Business Organization Coursework:
Mary and Joseph, stakeholders in Kings plc, are concerned about the company’s management practices by its current directors. One of these recent practices includes the desire by these directors of Kings plc, which owned a hotel, to acquire two additional hotels. As a result, these directors created a subsidiary company for the sole purpose of acquiring the two hotels. In this new development, Kings plc could only acquire few shares of the new subsidiary whereas the directors and the company solicitor purchased the majority of the new subsidiary’s shares. Therefore, the new subsidiary was eventually sold and the directors made significant profits. However, the shareholders of Kings plc i.e. Mary and Joseph want to know whether the directors were legally entitled to carry out such practices. These shareholders are specifically concerned with the legality of the directors’ actions and the relevant legal sanctions against the directors, which should be discussed in the next shareholders meeting.
The management of any company such as Kings plc usually involves the separation of duties between shareholders i.e. those who jointly own the company and directors i.e. those who manage it. This separation usually takes place because of the impossibility for all shareholders to be involved in the management and control of the organization’s affairs, especially when their number increases (Hannigan, 2012, p.105). While this separation is geared towards ensuring that the control and management of company’s affairs is conducted with the suitable number of people, it can sometimes contribute to the emergence of numerous problems.
As evident in the case of Kings plc, one of the major problems that arise from this separation is the difficulty by shareholders to limit any managerial excesses regardless of whether such practices are due to self ambitions, incompetence, and absolute fraud. This problem arises because the shareholders are relatively distanced from the day-to-day operation of the business. In most cases, the problem between shareholders and directors cannot be solved by a single mechanism because it requires a set of various responses. Actually, the need for a variety of responses in solving the issue at Kings plc is the reason Mary and Joseph are seeking for a memorandum regarding the legality of the directors’ actions and possible legal sanctions, which will be discussed in the next meeting of shareholders.
The corporate governance of Kings plc has a comprehensive internal structure with clear roles for directors and shareholders. The directors of the company are concerned with the day-to-day management of the company and have exclusive management powers. On the contrary, the shareholders are non-executive directors without executive management responsibilities, but are concerned with strategy and evaluation of the executive directors’ performance. Therefore, shareholders’ involvement in company management revolves around enhancing the stewardship role of the company’s investors (Hannigan, 2012, p.106). This implies that it’s the responsibility of the shareholders to examine the performance of the company’s directors, especially on whether their actions promote achievement of business objectives and comply with the law. Kings plc shareholders are concerned with the legality of directors’ actions and whether they contributed towards the achievement of the company’s business objectives.
Directors’ Duties and Responsibilities:
The company’s directors are regarded as officers of the company and sometimes as employees because of their role in the day-to-day running of the business. These individuals owe strict trustee-like fiduciary obligations to the firm, which implies that they need a high standard of loyalty and honesty, as well as the seemingly straightforward standards of competence. However, directors do not necessarily serve as agents of the shareholders in daily running of the company’s business activities. Nonetheless, the obligations of directors have developed by analogy to trustees despite of the fact that they are not trustees (Dignam, 2011, p.309).
While directors have general management powers in daily operation of the company, they are subject to restricted control by the shareholders in general meeting. In addition to the stewardship role played by the shareholders, there are laws that govern corporate governance to prevent abuse of powers by directors. Therefore, one of the major duties of directors is trustee-like obligations to the company in day-to-day operations of the company (Dignam, 2011, p.361). Secondly, directors owe the company a duty of skill and care when making management decisions and conducting managerial practices.
Notably, the fiduciary duties and the duty of care and skill of a company’s directors are products of the reform process that have been codified and are currently described as general duties. Since these duties are based on some common law rules and equitable principles, they must be interpreted based on these rules and principles in light of applying general duties.
Moreover, directors also have other general duties based on the provisions of the 2006 Companies Act. A director must act based on the provisions of the company’s constitution and exercise his/her powers for purposes that are detailed in the company’s constitution. In addition to being known as the proper purpose rule, directors are required to exercise their powers for proper purpose in accordance with the firm’s constitution regardless of whether their actions are carried out in the interest of the company. This implies that the director’s action is not primarily judged-based whether it’s in the interest of the company but based on the company’s provision. For instance, in Hogg v Cramphorn Ltd. (1967) case, the director was found guilty of issuing a share for an improper purpose despite acting in the interest of the company.
Legality of Directors’ Actions:
As an individual, a company’s director is in a fiduciary position in relation to his/her company, which implies that he/she has fiduciary trustee-like duties in the day-to-day functioning of the company. According to the rules of equity, a contract in which the director has interest that is not beneficial to that of the company is voidable as long as there is the absence of disclosure or authorization in the company’s documents (Sealy, 1971, p.359). Notably, the equitable rule is complemented by a statutory duty of disclosure, which contains criminal sanctions.
This rule implies that the director’s fiduciary relation to the company requires him/her not to make a secret profit by engaging in self-dealings carried out on behalf of the company. Actually, a contract is voidable for various reasons including when a director has a conflicting interest and when he has a conflicting duty, unless stated otherwise by the company’s articles or constitutional provisions.
Based on this equitable rule that governs directors’ actions, Kings plc directors violated the law by engaging in self-dealings in which they made substantial secret profits. These directors carried out business on behalf of Kings plc with the sole purpose of making significant profits for themselves rather than the company. Their decision to form a new subsidiary company in order to purchase the two hotels was motivated by their objective to make substantial profits by limiting the number of shares Kings plc could take from the subsidiary while purchasing majority of the shares. Generally, the decision by Kings plc to form a new subsidiary and make huge profits from its eventual sale was illegal because of their conflicting interest and duty to the company in which they acted as directors. Therefore, their actions can be considered as practices or contract that is voidable since they were not legally entitled to it.
An example of case that demonstrates the illegality of the actions of Kings plc due to conflicting interests and duties is the Transvaal Lands Co. v. New Belgium (Transvaal) Land & Development Co. (1914). In this case, the plaintiff firm had acquired a block of shares in the Lydenberg Gold Exploration Co. from the defendant company based on recommendations of Samuel, one of its directors, who had abstained from voting. The case focused on another director, Harvey, who took part in the decision to make the purchase despite having a legal but not beneficial interest in the sale of the company. The Court of Appeal ruled that the transaction or decision to sell was voidable on this account (Sealy, 1971, p.369).
The main issue in this case is whether a director of the company can buy shares or other property from another company he/she is peculiarly interested on behalf of the company he/she acts as the director. This is the major issue surrounding the scenario behind the actions of directors of Kings plc. The legality of these directors’ actions is also determined on whether they are legally entitled to enter into engagements with another company or subsidiary when they are in a fiduciary position towards and owes duty of care and skill to another company in which they act as directors.
Kings plc directors were not legally entitled to their actions that contributed to their substantial profits on behalf or at the expense of the company. As trustees, it was their responsibility and duty to do their best to act in the interests of the company despite of their personal benefits. As evident, their actions conflicted with the duty of care and skill as well as fiduciary trustee-like obligations which they owed to the Kings plc of which they were directors. Based on the equitable rule, these directors were driven by personal interests that conflicted with their duties to the company of which they were directors. These directors are bound to take the most appropriate actions for their cestui que trust as they would for themselves. The general principles requires directors to exclude themselves from acting on behalf of the company by entering into any dealings in which they have interests that may conflict those they are bound to protect by fiduciary duty as directors of the company.
Secondly, as a body, the directors are under an equitable duty in which they are required to act in the company’s best interests. This is based on the analogy of trustees in which the directors’ duties of skill, care, and diligence are based. In essence, directors must be honest and comply with the terms of their trust as demonstrated in corresponding rules in company law where a director must act honestly, lawfully, and based on the constitution of the company. As part of acting honestly and legally, directors may be required to not only disclose their interests in a specific contract but also state the nature of their interests. Directors non-compliance with this statutory obligation renders the contract voidable based on the principles of equity.
Kings plc directors violated the statutory obligations by their seeming failure to disclose the nature of their interests in the decision to form and subsequently sell the new subsidiary. As a result, they violated section 199 of the Companies Act where they are not held liable for any profit made from any contract or dealing provided the nature of their interests is declared (Birds & Boyle, 2011). Therefore, disclosure of the nature of interest is not only an attempt to act in honesty but also seems like a condition that is precedent to the formation of a contract, especially the formation of a subsidiary.
The illegality of the directors’ actions is also seen in the fact that the newly formed subsidiary company did not follow the instructions or constitution of its holding company, Kings plc. Therefore, these directors operated the newly formed subsidiary on their own terms without complying with the constitution and requirements of its holding company. Moreover, the new subsidiary was not formed based on the reasons stated in Kings plc constitution.
Relevant Legal Sanctions against the Directors:
As evident in the previous analysis of the actions of the directors of Kings plc, the directors acted illegally and are subject to several legal sanctions. Generally, the Companies Act of 2006 contains several legal implications for directors relating to their ability to bind a company in contracts, fiduciary obligations, and duty of care and skill. This Act also stipulates several criminal and regulatory measures that can be used to deal with directors who engage in criminal activities or violate the acceptable standards of conduct (Birds and Boyle, 2011). These criminal and regulatory measures have been used robustly in the past few years in light of the increase in cases of fraud and financial mismanagement in several global corporations.
The legal sanctions against the directors of Kings plc in the formation and sale of a new subsidiary are attributed to the breach of fiduciary duty and duty of skill and care. The first legal sanction against these directors is a breach of fiduciary duty claim, which is a civil action. In comparison to fraud, a breach of fiduciary duty is usually easy to prove since it does not require proof of false or criminal intent or elements of fraud. This claim only requires proof that the defendant was in a position of fiduciary obligation or trust, which he/she breached for personal gain or benefit.
This is a relevant legal sanction against the directors since they formed and eventually sold a new subsidiary for their personal benefit in violation of the fiduciary relationship and obligations. These fiduciaries acted carelessly or recklessly in violation of their obligations to their corporate shareholders and other members of the company’s management. The reckless actions are against the requirement of these fiduciaries or directors to act in the best interest of Kings plc without any self-dealing, conflict of interests, and abuse of the principle for personal advantage or privileges. As a civil action, a breach of fiduciary claim will be geared towards recovering profits that these directors earned through their illegal actions. Actually, the claimant may recover profits earned by the directors even though the claimant or Kings plc did not experience any actual loss.
The second relevant legal sanction against the directors is a breach of duty of care and skill. Since the English law stipulates general rules that determine the standard of care to be achieved in a fiduciary relationship, it’s the court that applies these legal standards to the specific details in the case to determine whether the defendant attained the standards. In case of professional activities, the courts evaluate the professional standard or duty of care and skill. As compared to the breach of fiduciary duty, this claim is made as a civil action for mismanagement, negligence, and waste of company’s assets.
In Kings plc scenario, this claim can be made on the basis that the directors were involved in mismanagement, which contributed to their infringement of duty of care and skill. The claimant will need to demonstrate that the company’s directors were involved in self-dealings with conflict of interests and disloyal to their legally required fiduciary obligation of care and skill.
The actions of Kings plc directors are a clear example of breach of fiduciary trustee-like relationship between directors and the company. This scenario also demonstrates violation of fiduciary obligations and duty of care and skill that the directors were required to comply with. Generally, the directors acted recklessly and carelessly in the formation of a new subsidiary to acquire two new hotels and sell the subsidiary to generate huge personal profits on behalf of the company. Therefore, these directors are subject to several legal sanctions, especially a breach of fiduciary duty claim and violation of duty of care and skill claim.
Birds, J & Boyle, A.J 2011, Boyle and Birds on company law, 8th edn, Jordan’s Publishing, St.
Thomas Street, Bristol.
Dignam, A 2011, Hicks and Goo’s cases and materials on company law, 8th edn, Sweet & Marxwell, Avenue Road, London.
Hannigan, B 2012, Company law, 3rd edn, Oxford University Press, Great Clarendon Street,
Sealy, L.S 1971, Cases and materials in company law, Cambridge University Press, Euston
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