Business basics Part 2: governance

Ricky Ghosh explains how companies are run – and what happens when there are disagreements

Power within a company is split between the directors (who are responsible for day-to-day management) and the shareholders (the investors/owners) who appoint them, and to whom they are ultimately accountable.

There are many potential conflicts of interest between shareholders and directors. Directors must be stopped from exploiting the company for their own benefit at the expense of the shareholders, for example, by paying themselves huge salaries, or not carrying out their management duties properly. However, directors must also be able to manage the company free from overbearing shareholders, especially where the interests of different shareholders conflict - think of an active investor with a small shareholding who may be deliberately obstructive to the detriment of the majority shareholders.

Companies Act 2006

Corporate mismanagement and arguments are usually damaging to

a company, and to third parties, such as employees, so the law steps in to regulate the decision-making processes of companies, particularly in matters which are likely to have a significant impact on the company's future direction. Most of the regulation of companies is statutory (that is, set out in law enacted by Parliament) because of the potential economic impact of corporate governance rules. How difficult or easy it is for a company to operate in a particular country is a major consideration for businesses when deciding where to base their operations, so over-draconian legislation could take jobs away from a particular economy.

The Companies Act 2006 (the Act) contains most of the current rules on how companies may conduct their businesses. The rules allow directors to make some decisions at board meetings, but require shareholder approval for more important ones, such as whether the company should make a loan to, or buy a significant asset from, a director.

Resolutions

Shareholders give their approval to these important decisions by voting on proposed "shareholder resolutions". For less important decisions, approval will be given in writing. The company will send out a proposed written resolution with a consent form attached for the shareholders to sign, which the shareholders will post to the company's registered address. Voting on major decisions, however, will usually take place at a general meeting, where shareholders will gather together in one place and vote by show of hands.

The thresholds of approval to be met will depend on the nature of the decision required. For some matters, an "ordinary resolution" will suffice, which requires the consent of more than 50 per cent of shareholders to pass. For more serious matters, a "special resolution" is necessary, requiring the consent of more than 75 per cent of the shareholders. Such more serious matters include making payments out of the company's "share capital" (the initial investments of shareholders, which must be kept as a "fund of last resort") and the changing of the company's name.

Directors' duties

Another important way in which the Act aims to ensure good corporate governance is by subjecting directors to special liabilities and restrictions. The most important of these are contained in the Act's list of seven key "directors' duties". These seven duties are:

  • To promote the success of the company
  • To act in accordance with the company's constitution and to exercise powers only for the purposes for which they are conferred
  • To exercise independent judgement
  • To exercise reasonable care, skill and diligence
  • To avoid conflicts of interest
  • Not to accept benefits from third parties
  • To declare interests in a proposed or existing transaction or arrangement with the company.

Personal or criminal liability can be imposed on directors who have acted improperly, particularly where their actions lead to a company becoming insolvent. Directors may also be disqualified from managing companies in the future, or subject to actions for wrongful or fraudulent trading under insolvency regulation.

Articles of association

However, it's important to note that many of the requirements of the Act can be overruled by the company's constitutional document, known as its "articles of association" (the articles). A special resolution of the shareholders is required to amend the articles. Many companies choose to amend their articles to limit shareholder influence as they grow bigger to avoid problems with activist investors.

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