Altering the Articles of Association to change the Method of Profits Distribution after Create Company UK and the Case Study of Peter’s American Delicacy Corporation Ltd


04 Jan

The better a person knows how to set up a business UK, the more are chances to run a successful company formation of UK. When you create company UK and start running it, the success of your British company register is determined by the profits it makes. The profit is then distributed amongst the members and other management of the company. This article focuses on a case study about alteration of articles to change the method of distributing profits.

Distribution of Profits

Companies are given certain authorities for making a distribution of its assets and profits. However, not every kind of distribution is allowed. According to Section 263(1) of Companies Act 1985, a company is not allowed to dispense something other than from the profits of the company that are kept for such purposes. There may arise cases after company formation of UK when these distributions have to be made and a dispute takes place upon the way these distributions are made. Such a case has been shared in detail in this article.

Case Study: Peter’s American Delicacy

The draftsman of company’s articles had made some mistakes in the articles with respect to the distribution of profits. The dispensation of profits in the form of dividends was to be done proportional to the sum that had been paid on the shares. Whereas the dispensation of capitalised profits was to be done according to the nominal value of shareholdings. Out of the total issued capital, 511,000 shares were paid fully and 169,000 shares were paid partially. A general meeting was arranged to change the articles by making the dispensation of capitalised profits in the same manner as the dividends were to be distributed. The persons who had paid a partial amount on the shares claimed against the alteration. At first, their appeal was accepted but later High Court overruled the appeal by terming the alteration correct.

It was held by Rich J:

  • An authority to change the articles via the passage of a special resolution by a 3/4th majority is given by the company law. The 3/4th majority remains prevalent over any right given by the articles and the rule is applicable on all. It is important that the intention for the alteration should be genuinely to benefit the company and not the majority shareholders.
  • But when it is to be decided whether the alteration is in company’s interest or not then the company’s constitution, the terms and consequences of articles, and the expanse of powers given by the articles to different groups of shareholders should be taken into consideration.
  • The problem is that there is a conflict of interests between different shareholders’ groups. But it does not mean that the authority to alter the articles has become inactive but that the sole reason for alteration should not be to benefit the majority at the cost of minorities. In the present case, the resolution was proposed as a solution to a difficult problem. And it seems to me that the directors were sincere in proposing an alteration that was not unfair to any group of shareholders but saved the majority shareholders’ interests.

Dixon J held:

  • Having a share in any company means that a part of the asset of company bestows rights and responsibilities on any person, in terms of dispensing the capital and income. These rights are outlined by the articles. Hence, articles may be altered to aggrandise the majority. If this power was not restricted then it might happen that by altering the articles, the majority shareholders would exclude the minorities from surplus assets at the time of liquidation or while dispensing the dividends.  
  • The power may be used for the conversion of assets of the company into a source of gains for the majority shareholders. It seems unbelievable that such changes could be brought via this power of alteration. However, depending upon the general principle, that states that the alteration should be bona fide in the best interests of the company has led to problems.
  • The shareholders are given this power but it is not a fiduciary authority. The shareholders are not holding trusts for one another, rather they are allowed to make use of the voting power in their best interests. Undoubtedly, the use of this power has its impact on the rights of other shareholders too. This analogy can be spotted in other authorities as well, for e.g. the power given to a mortgagee for sale. This probably made Buckley suggest that the power should be limited in a way that it does not compromise the rights of the minority for the benefit of majority for any reason other than the genuine benefit of the company on the whole.
  • The majority shareholders’ strength of voting can be utilised in issues concerning the governance of the company, to acquire any benefit which would otherwise have benefitted all the members. Also situations may arise where there is a contradiction in the attempt of majority to gain a benefit by prejudicing the minority and idea of fair dealing.
  • In such situations, the attempt will not fall within the capacity of members’ powers in the general meetings and the corporate authorities of the company. Any attempt that is ultra vires can be annulled because of the impact that it creates in giving advantage to a particular group of shareholders at the cost of others.
  • A general principle is that the minority and the company are entitled to have some rights. If they are endangered by any action of majority, the court will intervene on the basis of abuse of authority by the majority. The company’s articles govern the rights bestowed to shareholders as well as the way they are associated with the profits and extra assets of the company. The authority given for changing the articles is also an authority for changing the rights of shareholders especially regarding the surplus assets and gains of the company.
  • Therefore, it is tough to imply upon a resolution, the condition to keep the individual rights undestroyed. Apparently, all the provisions of articles can be changed or destroyed. So when a 3/4th majority votes for it, the provision will be changed. The general idea of justice and equity will distinguish how to term any alteration as fraudulent. To give a reason that the alteration affects rights of worthy nature to term it fraudulent is like adopting the rejected distinction between provisions of administration and provisions of constitution. To give a reason that majority is benefitting from the change is just like ignoring the voting power that is given to each shareholder to utilise it in his best interests.
  • The purpose for denial of the unrestricted impact that the power of alteration may have is the fear that such a power may be used for acquiring a personal gain that may not be acquired fairly or lies outside the capacity of that power. For the prevention of such malicious goals, Lord Lindley specified “bona fide in company’s interests on the whole.” A reference to this phrase helps in preventing all the goals that are alien to any company.
  • A bad luck is that the phrase has been misunderstood. If the accused change, alters the rights of any director for life or any shareholder who has to be expropriated by the change or any article that provides rights to shareholders mutually, the subject becomes disputable in terms of interests. To put a condition that in such matters the shareholders having majority shares should take care of the benefit of the company as a whole is improper. The company consists of all the members holding shares. If any resolution is proposed for altering the mutual rights of shareholders or their groups, the question that is to be addressed is that what adjustment can be made for the conflicting interests. However, it is to be decided by law that any such alteration can take place with a mere majority of 3/4th.
  • Whether the alteration concerns rights of voting, dispensing profits, division of extra property upon liquidation, rights regarding the matters of surplus property or profits or mutual rights, the subject of these matters are apparently governed mostly by the articles, an alteration of these is only redetermination of the interests of those who are given authorities. None will think the shareholders have to take care of the company’s benefit as an institution only, while voting. It would be impossible to check the intention of every shareholder at the time of voting.
  • When it is to be determined that how to resolve a conflict in interests regarding a resolution, the resolution will have the goal to resolve the issue either by supporting or negating any interest. I believe, it was within the capacity of the authority of alteration to take a decision regarding the method of dispensing the issued shares for the reason of monetizing sums of profits or profits gained from selling goodwill, and the shareholders were allowed to vote in their best interests.
  • I am far from admitting that if it was mentioned clearly in the present articles that the basis of dispensing should be the amount of shares given to each member no matter what effect it had on the capitalisation then the resolution proposing such an alteration was bad. However, the facts in the present case state that the old method would have affected the capitalisation, meaning a dispensation in accordance with the proportion of the capital that had been paid. There were doubts in adopting this method.
  • If there was no existence of capitalisation, then the sums of profit could not be dispensed proportionately according to the capital that was subscribed. In such a situation the persons who had paid a partial amount on the shares could not be given the right for receiving profits proportional to the capital that was paid. According to the articles, they were only authorised to get shares at that rate when their issuance was done via the direct capitalisation. And possibly, this would never happen, as the shareholders who paid a full amount on the shares were authorised for preventing this from happening and would undoubtedly prevent it.
  • In such a scenario, it seems to me that there was no unfairness in the proposed resolution and nor was it outside the capacity of the power of alteration.

A similar verdict was delivered by Latham CJ and Mctiernan J concurred.

Gambotto v WPC

The above mentioned case has no longer any worth in Australia. In the case of Gambotto, it was held by the High Court that the test of “Bona fide in company’s interests on the whole” should be substituted by the test of determining if the alteration is “exceeding the purpose of the articles or unjust in the terms of corporate law”. This case concerned a change in articles which allowed the company to buyout the shares held by members in minority necessarily. The court disowned the British line of authority generally. This suggested test is almost wholly objective in nature. Although there has been somewhat replacement of bona fide test with a test for appropriate purposes, yet the test suggested by Gambotto is less likely to be adopted by the British company register. According to CLR, the alteration in Gambotto was for the benefit of the company, and the bona fide test cannot be replaced with some other test in matter concerning expropriation.

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