Director disputes: removing a director or chairman from the board

September 2016 | EXPERT BRIEFING | LITIGATION & DISPUTE RESOLUTION

financierworldwide.com

Disputes between directors can be difficult to manage, particularly where the director in question is a shareholder. Businesses work because of the relationships between individuals, and when these relationships break down, problems can arise that affect the business, its reputation and also the reputation of the individuals. There are no easy solutions but the Companies Acts does provide for removal of a director by shareholders – although this must be seen as a last resort, particularly as the process can give rise to animosity, reputational damage and legal costs.

One particular case that provides some insight into the reality that surrounds the legal processes is Smith vs. Butler. This particular case related to a dispute between the chairman of the board and the managing director of the company, Contact Holdings Ltd. Interestingly, the chairman held 70 percent of the shares in the company and the managing director held the remaining 30 percent. The two fell out when the chairman decided to remove the managing director from office for underperformance, and the managing director accused the chairman of financial fraud on a significant scale. As mentioned, reputational damage is a significant danger in such disputes.

The fact that the chairman sought to remove the managing director was a clear indication that the relationship had irrevocably broken down some time prior to any formal action being taken.

In response to the action by the chairman, the managing director sought to suspend the chairman from office while the alleged financial fraud was investigated. The chairman responded by convening a shareholders meeting to remove the managing director from his office as a director in accordance with Part 10 of the Companies Act 2006. Now, Section 168 provides that a company may, by ordinary resolution at a meeting, remove a director before the expiration of his period of office, notwithstanding anything in any agreement between it and him. Section 169 provides the director who is the subject of the resolution a right to protest.

In Smith, the managing director sought to frustrate the chairman by refusing to attend the meeting, rendering it inquorate. The chairman applied to the High Court for a declaration that the managing director had no power to suspend him from office and for an order under Section 306 of the Act. Section 306 provides a power to the court to order a meeting to be called as it sees fit on application by a director or shareholder. In Smith, the company was joined to the proceedings to oppose the chairman’s application, which resulted in significant cost – financial and reputational.

In the High Court, Mr Justice Behrens found the decision to suspend the chairman was unlawful. It was for the board of directors as a whole to pass a valid resolution to suspend or remove the chairman and that had not happened. Mr Justice Behrens also found there should be an order under Section 306 of the Companies Act 2006, convening a meeting of the shareholders with a quorum of one. The chairman could not be deprived of his normal rights as a majority shareholder to appoint and remove directors, simply because allegations of fraud had been made against him. Nor could the managing director frustrate the wishes of the chairman, in his capacity as majority shareholder, by refusing to attend meetings. A costs order was also made against the managing director.

At this stage, one can only speculate as to the nature of the relationship, but it was clearly toxic and the involvement of lawyers and the Courts would have, together with the financial and reputational considerations, had a significant impact on the running of the company on a day to day basis.

The managing director appealed to the Court of Appeal who unanimously dismissed the appeal. Of particular interest was Arden LJ’s conclusion that: “the powers of a managing director were not statutorily defined. Mr Butler’s powers were not defined by the parties when he was appointed. Although the judge’s conclusions concerning the powers of a managing director were correct, the inquiry ought to have proceeded not from the special provisions of the company’s articles as to quorum but from the provisions of its articles setting out the powers of the board to appoint a managing director. The company’s articles of association provided the board of directors with the power to appoint a managing director, to delegate any of their powers to him and for that delegation to have the effect of excluding the director’s own powers. However, Mr Butler was simply appointed as managing director by a contract of employment and there was no express delegation of any specific powers by the board to him. It was clearly intended that some powers should be implicitly delegated to him, but it would be unusual for the powers of the board to be excluded and so the implied delegation of powers to Mr Butler could not be interpreted as having that effect.”

While this is interesting to a lawyer, in practical terms, companies are made up of the individual people that make up the board or the members. Relationship management, trust, communication and understanding are the key factors to consider from a risk-management perspective – particularly as every corporate body has the potential to descend into in-fighting when relationships break down. The law provides a range of rights, obligations and duties on directors and shareholders, but ultimately it is the shareholders who wield ‘power’ as the beneficial owners of the company.

In tight-knit corporate structures the risks may well be heightened, but that doesn’t mean larger bodies with more directors or shareholders are immune. Whether the articles are based on the statutory tables or prepared independently, or whether the shareholders’ agreement provides for dispute resolution through mediation or arbitration, once a dispute escalates and lawyers and the courts become involved, the impact on the corporation, its reputation, day-to-day running and finances can cause significant damage regardless of which party is ultimately found to be right in the eyes of the Courts.

Of course, there are other examples where matters can be resolved relatively easily, depending on the propensity of a particular party to fight or yield. Removing a director through Companies House web-filing is fairly easy to achieve. A shareholder can be forced out and shares transferred via a simple transfer.

A few years ago, a company was stuck in negotiations and legal costs associated with that, for over a year. They had made no progress, the business was in limbo and a lengthy and well drafted compromise agreement remained unsigned – but no attempt to exercise the Section 168 process had been made. In that instance, it was possible to step around the draft compromise agreement and effect an immediate removal and transfer of shares with a more informal agreement, including the return of company property and access to the bank account and funds in it. But as Smith shows, it is not always straightforward.

There is nothing that can be done to mitigate against breakdowns in relationships and with the best will in the world, or well drafted agreements, when people fall out it becomes more personal and emotive, regardless of the impersonal nature of the processes contained in the law. While Smith goes some way to determining the powers of a managing director, the reality is that it is the relationship between the individuals that shapes how such disputes are resolved.

Relationship management can go some way to ensuring things work effectively at the board level, at least for the duration of mutually respectful and functional relationships. But ultimately, there is little that can be done to mitigate the risk of such disputes, especially in smaller companies where the directors are the shareholders. The best we can hope for is to agree in advance for disputes to be resolved by mediation or arbitration with such provision in the articles or shareholders’ agreements. As for Contact Holdings Ltd, Mr Smith remains a director, but the Companies House Register makes for interesting reading.

Martin N Callan is the president of the Chartered Institute of Legal Executives. He can be contacted on +44 (0)1234 844 354 or by email: mcallan@cilex.org.uk.

Martin N Callan

Chartered Institute of Legal Executives