Model Answer

The articles of association of Cedar Ltd. provide that the company’s business is the

production of organic. The articles further provide that the company has the power to borrow

money and the power to purchase plant and machinery in furtherance of the business of the

company. Since the company’s formation in 1995, the company’s business of producing

organic food has been profitable. However, in light of a recent economic downturn, the

company has not been able to make a profit from the business as demand for organic food

has waned. Cedar Ltd’s board of directors resolve that, in order to arrest the decline in the

company’s fortunes, company should switch to the production of non-organic food. For this

purpose, the directors enter into the following contracts on the company’s behalf:

I. A secured loan agreement with HBAS Bank plc

II. The purchase of a substantial quantity of chemical fertilizers, insecticides and

pesticides from Direct Land Ltd.

Giles, a minority shareholder of Cedar Ltd and a committed organic grower, is concerned with

the activities of the board of directors, in particular (a) the validity of the two contracts and (b)

the action, if any, that can be taken. Advise Giles as to his legal position.

General Advice

There is a lot going in this extract but the essence of the question boils down to two themes:

I. Consideration of Cedar Ltd’s capacity to enter into contracts. This will require an evaluation of the company’s objects. If a company’s objects are restricted, its powers cannot be exercised for a purpose which lies beyond the restriction.

II. Consideration of any relief available to Giles as a minority shareholder of Cedar Ltd. The Chancery Division of the High Court will intervene in circumstances in which the majority shareholders have sought to oppress Giles or have committed a fraud.

We can note several things of importance from the outset:

I. The main objects of Cedar Ltd are ‘the production of organic food’.II. Cedar Ltd is a private limited company – in the event of a dispute between the

members / directors of a private company, Courts are more likely to intervene since share securities cannot be traded as easily as can be done with public limited companies (PLCs).

III. Since the company was formed in 1995, section 31(1) of the Companies Act 2006 does not apply and thus Cedar Ltd’s objects are restricted. Any existing objects clause will now be a provision of the articles of association by virtue of section 28 of the Companies Act 2006. Such articles may only be deleted by a special resolution of the shareholders, as per section 21 of the Companies Act 2006.

IV. Cedar Ltd’s articles provide for two express powers of the directors:a. The power to borrow money and raise capitalb. The power to purchase ‘plant and machinery in furtherance of the business of

the company’

V. The directors have resolved to switch to the production of non-organic food. This, in theory, would authorize any action which purports to violate the objects clause. However, since any pre-existing objects clause is now an article of the company constitution, the resolution may only pass if the shareholders vote to amend the company’s articles by a qualified majority vote (75%) of the subscribing members, as per section 21(1) of the Companies Act 2006.

VI. Giles is a minority shareholder. As such, he is entitled to apply to a Court for relief from unfair or prejudicial conduct which may adversely affect his shareholding.

When answering problem questions in law, the best approach is to adopt the CLEO method:

C – Case / Cause of Action. Who can sue and what for? What rights have been prejudiced and who is responsible? What are the grounds for the action - Statutory / Common Law / Equity?

L – Law. What are the relevant provisions of law applicable to the case. E – Evaluation. How do the relevant provisions of law apply to the facts of the

problem? (This is the hardest part.) O – Outcome. What are you advising your client to do? What relief is available? What

do the academics suggest?

Model Answer

This problem concerns discussion of the validity of contracts beyond Cedar Ltd’s capacity and

contracts beyond the directors’ authority. As an aggrieved shareholder, Giles may wish to

initiate proceedings in the Chancery Division of the High Court, claiming relief against the

actions of the directors.

At common law, contracts that exceeded a company’s objects, were illegal, void, and

unratifiable (ASHBURY RAILWAY CARRIAGE & IRON CO. -v- RICHE). The modern position

is now covered under Section 39 of the Companies Act 2006 which states that ‘the validity of

an act done by a company shall not be called into question on the ground of lack of capacity

by reason of anything in the company’s constitution’. This is reflective of the principles of the

EU’s First Company Law Directive that sought to reduce detriment on third parties by

removing limitations on directors to enter into company contracts. Since the coming into effect

of the Companies Act 2006, companies already formed under earlier iterations of the

Companies Acts will continue to have the same restrictions on their objects but the clause will

now be deemed to be contained within the articles of the company (CA 2006, s 28), and thus

can only be amended by a special resolution of the shareholders (CA 2006, s 21).

As a shareholder, Giles may petition the Court to have Cedar Ltd wound up on just and

equitable grounds, as the company has indicated it wants to change to its product base from

organic to non-organic food. A winding-up petition can be lodged if ‘that which the company

was formed to do can no longer be done’ (RE BRISTOL JOINT STOCK BANK), and the

‘substratum’ or ‘raison-d’etre’ of the company ceases to exist (RE SUBURBAN HOTEL

COMPANY). Assuming Cedar Ltd is registered in England, the relevant legislation would be

Section 122(1)(g) of the Insolvency Act 1986.