Over a series of weeks we examine some of the traps and pitfalls of operating within a private limited company structure without the protection of either a shareholders’ agreement or bespoke articles of association. Poor preparation of a company’s constitutional documents can lead to disputes and ultimately the business failing.
A common question often asked is ‘what is the difference between a director and a shareholder?’
The basic distinction is that the shareholders own a company (holders of a share of the company) and directors run the company (they direct the conduct).
A large proportion of smaller businesses are owner-managed, meaning the directors and shareholders are the same people, albeit they wear different hats, and have different rights and obligations in their different roles.
The general day-to-day operation of the business is generally undertaken by the directors, albeit responsibilities can be delegated. They will usually be responsible for operational decisions such as negotiating commercial contracts, pricing, recruitment and financial reporting.
However, some important decisions underpinning the value of the company must be made by the shareholders. Examples include certain transactions with the directors or people connected to the directors such as long-term service contracts, or the issue of fresh shares in the capital of the company
Whilst there are provisions within the Companies Act which permit the shareholders to bypass the directors and pass resolutions themselves, and a reserve power within the model articles which allows the holders of 75% of the issued shares to compel the directors to take, or refrain from taking, certain action, the usual course of action is for the directors to propose a resolution, and present this to the shareholders.
Bearing in mind the above, and that the vast majority of day to day matters are undertaken by the directors, which will of course impact greatly on the profitability, and hence value, of a company, the appointment of directors is clearly of great importance.
The default position within the model articles and the Companies Act, is that directors are appointed by a simple majority of the directors, or an ordinary resolution of the shareholders, which is also a simple majority. This is also the threshold for removal of directors.
Therefore, where there is a situation where one person, or indeed a group of people, hold a majority of the shares, it is open to them to appoint as many directors as they wish, and also remove those who are surplus to requirements, meaning that that person or group of people will be in effective control of the company’s day to day operation.
A shareholders’ agreement and bespoke set of articles will usually provide that certain particular shareholders, or the holders of a given percentage of shares in the company, have the right to appoint a set number of directors, and they and only they are able to remove those directors, which will prevent the holders of the majority of shares from flooding the board, and exerting a greater level of control over the operation of the company.
Coupled with this, a shareholders’ agreement will usually also include the appointment and removal of directors as a reserved matter which will be discussed in a future thrilling instalment!