As requested here is a report on the issues arising from the proposed diversification into gliding and the chances of the shareholders preventing Sid and Kenny from pursuing their plans.

To start it may be worth noting that Sid and Kenny have not even discussed the issue of diversification with the other shareholders, even if they had they would have had the majority decision as they own 60% of the shares and therefore have a majority. This would therefore seem to be of little consequence.

Firstly I will discuss the issues arising from the wishes of the remaining shareholders to block the proposed diversification. This is an issue that relates to the powers that minority shareholders have and under what circumstances they may attempt to overturn a decision made by the majority.

In Re Kong Thai1 Lord Wilberforce stated that “Those who take interests in companies limited by shares have to accept majority rule”. Majority rule and the existence of the company’s separate legal personality produce an important consequence. In Foss v Harbottle2, the directors were alleged to have misapplied company property. Two shareholders wished to bring an action to make them account to the company. But they could not: the company, as the victim of alleged misconduct, was the proper person to decide whether to sue. Despite the rule in Foss there are exceptions and the majority cannot always go unchecked by the courts. In Edwards v Halliwell3 certain exceptions to the rule in Foss were noted:

1) It did not apply to ultra vires acts, which by their nature could not be ratified by the majority.

2) Minority shareholders can complain of a fraud on the minority

3) A Bare majority cannot do something needing needing a larger majority

4) Individual member can always assert their personal rights.

In relation to this scenario it seems that the first exception would be enough for Bernie and the other shareholders to bring an action against Sid and Kenny to court in order to block them form pursuing their plans. The belief in majority control ignores the reality that a majority shareholder’s control can be side-stepped in particular situations. Minority shareholders are using Section 459 of the Companies Act 1985 to show their disapproval, which is proving invaluable for those who previously had little redress in the courts.

Section 459 allows a member to petition the court where a company’s affairs are being conducted in a manner that is unfairly prejudicial to the interests of the company’s members or to the petitioner.

The wording of section 459 is extremely broad and has led to differing interpretations from the courts. This makes it difficult to say with any certainty what sort of conduct is unfairly prejudicial. Generally, the test of what amounts to unfair prejudice is objective. So it isn’t necessary to show that those who have control of the company have acted with the conscious knowledge that their actions were unfair to the minority shareholders, or in bad faith.

The test is whether a reasonable bystander observing the consequences of the majority’s conduct would have regarded it as having unfairly prejudiced the minority shareholders’ interests. In O’Niell4 it was put across that the exercise of the remedy of section 459 depends on the non-fulfillment of the petitioner’s contractual rights or legitimate expectations on a way that is unfair. Section 459 is a personal action that may be suitable in this case, but the shareholders could also bring a derivative action, which is made on behalf of the company.

In the worst case scenario an option for Bernie and the other shareholders may to be bring an action under Section 122 of the Insolvency Act 1986 to wind up the company under circumstances listed in Section 122(1) IA 1986, the most popular of which being, where it is “just and equitable” to do so ( Re Bleriot Aircraft Co.5).

Secondly the matter of the proposed diversification will be looked at. The scenario states that the company’s memorandum of association is stated as ‘the provision of motorsport facilities’. The general consensus would seem to be that a gliding school would not be classed as a motorsport. So to start a gliding school could be seen as ultra vires (beyond the powers of) the company, in Ashbury6 the House of Lords was obliged to decide between two interpretations of the 1862 Act, namely:

a) that the legislature must be deemed to have conferred all the powers of a natural person upon a company unless such powers had been taken away either expressly or by implication, or alternatively;

b) that any matter which was not authorised expressly or by necessary implication within a company’s objects clause must be taken to have been forbidden.

The House of Lords preferred this latter interpretation on the grounds that it secured the protection of creditor interests. However, the House justified its decision in terms of both shareholder and creditor protection. Shareholders would be protected because a company would be unable to alter the direction of its business other than to follow its stated objects. Therefore, a prospective shareholder of a company could, by examining a company’s memorandum, decide whether to invest in a company on the basis of its set objects. If a company subsequently attempted to deviate from its objects clause a shareholder could either seek an injunction to restrain the company from entering into an ultra vires transaction and/or where a company’s main object (substratum) had failed, seek an order for the winding upon of the company. In addition, where a company entered into an ultra vires transaction, any shareholder would be afforded the right to have the offending transaction set aside.

Only 5 years later the courts seem to move from the strict interpretation of Ashbury and in Attorney-General v Great Eastern Railway Company7 Lord Selborne LC stated that:

“It appears to me to be important that the doctrine of ultra vires, as it was explained in that case [Ashbury Railway Carriage and Iron Co v Riche (1875) LR 7 HL 653], should be maintained. But I agree with Lord Justice James that this doctrine ought to be reasonably, and not unreasonably, understood and applied, and that whatever may fairly be regarded as incidental to, or consequential upon, those things which the Legislature has authorized, ought not (unless expressly prohibited) to be held, by judicial construction, to be ultra vires.”

The director’s of a company must observe the limitations in its memorandum of association and ensure that they act intra vires i.e. within powers (CA 1985 s.35(3)). Sid and Kenny may argue that starting a gliding school, though not strictly “motorsport” is not too far removed to fall ultra vires, this argument is likely to fail and the diversification classed as ultra vires. In the case of Stephens v Mysore Reefs8, a company which was formed to acquire a gold mine in India was prohibited from acquiring an interest in a gold mining property in West Africa. Taking this view into consideration it seems unlikely that that a gliding school would come under the umbrella of “motorsport facilities”.

As Bernie knows of a gliding school in a neighbouring town that has recently gone into receivership after failing to generate sufficient business, it is likely that this diversification planned by Sid and Kenny may also lead to losses. Any director who has entered into a contract outside the objects of the company is liable to replace any money/losses on the particular transaction/ venture (Re Lands Allotment Co.)9 Furthermore directors may face a disqualification of up to 15 years from being a director (Company Directors Disqualification Act 1986 s.1). In the case of Re Samuel10 a director of a company was disqualified from being a director for five years due to investing in money into activities outside its objects which generated losses.

A further issue arising from this scenario is that Sid and Kenny could attempt to change the memorandum of association to incorporate a general objects clause as set out in Section 3A of the Companies Act 1985. As there is no sign of this having happened or happening in the future, this is not of great relevance and that the object clause as it stands “the provision of motorsport facilities” continue.

In conclusion the powers given to minority shareholders are not extensive but they do give them the rights to bring a decision of majority shareholders/directors before the courts if the decision is made ultra vires. There are a number of legal routes that Bernie and the other shareholders may take ranging from an action for an injunction by the courts to an action to wind up the company. And furthermore it seems that transactions that are outside the objects of the company, may be restrained by the courts and also fines and or disqualifications imposed upon the “guilty” directors.