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Chairman v Managing Director – Let Battle Commence

Head of Business Services John Noctor looks at the implications of a recent High Court decision for directors of private limited companies. The case of Smith v Butler concerned a dispute between the Chairman and Managing Director.

The recent decision of the High Court in the case of Smith v Butler concerned a dispute between the Chairman and Managing Director of a private limited company. It restates some basic company law principles regarding the powers of Managing Directors, which may come as a surprise to those MD’s who believe they rule the roost.  

Background

The Chairman of the company held 70% of the shares and the MD held 30%. The Chairman was accused of a large scale cheque fraud amounting to at least £130,000, together with an expenses claim fraud amounting to at least £78,000. This came to the attention of the MD in 2009, but he did nothing about it until May 2011. In fact, the MD sat on the matter until the Chairman became unhappy with the way in which the business was being run. The Chairman decided to use his power as the majority shareholder to appoint a new Chief Executive Officer, effectively usurping the MD. That prompted open hostility and the outbreak of legal warfare.

The Legal Moves

In May 2011 the MD instructed his solicitors to investigate a possible fraud by the Chairman, but did not tell the Chairman what was going on. On 1st July, the Chairman was invited to a board meeting.  He was given a letter setting out his immediate suspension whilst the fraud was investigated. He was told to leave the premises with immediate effect, and following his departure the MD and Finance Director signed a board resolution authorising his suspension. From then on, the MD and the Finance Director ran the business without reference to the Chairman.

The Chairman instructed his own solicitors, and on 18th July he sought to convene a meeting of the shareholders to consider the removal of the MD and the Finance Director from their office as directors. The MD refused to attend the meeting of the shareholders, and because he held 30% of the shares the meeting was inquorate. On 19th July the Chairman tried a second line of attack. He issued proceedings against the MD and the company, first to obtain an order that the decision to suspend him from office was invalid, and second to obtain an order under section 306 of the Companies Act 2006 which would allow a meeting of the shareholders to take place with a quorum of one; himself.

In the meantime, the MD instructed a third firm of solicitors to act on behalf of the company, who in turn instructed forensic accountants to investigate the cheque fraud and the expenses fraud. By the time the case came before the High Court in September, the trial bundles amounted to over 1,100 pages of evidence, and the costs were already very substantial.

The Judgment

Mr Justice Behrens was essentially concerned with two things : did the MD have the power to remove the Chairman from office, and was the Chairman entitled to exercise his normal powers as a majority shareholder at a time when he was accused of significant wrongdoing against the company. The Judge found as follows:
 
1. The decision to suspend the Chairman was unlawful.  The MD had no implied authority to take that step, and in the absence of any specific authority in the company’s articles of association, or in the MD’s contract of employment, the MD had no greater power than any other director. 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.

2. 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 purpose of the meeting was to appoint a new director or to remove the MD. 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, especially where the decision to investigate the claims was clearly related to the MD’s desire to protect his own position. Nor could the MD frustrate the wishes of the majority shareholder by refusing to attend meetings.   

At first sight, these decisions might appear a little harsh. However, the Judge pointed out that the MD had other remedies available to him which he had not pursued. As a minority shareholder, he could have brought his own claim for unfair prejudice. Alternatively, he could have sought permission to bring a claim on behalf of the company (known as a derivative claim) although that would have to be supported by a resolution of the board of directors. The Judge was not saying that such claims would succeed, just that a different approach might have been taken.

This case is going before the Court of Appeal in early 2012. It will be interesting to see what results.

The Lessons

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 – is this how you operate ?

2. Contrary to popular perception, the MD has no greater power than any other director unless that power is conferred upon him. That might be through the company’s articles, but is far more likely to be contained in the MD’s contract of employment. Time to check those contracts ?

3. The will of the majority shareholder is meant to prevail, and in the absence of wrongdoing will usually do so. In particular, a minority shareholder cannot frustrate the will of a majority shareholder by refusing to attend meetings.

4. Where a majority shareholder is abusing his power, there are remedies available. However, those remedies have to be carefully selected, and appropriate authority obtained, in order to mount a successful challenge.

As mentioned earlier, the decision in Smith v Butler is going to the Court of Appeal although the grounds of appeal are not known. A further update will be provided on this important case once the appeal has been heard.

About the author

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John Noctor

John Noctor specialises in company and commercial work for major clients.

Published: Tuesday 18th October 2011
Categorised: Corporate Law

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