Thursday, 3 January 2013

The Importance of a Shareholders’ Agreement

Year on year many small limited companies are successfully set up by family members, friends and former colleagues with great business ideas, yet for some such happy beginnings may not last. Disputes may arise shortly after the company’s birth or many years after, often as a result of changes in the strategy and management of the company.  Ranging from the differing or competing business interests of individual shareholders to the implementation of a contentious dividend policy creating an contentious salary disparity between shareholders, these disputes can have serious financial implications and can cause irrevocable damage to a small business.  Despite this fact, the drafting of a shareholders’ agreement, the pre-nup of the corporate variety, is often way down the to-do list when individuals decide to start-up a company.  Ironically, a well drafted and structured shareholders’ agreement can provide a company and its shareholders with the very protection and flexibility it needs to flourish and grow in a dispute free environment.
At FWJ, we are seeing an increasing number of boardroom disputes or disgruntled shareholders as businesses face ongoing difficult trading conditions.  These conflicts between directors and/or shareholders can seriously destabilise a business by distracting valuable management time away from the essentials of attracting customers, delivering the product and maintaining cashflow. We can, of course, assist parties in progressing a claim against a business partner, be it a co-director, another shareholder or as an investor against a single director or the entire board, or by helping parties arrive at a satisfactory settlement of any such dispute, but these actions can be slow, divisive and expensive.  As with your domestic arrangements, forward planning is the answer. So what is the best preventive treatment?
When setting up a new business, or becoming involved as a new director or shareholder-investor of an existing business it is always best practice to record in writing the internal agreements that will govern the relationship between you: how are the decision making powers divided between you?  How are they challenged?  How can you replace a director or shareholder?  How do you get your value out of the company in future? No-one wishes to appear to be uncommitted or planning for failure, but time and again, these questions, if not thought about and the parties’ agreements recorded, will have the capacity to cripple a business if they occur at a later stage.  As financial pressures on a company or its directors or members increase, so these issues become more prominent.  There is no need to wait until a problem actually occurs; would your company benefit from an interim health-check?  A full, open discussion between all the relevant parties may be difficult at the outset, but could result in a robust organisation containing committed and confident members who trust each other and are motivated to maintain their investment of time, money or skills for the greater benefit of the company and its trading counterparties.

If you are about to enter into a new or significant commercial relationship or, as a financier, you are looking at taking on a new client, or simply as part of your regular client audit, ask if they have adapted their articles to reflect how the business is intended to run in reality, rather than just adopting the statutory Model Articles or some company incorporation agent’s standard form that does not take into account this company’s specific circumstances or needs.  Is there an agreement between the shareholders governing the scope of shareholder influence and control of the distribution of the company assets either on an ongoing basis or on a sale or break up?  From a financier’s objective, would you be more attracted to a business where the owners and management demonstrated in their business plan and constitutional documents that they were well prepared and forward-looking in their housekeeping as well as their commercial thinking?

FWJ’s Shareholders and Directors Advice team can assist your company, or your client,
in developing structural documents such as modified articles of association or shareholder agreements suitable for your business needs. It is recognised that further capital outlay, at this difficult time, may not be attractive, but our experience of dealing with disputes where no prior agreements are in place indicates that there is merit in making this investment. Whilst having a shareholders’ agreement is not the complete inoculation against the problem, such an agreement, properly drafted, can help structure discussions between parties and assist in the effective negotiation of a pragmatic solution to enable the company to survive the difficult market conditions.

For more information on  the drafting or interpretation of shareholders’ agreements or any of above, please feel free to contact Andy Wilks  0207 841 0390.

Wednesday, 2 January 2013

Directors' Duties – The Basics and the Risks

Directors' duties were codified by Part 10 of the Companies Act 2006:
  1. Chapter 1 of Part 10 (sections 154-169) sets out the laws relating to company Directors (appointment, register and removal).
  2. Chapter 2 of Part 10 (sections 170-180) sets out the statutory duties on Directors.
The provisions of the Act extend to all Directors, including shadow Directors (being those who are not appointed Directors but whose decisions the company follows) and de facto Directors (those who act as Directors although they have not been formally registered as a Director at Companies House).
The main statutory duties of a Director under the Companies Act 2006 are as follows: 
1.         Section 171 – Duty to act within powers Directors should not exceed the powers conferred on them by the company’s Articles of Association nor should the Company exceed (at the Director’s direction) what it is allowed to do in its Memorandum of Association.
2.         Section 172 – Duty to promote the success of the company – a Director must act in the best interests of the company and for the benefit of its Shareholders having regard to the likely consequences of any decision. This includes considering the interests of employees, business relationships with suppliers, customers and others, the impact on the community and environment, maintaining the reputation of the company and acting fairly between members of the company. 
3.         Section 173 – Duty to exercise independent judgement – As the company is a completely separate entity, its Directors must consider all decisions independently from their own interests, any professional advice received or any third party influences.  Directors have a duty to personally consider whether each decision taken is in the company’s best interests, rather than just relying on third party advice or influence as authority for their subsequent decisions. 
4.         Section 174 – Duty to exercise reasonable skill and care and diligence – Directors should act in a manner that any reasonably skilled Director would generally act in their particular area of management.  Directors should attend board meetings (or as many as reasonably possible) to ensure good corporate governance and supervision of their fellow Directors and to ensure the correct management of the company’s affairs.   Ignorance of decisions taken and lack of participation is often the catalyst for Director disqualification proceedings where Directors fail to act on information they ought reasonably to have been aware. 
5.         Section 175 – Duty to avoid conflicts of interest - Directors must avoid situations where they have or could have a direct or indirect interest that conflicts or may conflict with the interests of the company.  Where a conflict of interest may exist, the Director must ensure that the company’s interests prevail and a common way to avoid issues over conflicts is to disclose all matters to the board of Directors so that the company (acting through its Directors) can make a decision with all the facts in front of them (see Section 177 below).  This may mean that conflicted Directors do not participate in decisions where their conflict of interest exists.   
6.         Section 176 – Duty not to accept benefits from third parties – This section extends Section 175 as Directors must not prioritise their own interests above that of the company's when dealing with company business and property and must not, for example, make a secret profit from any undisclosed and unauthorised transaction or divert work away from the company for their own benefit. Any benefits obtained in this way may have to be accounted for to the company.  Furthermore, Directors should not accept loans or the benefit of guarantees from the company.  This duty can quite often overlap with a Director’s duty to promote the success of the company (Section 172 above). 
7.         Section 177 – Duty to declare the nature and extent of any interest in a proposed transaction or arrangement – Directors must disclose all interests in relation to all transactions (eg property, information, shares held etc) irrespective of whether or not the company could take advantage of it.  Directors should again obtain board and Shareholders approval, where required, before steps are taken.  Again, this extends the other duties in Sections 171 to 176.
8.         Insolvency - Whilst a Director is generally under a duty to act in the best interests of the company and its Shareholders, the moment the company is deemed to be insolvent, they are under a legal duty to protect the interests of the creditors instead of the Shareholders and the company must then function for the primary purpose of getting the best return for creditors. 

Risks Faced by Directors for Breach of their Fiduciary Duties
We list below the main claims for personal liability faced by Directors.
1.         Wrongful Trading - This is when a Director continues to trade or enter into contracts after he/she knew or ought to have known that there was no reasonable prospect of the company avoiding insolvent liquidation.
2.         Fraudulent Trading - This is when the Director carries on business with the intention to defraud creditors or for any other fraudulent purpose, eg taking deposits for orders they know the company cannot fulfil or entering into contracts when the Director knows there are insufficient funds to conclude the contract.
3.         Misfeasance - This is a breach of the fiduciary duties of care owed by a Director, as detailed above, e.g. wrongly taking out money from the company, using company money for matters not associated with company business or directing payment to associated parties.  Such a claim is normally issued to seek recovery of the losses arising from the misfeasance from the Director(s).
4.         Preferences – This applies where Directors make payments or transfer assets to one creditor (or a group of creditors) in preference to the remaining creditors.  Whilst such a claim would be issued against the Director personally, a liquidator or administrator can seek to reclaim such monies as a preference transaction from the recipient directly (together with their legal costs, if necessary).
5.         Transactions at an undervalue - Where the company transfers assets for significantly less than their market value, the undervalue amount can be reclaimed by a liquidator or administrator in a similar manner to a preference transaction. 
6.         Voidable transactions – This is another antecedent transaction (i.e. one occurring pre-insolvency) which allows the reclamation or setting aside of any transaction carried out between the date of the presentation of a winding-up petition and the final winding-up order.  This includes share transfers. 
7.         Transactions defrauding creditors – This provision applies to both companies and individuals where a transaction at an undervalue has occurred where it can be demonstrated to have occurred with the intention of putting such assets beyond the reach of creditors.  Directors can be liable under this section where they transfer company assets, either to a third party or for their own benefit.  This provision enables the Court to set aside the transaction, make a compensatory award or any other order deemed appropriate to protect the interests of the prejudiced creditor(s).
8.         Director Disqualification – A Director can be disqualified from acting in the promotion, formation or management of a limited company where it can be established that the Director’s conduct evidences them to be unfit to act as a Director.  The grounds of disqualification are very wide and unrestricted, in a similar manner to claims for misfeasance (see above).  It should be noted that, following disqualification, there is a statutory provision enabling disqualified Directors to seek leave to act as a Director of a specified company(s).

For more information, please feel free to contact Partner Andy Wilks Shareholder Disputes team on 0207 841 0390.