Professor T.A. Lee and Mr. D. P. Tweedie have found that the measure of
1/ This notwithstanding there are still many who advocate a sort of S.E.C. for British Companies to perform scrutiny functions identical to those performed by the S.E.C. in the U.S. See the recent report of the Committee to Review the Functioning of Financial Institutions
(the Wilson Committee) Cmnd 7937 (1980) which called for the creation of an authority which will keep the regulatory parts of the present financial system under regular review. See e.g. para. 1119. As to the merits of these demands, see Tom Hadden (1977) pp.361-363. See also David Sugarman (1980) 1 Co. Law 302-303 and 304-305. But cf. D.D. Prentice, op.cit., (1977) 40 M.L.R. 314, 316.
2/ Lee and TWeedie, The Private Shareholder and The Corporate Report. (1977).
Individual private shareholder's understanding of financial reports is in direct proportion to the accounting experience of the reader. Thus while financial disclosures in corporate reports are avidly read b y such knowledgeable users as aanagers of investment institutions and professional analysts most private shareholders are unable to use or understand the existing form of financial report, that is, the profit and loss account and the balance sheet, and appear to be looking for less complex state ments in the Chairman's report — ^ to provide them with relevant information. The greatest problem which confronts the "non-accountant" private shareholder in his understanding of the reports appear to be "the complexity o f the
2/
reporting system and the terminology used in financial statements". — Thus while complying with the accounting and disclosure requirements of the Companies Acts accountants quite unintentionally produce a financial reporting system which is capable of being used thoroughly and reasonably understood only by accountants or equivalent professionals. The result has been the creation of a considerable communication gap between companies and their private shareholders and to give an unfair advantage to other shareholders who are more knowledgeable in accounting.
The findings of these two writers as well as numerous other 3/
reports — highlight the inadequacy of disclosure provisions and support our demand here for a re-examination of further and more effective systems
1/ The Chairman's report is not usually covered in the auditors' report. 2/ P. 131.
3/ A useful 11st of references to other reports on accounts is contained — in The Private Shareholder and The Corporate Report. See also the
Green Papers, The Future of Company Reports ; A Consultative Document (1977) Cmnd 6888 and Company Accounting and Disclosure : A Consultative Document (1979) Cmnd 7654.
68
of control on corporate management in addition to publicity and disclosures in corporate reports. — ^ In order to bring about significant reform in the "structure" of Company L a w this thesis advocates the introduction of some new structural system of control, not in substitution for but in addition to the disclosure requirements of the Companies Acts. So far the Companies Acts have dealt very little w i t h this approach to the problem of shareholders' participation in corporate administration.
2
/The only legislation — which may be regarded as having affected this structure of corporate governance in some way, is the European C o m u n l t l e s Act, 1972, particularly, Section 9 which was enacted in order
1/ Lee and Tweedie suggest that a solution to this inadequacy is to simplify the present system in order to make it more easily comprehensible to the unskilled user. See p. 132. There is no denying the fact that the existing system of publicity and disclosure are quite essential to financial analysts, investment managers and especially the press who exert a most effective extra-legal form of control over corporate management. These users are n o t constrained by those factors which inhibit the private shareholder users.
2/
The Companies Act 1976 dealt mainly with rules relating to accounts, accounting records and the appointment, removal, resignation of auditors. The legal position of Auditors is outside the main focus of this thesis.to comply with the First Council Directive concerning publicity, pre incorporation contracts and the capacity of companies and the authority of directors.
—
2
/Section 9(1) of the E.C.A. 1972, — provides in favour of a person dealing with a company in good faith, that the directors' power to bind the company to a transaction decided upon by them shall be deemed to be free from any limitation under the memorandum or articles of association. The transaction so decided upon will bind the company even if the directors act:
(1) beyond the company's powers, or
(2) beyond the powers vested in them by the memorandum and articles of association.
1/ No. 68/151/EEC.
2/
For a very exhaustive examination of this section, see J. Segev, The Powers o f the General Meeting and the Board of Directors in the Company Law of Britain and Israel.(Unpublished Fh.D. Thesis, London School of Economics) (1973). See also Gower's Principles of Modern Company Law (4th edition) 1979, pp. 178, 184-190.
In relation to the general meeting this section can be seen as greatly strengthening the position of the board of directors by validating acts which they had no powers to perform and so diminishing in fact, if not in law, the relevance of any division of powers which exists between them. It is to be noted, however, that the section only affects the relations between directors and outsiders dealing with them and has the effect of saving for such persons contracts which would
2
/otherwise have been declared
ultra vires.
- The section does not alter in any material particular, the traditional relationship between the board and the general meeting including the rights of minority shareholders and the company.The latest companies legislation is the Companies Act 1980 (1980 Act) which was designed primarily to implement the European Economic
3/
Community Second Directive - on the reclassification of companies and the maintenance, increase and reduction of capital. The opportunity was seized, however, to introduce long awaited legislation on such matters as Insider Trading, the taking of loans by directors in their companies a n d conflict of interest cases. These new provisions became necessary to protect shareholders from fraud and mal-practices by company directors, of the sort which have been revealed in numerous Department of Trade Investigations.
1/ Such as the power to ratify acts which are ultra vires the directors. 2/ In other words, it mainly affects the law relating to ultra vires and
the rule in Royal British Bank v. Turquand (1856) 6 E.4.B. 327, tr, which provides that an outsider dealing with a company is,not bound to ensure that the internal regulations of the Company Law have in fact been complied with as regards the exercise and de legation of authority. See Gower,182-182
One of the provisions of the Act which is quite significant for the structure of corporate governance is Section 46 which provides:
(1) The matters to which the directors of a company are to have regard in the performance of their functions shall include the interests of the company's employees in general as well as the interests of its members.
(2) Accordingly, the duty imposed by subsection (1) above on the directors of a company is owed by them to the company (and the company alone) and is enforceable in the same way as any other fiduciary duty owed to a company by its directors.
The reason this section is regarded as significant is that for the first time in the history of Conpany Law, a positive duty has been imposed on directors to consider directly the interest by employees in their operation of the company. During the passage of the Bill
1/ This section widens the scope of the fiduciary duty of directors to act "bona fide" in what they consider - not what a court may consider - is in the interests of the company as a whole. Re: Smith and Fawcett Ltd £.9427 Ch.304, 306 per Lord Greene M.R. The traditional legal position has been that when performing their function in the "interests of the company" directors are required to take account of the interests of the company's present and future members only: The Savoy Hotel Ltd and The Berkeley Hotel Co.Ltd. Department of Trade Report, (14£4), per Mr.Milner Holland 6.C.
(as he was then) and that they could not take into account the interests of the company's employees except in so far as to do so would be in the interests of the members of the company: Hutton v West Cork Railway Co. {1883? 23 Ch.D.654; Parke v. Daily News L t d . ¿19627 Ch.927. The new section now makes it possible for directors within the context of their duties to consider directly the interests of the employees together with those of the members.
72.
fears were raised by some sections of the public and in Parliament about the possibility of employees seeking to control the board's policies under the guise of attempting to enforce directors' compliance with the section. It required careful draftsmanship to ensure that this absurdity did not arise and the section as it now stands serves only as a shield to directors who are challenged for taking actions in the interests of the employees and not as a sword for employees to compel them to take specific actions in furtherance of their (employees) interests.
—
It can be said, therefore, that the section does not affect the relations between shareholders and directors, except that itde jure
gives the latter, wider latitude of discretion to do those things which it is commonly agreed they have often done, in fact.At the international level there have been certain develop ments which are bound to have future consequences on the present frame work for corporate governance. These developments derive from the EEC directives of which the most important for the purposes of this thesis are the Fourth Directive and the Draft Fifth Directive.
1/ See Victor Joffe, The Companies Act 1980 : A Practical Guide (1980), 12.102 - 12.104.
The Fourth Directive — ^ is concerned with the disclosure of financial information and the contents of accounts. Article 2(3) of the Directive provides that the annual accounts of a c o m p a n y shall give "a true and fair view of the company's assets, liabilities, financial position and profit or loss". Article 2(4) provides that information must be added in order to give a true and fair view if compliance with a provision of the Directive would not ensure this. In the exceptional case where compliance with the rules of the Directive would not give a true and fair view they must be departed from and a full explanation given in the notes to the accounts (Article 2(5)). Article 47 requires that the annual accounts of all companies together with the annual or directors' report and auditors' report must be published. Article 51 requires that the accounts of large companies must be audited.
Further legislation for the implementation o f this Directive is to be expected but suffice it to say here that the requirements for the U.K. are hardly revolutionary and the main practical effect of the Directive here will be the provision of all information in a prescribed format and the provision of certain additional information. The existing over-riding requirement of existing law that the accounts must give "a
1/ 78/660/EEC, (1978). (This is now included in the 1981 Companies Bill).
74
true and fair view" of the c omp a n y 's financial position has been retained.
—
The Draft Fifth Directive is concerned with the structure
2
/of companies. — It applies to the large companies In member states with the exception of the United Klnddom and Ireland and requires
that companies employing more than 500 employees should have two- tier boards either with one-third appointed by the workers, or with the workers and shareholders having a veto as under the Dutch system. Considerable resentment against the almost unqualified adoption of the German co-determination system led to its subsequent revision and
1/ For details on this Directive see the Green Paper Company Accounting and Disclosure : A Consultative Docunent. (1979) Cmnd 7654 (HMSO), p. 10. See also Ernst and Whinney, The Fourth Directive (1979), 315, for the effect of this Directive on UK and Irish Companies.
2/ C. 131/49 (1972). See the detailed provisions and the amendments thereto in (1979) 66 European Industrial Relations Rev. 23. For a discussion of the likely effects of the Implementation of this Directive on UK and Irish Companies, see Temple Lang, "The Fifth EEC Directive on Harmonization of Company Law", (1975) 12 C.M.L.R. 155 and 345.
The three other Draft Directives are the Draft Sixth Directive which relates to the issuing and contents of prospectuses and aims at the co-ordination of national requirements for the admission of securities to listing. The Draft Seventh Directive
is
concerned with the contents of group accounts and is a necessary extension of the proposals con tained in the Fourth Directive. The Draft Eighth Directive deals with auditing and sets out who is entitled to audit the annual account and the minimus qualification of auditors.The First and Second Directives were implemented in the European Comnunlties Act 1972 and the Companies Act 1980 respectively while the Third Directive aims at the co-ordination of provisions regulating internal mergers within a member state, and is yet to be implemented.
amendment b y the European Parliament. The final version will have to be adopted b y the U.K. in future, and is bound to affect
inter alia
the existing rights of shareholders.Some of the features of the draft Fifth Directive and its highly German bias are also to b e seen in the Draft Statute on the European Company (1970).
The concept o f the European Company was first put forward by Professor Sanders in 1959, the idea being to have a new form of incorporation for two or more limited companies which decide to merge or form a joint holding or subsidiary company. Following the French and German pattern, the Statute proposes a division of the board of directors into two separate and independent corporate organs; the board of management and the supervisory board. Alongside these two organs the shareholders meeting continues to exist. According to Article 64(1) of the Proposed Statute the board of management is given wide authority to act for the corporation in all fields where authority is not expressly reserved by the Statute for some other organ. The board of management also has full authority to bind the corporation
vie-a-vis
third parties, unfettered b y the limits2
/of the corporation's object or the articles of association. - The competence of the shareholders' meeting is limited to matters enumerated in Article 83. Besides the election of the supervisory board, only basic de cisions are to be taken by the general meeting, such as modification of the articles of association, increase or reduction of capital or dissolution o r transformation or merger of the corporation. The only 1/ See Gower, 88. For a history of The European Company see Prof.
Peter Saunders, "The European Company", (1968) J.B.L.184.
2/ Art.67 of the Proposed Statute. The major powers of the respective organs in the governing structure of the European Company are discussed by Hans Claudius Picker in "The Proposed Statute of a European
76
active part the shareholders' meeting may take in the governance of their company, apart from electing the members of the supervisory board, is to nominate the auditors and to decide what should be done with the annual profits. The shareholders meeting is to be held only once a year, at which shareholders have the right to put questions on matters to be discussed in the agenda.
So alien are most of the provisions of the Proposed Statute to the present governing structure in the U.K. that one commentator has described the concept of the European Company as "a stumbling block" to future development of the pattern of corporate governance
in English Company Law. - In particular, th« existing machinery for shareholders' control will be so diminished at its introduction that one must heed the warning of Prof. Gower for more stringent requirements if mass "emigration" of companies electing for the "European form"
. . 3/
is to be avoided. -
The question of workers' participation in corporate governance is a central theme underlying most of the legislative initiatives from Europe. Although it was omitted in the 1980 Companies Act, this is a question which is so important for the future structure of corporate governance in this country and has been much discussed in debates under the general name of Industrial Democracy. In 1975, the President of the
1/ See Ibid.
2/ J.C.Davies, "The European Company : a Stumbling Block" (1972),116. Sol.J.227.
Board of Trade appointed a Committee of Inquiry to "advise on questions relating to representation (of employees) at board level in the private sector", "/&7aving regard to the interest of the national economy, employees, investors and consumers, to analyse the implications of such representation for the efficient management of companies and company lav". -
The Committee reported in 1977 and proposed that large British companies adopt a new unitary board system constituted under the famous
2
/2x + y formula. - Their proposals have received little enthusiasm for their implementation so far although a future labour government under,
3/ say, Mr. Tony Benn might be more favourably disposed towards it, - but this will not be for several years to come. It is safe to assume therefore, that the existing framework for corporate administration will remain unchanged for a long time yet - at least until such a time as there will be a change in the company law philosophy to accommodate an equal
1/ Cmnd 6707 p.V.
2/ The majority's central recommendation is that in order to provide a "new legitimacy for the exercise of the management function" and to ensure that employee representatives take equal responsibility for the board's decisions, the unitary board should be reconstituted so as to be composed of three elements,an equal number of employee and shareholders representatives and a third group of co-opted directors. This group should: (a) be co-opted with the agreement of a majority of each of the other two groups - the employees and shareholders represent atives; (b) be an uneven number of three or more; and (c) form less than one third of the total board. Thus, called 2x ♦ y formula, where x ■ the employee and shareholders representatives and y “ the co-opted group of directors. When applied the minimum possible for the