Management and Control of the Corporation

Management and Control of the Corporation Management, Control and Ownership • Corporations, since inception, have become dramatically more publicly owned, with dispersed shareholder ownership (no controlling shareholder) o This caused the ‘owners’ / shareholders of corporations to be more passive principals o Separation of ownership and control • Agency conflicts – arise naturally from delegation of authority – shareholders delegate power to directors and officers who also have personal interests as well as duties to the corporation Contractarian model of the corporation – corporation is simply a nexus for different contracts between different parties; and if that is the case, managers and shareholders will agree on contracts that maximize value and minimize agency costs • Markets work to align the interests of managers and shareholders • This suggests that corporate law is not really needed and it can be dealt with under contract law – however, corporate law outlines rules that allow these markets to operate – they outline voting rules, how investors realize returns, incorporating saves transaction costs, etc. o corporate law helps facilitate (standard form contract and legal personality), but that people should be able to choose what they agree to and contract out of a particular term if they want – should avoid mandatory corporate rules • Critiques – markets cannot effectively control agency costs – examples like Enron – regulators need to step in to fill the corporate governance void o 2008 crisis was brought about partly by failure of managers to manage risks and compensation Relevant BCA sections 1(3) – director – an individual is appointed as a director of a company if Appointed as a director in accordance with this act, or the memorandum/articles of the company (c) declared by the court to be a director of the company (court has power is person is avoiding being a director to avoid liability) 2 (3) – control – a person has control of a corporation if shares of the corporation are held by the person, or a corporation controlled by the person, and the votes carried are sufficient to elect or appoint a majority of the directors of the corporation 128 (3) – removal of director – a company may remove a director before expiration of their term (a) by a special resolution or (b) if memo or articles say differently, that threshold can be lowered (lawyer can override government here - Baron) CBCA 6(4) – cannot change threshold for removing directors 135(1)(a) – no directors in office – an individual (anybody) may be empowered by the shareholders to call a meeting of the shareholders for the election of directors; and appoint directors by simple majority appointment under (1)(b) may be effected by a unanimous resolution 136(1) – directors of a company must manage or supervise the management of the business and affairs of the company (subject to exceptions) Bushell v Faith [1970] F: Conflict between external rules and internal rules – family business in England with 3 shareholders (siblings with 100 shares each) • One brother is a director, and the other two siblings are trying to remove that director from office • However, the internal articles stipulate that in that situation, the shares of the director who is to be ousted give 3 votes per share in the resolution (this inevitably results in a 300 to 200 vote, so the brother stays in office) • Sister argues that the article that allows this is frustrating the whole object and purpose of the Act, so that a director can become irremovable • S 184 says that notwithstanding anything in its articles, ordinary resolution can remove a director A: an ordinary resolution means a bare majority of votes, but this depends on the voting rights that are attached to different classes of shares • Parliament has never sought to fetter the right of a company to issue a share with different rights or restrictions in different circumstances o Provision does not say that in this ordinary resolution, all special voting rights are removed C: finding for the brother (baron disagrees with decision; dissenting opinion says so too) • Baron – how can a solicitor prevent Bushell situation? – state in articles that attached to one class of shares, each shareholder is entitled to elect one director Some sections of BCA/CBCA cannot be modified by articles or shareholder agreement Polls: In a meeting, voting is usually done by show of hands – but after the result of vote, if someone disagrees, they can demand a poll with written ballot and one vote per share • Doesn’t change threshold required, but can change outcome Sale of the undertaking (sell off everything the company owns) • s 301 contains procedure – generally requires special resolution o protection for bona fide purchaser in good faith • But what if the majority controlling shareholder wants to vote one way, but directors disagree (clash between owners and management) Automatic Self-Cleansing Filter Syndicate v Cuninghame [1906] F: Articles of association stipulated that the management of the business is vested in the directors, unless there is 75% shareholder votes (extraordinary resolution) • one major shareholder wants to sell company’s assets, and the resolution passed by simple majority • management disagreed and refused to sell the assets because they felt it was not in the best interests of the company A: Majority shareholder cannot impose that obligation on the director (s 136) • The directors are not agents of the shareholders, they are agents of the corporation, so they do not have to be bound by the resolution • The only thing that can change this is an extraordinary resolution affecting the powers of the directors, and not a simple majority approving the sale Unanimous Shareholder Agreements (only federal) – alters relation between directors and shareholders – purpose to restrict, either completely or partially, the director’s powers • Historically, directors cannot fetter their discretion (contract into how they will act in future), but shareholders are allowed to; In 1970, this changed with USAs • USA makes shareholders liable as directors (not very common), but can be demanded by owners if they want more control • CBCA 146 – directors have a duty to comply with them; therefore, breaching USA is like breaching the articles • Examples of things you can do in a USA – change voting thresholds, make directors disclose more information at AGM, limit authority to issue shares, borrow money, appoint officers, set remuneration (traditionally decisions that directors would make) • Note BCA 137 – powers of directors may be transferred (but BC does not have USAs) o this takes place in the articles – not a contract; may be added to articles after special resolution o transfer recipient can be any person, not just shareholders – the transferee takes on rights, powers, duties and liabilities of the Directors, to the extent of the transfer (and director is relieved similarly) Bury v Bell [1984] F: Bury was employee and shareholder at Bell, company had USA that said that if he left employment at Bell, he would have to sell shares at price determined by Bell, bought within 6 months, but could be extended to 12 months • No one was contesting validity of the agreement • Bury left employment at Bell, and got job at new brokerage where shares were part of compensation package • But legislation held that you could only have shares at one brokerage house at one time – prohibiting him from taking new shares, so is trying to compel Bell to purchase the shares A: this is an unjustified delay, an act of penalizing Bury for leaving – the deprivation gives a prima facie case of oppression/unfairness, so the onus is on Bell to justify the deprivation (no justification advanced) • So, court forced them to buy back the shares at the six month mark (court empowered to disregard articles) • CBCA 241(2)(c) and (3) noted – powers of the court – 241(3)(c) brought up in Bury as court can regulate a corporations affairs by amending the articles / USA / etc. Ultra Vires Doctrine – old rule that says corporation can only act if it is specifically authorized to in articles if the company was made by memorandum (did not apply to letters patent companies) • In BC, enacted s 30 BCA – “rights, powers, and privileges of an individual of full capacity” o BCA s 33 – restrictions – company must not carry on any business or exercise any power that is restricted by its articles • BCA 154 – directors’ liability – directors who vote/consent to resolution that authorizes a company to do any of the following are jointly/severally liable to restore the company to its position o (a) do any act contrary to section 33 (against the articles) that results in company paying person o (c) to pay a divided contrary to section 70 • BCA 259 – procedure to alter articles (if want to change restriction) o BCA 260 allows for shareholder dissent, and sell-off of shares Protecting 3rd party reliance – Indoor Management Rule • BCA 146 – persons may rely on authority of companies and their directors, officers and agents o Unless they ought to have known by virtue of their relationship to the company (different than CBCA) • CBCA s 17 – no constructive notice (a person should have known, as RP, of an event or fact, whether they actually had notice or not) o s 18 – information in notice of articles can be taken at face value Shelf company – in the past, documents submitted to registrar would take several weeks to be approved, so lawyer would become director of a ‘shelf company’ and then give the company to a client who wants it immediately • Basically a pre-packaged corporation ready to go, transfer shares, title of director to client • Company is supposed to have never done anything before (should be fresh for client) Sherwood Design Services v Ontario [1998] F: Pre-incorporation contract made by a group of people to buy Sherwood, so lawyer sold shelf company to client which was supposed to secure contract • lawyer sent a letter to Sherwood’s lawyer stating the numbered company was incorporated and the asset purchase will be completed; attached unsigned copies of a certified copy of the director’s resolution adopting purchase agreement and other documents – but transaction never went through as buyers never showed up • The lawyer later transferred the shell company to another party for a different real estate transaction • Sherwood then sued the numbered company alleging the numbered company’s assets were liable for the earlier transaction (they had lost money as they were forced to sell for a lower amount to another purchaser) I: is numbered company liable for the breach? C: Majority: yes; dissent: no Majority: upheld protecting third party reliance – people involved in a corporation cannot rely on something that the other party did not know (third party does not have to do as much due diligence – can assume it is set up properly and people named as directors have authority to act, take articles at face value) • Lawyer had full authority of the law firm – he held authority to speak on behalf of the corporation and the clients • The company therefore cannot dispute the authority of the solicitor in his letter that made such representations Dissent: unsigned draft resolution was sufficient to give notice that the corporation had not adopted to contract – the documents made it clear that the corporation had not been formed, and not had the opportunity to turn its mind to the preincorporation contract Corporate Goals and CSR contractarian view – corporation can do whatever its directors decide it should do, but once decision is made, no singly person should have power to change (usually focuses on a profit-seeking motive as most investors want that) • Eg: if a shareholder invests in a for-profit corporation in order to receive a share of profits, if that corp donates those profits to charity instead, we have an agency problem (but if it was a C3 – it would make sense) second view: businesses are connected to the rest of the world – rejects contractarian model, profit maximization is too narrow, must also consider employees, consumers, communities (other stakeholders) Dodge v Ford [1919] Background: big merger movement in this period, much discussion about government intervention • extremely profitable company – so dividends were contentious F: Henry Ford had control over directors of company, decided goal was to produce more cars at lower price, wanted to reinvest in facilities/improvements, increasing employment, instead of dividends • Short term will be less profitable but arguably will be better long term o Immediate effect will diminish value of shares, reduce dividends • One shareholder (Dodge brothers) rejected this, brought claim to court – said this is like giving to charity rather than maximizing profits (reinvesting in workers, company) • Baron adds facts: Ford’s motive was actually that he did not want to pay dividends to Dodge brothers as it would allow them to compete with rival car company (they owned 10%) o Shareholders have no duty to the corporation, they just want the most money as possible, starting competing businesses (different if a director did this) I: are the directors (director) working in the best interests of the corporation? A: goal is to maximize value for shareholders – the directors have discretion over how to achieve that goal, but they cannot change the goal and devote profits for other goals • Directors do not have discretion to conduct affairs for the mere incidental benefit of shareholders, and for the primary purpose of benefiting others • But, it is tough to tell if the expansion is or is not in the best interests of the corporation - we are not business experts, we are not satisfied that the alleged motives of the directors menace the interests of the shareholders • Still the dividend should have been paid – the shareholders have a just grievance C: Ford, as director, does not have discretion to change profit seeking goal to lower consumer prices and raise employee salaries Parke v Daily News [1962] F: 2 subsidiary newspapers make up a large part of Daily News’ business, employing ~3000 people • the newspapers were not profitable, so they wanted to sell the companies and focus on other things • before the sale completed, directors decided that money left over from sale will be used towards benefit of staff/pensioners – vacation pay, severance, etc. (for employees in this massive sale as jobs are affected) • directors let shareholders know that the vote is coming up – shareholders did not like this plan at all so they applied to courts, spearheaded by majority shareholder Parke (seeking resolution that the vote is ultra vires) I: are the directors acting in best interest of the corporation? A: Court looks at 2 cases • 1st: on winding up, directors wanted to pay money to people who lost their jobs but had no legal claim to compensation – court said the company was no longer a going concern and sole purpose was winding up • 2nd: company granted a pension to a widow of a former managing director o When granting money such as this, which involves expenditure of company funds, it can only be spent for purposes reasonably incidental to the carrying on of the company’s business; must ask 3 questions: § is the transaction reasonably incidental to the carrying on of the company’s business; § is it a bona fide transaction; § is it done for the benefit and to promote the prosperity of the company? • Conclusions from cases – companies funds cannot be applied to do charitable things; court will inquire into the motives / objectives of the use of funds; court will uphold the validity of gratuitous payments if the test is satisfied; onus of upholding validity of payments lies on people asserting it (directors) • Directors argued they must take into account employees interests – rejected by court, they say you must only look at profits, what is best for the corporation as a whole • Court says it was noble what they were trying to do, but there was no legal basis for the application of funds Re Peoples Department Stores [1992] F: Marks and Spencer Department Store was department store, but also owned other businesses including Peoples • Spencer sells Peoples to Wise Stores in a leveraged buyout – instead of paying cash, borrow money from seller • Wise is the purchaser, integrating the companies did not go well though, recording inventory was a mess • One of the directors (Wise brothers) consults with everyone, says they are going to do a joint inventory procurement, Peoples will buy from US suppliers, Wise will buy from overseas, and then transfer inventory to each other, and record it on financial statements as the companies owing money to each other o Within a year, both companies are bankrupt o Trustee says Wise brothers favoured their own old store over the Peoples to the detriment of People’s creditors in breach of duties of directors under s 122 (142 BCA) o TJ found they owe FD to creditors in the vicinity of insolvency, and it was breached A: Although shareholders are commonly said to own a corporation, in absence of USA, it is directors appointed by shareholders that supervise the management of the corporation o Considerable power vested in directors under s 136, and vested in officers by delegation from directors o They have fiduciary duty, must respect trust and confidence vested in them, must avoid conflicts of interests, avoid using the position for personal benefit, maintain confidentiality of information they see in their position, etc. • Best interests of corporation is not simply best interests of shareholders – just means maximization of the value of the corporation • But courts have recognized that other factors are relevant in managing a corporation • When in vicinity of insolvency, shareholders may prefer directors to pursue high-risk alternatives with high potential payoff to maximize prospective claim; creditors may prefer in the same circumstances that directors steer a safer course as to maximize value of their claim against assets of corporation (2 different pressures from different groups) o Duties of directors do not change when they are in this zone (insolvency) o Directors owe a duty of care to creditors, but not a fiduciary duty o Any honest, good faith attempt to turn the business around, if unsuccessful, will not qualify as breach of fiduciary duty Re BCE [2008] F: Corporation made plan of arrangement to sell off shares of company in leveraged buyout • Three offers contemplated a substantial amount of debt which would be held by subsidiary company Bell CAN • Plan was approved by basically everyone except for some banks that said no, they had debentures and were worried about value of them (when complete, the short term trading value of their bonds will decline by 20%) • Seek relief under oppression remedy, and they say it is not fair and reasonable • TJ says its fair, CoA disagrees SCC: an essential component of corporation is capital stock, which is divided into fractional parts: shares • Shares do not confer right to underlying assets while it is running o A share is not an isolated piece of property, it is a bundle of interrelated rights and liabilities § Rights to assets on insolvency, right to oversee management of company • Directors are subject to two duties: fiduciary and duty of care of reasonably prudent person (this case is only FD) • If interests between shareholders and stakeholders conflict, the directors duty is to the corporation (Peoples) • Fiduciary duty is not confined to short-term profit or share value, must look to long term interests of corporations o Although directors must consider best interests of corporation, may also be appropriate (but not mandatory) to consider impact of corporate decisions on all stakeholders (shareholders, employees, creditors, consumers, governments and the environment to inform their decisions) • Courts should give deference to the judgements of directors who take into account these ancillary interests (BJR) • Directors are not making any decisions that are not in the best interests of corp, even if the decisions reduce the value of some debentures