HL Deb 07 November 1989 vol 512 cc675-81

131A Line 5, leave out ("a previous act of the Company") and insert ("an act of the Company done before the Company receives written notice from the member stating that there are grounds for such proceedings").

Lord Wedderburn of Charlton

My Lords, I beg to move Amendment No. 131A. We welcome the noble and learned Lord's introduction to Amendment No. 131 and the changes as regards the liability of directors in subsection (3) as it now is. However, I have heard many different views already from those who are in the field, as it were, of the meaning of the need to have relief for the directors agreed to separately by special resolution rather than by separate special resolution.

I do not pursue that matter because I believe it is a small point which may make for difficulty in practice. It is my task to move this amendment, which goes to a very important and difficult matter. I shall try to observe the advice that a noble Lord once gave me in this place. He said, "Please make your points quickly but speak more slowly".

It is not an easy matter. The Government intend to abolish the external effects of ultra vires but not its internal effects. The noble and learned Lord has repeated that the Government intend to give the shareholder a right to bring proceedings. From these Benches we have never quarrelled with the view that the ultra vires doctrine needed further legislative reform. We would have preferred more of the features of the Prentice Report which the Government have rejected.

We do not propose that the new section should do anything other than fully comply with our obligations under the Community's first directive on company law. We have doubts, which we have already put to the Government, that even these clauses comply as regards Article 2 (1) (d) of the directive. What we question here is whether the balance struck by the Government's new version is adequate or workable for the purposes of the internal aspect. The Minister, Mr. Maude, in Committee in the other place, as reported at col. 418 of Hansard, spoke of retaining the possibility of internal control by the shareholders.

Unless the right of action that is purported to be given to the shareholder in the new Section 35 is a reality, that balance is upset. We all know that these clauses will create on the statute book a situation where directors will have further power in addition to that which they have at the moment under the Companies Act. If a company is formed in Kent by shareholders who subscribe their funds solely for the purpose of opposing the bulldozing of their village for a proposed new railway line, and it so states in the memorandum, and if the directors dispose of the funds by contract or—I believe that the noble and learned Lord will agree—by gift in view of the definition of "act" in the clauses, or any other legally binding transaction, the third party takes good title.

It is true that the directors will remain liable for breach of duty. But they may be men of straw and unable to restore the company's funds. The issue therefore arises as to what chance a shareholder has of operating as an accountable control within the company concerning these matters, for there is no other control at this point. I ask the noble and learned Lord whether he can help us on the way to this very difficult balance by saying what the Government mean. They have spoken a number of times; for example, in Committee in another place, as reported at col. 415 of Hansard, and also at Committee stage in this House on 21st February —col. 512 of the Official Report. I quote from Mr. Maude speaking in the other place: We do not want to impair shareholders' ability to obtain damages from directors who breach their duties". The duties of directors are owed to the company and not, in the normal case, to the shareholders. The shareholder will normally be able to operate only by way of a derivative action, suing on behalf of the company, if one likes to put it that way. But even in that instance there is a division. In the most recent English authority, Mr. Justice Knox, in the case of Smith v. Croft in 1987, distinguished the case of a shareholder suing derivatively to recover for loss suffered by the company after an ultra vires transaction and the case of a shareholder suing personally to prevent an ultra vires transaction.

Most people seem to read this clause as preserving only the second type of shareholder action, where proceedings are brought to restrain the doing of an ultra vires act. There is therefore a possible loss. Where the gain is not made by the directors or where they cannot in any way restore the loss by some third party, obviously the company loses out there. It is to the improvement of the possibility of the shareholder moving in as a piece of internal control, to use the words Ministers have used themselves, that this amendment is directed. I hope that on this point the noble and learned Lord and I can be on common ground. We did not move in Committee to amend the new Section 35 because a subsection in new Section 35A gave the shareholder a much wider power to bring legal proceedings without the litigation that he could sue only, as it is now put, in respect of an act to be done in fulfilment of a legal obligation arising from a previous act of the company. What is now amended by Amendment No. 134 in the old Section 35A(2) gave him a much wider right. But now, both in respect of vires and in respect of directors' authority, the shareholder is limited to bringing proceedings in respect of an act to be done in fulfilment of a legal obligation arising from a previous act of the Company.

The question arises: an act "previous" to what? I have heard various arguments. Some have said that the clause might mean "an act previous to the obligation arising". Others have said, "an act previous to the commencement of the proceedings". The majority view seems to be "an act previous to the other act to be done"—an act creating a legal obligation before the act which the shareholder seeks to restrain. That seems to be the meaning of the clause. If it means that, as a matter of common sense, the shareholder will almost never have the chance to restrain the act to be done. The act which is done before it by the directors creates a legal obligation which, under Section 35A, is immediately binding in favour of the third party, provided he is acting in good faith. The shareholder cannot upset the transaction. There is nothing for him to restrain. He cannot restrain the execution of the executory contract because the company is bound to the contract under Section 35A. I take it that the noble and learned Lord agrees with that analysis.

When can the shareholder sue? Under the clause as it now stands, lacking the power that he used to have under the change to be made under Amendment No. 134 (we do not seek to upset that change in Amendment No. 134 because, having looked at it again, we think it is probably in accordance with the first directive to which I shall come in a moment) the shareholder can retain his right of action only where he gets to know of the act which creates the legal obligation. If on a Monday he believes that an impending transaction is arguably ultra vires—if a Kent shareholder gets wind of the coming transfer of the company's assets to the bulldozer company—by the time he has seen his solicitor (albeit that, under the reforms of the profession, solicitors are now more speedy than they used to be) and had him issue a writ on the Wednesday, the directors will, in the average case, have signed the contract on the Tuesday because the directors believe in what they are doing.

Our amendment is not a large one but it is important in practice. It proposes that the matter should not depend precisely on that legalism, if I may put it that way, but on whether the shareholder notifies the company formally that there are grounds for believing that the transaction is outwith the capacity of the company. In other words, it shifts the boundary, the cut-off point, between the external and the internal slightly in favour of the shareholder.

I should make one last point because I must pre-empt the question of whether our amendment is not only better—and we think it is—but that it is also within the terms of the first directive. Here of course we must look to the first directive of the Community all the time. I say to the noble and learned Lord quite straightforwardly that I hope he will not just tell us that our amendment is outwith the directive—if he thinks that it is—without putting forward careful grounds. We believe that the grounds for including our amendment within the directive are as good as those in respect of the Government's new subsection (2) as set out in Amendment No. 131.

The first directive requires the company to be bound to third parties by, acts done by the organs of the company", even though those acts may be outside the company's objects. However, it is subject to a proviso. In fact it is subject to two provisos, but the Government have always refused to use the second one which is that the third party is not bound if he has knowledge, providing certain formalities are observed, of the ultra vires transaction. Many member states have such a proviso in their commercial law. But the Government will not use it. Nevertheless, they cannot escape the other proviso which reads as follows: unless such acts exceed the powers that the law confers or allows to be conferred on those organs". Those words are contained in Article 9, paragraph 1, which is about ultra vires. Paragraph 2 of Article 9—about which there has been some confusion during previous debates—is not about ultra vires; it is about authority, and we cannot use that proviso in this case. That is why we do not oppose Commons Amendment No. 134.

We are not concerned here with the powers of directors—that is, the organs—we are concerned with the ultra vires transaction. We say that that proviso is well wide enough to allow for our amendment. The amendment ensures that the law shall not confer on the board of directors—as the corporate organ—the power to dispose of the company's assets beyond the stated purpose of the enterprise, after it has received formal notice from the shareholder that there are grounds for saying that it is outside the purposes for which they invested their money. That seems to us to be a reasonable proposition. It is one which is contained in the first directive. Perhaps I may, yet again, quote the Minister who said in another place: Of course it will remain possible for restrictions to be placed on a company by its shareholders. We believe that the ambition is better achieved by our amendment than it is by what has arisen—and we recognise this fact—from a very complex and difficult set of deliberations on the matter by the Government. However, at this last stage of the proceedings we would urge them to consider our amendment favourably.

Lord Mottistone

My Lords, I support Amendment No. 131—that is, without the refinements just referred to by the noble Lord, Lord Wedderburn. The CBI advises me quite simply that this amendment will codify the common law position whereby a minority shareholder may take proceedings to restrain the doing of an ultra vires act. I am assured that it is really quite simple and straightforward and not perhaps as elaborate as has been portrayed to us.

The CBI also advised me that it believes the wording, powers flowing from the company's memorandum", contained in subsection (3) of the amendment to Clause 95 could more accurately be expressed by the words, the powers flowing from a company's articles". It was not thought necessary to put this forward as an amendment but it is worthy of the Government's consideration. Perhaps there may be time for them to make such a correction if it proves to be necessary.

Lord Fraser of Carmyllie

My Lords, I shall respond as briefly as I can to what has been said. If I understood the argument of the noble Lord, Lord Wedderburn, correctly, he appeared to be suggesting that the provisions now provided are essentially exhaustive of the remedies available to a shareholder derivatively or otherwise. It is essentially a provision with a more restricted purpose. In order to protect that third party, acting in good faith, subsection (2) clearly illustrates the restrictions on his ability to bring proceedings to restrain the doing of an act. It is not intended to cover any other remedies that there might be.

As the noble Lord will appreciate, it is all being done in the context of establishing a balance between what is done internally in the company and how it affects those who are outwith it and operate with it in good faith.

In answer to my noble friend Lord Mottistone, originally we were dealing with what were essentially the objects of the company, but, as I sought to indicate in relation to the earlier amendment, what was said to us—it may at least in part be what is being said by the CBI—was that we should not deal just with the matter in relation to the articles or the objects, but ensure that any provision in the memorandum is covered rather than restricted in any way. That essentially reflects the present position under the Companies Act.

I turn now to Amendment No. 131A. I listened carefully to what the noble Lord, Lord Wedderburn, said about the first EC directive and, in particular, Article 9 thereof. It is the Government's view that if the noble Lord's amendment were to be introduced it would put us in breach of our international obligation, because the article provides that the acts of a company are to be binding on it, even if they are not within the objects, subject to the member state's option to provide that knowledge of the objects by the third party renders void a transaction with him which is beyond the objects. By allowing ultra vires acts to be set aside where a member of a company has given certain written advice to the company, without even introducing an element of knowledge on the part of the third party, it would appear to the Government that the amendment would be contrary to the article of that first directive.

Lord Wedderburn of Charlton

My Lords, I am grateful to the noble and learned Lord. I apologise for interrupting him, but I want to make clear the ground between us on the issue of the first directive. He read the opening words, but I shall read the whole of the first sentence. Article 9 paragraph 1 reads: Acts done by the organs of the company shall be binding upon it, even if those acts are not within the objects of the company, unless such acts exceed the powers that the law confers or allows to be conferred on those organs". The article continues with the point about knowledge, which is not between us, and which the Government do not wish to use. It is an option that they reject. However, it is clear that there is a proviso, which needs no exercise of any option, before we come to the second proviso. It is that upon which we rely, as do some other member states.

Lord Fraser of Carmyllie

My Lords, despite what the noble Lord has just said, he seems to agree with me that an ultra vires act can be set aside where the third party has no knowledge of it. The amendment would be contrary to the article of the first directive. That, I understand, the noble Lord agrees. If it is flawed in that respect, he must necessarily concede that his whole amendment must fail.

In any event, the amendment that he proposes would extend the circumstances in which a member of a company may bring proceedings to restrain the doing of an act which would be beyond the company's capacity. As I understand it, under the noble Lord's amendment, rather than no right to bring proceedings being effective where an act is in fulfilment of a legal obligation arising from a previous act of the company, no proceedings are to lie where the legal obligation arises from an act of the company done before the company receives written advice from the member stating that there are grounds for such proceedings.

I should like to suggest that this amendment would reintroduce an unnecessary degree of uncertainty on the part of third parties. Let us take a specific example of a company which, without having the legal capacity under its memorandum, has entered into a contract to purchase land but the conveyance has not yet been completed. Under the amendment the other party to the contract could not be certain of its being honoured, for a member of the company may have advised the company before it entered into the contract that there were grounds for restraining the doing of the act. The other party may be entirely unaware that the act was beyond the company's capacity and may have no idea that a member has advised the company of that effect. Yet under the amendment he could not enforce the contract and could face considerable losses in the course of its unravelling.

This is all the more objectionable because the Government Amendment No. 131 allows a member to take effective action in the circumstances with which we are concerned. The noble Lord's amendment concerns the case, and only the case, where a member is aware that a proposed act is beyond the member's capacity and wishes to prevent it. With respect, it seems to me that there is more than one ground for taking exception to this amendment. I hope that the noble Lord now understands the Government's position.

10 p.m.

Lord Wedderburn of Charlton

My Lords, I must not pursue this argument because I shall have to withdraw the amendment. I understand the Government's position. I had not realised that it was as wrong as I now think it is. While we are discussing the directive, I must say that the noble and learned Lord has not engaged with me upon it. It is not a question of the third party's knowledge. Of course the case that I am out for is where the third party may lose out. But that is the whole point: that there may be some cases where a third party loses out and where a shareholder stops the ultra vires transaction.

What is wrong with the Government's new formula is that there will almost never—I shall not say never—be a case where the proposed right of the shareholder to sue can be operated. There will always have been an act which creates some legal obligation under Section 35A. The shareholder will never have an action, except possibly in the case of a gift. There, there is no previous act to the act which creates the obligation, and no subsequent act. It is all one and the clause does not seem to cover it. However, that is a strange point about the drafting. Other than that, the shareholders lose out completely.

The directive allows us to give, and member states have given, to the organs of the company a restricted power under the proviso of Article 9(1). Every time we have legislation on the matter, what is put forward, with great respect, appears to misunderstand the first directive. This is well known in Brussels to be one of the Achilles' heels of the British. There are not many of them—most are largely unassailable—but this is one of them.

The Government are making a great mistake here. After this comes into operation—I am surprised at the constituency which the Government will be offending—what will be seen is that there is no balance between internal and external, except in regard to directors' liabilities. I must of course add that; and I agree that directors' liabilities remain. But apart from that, the shareholder will in effect have no right of action at all. However, the Government insist on enacting that. Therefore I must beg leave to withdraw the amendment.

Amendment No. 131A, as an amendment to Commons Amendment No. 131, by leave, withdrawn.

On Question, Amendment No. 131 agreed to.