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.
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