Head of Business Services, John Noctor explains the impact of a recent Court of Appeal judgment on the role of the Managing Director.
In October of last year we reported on the decision of the High Court in the case of Smith v Butler concerning a dispute between the chairman and managing director of a private limited company. The managing director lost the argument in the High Court, and took his case to the Court of Appeal. The Court of Appeal has now issued its judgment which clarifies some important points of principle regarding the powers of managing directors.
The High Court
Just to recap, the chairman held 70% of the shares in the company and the MD held 30%. The two men fell out when the chairman decided to remove the MD from office for under-performance, and the MD accused the chairman of financial fraud on a significant scale. The following actions resulted:
• The MD sought to suspend the chairman from office whilst the alleged fraud was investigated.
• The chairman responded by convening a shareholders meeting to remove the MD from his office as a director, utilising the chairman’s powers as a majority shareholder.
The MD sought to frustrate the actions on the part of the chairman, by refusing to attend the meeting of shareholders thus rendering it inquorate. The chairman therefore applied to the High Court for a declaration that the MD had no power to suspend him from office as chairman, and for an order under Section 306 of the Companies Act 2006 convening a meeting of the company at which one member, namely the chairman, would be a quorum. The purpose of that meeting being to remove the MD from his office as a director.
In a move which later turned out to be very costly, the companywas joined in the proceedings to oppose the chairman’s applications.
The matter came before Mr Justice Behrens in the High Court and he found as follows:
• 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.
• 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 MD frustrate the wishes of the chairman, in his capacity as majority shareholder, by refusing to attend meetings.
• The MD should pay the company’s costs.
The MD appealed to the Court of Appeal, and the judgment of the Court of Appeal is summarised below.
The Court of Appeal
The Court of Appeal rejected the MD’s arguments and dismissed the appeal. The Court found as follows:
• There had been no express delegation of powers by the board of directors to the MD. He simply had a contract of employment appointing him as managing director. That appointment did not supplant the role of the board, and the MD had to operate within the strategy set by the board. The suspension of the chairman was a matter for the board and not for the MD acting alone.
• An order would be made under Section 306 of the Companies Act 2006, to convene a meeting of shareholders at which the chairman alone would constitute a quorum.
• Since the MD had no power to act as he did, it followed that he had no power to cause the company to support his actions, and no power to require the company to incur substantial costs in doing so.
The MD must therefore pay the company’s costs.
In essence, the Court of Appeal supported the decision of the High Court in its entirety. Not only is the MD now facing removal from his office as a director of the company, he will also be left facing a very substantial bill for the costs incurred throughout the proceedings.
From a practical point of view, the lessons to be learned from this case are as follows:
1. The business of the company is meant to be conducted by the board of directors as a whole, unless specific matters are specifically delegated to individuals.
2. Contrary to popular perception, the MD has no greater power than any other director unless that power is conferred upon him. That power might be conferred by a resolution of the board of directors as a whole, or it might be set out in the MD’s contract of employment, but failing that the power does not exist.
3. The will of the majority shareholder is meant to prevail, and in the absence of wrong doing will usually do so. In particular, a minority shareholder cannot frustrate the will of a majority shareholder by refusing to attend meetings.
4. If an MD (or any other director) joins the company into proceedings to support his position, and that position is not substantiated, the probability is that the director will be required to pay the company’s costs.
The decision in Smith & Butler is very significant in determining the powers of a managing director. If you wish to confer additional powers upon a managing director, those powers have to be approved by the board as a whole, and spelled out either in a board resolution or in the MD’s contract of employment. In the absence of any such power, the MD may find that he has overstretched his authority, and has incurred significant personal liabilities in doing so.
Any managing director who feels he is exposed in this way, may wish to review the matter in conjunction with his board of directors, with a view to clarifying his position and documenting the arrangements in an appropriate manner.