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Directors' duties: improper purposes or implied terms?

Published online by Cambridge University Press:  02 January 2018

Ernest Lim
Ernest Lim*
Affiliation:
University of Hong Kong
*
Ernest Lim, Faculty of Law, University of Hong Kong, 10/F, Cheng Yu Tung Tower, Centennial Campus, Pokfulam Road, Hong Kong. Email: elimwk@hku.hk
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Abstract

This paper challenges the prevailing assumption that the directors' duty to act for proper purposes under s 171 (b) of the Companies Act 2006 is well-grounded on authorities such as Howard Smith Ltd v Ampol Petroleum Ltd, Hogg v Cramphorn Ltd, Lee Panavision Ltd v Lee Lighting Ltd and Extrasure Travel Insurances Ltd v Scattergood. It advances the argument that a close analysis of these authorities shows that, despite the use of the language of proper purpose, the primary and central justification for impugning the director's exercise of powers in question is that an implied term of the company's constitution was contravened. Given that case-law support for the proper purpose duty is at best overstated and at worst misconceived, a consideration of whether future cases concerning whether directors have breached their duties should be decided on the basis of whether an implied term of the constitution has been contravened under s 171(a), instead of whether directors have exercised their powers for proper purposes under s 171(b), is warranted. It is submitted that deciding cases based on implied terms under s 171(a) is more defensible because: (i) high authorities such as Attorney General of Belize v Belize Telecom and Equitable Life Assurance Society v Hyman endorse the use of implied terms as a technique for controlling the exercise of discretionary powers conferred on directors; (ii) a principled approach for implying terms can be derived from these authorities; (iii) there are safeguards that are built into the doctrine of implied terms; (iv) the application of the improper purpose doctrine gives rise to perennial problems; and (v) that doctrine is based on a fallacious conceptual justification.

Type
Research Article
Information
Legal Studies , Volume 34 , Issue 3 , September 2014 , pp. 395 - 418
Copyright
Copyright © Society of Legal Scholars 2014

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Footnotes

*

Debts of gratitude are owed to Professor Sarah Worthington, Professor Lusina Ho, Cora Chan, Jolene Lin, Peter Chau, the two anonymous referees and the editor, Professor Colin Scott. The usual caveat applies.

References

1. Modern Company Law for a Competitive Economy: Completing the Structure, A consultation document (Dublin: Company Law Review Steering Group, November 2000) ch 3, para 3.15.

2. See s 170(4) of the Act.

3. See eg Davies, Pl Gower and Davies' Principles of Modern Company Law (London: Sweet & Maxwell, 8th edn, 2008), paras 16–21 (citing Howard Smith Ltd v Ampol Petroleum Ltd);Google Scholar Morse, G etal (eds) Palmer's Company Law: Annotated Guide to the Companies Act 2006 (London: Sweet & Maxwell, 2007) p 165 (citingGoogle Scholar Punt v Symons & Co Ltd, Hogg v Cramphorn Ltd and Howard Smith Ltd v Ampol Petroleum Ltd); Arden, Dame Mary etal (eds) Buckley on the Companies Acts (London: LexisNexis UK, 2012) para 866 (citingGoogle Scholar Extrasure Travel Insurances Ltd v Scattergood) and Sealy, L and Worthington, S Sealy's Cases and Materials in Company Law (Oxford: Oxford University Press, 9th edn, 2010) pp 311–316 (citingGoogle Scholar Punt v Symons & Co Ltd, Hogg v Cramphorn Ltd and Howard Smith Ltd v Ampol Petroleum Ltd).

4. [1974] AC 821 (PC).

5. [1967] Ch 254.

6. [1991] BCC 620 (CA).

7. [2002] EWHC 3093; [2003] 1 BCLC 598.

8. Although s 17 of the Act defines a company's constitution to include the articles as well as any resolutions and agreements stipulated under s 19, for the purpose of this paper, there is no need to refer to the resolutions and agreements.

9. Although it will not necessarily make a difference to third parties who may be able to enforce the transaction if they are able to rely on s 40 of the Act. See Criterion Properties Plc v Stratford UK Properties LLC [2004] 1 WLR 1846.

10. This is on the assumption that members do not ratify the breach committed by the director.

11. Shernborne Park Residents Co Ltd, Re (1986) 2 BCC 99528 at 99531 (per Hoffmann J).

12. Ibid, at 99530 (per Hoffmann J). By contrast, it was stated in Bamford v Bamford [1970] Ch 212 that an exercise of powers to allot shares for improper purpose ‘is a harm done to the company of which only the company can complain’.

13. See also the Supreme Court of South Australia case of Residues Treatment and Trading Co v Southern Resources (No 4) (1988) 14 ACLR 569, where it was held that the claimant member was entitled to sue the company for an infringement of its personal rights when the directors exercised their powers to allot shares for improper purpose, as that resulted in a wrongful dilution of that member's voting rights.

14. In Shernborne Park Residents Co Ltd, Re (1986) 2 BCC 99528, Hoffmann J refused to order the company to indemnify the petitioner for the costs it incurred for a claim it brought under the unfair prejudice provisions. See Davies, above n 3, p 504.

15. Winthrop Investments v Wins [1975] 2 NSWLR 666 at 690–698 (per Mahoney JA) (NSWCA). By contrast, J Hoffmann in Shernborne Park Residents Co Ltd, Re (1986) 2 BCC 528 held that acting for improper purposes constitutes an infringement of the members' rights under the articles.

16. One qualification to the argument advanced here is the case of Hunter v Senate Support Services Ltd [2005] 1 BCLC 165. There, John Randall QC, sitting as deputy High Court judge, held that the directors' decision to forfeit the claimant's shares for non-payment of a call and to transfer the forfeited shares to the group holding company was not made for any improper purpose. However, that case, unlike the cases referred to on the second page of this paper, is not cited in the leading commentaries as an authority for the proper purpose duty. It is instead cited as supporting the claim that the improper purpose doctrine can be aligned with public law principles. Morse etal, above n 3, p 165.

17. [2009] 1 WLR 1988 (PC).

18. [2002] 1 AC 408 (HL) (per Lord Steyn).

19. [1974] AC 821.

20. (1938) 60 CLR 150 (HC of Australia).

21. [1974] AC 821 at 831.

22. (1938) 60 CLR 150 at 163.

23. Ibid, at 164.

24. Ibid, at 170.

25. Ibid, at 179.

26. Ibid, at 188.

27. Ibid, at 186.

28. [1974] AC 821 at 831.

29. Ibid, at 833.

30. Ibid, at 835.

31. Ibid, at 836.

32. [1903] 2 Ch 506.

33. [1920] 1 Ch 77.

34. [1967] Ch 254.

35. [1974] AC 821 at 834.

36. Ibid, at 837.

37. Equitable Life Assurance Society v Hyman [2002] 1 AC 408 at 459 per Lord Steyn.

38. Ibid.

39. Attorney General of Belize v Belize Telecom [2009] 1 WLR 1988 at 1993.

40. [1906] 2 Ch 34 (CA).

41. Ibid, at 41–42 (per Collins MR).

42. Attorney General of Belize v Belize Telecom [2009] 1 WLR 1988 at 1993–1994 (per Lord Hoffmann); Equitable Life Assurance Society v Hyman [2002] 1 AC 408 at 459.

43. Attorney General of Belize v Belize Telecom [2009] 1 WLR 1988 at 1993 (per Lord Hoffmann).

44. Ibid, at 1994 (per Lord Hoffmann).

45. Cf John Shaw & Sons (Salford) v Shaw [1935] 2 K.B. 113 at 134 (CA) (per Greer LJ).

46. See below n 64 and accompanying text.

47. [1935] 2 K.B. 113 at 134 (CA) (per Greer LJ).

48. [1974] AC 821.

49. [1906] 2 Ch 34 (CA).

50. [1974] AC 821 at 837.

51. Equitable Life Assurance Society v Hyman [2002] 1 AC 408 at 459 (per Lord Steyn).

52. Attorney General of Belize v Belize Telecom [2009] 1 WLR 1988 at 1994 (per Lord Hoffmann).

53. [1991] BCC 620.

54. [1903] 2 Ch 506.

55. [1920] 1 Ch 77.

56. [1967] Ch 254.

57. [1974] AC 821 at 837.

58. [1991] BCC 620 at 635.

59. [1903] 2 Ch 506.

60. [1903] 2 Ch 506 at 515–516 (emphasis added).

61. [1920] 1 Ch 77.

62. Ibid, at 84 (per Peterson J).

63. [1967] Ch 254.

64. Ibid, at 268.

65. Kershaw, D ‘The illusion of importance: reconsidering the Uk's takeover defence prohibition’ (2007) 56 Int'l & Comp L Q 284–285.CrossRefGoogle Scholar

66. [2002] EWHC 3093; [2003] 1 BCLC 598. This case is cited as authority for the proper purpose duty in Arden etal, above n 3, para 866.

67. See also CAS (Nominees) Ltd v Nottingham Forest FC plc [2002] 1 BCLC 613 (where directors of a parent company bypassed its shareholders and sold shares in a subsidiary to an outsider in order to raise funds for the subsidiary).

68. [2003] 1 BCLC 598 at 619.

69. Ibid.

70. Arden etal, above n 3, para 866.

71. Ibid, at 633 (emphasis added).

72. Ibid.

73. Ibid.

74. Nolan, Rc ‘Controlling fiduciary power’ (2009) 68 Cambridge L J 293 at 302.CrossRefGoogle Scholar

75. Ibid, at 302.

76. Nolan, Rc ‘The proper purpose doctrine and company directors’ in Rider, B (ed) The Realm of Company Law (Dordrecht: Kluwer Law International, 1998) p 4.Google Scholar

77. Attorney General of Belize v Belize Telecom [2009] 1 WLR 1988 at 1993 (per Lord Hoffmann).

78. Equitable Life Assurance Society v Hyman [2002] 1 AC 408 at 459.

79. [2009] 1 WLR 1988 at 1994 (emphasis added). But note that additional terms cannot be implied into the articles from extrinsic circumstances: Bratton Seymour Service v Oxborough [1992] BCLC 693. Lord Hoffmann recognised this in Belize at 1998.

80. [2002] 1 AC 408.

81. Ibid, at 415.

82. Ibid, at 458.

83. Ibid, at 460.

84. Ibid, at 458.

85. Ibid, at 458.

86. Ibid, at 459.

87. See eg Re Coroin Ltd, McKillen v Misland (Cyprus) Investments Limited [2012] EWCA Civ 179; [2012] BCC 575 and Cream Holdings Limited v Stuart Davenport [2010] EWHC 3096 (Ch); 2010 WL 4365906.

88. Davies, above n 3, paras 16–22. Professor Davies suggests that it is a matter of construction of the articles, but without explicating how such a construction should be carried out.

89. But note that although the articles constitute a contract between the company and the members, the principle of rectification is not applicable to the articles: Scott v Frank F Scott (London) [1940] Ch 794 (CA). Also, the articles cannot be subsequently supplemented by additional terms implied from extrinsic circumstances: Bratton Seymour Service Co v Oxborough [1992] BCLC 693 (CA).

90. Cream Holdings Limited v Stuart Davenport [2010] EWHC 3096 (Ch); 2010 WL 4365906 (John Randall QC, sitting as deputy High Court judge, citing counsel's submission) at para 27 (affirmed on appeal).

91. (1977) 180 CLR 266 at 282–283.

92. [2009] 1 WLR 1988 at 1995.

93. Ibid.

94. John Shaw & Sons (Salford) v Shaw [1935] 2 KB 113 at 134 (CA) (per Greer LJ).

95. But note that the power to alter the company's articles must be exercised bona fide for the benefit of the company as a whole: see Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656 (CA).

96. One qualification to this is that the transfer has to be for the former company's benefit. See eg Walker v Wimborne (1976) 137 CLR 1 (Aust HC).

97. Movitex Ltd v Bulfied [1988] BCLC 104 (per Vinelott J).

98. Wilkinson v West Coast Capital [2007] BCC 717 (per Warren J). See Sealy and Worthington, above n 3, p 248.

99. But it is worth clarifying that this paper does not make the broader claim that company law or directors' duties should be solely or primarily viewed through the lens of contract or contractarian theory. This is a conceptually complex and contentious issue that deserves separate treatment and is beyond the scope of this paper.

100. Fulham Football (1987) Ltd v Richards & Anor [2011] EWCA Civ 855 (CA). See McVea H ‘Section 994 of the Companies Act 2006 and the primacy of the contract’ (2012) 75 Mod L Rev 1123.

101. Bushell v Faith [1970] AC 1099.

102. Russell v Northern Bank Development Corpn Ltd [1992] 1 WLR 588 (HL).

103. Easterbrook, F and Fischel, D ‘The corporate contract’ (1989) 89 Colum L Rev 1416.CrossRefGoogle Scholar

104. Kraakman, R etal The Anatomy of Corporate Law: A Comparative and Functional Approach (Oxford: Oxford University Press, 2nd edn, 2009) ch 1.Google Scholar

105. This includes fees of professional advisers such as lawyers and accountants, or other advisers.

106. It is very time-consuming to examine and negotiate in detail all the relevant terms that cover all possible contingencies.

107. For example, Professor Cheffins observes that when a company is at its formative stage, people are generally optimistic and hence reluctant to discuss or prescribe in detail the rules and standards that should be imposed on directors and managers for fear of undermining the trust and goodwill among the parties. Another example is that discussing remote and contentious contingencies can make parties nervous and potentially scuttle a deal. The result is that parties could finalise a deal but the documentation will contain crucial gaps. See Cheffins, B Company Law: Theory, Structure and Operation (Oxford: Clarendon Press, 1997) pp 133–134.Google Scholar

108. Easterbrook, F and Fischel, Dr ‘Contract and fiduciary duty’ (1993) 36 J L & Econ 425 at 426–427;CrossRefGoogle Scholar Easterbrook, F and Fischel, Dr The Economic Structure of Corporate Law (Cambridge, MA: Harvard University Press, 1991) chs 4–5.Google Scholar See also Duggan, A ‘Contracts, fiduciaries and the primacy of the deal’ in Bant, E and Harding, M (eds) Exploring Private Law (Cambridge: Cambridge University Press, 2010) pp 275–297. On the criticisms of the contractarian theory of fiduciary relationships,CrossRefGoogle Scholar see eg FitzGibbon, S ‘Fiduciary relationships are not contracts’ (1999) 82 Marq L Rev 303; andGoogle Scholar DeMott, Da ‘Beyond metaphor: an analysis of fiduciary obligation’ (1988) Duke L J 879. On the criticisms of the contractarian theory of corporate law,CrossRefGoogle Scholar see eg Bratton, Wm ‘The “nexus of contracts” corporation: a critical appraisal’ (1989) 74 Cornell L Rev 407; andGoogle Scholar Brundney, V ‘Corporate governance, agency costs, and the rhetoric of contract’ (1985) 85 Colum L Rev 1403. It bears emphasis that the arguments in this paper do not necessarily rely on the economic justifications underpinning the contractarian theory and thus the validity of the thesis here does not require us to evaluate the merits of the debate between contractarians and their detractors. While an enquiry into the economic justifications is worthwhile, it deserves separate and detailed treatment, which is beyond the scope of this paper.CrossRefGoogle Scholar

109. Easterbrook and Fischel ‘Contract and fiduciary duty’, above n 102, at 426–427.

110. This is similar to the distinction between terms implied in fact and terms implied in law, which distinction has been subject to trenchant criticisms by A Phang in ‘Implied terms revisited’ [1990] J Bus L 394 and ‘Implied terms in English law – some recent developments’ [1993] J Bus L 242, but which the law has nevertheless maintained.

111. Edelman, J ‘When do fiduciary duties arise?’ (2010) 126 Law Q Rev 302 at 307 (emphasis added), cited with approval inGoogle Scholar F & C Alternative Investments (Holdings) Ltd v Barthelemy (No 2) [2012] 3 WLR 10 (Ch) (per Sales J) at para 225.

112. Edelman, above n 105, at 316.

113. [2009] 1 WLR 1988 at 1994 (PC).

114. Edelman, above n 105, at 317.

115. Ibid (emphasis added).

116. Ibid, at 317–318.

117. Nolan, above n 68, at 303.

118. Attorney General of Belize v Belize Telecom [2009] 1 WLR 1988 at 1993.

119. Ibid, at 1995.

120. Equitable Life Assurance Society v Hyman [2002] 1 AC 408 at 459, citing Banque Bruxelles Lambert SA v Eagle Star Insurance Co Ltd [1997] AC 191 HL at 212.

121. Nolan, above n 70, p 4.

122. Ibid, p 5.

123. Sealy, Ls ‘“Bona fides” and “proper purposes” in corporate decisions’ (1989) 15 Monash U L Rev 265 at 276.Google Scholar

124. Lord Hoffmann's approach in Belize has been criticised by one academic as ‘giving the court greater room to alter the bargain made. This may lead to judges attempting to improve an agreed contract’: Davies, Ps ‘Recent developments in the law of implied terms’ (2010) LMCLQ 140 at 145. This criticism is unfounded.Google ScholarLord Clarke MR said in Mediterranean Salvage & Towage v Seamar Trading & Commerce Inc [2009] 1 CLC 909 at 916: ‘As I read Lord Hoffmann's analysis, although he is emphasising that the process of implication is part of the process of construction, he is not in any way resiling from the often stated proposition that it must be necessary to imply the proposed term. It is never sufficient that it should be reasonable.’ See also Groveholt v Hughes 2010 WL 1944390 at para 45 (per Arden LJ), in which Lord Hoffmann's approach was endorsed. See also Grabiner, Lord Qc ‘The iterative process of contractual interpretation’ (2012) 128 Law Q Rev 41 at 58–61, who commended Lord Hoffmann's approach and who rejected the assertion that Lord Hoffmann's approach rendered the test of implication no longer one based on necessity. Lord Hoffmann's judgment in Belize has received overwhelmingly favourable treatment by commentators.Google Scholar See eg Low, K and Loi, K ‘The many “tests” for terms implied in fact: welcome clarity’ (2009) 125 Law Q Rev 561; andGoogle Scholar McCaughran, J ‘Implied terms: the journey of the man on the Clapham omnibus’ (2011) 70 Cambridge L J 707 concluded that Lord Hoffmann's approach will prevail.CrossRefGoogle Scholar

125. [2009] 1 WLR 1988 at 1993.

126. Ibid.

127. Equitable Life Assurance Society v Hyman [2002] 1 AC 408 at 459.

128. Howard Smith v Petroleum [1974] AC 821 at 834 (per Lord Wilberforce).

129. Ibid, at 835 (per Lord Wilberforce).

130. Sealy, above n 117, at 277.

131. Ibid, at 274.

132. Nolan, above n 70, p 20.

133. Howard Smith v Petroleum [1974] AC 821 at 834 (per Lord Wilberforce). See eg B Hannigan Company Law (Oxford: Oxford University Press, 2nd edn, 2009) at para 8–56.

134. Howard Smith v Ampol Petroleum [1974] AC 821 at 835.

135. Whitehouse v Carlton Hotel Pty Ltd (1987) 162 C.L.R. 285 at 294. Mortimore (ed) Company Directors: Duties, Liabilities and Remedies (Oxford: Oxford University Press, 2008), para 10.32.

136. Nolan, above n 70, pp 19–20.

137. Ibid, p 19.

138. Ibid. The other case that Mr Nolan cites in his footnote, which is inapplicable, is Hindle v John Cotton (1919) Sc. L.R. He relies on a dictum from Viscount Finlay concerning the necessity of good faith.

139. Hampden v Earl of Buckinghamshire [1893] 2 Ch 531 at 544.

140. Attorney General of Belize v Belize Telecom [2009] 1 WLR 1988 at 1993.

141. Ibid.

142. Ibid.

143. Ibid.

144. It bears emphasis that the argument here and elsewhere in this paper does not endorse the contractarian theory of corporate law that views firms as a complex set of contracts. The classic exposition and defence of this theory can be found in Easterbrook and Fischel, above n 102. The classic critique is Bratton, above n 102. See also Charny, D ‘Hypothetical bargains: the normative structure of contract interpretation’ (1991) 89 Mich L Rev 1815;CrossRefGoogle Scholar Ayres, I ‘Making a difference: the contractual contributions of Easterbrook and Fischel’ (1992) 59 U Chi L Rev 1391.CrossRefGoogle Scholar

145. See Brudley, V ‘Contract and fiduciary duty in corporate law’ (1997) 38 BC L Rev 595, 622–635; FitzGibbon, above n 102.Google Scholar

146. Ibid.

147. See above n 73.