QUESTION
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19
SHARES
AND SHAREHOLDING
2
Introduction
Prohibited
setf-acquisition
\7har is the
prohibition
on
self-acquisition?
Are
there
any
exceptions to the rule? .
\fhat
are
the
consequences
ofa breach?
Prohibited financiaI assistance
-Vhat
is
rhe
rule
prohibiting
financial assistance?
S7hat is financial assistance?
\7hen is financial assistance
permitted?
Are directors’ duties relevant?
$7hat are the consequences ofa breach?
.
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i1T19-600
llt9-620
nrg-640
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nt9-140
nt9-760
fl19-780
COMMERCIAT
APPLICATIONS
OF
COMPANY
LAW
oes
the
law permit
a
company
to reduce
its
capital
in
any
circumstahces?
…
\Thatisabuy-back?
$7hat
types
of
buy-backs
are
allowed?
N7hat
are
the procedural
requirements?
.
.
. .
\Mhat
are
the
consequences
Permltted
reductions
of
caoital
wnat
ts
a feduccton
ot
caprtal/
of a breach?
NThen
is a reduction
of
capital
allowed?
$7har
are
the procedural
requirements?
.
.
N7hat
are
the
consequences
ofa
breach?
\7hat
other
capital
reductions
are
permitted?
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SOLUTION
Shares and Shareholders
A share can be described as the unit of ownership interest in a company or financial assets. Shares entitle their possessor to the equal distribution of profits if any declared in the form of dividend although shares do not provide any direct control over the day-to-day operations of the organization. There are two major types of shares, preferred shares and common shares (Khatchaturyan, 2004).
The term share means that the holder of the share has a claim on a part of the share capital but does not represent a right of ownership in part regarding the net assets of the company. Shares held in the company are not a corporeal object but are a complex set of rights and duties. In the past, physical paper stock certificates were issued to the shareholders that indicated that a given number of shares are owned by them in a particular company (Li et al, 2006). These days, electronic records are also maintained by brokerages which show the ownership details of the shareholders. While shares are generally used to refer to the stock of a company, they can also be used to represent the ownership of financial assets of other classes like the mutual funds (Baums and Scott, 2003).
Introduce Shares and Shareholders: shareholders are the persons who invest in the company. They pay money to the company and get shares of the companies in return. The level of control they have over the company is determined by the number of shares held by them. For example if a shareholders has 750 shares out of the total 1000 shares, that shareholders owns 75 percent of the company as each share represents one vote in the company. These shareholders vote for the appointment of directors in the company and these directors provide direction for the company. Shareholders do not make direct decisions regarding the management of the company unless they are the directors of the company. In small companies it is common that the major shareholder is also the managing director of the company (Porter, 1992).
Shares can be explained through the following case study. In this case an experienced businessman that when he established his first company he was the sole director and set up the share capital of the company as one share of $1. Later on he wanted to pass on some shares of the company to his children. For this purpose he had to increase the number of shares. It was possible but a number of administrative steps were involved in this process. So when he started his second company, he selected 1200 shares of 10 cent each. The reason was that he could divide these shares among his four children later on. Similarly he could issue some of these shares to another director of the company at the later stage.
The duties of directors: The directors have a duty to act bona fide in the interest of the company and its shareholders. The directors are not always expected to act purely in the economic interests of the company while ignoring the interests of the members, creditors and employees of the company. The director could have acted wrongly but if he was acting within his authority, he will be considered to have acted in good faith unless proved otherwise. Directors are required to make continuous disclosures about their interest in various transactions of the company and with the company. In order to establish a breach of duty by the director of company it has to be shown that what the directed did was related with the affairs of the company in such a way that can be said to have been during the course of management and by utilizing the special knowledge and opportunities available to a director of the company. It should also be shown that the act of the director resulted in profit for him (Short, Zhang and Keasey, 2002).
The test has to be applied in this case is to see whether the directors have acted in good faith and honesty. Directors fail in this test if they do not give proper consideration to the interests of the company and its shareholders. Such a situation could arise for example when the director assumes that the interests of the company correspond with his own interests and fail to consider his own interests as a separate entity (Berghe and Levrau, 2002).
The directors are also required to not to use their powers for any improper purpose. Improper purpose includes creating a new majority to defeat the voting power of existing shareholders or obtaining a personal advantage. To see if the powers have been exercised by the directors for a proper purpose, an objective test has to be applied. The directors are also required to exercise due care and diligence while performing the duties. It should make informed and independent decisions and place them in a position where they can guide the company and also monitor its management. Directors should not just themselves in such a position where they cannot make decisions which are favorable for the company and its shareholders. This includes entering into transactions which could result in a situation where the director cannot take part in the decision-making process of the company. Such a situation could be a situation where, for example, the director may have to put the interests of other parties before the interests of his company and its shareholders (Villalonga and Amit, 2006).
The directors also have a fiduciary duty to avoid any conflict of interest and place the interests of the company and its shareholders ahead of their own interests. Such a conflict of interest could be either direct or indirect and it is the duty of the directors to not to have a personal interest in the transactions of the company. Such a duty will be breached if the director enters into a contract, directly or indirectly with the company. It is also the duty of directors to not disclose any confidential information received by them as the result of their position in the company. Information is considered as confidential when the owner believes that the disclosure of information could be detrimental to him or advantageous to others. Information secret and is not in public domain is also considered as confidential (Maury and Pajuste, 2005). The members of the board of directors have a fiduciary duty towards their company and its shareholders and this duty includes the duty of exercising due care while discharging the responsibilities by the directors and they’re also required to exhibit a loyalty towards their organization. Courts have provided guidelines regarding what amount to a breach of fiduciary duty but such an analysis is generally fact intensive and guided by an objective standard of what a reasonable person would to the similar circumstances (Woolridge, 2002).
Similarly it is also the duty of the directors to act within the powers of the company. They are also required to make independent decisions and even while taking advice from others, they should exercise their independent judgment while considering the suggestions and recommendations made by the advisers.
Shareholders have a number of option available if they feel that the decisions taken by the company or its directors could be detrimental to their interests. These remedies are also available even for the minority shareholders. They can protect their interest through preventive action like blocking a resolution or restraining the acts which are beyond the powers of the directors. Additional protection is provided to the shareholders by law in certain cases where it has been felt that the shareholders could be vulnerable. Remedial action available to the shareholders includes the removal of a director or raising objections to a particular decision through Court. It is appropriate for the shareholders to initiate Court action on behalf of the company or against the company when for example there is a claim by the company against its directors for breach of a duty and the board of the company is not ready to pursue such a claim on behalf of the company. In such a situation, shareholders can take action on behalf of the company and also in their own name. Some times even these remedies and protections are not enough to protect the shareholders especially those in minority from the directors and the powerful shareholders of the company who are in a position to take advantage. These remedies are called the remedies of last resort and allow the shareholders to issue derivative claims in the name of the company when there is a breach of duty by a director. They can also bring action against unfair prejudice when the affairs of the company have been conducted in a manner which is unfairly prejudicial. The shareholders can also apply for the winding up of the company on equitable and just grounds in extreme cases (Maury and Pajuste, 2005).
Conclusion/Opinion: the consequences of breach of duty on the part of a director generally depend on local laws. It has been seen that generally the courts hold down the tainted transactions where the director acted poorly. In case the director had behaved very badly during a particular transaction courts can even permit the shareholders to hold the director individually responsible for his actions and sue him in a court of law. Usually any breach of a fiduciary duty results in at least the remove him from his position in the company.
References:
A. Khatchaturyan, The Economics of Corporate Governance Regulation in the EU (University of Siena, Working Paper 2004)
Li, D., F. Moshirian, P. Kien Pham and J. Zein: 2006, ‘When Financial Institutions Are Large Shareholders: The Role of Macro Corporate Governance Environments’, Journal of Finance 61(6), 2975–3007.
Maury, B. and A. Pajuste: 2005, ‘Multiple Large Shareholders and Firm Value’, Journal of Banking & Finance 29(7), 1813–1834.
Porter, M. E.: 1992, ‘Capital Choices: Changing the Way America Invests in Industry’, Journal of Applied Corporate Finance 5(2), 4–16.
Short, H., H. Zhang and K. Keasey: 2002, ‘The Link Between Dividend Policy and Institutional Ownership’, Journal of Corporate Finance 8(2), 105–122.
T. Baums & K. Scott, Taking Shareholder Protection Seriously? Corporate Governance in the United States and Germany (Stan. L. Sch., Working Paper No. 272, 2003).
Van den Berghe, L.A.A. and Levrau: 2002, “The role of the venture capitalist as monitor of the company: A corporate governance perspective”, Corporate Governance: An International Review 10(3), 124 -135
Villalonga, B. and R. Amit: 2006, ‘How Do Family Ownership, Control, and Management Affect Firm Value?’ Journal of Financial Economics 80(2), 385–417.
Woolridge, J. M.: 2002, ‘Econometric Analysis of Cross Section and Panel Data (MIT Press. Cambridge, MA).
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