Company Law in Context

Transcription

1 Company Law in Context Text and Materials David Kershaw London School of Economics David Kershaw is a Senior Lecturer in Law at the London School of Economics. He qualified as a solicitor at Herbert Smith and practiced corporate law with Wolf Theiss, Vienna and in the Mergers & Acquisitions Group of Shearman & Sterling in New York and London. He holds degrees from the University of Warwick and Harvard Law School. OXFORD UNIVERSITY PRESS

2 CONTENTS IN FULL Preface vii Guide to the Book x Guided to the ORC xii Table of Cases xxvii Table of Legislation xxxvii Acknowledgements xliii PART I INCORPORATION AND SEPARATE LEGAL PERSONALITY 1 An introduction to the context and consequences of incorporation 3 I Bob's Electronics as a sole trader 3 1 The business idea 3 2 The inputs required to run the business 4 3 Sole-trading/sole proprietorship 4 4 Running Bob's Electronics: decision-making by a sole trader 5 5 What does it mean for Bob to own the business; what is his equity in the business? (, 6 Investing in Bob's Electronics; an introduction to risk and return Risk and return Risk and the nature of the investment An acceptable return in light of the risk and expected return calculation 8 7 The limitations of sole trading as a way of carrying on a business 9 II Introduction to incorporation 11 1 Incorporation options 11 2 Formation basics 14 3 From Bob's Electronics to Bob's Electronics Ltd 15 III The consequences of incorporation 17 1 Separation of personal and business assets: entity shielding 17 2 Introduction to limited liability Why does law provide for limited member liability? 20 3 Managing succession 28 2 The entity doctrine 30 I Reality and incorporation 30 1 The entity doctrine: Salomon v Salomon 30 2 The implications of separate legal personality 41 II Piercing the corporate veil 46 1 Questions that cannot be answered by incorporation 47 2 Evading existing obligations 54 3 Agency 57

3 Xviii CONTENTS IN FULL 4 Single economic unit " 5 The facade concealing the true facts 70 6 Doing justice to the facts 74 7 Summary '$ 3 The corporate constitution/the mechanics of the general meeting 79 A The corporate constitution 79 I Introduction 79 1 What is a constitution and does a company have one? 79 2 The constitutional documents 0 3 The Model Articles of Association 81 4 Amending the articles of association 83 II The legal status of the constitution: the corporate contract 85 III Enforcing the corporate contract 87 1 Qua member and only qua member? 87 2 Internal irregularities versus personal rights 89 IV Shareholders' agreements 93 B The mechanics of the general meeting 96 I How do members act? 96 1 Resolutions 96 2 Shareholder meetings 97 3 Voting at general meetings 98 II Shareholder action through informal consent Corporate actions 105 I Introduction 105 II Capacity 106 III Contract and the company Primary and general rules of attribution The common law of agency: actual authority The common law of agency: apparent authority (sometimes referred to as ostensible authority) The structure of the apparent authority doctrine An alternative lens: the constructive notice doctrine The indoor management rule The Companies Act 2006 and apparent authority The effect of section Substantive and procedural limitations The preconditions to the application of section Shareholder action in relation to unauthorized transactions 131 IV Tort and the company Attributing tortious acts to the company Vicarious liability Vicarious liability or vicarious attribution? Directors as the embodiment of the company: the identification doctrine Liability of directors and officers for acts undertaken on behalf of the company 139

4 CONTENTS IN FULL X1X V Crime and the company Attributing crimes to companies: special rules of attribution Corporate manslaughter I54 PART II CORPORATE CONTROL AND ACCOUNTABILITY 5 The corporate agency problem 163 I The problem of non-aligned interests 163 II The language of economic agency costs The economist's view of the principal-agent problem Managerial agency cost categories Direct transfers of value Indirect agency costs 170 III Private and regulatory responses to managerial agency costs Shareholder responses to the managerial agency problem Regulatory responses to the managerial agency problem 175 IV The problem of authority The balance of power between the board, management and the shareholder body 179 I Introduction 179 II Decision rights Who should make corporate decisions? The basic distribution of decision-making power in UK company law The default distribution of decision making power Exercising instruction rights The enforcement of the distribution of power Shareholder veto and approval rights Significant transactions: who is best placed to make a decision? UK significant transaction regulation Other shareholder approval rights in UK company law Changing the distribution of power The formal distribution of power between the board and management Decision rights in the US Corporate law in the US The distribution of decision rights in Delaware law Delaware companies: veto rights in significant value transactions Delaware companies: other shareholder approval rights Delaware companies: the distribution of power between the board and management Delaware companies: amending the distribution of power Decision rights in German corporate law Management board and supervisory board decision rights Significant transaction and other shareholder approval rights in German law 207 III Appointment and removal Appointment and removal rights in theory Appointment and removal rights in UK company law Appointment Removal 210

5 xx CONTENTS IN FULL 3 Removal rights in comparative perspective Removal rights in the US Removal rights in Germany 218 IV Shareholder versus director primacy Board composition and structure regulation 222 I Introduction to board function and composition The core functions of the board The board's managerial role and the number of executive directors The function, number and characteristics of non-executive directors How many non-executive directors? The independence of the non-executive directors Board activity to be controlled by the non-executive directors Chairing the board of directors 235 II Board structure and composition regulation: the Combined Code The number and independence of non-executive directors The number of non-executive directors The definition of independence The independence-knowledge trade-off The structure of the board and the role of the non-executive director The Combined Code's committee structure A comparative note on NYSE committee structure Separation of chairman and CEO The Combined Code's separation recommendation A comparative US note on separation of chairman and CEO roles Other Combined Code recommendations to enhance the monitoring function 254 HI The relationship between board composition regulation and company performance Regulating directors'remuneration 261 I Introduction The objectives of remuneration The executive remuneration problem 262 II The types and trajectory of remuneration for executive directors Types of executive pay and benefits The structure and trajectory of executive pay for listed companies 266 III Legal strategies to ensure that pay is not a managerial agency cost The regulation of conflicts of interest and executive directors' pay Remuneration committees Disclosure and shareholder voice Executive remuneration arrangements subject to shareholder approval Has UK executive pay regulation been successful? 279 IV Remuneration for service as a non-executive director 282 V Regulating executive remuneration across the Atlantic Introduction to directors' duties 288 I Rules versus principles 288 II Designing behavioural expectations 289

6 CONTENTS IN FULL XXI III Introduction to the key duties owed by directors 290 IV The sources of directors' duties 292 V Who owes the duties? 294 VI To whom are the duties owed? Regulating discretion I: acting in the company's interests 303 I The pre-2006 Act common law duty to act in good faith in the best interests of the company What are the company's interests at common law Does the company have its own interests? The company's interests as shareholders'interests The 'interests' of other constituencies Evaluating director's actions judging with hindsight Why is the standard for evaluating directors' decisions so low? Evaluating the failure to consider the company's interests Restricting discretion in the best interests of the company 320 II Rethinking what is in the company's interests The interests of the company's'owners' Contract and company interests Justifying state regulation of company interests: trusteeship and social responsibility Objections to multiple-interest approaches to the company's interests Social responsibility means maximizing shareholder value Justifying regulation: could multiple interest trusteeship increase the size of the economic pie? The UK reform debate on the company's interests 346 HI The Companies Act The duty to promote the success of the company Key points to note on the duty to promote the success of the company To what extent does section 172 change the existing law? The duty to exercise independent judgment Regulating discretion II: using corporate powers for proper purposes 354 I The development of the improper purpose doctrine: from rule to principle 354 II Can good reasons ever make an improper purpose proper? 364 III The Companies Act IV A US comparison Competence and the duty of care 375 I Introduction Directors'decision-making activity and function What does taking care involve in a company context? The structure and design of a duty of care 382 II The duty of care at common law The common law position prior to the 1990s 384

7 xxii CONTENTS IN FULL 2 The evolution of the common law position in the 1990s Monitoring and reliance on management and employees 397 III The duty of care and the Companies Act IV Indemnifying directors for breach of duty Company waivers, indemnities and insurance Court discretion to grant liability relief 408 V The duty of care in US comparative perspective The standard of care The standard of review for business decisions The standard of review in relation to the decision-making process The standard of review and board monitoring 426 VI Does the UK have a business judgment rule? Regulating conflicts I: self-dealing I Introduction 431 II Strategies for regulating self-dealing Introduction Regulatory strategies Prohibition Disclosure Ex-ante approval mechanisms Ex-post court review 435 III Self-dealing and the common law: the duty of loyalty The common law Opting out of shareholder approval and Table A 444 IV Self-dealing regulation under the Companies Act Ex-ante board disclosure Background to reform The disclosure requirement pursuant to section Is there a continuing role for disinterested directors? Is section 177 a safe harbour or a mandatory approval rule? Mandatory ex-post disclosure Shareholder approval and substantial property transactions Loans to directors 457 V Self-dealing regulation beyond the Companies Act Additional self-dealing regulation for listed companies Ex-post disclosure and accounting regulation 459 VI UK self-dealing regulation in comparative US perspective Regulating conflicts II: corporate opportunities 468 I Introduction An opportunities hypothetical Strictness versus flexibility/deterrence versus fairness 472 II Opportunities and the common law Regal (Hastings) v Gulliver The no-profits-rule Capability facts and financial capacity Boardman v Phipps 479 4^1

8 CONTENTS IN FULL 2.1 No-profit versus no-conflict 4g6 2.2 What is the nature of'possible conflict'? Accounting for profits and the scope for an equitable allowance The no-conflicts approach and the company's interests Approval mechanisms at common law Resignation of office in order to take the opportunity The resignation problem Post-resignation opportunities regulation 509 III The Companies Act Section 175(1) 5lg 2 Section 175(2) Section 17S(4)(b) Board rejection of the opportunity Area of business restrictions Approval mechanisms under the 2006 Act The status of the no-profit rule Former directors 522 IV Directors competing with the company and holding directorships in competing companies 523 V Strictness versus flexibility in US comparative perspective Enforcing directors'duties 535 I Introduction 535 II 1 Only the company can enforce rights owed to the company Which corporate body should make the decision to commence litigation against a director? Choosing between the regulatory options 540 Control of the litigation decision by the board or the general meeting 541 III The common law's regulation of derivative actions 546 IV Derivative actions under the Companies Act The new statutory derivative action mechanism Structure and ground rules of the derivative claim Who can bring a derivative claim? Who can a derivative claim be brought against? Permission to continue the derivative claim Situations in which the court must refuse permission to continue the derivative claim Actual ratification or authorization The court's business judgment Situations in which the court has a discretion to allow the derivative claim to be continued Turning company-initiated litigation into derivative litigation 567 V Funding derivative claims The relationship between legal cost rules and the effectiveness of the derivative claim Costs rules in derivative claims Company indemnities Contingency fees and conditional fees 574

9 XXIV CONTENTS IN FULL VI Reflective loss: enforcing the priority of the company's claim Introduction The reflective loss principle Minority shareholder protection 582 I Introduction The controlling shareholder agency problem Regulating controlling shareholder actions Regulating the shareholder vote Controlling shareholder activity outside of the general meeting 586 II Common law regulation of controlling shareholders Common law limits on shareholder voting Shareholder votes to ratify breaches of duty: common law oppression Amending the articles of association: acting bona fide in the interests of the company Regulation of controlling shareholder activities where they do not exercise corporate power 603 III Statutory regulation of controlling shareholder power Just and equitable winding-up The unfair prejudice remedy Conducting the company's affairs Unfair prejudice to members' interests 617 IV The unfair prejudice remedy beyond the equitable considerations category The move towards independent illegality Testing the boundaries of the independent illegality requirement 628 V The remedies available through an unfair prejudice petition The available remedies Encouraging out-of-court settlements: buy-out offers and unfair prejudice Corporate remedies for breach of duty, the unfair prejudice remedy as a 'derivative action' 635 VI Listed company-related party transactions 638 VII Minority shareholder protection beyond this chapter 640 PART III CORPORATE FINANCE 17 Shares 643 I Introduction Shares as financial contractual claims Shares and control rights Choice of finance: equity versus debt; ordinary shares versus preferred shares 649 II Issuing shares Who should make the decision to issue shares? The regulation of share issues in UK company law Basic concepts and vocabulary "52

10 CONTENTS IN FULL XXV 2.2 The distribution of the corporate power to allot, issue and attach rights to shares Authority to allot shares Pre-emption rights Pre-emption rights in practice Consideration paid for the shares Registration; return of allotment and the statement of capital 668 III Class rights Variation of class rights What rights are class rights? Variation in rights versus detriment to class interests? Protecting minority class shareholders 674 IV Share buy backs Why would a company repurchase its own shares? Regulation of share buy backs at common law Regulation of share buy backs pursuant to the Companies Act Purchase of the company's own shares Treasury shares Issue and redemption of redeemable shares 684 V Financial assistance Introduction The prohibition on the provision of financial assistance The prohibition The meaning of'financial assistance' Prohibited financial assistance Exceptions and exemptions 698 PART IV CREDITOR PROTECTION 18 Company law and creditor protection 705 I Introduction 705 II Problems generated by limited liability Transferring risk from members to creditors Limited liability and the opportunistic transfers of wealth from creditors to shareholders Limited liability and incentive to invest in hazardous activities 710 III Reconsidering unlimited liability for tort victims 715 IV Creditor-regarding obligations Introduction Directors' duties and creditor protection Creditor regarding duties in insolvency Creditor regarding duties when approaching insolvency Fraudulent trading Wrongful trading When does section 214 apply and how does it protect creditors? When is there 'no reasonable prospect' of avoiding insolvent liquidation? Taking steps to minimize creditor losses Mediating between directors' duties and section 214 liability Section 214 and financial agency costs Who does section 214 apply to? 7^8

11 XXVI CONTENTS IN FULL 4.7 Nature and quantum of contribution for breach of section The effect of section 214 in practice: funding section 214 applications 739 V Directors' disqualification Regulating legal capital 745 I Introduction 745 II Minimum capital requirements Do minimum capital requirements protect creditors? UK and European approaches to minimum capital 750 III Distributions Approaches to distribution regulation UK distribution regulation prior to Distribution regulation under the Companies Act The accumulated profits test The 'net assets' test Comparing the effects of the accumulated profits test and the net assets test Creditor protection through post-1980 distribution regulation Reforming the distribution rules The logic of reform if distribution rules protect only adjusting creditors The costs of the distribution rules Distributable profits and share buy backs and redemptions Liability for unlawful distributions Shareholder recipient liability Director liability for unlawful dividends 780 IV Reducing capital Court confirmation capital reduction procedure Solvency statement and the board approval strategy Should boards rather than courts determine solvency? Board solvency approval of capital reduction under the Companies Act Board-approval solvency approach to share repurchase out of capital Classes of shares and capital reductions Will private companies continue to use the court-confirmation procedure or the share-repurchase procedure? 797 V Structuring around capital and distribution regulation Legal engineering Substance over form in distribution regulation 798 Glossary 803 Index 809