SHAREHOLDERS REMEDIES [1997] EWLC 246(7) (24 October 1997)

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7.1 In this part we consider the other reforms which we canvassed in the consultation paper. These are reform of section 14 of the Companies Act 1985 and pre-action discovery in shareholder proceedings.

Reform of section 14

7.2 The issue with which we are concerned here is the extent to which a shareholder has enforceable rights arising under the companys constitution. The constitutions of companies registered under the Companies Acts comprise two separate documents - the memorandum of association and the articles of association. (1) The legal effect of those documents is set out in section 14 of the Companies Act 1985 which provides that, when registered, they bind the company and its members "to the same extent as if they respectively had been signed and sealed by each member and contained covenants on the part of each member to observe all the provisions of the memorandum and of the articles". In essence, therefore, section 14 creates a contract which forms the basis of legal relations between the company and its members and between the members inter se. (2)

7.3 We drew attention to two potential problems in respect of the rights arising under section 14. The first is that section 14 does not expressly state that the company is bound by its own articles. (3) However, our view was that it is clear on the wording of the section that the company is bound; the only point is that it is not deemed to have executed the articles under seal. As the only practical consequence of this is in relation to the limitation period for actions against the company, (4) and as we were not aware of any particular difficulties to which this gave rise, our provisional view was that there was no reason to amend section 14 in this respect. (5)

7.4 The vast majority of respondents agreed with our provisional view and we therefore remain of the view that there should be no amendment to section 14 to provide that the company is also deemed to have executed the memorandum and articles of association under seal. (6)

7.5 The second potential problem to which we drew attention was the difficulty in identifying enforceable personal rights conferred by the articles. As we explained in the consultation paper, (7) there are restrictions on a members ability to bring a personal action to enforce the provisions of the articles of association. There are two aspects to this which we examined.

7.6 First, it seems to be generally accepted that the statutory contract only confers rights on a member in his capacity as member (sometimes referred to as "insider rights"), not in any "outsider" capacity such as his position as a solicitor or director of the company. (8) We took the view that examination of these "outsider" rights was beyond the terms of reference of the project, (9) but in any event we considered that there would normally be a contract between the company and the member in his other capacity so that there would be no need for him to seek to rely on the provisions of section 14. (10)

7.7 Secondly, the courts have classified breaches of certain constitutional provisions as "internal irregularities" for which no personal action will lie. This restriction stems from the majority rule and proper plaintiff principles discussed above. (11) The courts have held that if the internal affairs of the company are not being properly managed, then the company is the proper person to complain; there is no use in having litigation "the ultimate end of which is only that a meeting has to be called and then ultimately the majority gets its wishes". (12) But there are cases where shareholders have been entitled to bring claims based on irregularities in voting procedures, such as the wrongful exclusion of proxy votes which would otherwise have resulted in the defeat of a resolution. (13) Similarly, in cases involving defective notices of meetings, or inadequate notice of certain resolutions, the courts have allowed personal actions to proceed. (14) It was the potential difficulty in identifying membership rights to which the "internal irregularities" restriction did not apply to which we drew attention in the consultation paper.

7.8 Our provisional view, having had preliminary discussions with a number of interested parties, was that no hardship was being caused by any such difficulty. Moreover, we considered that there could never be a comprehensive definition of what constitutes a personal membership right under section 14, since regard has to be had to the terms of the particular articles in question and to the circumstances of the alleged breach.

7.9 We did, however, canvass the possibility of a non-exhaustive list of personal rights enforceable under section 14 to be included in the section. (15) This would set out the rights which the courts have to date allowed shareholders to enforce by personal action, but make it clear that the fact that these rights can be enforced by personal action does not mean that there are not others that can be enforced by the same means.

7.10 We provisionally considered that this would not be a useful addition to the statute for a number of reasons. First, the list could not state every breach of the articles which could give rise to a personal action, and so cases would still arise which were not expressly mentioned. Secondly, breaches of the articles vary from the trivial to the grave. Where they are trivial, we did not want to encourage litigation, and considered that setting out examples in a statute might have just this effect. The list would not reflect the exercise by the court of its discretion to refuse to give remedies for breaches of personal rights, for example, where a meeting had been improperly convened and another could be properly convened and take the same steps. We also reiterated our provisional view that there was no evidence of hardship being caused by the absence of a list, and noted that in practice actions to enforce personal rights appeared to be effectively eclipsed by proceedings under section 459, in which the remedies available are far wider.

7.11 The vast majority of respondents agreed that no hardship was being caused by any difficulty in identifying personal rights conferred by the articles. (16) A large majority also rejected the proposal that there should be a statutory non-exhaustive list of personal rights enforceable under section 14. The reasons given were similar to those set out in the previous paragraph. In the light of the responses to the consultation paper, we remain of the view that there should not be of a statutory non-exhaustive list of personal rights enforceable under section 14.

7.12 Accordingly, we do not recommend any reform of section 14 of the Companies Act 1985.

Pre-action discovery

7.13 Another issue which we raised for consideration, without making any recommendation, was whether shareholders should be given rights of pre-action discovery of relevant documents. There were two aspects to this: pre-action disclosure against persons who are likely to be parties to the proceedings; and pre-action disclosure against persons who are not likely to be parties to the proceedings. (17)

7.14 Under the current law, it is possible to obtain pre-action discovery of documents against persons who are likely to be parties to proceedings involving a claim in respect of personal injury or death, (18) but not in other cases. The Woolf Report recommends that the current rules for personal injury claims should be extended to all cases. (19) At present it is not possible to obtain pre-action disclosure from non-parties, (20) even in relation to claims in respect of personal injury or death. The Woolf Report included a recommendation that in respect of such personal injury and death claims the courts powers should be extended so that it may order a third party to disclose documents before proceedings have begun whether or not it is intended to join them as a defendant. (21) However, Lord Woolf stated: "Without experience of how the power would work in relation to the limited category of personal injury and death claims, I would not put it forward on a wider basis."

7.15 A majority of respondents considered that current discovery rights were generally adequate, although just under half were in favour of having a right of pre-action discovery similar to that available in relation to personal injury claims. The point was made by a number of respondents that there was no compelling reason why shareholder proceedings ought to be treated differently from others. We agree with this last point. Assuming the Woolf proposals on pre-action discovery against potential parties are to be implemented, we see no reason why these should not apply to shareholder proceedings. We see no need for them to be extended to include pre-action discovery against non-parties. If for any reason the Woolf proposals are not implemented, we do not consider that there are particular factors which would require special rules (22) to be put in place for shareholder litigation.

7.16 We do not recommend any extension to the right to disclosure of documents specifically for shareholder proceedings.

Conclusion

7.17 To summarise, we do not recommend any amendment to section 14 of the Companies Act 1985 to provide that the company is deemed to have executed the memorandum and articles of association under seal. Nor do we recommend any reform to the section to assist in identifying enforceable personal rights conferred by the articles. Our view is that neither of these issues causes hardship in practice.

7.18 We do not see any particular need for specific rules on pre-action discovery in relation to shareholder proceedings.

(1) In broad terms, the memorandum governs the relationship between the company and the outside world, whereas the articles represent the domestic regulations of the company and govern its internal management.

(2) The precise nature of this statutory contract has been the subject of much academic debate. See, for example: K W Wedderburn, "Shareholders Rights and the Rule in Foss v Harbottle" [1957] CLJ 194; G D Goldberg, "The Enforcement of Outsider Rights under Section 20 of the Companies Act 1948" (1972) 35 MLR 362; G N Prentice, "The Enforcement of Outsider Rights" (1980) 1 Co Law 179; R Gregory, "The Section 20 Contract" (1981) 44 MLR 526; G D Goldberg, "The Controversy on the Section 20 Contract Revisited" (1985) 48 MLR 158; R Drury, "The Relative Nature of a Shareholders Right to Enforce the Company Contract" [1986] CLJ 219.

(3) The reason for this is historical. The source of the present wording is the Joint Stock Companies Act 1844 which relied on the existing common law method of forming companies by "deed of settlement", with a trustee covenanting on the part of the company. The Joint Stock Companies Act 1856 subsequently substituted the modern form constitution for the deed of settlement but in adopting wording similar to that now in force it did not take fully into account the new development of the incorporated company as a separate legal entity. See Consultation Paper No 142, paras 2.6-2.8.

(4) This is 6 years. If the articles were deemed to be sealed by the company, the limitation period for claims against it would be 12 years; see Re Compania de Electricidad de la Provincia de Buenos Aires Ltd [1980] Ch 146.

(6) For a brief discussion of changes which have been made to the equivalent provision in Australia to address this point, see Brian R Cheffins, Company Law: Theory, Structure and Operation (1997) p 462.

(8) Hickman v Kent or Romney Marsh Sheep Breeders Association [1915] 1 Ch 881. See Consultation Paper No 142, paras 2.15-2.20.

(13) Oliver v Dalgleish [1963] 1 WLR 1274. See also Consultation Paper No 142, para 2.24, n 53.

(14) See, for example, Alexander v Simpson (1890) 43 Ch D 139; Musselwhite v C H Musselwhite & Son [1962] Ch 964; Johnson v Lyttles Iron Agency (1877) 5 Ch D 687; Kaye v Croydon Tramways Co [1898] 1 Ch 358; Tiessen v Henderson [1899] 1 Ch 861; MacConnell v E Prill & Co [1916] 2 Ch 57.

(16) This view is supported by Brian R Cheffins in Company Law: Theory, Structure and Operation (1997) where he concludes, at page 462: "Since Australias experience indicates that reform will not be a straightforward exercise and since there is little direct evidence that section 14 is causing difficulty for shareholders, Parliament should let matters rest for the time being".

(17) The issue of discovery against non-parties during the course of proceedings was not raised in the consultation paper. At present it is only allowed in personal injury actions; Supreme Court Act 1981, s 34. Rule 27.20 of the Draft Civil Proceedings Rules proposes limited rights of non-party disclosure in all cases (although there is no specific reference to this change in the law in the Woolf Report).

(19) See Woolf Report, ch 12, paras 48-50 and Recommendation 140; see also Rule 27.19 of the Draft Civil Proceedings Rules.

(21) Chapter 12, para 52 and Recommendation 142. However, this recommendation does not appear to have found its way into the Draft Civil Proceedings Rules.

(22) On the other hand, pre-action disclosure might usefully be considered in the context of a pre-action protocol; see para 2.36 above.

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You are here: BAILII >> Databases >> The Law Commission >> SHAREHOLDERS REMEDIES [1997] EWLC 246(7) (24 October 1997) URL: http://www.bailii.org/ew/other/EWLC/1997/246(7).html Cite as: [1997] EWLC 246(7)

The Law Commission

Reform of section 14

Pre-action discovery

Conclusion