What are the most common types of directors?

In the UK, there are two main types of directors, executive directors and non-executive directors. There is nothing preventing companies from giving official titles such as creative directors or finance directors. Legally, it does not make a difference and in fact only in business sense there is a difference between non-executive directors and executive directors.

Executive Directors

Executive directors are people who sit on the board of directors and take charge of the company’s business affairs including:

• Business development and management;
• Recruitment;
• Company’s assets management.

Typically, executive directors are engaged on a full-time basis. This is achieved either by formal employment or self-employment.

Non-Executive Directors

A non-executive director is a person who is a member of the board of directors but who is not involved in a day to day running of the business. Non-executive director is usually not an employee of the company nor is related to it in any other way than being a member of the board of directors. He or she is not an employee of the company or affiliated with it in any other way. Non-executive directors can however also own shares in companies.

In the UK, the Higgs Report published in 2003 reviewed the role and effectiveness of non-executive directors. The report states that non-executive directors are usually involved in the following areas:

• Business Strategy – while executive directors are employed by the company to form future business strategies, non-executive directors’ responsibility is to actively evaluate viability of the plans and provide feedback.
• Business Performance – as well as helping to develop an effective and efficient commercial strategy, non-executive directors should monitor performance of executive directors in meeting overall objectives. This includes making necessary adjustments to the board of directors by replacing non-performing directors with more experienced and adequately experienced members of the executive management.
• Risk Management Procedures – non-executive directors should work to implement effective financial control and risk management strategies.
• Financial Risk Management – a non-executive director should always assess financial data provided and identify potential risk. All data should be verified for its accuracy and adherence to financial controls and risk management systems.
• Human Capital – part of non-executive directors’ duties involves ensuring that levels of salaries and bonuses are adequately set for the executive board members. This not only includes ensuring that remunerations are not excessive but that packages are proportionate to goals and remain competitive for the best performers.
• Succession Planning – non-executive directors are responsible for appointments and removals of executive directors and as such should ensure that the company has sufficient human resources to ensure that appropriately trained and experienced people can be utilised to their full potential as replacements for most senior roles that become available.

It is vitally important that non-executive director always remains impartial in relation to his decision-making.

A Special Resolution is a resolution which is passed by the members of the company or a specific class of the company by:

• on a poll at a general meeting – members which represent at least 75% of the total voting rights of members who are entitled to do so to exercise their rights, either personally or by appointing a proxy;

• in a general meeting if there is a vote, on a show of hands, the majority of at least 75% of the members who are entitled to vote do so personally or by proxy.

A Special Resolution is required to enable companies to do certain things, for example:

1. Alter the Articles of Associate for a company;
2. Change the company name;
3. To re-register a private company as a public company and vice versa to re-register a public company as a public company;
4. To reduce the notice period for a general meeting from 21 days to 14 days for a private trading company;
5. For a private company that has a single class of shares to apply any applicable pre-emption right.

There are additional special resolutions set out in the Companies Act 2006.

A Special Resolution assures that certain scenarios which affect the company on a fundamental level cannot happen without a large majority if the members of the company agreeing. It is effectively to protect a member/shareholder rights and position within the company.

If you have concerns about how a company is to be run or you are a minority shareholder and want to ensure the protection of your rights within the company and ensure that the company will not undertake certain actions without your approval and you consider that the protections contained within the Companies Act 2006, and special resolutions are not enough you could consider amending the Articles to ensure that they are minority shareholding protections placed within these or to put in place a shareholders agreement which governs how the company will be run on day to day basis and will contain a list of minority shareholder protection.

This is often done when parties invest in a company and have a small percentage of shares which would not allow them enough to vote on how the company is going to be run on a day to day basis. For example, you could have a minority shareholding protection that the company will not take out any borrowings in excess of a certain figure without your approval or that the company will not factor any of its debts, lend any money through any third party, shareholder or director, appoint any directors etc.

A Shadow Director is an individual with whom they are directors of a company are accustomed to act in accordance with directions or instructions. It should be noted that this does not include a professional advisor such as a lawyer or an accountant who is actually acting in that professional capacity.

It should be noted that if a non-director has significant influence within a company, and on how its run, it is important to consider whether or not that individual is a Shadow Director, or could be considered to be. If it is found that the individual is a Shadow Director, they could potentially get caught under certain offences under the Insolvency Act 1986 as well as under the Companies Act 2006 itself, and other relevant legislation.

It is important to consider that the codified duties of a director set out in the Companies Act 2006, in addition to common law duties will apply to both directors and Shadow Directors. Whilst someone may not consider themselves a director, as they are not registered at Companies House or formally part of a board, they could still be bound by this legislation.

The duties that a Shadow Director would need to comply with directors are the same as the directors as set out above. For example, they must act in accordance with the company’s constitution which is set out at Section 171a of the Companies Act 2006. Further they must only exercise their powers for the purposes for which they are actually conferred under Section 171b of the Companies Act 2006. Also they have a duty to promote the success of the business. They must consider any decisions that they make, and the consequences of these in the long term, also the need to foster the company’s business relationships with both suppliers, customers and other third parties, consider the impact of the company’s operation on the community and the environment, at fairly between each of the shareholders of the company, as well as the other duties list in the Companies Act 2006 and a common law.

Shadow Directors often get caught by this as they feel that they are not “proper directors”, and there can be both civil and criminal penalties for breach on the directors’ duties, for which they need to consider, for example, the fiduciary duty of a director. This is particularly important when a Shadow Director is actually a director of another company that is either in conflict or direct dealings with this company and does not declare it because they feel that they are not formerly a director, despite the fact that when you look closely they would be considered to be a shadow director.

A UK company which is limited by shares can reduce its share capital. The relevant legislation is set out in Chapter 10 of Part 17 of the Companies Act 2006 (Act).

Process & considerations

• A Special Resolution needs to be passed by the Shareholders of the Company. This must be accompanied by a director’s solvency statement. Only private limited companies may reduce their share capital in this way (see s642 – 644 of the Act). The statement of solvency must be signed by all of the directors. When producing the statement the directors must look at the financial position of the company as a whole and how the reduction could potentially effect it. They must look at current liabilities and debts as well as any that may occur in the future (12 months). A good place to start is with the company’s financial advisor and reviewing the current filed accountants as well as any recent management accounts.
• Before the company takes the decision to reduce its capital using this method there are a number of important considerations that it must first take into account, firstly the company’s articles of association must be reviewed, under the Act as long as there is no specific prohibition or restriction contained within its articles then they can proceed.
• It should be noted that if the company’s articles do contain a restriction then it can of course alter its articles by way of a special resolution. This will need to be carried out prior to the special resolution to reduce its capital.
• The shareholders will also need to confirm that there is no shareholders agreement (or other agreement) in place which would prevent them from reducing its capital. If there is a restriction contained within the shareholders agreement then, depending on what is contained within the document, it may be possible to vary the document on the agreement of all of the parties to remove the prohibition.
• The directors and shareholders will also need to be aware that a reserve will be created as a result of the proposed reduction and this is dealt with under s654 of the Act together with article 3 of The Companies (Reduction of Share Capital) order 2008. The government have taken the decision that any reserve which may be created as a result of this if it is supported by a solvency statement will actually be considered to be a realised profit in respect of Part 23 of the Act and can be distributed to members.
• Directors will need to consider whether there are any options in place over the shares of company as this could prevent the company from reducing its capital depending on the terms of the option agreement.
• Often a company that has taken the decision to reduce its share capital will also require authority to reduce or to cancel their share premium account and or their capital redemption reserve. In this respect they are considered to form part of the company’s share capital so again when reduced they can be distributed to members.

Benefits of reducing share capital

• A benefit of reducing the capital by special resolution and solvency statement rather than by the court order is that creditors will have no right of objection to the proposed reduction. However the directors must take any creditors and liability of the company into account when producing the statement. The company may for example have loans or debentures etc outstanding and the company may need to seek the lenders approval prior to reducing the share capital.

An alternative way to reduce the capital of a company is by court order (a special resolution which is confirmed by the court). This is a much more expensive and time consuming method.

You have taken advice to carry on business in a limited company and you have some vague notion that you need a shareholders’ agreement-but why ?

Value of a shareholder agreement ?

The shareholders agreement is a form of insurance. It protects shareholders from the excesses of their fellows. It regulates the way in which the shareholders as a body will influence the manner in which the company will carry on business. It determines how shareholders may part with their shares and how to deal with approaches by potential buyers. It deals with issues which on their face ought not to be controversial but nevertheless can become fundamental.

In this first of a series of articles I will try to explain some of the typical and/or essential ingredients of this most important, and often underappreciated, business tool.

Deadlock and Exit

We believe that an important, perhaps most important, element of the shareholders agreement is to address the possibility of fundamental differences. The best shareholders’ agreements should provide for a means by which to resolve disputes between shareholders and, in particular, how to resolve disputes which cannot otherwise be resolved because there is no built-in majority to carry the day. In other words the shareholders are deadlocked.

We all know what a deadlock is. It’s a dispute, or argument, which no one is entitled, by reason only of a built-in majority shareholding, to win. So a 50:50 shareholding is a classic inbuilt deadlock.

If differences can’t be resolved by discussion the deadlock will not exist because there is a shareholder majority able to carry any resolution as of right. Either the minority shareholder(s) take it on the chin or they must extricate themselves from the company.

But does it end there? What if you wake up one morning with the realisation that you can no longer work with some of your fellow shareholders, or any of them. Supposing personal issues have invaded the boardroom. Supposing you have simply had enough and you want out. What if you just don’t agree with the way the company is going. Isn’t that just as bad as a technical deadlock? In truth, whatever the shareholding, a deadlock exists when one shareholder says so. Should that not also trigger the exit mechanism?

The longer deadlock exists, real or virtual, so the company has the greater potential to suffer as minds turn to the battle rather than the business.

If the company is to be protected from paralysis the deadlock, real or virtual, must be resolved. Usually this means that one party must go and it is essential that your shareholders’ agreement contains a mechanism for one party to exit the company. A company with a board that cannot pass resolutions is doomed unless that can be changed. A company whose shareholders can’t agree is on the slippery slope.

Management may be in the hands of a board which may not necessarily consist entirely of shareholders but the views of shareholders will ultimately prevail because a majority of the shareholders has the power to remove directors who, in their opinion, step out of line.

It is important to distinguish between the Board, which manages the business and the shareholders who may be on the board but may merely own shares. The ultimate power is theirs.

Exit strategy

Exit Strategy can take many forms but they all end up with one or more parties going and one or more staying. Shareholders embarking on a new venture (or waking up to the vulnerability to discord) are well advised to provide the exit strategy in advance so that the parties have the comfort of knowing that any deadlock will be resolved with the minimum disruption to the business. Do not assume the best. Always assume the worst, hope it doesn’t happen but be prepared if it does.

Whatever the exit strategy it would be foolish to rule out friendly discussion, by far the best, least painful and quickest means to resolve disputes. Who knows when your paths will cross again ?

A quick and friendly solution may yet have a sting in its tail. One wants to sell and the other will buy but do they have the money and how will the shares be valued? A formal share valuation process is often, if not always, slow, expensive and time consuming for the parties. The eyes can be off the ball whilst the process takes its course and suddenly a good business can become a bad business just because the parties did not have the foresight to legislate in advance for the worst.

A suggested exit strategy

Our favoured exit strategy is not the only good one but in over 40 years as a commercial lawyer I think it is the most effective. It is not possible to set out the whole process but here is a brief step by step illustration, which will give you an idea of how it works:

Step one – a dispute notice

Step two - consultation

Step three – a “buy/sell” notice served by the shareholder who served the dispute notice.

The buy sell notice is a notice served by one shareholder on all the others stating a price at which he or she will either buy the shares of the others or sell to them. Parties receiving the notice may agree either to buy or sell at the nominated price and the formula can be adapted to allow for multi-shareholders so that the body of shareholders will ultimately be divided into buyers and sellers. The Buy/Sell agreement will allow the parties time to put their funding in place and for shareholders to be obliged to sell if they fail to respond to a notice. You may have noticed the absence of any valuation. The Buy/Sell avoids the cost and inconvenience of independent valuation. It is a self regulating mechanism. The party serving the notice will not put too high a price on his shares for fear that he may have to pay it nor too low a price lest he be required to sell.

In order to concentrate the minds a Buy/Sell agreement is sometimes produced separately from the shareholders agreement but it occupies the same locked safe until the parties may feel the need to implement it. The great thing about Buy/Sell is that the process is so stark and finite that the vast majority of deadlock disputes are resolved by negotiation at the consultation stage with all parties aware that there is an infallible solution locked away in the safe should negotiations fail.

It may seem strange when starting a new company to contemplate its failure but our advice is to promote pragmatism over sentiment and make exit terms a priority.

David Swede is a Consultant in commercial law and offers experienced and cost effective advice on shareholder agreements at Darlingtons Solicitors in London.

Despite the somewhat strange latin name, ultra vires is a legal concept and not in fact a disease. It prevents companies carrying out actions which are beyond their scope of power.

Origin & Development

The doctrine of ultra vires has been developed in the interest of the investors and creditors of a company. The concept dates back over 140 years to case in which a railway company was incorporated as a company under the Companies Act 1862. The object clause in the Memorandum of Association stated that the company was to make, sell, lend, or hire railway carriages and wagons and all kind of railway machinery, plant, fittings and rolling stock; to carry on the business of general contractors and mechanical engineers; to purchase, sell, and lease minerals, mines, buildings.

The directors of the company agreed to purchase a concession for making a railway in a foreign country. The object clause in the Memorandum of Association was to supply and sell materials required to construct railways and not to undertake the construction. This was contrary to the company’s Memorandum of Association and the court held that the construction contract entered by Ashbury Ltd was ultra vires not only to the directors but to the whole company.

Meaning & Definition

Ultra vires means “beyond the powers”. It is a concept relating mainly to corporate law. In corporate law, the act is ultra vires, when the company perform acts which are beyond it’s powers. Such actions may include acts which are specifically prohibited by the company’s articles or memorandum or excessive use of the corporate power that has not been granted to the company.

Important points to note

• Acts performed by the company that are beyond the scope of its charter are void or voidable.
• The shareholders can ratify an ultra vires act if they wish it to be ratified.
• If the company’s agent commits a tort within the course of its employment then the company cannot exclude liability on the basis that the act is ultra vires.

Exceptions to the doctrine of Ultra vires

• An act that is within the ambit of the company but beyond the authority of the directors can be ratified by the shareholders in proper form.
• If the company has purchased a property by an ultra vires act, the company’s right over such property shall still be secured.
• The company can alter its articles in order to validate an otherwise ultra vires act.

Ultra vires is a complicated subject but has less significance since the Companies Act 2006 has simplified many issues including the need for a memorandum of association.

This post provided courtesy of Darlingtons Solicitors. If you have any additional questions about company law or the concept of ultra vires, please contact darlingtons.