the companyand its members, acting ultra viresmight place the company in breach of the statutory contractcreated by Section 30, CA 2015

o   As acting ultra vires can amount to breach of duty, the members may be able to bring a derivative claim on behalf of the company against the directors who have acted ultra vires (‘the derivative claim’)

o   If the companyacts ultra vires because it has become impossible for it to fulfil the purposes for which it was set up, it

may be wound up on just and equitable grounds (‘the petitionfor winding up’)



·       As a company,or the market in which it operates, evolves, it may become necessary for it to alter its articles

·       Section 22, CA 2015 provides that a company may amend its articlesby passing a special resolution (and in certaincases the courtsmay also have power to amend the articles)

·       However, this ability is not limitless both common law and statute have imposed limitations on alteration of articles



·       The ability to alter the articles is limited by the provisions of the Companies Acts (Allen v Gold Reefs of West Africa Limited [1900])

·       Section 23, CA 2015: a member is not bound by any change in the articles made after he became a member, if the effect of the change is to require him to take or subscribe for more shares than the amount he had at the date of alteration, unless he expressly agrees in writing to the change

·       Section 78, CA 2015: in certain situations, statute empowers the court to prohibit a company from altering its articles

without the court’s permission e.g. wheremembers of a public companyobject to re-registering it as private









Allen v Gold Reefs of West Africa Limited [1900]  

Held: the power to alter articles must ‘like all other powers, be exercised subject to those 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’

Shuttleworth v Cox Brothers & Company (Maidenhead) Limited [1927]

The company’s articles provided that its directors (one of whom was the claimant) would hold office for as long as they wished, unless they became disqualified by virtue of one of six specified events. The claimant engaged in a financial irregularity, but it did not fall within one of the six specified events. The other directors therefore used their shares to pass a special resolution altering the articles by adding a seventh event, namely that a director must resign if all the other directors required him to. Following the alteration, the claimant’s co- directors demanded his resignation. The claimant challenged the alteration.

Held: The test imposed by Lindley MR is predominantly subjective, meaning that if the majority shareholders honestly believed that the alteration was for the company’s benefit as a whole, then the alteration would be valid, even if the court disagrees with the majority’s assessment. On this basis, the Court held that the alteration was valid, as the other directors did believe that it was for the company’s benefit. The Court did, however, impose an objective requirement, namely that an alteration would not be valid if ‘no reasonable man could consider it for the benefit

of the company’



à à it is therefore apparent that a minority shareholder who wishes to challenge an alteration on this ground will face a difficult task, as our system of law is based

heavily on the principle of majority rule

Greenhalgh  v  Ardene     Cinemas Limited [1951]

The company’s articles provided that a shareholder could not sell his shares directly to an outsider if an existing shareholder was willing to purchase them. The company’s managing director was also its majority shareholder and he wished to sell his shares to an outsider. Accordingly, in his capacity as majority shareholder, he altered the articles to permit a shareholder to sell his shares to an outsider, without first offering them to an existing shareholder, providing that an ordinary resolution was passed (which would be a certainty given that he was the majority shareholder). A minority shareholder challenged the alteration.

Held: The phrase ‘the company as a whole’ meant the shareholders as a body and the court should take the case of a hypothetical member and ask whether the alteration was for his benefit. On this basis, if an outsider was to wish to purchase the shares of a hypothetical member, it might well be in that member’s benefit to sell his shares directly to an outsider. Further, the advantage obtained by the majority shareholder was also obtained by all the other shareholders, so the

alteration was not discriminatory. Accordingly, the alteration was deemed valid



·       While the terms ‘member;and ‘shareholder’ tend to be used interchangeably, there is a distinction

·       Members ordinarily exercise their decision-making powers via the passing of resolutions (which are a formal vote), and these couldbe either ordinary resolutions (simplemajority, 50%) or special resolutions (75%)

·       Resolutions are only validly passed ifsufficient notice of the meetingat which they are to be tabled is providedand quorum is present (namely, the minimumnumber of persons required to be presentin order to conductbusiness)

·       Members can appoint a proxy to attend, speakand vote at general meetingson their behalf

·       Members of a companyplay two vitalroles:

(i)            Through the purchaseof shares, they contribute capitalto the company

(ii)            Through the passing of resolutions, they make decisions à a significant amount of power is placedinto the hands of membersand numerous key decisions are reserved for them alone



·       ‘Member’ and ‘shareholder’ are often used interchangeably, and in the majority of cases, a member will be a shareholder

and vice versa as the term ‘member’ is widerthan the term ‘shareholder’ is it preferable to use the term ‘member’

·       In companies without a share capital will ordinarily have members and not shareholders

·       On the other hand, in companies with a share capital, a purchase of shares will make an individual a shareholder but not automatically a member – Section 92, CA 2015 provides that a person will only become a member once he has agreed to become a member and his name is entered on the register of members



·       The generalpower to managethe company is usually vestedin the directors by the company’s articles

·       Despite this, the CA 2015 and the Insolvency Act place considerable decision-making power in the handsof the members:

(i)            The members can alter the company’s articles;

(ii)            Ifthe company wishes to convertfrom a public company to a private company, or vice versa, or if an unlimitedcompany wishes to convertto a private limited company,then approval of the membersis required;

(iii)            The members can remove a director (or directors) from office;

(iv)            Numerous loans and other transactions involving directors requirethe approval of members;

(v)            The members can petition the court to have the company wound up

·       This decision-making power is exercisedvia the passingof resolutions a resolution is simply a more formalword for ‘vote’






S. 256(1) CA 2015 Passed by a simple majority

S. 257(1) CA 2015 Passed by a majority of not less than

seventy five percent

This means that an exact 50% split will mean that the

resolution is lost

These tend to be reserved for more important decisions

and constitutional changes


·       Where the CA 2015 states that a resolution is required without specifying the type, the resolution required will be an ordinary resolution although the company will be free to specifya higher majorityby inserting a provision in the articlesto that effect(Section 207(1), CA 2015)

·       Where statutespecifies that an ordinary or special resolution is required, the articles cannotalter the majorityneeded

·       Resolutions of public companiesmust be passed at a meeting of the members(Section 255(2), CA 2015) while resolutions of private companies can be passedat a meeting or by way of a written resolution (Section 255(1), CA 2015)



·       The passing of formal resolutions at a meeting involves compliance with a body of rules and procedures that can prove burdensome and costly (e.g. for smallcompanies, where the number if members is small, etc.)

·       Accordingly, the CA 2015 allows private companies to pass written resolutions in substitute for resolutions passed at a meeting (exceptwhere statute provides that a meeting must be convened,e.g. for removalof directors from office)

·       Written resolutions require the same majorities and have the same force as resolutions passedat meeting (Section262(4), CA 2015)

·       Where a written resolution is proposed, a copy of the proposed resolution + a statement informing the member how, and by when, to signify an agreement is sent to each memberà once a memberhas signified agreement, it cannot be revoked

·       Accordingly, it is possible for a private company to go its entire existence without having to call a meeting, while public companies must hold at least one generalmeeting every year that constitutes an AGM (Section310(1), A 2015)

·       The writtenresolution procedure is an exampleof the ‘think small first’ philosophy behind the CA 2015


3.       MEETINGS

·       Except where the written resolution procedure is used, the members will exercise their decision-making powers by passingresolutions at meetings, of which there are two types:




All members are entitled to attend general meetings the majority of meetings, including the Annual General

Meeting (AGM), will constitute general meetings

Only a certain class of the members are allowed to attend class meetings

It used to be the case that any meeting that was not an

AGM was known as an extraordinary general meeting (but this phrase should no longer be used)

These meetings are reserved for determining the class of certain members with special rights


·       Resolutions passed at generalmeetings are only valid if the procedural requirements are complied with (Section 275, CA 2015), and these usually cannot be excluded by the articles



·       Section 276, CA 2015: the power to call a general meetingis vested in the directors

·       Section 277, CA 2015: however, the members are allowed to request that the directors call a generalmeeting, provided:

o   The request comes from membersrepresenting at least 5% of the company’s paid-up share capital;or

o   For a company without a share capital, members representing at least 10% of the voting rights of the members (this is reducedto 5% if more than 12 months have lapsed since the last generalmeeting was convened)

·       Section 279, CA 2015: if directors fail to comply with avalid request for a meetingfrom the members,then those members(or members representing over half of the total voting rights of the company) are granted the power to call a meeting themselves at the expense of the company

·       Section 280, CA 2015: where it is impracticable to call a meeting in accordance with the above provisions, the court may order a meeting to be called

·       Note: the power to call a generalmeeting may coincidewith other areasof the law:

o   E.g. directors are under a statutory duty to use their powers for a proper purpose (‘duty to act within the company’s powers’ and ‘promote the best interests of the company’) and if the directors call a meeting for an improper purpose(or improperly refusea members’ requestfor a meeting), a breachof duty may have occurredwhich may form the basis of a derivative claim

o   Similarly, if the majority shareholders call a meeting in order to adversely affect the minority, the majority’s conduct may be regarded as unfairly prejudicial (‘unfairly prejudicial conduct’)



·       Section 284, CA 2015: resolutions passed at a generalmeeting are only valid if adequate noticeof the meeting is provided

to all persons entitledto such notice, namely: all of the company’s directors, members and the auditor

·       Notice must be providedwithin a sufficient period prior to the meeting

·       The general rule is that notice of a meetingmust be provided at least 21 clear days prior to the meeting in the case of an AGM, and 14days for any other general meeting (Section 281(1) and 281(2),CA 2015)

·       The company’s articles are free to specify a longer notice period (Section 281(3), CA 2015), but cannot specify a shorter notice period(although the members themselvescan agree to a shorter notice period)

·       Section 287, CA 2015: if a provision of the CA requires a special notice of a resolution to be given, the resolution is not effectiveunless notice of the intention to move it has been given to the companyat least 28 days beforethe meeting


3.3    QUORUM

·       A generalmeeting, and any decisions made at it, will only be valid if quorumis present quorum is the minimum number

of ‘qualifying persons’ required in order to validly conductbusiness. A ‘qualifying person’ is:

o   A member of the company; or

o   A representative of a corporatemember; or

o   A proxy of the member

·       Where a limited companyhas only one member, that member will constitute quorum(Section 292(1), CA 2015), and in all other cases,two qualifying personswill constitute quorum unless the articles provideotherwise (Section 292(2), CA 2015)

·       If quorum is not present, the meeting is said to be ‘inquorate’ and no businesscan be conducted at that meeting, save for

appointment of a chairman for the meeting


3.4    VOTING

·       Regarding the passing of resolutions at a meeting,there are two methods of voting:

(i)            By a show of hands: each memberwill have one vote; or

(ii)            Bypoll: unless the articlesso provide, each member will have one vote per share, exceptwhere the companyhas no share capital, in which case each member will have one vote (Section 295, CA 2015)

·       The model articles under the CA 2015 provide that a resolution at a meeting will be decided on a show of hands, unless a poll is demanded in accordance with the articles

·       The members have the right to demand that a vote be taken on poll, but the articles can stipulate that a certain number of membersare required in order for such a demand to be valid (the model articles providethat two membersare needed to demand a poll,and also the chair of the meeting can demand a poll)


3.5    PROXIES

·       Members need not attenda meeting to exercise their voting rights

·       Section 298, CA 2015: members have the right to appointanother person to exercise their right to attend, speak and vote at generalmeetings – this person isknown as a ‘proxy’

·       In large public companies, the appointment of proxies is importantas only a small minorityof members will actually attend the meetings



·       As public companies are required to hold meetings and since the members can only exercise many of their key decision – making powers at such meetings,the general meeting as a forum for shareholder democracy is of fundamental importance

·       In fact, general meetingsare the only formal link between the company’s membersand the Board

·       Unfortunately, there is widespread dissatisfaction with the utility of general meetings as a forum for shareholder democracy for several reasons:

o   In order for general meetings to provide a forum for shareholder democracy, they need to be well attended. In large publiccompanies, however, meetings tend to be poorly attended

o   In order for general meetings to effectively hold the directors to account, the majority of shares should not be in the hands or control of the directors. In many private companies, the directors will be the members, so general meetings become largely redundant as the directors will own all, or the majority of, the company’s shares. In public companies, many members will appoint one of the directors to act as their proxy, so the directors may have controlof a significant proportion of the company’sshares, thereby allowingthem to defeat the resolutions of those who mightwish to hold them to account



·       Asnoted, convening meetings can be a burdensome process. Even the written resolution procedure may appear unnecessary where all the members know they are in agreement on an issue

·       Accordingly, the common law has long provided that if all the members entitled to vote on a matter are in agreement on that matter, then that agreement will be valid even if no meeting was convened and no resolution took place (Baroness Wenlockv The River Dee Co [1883])

·       This rule is known as the Duomatic principle, named after the case of Re Duomatic Ltd [1969],where Buckley J stated that as this rule circumvents rules and procedures relating to meetings and resolutions, it is unsurprising that strict rules and safeguards are in place, including:

o   Nothing less than unanimitywill suffice—a member holding 99 per cent of the shares cannot, by himself,take advantage of theDuomatic principle (Re D’Janof London [1993])

o   The Duomatic principle cannot be used where the decision in question could not have been taken at a meeting (Re New CedosEngineering Co Ltd [1994])

o   It is likely that decisions that cannot be taken by written resolution (namely the removalof an auditor or director)are not subjectto the Duomatic principle

·       An agreement taken by unanimous consent is likely to be classified under the CA 2015 as an agreement that affects the company’s constitution. Accordingly, such agreements may form part of the company’s constitution and may be enforced by the company or its members. It is also likely that such agreements will need to be registered with the Registrar of Companies



·       Itis possible that problems may arise wherethe company or the membersare wronged by the actionsor omissions of the directors or the majority shareholders – this is problematic because the persons who cause the harm in these situations are also the persons who have standingto obtain redress

·       Without the law’s aid, members especially minorityshareholders – would be left withouta remedy. Accordingly, statute provides members with three principal remedies, namely:

(i)            The derivative claim Part 11, CA 2015;

(ii)            The unfair prejudiceremedy Part 24, CA 2015;and

(iii)            The petition for winding up the company Section 424, Insolvency Act 2016 (‘IA 2016’)

·       These memberremedies are not mutually exclusive and there exists significant overlapbetween the three

·       It is worth noting that in Fulham Football Club (1987) Limited v Richards [2011], the Court of Appeal stayed an unfair prejudice claim on the ground that the FA Rules (by which the claimant was bound) provided that disputes be referred to arbitration before commencing legal proceedings à the effect that such a clausewould have on other memberremedies is not yet known, though it was well established that an arbitration clause contained within the articles can form part of the statutory contract

·       In addition, where the constitution of the company has been breached, a member may be able to enforce the provision that was breached or obtain a remedy for breach of contract



·       If A sustains loss due to the actions of B, then generallyonly A can sue B to obtain redress C cannot sue B on A’s behalf

·       As companies have separate corporate personality, this principle applies equally inthe corporate context i.e. if a company sustainsloss due to the actionsof another, then generally only the company can sue to obtain redress

·       However, the problem arises where a company sustains loss due to the actions of its directors, as powers of the company are usually delegated to the directors – including authority to determine whether or not the company will commence litigation (and clearly, the directors will not agree to initiatelitigation against themselves)





Foss v Harbottle [1843]  

1.       Proper claimant: only the company, and not the members, can commence proceedings for wrongs committed against it. This principle is a corollary of a company’s corporate personality

2.       Internal management: where a company is acting within its powers, the courts will not interfere in matters of internal management, unless the company itself commences proceedings. This principle is a corollary of the courts long-established reluctance to becomes involved in the internal affairs of businesses

3.       Irregularity: where some procedural irregularity is committed, an aggrieved member cannot commence proceedings where the irregularity is one that can be ratified by a simple

majority of the members. This principle is a corollary of the principle of majority rule

·       The rule in Foss v Harbottle, however, is not absolute – if it were, wrongs committed by the directors would rarely be thesubject of litigation à accordingly, the courts crafted four ‘exceptions’ to the rule, whereby members could commence an action on the company’s behalf (‘exceptions’ because only oneof them is actuallyan exception)

·       Such actions were known as ‘derivative actions’ because the member was bringing an action basedon rights derivedfrom the company reinforced by the fact that, if the action succeeded, the remedy was granted to the company

·       With the creation of the statutory derivative claim, the derivative action was abolished. However,the exceptions enshrined under the previouscommon law derivative action were asfollows:

(i)            Where the act complained of was illegal(Taylor v National Union of Mineworkers [1985]) or ultra vires (Simpson v Westminster Palace Hotel Co [1860]), a member could commence a derivative action;

(ii)            Where the act infringedthe personal rightsof a member, a derivative action could be brought. Rightsbreached could include:a failure to provide sufficient notice of generalmeetings, a failureto pay dividends in accordance with the articles, or the improper rejection of a member’s votes;

(iii)            Where the act complained of could only be done or sanctioned bythe passing of a specialresolution, a derivative action could be brought (Edwards v Halliwell [1950]); and

(iv)            Where those personswho controlled the company had committed some sort of fraud on the minority

·       Negligence, even gross negligence, would not suffice (Paldives v Jensen [1956]), but where the negligence benefitted those who controlled the company, this would suffice as the negligence would be tainted by impropriety (Daniels v Daniels [1978])

·       The courtswould not allow a claim based on fraud on the minorityto succeed if it would not serve the interests of justice,

e.g. where independent members indicate that they do not wish the claimto proceed (Smith v Croft (No. 2) [1988])



·       The statutory derivative claim was introduced as a result of the rules related to derivative actions becoming ‘complicated and unwieldy’ it can be found in Part XI, CA 2015

·       Part XI does not abolish the rule in Foss v Harbottle the rule retains much of its force, however, the common law derivative actionhas been abolished and replaced by the statutoryderivative claim






The common law derivative action no longer


A statutory derivative claim can only be brought

under the Companies Act 2015

Source of law?

Case law spanning over 150 years

Governed by Part XI of the Companies Act 2015

Grounds for a claim?

(i)          Illegal/ultra vires acts

(ii)          Acts which infringe on personal rights of a member

(iii)          Acts requiring a special majority

(iv)          Acts which are a fraud on the minority

(i)           Negligence

(ii)          Default

(iii)           Breach of duty

(iv)           Breach of trust

Covers acts/omissions

committed by?

Directors or members

Directors only

Claim can be brought by?

A member only

A member, or a person who is not a member, but to             whom         shares             have            been

transferred/transmitted by operation of the law

Claim can be brought


A director of the company

A direction of the company or another person

(or both)

Claim for negligence?

Claim could only be brought if a director

benefitted personally

Claim can be brought, irrespective of whether or

not a director benefitted personally



·       Section 238(2), CA 2015 provides that a derivative claim can only be broughtunder Part XI, CA 2015 or in pursuanceof a court order underSection 780, CA 2015 (‘unfairly prejudicial conduct’)

·       Section 238(3), CA 2015 provides that a derivative claim can only arise from an actual or proposedact or omission involving:

o   Default: ‘default’ is a generalterm used in many pieces of legislation that refers to a failureto perform a legally

obligated act (e.g. to appear in court when required)

o   Negligence:negligence could not found a common law derivative action, unless the wrongdoer gained benefit from the negligentact. This limitation has not been preserved by the CA 2015, leadingmany directors to fear an increase in the numberof derivative claims (however, this increase in claims has not actually occurred)

o   Breach of duty: a derivative claim can accordingly be founded on the basis of a breach of the general duties, aswell as any other breach of duty

o   Breach of trust

·       The scope of the statutory derivative claim is, in many respects, wider than the common law derivative action, especially in relation to negligence and breach of duty

·       The persons against whom a derivative claim can be brought have also widened – under the common law, a derivative action could only be brought against a director, but now a derivative claim may be brought against a director or another person (or both) (CA 2015, Section 238(3))

·       In one respect, the derivative claim is narrower,namely the fact that the act or omission must be made by a director

under the commonlaw, the actionsof members couldfound a derivative action, but this is no longer the case


·       NOTE: therefore, the currentposition is as follows:

o   Where a member has engaged in the wrongful act or omission, a derivative claim cannot be brought à the appropriate remedy will be under Section 780, CA2015 (unfairly prejudicial conduct)

o   Where the wrongdoer is a director, a remedy may be available under Section 780 ORby way of a derivative claim. However,the derivative claim may ALSO be brought againsta member who was involvedin the director’s wrongful act or omission



·       Section 239(1), CA 2015 provides that a member who brings a derivative claim must apply to the court for permission to continue it, with Sections239 242 establishing a two-stage test for determining whether permission shouldbe granted

a)       First, the member must establishthat he has a prima facie case. If the member cannot establisha prima facie

case for permission, the court must dismiss the claim and make any consequential order it considersappropriate

b)       If a prima facie case is established, a hearing will be convenedand the company directed to provide evidence

·       The purpose of this process is to screen out weak or unmeritorious claims before the defendant becomes involved (however,establishing a prima facie case is not a very difficulthurdle to overcome)

·       If a prima facie case is established, we move to the second stage, under which the court decides whether or not to grant permission to continue with the claim under Section 241, CA 2015 à Under Section241(2), CA 2015 thecourt must refuse permission if it is satisfied that any of the following principles applies:

a)       Where a person acting in accordance with Section 144, CA 2015 (duty to promote the success of the companyfor the benefit of its members) would not seek to continue the claim

§  Reinforced the fact that a derivative claim must be for the benefit of the company

§  Refusal of permission on this ground is rare à Iesini v Westip Holdings Limited [2009]: the court held that permission would only be refused on this ground if no director acting in accordance with S. 144 would seek to continue the claim

b)       Where the cause of action arises from an act or omission that is yet to occur,or that the said act or omissionhas been authorised by the company; and

c)       Where the cause of action arises from an act or omission that has already occurred, and that the act or omission was authorised by the company beforeit occurred orhas been ratified by the companysince it occurred

·       If none of the above conditions apply, Section 241(3), CA 2015 provides that the court should have regard to the views of the members who have no personal interest in the matter à the company may have perfectly legitimate reasons for not pursuing the claim, e.g. waste of time and expense, and seeking the views of members with no interest in the matter may help the court determinewhether or not the claim should go ahead





Mission Capital Plc. v Sinclair [2008]

The defendants were two directors, whose service contracts provided that their employment could be immediately terminated if they engaged in unacceptable conduct. The claimant company terminated their employment on the grounds that they failed to submit financial information and failed to meet financial forecasts. The defendants disputed this. The claimant obtained an injunction that excluded the defendants from the claimant’s premises. The defendants, inter alia, brought a derivative claim and sought permission to continue it.

Held: Permission to continue the claim was denied. Although the court believed that the defendants were acting in good faith, the court held that a notional director acting in accordance with Section 172 would not seek to continue the claim, as the damage suffered by the company was ‘speculative’. Further, the court held that the defendants were not seeking anything that could not be recovered via a personal claim

under Section 994 of the CA 2006



·       Anact or omission of a director may cause loss to both the companyand, in turn, to its members (e.g. an act of negligence by a director causes the company loss, which in turn reduced the profits and so lowers the members dividends/value of their shares)

·       Such act/omission provides the company and its members with a cause of action against the director, i.e. the company and the members may have a personal claim against the director orthe members might be able to bringa derivative claim against the director on behalf of the company

·       In these cases, the ability of members to recover certain personal losses is limited by what is called the ‘ no reflective lossprinciple’ à where the loss sustained by the member is reflective of the loss sustained by the company, then the members will not be permitted to recover those losses that are reflective of the company’s loss, that could properly be recovered by the company itself (i.e. the company will be the proper claimant, as per the first rule in Foss v Harbottle, and its claim trumps that of the members)





Prudential Assurance Co. Ltd v Newman Industries Ltd (No. 2) [1982]

The directors had breached their duty by selling an asset of the company to a third party for less than it was worth, thereby causing the company loss. In order for the sale to be valid, the Listing Rules required the consent of the members, which the directors obtained by providing the members with misleading information regarding the sale. The transaction at an undervalue caused a reduction in the value of the company’s shares. The members commenced a personal action against the directors.

Held: The members’ claims were ‘misconceived’. The loss suffered by the members was reflective of the loss suffered by the company, which could be recovered by the company by bringing a claim against the directors. In such a case, the company should bring the action and the members would not be permitted

to recover the reflective loss.


·       The rationalebehind this principle is to preventdouble recovery

o   If both the company and the members could recoverthe loss sufferedby the company, then the defendant would be forced to pay compensation twice or if the member were allowed to recover his loss at the exclusion of the company, then thecompany and its creditors would beharmed

o   Johnson v Gore Wood & Company (No. 1) [2002]: ‘justice to the defendant requires the exclusion of one claim or the other;protection of the interests of the company’screditors requires that it is the companywhich is allowedto recover to the exclusion of theshareholders’

·       Whilst the no-reflective loss principle may prevent personal claims from succeeding, it will not prevent a member from succeeding in a derivative claim à this is because benefits of a derivative claim go to the company, and so no issue of double recovery arises and the company’s creditorsare not adversely affected

·       Thus, the principle applies to any situation where the company and members have a cause of action deriving from the same facts, and not just where the members have a derivative cause of action. It can therefore apply in cases where the wrongdoer was not a director

·       However, the principle will not apply where the defendant’s actions leave the company unable to commenceproceedings,

e.g. where the defendant’s actions cause the company such loss that it cannot afford to commence proceedings ( Giles v Rhind [2002])



·       Section 780, CA 2015allows a member to petitionthe court for a remedyon the ground that the company’s affairswill be, or are being,or have been, conducted in a mannerthat is unfairlyprejudicial to the interests of the membersgenerally (or some part of the members)

·       This is an extremely useful remedy, especially with the courts’ liberal interpretation of phrases such as ‘unfairlyprejudicial’

and ‘interests of members’



·       The conductcomplained of must ‘unfairly prejudicethe interests of members’

·       Historically, the courts would only grant a remedy where the petitioner was bringing the claim in his capacity as a member,

e.g. where an employee of a company (who was also a member), was dismissed by the company, the court refused to grant a remedy on the ground that the member had brought his claim in his capacity as an employee and not a member (Re John Rein &Sons (Strucsteel) Limited [2003])

·       Section 780 focuses on the members interests as opposed to their rights (and their interests are much wider than their rights)

·       In particular, in certain companies, the members may agree that the companyshould be run in a certain manner,but such agreements may never be formalised or inserted into the constitution. In such companies, the courts will not permit the constitution to be relied upon if such reliance unfairly prejudices the interests of members by defeating the ‘legitimate expectations’ (whichhas since been rephrased to, ‘equitable considerations’ (of the members))





O’Neill            v

Phillips [1999]

The defendant gave 25 per cent of a company’s shares to the claimant and appointed him as a director. The defendant also retired from the board, leaving the claimant as the de facto managing director. The profits of the company were initially split 75:25 in favour of the defendant, but this was later amended to provide for an equal share. The company experienced financial difficulties and the defendant returned to oversee management. He also claimed to once again be entitled to 75 per cent of the company’s profits. The claimant left the company and commenced an unfair prejudice claim

Held: The House held that the defendant had not promised that the claimant would always receive 50 per cent of the profits and, at most, had promised that the claimant would receive 50 per cent of the profits only while he acted as de facto managing director. The defendant had not breached the company’s constitution, nor was there anything giving rise to the equitable considerations of which Lord Hoffmann spoke. Accordingly, the claimant’s action failed.


As for equitable considerations – Lord Hoffman stated: “A member of a company will not ordinarily be entitled to complain of unfairness unless there has been some breach of the terms on which he agreed



that the affairs of the company should be conducted. But there will be cases in which equitable considerations make it unfair for those conducting the affairs of the company to rely upon their strict legal


Gamlestaden Fastingheter AB  v  Baltic Partners Limited [2007]

Baltic Partners Ltd (‘Baltic’) was set up to operate a joint venture entered into by the claimant and a man named Karlsten. To finance the venture, the claimant made substantial loans to, and purchased a substantial number of shares in, Baltic. However, shortly thereafter, the claimant alleged that Karlsten and Baltic’s directors had improperly removed funds from Baltic. The claimant alleged that this constituted unfairly prejudicial conduct and that Baltic’s directors should account to Baltic for the withdrawals made. At the time of the hearing, Baltic had become insolvent, and so its directors argued that the payment of compensation to Baltic would benefit the claimant in his capacity as a creditor of Baltic, and so the claim should be dismissed

Held: The court rejected the directors’ arguments and found for the claimant. Lord Scott stated that, in such cases, the claimant should not be precluded from a remedy simply because the remedy would benefit him as a creditor and not as a member.


This case clearly demonstrates how far the courts will relax the member qua member requirement in order to achieve a just and equitable result. Further, as the claimant was apparently seeking to enforce a right that belonged to Baltic, one would assume that the rule in Foss v Harbottle would prevent the claim. This clearly demonstrates that a principal reason for the creation of the unfair prejudice remedy was to

outflank the rule in Foss v Harbottle where fairness requires.


·       What O’Neill establishes is that, in the majorityof cases, the members’ rightsand interests will be the same and will be set out in the company’s constitution. In other cases, however, notably those involving quasi-partnership companies, equitable considerations will arise which can widen the members’ interestsbeyond those found in the constitution

·       The category of equitable considerations is wide and open-ended, however, exclusion from management is a good example and is the issue that arises in most Section 780 cases



·       Upon determination that the interestis one recognised by Section 780, the next step is determination of whether the

company’s affairs have been run in a way so as to unfairly prejudice that interest

·       The courts have taken an objective approach when determining whether or not the conduct complained of is unfairly prejudicial

·       Accordingly, there is no requirement for the petitioner to come with ‘clean hands’, but unmeritorious conduct on behalf of the petitioner might lead the court to hold that the conduct is not fair or that the remedy granted should be reduced (Re London Schoolof Electronics Limited [1986])

·       Re Saul D Harrison and Sons Plc [1994]: the conduct complained of must be unfair and prejudicial

·       Grace v Biagioli [2005]: the petitioner was a member and director of a company. He was removed from office because he was attempting to set up a rival company. The court held that the conduct complained of (i.e. removinghim) was prejudicial, but given the obvious conflictof interests that his actions had created,it was not unfair

·       The courts have repeatedlystated that the words ‘unfairlyprejudicial’ are not to be given a narrow, technicalmeaning,

nor have the courts sought to establisha general test to determine whether or not conduct is unfairly prejudicial

o   Lord Hoffmanin O’Neill: the rationalebehind this is to‘free the court from technicalconsiderations of legalright and to confer a wide power to do what appeared just and equitable’

o   What is fair dependson the context of the case, i.e. ‘conduct which is perfectlyfair between competing businessmen may not be fair between members of family’

·       Examples of conduct which courts have held capableof being unfairlyprejudicial include:

(i)            Non-payment of dividends (Re a Company (No 00370 of 1987) [1988]) or payment of low dividends (Re Sam Weller & Sons Ltd [1990])

(ii)            Exclusion from the management of a quasi-partnership company (Re Ghyll Beck Driving Range Ltd [1993])

(iii)            Serious mismanagement (Re Macro (Ipswich)Ltd [1994]) à Note that the mismanagement must be serious—normal mismanagement will not normallyconstitute unfairly prejudicial conduct (Re ElgindataLtd (No 1) [1991])

(iv)            Preventing the membersfrom obtaining the best price for their shares (Re a Company (No 008699 of 1985) [1986])

(v)            The payment of excessive remuneration to the directors(Re Cumana Ltd [1986])

(vi)            Improper transfer of assets (Re London Schoolof Electronics Ltd [1986])


4.2.3       REMEDIES

·       Where a Section 780 petition is successful, the court has considerable remedial flexibility in that it can make ‘such order as it thinks fit for giving relief in respect of the matters complained of’ (Section 782(1), CA 2015)

·       Section 782(2),CA 2015 providesa non-exhaustive list of examplesof orders that the courtcould make, including:

(i)            An order regulating the conduct of the company’s affairs in the future (e.g. deprivinga director of certain powers);

(ii)            An order requiringthe company to refrain from doing an act, or to performan act that it has failed to perform;

(iii)            An order requiring the company not to make any changesto its articles without the court’s permission;

(iv)            An order requiringthe petitioner’s shares to be purchased by the companyor by another member

·       A Section 780 petition is not subject to a limitation period but, as the granting of relief under Section 782 is discretionary, the court may refuse to grant a remedy where a significant period of time has elapsed between the conduct complained of and the petition being brought



·       Perhaps the most extreme remedy available to an aggrieved member is to petition the court for an order winding up the company – this remedy is available under Section 393(1), IA 2015

·       The two principal circumstances in which a winding up may be ordered are:

(i)            Where the company passesa special resolution resolving that the company shouldbe wound up (Section 393(1)(b), IA 2015). However, this remedy will be of little use to a minority shareholder

(ii)            Where the court is of the opinion that it is just and equitable to doso (Section 429(1)(g), IA 2015). A single member can petitionthe court underthis section, so it is a potentially significant remedy



·       The words ‘just and equitable’ are broad terms and the courts have not sought to exhaustively define when a winding up will be ordered. Despitethis, certain instances can be identified where courts are more likelyto order a winding up:

(i)            Where the company is fraudulently promoted(Re London and CountyCoal Co [1886]) or is set up for a fraudulent purpose (Re Walter JacobLimited [1989])

(ii)            Where the company is deadlocked (i.e.where management or the membersare divided and refuse to be reconciled) and is unable to make any decisions (Re Yenidje Tobacco CompanyLimited [1916])

(iii)            Where the company’s objectsclause indicates that it has been formedfor a specific purpose (this is known as the company’s‘substratum’) and it becomes impossible to fulfil this purpose (Re GermanDate Coffee Company[1882])

à with the introduction of default unrestricted objects, cases involving loss of substratum will lessen significantly over time

(iv)            Where the directors display a lack of probity(i.e. honesty or decency) (Loch v John BlackwoodLimited [1924]) à

note: mere negligence or inefficiency will not suffice




·       A companymay be run by personswho call themselves ‘governors’ or ‘managers’and, increasingly, personsnot involved

in management at Board level are called ‘Directors’

·       Section 3, CA 2015 defines a ‘director’ as follows: In relation to a body corporate, a director includes:

a)       Any person occupying the position of a directorof the body (by whatevername the personis called); and

b)       Any person in accordance with whose directions or instructions (not being advice givenin a professional capacity) the directors of the body are accustomed to act

·       A director can be a natural or legal person, but every company must have at least one director who is a natural person (Section 129(1),CA 2015)

·       The broad definition of ‘director’ will cover those who have been validly appointed to the office of director (known as de jure (‘in law’) directors), but will also cover persons who have not been validly appointed, but who act as directors (known as de facto (‘in fact’) directors). De facto directors, although not validly appointed, are therefore directors under the Act and subject to therelevant provisions (‘Directors’ duties’)

·       A person who has neither been appointed a director, nor acts as a director, may be treated as a director if he is ‘a person in accordance with whose directions or instructions the directors of the companyare accustomed to act’, other than where that adviceis given in a professional capacity à such a personis known as a ‘shadow director’.



·       Section 128,CA2015: every private company must have at least one directorand every publiccompany must have at least two directors à The proposed directorsof the company will become its directors officially upon incorporation

·       Thereafter, the power to appoint directors is a matter for the articles, but where the articles are silent on this issue, the power to appoint directors is vested in the members and is usually exercised by passing an ordinary resolution (Worcester Corsetry Limited v Witting[1936])

·       The model articles for private companies limited by shares and the model articles for public companies provide that directors may be appointed by an ordinary resolution of the members, or by a decision of the directors

·       Whilst generally anyone can act as a director, certain types of persons are prohibited by statute from being appointed (e.g.

a minor, or a company’s auditor,cannot be appointed as its director)



·       Collectively, the directors of a companyare referred to as the ‘Board’à Much of a company’s power is concentrated in its

Board, which exercises its powers via board meetings(not to be confused with general meetings of the company)

·       The procedures relating to Board meetings are a matter for the company’s articles and decisions of directors are only valid if made at a board meeting, unless all the directors agree to, or acquiesce to, a decision (Charterhouse Investment Trust Ltd v Tempest DieselsLtd [1986])

·       The law does not require that all the directors must be present at a board meeting, but decisions of board meetings will only be valid if a quorum can be obtained. The model articles set the quorum at two (unless the company is private and only has one director, in which case, it will be one), and decisions taken at a meeting that lacks a quorum (‘inquorate’) are invalid

·       The power to run a company is initially vested in its members. However, in all but the smallest private companies (where the directors and members are usually the same persons), it is impractical for the membersto exercise day-to-day control over the company’s affairs. Accordingly, the members’ powers are usually delegated to the company’s directors via the article

·       The directors only have such power as is delegated to them by the members, with most companies having a provision in their articles that delegatesthe day-to-day controlof the company to the directors. In such cases,the power to manage is vested in the directors and the members have no right to interfere with management, unlesssuch power has been reservedfor the members via the articles or statute

·       Article 3 of both the model articles for private companies limited by shares and public companies provides that ‘subject to the articles, the directors of the company are responsible for the management of the company’s business, for whichpurpose they may exercise all the powers of the company’ à this vests considerable power in the directors, but as it is ‘subject to articles’, provisions can be inserted into the articles that affect this balance of power




Automatic Self Cleansing Filter Syndicate Co Ltd v Cuninghame


The articles of a company conferred general powers of management upon its directors and provided that they could sell any property of the company on such terms as they deemed fit. The members passed an ordinary resolution resolving to sell the company’s assets and undertakings, but the directors did not believe that such a sale was in the interests of the company and so refused to proceed with the sale.

Held: The right to manage the company and the right to determine which property to sell was vested in

the directors. Accordingly, the directors were not required to comply with the resolution, unless the articles so provided

Salmon v Quin & Axtens Limited [1909]

The company’s articles conferred general powers of management upon the directors, but such powers were subject to the articles. Article 80 provided that decisions of the directors relating to the acquisition of certain properties would be invalid if two named members were to dissent. The directors decided to acquire such property, but the two named members vetoed the decision. A general meeting was called, and the other members passed an ordinary resolution resolving to acquire the property. The two members who vetoed the decision sought an injunction to restrain the property acquisition.

Held: Whilst the directors had a general power of management, it was subject to the articles. Accordingly, the veto exercised by the named members was valid and the company could not override it by passing an

ordinary resolution. The House therefore granted an injunction restraining the acquisition


·       In both Automatic Self Cleansing and Salmon, ordinary resolutions passed by the members could not affect the powers conferredby the articles, as this would permit the membersto indirectly alter the articlesby way of an ordinaryresolution (when the correct procedure is to go by way of a special resolution)

·       However, whilst general power is vested in the directors, the members retain a specific statutory supervisory power exercisable by passing a special resolution à Article 4(1) of the model articles: ‘Members reserve powers’ states that ‘the members may, by specialresolution, direct the directors to take, or refrain from taking, specifiedaction’

·       It is noteworthy that where the directors are unable or unwilling to exercise the powers of management conferred by the articles, then the general powers of management revertback to the members(Barron v Potter [1914])



·       The problemwith having such a concentration of power vestedin the directors is that they might be tempted to use their

powers to benefitthemselves, or to engage in acts that are not in the company’s interests

·       The law aims to discourage such behaviour in several ways, with the principal methodbeing the imposition upon directors of a number of legal duties

·       The common law duties of directors (spanning over a mass amount of case law, making it unclear, inaccessible and out of date) has been abolishedand replaced by the new codified directors duties under the Companies Act the general duties are found in Section 140 – 147, CA 2015 while the law relating to director transactions that require member approval hasbeen re-stated at Sections155 – 179, CA 2015

·       The CA 2015 refers to the newly codified duties as the ‘general duties’ and provides that they are ‘based on certain common law rules and equitableprinciples as they applyin relation to directors’ (Section140(3), CA 2015)

o   This makes clear the fact that codification has not radically altered the content of the duties, but has merely restated them in a more appropriate manner(although notable reformshave been made)

o   The lack of change ensuresthat the significant and authoritative pre-2015body of case law that exists will remain relevant—a fact backed up by Section140(4), CA 2015, which providesthat ‘regard shall be had to the corresponding common law rulesand equitable principles in interpreting and applying the general duties’ 

o   By preserving the remedies already set out in case law, the law remains flexible as the courts can continue to develop existingcase law in a way that would not have been possibleif the remedies had been set out in statute.

·       As under the common law, the directors owe their duties to the company (section 170(1), CA 2015) and do not generally owe their duties to members, creditors, employees, or anyone else à the result is that generally, only the company itself can commence proceedings to remedy a breach of the directors’ duties, although in some cases the members might be able to commence proceedings via the derivative claim



·       Section 142, CA 2015:this first general duty is an amalgamation of two prior common law duties, namely:

a)       The duty to act in accordance with the company’s constitution; and

b)       The duty to exercise powersonly for the purposes for which they are conferred

·       While the capacity of the company and the powers of the company are predominantly set out in the company’s articles, and the default position is that companies created under the CA 2015 will have unrestricted objects, it is common for companies to impose some form of limitation on the directors’ power and directors who breach such limitations (e.g. by acting ultra vires) will likely breach the duty found in Section 142(a)

·       The second strand of Section 142 is arguably more important, and this strand is based on the common law ‘proper purpose’

doctrine it provides that directors must exercise their powers only for the purposesfor which they are conferred

o   This duty is wide-ranging and applies to all the powers of a director

o   However, much of the case law in this area circles around the directors’ powers to allot shares, or the extent to

which directors can frustratea takeover bid

·       If the directors’ have acted for the dominantpurpose of maintaining themselves in office, manipulating voting power or

benefitting themselves financially, then the duty will likelyhave been breached





Howard Smith Limited v Ampol Petroleum Limited [1974]

The claimant controlled 55 per cent of shares in company X, and wanted to take it over. The defendant made a rival bid which was rejected by X’s majority shareholder, namely the claimant. The directors of X favoured the defendant’s bid, but this bid could not succeed so long as the claimant was the majority shareholder. Accordingly, the directors of X issued a batch of shares and allotted them to the defendant. The purpose of the share issue was (i) to raise capital to purchase a new oil tanker and (ii) to reduce the claimant’s shareholding to 37 per cent, thereby preventing it from rejecting the defendant’s bid. The claimant alleged that the issue of shares was for an improper purpose.

Held: Where the directors exercise their powers for several purposes, the court should objectively determine what is the dominant purpose. If the dominant purpose is proper, no breach of duty will occur, even though subservient improper purposes might exist, and vice versa. Applying this, the court held that

the dominant purpose of the share issue was to relegate the claimant to the status of minority



shareholder. This was unsurprisingly deemed to be an improper purpose, and so the directors of X had

breached their duty to act for a proper purpose

Hogg v Cramphord


Where directors act for an improper purpose, such acts are voidable at the company’s instance and the

directors in question may be required to compensate the company for any loss sustained. However, both consequences can be avoided if the members ratify the breach of duty



·       Section 143, CA 2015: a director must ‘act in the way he considers, in good faith, would be most likely to promote the success of thecompany for the benefitof its members as a whole’

·       This is a reformulation of the common law duty to act bona fide in the interests of the company (Re Smith and Fawcett Limited [1972]), and it is arguably the most important general duty and the duty that has undergone the most change as a result of codification

·       The wording of Section 143 clearly indicates that the duty is subjective, meaning that what matters is what the directors honestly believed would promotethe success of the company

o   Itis not the court’s place to substitute its views for those of the directors. Accordingly, provided that the decisionof the directors was honest, it does not matter that it was unreasonable (Extrasure Travel Insurance Ltd v Scattergood [2003])

o   However, there are limits on the subjectivity of the duty. In Hutton v West Cork Rly Co [1883], the court held that if the duty was entirely subjective then ‘you might have a lunatic conducting the affairs of the company, and paying away its money with both hands in a manner perfectlybona fide yet perfectly irrational’

·       Therefore, the courts will closely examine the evidence and try to determine whether or not the directors honestly believed that their actions were aimed at promoting the success of the company for the benefit of its members

·       Where a director’s act or omission causes the company harm, the court will not be easily persuaded that the director honestly believed his actions to be in the company’s interest (Regentcrest Plc v Cohen [2001])

·       Where the evidence does not provide a conclusive answer, the courts will temper the subjective test with an objective examination, but the test still remains primarily subjective

·       In situations where the director has not considered whether his act or omission will promote the success of the company for the benefit of the members, the proper test would be ‘whether an intelligent and honest man in the position of the directorof the company concerned could … have reasonably believed that the transaction was for the benefit of the company’ à accordingly, in such a casethe test becomes primary objective

·       In cases where the interests of the company and the membership conflict, preference should be given to the interests of the company(however, whether the directors can favour the company over the members as a whole is unclear)

·       A common criticism levelled at the previous common law duty was that it overly prioritized the interests of members and failed to acknowledge the effect that the directors’ actions can have on other constituents, such as employees, creditors or the environment. Therefore, Section 143(1) provides that when directors are considering what would promote the success of the company for the benefit of its members,regard must be had (amongstother things) to:

o   The likely consequences of any decisionin the long-term;

o   The interests of the company’s employees;

o   The need to foster the company’s businessrelationships with suppliers, customers, and others;

o   The impact of the company’s operation on the community and the environment;

o   The desirability of the companymaintaining a reputation for high standards of business conduct;and

o   The need to act fairly as betweenmembers of the company

·       Where a director acts in a manner that breaches Section143, that act is voidableat the company’s instance

·       Where the act also causes the company to sustain loss, those directors in breach will be required to indemnify the company for such loss

·       Of course, as the duty is owed to the company, the company will be the proper claimant unless the members can bring a derivative claim. Given the breadth of the duty, it can be difficult for the members to determine whether or not the directors have breached the duty




Mutual Life Insurance Co. of New York v Rank Organisation [1985]

The defendant company issued 20 million shares, half of which were made available, on preferential terms, to existing shareholders. However, existing shareholders in the USA and Canada were excluded from this offer on the ground that to include them would require the company to comply with complex legislation in those countries, which would prove costly and therefore would not be in the company’s interests. The claimant (an organization acting on behalf of a number of the defendant’s American shareholders) objected to the exclusion.

Held: The directors of the defendant had exercised their powers in the interest of the company, and so, in favouring the company over some part of the shareholders, had not breached their


Item Software (UK) Limited v Fassihi [2004]

The court held that a director who breaches a fiduciary duty will be required to disclose that breach of duty to the company if the duty to act in the interests of the company requires such


British Midland Tool Limited v Misland International Tooling

Limited [2003]

The court held that this obligation extends to disclosing the breaches of fellow directors. In keeping with the subjective nature of this duty, the key factor is whether the director honestly considers that it is in the company’s interest to know about the breach (Fulham Football Club

(1987) Ltd v Tigana [2004])

GHLM Trading Ltd. v Maroo [2012]

Newey J went further and stated, obiter, that this duty of disclosure could extend to disclosing matters other than wrongdoing and that disclosure might be justified to a person other than a

board member

Tesco Stores Limited v

Pook [2003]

A failure to disclose can result in a loss of employment benefits (e.g. share options, or certain

employment rights) and may provide a justification for summary dismissal



·       Section 144, CA 2015: the third general duty, namely the duty to exercise independent judgment, is a reformulation and encapsulation of the commonlaw duty placed upon directors not to fettertheir discretion when exercising theirpowers

·       However, this duty was not absolute, and the courts recognized that directors could fetter their discretion and bind themselves to act in a certain way if they bona fide believed such an action to be in the interests of the company (Fulham Football Club Ltd v Cabra EstatesPlc [1992])

·       This principle has been preserved by Section 144(2)(a), which provides that the duty to exercise independent judgment will not be breached where the directors act ‘in accordance with an agreement duly entered into by the company that restricts the future exerciseof discretion by its directors’. Additionally, Section 144(2)(b) provides that the duty will not be breached where the director acts in a way that is authorized by the company’s constitution

·       Any agreement entered into that contravenes Section 144, CA 2015, will be voidable at the company’s instance à Any directors in breach will also be required to account for any gains made and indemnifythe company for any lossessustained as a resultof the breach



·       Section 145, CA 2015: this places a duty on directorsto ‘exercise reasonable care, skill and diligence’

·       The common law had imposed a similar duty on directors long before the CA 2015 was passed (Re City Equitable Fire Insurance Co Ltd [1925]), but the common law duty was heavily subjective and based on the skills and experience that the director actually had. Accordingly, a director with little skill or experience would be subject to an extremely low standard of care (e.g. Re CardiffSavings Bank [1892]; Re Brazilian RubberPlantations and EstatesLtd [1911])

·       The effect of the subjective duty was to allow unskilled, inexperienced, and incompetent directors to use their deficiencies as a shield against liability

·       Therefore, the courts added an objective element to the duty and this dual subjective/objective test has now been incorporated into the Section145 duty à Section 145 now provides that the standardof care, skill,and diligence expectedof a director is based on that of a reasonably diligent person with:

a)       The general knowledge, skill and experience that may reasonably be expected of a person carrying out the functionscarried out by the director in relation to the company; and

b)       The general knowledge, skill and experience that the directoractually has

·       The test found in (a) imposes an objective minimum standard of care that will apply to all directors, irrespective of their individual capabilities, i.e. Directors can no longer use their lack of skill or experience as a means of lowering the standardof care

·       However, this standard will take into account the functions of the director, so the standardwill likely vary from directorto director (e.g. the standard imposed on a director of a small private company will likely differ to the standard imposed on a director of a listedcompany), thereby providing the courts with a measure of flexibility

·       The test found in (b) imposes a subjective standard that will apply where the director has some special skill, qualification, or ability (e.g. he is a lawyer or an accountant) and will serve to raise the standard expected of the director (there is the argument advanced that such a higher standard might deter such qualified persons from undertaking directorial office for fear of the repercussions)





Re Barings Plc (No. 5) [2001]

Barings Bank collapsed in 1995 following the unauthorised trading activities of a trader named Nick Leeson, which resulted in the bank sustaining losses of £827 million. The case concerned three of the bank’s directors who, it was alleged, had made serious errors of management in relation to Leeson’s activities. At first instance, Parker J held that the three directors should be disqualified. The Court of Appeal upheld the disqualifications and it also affirmed principles in relation to the duty of skill and care, namely:

·       Directors have a continuing duty to acquire and maintain a sufficient knowledge and understanding of the company’s business to enable them property discharge their duties;

·       Whilst directors are entitled to delegate particular functions to those below them, and trust their competence and integrity to a reasonable degree, such delegation will not absolve the director of the duty to supervise the discharge of the delegated functions;

·       The extent of the duty, and the question as to whether it has been discharged, must depend on the facts of each particular case, including the director’s role in the company’s management.


I.E.: continuous acquisition of knowledge for discharge of functions; delegation is permissible but with supervision; and, discharge of duty is dependent on the facts of each case.



·       Section 146, CA 2015: provides that a director of a company shall avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or may conflict,with the interests of the company

·       Section 146(2), CA 2015 provides that this duty arises in particular to ‘the exploitation of any property, information, the director’s position or opportunity’ and it is irrelevant whether or not the company wishes or is able to take advantage of the property, information or opportunity

·       The fact that the profit made bythe director is negligible and also irrelevant (Towers v Premier WasteManagement Limited [2011])

·       However, Section 146(3) states that the section does not apply to transactions which have been authorised by other directors





Bhullar v Bhullar [2003]

For over 50 years, the families of two brothers (M and S) had run a company that let commercial property. Following an argument, it was decided that the families would part ways. The claimants (M’s family) proposed that the company should not acquire any further properties and the defendants (S’s family) agreed. A director, who was part of the defendants’ family, discovered, by chance and not whilst acting in the course of the company’s business, a piece of property near

to a piece of property owned by the company. Through another company that they owned; the



defendants acquired this property without informing the claimants. The claimants alleged that the defendants had acted in conflict with the interests of the company.

Held: Although the defendants acquired knowledge of the property in a ‘private’ capacity, the opportunity to purchase the property was one that belonged to the company. Whether or not the company could have or would have acquired the property (because it was in the process of

being wound up) was irrelevant.


·       Under pre-2015 law, the director could disclose the conflict and obtain authorization from the companyin general meeting,but companies could provide,in their articles,that disclosure and authorization from the board would be sufficient

·       Under the CA 2015, authorisation works in the following manner:

o   Private companies: authorization from the directors alone will suffice (unless the constitution provides otherwise, as the model articlescontain no such prohibition) therefore avoiding the need to organizea general meeting

o   Public companies:the directors can provide authorization, but only if the constitution so provides (the model articles do not contain a provision allowing the directors to authorize a conflict). However, transactions involving more than 10% of the value of the assets of the company must be authorized by members in general meeting (Section 146(5)(b), CA 2015)

·       Where a director fails to obtain valid authorization, any resulting contract is voidable at the company’s instance, provided that the third party involved had notice of the director’s breach (Hely-Hutchinson & Co Ltd v Brayhead Ltd [1968]). In addition, the company can require the director to account for any profitmade as a result of the conflict(Aberdeen Railway Co v Blaikie Bros [1854])

·       NOTE: statutory duties are not mutually exclusive, and a single act may breach several duties. In Industrial Development Consultants Ltd v Cooley [1972], the court held that a director who fails to disclose the existence of a conflict may, in additionto breaching a duty involving a conflict of interest, also breach the duty to act in the interests of the company



·       Section 147, CA 2015: provides that a director must not accept from a third party a benefit conferred by reason of his being a director, or by doing (or not doing) anything as a director

·       As with Section 146, motive is irrelevant, and it will be no defence for the directorto argue that he acted in good faith

·       However, the Section 147 duty will not be breached where ‘the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest’. Accordingly, the duty only arises in relation to benefits that are likely to give rise to a conflict of interest

·       The key difference between Section 146 and Section 147 is that a conflict under s 146 can be authorized by the directors, whereas a conflict under s 147 can only be authorized by the membersin general meeting(this is not expressly stated,but is a consequence of Section 148(1),CA 2015, which preserves the common law rules relatingto authorization). This clearly indicates that the receipt of benefits from third parties constitutes a greater dangerto board impartiality than the conflicts of interest

·       Should a director acceptan unauthorized third-party benefit, the companycan:

o   Rescind the contractand the benefitcan be recovered (Shipway v Broadwood[1899]);

o   Instead of recovering the benefit, claim damages in fraud from either the director in breach or the third party; and

o    Summarily dismiss the director (Boston Deep Sea Fishing Co v Ansell[1888])



·       Section 151, CA 2015: if a director of a company is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, or in a transaction or arrangement that the company has already entered into, the director shall declare the nature and extent of that interest to:

a)       The other directors; and

b)       If the companyis a public company,to the members of the public companywithin 72 hours

·       Under Section 151(5), CA 2015, the declaration must be made before the company enters into the transaction or arrangement (which is absurdfor transactions the company has already entered into). Two points should be noted:

o Like Section 146, the duty under Section 151 only applies to transactions or arrangements likely to give rise to a conflict of interest; and

o   As the duty covers indirect transactions/arrangements, the director does not actually need to be a party to the transaction/arrangement in orderfor the Section 151 duty to be breached

·       The duty relates to both existing andproposed transactions or arrangements

·       Where a director enters into a transaction in contravention of Section 151, the transaction is voidable at the company’s instance. For existing transactions, it is unlikely the company would void the transaction, but would probably seek other remedies from the director

·       Under Section 151(10), CA 2015, a director who contravenes this section commitsan offence and is liableon conviction to a fine notexceeding one million shillings








SECTION 146 Duty to

avoid               conflicts         of interest

The CA 2015 does not expressly require the director to disclose the conflict of interest/benefit. However, as authorisation is required for the transaction, the director will (in practice) need to disclose the existence of the conflict/benefit prior to obtaining authorisation. Further, the courts have made clear that a director should disclose the existence of a conflict/interest in order to comply with the duty to act in the best interests of the company

Private companies: Yes directors can authorise the interest, provided that the constitution does not prohibit such authorisation


Public companies: Yes only if the constitution so provides and the amount is below 10% of company asset value

SECTION 147 Duty not to accept benefits from

third parties



Yes the benefit must be authorised by members in a

general meeting

SECTION 151 Duty to

declare interest in proposed transaction or arrangement with the company

Private companies: Yes the director must disclose the nature and extent of the interest to the other directors


Public companies: the director must disclose the nature and interest to the other directors if the amount is above 10% of the

company asset value

Disclosure must be made prior to the company entering the transaction or arrangement in accordance with Section 152, and for a public company the disclosure must be made within 72 hours

No, but if the directors do not approve        of                          the transaction/arrangement, they will likely prevent the company from entering into it

SECTION 151 Duty to

declare interest in existing transactions or arrangements with the



Disclosure must be made as soon as is reasonably practicable




·       In addition to the general duties, the law imposes more specific ‘duties’ in relation to certain transactions or arrangements

the directors enterinto with the company

·       Asthese transactions are between the company and the director,they could be regarded as specific cases involving a conflict of interest

·       In relation to such transactions or arrangements, compliance with the general duties is insufficient (Section 150(3),CA 2015) and member approval is also required



·       Historically, directors would try and make it expensive to remove them from office by negotiating lengthyservice contracts. E.g., if a company wished to remove a directorfive years before his service contract is to end, and he was paid Kshs. 2

million per year, the company would have needed to pay the director Kshs. 10 million in compensation for early termination of his contract.

·       Section 157, CA 2015 has curtailed this practice by providing that a director cannot have a guaranteed term of employment of over two years, unless it has been approved by a resolution of the members à Where Section 157 is breached, the relevant contractual provision will be void and the contract will be deemed to contain a term allowing the company to terminate it atany time by giving reasonable notice (Section 157(8), CA 2015)



·       Under the general duties, a director with a conflict of interest can avoid committing a breach of duty if he discloses that interest to the other directors

·       However, where the arrangement constitutes a ‘substantial property transaction’, disclosure alone is insufficient and the company must not enter into the arrangement unless it has first been approved by a resolution of the members, or is conditional upon such approval being obtained (Section 158(1), CA 2015)

·       There are two types of arrangement require such approval:

a)       Where a director of a company,or a person connected with the director,acquires, or is to acquire,a substantial non-cash asset; or

b)       Where the company acquires,or is to acquire, a substantial non-cashasset from such a directoror person so connected

·       A ‘non-cash asset’is any property or interest in property, other than cash, and it will be substantial if its value:

a)       Exceeds ten per cent of the company’s assetvalue and is more than five millionshillings; or

b)       Exceeds ten millionshillings. (Section 158(7),CA 2015)

·       A substantial property transaction enteredinto without memberapproval is voidableat the company’s instance, unless:

o   Restitution is impossible;

o   The company has been indemnified; or

o   A third party’s rights would be affected(Section 162(1), CA 2015)

·       Additionally, any director or connected person involved in the arrangement will be liable to account for any gains made, and will be liable to indemnify the company for any losses sustained as a result of the arrangement



·       Under the repealed Companies Act, companies were generally prohibited from making any form of loan to dire ctors, and breach of this prohibition constituted a criminal offence

·       The CA 2015 takes a very different approachthat is dependent upon the type of transaction in question:

(i)            Section 164(1): no company can make a loan to a director unless the transaction has been approved by a resolution of the members

(ii)            Section 165: a public company cannot make a quasi-loan to a director unless the transaction has been approved by a resolution of the members à A quasi-loan occurs where a company agrees to pay a sum on behalf of the director, or where it reimburses expensesincurred by anotherdue to the actions of the director

(iii)            Section 166: a public company cannot make a quasi-loan to persons connected to a director unless the transaction has been approved by a resolution of the members

(iv)            Section 167(2): a public company cannot enter into a credit transaction (e.g. hire purchase or conditional sale agreements, the leasing or hiring of goods) with a director unless it has been approved by a resolution of the members



·       Section 180(1), CA 2015: the law requires that the members approve certain voluntary payments made by the company to directors losingoffice

·       Section 182(1), CA 2015 prescribes that a company cannot make such a payment unless the payment has been approved by a resolution of the members à however, certain payments are excluded from this requirement, e.g. payments not exceeding Kshs. 30,000/= or paymentsthat discharge an existing legal obligation

·       Where approval is not obtained, the recipient holds the payment on trust for the company and the director who authorised the payment is jointly and severally liableto indemnify the company for loss resulting from the payment(Section 187(1))


·       A directorwho has committed a breach of duty may attempt, or be able, to obtainrelief from liability in several ways:

(i)            A director’s service contract or the company’s articles may contain a provision excluding liability for negligence, default, breach of duty, or breach of trust. Such provisions are void (S. 194(2)). Similarly, provisions requiring the companyto indemnify the director for losses sustained due to his breach of dutyare also generallyvoid (S. 194(3)).However, it is not illegalto obtain insurance againstliability for director’s negligence (S. 195)

(ii)            S. 207 puts in place, for the first time, a statutory scheme concerning ratification of acts committed by directors that amount to negligence, default, breach of duty, or breach of trust. Such ratification can serve to prevent a derivative claim from being brought (indeed, S. 241(2)(c) provides that permission to continue a derivative claim will be refused where the act has been ratified). Ratification requires a resolution to be passed, and where it occurs, any causeof action is extinguished. However,acts that cannot be ratifiedunder pre- 2015 law

(iii)            Where an officer of the companyis found liable for negligence, default,breach of duty,or breach of trust, then s 763 of the CA 2015 allows a court to grant that officer, either wholly or partly, relief from liability on such terms as it sees fit. An officer of the company can also petition the court for such relief



·       A director’s term of officemay be terminated in numerousways:

o   The articles may provide that a director’s office will terminateupon the occurrence of a certain specifiedevent,

e.g. where an individual is prohibited from law by being a director;

o   Where the directorrelinquishes office by giving noticeto the company and the company acceptshis resignation;

o   Or, where the articles providefor the retirement of directorsby rotation (common in public companies)



·       Section 139(1), CA 2015: a company may, by ordinary resolution at a meeting, remove a director before the expiration of his period ofoffice, notwithstanding anything in any agreement between it and him

·       This sectioncan also be used to remove multipledirectors

·       The words ‘at a meeting’ indicatethat the writtenresolution procedure cannotbe used

·       While the power granted to members under this section appears extremely substantial, Section 139(6)(a) mitigates its usefulness by stating that removal does not deprivea director of compensation payableas a result of the removal à ifthe directors’ remuneration is substantial or his service contract lengthy, this compensation may be extremely high

·       In addition, Section 139 should not be construed as derogating from any power to remove a director that exists outside the section, e.g. the articles may contain a provision allowing removal of a Board member via a Board resolution, and the advantage of using a separate Board power is thatit will not be subjectto the procedural requirements of Section 139



·       The CA 2015 also grants the courts power to make orders disqualifying persons from being directors as a sanction for breach of a duty (Section 146(12), CA 2015 sets out the provisions for disqualification)

·       The effectof a Disqualification Order (under Part X, CA 2015)is that the person is disqualified from:

a)       Being or acting as a director or secretary of a company;

b)       Being or acting as a liquidator, provisional liquidator or administrator of a company;

c)       Being or acting as a supervisor of a voluntary arrangement approved by a company;or

d)       Inany way, whether directly or indirectly, being concerned in the promotion, formation or management of a company,for such period as may be specified in the order(Section 214(1), CA 2015)

·       The period of disqualification specified in a Disqualification Orderbegins at the end of 21 days from and including the date of the order, unless the relevant court otherwise orders



·       On convicting a person of an offence relating to the promotion, formation, management, liquidation or administration of a company, the court may make a disqualification order against the person

·       The maximum period of disqualification that can be imposed in a disqualification order made under this section is, if the disqualification order is made by a magistrate’s court, five years; and in any other case, fifteen years. The application of this section is not limited to offences under this Act



·       This section applies to an officer of the company; a liquidator or provisional liquidator of the company; or if the compan y is under administration the administrator

·       A court may make a disqualification order against such person if, while the company was under administration or in liquidation, it is satisfied that the person has, been found guilty of fraud in relation to the company; or any breach of duty as the holder of such an office

·       The maximumperiod that can be imposedin a disqualification order made under this section is fifteen years



·       The CA 2015 has now made it an offence to fail to comply with any provision of the Act or the insolvency related laws requiring:

a)       A return, financial statement or other document to be lodgedwith, or sent to the Registrar; or

b)       Amatter to be notified to the Registrar, whether the failureis by the person or any companyof which the person is an officer

·       If a person is convicted of an offence to which this section applies, the convicting court may make a disqualification order against the person if, during the five years ending with the date of the conviction, the person has been convicted of no fewer than three such offences

·       The maximumperiod that can be imposedin a disqualification order made under this section is five years



·       The CA 2015 has also now given directorsstatutory responsibility for the propermanagement of companies

·       A court shall make a disqualification order against a person if satisfied, onan application made to it under Section219, that the person is or has been a director or secretary of a company that has at any time become insolvent whether while the person was a director or secretary or subsequently; and that the conduct of the person as a director or secretary of that company either taken alone or taken together with the person’s conduct as a director or secretary of any other company or companies makes the person unfit totake part in the management of a company



·       If the Attorney General is satisfied that it would be in the public interest for a disqualification order under section 218 to be made againsta person the Attorney General;or at the Attorney General’s direction, the OfficialReceiver, may make an application to a court for such an order

·       Except with the leave of the relevant court, anapplication for the making of an order under section218 of a disqualificatio n order against a person may not be made after the expiry of two years from and including the day on which the company of which the person is or has been a director or secretary became insolvent

·       Alternatively, the Attorney General may accept a disqualification undertaking if of the view that it would be in the public interest to do so, insteadof applying, or proceeding with an application, for a disqualification order à He must be satisfiedthat the conditions referred to in Section 218(1) are complied with in relation to a person who has offered to enter into a disqualification undertaking

·       A disqualification undertaking(Section 220, CA 2015) is an undertaking by a person that for a period specified in the undertaking, the person will not, without the leave of a court of competent jurisdiction, act or accept an appointment as a director or secretary of a company; or in any way (whether directly or indirectly) be concerned in the promotion, formation or management of a company; and will not act as a liquidator, provisional liquidator or administrator of a company

·       The maximum period that may be specified in a disqualification undertaking is fifteen years and the minimum period that may be so specified is two years



·       If, as result of a report of an investigation conducted under Part XXX, the Attorney General considers that it would be in the public interest for a disqualification order to be made against a person who is or has been a director or secretary of any company,the Attorney Generalmay apply to the Court for a disqualification order to be made againstthat person

·       The court may make a disqualification order against a person if, on an application underthis section, it is satisfiedthat the person’s conduct in relation to the companymakes that person unfitto take part in the management of a company

·       The maximumperiod that can be imposedin a disqualification order made under this section is fifteen years



·       The two principal types of capital that companiesacquire are sharecapital (capital obtainedby selling shares) and debt capital (capital borrowed from others)

·       A new allotment of shares must usually be offered to existing shareholders first

·       Companies are prohibited from allotting sharesfor less than their nominalvalue

·       Companies can issue different classes of shares with different class rights, and the law regulates the ability to vary such class rights

·       Public companies are subjectedto minimum capital requirements when commencing a business, whereas privatecompanies are not a reduction of share capital is only valid if the strict procedures relating to a reduction of the capital, found in the Companies Act 2015, are complied with

·       Companies are generally prohibited from purchasing their own shares, but the Companies Act 2015 does provide exceptions to this prohibition

·       Private companies are permitted to provide financial assistance to acquire their own shares, while public companies are generally prohibited from providing such assistance (but there are exceptions)

·       Companies can only pay a dividend out of ‘profitsavailable for the purpose’

·       The two principal types of charge are fixed charges and floating charges and, in order to be enforceable, charges need to be registered in accordance with the Companies Act 2015



·       A share is an item of property known as a ‘thingin action’ in a legal sense,a ‘thing’ (formallyknown as a ‘chose’) is simply an item of property other than land, and a thing in action is simply an intangible thing which – being intangible – can only be claimed or enforced by legal action, as opposed to takingpossession of it

·       Being intangible, a share has no physical existence, but instead confers a number of rights and liabilities upon its holder, including providing evidence of the existence of a contract between the shareholder and the company (‘the constitution as a contract’)

·       However, share ownership does not give the shareholder a proprietary right over the assets of the company ( Borland’s

Trustee v Steel Bros & Co Ltd [1901]), as the assetsbelong to the corporate entity

·       The Companies Act 2015 defines‘shares’ as:

a)       In relation to an undertaking with a share capital, means shares in the sharecapital of the undertaking;

b)       In relation to an undertaking with capital but no share capital, means rights toshare in the capital of the undertaking; and

c)       In relation to an undertaking without capital, means interests: (i) conferring a right to share in the profits, or the liability to contribute to the losses,of the undertaking, or (ii) giving rise to an obligation to contribute to the debts or expensesof the undertaking in the event of a liquidation




·       Section 324(3), CA 2015: all shares ina limited companywith a share capital are required to have a fixed ‘nominalvalue’

and failure to attach a nominal value to an allotment of shares will render that allotment void

·       The nominal value is a notional value of a share’s worth but, in reality, it may bear no resemblance to a share’sactual value

à it represents the minimum price for which the share can be allotted and it also helps in determining the liability of a shareholder in the event of the company being liquidated

·       Whilst shares cannot be allotted for less than their nominal value, it is common for shares to be allotted for more than their nominal value and the excess is known as the ‘share premium’ (i.e. the share premium represents the difference between the nominal value and the market value of the share)



·       The conceptof authorized sharecapital has been abolished by the CA 2015 but it is still of relevance

·       Under the CAP 486, companies were required to state in their memoranda the total nominal value of shares that may be allotted by the company,and this value represented the company’s authorized share capital. Accordingly, a company with an authorized share capital of Kshs. 1 million could not allot shares with a combinednominal value of more than KES 1

million. For example, it could allota million shareswith a nominal value of Kshs. 1, or 500,000shares with a nominal value of Kshs. 2, and so on

·       Companies incorporated under the CA 2015 are not limited in terms of the number of shares they can issue (unless they choose to state an authorized share capital in their memoranda) à However, companies incorporated under the CAP 486 may still have their authorized share capital stated in their memoranda and, as regards such companies, their ability to allot shares will be limited to the amount stated



·       A company’sauthorized share capitalrepresents the total nominal value of sharesthat can be allotted

·       The total nominal value of shares that actually has been allotted is known as the ‘issued share capital’. So, for example, a companythat has allotted three million shares that have a nominalvalue of Kshs. 5 each would have an issued share capitalof Kshs. 15 million

·       The difference between a company’sauthorized share capitaland its issued share capital(i.e. the nominalvalue of shares

that could still be issued) is known as the ‘unissued share capital’

·       With the abolition of authorized share capital, the concept of unissued share capital has also been abolished, except for those companies that still state in their memoranda their authorized share capital



·       Shareholders may not have to pay fully for their sharesupon allotment

·       Shares may be partly paid for when allotted,with the remainderto be paid at a later late

·       The combinedtotal of the nominal share capital that has actuallybeen paid is known as the ‘paid up share capital’

·       If shares are partly paid for on allotment, the company can call for the remainder (or part of the remainder) to be paid, or the companymight have requiredpayment in instalments and an instalment has become due à the paid-upshare capital plus the amountcalled for or the instalment due is known as the ‘called-upshare capital’

·       The difference between the company’s issued share capital and it’s called-up share capital is known as the ‘uncalled share capital’ (i.e. the amount remaining to be called upon by the company)



·       There are two principal methods by which a personcan become a shareholder in a company:

(i)            He can becomea shareholder by purchasing new shares from the company;or

(ii)            As shares are freely transferable items of property (subject tothe limitations found in the articles), he can become a shareholder by obtaining shares from anexisting shareholder (e.g. through sale, gift, bequest,etc.)

·       Whilst the terms ‘allotment’ and ‘issuance’ are used interchangeably, there is a distinction betweenthe two:

o   Shares are allotted whena person acquires the unconditional right to be included in the company’sregister of

members with respect to the shares (Section 3(4), CA 2015)

o   Shares are issued whenthe person’s name is actuallyentered into the register of members. From this, it follows

that the issuance of shares takes place after they have been allotted(National Westminster Bank v IRC [1995])



·       The CA 2015 lays down strict procedures regardingthe allotment of shares

·       Section 327(4) Section 327(5), CA 2015: any director who knowingly permitsor authorizes an unlawful allotmentwill commit an eitherway offence, although the allotment itself will remainvalid

·       Section 328, CA 2015: where a private company has only one class of share, the power to allot shares is vested in the directors, subjectto any limitations found in the articles (the model articlescontain no such limitations)

·       Section 329, CA 2015: in all other cases, the directors can only allot shares if they are authorized to do so by the company’s

articles (the model articlesdo not contain such authorization) or by a resolution of the company





Private company with only one class of shares, that wishes to issue shares of the

same class

S. 328 CA 2015: the directors may allot shares of the same class, except to the

A provision in the articles empowering the directors to issue shares is not

required, but the articles may limit the



extent that they are prohibited from

doing so by the company’s articles

directors’ powers to issue shares (the

model articles contain no such limitation)

Any other type of company, namely:

S. 329 CA 2015: the directors will only

The model articles for private companies


have the power to issue shares if:

limited by shares and the model articles

·   A private   company   with   multiple


for public companies provide that the

classes of shares;

·   A private company with only one class

a) They are authorised to do so by the

company’s articles; or

company may issue shares with such

rights    or    restrictions             as    may             be

of shares   that   wishes   to   issue   a

b) The members   pass   a   resolution

determined   by    ordinary    resolution.

different class of shares; or

·   A public company

authorising the   directors   to   issue


Accordingly, under the model articles,

the directors are not authorised to issue



shares without the passing of an ordinary






·       Aninevitable consequence of a new allotment of shares is that the shareholdings of existing shareholders (and consequently, their voting power and the return on their investment) will be diluted

·       The allotment may even cause control of the companyto be transferred to a new person

·       To prevent these consequences occurring without shareholder consent, existing shareholders are given a right of pre- emption à i.e. under Section 338(1), CA 2015, any new allotment of shares must first be offered to the existing shareholders

·       If an allotment is made that contravenes the pre-emption rights of existing shareholders, then the allotment will remain valid, but the company and every officer who knowingly authorized the allotment will be liable to compensate the shareholders who would have benefited from the pre-emptive offer

·       Note: in certain circumstances, the shareholders’ pre-emption rights can be limited (e.g. where the shares allotted are bonus shares) or even completely excluded (e.g. where a private company has a provision in its articles excluding pre- emption rights)



·       Section 356, CA 2015 provides that shares cannot be allottedat a discount (i.e. for less than their nominalvalue)

·       Any contract that purportsto allot sharesat a discount is void and, if shares actuallyare allotted at a discount,the allottee is liable to pay the company an amount equal to the discount including interest. The company and every officer in default also commit an either way offence

·       However, the effectiveness of the prohibition, at least in relation to private companies, is weakenedby the fact that sharesdo not have to be paid for in cash à Section 358, CA 2015 provides that shares can be paid for in ‘money or money’s worth,’ and it is reasonably commonfor shares to be paid for in goods, property, by providing a service, or by transferring an existing businessto the company in return for shares

·       By overvaluing the non-cash consideration, private companies can effectively issue shares at a discount. The courts have stated that they will only interfere where the consideration is manifestly illusory or inadequate (Re Wragg Ltd [1897]). Accordingly, privatecompanies can easilyavoid the prohibition should they choose to do so

·       Regarding publiccompanies, the rules are more stringent in two ways:

o   First, public companies cannot accept paymentfor shares in the form of services (Section 361(1), CA 2015);

o   Second, if a public company allots shares for non- cash consideration, then that consideration must be independently valued by a person eligible for appointment as the company’s auditor. This person must confirm that the valueof the non-cash consideration is at least equal to the amountpaid up on the shares



·       Most companies will only have one class of share (known as ‘ordinary shares’) and all the shareholders will have the same


·       However, provided that the articles so authorize (and the model articles do), a company is free to issue different classes of shares that conferdifferent rights upon the holder(e.g. shares with increased or decreased votingrights, or shareswith differing nominal values)

·       A common form of share class is the preference share, which usually entitles the holder to some sort of benefit or preference over and above the ordinary shareholders à the exact nature of the preference will vary from company to company, but most preference shares provide their holders with fixed or preferential rights to a dividend, and/or priority claims on the assets of the company upon liquidation

·       The rights attached to differing classes of shares are known as ‘class rights’ and shareholders of one class might attempt to remove the class rights of shareholders of another class (especially if the class rights confer a benefit upon the latter class of shareholders)

·       The CA 2015 provides that a variation of class rights will only be effective if strict formalities are complied with. It is therefore important to know what constitutes a ‘variation’. It is clear that abrogation (abolition) of a right will constitute a variation, but the courtsare reluctant to hold that a mere alteration of a right will constitute a variation

·       Section 393 393, CA 2012: class rights can only be varied if the same is:

(i)            Approved in writing by the holders of three-quarters in nominal value of the issued shares of the class in question;

(ii)            Or, approved by the passingof a special resolution at a meetingof holders of that class ofshare





Re Mackenzie & Co Ltd [1916]  

The company issued preference shares with a nominal value of £20 each. These shares entitled their owners to a 4 per cent dividend on the amount paid up and, as the shares were fully paid up, this equated to 80 pence per share. The articles were amended to reduce the nominal value of the preference shares to £12, thereby reducing the dividend to 48 pence per share.

Held: The alteration of the articles did not constitute a variation of a class right, as the right remained the same (i.e. 4 per cent of the amount paid up). Providing that the right itself remains the same, the fact that an alteration renders the right less valuable (or even worthless), will prevent the

alteration from amounting to a variation



·       Private companies with a share capital are not subjectto a minimum share capitalrequirement and can accordingly be set up by issuingKshs. 1/= to a singleshareholder

·       Conversely, a public companycannot conduct businessuntil it has beenissued with a trading certificate, and the Registrar of Companies will not issue such a certificate unless he is satisfied that the nominal value if the company’s allotted share capitalis not less than Kshs. 6, 750, 000/= (Section516 – 518, CA 2015)

·       This minimum capital requirement aims to ensure that there is always a minimum level of capital availablein order to

satisfy the company’s debts

·       However, it is acknowledged that the minimumcapital requirement does little to aid creditorsfor three reasons:

(i)            The figure of Kshs. 6,750,000/= is too low to offercreditors any real protection;

(ii)            The shares do not need to be fully paid up—onlyone quarter of the nominalvalue and the whole of the premiumneeds be paid up at the time of allotment (Section 362(1), CA 2015), and shares issued at the time of incorporation must be paid for in cash. Thus, a newly formed public company may have only Kshs. 1,687,500/= in cash when it startsbusiness (with the right to call on the shareholders for at least a furtherKshs. 5,062,500/=);

(iii)            The authorized minimum is measured at the time the companycommences trading, but little accountis taken of the fact that it may be reduce once trading commences. If the level of capital does fall below half the company’s called-up capital, then a general meeting must be called to discuss what steps should be taken (Section 4161, CA 2015), but by the time the assets reach this level, it is likely that some form of insolvency procedure will be in place, thereby rendering the general meeting useless. Even if this is not the case, the Act does not require that the meetingtake any action



·       Having obtainedshare capital through the sellingof shares, the law requiresthe company to ‘maintain’ the same (no

unauthorised distributions)

·       The rationalebehind this is creditor protection the creditorslook to the company’s capital for payment and the less

capital the company has, the greaterthe risk that the companywill default, and the creditors will not be paid

·       At its most basic level, the creditors will expect capital to rise and fall in the course of trading, but will not expect the company to return capital to the shareholders

·       Through a series of rules known collectively as the ‘capital maintenance regime’, the law prohibits capital from being returned to the shareholders (this can be through:the restructuring of share capital,or the acquisition by a company of its own shares)



·       A company may increase its share capital by: allotting new shares; subdividing existing shares into shares of a smaller nominal value; or, consolidating shares by merging existing shares into shares of a highernominal value

·       These forms of share capital restructuring do not adversely affect the level of share capital and so creditor interests are not jeopardized

·       However, a reduction of sharecapital may adversely affect the creditors’ interests, and so is heavilyregulated. A reductionof capital will be unlawful unless the procedures found in Sections 407 – 422, CA 2015 are complied with. These sections provide companies with twomethods to reduce share capital

·       Note: provided that companies could only reduce capital if their articles so permitted, a special resolution was obtained, and the reductionwas approved by the courts. Obtaining court approval proved to be unduly burdensome for many smallercompanies



·       This method is available to all types of companies

·       Section 407 108, CA 2015: provides that areduction will be valid where the companyauthorizes the reductionby passing a special resolution and then then appliesto the court for an orderconfirming the reduction

·       Section 417, CA 2015: where a public company wishes to reduce its share capital below the authorized minimum, the Registrar of Companies will not register the reduction unless the company first re-registers as private, or unless the court so directs



·       The secondmethod of effecting a reduction is available to private companies only and does not requirecourt approval

·       Section 419(1)(a), 420, CA 2015: a private company can effect a reduction of capital by passing a special resolution authorizing the reduction, supported by a statement of solvency from the directors à this statement must be made no more than 14 days before the resolution is passed evidences the opinion of the directors that:

o   There is no ground on which the company couldthen be found to be unable to pay its debts, and

o   The company will be able to pay its debts as they fall due during the year immediately following the date of the statement (if the companyis to be wound up within 12 months of the statement being made, the directors must be of the opinion that the company will be able to pay its debts in full within 12 months of the winding-up commencing)

·       Ifthis statement is made withoutreasonable grounds for the opinionsexpressed within it, every directorwho is in default commitsan offence, although the reduction remains valid



·       The common law absolutely prohibited companies from purchasing their own existing shares on the ground that this would involve returning capital to the shareholders (Trevor v Whitworth [1887]) and would therefore reduce the funds available to pay the creditors

·       Section 424, CA 2015 maintains a strict approach by providing that limited companies cannot purchase their own shares, except in accordance with theprocedures laid down in the CA 2015

·       Ifthese procedures are not followed,the purported acquisition of shares is void, and the companyand every officerof the company in defaultwill commit an offence. A company can purchase its own shares in oneof two ways



·       Section 684, CA 2015: a companycan purchase sharesthat it has issued as redeemable shares

·       Redeemable sharesoffer temporary membership of a companyand tend to provide that the sharescan be redeemed (i.e. boughtback) by the company, usuallyupon the insistence of the companyor the shareholder, or after a statedperiod has passed

·       Toensure that capitalis not reduced, the companymust pay for the sharesout of its distributable profits,or out of a fresh issue of shares



·       Whilst redeemable shares are useful, they are inflexible in so much as the company must decide, prior to issue, that the shares are to be redeemable and the company can only then purchase thoseredeemable shares

·       What companies wanted was the general ability to purchase any shares (including redeemable shares) and such a power exists under Section 424, CA2015. Several safeguards exist, including:

o   Only limited companiesmay purchase their own shares;

o   The shares purchased must be fully paid up; and

o   When purchasing the shares, the company must pay for the shares upon purchase

·       Purchase of the shares must bemade from distributable profits, or out of a fresh issue of shares(although there is a specificmethod whereby private companies can purchase theirown shares out of capital)

·       Additional safeguards are provided depending whether or not the purchase is to take place on a recognized investment exchange. Where the purchaseis to take place on such an exchange,the additional safeguards imposed by the Act are less extensiveas investment exchangeshave their own safeguards in place



·       Historically, companies have been prohibited from providing financial assistance for purchaseof their shareson the ground that it would allow a company to manipulate its share price (exceptions were narrow and strictly regulated)

·       However, this restriction hamperedinnocent and commercially beneficial transactions, especially ones involving privatecompanies. Accordingly, this prohibition has now been abolished for private companies

·       Section 442, CA 2015 still retainsthe prohibition for public companies contravention of the same constituted an offence, and an agreement to provide unlawful financial assistance will be voidable



·       The pro-member nature of directors’ duties indicates that the principal purposeof most commercial companies is to make a profit

·       Members expect a shareof the company’s profits to be distributed to them, usuallyin the form of a dividend

·       Dividends are the distribution, usually in cash, of profits to the members, usually at a fixed amount per share à accordingly, the more shares a member owns, the greater the dividend he will receive

·       It is important to rememberthat members do not have a right toa dividend à Burland v Earle [1902]: until a dividendis declared, or a companyis wound up, companies are not under a legal obligation to distribute profitsto their members

·       However, failure to pay a dividendmay amount to unfairlyprejudicial conduct or even justifywinding up of a companyon equitable grounds




·       Section 486(1), CA 2015: provides that companies cannot pay a dividend out of capital – instead, a ‘company may only make a distribution out of profits available for the purpose’, with such profits being defined as the company’s‘accumulated, realised profits less its accumulated, realised losses’ (Section 486(2), CA 2015):

o   The word ‘accumulated’ is included to require companiesto include previousyears’ losses when determining the profits available for the purpose. The aim of this is to prevent a situation whereby a company has several years’ poor performance and sustains significant losses, but then has a profitable year and pays out a dividend, even though that profitable year hasnot replaced the lossessuffered in previousyears

o   The word ‘realised’ is included to prevent companies from paying out a dividend based on estimated profits. Companies used to be able to pay out a dividend based on estimated profits, but if that level of profit were not reached, the shortfall would have to be paid out of capital. Companies are now required to determine profits based on gains and losses that are realized, and what is realized is to be determined using generally accepted accounting principles, with the Financial Reporting Standard 18 providing that profits are realized only whenrealized in the form of cash or other assets, the cash realization of which can be assessed with reasonable certainty

·       When determining whether or not a distribution is lawful, the courts will focus on the purpose and substance of the transaction, as opposed to its form (e.g. a distribution described as a dividend, but paid out of capital, would be found unlawful, despite the label attached to it)

·       Although an objective approach is favourable, the courts will look atall the facts,including the state of mind of the persons orchestrating the transaction (Progress PropertyCo Ltd v Moorgarth Group Ltd [2010])



·       Section 494(1), 494(2), CA 2015: any shareholder who, at the time of the distribution, knew or had reasonable groundsto believe that the distribution was unlawful, is required to repay it, or part of it, tothe company

·       Section 486(3), CA 2015: where directors are concerned, the company, and each officerof the company who is in default,commit an offenceand on conviction are each liableto a fine not exceedingone million shillings

·       Under common law, the directors who authorized the distribution are liable to repay the money to the company if they knew or ought to have known that the distribution was unlawful (Re NationalFunds Assurance Co (No 2) [1878])

·       This is a severe deterrent, as was seen in the case of Bairstow v Queens Moat Houses plc [2001] where the directors were required to pay back an unlawful distribution of £26.7million, plus an additional £15.2 million in interest

·       If an unlawful distribution is made based on erroneous accounts, the company’s auditor, if negligent in failing to detect the error, will be liable to repay the companythe amount of the unlawfuldistribution (Leeds Estate Buildingand Investment Co v Shepherd[1887])



Law Notes (Knowledge Tree ) 

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