Role of shareholders in decision making: Formal and Informal

It is a known fact that when a shareholder owns a share, he owns a Right to vote along with the share. This voting right allows him just to vote for the Board of Directors. As the directors are considered to be the operators and controllers of the Company, maximum decision-making power is given to them. Still, there are situations where shareholders’ decisions or their approval for corporate decisions are required. Such decision-making power of shareholder is exercised in few situations when the matter to be decided upon, is related to the shareholders’ legal or contractual rights. Without giving an exhaustive list of such situations, the following can be said to constitute the main examples of this policy:[1]

1. Alterations to the Company’s articles;
2. Alteration of the type of company;

• Decisions to issue shares or not to apply pre-emption rights on issuance;

1. Decisions to reduce share capital, re-purchase shares, redeem or re-purchase shares out of capital in the case of private companies or give financial assistance in the case of private companies;
2. Alterations to the class rights attached to shares;
3. Adoption of schemes of arrangement;

• Decisions to wind the company up voluntarily.

This shows that shareholder decision-making has a very important role to play in corporate governance of the companies. However, shareholders should not be given the power to decide upon other issues because they are not well-informed about the internal controlling procedure of the company other than the ones affecting them. Shareholders also own the ability to review the performance of Board of Directors and if performance has not been adequate, they can remove the existing directors to install a new board with the help of the voting rights they have received along with the share they have bought. This can be done during a general meeting among the shareholders. These general meetings are where the formal decision making takes place. There has been a failure in such a decision-making process because it has been noticed in a practical sense that shareholders hardly do show any kind of interest to attend such formal meetings. These meetings are then, captured by single-issue pressure groups whose primary objective is to plan out implementation of their own policies rather than shareholder interests.

Another way in which a company can take decisions, as recognised in common law, is through a unanimous consent. This rule is of particular use to small companies, which often act informally, as it prevents many unanimous decisions of their members being invalidated through a mere procedural irregularity.[2] Informal decision-making occurs where the same people are shareholders as well as directors. They refrain from attending the general shareholder meetings and prefer to make decisions as the director of the Company. In such cases the decisions on behalf of shareholders are taken, but outside the formal meetings. But, there are situations where formal decision-making is given utmost importance. In a recent case namely Minmar Ltd. v Khalatschi[3], a company director successfully argued for an order to set aside the appointment of an administrator on the grounds that the formalities set out in the company’s articles had not been complied with. Ultimately, the Court invalidated the appointment saying that the procedures of appointment did not comply with the Articles of Association. Where a small point even is seen going against the Articles of Association, the whole argument gets over as Articles are considered to be the Constitution of a Company, if a formal meeting is made mandatory in the articles, then informal meetings cannot be held for whatsoever reason.The most effective way to ensure a corporate decision is free from challenge is to follow all procedures and seek legal advice when in doubt.[4]

Shareholder democracy:

For the proper functioning of a democracy,people must have the ability to vote. This brings up the question of whether shareholders have the right to vote. They do have the right to vote, but not all the shareholders. In some situations, it’s only the equity shareholders who own this right. Usually, only registered shareholders are considered to have the right to fully exercise their votes that are attached to the shares they hold. Shareholders whose names are not entered on the register of shares are not shareholders within the meaning of most corporation laws, and have no standing to vote.[5] Charles Kahn talks about a Wall Street Rule according to which the investors or shareholders could walk out of the firm if they find the firm to be heading towards trouble.Because of this rule, the shareholders got a reason to exercise their rights and intervene into the corporate decisions. Suppose the shareholder is an institution and the institution feels that the firm whose shares it holds is showing a poor performance and such poor performance can be changed by bringing about a change in direction in which the firm is moving, the institution can bring out the change. The institution can buy additional shares from the firm in order to profit the firm or sell its existing holdings to a third party immediately before the firm does badly so as to save the firm from bearing further losses.[6] This is how the Wall Street Rule allows a shareholder to intervene into the corporate decision-making for more profitable reasons.

In Re Imperial Chemical Industries Ltd.[7], Lord Maugham said,

“A shareholder’s vote is a right of property and prima facie may be exercised by a shareholder as he thinks fit in his own interest.”

In a leading case, it was held that voting by a shareholder could not be impugned simply on the grounds that it was causing harm to others.[8] In Pender v. Lushington[9], Jessel MR said,

“There is no obligation on a shareholder of a company to give his vote merely with a view to what other persons may consider the interests of the company at large. He has a right, if he thinks fit, to give his vote from motives or promptings of what he considers his own individual interest. Whether or not the object for which the votes were given would bring about the ruin of the company, or whether or not the motive was an improper one which induced the shareholders to give their votes, or whether or not their conduct shows a want of appreciation of the principles on which the company was founded, are wholly irrelevant.”

Though the right of an individual shareholder to vote in a meeting is a right which he may exercise in his own discretion, that right is subject to certain limitations and cannot be exercised arbitrarily or unreasonably, one such limitation being that it should be exercised in the interest of the company as a whole, and the other that it should not be exercised so as to constitute an oppression of the minority shareholder.[10]

Rules regarding corporate governance are available in the statutory framework as well as the company’s way of incorporation. There are situations where a decision needs to have been made whether to follow the statute or the company’s Articles. Such decisions are also to be made when a question of amendment of rules has arisen. A shareholder can vote for such an amendment to be brought upon the company only when the Board of Directors first elects to have such a vote. Here, the shareholder lacks the power to initiate changes to the state of incorporation and amendment of the same.[11]  Here, the shareholder democracy is seen to have been dragged backwards as the availability of his rights is curtailed by the Board of Directors’ selection of exercising such a right. Furthermore, it is worth noting that these powers grant shareholders the concurrent authority with the board to amend the company’s bylaws, which can regulate some aspects of the company’s governance. These bylaws, however, are subordinate to the charter and cannot alter any of the charter’s arrangements.[12] This again cuts down the importance of shareholder power as compared to the directors.

According to the existing securities law, even shareholders with a small stake may initiate shareholder resolutions that call for management to initiate an amendment, reincorporation or policy-making.[13] But, the corporate laws have not allowed these resolutions to be binding. Directors have the discretion to either follow these proposals or not to follow them. This is another situation where the theory of shareholder democracy gets negated due to power handed over to the directors.

Even at the course of winding up, the majority votes corresponding to the number of outstanding shares is required for the approval of the dissolution and sale of assets. But, this voting power is a mere veto power and here also, shareholders lack the power to initiate decisions. They can exercise their vote only when the Board of directors brings it up to them. Other than all that is mentioned, there are other corporate decisions where shareholder holds no power at all- neither power to initiate or veto power. This mostly applies to decisions regarding distribution which is completely handled by the Board of Directors.

The issue of unfair prejudice in United Kingdom Company Law emerged after the Companies Act of 2006 laid out a provision wherein the aggrieved shareholders can take action against the company. This is nothing new, but a mere look-alike of the derivative action. A derivative action was raised as an exception to the case of Foss v. Harbottle[14]. In this case it was held that only the company itself is the proper claimant to bring an action against the company in its wrong doings. A derivative action can be taken by a minority shareholder on behalf of the company when the so called ‘proper claimant’ or the company’s controlling head is the wrongdoer and does not want to bring an action against own self. A derivative claim under this Chapter may be brought only in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company.[15] The cases in which the minority can maintain such an action are confined to those in which the acts complained of are of a fraudulent character or beyond the powers of the company.[16]

In Estmanco v. GLC[17], Megarry J. stated:

I cannot see why the right of the minority to sue under that exception should be taken away from them merely because the majority of the company reasonably believe it to be in the best interests of the company that this should be done. This is particularly so if the exception from the rule falls under the rubric of “fraud on a minority. …”

[1]Gower and Davies, ‘Principles of Modern Company Law’ (Sweet and Maxwell 2008) 375

[2] Andrew Hicks, S.H Goo, Cases and materials on Company Law, ( 6th ed., Oxford University Press)

[3][2011] B.C.C. 485

[4]Richard Britain and Trefor John, ‘United Kingdom: Shareholder and Director Decision Making: CorrectingDefectiveDecisions(Corporate/Company Law, 5 March 2012)

http://www.mondaq.com/x/167272/Directors+Officers+Executives+Shareholders/Shareholder+And+Director+Decision+Making+Correcting+Defective+Decisions

[5]Clusterstock Contributors, ‘Why shareholder democracy matters’ (Business Insider 5 October 2011) http://articles.businessinsider.com/2011-10-05/wall_street/30245556_1_proxy-voting-shareholders-voting-rights#ixzz1rYEzgIvg

[6] Charles Kahn and Andrew Winton, “ Ownership Structure, Speculation, and Shareholder Intervention”, [1998] The Journal of Finance

[7] [1973] AC 707

[8] Bradford Corporation v. Pickles

[9] [1877] 6 Ch D 70

[10] LIC of India v. Escorts ltd., [1986] 59 Comp Cas 548

[11] See, Lucian AryeBebchuk, “The Case for increasing Shareholder Power”, (2005) 118 HLR 844

[12] Ibid 845

[13] Ibid 846

[14](1843) 67 ER 189

[15]The Companies Act 2006, Section 260(3)

[16]Atwool v. Merryweather (1867) LR 5 EQ 464; Menier v. Hooper’s Telegraph Works (1874) 9 Ch App 350

[17] [1982] 1 All E R 437