SHAREHOLDERS V. DIRECTORS: A WAR FOR CORPORATE DOMINATION

SHAREHOLDERS V. DIRECTORS - Saloni Bhambi

A shareholder also referred to as a stockholder, is any person, company, or institution that owns at least one share of a company’s stock (equity). Shareholders are a company’s owners, and so they reap the benefits of the company’s successes which may include increased stock valuation or profits distributed as dividends. If the company does poorly and the price of its stock decline, however, shareholders can lose money. The company’s performance depends upon the decisions which are made by the directors of the company. A board of directors is a group of individuals elected to represent shareholders, by the shareholders. The board’s function is to establish policies for corporate management and oversight, making decisions on major company issues,[1] which means that in essence, the board carries out fiduciary duty, which includes the duty of loyalty and care.

In any corporation, there is a balance of power that needs to be struck between the board of directors and the shareholders. It aims at dividing ownership and control between them. There are several ways in which each can be empowered. However, this may vary by country. The UK, and USA’s Delaware (known for its modern and up-to-date corporation statute and 60% of USA’s incorporation[2]) have their own set of rules, which we shall look into.

Expressions such as “strong managers and weak owners” and “pay without performance” are used to expose the dominance of managers over shareholders and boards, and measures such as “say on pay” and the “two-strike rule” may hold directors accountable and have unintended consequences.[3] There are several shareholder and director primacy mechanisms in both the nations that ensure equality in the power distribution and keep both sides in control.

For the basic distribution of decision-making power in UK company law, the 955-page long statute has no general statement about the powers of the board of directors.[4] In the UK Company Act, after 2006, the general distribution of decision-making power was shifted to the Model Articles for public and private companies. Hence it can be gathered that the articles default terms can be altered only and only by the shareholder body, a special resolution.[5] In a Delaware corporation, however the board’s authority to manage the corporation is provided by the Delaware General Corporation Law[6]. Hence the statute, not the shareholders, empowers the board.

The shareholders can exercise instruction rights in the company’s Annual General Meeting. To get the resolution on the AGM agenda, the resolution must be passed and given to the other shareholders. However, if the shareholders need to get a resolution passed for immediate action, they need to hold an interim meeting, but this meeting can be refused by the directors. Hence the directors have an upper hand in an interim meeting in the UK. The right to vote on essential topics gives shareholders a limited voice in corporate affairs. They cannot propose their transaction, nor can they amend the proposed transaction.

In the UK, shareholders retain veto rights concerning decisions that have the ability to change the shareholder’s relationship with the company. According to S271 Delaware General Corporation Law, the shareholders have an approval right about the sale of all assets of the company. But this is the only significant transaction right provided to the shareholders.

Shareholder vote, in the UK, is a pro-shareholder mechanism. Since the shareholders nominate the directors, they retain some power over them. Shareholders also vote on importance decisions of the board of directors. Shareholders have a minimum say in the US. This can be viewed in a positive and negative perspective, as by negative it can be seen as a way of empowering the directors over the shareholders, but in a positive light, it can be agreed that not all the shareholders monitor all the day to day transactions of a company, as keeping a track of the directorial actions is expensive and not worth it for the returns they are getting.

To amend the distribution of power in the UK, shareholders can force an interim meeting to be convened and to alter the articles by a special meeting, but in Delaware, the shareholders as well as the board need to vote, to propose the amendment. Hence the shareholders can be stopped from intervening in the earlier stages itself and minimise expenses.

In the UK the statute does not say anything explicitly, however, a simple majority and individual voting is the guided appointment method in the Model Article. For a private company, the term of appointment is not specified. In Delaware however, every shareholder, holding one share in the company can nominate one person. This sounds like a chaotic course of action and does not work in theory as the nomination process is very expensive and extensive. A plurality voting system helps incorporate this pro-managerial regime.

Litigation is another shareholder primacy, wherein the shareholder may bring in a suit on behalf of the corporation against an individual who has committed a wrong. (If they are still not satisfied, they can engage in the “wall-street walk”, in essence selling their shares in a move to signal that there is trouble within the corporation)[7]. This can be found in Article 3 of the Model Articles in the UK. In John Shaw and Sons Ltd v Shaw,[8] Justice L. Greer states that “If power of management is vested in the directors, they and they alone can exercise that power”, which in essence means that the general meeting can not usurp the power of the directors. The shareholders have the right to seek legal aid especially in the case of violation of management’s “fiduciary duty” and can also file a suit on behalf of the company.

However, the shareholders still might have some influence, and dismiss the director. The shareholders have the right to remove a director in Section 168 of 2006 CA[9], by an ordinary shareholder resolution and simple majority with a mandatory rule guiding without cause clause. The purpose of these actions is to provide a guarantee that the shareholders can dismiss directors by an ordinary resolution and to provide justice to the directors. This view was supported by the John Shaw and Sons Ltd v Shaw case. The default removal clause in Delaware is like the UK, but if the type of board is changed to a staggered type, then the default removal right is with a clause. The removal of directors has also been one of the vital powers of the shareholders, as this helps in aligning the company’s interest with the directors.

In the UK the board of directors has a duty of loyalty, and the duty of care is owed to the company and not the shareholders directly. In Delaware, the directors have a fiduciary duty, which includes a duty of loyalty and care and the duty of care is owed to both- the shareholder and the company.

In conclusion, we can say that the division of the powers of the directors and the shareholder in the UK and US (Delaware) is blurred. The law tries to bring a balance in between the shareholders and the directors but somehow aggravates the loss of power of the shareholders, not leaving them completely powerless but significantly restricted, which helps in reducing interference in the day-to-day activities of the board. And as Advocate Johan Myburgh said, “Corporate governance is not a matter of right or wrong- it is more nuanced than that.”[10]

Author(s) Name: Saloni Bhambi (ILS Law College, Pune)

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References:

[1] Board of Directors as reviewed by James Chen on investopedia.org (last seen on 7th May,2021)

[2] Should your company incorporate in Delaware? Not So Fast by Janet Novack and Alan M. Dershowitz https://www.forbes.com/sites/janetnovack/2017/10/27/should-your-company-incorporate-in-delaware-not-so-fast/?sh=7ae5e39723de (last seen on 11th May, 2021)

[3] “In search of the Shareholder- Manager Balance of Power”- Razeen Sappideen (last seen on 7th May,2021)

[4] Company Law in Context- text and materials, second edition- David Kershaw

[5] Section 21 CA 2006

[6] Title 8 Corporations, Chapter 1. General Corporation Law, Sub chapter IV. Directors and Officers of the Delaware Code. https://delcode.delaware.gov/title8/c001/sc04/

[7] Shareholders vs Directors, Brett Trembly on tremblylaw.com (last seen on 7th May, 2021)

[8] [1935] 2 KB 113.

[9] Section 168 of 2006 CA, Resolution to remove director https://www.legislation.gov.uk/ukpga/2006/46/section/168

[10] https://governanceriskandcomplianceclinix.com/

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