It is often the case that one person acts in two different capacities/wears two different hats: as well as being a director he may also be a shareholder or a representative of a shareholder.
Those two positions can, in certain circumstances, conflict. Therefore, in order to ensure each individual shareholder is protected when conflicts arise, it is imperative that the parties agree and enter into a suitable and comprehensive shareholders’ agreement.
The importance of this has been highlighted in a recent case where under the terms of a shareholders agreement it was agreed that one of the shareholders (Shareholder A) would be appointed as director of the company at its annual general meeting, and subsequently re-appointed at each successive annual general meeting. The other individual parties to the shareholders agreement were also directors of the company.
The articles of association of the company also provided that a director’s office would be vacated in certain circumstances (for example, in the event of the director’s insanity or bankruptcy), but also where all the other directors so resolved.
After one of the company’s annual general meetings (and following Shareholder A’s re-appointment), the other individual parties, in their positions as directors, joined in a resolution to remove Shareholder A pursuant to the articles, arguing that their fiduciary duties as directors of the company required them to do this, as they considered Shareholder A unsuitable to act as a director of the company. They argued that they had not acted voluntarily, but had no choice but to comply with their duties as directors.
The Court acknowledged that upholding an agreement that potentially constrained the other directors from acting in accordance with their perception of their duties as directors could be problematic. However, in this instance the shareholders agreement contained an appropriate further assurances clause under which the parties agreed to take such actions as might be reasonably required to give effect to the agreement.
In light of this, the Court held that the directors could (and should) have avoided their fiduciary difficulties by getting the company to sanction the breach of duty in not removing an allegedly unfit director despite having the power to do so, or to change it’s articles, or give a direction to the board not to remove Shareholder A.
The case also highlighted that it is a breach of a lawful contract to do something voluntarily that will make performance of the contract impossible or futile and that although parties can contract in one capacity (as shareholder) they are not free from their contractual obligations when acting in a different capacity (as director).
However, had the shareholders agreement not contained the further assurances clause, the Court may have found against Shareholder A.
- If you have shareholders’ agreement already in place – review it now!;
- If you don’t – get one!