Comparative Corporate Governance Shareholders as a Rule-maker
Petri Måntysaari
Comparative Corporate Governance Shareholders as a Rule-maker
12
Professor Petri Måntysaari HANKEN Swedish School of Economics and Business Administration Kauppapuistikko 2 65100 Vaasa Finland
[email protected]
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ISBN 3-540-25380-7 Springer Berlin Heidelberg New York This work is subject to copyright. All rights are reserved, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilm or in any other way, and storage in data banks. Duplication of this publication or parts thereof is permitted only under the provisions of the German Copyright Law of September 9, 1965, in its current version, and permission for use must always be obtained from Springer-Verlag. Violations are liable for prosecution under the German Copyright Law. Springer is a part of Springer Science+Business Media springeronline.com ° Springer Berlin ´ Heidelberg 2005 Printed in Germany The use of general descriptive names, registered names, trademarks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. Softcover-Design: Erich Kirchner, Heidelberg SPIN 11408284
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Foreword
It is fairly easy for a Finnish Jurist to understand German Company law. On the other hand, UK Company law seems very confusing. What is even more confusing is that the UK corporate govemance model is often regarded as one of the best in the World. Clearly German law cannot be as bad as it is often said to be. This books results from these kinds of thoughts and an interest in comparative law, Company law and securities markets law. I wanted to find out whether the functional method would give anything new to say about the regulation of corporate govemance in Germany and the UK. As I have been lecturing on Company law and corporate govemance myself, I also wanted to write a book that I could use as a textbook in my courses. For this reason, I focused on one of the key questions in corporate govemance: the regulation of shareholder activism. Petri Mäntysaari HANKEN Swedish School of Economics and Business Administration Vaasa, Finland 2 March 2005
Table of Contents
1 Introduction
1
2 Comparative Law and Corporate Governance 9 2.1 Introduction 9 2.2 The Comparative Legal Method in General 10 2.3 Comparative Corporate Governance inParticular 15 2.3.1 Introduction 15 2.3.2 The Objectives of Corporate Governance 16 2.3.3 The Choice of a Social Need 16 2.3.4 The Choice ofa Social Need and the Amount of Rules 18 2.3.5 The Choice of a Narrow Social Need 19 2.3.6 Rules on Governance and Rules on Constraints on Governance 21 2.3.7 The Legal Nature of Companies and the Organisation of Firms....... 22 2.3.8 The Sources and Natureof Rules 34 3 The Law of the European Union 3.1 The Legal Basis 3.2 The Harmonisation of Corporate Governance Rules 3.2.1. The General Approach in the Fast 3.2.2 Reasons for Harmonisation in the Future 3.2.3 The Effect of the Sarbanes-Oxley Act 3.2.4 The Present Approach to Harmonisation 3.3 Freedom to Choose the Company Form in the EU 3.4. The European Company 3.4.1 Introduction 3.4.2. The Applicable Rules in General 3.4.3 Party Autonomy under the SE Regulation 3.4.4 The Basic Governance Structure under the SE Regulation 3.5 Conclusion
35 35 37 37 38 44 47 53 58 58 60 64 66 77
4 The United Kingdom 4.1 General Remarks 4.1.1 Introduction 4.1.2 The Most Important Legal Forms of Business Organisation 4.1.3 Sources 4.1.4TheExtentof Party Autonomy in Rule-making 4.2 Basic Governance Structure
79 79 79 81 82 86 93
VIII
Table of Contents
4.2.1Introduction 4.2.2 General Meeting of Shareholders 4.2.3 Board ofDirectors 4.2.4 Managing Director 4.2.5 Company Secretary 4.2.6 The Location of Management 4.3 The Importance of Articles of Association 4.3.1Introduction 4.3.2 Parties Bound by the Memorandum and Articles 4.3.3 Enforcement by Shareholders 4.4 The General Meeting and Internal Management 4.4.1 Introduction 4.4.2 Division of Powers: General Remarks 4.4.3 Procedure of Decision-making 4.4.4 The Memorandum and Articles of Association 4.4.5 Decisions on Management Matters 4.4.6 The Appointment, Remuneration and Removal of Managers 4.5 Agreements and Internal Management 4.5.1 Introduction 4.5.2 Unanimous Consent 4.5.3 Shareholders' Agreements 4.5.4 Shareholders' Agreements with the Company 4.6 Disclosure, Remedies and Management Duties 4.6.1 Introduction 4.6.2 Disclosure of Information 4.6.3 Shareholder Remedies 4.6.4 Right to Sue: General Remarks 4.6.5 Proceedings Brought by Shareholders for Breach of Duty 4.6.6 Other Shareholder Remedies 4.6.7 The Duties of Board Members 4.6.8 The Duties of Sub-board Managers 4.6.9 The Duties of Company Secretary 4.6.10 Auditors'Duties 4.6.11 Shareholders'Duties 4.7 Shareholders and Dealings with Third Parties 4.7.1 Introduction 4.7.2 Representation of the Company: General Remarks 4.7.3 Company Acting through its Board ofDirectors 4.7.4 Company Acting through Other Representatives 4.7.5 Shareholders as a Rule-maker 4.8 The Govemance of Groups in the UK 4.8.1 Introduction 4.8.2 Legislation on Groups 4.8.3 The Effect of the Group Structure on the Scope of Rules 4.8.4 The Parent Company as a Rule-maker in the Subsidiary 4.8.5 Duties of the Board of the Subsidiary Company
93 94 95 100 101 104 105 105 105 112 114 114 114 116 120 122 135 143 143 143 146 149 151 151 152 159 166 169 179 181 191 196 198 202 202 202 203 204 206 210 216 216 217 218 221 222
Table of Contents
IX
4.8.6 Duties of the Board of the Parent Company 4.8.7 Duty of Board Members to Supervise Outsourced Activities 4.8.8 Duties of Outside Managers 4.9 Constraints on the Exercise of Shareholders' Powers 4.9.1 Introduction 4.9.2 Constraints on Voting 4.9.3 Enforcement of the Constitution of the Company 4.9.4 Constraints on Other Acts 4.9.5 Fraud on the Minority 4.9.6 Croups 4.9.7 Sanctions Against Shareholders
224 225 226 226 226 228 233 233 234 234 237
SGermany 5.1 General Remarks 5.1.1Introduction 5.1.2 The Most Important Legal Forms of Business Organisation 5.1.3 Sources 5.1.4 The Extent of Party Autonomy in Rule-making 5.2 Basic Govemance Structure 5.2.1 Introduction 5.2.2 The General Meeting 5.2.3 The Two-tier System 5.2.4 The Management Board 5.2.5 The Supervisory Board 5.2.6 Prokurist 5.2.7 TheLocation of Management 5.3 The Importance of Statutory Rules..... 5.3.1 Introduction 5.3.2 Effect on Board Members and the Statutory Auditor 5.3.3 Effect on Sub-board Managers and Employees 5.3.4 Derogation from the Aktiengesetz 5.4 The General Meeting and Internal Management 5.4.1 Introduction 5.4.2 General Remarks on the Division of Powers 5.4.3 Procedure of Decision-making 5.4.4 Articles of Association 5.4.5 Decisions on Management Matters 5.4.6 The Appointment, Removal and Remuneration of Managers 5.5 Agreements and Internal Management 5.6 Disclosure, Remedies and Management Duties 5.6.1 Introduction 5.6.2 The Rights of Shareholders to Disclosure of Information 5.6.3 Shareholder Remedies 5.6.4 Renal Sanctions 5.6.5 The Duties of Management Bodies 5.6.6 The Liability and Management Duties of Sub-board Managers
239 239 239 242 243 246 250 250 250 252 253 261 271 271 272 272 273 276 276 277 277 278 279 284 287 296 305 306 306 307 316 336 339 348
X
Table of Contents 5.6.7 The Liability and Duties of Statutory Auditors 5.7TheRoleofIndividualShareholders 5.8 Shareholders and Dealings with Third Parties 5.8.1 Introduction 5.8.2 Representation of the Company by its Shareholders 5.8.3 Representation of the Company by Other Representatives 5.8.4 Shareholders as a Rule-maker 5.8.5 Statutory Provisions on the Representation of the Company 5.9 The Govemance of Croups in Germany 5.9.1 Introduction 5.9.2 Fiduciary Duties of Group Members 5.9.3 The GmbH 5.9.4 Co-determination in Groups 5.9.5 Konzemrecht 5.9.6 Shareholders' Rights to Disclosure of Information in Company Groups 5.9.7 Shareholder Remedies in Company Groups 5.10 Constraints on the Exercise of Shareholders' Powers 5.10.1 Introduction 5.10.2 DutyofLoyalty 5.10.3 The Right to Contest Resolutions of the General Meeting 5.10.4 Capped Voting, Restrictions on the Use of Proxy Votes 5.10.5 Liability
6 Comparison 6.1 General Remarks 6.2 Convergence 6.3 Fundamental differences 6.4 Conflicts between models 6.5 Basic Govemance Structure 6.5.1 Germany 6.5.2 The United Kingdom 6.5.3 Two-tier Boards and Board Structures 6.5.4 The Fundamental Problems of UK Company Law 6.5.5 Commission Recommendation on the Role of Directors 6.5.6 The SE Company 6.6 Shareholders and Internal Management 6.6.1 Articles of Association 6.6.2 Appointment of Managers 6.6.3 Decisions on Management Matters in General 6.6.4 Shareholder Remedies 6.6.5 Legal Costs 6.6.6 Management Duties 6.6.7 Stakeholders' Interests 6.6.8 Voting 6.7 Proximity and Objectivity in Monitoring
352 353 354 354 355 355 358 360 362 362 363 364 365 366 373 374 379 379 380 380 384 385 389 389 393 394 395 397 397 398 399 401 404 406 407 407 408 409 410 412 413 413 414 415
Table of Contents 6.7.1 Approximation of Laws 6.7.2 Geraiany 6.7.3 The United Kingdom 6.7.4 Authorities as Objective Monitors 6.8 Consensus 6.9 Which Monitoring Model is Better? 6.10 Constraints on the Exercise of Shareholders' Powers 6.11Groups 6.12 Government Policy on Enforcement 6.12.1 Private Enforcement 6.12.2 Self-enforcement 6.12.3 Self-govemance of the Business Organisation 6.12.4 Public Enforcement References
XI 416 416 418 419 419 421 423 423 426 426 426 427 428 431
1 Introduction
As suppliers of capital, shareholders are expected to want corporate efficiency, honesty, productivity, and profitability. It is in their interests to restrict expropriation by managers and waste. If all goes well, managers will effectively represent these basic shareholder interests. But this is not always the case. When things go wrong, shareholders must do something. Shareholders are normally assumed to have the power to demand change at companies whose shares they hold. But small investors are oflen apathetic, and many institutional investors prefer not to demand change. They either vote with management or do not vote at all.^ There are many reasons for shareholders to remain only passive investors. For example, it costs money to be active; the benefits of improved corporate govemance are spread among all shareholders; institutions that merely track indices are not strong activists; and asset-management firms that are part of a bank are especially at risk from conflicts of interest. Sometimes shareholders are activists. Shareholder activism tends to increase in direct proportion to ownership concentration. Shareholder activism is often regarded as a good thing. Both the Commission of the European Communities and the US Securities and Exchange Commission (SEC) would prefer institutional investors to become more active, and involvement of institutional investors in the govemance of companies is encouraged by mies or proposed rules on the disclosure of their voting records and policies.^ Shareholder activism is not always regarded as necessary. It is thought that most shareholders lack the expertise and incentive to decide how to vote.^ Eisenberg MA, Corporate Law and Social Norms, Colum L Rev 99 (1999) pp 1283: "Twenty or thirty years ago, the basic norm that govemed institutional participation in corporate govemance was a passivity norm, reflected in part in the Wall Street Rule: If you don't like management, seil; if you don't seil, support management. Under the passivity norm, taking sides against management - voting against management proposals, supporting shareholder proposals, selling into tender offers, and so forth - 'was not done'." In January 2003, the SEC adopted rules that require mutual flinds to disclose their proxy voting records. These rules enable fund shareholders to monitor their funds' involvement in the govemance activities of portfolio companies. See also Communication from the Commission, Modemising Company Law and Enhancing Corporate Govemance in the European Union - A Plan to Move Forward. See Easterbrook FH, Fischel DR, The Economic Stmcture of Corporate Law (1991) pp 83 and 88.
1 Introduction In any case, one of the main differences between shareholders and other stakeholders is that shareholders alone have voting rights. The most commonly stated reason is that shareholders are the residual claimants to the firm's income.'^ The purpose of this book. This book has three purposes. Firstly, it examines whether legal rules allow shareholders to act as a rule-maker in a public limitedliability Company. Can activist shareholders run a public limited-liability Company or decide how it should be run by its managers? Secondly, this book examines some aspects of comparative corporate govemance as a legal discipline. Which things should one compare when one compares the regulation of corporate govemance under the laws of one country with that of another country? Thirdly, this book is intended as a text for university or business school students who take a course in comparative corporate govemance. One of the objectives of this book therefore is to also offer an introduction to two major European corporate govemance Systems. The book focuses on UK law and German law. The importance ofUK law and German law. One of the first questions to ask is to what extent the govemance of companies has been harmonised by provisions of EU Company law and whether UK and German law have played any role in this. The laws of these two countries have been quite important in the EU. The origins of much of EU Company law can be traced to German and UK law. While EU Company law is the main source of convergence of Company laws in Europe, EU Company law has also been influenced by Member States' laws and will probably continue to do so in the future.^ The beginning of the European process of Company law harmonisation was marked particularly by the influence of German ideas. While French law had been used as a model for the Third and Sixth Directives (merger and Splitting up), German law had prevailed in all other matters. The German point of view used to be that stock exchange and banking harmonisation are clearly separable from Company law harmonisation. The influence of Anglo-American ideas has been dominant for quite a considerable time. The Anglo-American view is that the regulation of stock exchange activity and banking on the one hand and Company law on the other are strongly interdependent.^ The change from the German model to the Anglo-American one happens at the same time as the move towards a Single securities market in the EU, the growth of European securities markets and a change in how large European companies raise finance. The main principle of UK Company and securities markets laws is that of disclosure. In addition to EU legislation, this principle has played an important role in some of the key Company law judgements of the European Court of Justice Easterbrook FH, Fischel DR, The Economic Structure of Corporate Law (1991) pp 63 and 67; Easterbrook FH, Fischel DR, Voting in Corporate Law, J L & Econ 26 (1983) pp 395-396. See for example Lenaerts K, Interlocking Legal Orders in the European Union and Comparative Law, ICLQ 52 (2003) pp 873-906. Hopt KJ, Company Law in the European Union: Harmonization or Subsidiarity, 31 Saggi, conferenze e seminari del Centro di studi e ricerche di diritto comparato e straniero di Unidroit (1998) pp 6-8.
1 Introduction (ECJ) interpreting the EC Treaty.-^ Furthermore, the new regime of International Accounting Standards (lAS/IFRS) concems far more disclosure than before. German law and UK law can influence the Company laws of other Member States even in other ways. The Company laws of different Member States have been influenced not only by EU Company law but also by the Company laws of other Member States and other countries. For example, courts may look for guidance in the judgments of courts in other jurisdictions, the laws of one country can be used as a model in another by tradition, or there may be competition between Company law legislators.^ Even rules that do not directly originate from the State are influenced by rules applied in other countries; this is quite clear in the context of corporate govemance guidelines. German law is seemingly insignificant in the Company law books published in the UK, and vice versa. In the UK, it seems to be normal to discuss the German two-tier board stmcture, the role of employee representatives in the supervisory boards of large German companies and the relatively small number of hostile takeovers, but not much eise. In German Company law books, US law seems to be more important than UK law as a benchmark. Public limited-liability companies. Only listed companies, companies whose equity can be traded on a stock exchange, are discussed in this book. From a corporate govemance perspective, private limited companies, that is, companies whose equity cannot be traded on a stock exchange, are not less important. There are by far more private limited companies than listed companies in all member states of the European Union, and not all public-limited liability companies are listed on a stock exchange. Concentrated, not dispersed, ownership is the dominant worldwide pattem. At the moment, public limited-liabihty companies are nevertheless more interesting as regards future harmonisation and convergence of Company laws in Europe. There are economic and political pressures pushing European corporate govemance Systems towards convergence. But while the needs of European capital markets favour the convergence of national corporate govemance regimes that apply to public limited-liability companies, there are no such acute needs as regards private companies. Regulation andparty autonomy. The scope of party autonomy is one of the underlying questions in this book. The amount of statutory regulation and its compulsory nature vary, and so does the scope of party autonomy. Again there is a difference between Anglo-American laws and German law. There are roughly speaking two main models for the regulation of the govemance of public limited-liability companies.^ In both cases companies are regulated C-212/97 Centros [1999] ECR 1-1459; C-208/00 Überseering [2002] ECR 1-9919; C167/01 Inspire Art [2003] ECR 1-10155. See for example Centros, paragraph 36. See also Merkt H, Die Pluralisierung des europäischen Gesellschaftsrechts, RIW 1/2004 p 6. Hopt KJ, Company Law in the European Union: Harmonization or Subsidiarity, 31 Saggi, conferenze e seminari del Centro di studi e ricerche di diritto comparato e straniero di Unidroit (1998) pp 12-16. Merkt H, Untemehmenspublizität (2001) p 129; Merkt H, Zum Verhältnis von Kapitalmarktrecht und Gesellschaftsrecht in der Diskussion um die Corporate Govemance, AG
1 Introduction by a mix of, firstly, securities markets rules and traditional Company law rules and, secondly, mandatory rules and rules which are not compulsory. The Contents of this mix depend on the default form of raising finance chosen by the legislator. While this choice is probably influenced by path dependency and the economic climate, in particular by the prevailing ownership and control structure of firms and the way they raise finance,^^ the latter are also influenced by path dependency, in particular by existing and previous laws.^^ Regulation and business are in other words developed in tandem. According to the US model, it is assumed that companies raise equity in the capital markets. In order to protect investors and the functioning of effective capital markets, capital market transactions are regulated in the USA by federal laws that lay down mandatory rules.^^ These rules are complemented by Standards issued by securities exchanges. As regards traditional Company law matters, State Company laws set out only the most fundamental rules. Mandatory rules are necessary where disclosure requirements would not prevent expropriation by the management. Party autonomy can cover many traditional Company law matters. According to the Continental European model, companies are primarily assumed to raise finance privately. In order to protect minority shareholders and creditors, companies are to a large extent regulated by mandatory provisions of Company law.^^ The choice of one model instead of the other does not say anything about the quality of investor protection. For example, one of the fundamental purposes of Company law in Europe is to protect creditors. Law, not contract, protects creditors according to the European model. In the USA, the reverse is true. Creditors who wish to protect themselves from shareholders or managers behaving opportunistically must do so by contract.^"* Regardless of the model, the quality of investor protection depends on the quality of legal rules and the quality of acts done by market participants within this legal framework.
2003 p 127. See also Hopt KJ, Gestaltungsfreiheit im Gesellschaftsrecht in Europa Generalbericht. ZGR Sonderheft 13 (1998) pp 123-147. See Black BS, Kraakman R, A Self-enforcing Model of Corporate Law, Harv. L. Rev. 109 (1996) p 1913. Compare La Porta R, Löpez-de-Silanes F, Shleifer A, Corporate ownership around the World, J. Finance 54 (1999) pp 471-517. The authors found that, except in economies with very good shareholder protection, relatively few firms are widely held. See also Coffee JC, The Future as History: The Prospects for Global Convergence in Corporate Govemance and Its ImpHcations, Nw. U. Law Review 93 (1999) pp 644 and 661. 15 USC Section 77n (the Securities Act of 1933, Section 14); 15 USC Section 78cc(a) (the Securities Exchange Act of 1934, section 29(a)). See for example Hopt KJ, Gesellschaftsrecht im Wandel. In: Festschrift für Herbert Wiedemann (2002) pp 1015-1016. For the history of investor protection in Germany see also Cheffins BR, Mergers and Corporate Ownership Structure: The United States and Germany at the Tum of the 20th Century, AJCL 51 (2003) pp 499-500. Enriques L, Macey JR, Creditors Versus Capital Formation: The Case Against the European Legal Capital Rules, Comell L. Rev. 86 (2001) p 1173; Merkt H, Der Kapitalschutz in Europa - ein rocher de bronze? ZGR 2004 p 318.
1 Introduction Furthermore, dispersed share ownership is not necessarily caused by laws that deal with problems related to it. It is possible that these laws are caused by dispersed ownership. ^^ The choice of the US regulatory model thus does not necessarily lead to a US type of capitalism. Management. This book seeks to consider the relationship between shareholders and the "industrial bureaucrats" who actually run a public limited-liability Company. It is possible that the Company is run by managers who are recognised as organ members, managers who have broad authority over corporate affairs without being members of Company organs, or both. The Company may to some extent be run by its employees. The employees of the Company are not only affected by the govemance structure, they are representatives of the Company and part of the govemance structure themselves. How can shareholders teil these persons how to run the Company? There must be an examination of how each of the govemance mechanisms available to shareholders acts as a constraint at the relevant levels of the Company hierarchy, e.g. at the level of organ members, senior managers and employees. Shareholders, When discussing how a shareholder can run the Company or decide how it should be run, it is necessary to distinguish between active shareholders and passive shareholders. Active shareholders are actively involved in the business of the Company. Active shareholders will operate the business or at least be vocal, influence Company decisions and use their voting and other rights. Passive shareholders are merely investors. Passive shareholders rely on the rules that govem management and the fact that active shareholders can at least sometimes represent the interests of passive shareholders. Since the interests of active and passive shareholders can clash, there may be rules designed to prevent active shareholders from making gains at the expense of passive shareholders or from doing things that passive shareholders might not do, and rules setting out fiduciary-like duties owed by active shareholders to passive shareholders. Rules. It is also necessary to distinguish between legal rules that govem rulemaking and rules made by different rule-makers. Different rule-makers can make different kinds of rules ranging from enforceable legal rules to social norms.^^ The purpose of this book is to study legal rules that govem mle-making by shareholders and the type of mies that can be made by shareholders. For the purpose of this book it is sufficient to focus on those legal mies that affect management (that is, the intemal decision-making of the Company; the representation of the Company in its dealings with third parties; and the supervision of ^^ See Cheffins BR, Mergers and Corporate Ownership Structure: The United States and Germany at the Tum of the 20th Century, AJCL 51 (2003) pp 474, 489 and 499-501; Coffee JC, The Rise of Dispersed Ownership: The Roles of Law and the State in the Separation of Ownership and Control, Yale L J 111 (2001) p 44. ^^ See Eisenberg MA, Corporate Law and Social Norms, Colum L Rev 99 (1999) pp 1253-1255.
1 Introduction its activities) and rules that govem either the management procedure (for example the allocation of power in a Company) or the material constraints that apply to management generally (for example the duty of care and sanctions for the breach of rules). Many legal rules do not fall within these categories. For example, it is not necessary to focus on the vast amount of sector-specific legal rules protecting the workforce, the environment and so forth. These rules can be regarded as general constraints on the govemance of companies, and they do not govem the govemance as such (see Chap. 2.3.6 below). However, labour law rules do govem the govemance of companies where they provide that the workforce shall participate in management. About the structure of the book. The book consists of a brief introduction to comparative corporate govemance as a legal discipline, a chapter on the harmonisation of corporate govemance in the EU, two country surveys and an examination of major differences between these two jurisdictions. In the two country surveys, the legal regime and basic corporate govemance stmcture that apply to companies are described first. Next, four fundamental problem areas are examined: (a) shareholders acting as a mle-maker directly (for example, questions relating to articles of association and decisions on matters of management); (b) shareholders limiting the discretion of managers by monitoring them (in particular, questions relating to shareholders' rights to information, to the duties of members of the management of the Company, and to remedies available to shareholders for breach of duty or otherwise); (c) the Situation in a Company group; and (d) general constraints on shareholders' decision-making. The two country surveys are followed by a chapter where some aspects of UK and German law are compared. This chapter will not attempt to answer whether Germany's consensus-based model of capitalism is better than the market-oriented British model of capitalism. Rather, it deals with the legal framework of shareholder activism, in particular, the mle-making powers of shareholders or measures that are being used as an altemative to vesting these powers in the shareholders. About the results, One of the results of this study is that mies on govemance make it very difficult for shareholders to make managers mn a public limitedliability Company in a certain way. Where each shareholder has a small stake only, shareholders are relatively powerless.^'' However, a powerful shareholder can in real life influence management regardless of the formal mies. There are both similarities and differences between German and UK law. There is not only convergence of German law towards the UK model but also convergence of UK law towards the German model. As ownership diminishes in its ability to control management, the Organisation of the firm becomes more important; at the same time, extemal and intemal mies that govem Organisation become more important. This has happened in both countries. Mandatory mies play an important role in both countries. Company insiders and Outsiders know how a Company should be mn where the persons who actually ^"^ Easterbrook FH, Fischel DR, The Economic Structure of Corporate Law (1991) p 1.
1 Introduction manage the Company must comply with clear and enforceable extemal rules. These rules are clearer in Germany, and it is easier for shareholders to enforce them in a German Company. Shareholders benefit from mandatory rules provided that they are effectively enforced against wrongdoers or not breached in the first place. Effective monitoring would make it more difficult to breach mandatory rules. There is interaction between monitoring and compliance, but from the shareholders' perspective, the main control mechanism is voluntary compliance by managers due to cultural or other reasons. On the other hand, it is difficult for non-controlling shareholders to monitor management unless there are mandatory rules that can be enforced by them. The amount of mandatory rules, the right of minority shareholders to sue and their right to be indemnified by the Company against legal costs influence their chances to monitor management. ^^ There are differences between the UK and Germany in this respect. In practice, it is difficult for non-controlling shareholders to enforce mandatory rules even when these rules exist. If shareholders cannot enforce the rules that protect them, these rules will not be enforced unless: (a) there is an effective extemal or internal monitoring body that has an Obligation to punish management for breach of rules; or (b) managers comply with these rules voluntarily. It is nowadays clear that there are two-tier board structures in both countries with an "independent" body or "independent" persons acting as an internal monitoring body. Although public enforcement has been relatively unimportant in the past, it is becoming increasingly important in both countries. It is interesting that in Germany, the legislator has encouraged voluntary compliance by a relatively wide network of mechanisms that complement one another. Irene Lynch Fannon wrote recently: "The division of shareholders and Controllers has become the established reality in large publicly held firms. The consequent rise in managerial power and prerogative raises issues of accountability. How should the lack of management accountability to shareholders be remedied? Giving non-controlling shareholders more voice would not be sufficient in the light of the fact most shareholders do not want more voice and prefer the passive role."^^ "[T]he Operation of capital markets is a very incomplete reflection of the entire function of management."^^ "Since the division of ownership and control allows managers of the Company to attain a position of control and most shareholders prefer a passive role, mandatory Company law should support the idea of a monitoring organ - such as the German Aufsichtsrat without Mitbestimmung which acts independently from both shareholders and management."^^ "If there are meaningful mandatory rules and an independent monitoring organ acting under a ^^ See Ulmer P, Die Aktionärsklage als Instrument zur Kontrolle des Vorstands- und Aufsichtsratshandelns, ZHR 163 (1999) pp 306-307 on US law. ^^ See Lynch Fannon I, Working Within Two Kinds of Capitalism. Corporate Govemance and Employee Stakeholding: US and EC Perspectives (2003) p 19. ^^ Lynch Fannon I, op cit p 21. ^^ Lynch Fannon I, op cit p 19.
8
1 Introduction
duty to penalise any breach of these rules, the debate on the constituencies to whom management should be accountable could become less important."^^ One can only agree.^^ One of the findings of this book is that although there is some convergence towards the German model in the UK, the recent reforms of UK Company law do not go far enough. In a group of companies, both German and UK corporate govemance rules make it relatively easy for the parent Company to teil the managers of a subsidiary how to run the subsidiary. In Germany, there are effective statutory rules on the govemance of controlled companies and the duties of Controlling companies (Konzemrecht), but the choice of the GmbH as the main Company form for subsidiaries is in practice more important than the Konzemrecht.
^^ Lynch Fannon I, op cit p 21. ^^ See Roth GH, Die (Ohn-)Macht der Hauptversammlung. Oder: Unlautere Werbung für Aktienrecht, ZIP 2003 pp 376-377; Hommelhoff P, Die OECD-Principles on Corporate Govemance - ihre Chancen und Risiken aus dem Blickwinkel der deutschen corporate govemance-Bewegung, ZGR 2001 pp 242-243; Coffee JC, The Future as History: The Prospects for Global Convergence in Corporate Govemance and Its Implications, Nw U Law Rev 93 (1999) p 691: "dispersed ownership requires special legal mies if it is to persist". See also Säle HA, Delaware's good faith, Comell L Rev 89 (2004) pp 461-462; Rashkover BW, Reforming corporations through prosecution: perspectives from an SEC enforcement lawyer, Comell L Rev 89 (2004) pp 537-538.
2 Comparative Law and Corporate Governance
2.1 Introduction Corporate governance mechanisms are very complex, and national models of corporate governance are often described at a high level of generality. But a high level of generality here can mean that the study does not add anything new. What should comparative corporate governance be in order to add something new? To begin with, comparative corporate governance is understood here as a legal discipline. Comparative law has its own methods and traditions. The starting point is not with any particular definition of corporate governance. Corporate governance is a flexible term covering a vast number of questions related to Systems by which the activities of companies, Company representatives and Company stakeholders are directed and controlled.' For example, the OECD Principles of Corporate Governance 2004 State that: "Corporate governance involves a set of relationships between a Company's management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the Company are set, and the means of attaining those objectives and monitoring Performance are determined." The starting point should be the choice of a purpose, method and audience. (a) In any discipline, each serious study should have a purpose. (b) Depending on the purpose of the study, the writer will choose one of many alternative methods. These methods can sometimes lead to the same result and at other times to very different results. Sometimes the writer finds the comparative legal method appropriate. (c) In addition to a purpose and a method, the writer must choose an audience. The audience's prior knowledge of the matter (Vorverständnis), information needs and language determine how the study must be carried out.^ For example, a judge of the European Court of Justice (ECJ) might, in order to Interpret EU law in a way acceptable to his colleagues and most Member States (purpose), compare existing national laws of Member States (method). In this For questions relating to the regulation of corporate governance generally see Kraakman R, Davies P, Hansmann H, Hertig G, Hopt KJ, Kanda H, Rock EB (eds) The Anatomy of Corporate Law. A Comparative and Functional Approach (2004). See for example Coester M, Markesinis B, Liability of Financial Experts in German and American Law: An Exercise in Comparative Methodology, AJCL 51 (2003) p 277. The authors compared German and American law for American readers.
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case, he will try to convince highly knowledgeable jurists specialised in EU law (audience).^ Let US assume that the writer chooses the comparative legal method. What are the characteristics of comparative corporate govemance as a legal discipline?
2.2 The Comparative Legal Method in General Comparative law is about comparing things. It is therefore not sufficient to describe just one national model of corporate govemance. A comparative lawyer must choose at least two jurisdictions. An article on, say, co-determination in Germany and nothing eise is not a comparative study. A State. Comparative law is always linked to one or more states. Each Jurisdiction has its own mies. As different jurisdictions have different mies, it is not meaningful to write about corporate govemance without choosing the laws of one or several jurisdictions first. There is no such thing as universally applicable legal mies on corporate govemance common to all states, and corporate govemance ideas developed in one State do not necessarily work in another. Choice of jurisdictions. The purpose of the comparative study will determine the choice of jurisdictions. Sometimes it is meaningful to choose jurisdictions closely related to one another, at other times jurisdictions that belong to markedly different cultures. It is technically possible to compare any two things with each other, but the work of the comparative lawyer is not meaningful unless the choice of jurisdictions is meaningful. For example, the extent of differences between the laws of the USA and Finland can make the choice of US law unhelpful if the purpose of the study is to help interpret existing Finnish law; this purpose would often be better served by the choice of German law or Swedish law or the law of any other Member State of the EU. The purpose of the study also determines whether the comparative lawyer should concentrate on the differences or similarities between different legal Systems."* For example, an advocate may sometimes need to concentrate on differences between Systems within the same cultural sphere in order to win his case; an academic may want to concentrate on similarities between culturally remote Systems in Order to find characteristics common to many Systems; or a judge of the ECJ may need to concentrate on both in order to find a Solution which best suits
See for example Lenaerts K, Interlocking Legal Orders in the European Union and Comparative Law, ICLQ 52 (2003) p 873: "For the Court of Justice [of the European Communities] and the [Court of First Instance], it is one method amongst other methods of interpretation of the law (such as literal, exegetic, historical, systematic interpretation) and it constitutes a tool for establishing the law." The writer refers to Fennelly N, Legal interpretation at the European Court of Justice, Fordham Int'l LJ (1997) pp 656-679. Compare Husa J, Farewell to Functionalism or Methodological Tolerance? RabelsZ 67 (2003)p 425.
2.2 The Comparative Legal Method in General
11
the objectives of the Community and is acceptable for the different national legal Orders responsible for implementing Community law.^ The functional method, The main method used by modern comparative law is the functional method.^ It is more useflil in micro-comparison than in macrocomparison (the comparison of legal families, mentalities or legal cultures)7 The functional method is based on the idea that it does not make any sense to compare things unless they are comparable. The functional method is a value-neutral technique, but a comparative lawyer neither can be nor has to be value-neutral. The comparative lawyer is not valueneutral when deciding why he should write about something in the first place, when defining the topic of the study and choosing the purpose of the study and the point he wants to make. The fact that the functional method is a value-neutral technique means the following: (a) When using the functional method, it is first assumed that societies try to deal with perceived social needs in many ways, one of which is to address them by legal rules. In comparative law, it is necessary to identify both a social need that can be solved by legal means and the legal rules applied in different jurisdictions to deal with this need. The question will normally be subdivided into separate subquestions, because the main question is normally far too general in light of the purpose of the study and the information needs of the audience. (b) The comparative lawyer finds out what the Solution would be in each Jurisdiction according to the views of persons trained in law in the Jurisdiction in question. The comparative lawyer then tries to give a sufficiently accurate view - one could call it a "true and fair view" - of the Solution in each Jurisdiction to the extent necessary in light of the purpose of the study and the information needs of the audience. Different jurisdictions sometimes deal with the perceived social need in similar ways and at other times in very different ways. (c) An important task is to identify these similarities and differences. To what extent the comparative lawyer is expected to identify them and to explain why they exist depends again on the purpose of the study. For example, a judge of the ECJ would, due to the teleology of the comparative method used by him,^ probably not need very detailed information on the causes of similarities and differences. In comparative studies with an academic Status, the comparative lawyer is often expected by the audience (that is, by his colleagues and law professors) to provide an explanation of similarities and differences. It is probably impossible to find exact causal explanations for the existence of individual rules. However, this does not exclude efforts to give rational explaLenaerts K, Interlocking Legal Orders in the European Union and Comparative Law, ICLQ 52 (2003) pp 879, 884-887, 893. See generally Zweigert K, Kötz H, Einführung in die Rechtsvergleichung (1996) § 3 II. See Husa J, Farewell to FunctionaHsm or Methodological Tolerance? RabelsZ 67 (2003) pp 421-422. For example, the functional method as it is known in comparative law would not be the optimal method for a work like Kraakman R, Davies P, Hansmann H, Hertig G, Hopt KJ, Kanda H, Rock EB (eds) The Anatomy of Corporate Law. A Comparative and Functional Approach (2004). See for example Lenaerts K, Interlocking Legal Orders in the European Union and Comparative Law, ICLQ 52 (2003) p 879.
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nations for similarities and differences.^ The similarities and differences can be caused by many reasons and the comparative lawyer must have an open mind. For example, a legal System will probably choose the rule that, among the various alternatives, appears to be the most acceptable to the rule-maker at the time, but this rule does not necessarily have to be efficient or fair or provide the greatest net social benefit - even communist countries and brutal dictatorships have laws. It is also clear that law is not exclusively concemed with economic factors; some goals are thought worthy of public pursuit although they are not necessarily cost effective. One of the reasons why important differences persist is path dependency (laws and corporate structures that an economy has at any point in time depend in part on those that it had at earlier times).^^ Harmonisation, legal transplants (copying the rule from another legal System),^^ and economic factors belong to the reasons that promote convergence. (d) What the comparative lawyer does at the end is teil the reader what the result of the study is in Hght of its purpose. For example, will the Solutions adopted in Germany or the UK help draft a new Statute in Sweden, and if so, how? Can the Solutions adopted in continental Europe help interpret existing British law, and if so, how? Can govemance principles adopted by institutional investors in the USA be enforced in Germany with different equity markets, legal norms, business culture and traditions?^^ The functional method thus means the comparison of how a social need has been dealt with by legal means. A comparative lawyer does not compare individual rules as such. Neither does he compare legal concepts; legal terms like the "board" or "good faith" are not comparable because they can mean basically anything and different things in different jurisdictions. For example, the comparative lawyer should not compare rules that apply to whatever is meant by the "board" in different jurisdictions, because "boards" can mean different things in different countries and the rules that apply to them do not necessarily share the same function.^^ The concept "board of a UK Company" is not directly comparable with the concept "supervisory board (Aufsichtsrat) of a German AG", but the rules of UK law and the rules of German law are comparable to the extent that they deal with the same social need. Comparability and complementarity. The functional method is about comparing reasonably comparable things. Much depends on what is compared. Which See Husa J, Farewell to Functionalism or Methodological Tolerance? RabelsZ 67 (2003) p433. See especially Bebchuk LA, Roe M, A Theory of Path Dependence in Corporate Ownership and Govemance, Stan L Rev 52 (1999) p 127. See especially Watson A, Legal Transplants: An Approach to Comparative Law, Second Edition (1992). See Andre TJ, Cultural Hegemony: The Exportation of Anglo-Saxon Corporate Govemance Ideologies to Germany, Tul L Rev 73 (1998) pp 69-171. See for example Hopt KJ, The German Two-Tier Board: Experience, Theories, Reforms. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) Comparative Corporate Govemance - The State of the Art and Emerging Research (1998) pp 234-250; Davies PL, Stmktur der Untemehmensfuhmng in Großbritannien und Deutschland: Konvergenz oder fortbestehende Divergenz? ZGR 2001 pp 270 and 283.
2.2 The Comparative Legal Method in General
13
rules deal with the same social need? Complementarity can sometimes be a helpful concept, because two distinct phenomena can be interdependent in different ways depending on the context. Two choice variables are complements when doing (more of) one of them increases the attractiveness of doing (more of) the other. In contrast, two choice variables are Substitutes if doing (more of) one reduces the attractiveness of doing (more of) the other. For example, direct monitoring of employees' behaviour and the use of performance-based incentive pay may be Substitutes.^"* Now, lawmakers like legislators and judges often try to do fairly reasonable things. As the impact of adopting one complement is oflen increased by adopting other complements as well, lawmakers often adopt rules that are complements. There can be a rieh web of complementary relationships between rules. When existing rules are complements, each of them may or may not be attractive on their own, but together they are more powerful. A comparative lawyer should thus compare these wholes of complementary ways to deal with a given social need by legal means in different jurisdictions. For example, a German rule providing for the board membership of employee representatives may not seem attractive when judged separately, but this rule should not be judged without taking into account complements such as the two-tier board structure, the existence of a large body of mandatory rules, and so forth. The soundness of a certain rule can thus be ensured by a Cluster of rules and practices, which are not always immediately apparent to a foreign lawyer. ^^ The interdependence between different rules and other phenomena can partly help to explain the existence of a certain rule. There can be a causal relationship between the simultaneous existence of two complements, and between the existence of one Substitute but not the other. Law. Comparative law is about the study of law. A comparative lawyer is basically not required to think like an economist or a sociologist. For example, a comparative lawyer would not study how companies are run in real life; companies are run and organised in an endless number of ways.^^ The comparative lawyer could though study how legal rules enable the Company to be run and how the running of the Company is constrained by them. Furthermore, it is not the task of the comparative lawyer to study different socio-economic or politically inspired views on which stakeholders should have a say in the internal decision-making of companies. Instead, the comparative lawyer might study how the internal decisionmaking of companies is regulated and controlled in some jurisdictions in order to find out which stakeholders should, in light of the findings of this comparative le^"^ These definitions cited from Roberts J, The Modem Firm (2004) pp 34-35; see also pp 46-51 and 232. For the use of complementarity as a tool in comparative law see Coffee JC, The Future as History: The Prospects for Global Convergence in Corporate Govemance and its Implications, Nw U L Rev 93 (1999) pp 659-660; Chodosh HE, Comparing Comparisons: In Search of Methodology, Iowa L Rev 84 (1999) pp 1121-1127. ^^ See Coester M, Markesinis B, Liability of Financial Experts in German and American Law: An Exercise in Comparative Methodology, AJCL 51 (2003) p 309. ^^ See for example Easterbrook FH, Fischel DR, The Economic Structure of Corporate Law (1991) pp 13-14; Roberts J, The Modem Firm (2004) pp 19-20.
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gal study, have a say in the internal decision-making of companies in another Jurisdiction. The comparative lawyer's views on the contents of foreign law are based on things that lawyers in that foreign country find authoritative or otherwise relevant when answering a similar question. When studying foreign law the comparative lawyer reads texts like Statutes, judgments and professional literature because foreign lawyers usually find them authoritative. In addition to formal rules (laid down by Statute, developed by the courts, included in Standard contracts and so forth) found in authoritative texts he should even take into account other things that would be relevant in the opinion of foreign lawyers. ^^ What is relevant varies depending on the Jurisdiction and the question. It is generally accepted that law should not be viewed separately fi'om the legal culture in which it exists. It is also useful to study the question from different perspectives (preparatory works, judgments, the views of practitioners) and read materials written at different levels of generality (scholarly articles, Student textbooks, comparative studies). The comparative lawyer thus studies legal rules or related rules instead of merely social rules. Social rules, among other things, may nevertheless help explain the contents of legal rules. The functional method can require the study of many fields of law. The potential diversity of disciplines poses problems for would-be comparative lawyers. In addition to a ränge of expertise spanning several jurisdictions, the comparative lawyer may need a ränge of expertise spanning many fields of law, so that a "true and fair view" can be synthesised. The comparative lawyer does not assume that all lawyers understand existing law in the same way in the relevant Jurisdiction. It is possible that the content of existing law is unclear. It is possible that the sources used by the comparative lawyer show that the contents of law are understood in different ways by different groups of lawyers; it is not unusual in many countries that courts, practising lawyers and academics think differently.^^ The comparative lawyer should describe these different views to the extent that it is necessary in order to give a sufficiently "true and fair view" to his chosen audience. The audience. The work of a comparative lawyer is directed to the audience chosen by him. The comparative lawyer will try to do all this in a way that is meaningful to this audience.^^ Sometimes the readers know one language and not the other. Sometimes the readers know a lot about the field of law and the different jurisdictions in question, sometimes not. Sometimes the readers can take in information in very abstract form, whereas sometimes they lack this ability. Sometimes the readers, for example a professor supervising the work of a doctoral ^^ See generally Zweigert K, Kötz H, Einfiihrung in die Rechtsvergleichung (1996) § 3 III. Actually, the same should be said of domestic law when the comparative lawyer writes about the law of his own country. ^^ See for example Coester M, Markesinis B, Liabihty of Financial Experts in German and American Law: An Exercise in Comparative Methodology, AJCL 51 (2003) pp 301 and 306. ^^ See for example Cheffins BR, Using Theory to Study Law: A Company Law Perspective, CLJ 58(1) (1999) pp 199-200.
2.3 Comparative Corporate Govemance in Particular
15
Student, expect the results to be presented in a certain form, at other times the comparative lawyer may be free to choose the way he presents his ideas. While the identity of readers and their Vorverständnis play a key role in comparative law, the person of the comparative lawyer and his prior knowledge of the matter are just factors that make research in practice easier or more difficult for him; it is as a rule more difficult to understand foreign law than domestic law and more difficult to write in a foreign language than in one's own language. For example, a Continental European lawyer does not think like a common law lawyer, but a comparative Continental European lawyer should try to understand how common law lawyers think. A true and fair view. Comparative law can only be pragmatic. The way the comparative lawyer presents the results of the study is dependent on the purpose of the study and the audience (that is, the prior knowledge and expectations of the intended readers). These two things will also determine what the comparative lawyer must do in order to be able to give a sufficiently accurate view - a "true and fair view" - of the relevant jurisdictions. Single authorship. These requirements seem at first to demand a multi-author work. But in a single author work, the simultaneous analysis of different legal Systems helps the author to look at the problem from unfamiliar perspectives, to ask new questions simultaneously relevant to many different jurisdictions and to develop a unified synthesis. These considerations favour single authorship, despite all the difficulties that it poses.^^
2.3 Comparative Corporate Governance in Particular 2.3.1 Introduction Now, let US think about the govemance of limited-liability companies. All comparative lawyers should, of course, use the comparative legal method. In addition, a comparative lawyer should take into account the special characteristics of the comparative legal study of corporate govemance. A comparative lawyer should at least take into account the following four things (as will be explained below): the special aspects relating to the choice of a social need in comparative corporate govemance; the distinction between mies on govemance and mies on constraints on govemance; the effects of the legal nature of companies; and the effects of the Organisation of firms. Before discussing any other special aspects of the comparative legal study of corporate govemance, it is necessary to deal with, firstly, the relevance of the general objectives of the regulation of corporate govemance and, secondly, the choice of a social need in comparative corporate govemance. ^^ For example, most surveys published in Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) Comparative Corporate Govemance - The State of the Art and Emerging Research (1998) can hardly be described as comparative.
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2.3.2 The Objectives of Corporate Governance As Said above, corporate govemance can mean many things. From the perspective of comparative law, the definition of corporate govemance is basically irrelevant. With the functional method being a value-neutral technique, it is probably unsurprising that comparative law is neutral as regards the objectives of mies relating to corporate govemance. For example, it is wrong for a comparative lawyer to blindly accept the view that the principal goal of mies related to corporate govemance is, say, to restrict the expropriation of investors by Company insiders and to maximise profits for shareholders; this could tum out to be the principal goal of some mies in a certain Jurisdiction but it does not have to be so and the comparative lawyer will know this only after studying the Jurisdiction and mies in question. The same can be said of the view that the goal of corporate govemance mies is the pursuit of overall social efficiency. Existing law does not always serve that goal.^^ This does not prevent the comparative lawyer from evaluating the Solutions adopted in different jurisdictions by analysing how well certain goals chosen by him are met. The comparative lawyer may have to do this because of the purpose of the study.
2.3.3 The Choice of a Social Need What is relevant is the choice of a social need. There is a vast amount of different social needs.22 For example, it is clear that comparative corporate govemance as a legal discipline is more than the study of different ways in which countries allocate power among participants in a Corporation. Which kinds of social needs are we dealing with then in the context of the govemance of companies? To begin with, at least some social needs arise out of the fact that a Company is an artificial person. The following basic questions are likely to be discussed in most comparative corporate govemance studies. To whom do assets linked to the Company belong? Some form of "asset partitioning" is necessary. It is necessary to designate a separate pool of assets that are associated with the Company, and that are distinct from the personal assets of the Company's owners and managers. The second component of asset partitioning is
Compare Hansmann H, Kraakman R, What is Corporate Law? In: Kraakman R, Davies P, Hansmann H, Hertig G, Hopt KJ, Kanda H, Rock EB (eds) op cit p 19: "To say that the pursuit of aggregate social welfare is the appropriate goal of corporate law is not to say, of course, that the law always serves that goal." See also Leyens PC, Deutscher Aufsichtsrat und U.S.-Board: ein- oder zweistufiges Verwaltungssystem? Zum Stand der rechtsvergleichenden Corporate GovemanceDebatte, RabelsZ 67 (2003) p 60.
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the assignment of rights in this distinct pool of assets.^^ As a rule, the assets of a limited-liability Company do not belong to shareholders; only shares do. Who is to be regarded as acting as or on behalf of the Company? A Company cannot act on its own in the physical sense. Somebody must represent it by taking care of its internal decision-making, somebody must represent it in its dealings with Company Outsiders (such as customers, suppliers and persons providing finance) and Company insiders (such as organ members, directors, managers, employees and shareholders) and somebody must represent it by taking care of its internal supervision and control. A Company must have an Organisation if it is to carry out business. "The decisive power in modern industrial society is exercised not by capital but by Organisation, not by the capitalist but by the industrial bureaucrat."24 How should the persons acting as or on behalf of the Company act? It may be necessary to make these persons act in a certain way. For example, in some jurisdictions it may be necessary to prevent internal abuse and waste (abuse and waste in relation to the Company itself), derivative abuse and waste (internal abuse and waste which affect stakeholders and society as a whole), stakeholder abuse and waste (abuse and waste in relation to the various stakeholders), and general abuse and waste (abuse and waste in relation to the society as a whole). One can assume that there are rules telling these persons what to do and what not to do. In addition to clear rules or general Standards, one of the legislative strategies dealing with this Problem is to set out in whose interests these persons must act. For example, depending on the Jurisdiction, they could be expected to act: in an economically effective way; or for the benefit of the Company; or for the benefit of shareholders; or for the benefit of the workforce; or for the benefit of the society as a whole; or for the benefit of a certain political movement and so forth. How should the various stakeholders act? It may also be necessary to make stakeholders act in a certain way. For example, in some jurisdictions the personal rights of shareholders can be affected by rules protecting the Company or other stakeholders (the use of voting rights is subject to rules protecting minority shareholders, the sale of shares is subject to rules protecting the workforce or competition and so forth); the personal rights of creditors can be affected by insolvency rules protecting the Company, its workforce and other creditors; and the personal rights of employees can be affected by rules protecting the interests of the employer. How are these persons and stakeholders motivated? The self-interest of all these parties may not always lead them to act in ways that the rule-maker, Organisation or society in general would want. For example, investors do not fulfil their role in the Company if they either have not invested in the first place or have already exited the Company; investors usually invest in companies that generate value for them. From an Organisation design perspective, the motivation problem ^^ See Hansmann H, Kraakman R, The Essential Role of Organizational Law, Yale L J 110 (2000) pp 392-393; Fleischer H, Gesetz und Vertrag als alternative Problemlösungsmodelle im Gesellschaftsrecht, ZHR 168 (2004) p 679. 2^ Galbraith JK, The New Industrial State, Third Edition (1978) p xiv.
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is to shape the Organisation to bring closer alignment of interests between the Organisation and its members and thereby increase the efficiency of the choices they make.^^ Corporate govemance scholarship usually deals with agency problems at the top level of Company hierarchy.^^ However, from the perspective of a comparative lawyer, the main questions usually relate to the regulation of monetary retums, the regulation of duties, and the enforcement of sanctions. At another level, motivation is affected by rules that are necessary because of the Organisation of the firm (that is, by rules on the allocation of power, the allocation of risk, and the distribution of information; see Chap. 2.3.7 below).
2.3.4 The Choice of a Social Need and the Amount of Rules But there is a vast amount of rules goveming the questions listed above. Every Jurisdiction addresses these problems in a variety of contexts.^^ Some rules can be general and not limited to the activities of companies or persons acting as or on behalf of companies. Not only are there rules on agency and employment, there are even rules protecting the environment, the physical integrity of humans, and so forth.^^ Rules can also be special and intended to deal with problems arising out of the activities of companies. These special rules can be based on external sources. Relevant extemal sources may include, among others, mandatory legislation, dispositive legislation and legislation providing for recommendations. Extemal sources may also include industry self-regulation and generally applicable practices. Industry self-regulation - for example by corporate govemance codes and accounting Standards - plays an important role in the modern regulation of companies. The sources of extemal mies can be national or intemational. For example, there are intemational mies based on EU Company and securities markets law and intemational accounting Standards. There are also several intemational recom-
Roberts J, The Modem Firm (2004) pp 118-119. Compare Hansmann H, Kraakman R, Agency problems and Legal Strategies. In: Kraakman R, Davies P, Hansmann H, Hertig G, Hopt KJ, Kanda H, Rock EB (eds) op cit pp 26-27. See for example La Porta R, Löpez-de-Silanes F, Shleifer A, Vishny RW, Investor Protection and Corporate Govemance, J Finan Econ 58 (2000) pp 5-7; Cheffins BR, Law as Bedrock: The Foundations of an Economy Dominated by Widely Held Public Companies, OJLS 23 (2003) pp 2-3. Economic reality requires Company representatives to take into account general constraints such as the interests of consumers of the Company's products, the activities of competitors, the pressures of intemational trade, the interests of the workforce, and trade Union negotiations. Since such general constraints are not legal rules, they do not show how different jurisdictions solve problems by legal means, but they can help explain why a certain Jurisdiction has chosen a certain mle.
2.3 Comparative Corporate Govemance in Particular
19
mendations for multinational enterprises,^^ such as the OECD Guidelines for Multinational Enterprises. These Guidelines are recommendations that provide principles and Standards of good practice. Like the OECD, the ILO has adopted several Standards for multinational enterprises. In addition to extemal sources, special rules can be based on internal sources such as articles of association, internal guidelines and ad-hoc decisions. One can therefore distinguish between internal control mechanisms (internal corporate govemance) and extemal control mechanisms (extemal corporate govemance). These extemal and intemal mies do not necessarily have to be linked directly to action on the part of the State. Even non-state institutions, Company bodies and individuals such as shareholders can perform the function of a mle-maker. In any case, the possibihty that they can act as a mle-maker is linked at least indirectly to action on the part of the State because the State may choose the scope and binding nature of both legislation and matters that may be regulated by non-state institutions or the parties themselves. In comparative corporate govemance, it is basically wrong to focus on special mies intended to deal with problems arising out of the activities of companies. This is so because a comparative lawyer does not compare mies as such but how a social need has been addressed by legal means. But what should the comparative lawyer focus on in corporate govemance in light of the fact that there is a vast amount of mies affecting corporate govemance at least indirectly?
2.3.5 The Choice of a Narrow Social Need For many reasons, a comparative lawyer should choose a very narrow social need for the comparative legal study of corporate govemance.^^ Taking into account the amount of mies goveming companies, it is not meaningful for the comparative lawyer to choose a very broad social need.^' (a) For example, the comparative lawyer should not choose the regulation of "matters related to the agency theory and the Separation of corporate management and ownership". This is because the management is normally expected to comply with most mies that govem the activities of companies generally and it would in practice be impossible for the comparative lawyer to study all such mies or even the most important ones. (b) For the same reason, the comparative lawyer should not choose the need to restrict "expropriation". According to one view, the principal goal of corporate govemance is to restrict expropriation by Company insiders (such as managers and Controlling shareholders) of the Company, Investors (such ^^ See Gordon K, Miyake M, Deciphering Codes of Corporate Conduct: A Review of their Contents. OECD, Working Papers on International Investment 1999/2. Last revised: March 2000. ^^ See also Coester M, Markesinis B, Liability of Financial Experts in German and American Law: An Exercise in Comparative Methodology, AJCL 51 (2003) p 309. ^^ For a different view see Davies PL, Hertig G, Hopt KJ, Beyond the Anatomy. In: Kraakman R, Davies P, Hansmann H, Hertig G, Hopt KJ, Kanda H, Rock EB (eds) op cit pp 222-226 where the authors in effect suggest very wide research topics.
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as shareholders, minority shareholders and credit institutions) or creditors (such as suppliers and other contract parties).^^ However, the choice of this social need would make the comparative study impossible to be carried out. (c) It has been argued that Company law addresses three basic agency problems: the opportunism of managers vis-a-vis shareholders; the opportunism of Controlling shareholders visa-vis minority shareholders; and the opportunism of shareholders as a dass vis-avis other corporate constituencies, such as corporate creditors and employees. At least the first of these three basic agency problems looks too wide for a meaningful comparative legal study, (d) It is also üitile for the comparative lawyer to compare "background rules that supply Solutions to the unforeseen contingencies facing investors".^^ In comparative corporate govemance, the comparative lawyer should preferably define the relevant social need in a narrow way in order to be able to: minimise the relevance of rules which govem business activities in general; and focus on rules which are intended to deal with problems relating to companies in particular.^"^ This does not mean that the comparative lawyer should focus only on rules that belong to the latter group. (a) Companies are part of society. It is necessary to take into account rules that protect stakeholders outside the traditional field of Company law.^^ (b) Even traditional Company law matters may be regulated by rules which do not necessarily belong only to Company law; they can be regulated for example by the general principles of the law of agency, the law of obligations, and torts law. A related matter is that the comparative lawyer should not define the social need unless he already knows enough of the issues that may become relevant during the course of the study. This usually requires some prior research. For example, the comparative lawyer could find out that to focus on "extemal" control mechanisms only, "intemal-vertical" control mechanisms only, or "intemalhorizontal" control mechanisms only, would not give a true and fair view of law, because these control mechanisms can partly serve the same function and over32
34
La Porta R, Löpez-de-Silanes F, Shleifer A, Vishny RW, Investor Protection and Corporate Govemance, J Finan Econ 58 (2000) p 4. Compare Boot AWA, Macey JR, The Role of Objectivity, Proximity and Adaptability in Corporate Govemance, Comell L Rev 89 (2004) p 364. Compare La Porta R, Löpez-de-Silanes F, Shleifer A, Vishny RW, Law and Finance, 106 J Polit Economy (1998) p 1120: "We look only at laws pertaining to investor protection, and specifically only at Company and bankruptcy / reorganization laws ... There are several conspicuous omissions from the data set. First, this paper says little about merger and takeover rules, except indirectly by looking at voting mechanisms ... Second, this paper also says little about disclosure rules ... Third, in this paper we do not use any information from regulations imposed by security exchanges ... Finally, a potentially important set of rules that we do not deal with here is banking and fmancial institution regulations ..." Such a study would not give a true and fair view of law. For a narrower view see Hansmann H, Kraakman R, What is Corporate Law? In: Kraakman R, Davies P, Hansmann H, Hertig G, Hopt KJ, Kanda H, Rock EB (eds) op cit p 17. The authors focus on traditional corporate law.
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lap.^^ And the comparative lawyer should of course focus on the flinction, not the rules. 2.3.6 Rules on Governance and Rules on Constraints on Govemance In addition to choosing a narrow social need, the comparative lawyer could distinguish between rules that act as constraints on the govemance of companies and rules on the govemance of companies. Most sector-specific mies outside the fields of Company law and related areas, for example environmental legislation and mies protecting workers, are mere constraints that do not affect the govemance of companies as such. This distinction can be illustrated by mies on co-determination and worker participation. These mies can either be constraints on govemance or mies on govemance or both. In order to be regarded as rules on govemance, it is not enough that the mies on co-determination and worker participation affect the procedure of the Company's decision-making in some way. Examples of rules on governance. Rules on co-determination and worker participation affect the govemance of companies directiy and should be regarded as mies on the govemance of companies instead of mere constraints on govemance where they set out that the workforce should participate in the management of the Company. This is the case when, under these mies, the representatives of the workforce represent the Company by taking care of its intemal decision-making, or the representation of the Company in its dealings with Outsiders, or the supervision of its activities. For example, mies which set out that a number of representatives of the workforce must be appointed to the organs which take care of the Company's intemal decision-making (especially mies on worker participation on the board of directors^^) belong to this category. The same can be said of mies according to which the company's intemal decision-making is subject to the consent of the workforce or a neutral organ or a third party that protects the interests of the workforce; this may be the case, for example, where a trade union is empowered to deCompare Cunningham LA, Commonalities and Prescriptions in the Vertical Dimension of Global Corporate Govemance, Comell L Rev 84 (1999) p 1134: "Corporate govemance mechanisms can be divided into the following three categories: (1) intemal-vertical, (2) intemal-horizontal, and (3) extemal. Internal govemance mechanisms are classified as vertical when they address the relationship between those in control of the Corporation and all other constituents (including shareholders, workers, lenders, and communities). Intemal govemance mechanisms are considered horizontal when they directly regulate the relationships among these various constituencies inter se. Extemal govemance mechanisms are those mies and regulations imposed upon the corporate entity to address concems beyond the direct interests of the Corporation. They include mies about competition and antitmst, national trade, and public health and safety." See for example Lynch Fannon I, Working Within Two Kinds of Capitalism. Corporate Govemance and Employee Stakeholding: US and EC Perspectives (2003) p 48-49. See also Davies PL, Stmktur der Untemehmensfühmng in Großbritannien und Deutschland: Konvergenz oder fortbestehende Divergenz? ZGR 2001 p 289.
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cide whom the Company may employ. Even the duty to negotiate with the workforce can belong to this category because increased disclosure and observability can lead to better monitoring and increase the management's motivation to act in the desired way. Example of constraints on governance. Rules on co-determination and worker participation could be regarded as mere constraints on the govemance of companies to the extent that they set forth that an employer is legally obUged to consider the effect of its decisions on the workforce or prohibited from taking certain decisions which are contrary to the interests of the workforce. Borderline cases, Sometimes it is not easy to draw the line between these two categories. Rules that apply to certain activities generally can affect the govemance of companies directly. They should then be regarded as mies on the govemance of the Company. For example, environmental laws could in principle affect the allocation of power in the Company by providing for corporate environmental management Systems or lay down the duties of the persons responsible for environmental management and provide for the civil or criminal liability of these persons (statutory board members or other managers). However, mies on the environmental liability of companies, the criminal liability for corporations or the extent of the liability of corporations for loss sustained by third parties can be classified as mere constraints on govemance.
2.3.7 The Legal Nature of Companies and the Organisation of Firms Two fundamental things should influence comparative corporate govemance: The effect of the legal nature of companies and the Organisation of firms. The effect of the legal nature of companies has been discussed above. A legal fiction, a Company cannot do anything on its own but must be represented by others. This leads to some general needs that will be taken into account in most comparative corporate govemance studies. In addition, a Company needs an Organisation. A comparative lawyer should focus on the stmcture and hierarchy of the Organisation of firms. The Organisation of a modem firm is flexible.^^ It is not defined by ownership. There is interaction between Organisation and strategy; strategy and Organisation should in practice be developed in tandem.^^ Not necessarily permanent, the organisational stmctures may exist on a project-by-project basis. What is characteristic of the Organisation of a modem firm is that: relatively small subunits are created within the Organisation; the managers of these subunits are given substantial decision rights; and outsourcing and networking are important."^^ As will be seen below, the legal nature of companies as well as the stmcture and hierarchy of the Organisation of firms give rise to phenomena such as the ^^ See also Collins H, Regulating the Employment Relation for Competitiveness, ILJ 30 (2001) p 20. 39 See Roberts J, The Modem Firm (2004) pp 281-282. ^0 See Roberts J, The Modem Firm (2004) pp 2, 180,182-190 and 231-232.
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Penetration and dilution of rules. In addition, there are a number of social needs related to Organization. Hierarchy and the Location of Management in a Single Independent Company The traditional approach to corporate govemance is based on a single-company model. It is usual for Company law writers to focus on the relationship between shareholders and those in control of the Company. According to this view, a limited-liability Company is owned by its shareholders and its business activities are controlled by members of a board of some kind and/or Controlling shareholders. This approach fails to recognise the importance of Organisation."*^ Most decisions taken on behalf of the Company are clearly not taken by its shareholders or members of any statutory board but by professional managers and employees at relatively low levels of hierarchy. The same applies to most transactions carried out on behalf of the Company. It would indeed be cumbersome if a large number of issues had to be passed through several levels of management before a decision could be taken; a Company would not function effectively if minor issues had to be referred to senior management. The Company usually has divisional structures, and different management flinctions are organised along divisional lines. Divisionalisation involves structuring the Organisation on the basis of subunits defined by product, customers or geography.42 On the other hand, the management structure is not necessarily linear. In order to ensure that its Operations are well inter-coordinated, the Company may adopt a matrix management System whereby staff are accountable both to managers in business divisions and to those within their own particular specialism. The result can be a complex structure within which lines of decision-making and accountability are unclear."*^ For example, the Finnish telecommunications giant Nokia Corporation consisted of four vertical business groups in 2004: Mobile Phones; Multimedia; Networks; and Enterprise Solutions. In addition, the organisational structure included three horizontal groups that supported the business groups: Customer and Market Operations; Technology Platforms; and Research, Venturing and Business Infrastructure.'*'* According to the articles of association of Nokia Corporation, a non-statutory body called the Group Executive Board was responsible for managing the Operations of Nokia. The members of this large body included the chairman of the board of directors, the managing director and "Head of Customer and Market Operations", a "Chief Technology Officer", a "Technology Advisor", a "Senior Vice President, Human Resources", a "Chief Financial "^^ For a traditional view on corporate govemance and corporate law see, for example, Davies PL, Hertig G, Hopt KJ, Beyond the Anatomy. In: Kraakman R, Davies P, Hansmann H, Hertig G, Hopt KJ, Kanda H, Rock EB (eds) op cit pp 222-226. "^^ See for example Roberts J, The Modem Firm (2004) pp 1 and 167-168. "^^ See also Roberts J, The Modem Firm (2004) p 183. Roberts describes the matrix Organisation of BP plc before the 1990s. "^"^ This horizontal group was dropped within a year.
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Officer", a "Senior Vice President, Corporate Relations and Responsibility of Nokia Corporation", a "Chief Strategy Officer", a "General Manager of Mobile Phones", a "General Manager of Multimedia", a "General Manager of Networks", a "General Manager, Business Units, Networks", and a "General Manager of Enterprise Solutions". In real life, a Company is probably managed at different levels of the Company hierarchy. A Company is not managed only by the body that has the largest powers or only by what could be described as its "centre of gravity" of management, that is, a point in the structure of a Company's management where all of the weight of the Company's management could be thought to be. A comparative lawyer should identify the most important levels for the purposes of the study. The most important levels of the Company structure can vary depending on the nature of the matter. For example, it may be necessary to distinguish between the Company's internal decision-making, representation of the Company in its dealings with third parties, the monitoring of management and the enforcement of sanctions for breach of duty. These functions are unlikely to coincide completely. Although hierarchies are reduced, discretion is increased and direct control and supervision are diminished in a modern Company, some levels of hierarchy will remain. Some managers will necessarily have an "agency role" on behalf of external suppliers of capital. Some managers must decide on the Organisation of the firm. Some managers must specify the work to be performed. Some managers will coordinate production by directing labour and some managers will monitor Output in Order to determine whether employees are performing their contracts of employment satisfactorily."^^
Company Groups It is not sufficient to study the govemance of Single independent companies. The Single independent Company model is a thing of the past. In corporate practice, a web of wholly or partly owned subsidiaries is for public companies the main form of doing business. Market forces have lead to the growth of a large number of large and small multinational firms."*^ In Company groups, the economic and legal units of business do not necessarily coincide; each legal unit of business operates to some extent in the interests of one or more other legal units or the corporate group as a whole. The structure of Company groups varies a lot, as has been recognised by the OECD Guidelines for Multinational Enterprises: "These usually comprise companies or other entities established in more than one country and so linked that they may co-ordinate their Operations in various ways. While one or more of these entities may be able to exercise a significant influence over the activities of others, ^^ See CoUins H, Regulating the employment relation for competitiveness, ILJ 30 (2001) pp 25-31. ^^ See also Blumberg PI, The Corporate Entity in an Era of Multinational Corporations, Del J Corp L 15 (1990) pp 326-327; Roberts J, The Modem Firm (2004) pp 180-181.
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their degree of autonomy within the enterprise may vary widely from one multinational enterprise to another.'"^'^ Group structures differ according to the type of firm and the kinds of markets in which it operates, and they will also evolve over time. The firm normally ends up with a multidivisional structure. In Company groups, divisionalisation means that the operating functions of many legally separate subsidiaries are performed within one subunit of the firm, and separate operating functions are organised within separate subunits of the firm/^ The roles of shareholders vary. While there may be passive investors in different companies belonging to the group, the parent Company is typically not a passive investor in its subsidiaries."^^ The degree of centralised control over subsidiaries and affiliates varies. For example, the ILO has stated that the "degree of autonomy of entities within multinational enterprises in relation to each other varies widely from one such enterprise to another, depending on the nature of the links between such entities and their fields of activity and having regard to the great diversity in the form of ownership, in the size, in the nature and location of the Operations of the enterprises concemed..."5o There is a trade-off between the integration of functions within the firm and the responsiveness of individual subunits of the firm to markets. Although divisional structures represent an effective Communications System between the decisionmaking centres of the firm and the markets in which it operates, the size and complexity of the managerial structure could itself become a hindrance to such communication in a large firm.^^ The following conclusions have been drawn. (a) A foreign subsidiär/ may have relatively little autonomy: if it belongs to a large multinational group established in many foreign countries; if it manufactures fairly standardised products; if the activities of the members are largely integrated; if it has been created to serve a market larger than the country in which it is established; or if the parent Company holds a large portion of the equity.^^ (b) A foreign subsidiary may enjoy more autonomy: if it was acquired to serve mainly the local market; if it belongs to a small group: if it has interchange of products with the rest of the group and is operating in an activity slightly different from that of other members; if an important part of its shares is held by local investors; and if the whole concem pursues
^'' The OECD Guidelines for Multinational Enterprises (2000), Concepts and Principles. "^^ See Muchlinski P, Multinational Enterprises and the Law (2004) p 58; Roberts J, The Modem Firm (2004) p 1. "^^ Blumberg PI, The Corporate Entity in an Era of Multinational Corporations, Del J Corp L 15 (1990) p 327. ^^ ILO, Tripartite Declaration of Principles conceming Multinational Enterprises and Social Policy (1977), Article 6. See also Roberts J, The Modem Firm (2004) pp 182-190. ^^ See Muchlinski P, Multinational Enterprises and the Law (2004) p 58; Roberts J, The Modem Firm (2004) pp 183-190. ^^ OECD, Stmcture and Organization of Multinational Enterprises (1987) p 35; cited from Muchlinski P, Multinational Enterprises and the Law (2004) p 60.
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growth strategy.^^ (c) In addition: US firms tend to be relatively centralised; centralisation may decrease over time; a new establishment may be more closely controlled than an acquired local Company; some Industries will be more globally integrated and centralised than others; poor Performance increases central control; and geographically organised multinational enterprises tend to be less centralised than functional, product or matrix-organised firms.^"^ What is characteristic of modern firms is creating relatively small subunits within the Organisation in which significant decision rights are lodged and decreasing the number of layers of management and the extent of central staff.^^ In any case, group management structures require effective monitoring Systems. Divisionalisation can be complemented by a matrix management System. For example, a Company manufacturing large diesel engines could have three divisions Marine, Power Plants and Service - operating globally. Local companies could Support the Operations in their respective countries. This matrix Organisation would ensure that the business areas carry prime responsibility for their customers and also interact with them directly. Matrix management Systems can be complicated,^^ and they do not always work. For example, Baring Securities Limited operated a matrix management System from the end of 1992 onwards. Different functions were organised and managed "globally", meaning that a particular activity of subsidiary A might be managed by directors or executives actually employed by subsidiary (or parent) B. Therefore, responsibility for the trading aspect of the business of Baring Futures (Singapore) was split from that for the settlement side, and both were managed by executives nominally employed by, or directors of, other companies in the Barings group.^^ As is well known, Barings bank collapsed in spectacular fashion.
Networks Networks are an important part of the Organisation of modern firms. The OECD Guidelines for Multinational Enterprises recognise that "[mjultinational enterprises, like their domestic counterparts, have evolved to encompass a broader ränge of business arrangements and organisational forms. Strategie alliances and closer relations with suppliers and contractors tend to blur the boundaries of the enterprise."^^ Firms are thus evolving into co-ordination centres of outsourced Services and activities. Even management functions may to some extent be outsourced and occur in a network to which the Company belongs.
OECD, Structure and Organization of Multinational Enterprises (1987) p 35; cited from Muchlinski P, Multinational Enterprises and the Law (2004) p 60. Muchlinski P, Multinational Enterprises and the Law (2004) pp 60-61. Roberts J, The Modem Firm (2004) pp 180 and 232. 56 See Roberts J, The Modem Firm (2004) pp 109-110. ^"^ This management System of the Barings group was explained by Mr Justice EvansLombe in Barings Plc v Coopers & Lybrand (a firm) [2002] EWHC 461 (Ch). ^^ The OECD Guidelines for Multinational Enterprises (2000), Preface.
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For example, extemal auditors appointed by the Company report on the Company's accounts and management. Internal audits may be outsourced. In a group of companies, the parent normally monitors the business of its subsidiaries. But monitoring is not the only activity to be affected. As an increasing number of companies concentrate themselves on their core business, important parts of a Company's business may actually be carried out by other companies. For example, in a supplier partnership the buyer binds its management System to that of the seller in order to coordinate production and delivery times and to ensure sufficient attention on efficiency and quality; the parties also share knowledge, information and know-how in order to promote innovation, improve quality and reduce costs. Networking and outsourcing reduce hierarchies inside the Company. As work will be performed in networks that may extend over different legally independent Company structures, the internal Organisation of a modern Company becomes flatter and more lateral. At the same time, the rights and obligations of "extemal" persons participating in the govemance of the networked Company might not be the same as those of their counterparts within a Single independent Company.
Economic and Legal Theories ofttie Firm A comparative lawyer's opinion of what constitutes the business enterprise or the "firm" for the purpose of the comparative study of the govemance of companies does not have to coincide with economic and legal theories of the firm. Economics offers several distinct theories of the firm. Each theory explains a particular feature of the business enterprise but does not capture its whole.^^ The same is tme of the legal theory of the firm. There is no Single, dominant legal conception of the business enterprise, but rather a series of accounts that view it fi*om particular perspectives. For example, Company law is to a large extent concemed with a set of fmancial claims on the assets and income streams of the firm.^^ Even in the field of Company law there have been several competing schools of thought over the years.^^ 5^ Deakin S, 'Enterprise-Risk': The Juridical Nature of the Firm Revisited, ILJ 32 (2003) p 97: "Coase's account in *The Nature of the Firm' focused on the relations of production and the firm-market boundary, which he associated with the legal distinction between employees and independent contractors. The *Nexus of Contracts' theory widened the field of inquiry to include the firm's relations with suppliers of finance. The Troperty Rights' approach, in tum, built a theory of vertical integration and disintegration around aspects of the control of the firm's non-human assets." See also Ronald Coase, The Nature of the Firm, Economica 4 (1937) p 386, reprinted in Ronald Coase, The Firm, the Market and the Law (1988); Michael C. JensenAVilliam H. Meckling, A Theory of the Firm: Managerial Behaviour, Agency Costs and Financial Structure, J Finan Econ 3 (1976) pp 305-360; Oliver Hart, Firms, Contracts and Financial Structure (1995). 60 Deakin S, 'Enterprise-Risk': The Juridical Nature of the Firm Revisited, ILJ 32 (2003) pp 97-99. ^1 See Cheffms BR, The Trajectory of (Corporate Law) Scholarship, CLJ 63 (2004) pp 456-506; Skeel DA, Corporate Anatomy Lessons, Yale L J 113 (2004) pp 1519-1520.
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Each comparative study of the govemance of companies explains a particular feature of the business enterprise. The boundaries of the "firm" depend on the purpose of the study and the chosen social need. But even if the boundaries of the firm were defined and re-defined on a case-by-case basis in each comparative study, these definitions would not necessarily be less accurate than those used in other theories of the firm.^^
The Penetration and Dilution ofRules The legal nature of companies and the Organisation of firms can have an effect on the scope of rules. It may be that the rules apply at a certain level of hierarchy in a certain Company. It is possible that the rules penetrate only some levels of hierarchy and that their effect is diluted by the existence of many levels of hierarchy. Furthermore, the fact that part of the Company's functions are carried out by other group companies or network members can dilute the effect of rules when the rules do not penetrate the separate legal personality of companies. How do rules penetrate the Organisation of the firm in the case of a Single independent Company? To what extent are rules diluted by the structure and hierarchy of the Organisation of the Company? (a) To begin with, it is possible that the relevance of different rules is dependent on the relevant level of hierarchy. For example, the duties of blue-collar employees are to a large extent govemed by rules that are found in labour law and contract law, but special rules applicable to limited-liability companies are probably more relevant as far as the duties of board members, chief executive officers, chief financial officers, and other persons at top levels of management are concemed. (b) Two of the most common things that prevent the penetration, and dilute the effect, of rules are the separate legal personality of companies and the limited liability of shareholders. For example, many rules that govem the contractual rights of employees do not penetrate the Company hierarchy "upwards" up to the level of Company owners because a Company as a contract party is deemed to be distinct from its shareholders and the limited liability of shareholders for obligations of the Company is regarded as one of the most fundamental principles of Company law. (c) It is possible that in addition to the level of management, the relevance of different rules is dependent on the nature of the act done on behalf of the Company. For example, a certain rule may affect the validity of the Company's internal decision-making in one way and the validity of contracts concluded on behalf of the Company in another way or not at all. (d) It is also possible that the relevance of the rule is dependent on which persons are party to the legal relationship. For example, the fiduciary duties of the board of directors could in principle encompass obligations to the Company, its shareholders, employees, stakeholders, or only some of them. (e) The question of penetration affects not only rules based on sources outside the Company (such as statutory law) but even rules based on the Company's internal decision-making (such as articles of association or ad-hoc decisions). For example, resolutions by shareholders are ^2 Deakin S, *Enterprise-Risk': The Juridical Nature of the Firm Revisited, ILJ 32 (2003) pp 97-113.
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not necessarily binding on blue-collar workers. It is of course possible that resolutions by shareholders are not binding on the management, either. For example, shareholders in Britain get to vote each year on their firm's executive-pay plans but these resolutions are not binding on management.^^ The workforce can play an important role in comparative corporate govemance. This is true regardless of the fact that it is not usual to recognise the workforce in the organic structure of companies. The traditional focus upon the relationship of Company organs and financial capital is often too narrow because it ignores the fact that the day-to-day management of large companies is dealt with at relatively low levels of hierarchy. A pubHc Company is hardly run by a handful of people who convene a few times a year; most of the work will be carried out by a large number of people who work at different levels of hierarchy every day. The role of the workforce is not limited to Cooperation on the shop floor, works Councils, collective bargaining, and worker representation on boards.^"^ The workforce is not only a stakeholder,^^ a constituency that needs to be protected against the opportunism of capitalists.^^ In practice most of the Company's internal decision-making and its representation in its dealings with third parties will be taken care of by its workforce: the company's managers, middle-management and shop floor employees.^*^ How do rules penetrate the Organisation of the firm in a group of companies? This is a case of the management of two or more companies. Some questions will be govemed by the general rules applicable to the management of the parent Company. For example, the parent Company will be able to control the subsidiary and manage its business through its own representatives whose powers to act on behalf ^^ The Commission has recommended a similar procedure; the vote may be either mandatory or advisory. Commission Recommendation on fostering an appropriate regime for the remuneration of directors of listed companies. ^^ For example, the European Works Council Directive (94/45/EEC) is focused on transnational issues within multinational companies. It covers topics such as keeping staff informed of how their firm is doing across the European Community and whether any pan-European redundancy programmes are planned. The Information and Consultation Directive (2002/14/EC) gives employees a right to be informed about the business's economic Situation, informed and consulted about employment prospects, and informed and consulted about decisions likely to lead to substantial changes in work Organisation or contractual relations, including redundancies and transfers. ^^ See Wedderbum A, Employees, Partnership and Company Law, ILJ 31 (2002) pp 99111. ^^ Compare Lynch Fannon I, Working Within Two Kinds of Capitalism. Corporate Govemance and Employee Stakeholding: US and EC Perspectives (2003) p 22: "The corporate govemance debate has reached a point where the only real question is whether we ought to abandon the legal structure of the corporation, which has existed more or less intact since the nineteenth Century, so that modem management (an unelected, careerist constituency with clear vested interests of its own) is legally obliged to consider its obligations to labour, suppliers, customers and others? This work focuses only on labour, as a deserving beneficiary." ^^ Compare CoUins H, Regulating the employment relation for competitiveness, ILJ 30 (2001) p 23.
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of the parent Company are determined in accordance with the rules applicable at the level of the parent Company. The scope of some rules that govem the management of the parent Company may be limited by the fact that the subsidiär/ is a legal person distinct from its shareholders. For example, a decision by the board of the parent Company may not be sufficient where the rules that govem the management of the subsidiary provide that the matter must be decided on by the board of the latter. The scope of general rules may be limited by the a distinct body of rules applicable to groups (like in German law). And most importantly, the scope of both general rules and special rules on groups may be limited by the fact that many subsidiaries are foreign companies regulated by foreign law designated by the applicable rules of international private law. How do rules penetrate the Organisation of the firm in a network Situation? Even this is a case of the management of two or more companies. The same kinds of questions arise as in the case of groups of companies. Relevant levels of hierarchy. A comparative lawyer should find out whether a rule penetrates the hierarchy and structure of the firm to the effect that it is valid in the relevant Company and at the right level of hierarchy. The comparative lawyer should identify the relevant rule in the context of the study. For example, if the comparative lawyer finds out that a Company is represented in its dealings with third parties primarily by its middle management, he should also find out whether a rule that govems the representation of the Company in its dealings with third parties applies to acts done by those representatives of the Company. This is not necessarily the case.^^ It is also possible that the largest part of corporate crime occurs at the level of lower to middle management and that a Company is not criminally liable for the acts or omissions of another Company within the group;^^ a rule that applies to only statutory board members of the parent Company would not necessarily be very effective in real life. Social Needs and Organisation There are quite a few social needs that arise out of the Organisation of limitedliability companies. The most fundamental of these needs relate to the allocation of power, allocation of risk and distribution of information. The following basic questions are likely to be discussed in many comparative corporate govemance studies. How is power allocated in a limited-liability Company? Many persons may act as or on behalf of the Company in some way but somebody must (a) actually mn the Company (formulate and decide on the Company's policy; decide on the Organisation of the firm; put the Company's policy into effect and carry it out; and enter into related contracts with third parties on behalf of the company);'^^ (b) appoint the persons who mn the Company; (c) monitor the persons who mn the com^^ For example, Article 9(1) of the First Company law Directive Covers only acts done by the "organs" of the Company but not acts done by other representatives. ^^ See Hill J, Corporate Criminal Liability in Australia, JBL 2000 pp 12 and 14. ^^ Davies PL, Gower's Principles of Modem Company Law, sixth edition (1997) p 178.
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31
pany; and (d) provide information to shareholders and stakeholders to enable them to act in a rational way. How is risk allocated in a limited-liability Company? The risk can be allocated in many ways between stakeholders and Company representatives acting as or on behalf of the Company. Power and risk do not necessarily coincide.^^ (a) For example, shareholders have some fundamental powers in the Company although the risk of losing the amount invested can be quite low. If the Company faces fmancial min, the amount invested by shareholders is wiped out first. However, shareholders are normally under no Obligation to make payments to the Company or its creditors after the shares have been paid up in füll (limited liability) and shareholders may be able to reduce the risk of losing the value of their shares by diversifying their holdings. (b) Members of a statutory body such as a board of directors can have wide powers in the Company, but even they can reduce their risk. The risk of liability for economic loss sustained by the Company or its stakeholders by reason of bad management is not necessarily high and can be further reduced by D&O insurance policies.*^^ The risk of loss of human capital invested in the Company can be decreased by multiple board memberships. Factors that can decrease the likehhood of such events occurring include, for example, the lack of effective Systems for the enforcement of sanctions against board members and the lack of effective Systems for the removal of ineffective board members. (c) The employees have generally very limited powers in the Company, but their risk of losing the human capital invested in the Company can be quite high. It can also be difficult for employees to reduce this risk by diversification. (d) The liability of creditors is limited to the amount invested in the Company. Creditors can decrease the risk of losing the amount invested by diversification. The powers that creditors have during the ordinary course of the Company's business depend usually on contract, but creditors can have wider powers in corporate crises. The allocation of risk is linked to the availability of remedies. Remedies against Company representatives and the duties of Company representatives go hand in hand. There are different kinds of remedies and they affect the duties of Company representatives in different ways. For example, some remedies available to shareholders are linked to a breach of duty, but other remedies do not require any such breach. Some remedies (for example the power to appoint and remove managers) can enable shareholders (at least Controlling shareholders) to force managers to run the Company in a certain way, but other remedies (for example disclosure and the following negative Publicity) act merely as a constraint discouraging the management from doing certain things. Some remedies exist in name only because they cannot be enforced in practice. How is information distributed and disclosed in a limited-liability Company? In a public Company, the flow of information is important in four respects. Firstly, it See for example Easterbrook FH, Fischel DR, The Economic Structure of Corporate Law (1991) pp 29-30, 37 and 53; Ong DM, The Impact of Environmental Law on Corporate Govemance, EJIL 12 (2001) pp 702-707. See for example Black BS, Cheffins BR, Klausner M, Outside directors and lawsuits: What are the real risks? McKinsey Quarterly (2004) Issue 4 pp 70-77.
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is important for persons who act as or on behalf ofthe Company because it enables them to take decisions on a rational basis. Secondly, Investors and other stakeholders also need to make decisions on a rational basis. For example, the disclosure of information is necessary in order to facilitate extemal financing and the efficient allocation of resources through extemal capital markets. Thirdly, the flow of information is closely connected with how the govemance of companies is monitored and how effective different monitoring Systems are. There can be either proximity or objectivity in monitoring, but only well informed monitors perform well.'^^ Fourthly, the flow of information is connected with the observability of the actions of managers and employees. While limited observabiHty is a source of motivation problems, increased observability makes it possible to motivate them.^"* How are these problems solved in Company groups and networks? The same Problems exist in Company groups and networks7^ (a) The allocation of power plays a major role for groups. Since a Company group consists of many separate legal entities, mies on the allocation of power must be applied separately to each participating entity. These mies are not necessarily identical or compatible with each other. While some mies on the allocation of power apply to the parent Company, different mies can apply to the subsidiary, and even more so in multinational enterprises. The stmcture of the group makes it necessary to allocate power in two ways. Firstly, power must be allocated between different participating entities. Secondly, power must be allocated intemally within each entity. These mies are applied cumulatively. For example, the mies that govem the subsidiary can provide the parent Company with certain powers in the capacity of a Controlling shareholder. The mies that govem the parent set out to what extent the exercise of any of these powers is vested in its managers, statutory board members, or shareholders ("end-shareholders"). The mies that govem the subsidiary determine to what extent acts done by a Controlling shareholder are binding on the managers or statutory board members of the subsidiary, and can provide to what extent acts done by a Controlling shareholder's managers, statutory board members, or endshareholders are binding on the subsidiary itself. (b) The allocation of risk is gov-
Boot AWA, Macey JR, The Role of Objectivity, Proximity and Adaptability in Corporate Govemance, Comell L Rev 89 (2004) pp 357-358: "Monitors are crucial to effective corporate govemance and assume a variety of forms: directors, auditors, credit rating agencies, stock market analysts, takeover firms, arbitrageurs, large shareholders, and outside lenders. Even customers and suppliers act as monitors when they exercise their ability to observe management quality and to send effective Signals to the market about management's Performance." See Roberts J, The Modem Firm (2004) pp 123-128, 135-137 and 161. See the recommendations published by Fomm Europaeum, a network of university professors in the field of Company law and related subjects: Fomm Europaeum Konzemrecht, Konzemrecht für Europa, ZGR 1998 pp 672-772. In that article, the following topics were discussed: "Begriff der Gmppe" (the defmition ofthe group), "Gmppenpublizitäf (group disclosure), "Ordnungsgemäße Konzemgeschäftsfuhmng" (proper management of the group), "Sonderprüfung" (special audit), "Pflichtangebote" (mandatory bid), "Auskauf, Austritt" (squeeze-out, sell-out), "Konzem-Erklämng" (declaration of the existence ofthe group), "Geschäftsleiterpflichten in der Krise (wrongful trading)".
2.3 Comparative Corporate Govemance in Particular
33
emed by similar principles. Risk will have to be allocated between different participating entities and within each participating entity. As regards the allocation of risk between different entities, one of the central questions is to what extent the legal consequences of the actions of any subsidiary or affiliated Company should extend to its parent.^^ In Company law, this problem has sometimes been dealt with by modifying the scope of the limited liability of shareholders (the doctrine of "Piercing the corporate veil" or "Durchgriff')7'^ An alternative way would be the use of identification rules to determine the acts or omissions attributable to the Company; the scope of rules originally designed for a separate legal entity can be extended to cover even other relevant entities, all relevant persons within these entities, and all relevant acts done by these persons. This regulatory practice can make the scope of rules that set out rights and duties depend on the extent of control by the parent, centralised management, functional integration or similar factors."^^ For example, in the Amoco Cadiz case the US District Court was faced with Claims of neghgence arising out of a major oil spillage off the coast of Northern France in 1978. The parent of the Company that owned the Amoco Cadiz was held to be liable on two grounds: by its own active involvement in the alleged negligence, and through its close control over the operating subsidiaries.^^ As regards the allocation of risk within each participating entity, one of the interesting questions is the liability of the shareholders, statutory board members, managers, auditors or lenders of the parent for acts or omissions relating to the business of subsidiaries or affiliates. (c) What has been said of the allocation of power and risk can also be said of the distribution of information. In a group, it is necessary to distribute information both between different participating entities and within each participating entity. Traditional recipients of corporate information may need information about other entities in the group, the group as a whole, transactions carried out by other entities in the group, or intra-group transactions.^^ (d) The rules on the allocation of power will determine the persons who may act in the name of an entity that belongs to a group. There can also be special rules on how the different entities and the persons within these should act. There is a trade-off between centralised management in the interests of the parent and the protection of stakeholders in the entities that belong to the group. In a group, this problem is often addressed with rules on the power to give binding directions and fiduciary duties.
79
Blumberg PI, The Corporate Entity in an Era of Multinational Corporations, Del J Corp L 15 (1990) pp 285-286. See Blumberg PI, The Corporate Entity in an Era of Multinational Corporations, Del J Corp L 15 (1990) pp 288 and 321. Blumberg PI, The Corporate Entity in an Era of Multinational Corporations, Del J Corp L 15 (1990) pp 288, 290-291 and 322; Forum Europaeum Konzemrecht, Konzemrecht für Europa, ZGR 1998 pp 679-680; Hofstetter K, Parent Responsibihty for Subsidiary Corporations, ICLQ 39 (1990) p 595; Hill J, Corporate Criminal Liability in Australia, JBL 2003 p 15. See Muchlinski P, Multinational Enterprises and the Law (2004) pp 323-333. See Muchlinski P, Multinational Enterprises and the Law (2004) pp 346-348.
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2.3.8 The Sources and Nature of Ruies As Said above, the relevant rules may be extemal or internal and they can be based on a variety of sources. Rules do not always have to be linked to action on the part of the State. Extemal rules include not only rules supplied by law, but can include even rules supplied by other extemal sources. Intemal mies can appear in the Company's Constitution, resolutions, contracts, decisions by individual persons and so forth. All these mies can be mandatory, dispositive or non-binding. Mandatory mies apply regardless of what the parties have decided. Dispositive mies apply to the extent that the parties have not decided otherwise. Unlike mandatory and dispositive mies, non-binding mies are not complemented by any legal sanctions for their breach.^^ A comparative lawyer should also distinguish between the nominal nature of these mies and their de facto nature. For example, the recommendations of a nongovemmental Organisation or Standards can in fact be mandatory where the failure to observe them can lead to liability for loss caused by negligence; nongovemmental codes of corporate govemance can in fact be mandatory where the failure to observe them can lead to the delisting of securities; and certain provisions of statutory law can in fact be non-binding where they are not complemented by sanctions enforced against persons who do not comply with them. The differences between the nominal nature of rules and their de facto nature can be quite important in corporate govemance practice. For example, the effective enforcement of sanctions against Company representatives for the breach of nominally mandatory statutory mies is a problem because many shareholders prefer not to be confrontational and the few activist shareholders often lack power to enforce sanctions. The lack of enforcement can make nominally mandatory mies de facto non-binding. On the other hand, some regulations in intemal guidelines can be de facto mandatory due to sanctions for their breach, but nominally nonbinding in some countries because they violate mandatory laws.^^
^^ In Company law, it is normal to distinguish between "soft law" and "hard law". However, this distinction does not seem sufficiently clear. See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 322-323: "We referred above to the Combined Code as 'soft law'. This is not because it is enforced via the Listing Rules. Non-compliance with the Listing Rules can have consequences for companies which are perhaps even more serious than those arisingfrombreaches of the Companies Act. Those consequences include financial penalties of an unlimited amount on both defaulting companies and defaulting directors, actions by the FSA to obtain an injunction or restitution, and, ultimately, de-listing of the Company. However, the Combined Code can be classified as *soft law' if regard is had to the nature of the Obligation placed on the Company by the Listing Rules with regard to the Combined Code. In effect, it is only a disclosure obHgation." ^^ See for example "The Spirit & the Letter of Our Commitment", the General Electric integrity policy.
3 The Law of the European Union
3.1 The Legal Basis EU institutions have taken a number of initiatives in the area of corporate govemance. The main aspects of the regulation of corporate govemance can be summarised as follows: (a) There is freedom to choose the Company form in the EU. This freedom is based on the freedom of establishment and the recent case law of the European Court of Justice (ECJ). Public limited-liability companies also have the Option to incorporate as a European Company under the SE Regulation, (b) There is extensive harmonisation of the regulation of securities markets and financial reporting in the EU. The disclosure of information to investors is largely govemed by derivative EU law. (c) EU Company law contains few binding rules on the subject of corporate govemance. However, measures relating to share capital, mergers or divisions are covered by EU law, and there are non-binding Commission recommendations on the role and remuneration of directors, minimum quality assurance Standards for statutory audits, and the independence of statutory auditors. Freedom of establishment is the principal basis of EU Company law. Article 43(1) of the EC Treaty provides that "restrictions on the freedom of establishment of nationals of a Member State in the territory of another Member State shall be prohibited" and Article 43(2) that freedom of establishment shall include "the right to ... set up and manage undertakings .., under the conditions laid down for its own nationals by the law of the country where such establishment is effected".^ The approximation of Member States' Company laws by means of directives is primarily based on Article 44 of the EC Treaty.^ Article 44(2)(g) provides that the protection of shareholders shall be coordinated by means of directives "to the necessary extent" with a view to making such safeguards equivalent throughout the Community. In addition, Article 44(2)(c) sets out that administrative procedures and practices the maintenance of which would form an obstacle to freedom of establishment shall be abolished by means of directives.
In the future, the Treaty establishing a Constitution for Europe will repeal the EC Treaty when it enters into force (Articles IV-437 and IV-447). The Constitution nevertheless contains similar provisions on freedom of establishment as the EC Treaty (Article III137). The approximation of securities markets and accounting legislation is based on Article 95(1) oftheEC Treaty.
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3 The Law of the European Union
Article 44(2)(g) has been interpreted to include two main grounds for the adoption of EU initiatives in the area of Company law: (a) facilitating freedom of establishment of companies (because the harmonisation of a number of minimum requirements makes it easier for companies to establish themselves in other Member States in which the regulatory framework is similar); and (b) ensuring legal certainty in intra-Community Operations (because the presence of a number of common safeguards creates trust in cross-border economic relationships). In practice, EU Company law pursues many objectives. The stated objectives of secondary Company legislation reflect the wording of Articles 2, 3 and 44 of the EC Treaty: (a) The completion of the internal market means that it is necessary to remove barriers to trade and adapt the structures of production to the Community dimension.^ While the activities of companies often extend beyond the frontiers of national territories,"^ the legal framework is still largely based on national laws.^ There are divergences between the laws of the Member States, and these divergences give rise to legal and psychological difficulties and tax problems.^ (b) It is necessary to ensure minimum equivalent protection for both shareholders and creditors of companies as well as other people doing business with companies^ (c) It is necessary to ensure that the principles of equal treatment of shareholders in the same position are observed and harmonised.^ (d) It is necessary to ensure that competition in the internal market is not distorted by divergences between Member States' laws. Furthermore, Community companies should be able to compete on an equal footing in world markets. (e) Legal obstacles to Company development on a European scale must be removed. The Single market implies the creation of Europe-wide companies, which must be able to act throughout the Community in the same way as in their own country. It is necessary to ensure as far as possible that the economic unit and the legal unit of business in the Community coincide.^ Furthermore, it is necessary to help Community companies to compete on an equal footing for financial resources available in the Community capital markets, as well as in world capital markets.^^ (f) It is necessary to ensure that the Community capital market functions in an efficient and cost-effective way. The protection of investors and the maintenance of confidence in the financial markets is an im-
^ See for example recital 1 of Regulation 2157/2001/EC on the Statute for a European Company (SE). 4 Recital 1 of the First Company Law Directive (68/151/EEC). ^ Recital 4 of Regulation 2157/2001/EC on the Statute for a European Company (SE). ^ Recital 3 of Regulation 2157/2001/EC on the Statute for a European Company (SE); recital 4 of the Twelfth Company Law Directive (89/667/EEC). •^ Recital 5 of the First Company Law Directive (68/151/EEC); recitals 2 and 3 of the Second Company Law Directive (77/91/EEC); recitals 3, 6 and 8 of Third Company Law Directive (78/855/EEC). ^ Recital 4 of the Second Company Law Directive (77/91/EEC). ^ Recital 6 of Regulation 2157/2001/EC on the Statute for a European Company (SE). ^^ Recital 4 of Regulation 1606/2002/EC on the application of international accounting Standards.
3.2 The Harmonisation of Corporate Govemance Rules
37
portant aspect of the completion of the internal market. ^^ (g) It is also necessary to ensure that the financial reporting Standards applied by Community companies participating in financial markets are accepted intemationally and become global Standards P
3.2 The Harmonisation of Corporate Governance Rules 3.2.1. The General Approach in the Past The development of EU Company law has been proceeding hand in hand with the general process of harmonisation of law within the EU.^^ The harmonisation of Company law has nevertheless long suffered from the lack of clear objectives and a clear programme. In the beginning, EC institutions neither set out clearly the goals to be achieved nor agreed on the rationale of Company law harmonisation.^'* The Commission aimed originally at full-scale harmonisation with regard to both public and private limited-liability companies, but this approach only led to the adoption of the First Directive in 1968 before the financial accounting directives. A piece-meal approach followed after the First Company Law Directive. Efforts were made to first harmonise the rules for public companies on a step-bystep basis. These efforts were not very successful.^^ A few more Directives were adopted but attempts to harmonise core issues of Company law - such as the institutional structure of the public Company, minority protection and directors' liability - failed. Instead of major initiatives, the efforts of the Commission were concentrated on getting the Statute for the European Company adopted. The piece-meal approach and the use of legal transplants based on Community law may have increased the number of internal conflicts within Member States' national Company law Systems. National Company laws are Systems of individual rules intended to complement one another in a reasonable way. They are also embedded in national bodies of private law. For example, Company law makes use of
Recital 4 of Regulation 1606/2002/EC on the application of international accounting Standards; recitals 1 and 2 of Directive 2003/6/EC on insider dealing and market manipulation (market abuse). Recitals 2 and 5 of Regulation 1606/2002/EC on the application of international accountting Standards. Hopt KJ, Company Law in the European Union: Harmonization or Subsidiarity, 31 Saggi, conferenze e seminari del Centro di studi e ricerche di diritto comparato e straniero di Unidroit (1998) p 1. Timmermans CWA, Company Law as lus Commune? First Walter van Gerven Lecture, Leuven Centre for a Common Law of Europe (2002) p 3. See for example Merkt H, Die Pluralisierung des europäischen Gesellschaftsrechts, RIW 1/2004 pp 2-3; Coffee JC, The Future as History: The Prospects for Global Convergence in Corporate Govemance and Its Implications, Nw U L Rev 93 (1999) pp 667671.
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private law concepts such as "legal acts", "good faith" and "power of attomey". Legal transplants based on Community law have sometimes become "legal irritants" within Member States' national Company law Systems.^^ Since the 1990s, the EU Company law legislative process has been characterised by more political deference to national law with a higher number of references to national rules in the legislative proposals. The legal basis of this approach is the principle of subsidiarity, inserted into the EC Treaty by the Maastricht Agreement.^^ This more flexible approach to harmonisation resulted in the adoption of the Regulation on the European Company Statute (Societas Europaea) in October 2001.^8
3.2.2 Reasons for Harmonisation in the Future Many factors may give a new impetus to the approximation of corporate govemance rules in the EU.^^ The prevention of a race to the bottom. In the past, there was no need to develop more uniform or harmonised rules in order to prevent a race to the bottom with investors choosing the Member State of incorporation for a Company according to the least demanding Company law System.^^ This was so despite the fact that fear of Delawarisation in Europe used to be one of the reasons why the EC Treaty provides for the harmonisation of Company law. To counterbalance the liberal granting of the right of establishment by the EC Treaty, harmonisation was thought to be required to bring the Standards of protection granted by Member States' Company laws to equivalent levels. The real seat doctrine applied by many Member States may have made it unnecessary to develop more uniform or harmonised rules in the past. The real seat principle requires that every Company intending to have its actual centre of administration in a certain country must incorporate according to the law of that country. The case law of the ECJ may now have changed this. Case law of the ECJ. The case law of the ECJ now permits "corporate law Shopping" by undertakings. The main cases are Centros (case 212/97), Überseering (case 208/00) and Inspire Art (case 167/01). The ECJ first limited the effect of the real seat doctrine in Centros and Überseering and then went on to Interpret the connecting factors under Article 48 of the EC Treaty in Inspire Art.
See generally Teubner G, Legal Irritants: Good Faith in British Law or How Unifying Law Ends Up in New Divergences, MLR 61 (1998) pp 11-32. Article 5 of the EC Treaty. Council Regulation 2157/2001/EC on the Statute for a European Company (SE). See for example Hopt KJ, Gesellschaftsrecht im Wandel. In: Festschrift für Herbert Wiedemann (2002) pp 1012-1032; Wymeersch E, Gesellschaftsrecht im Wandel: Ursachen und Entwicklungslinien, ZGR 2001 pp 294-324. Timmermans CWA, Company Law as lus Commune? First Walter van Gerven Lecture, Leuven Centre for a Common Law of Europe (2002) pp 9 and 13.
3.2 The Harmonisation of Corporate Govemance Rules
39
Whether the case law of the ECJ will give a new impetus to Company law harmonisation by EU institutions is still unclear,^^ but what is clear is that "corporate law Shopping" by undertakings may lead to competition between Member States. These judgments - especially Inspire Art - may also have an impact on the regulatory techniques that Member States will use in the future. Competition between Member States. "Corporate law Shopping" and fears of the popularity of incorporating as a UK limited liability Company have already resulted in the amendment of the Company laws of some Member States. The UK limited liability Company is often regarded as a flexible and competitive Company form. 22 There is also competition between Member States as regards the way laws affecting corporate govemance are being approximated. For example, while the Takeover Directive (2004/25/EC) was largely modelled on the City Code on Takeovers and Mergers and supported by the UK govemment, the SE Regulation (2001/2157/EC) and the Directive on Cross-Border Mergers^^ contain provisions on employee co-determination as required by the German govemment. Existing harmonisation. Fast harmonisation may make future harmonisation easier or lead to flirther convergence. For example, the piece-meal approach of Company law harmonisation may in practice force Member States to change even those parts of their national laws that have not yet been harmonised, because legislators need to ensure that the provisions of national law form a meaningflil whole. In the long mn, the approximation of core issues of Company law may thus result in greater homogenity of non-core issues. The SE Regulation is an example of how piece-meal harmonisation can lead to the convergence of provisions not directly affected by it. At first sight, the adoption of the SE Regulation in October 2001 would not seem to have any major consequences for the further harmonisation of European Company laws.^^ One might think that the SE Regulation can only rarely be used as a model for further harmonisation because it contains uniform mies only on very few issues of Company law. On the other hand, when implementing the provisions of the Regulation, Member States may find it necessary to change their laws even when there is no Obligation to do so. For example, when implementing the provisions of the Regulation on the one-tier and two-tier board stmcture of an SE, a Member State may feel 2^ See Timmermans CWA, Company Law as lus Commune? First Walter van Gerven Lecture, Leuven Centre for a Common Law of Europe (2002) p 13; Merkt H, Die Pluralisierung des europäischen Gesellschaftsrechts, RIW 1/2004 p 4. ^^ See Mankowski P, Entwicklungen im Internationalen Privat- und Prozessrecht 2003/2004 (Teil 1), RIW 7/2004 p 486; Enriques L, Schweigen ist Gold: Die Europäische Aktiengesellschaft als Katalysator für regulative Arbitrage im Gesellschaftsrecht, ZGR 2004 p 742. ^^ The Council reached an agreement on the Directive on cross-border mergers on 25 November 2004. ^^ See especially Timmermans CWA, Company Law as lus Commune? First Walter van Gerven Lecture, Leuven Centre for a Common Law of Europe (2002) pp 7-8.
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3 The Law of the European Union
compelled to change even provisions applicable to public limited-liability companies in general if failure to do so would lead to intolerably large divergences between national provisions that govem these two Company forms. To some extent it is possible that large companies press for domestic law to be altered so as to give them the same options.^^ Where the SE Regulation does set out detailed rules, it can be applied as a model for further harmonisation. For example, it has already been possible to agree on a Directive on cross-border mergers after a deadlock of more than 15 years. The core provisions of the Directive are based on the principles and rules already laid down for the formation of an SE. International initiatives. In contrast, international initiatives have so far not played any significant role in the regulation of corporate govemance in the EU. For example, soft law initiatives such as the codes of conduct of the UN and the OECD regarding multinational/transnational companies and on Corporate Govemance have not had any direct impact on Company law. There are nevertheless two exceptions. Firstly, listed companies are required to use IFRS from 1 January 2005. The International Accounting Standards (lAS) Regulation (1606/2002/EC), adopted in June 2002, requires all EU companies listed on a regulated market to use IFRS and allows Member States to extend this requirement to all companies. Where IFRS are not applied, the Accounting Directives will continue to be the basis of EU accounting requirements. In the short term, the result is two levels of comparability of fmancial information to be produced by companies: a first level of minimal comparability established by the Fourth and Seventh Company Law Directives (78/660/EEC, 83/349/EEC), and a second level of enhanced comparability for financial Statements of companies covered by the lAS Regulation. In the long term, there will be a gradual alignment of national accounting requirements with IFRS. The second exception relates to corporate govemance codes. Corporate govemance Codes adopted in the Member States are already surprisingly similar. According to the Commission, forty or so corporate govemance codes relevant to the EU have been adopted since the 1990s at national or intemational level.^^ The Commission is of the opinion that the EU should shape intemational regulatory developments in the future. At the moment, corporate govemance Standards are to a large extent being set unilaterally by the USA. For this reason, it becomes necessary for the EU to define its own European corporate govemance approach, tailored to its own cultural and business traditions.^''
See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 317318; Fleischer H, Gesetz und Vertrag als alternative Problemlösungsmodelle im Gesellschaftsrecht, ZHR 168 (2004) p 682. In March 2002, the European Commission produced a comparative study on corporate govemance codes in the EU. See Merkt H, Die Pluralisiemng des europäischen Gesellschaftsrechts, RIW 1/2004 p 2.
3.2 The Harmonisation of Corporate Govemance Rules
41
Regulatory developments in the USA. The regulatory developments in the USA, in particular the Sarbanes-Oxley Act of 2002, contribute to the harmonisation of rules that govem corporate govemance in Europe. The Sarbanes-Oxley Act was adopted on 30 July 2002 as a response to a series of scandals. From a European perspective the Act creates a series of problems due to its extra-territorial application and its effects on those European companies that are listed or want to list on a US stock exchange,^^ and auditors. For European companies, compliance with the Act can mean conflicts with home country laws. The European Commission is therefore engaged in a regulatory dialogue with the US Securities and Exchange Commission (SEC). The SEC is charged with implementing most of the provisions of the Act.^^ What the Commission tries to achieve is the recognition by the SEC of EU rules as at least "equivalent". But the Commission cannot speak with the voice of Europe unless the rules applied by different Member States are sufficiently similar. This makes it necessary to harmonise, at least to some extent, matters covered by the Sarbanes-Oxley Act. Financial Services Action Plan. The rules made necessary by the need to match the Sarbanes-Oxley Act in Europe can at the same time be motivated by the need to restore confidence in European capital markets. The purpose of these rules is to increase transparency and empower shareholders. But even more generally, the regulation of corporate govemance by EU Directives is to some extent necessary due to the Integration of capital markets in Europe. There is a Financial Services Action Plan (FSAP) according to which a framework for an integrated capital market should be in place by 2005. The FSAP consists of an ambitious programme of mies for the financial industry. In addition to the FSAP, there is a "disclosure and transparency agenda"; several directives have been necessary in order to achieve a greater level of transparency and information in respect of issuers whose securities are traded on regulated markets.^^ Industrial policy. EU Company law is influenced by industrial policy in two ways. Firstly, Company law sets a part of the general market framework, and it is relevant from an industrial poHcy perspective generally.^ ^ Secondly, Company law 28
See Coffee JC, The Future as History: The Prospects for Global Convergence in Corporate Govemance and Its Implications, Nw U L Rev 93 (1999) pp 673-679 on the migration of foreign firms to the US market. See also Merkt H, Zum Verhältnis von Kapitalmarktrecht und Gesellschaftsrecht in der Diskussion um die Corporate Govemance, AG 2003 pp 130-131 on the effect of the Sarbanes-Oxley Act on the intemal corporate govemance of German companies. The SEC is an 'independent agency' which has executive, legislative and judicial powers. The Sarbanes-Oxley Act required the SEC to make many mies within specific time limits. See Moloney N, Time to Take Stock on the Markets: The Financial Services Action Plan Concludes as the Company Law Action Plan Rolls Out, ICLQ 53 (2004) pp 9991009. See also Norman P, Bück T, A legislative mountain: Europe wants to slow the pace of financial Services reform, Financial Times, 18 January 2005 p 11. See Commission of the European Communities, Industrial Policy in an Enlarged Europe, Communication of the Commission, COM (2002) 714.
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harmonisation can be an instrument of European industrial policy in certain crossborder situations. Harmonisation can remove obstacles to the free movement of companies within the internal market and obstacles to structuring and restructuring multinational firms. The principles of the SE Regulation have already been used as a model for further legislative initiatives. Enlargement, The enlargement of the EU is an important reason to modemise the European regulatoiy framework for Company law and corporate govemance. When joining the EU, "old" Member States were market economies with established rules on the regulation of companies. These rules were often based on the mies and principles developed in other Member States. Many of the new Member States still face a füll transition to flilly competitive modern market economies. More harmonisation may be necessary in order to maintain a high level of legal certainty in intra-Community Operations and also to ease this transition. The Views ofthe Commission. The Commissi on is convinced of the need for an initiative in the area of Company law and corporate govemance. In November 2002, a High Level Group of Company Law Experts chaired by Jaap Winter presented its Final Report on 'A modem regulatory framework for Company law in Europe'. In May 2003, the Commission published its response in the form of a Communication.^2 The Commission's Communication on Modemising Company Law and Enhancing Corporate Govemance explains why, according to the Commission's view, the European regulatory framework for Company law and corporate govemance needs to be modemised. It defines key policy objectives, contains an action plan and indicates which type of regulatory instmment should be used. In parallel with this Action Plan on Company Law, the Commission presented a Communication on Statutory Audit. The Company Law Action Plan thus rolls out as the FS AP concludes. However, the Company Law Action Plan is considerably less interventionist than the FSAP.33 Action Plan on Company Law. In the Action Plan on Company Law, the Commission listed many general reasons for new initiatives at EU level: the completion of the Internal Market; the integration of capital markets; the use of modem technologies (above all the Intemet); enlargement; and the restoration of confidence after the recent financial scandals. The Commission presented two key policy objectives in the area of Company law. The Commission considered that fliture actions at EU level should: strengthen the rights of shareholders and the protection of third parties; and foster the efficiency and competitiveness of business.
^^ Communication from the Commission to the Council and the European Parliament Modemizing Company Law and Enhancing Corporate Govemance in the European Union - A Plan to move forward, COM (2003) 284. ^^ See Moloney N, Time to Take Stock on the Markets: The Financial Services Action Plan Concludes as the Company Law Action Plan Rolls Out, ICLQ 53 (2004) pp 10091012; van Hülle K, Maul S, Aktionsplan zur Modernisierung des Gesellschaftsrechts und Stärkung der Corporate Govemance, ZGR 2004 pp 484-505.
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The Action Plan contains measures which the Commission wants to implement over the short term (until 2005), medium term (until 2008) and long term (until 2010).34 The Commission referred to the benefits of piece-meal harmonisation and flexibility available to companies. According to the Commission, "a certain degree of harmonisation of defined national issues reduces legal uncertainties and can thereby significantly enhance business efficiency and competitiveness". In addition, the Commission pointed out that "[fjlexibility should be available to companies as much as possible: where Systems are deemed to be equivalent, maximum room should be left open to the freedom of the parties involved". It is clear that "corporate law Shopping" permitted by the ECJ will guarantee some flexibility. However, the Commission's proposals would not necessarily make those corporate govemance rules that companies must be comply with more flexible. Corporate govemance is regulated by legal mies. The proposals would increase flexibility if corporate govemance were deregulated or Member States' existing corporate govemance mies made less binding. However, this is not the case. The Commission proposes more mies at national level: the mandatory, dispositive or non-binding nature of these mies would be determined by the Member States. Flexibility is thus basically guaranteed by the case law of the ECJ on the freedom to incorporate the Company anywhere within the EU and by Member States' laws. Furthermore, the proposed measures, the stated purpose of which is to strengthen shareholders' rights, relate mainly to disclosure of Information and the exercise of shareholders' rights through electronic means but not, for example, to the distribution of powers within the Company or the effective enforcement of shareholders' rights through courts. They are not designed to make shareholders more powerful. In addition to its stated policy objectives, the Action Plan seems to have at least two other objectives at a higher level. The scope of actions proposed by the Commission implies that the objectives of the Action Plan include reacting to the Sarbanes-Oxley Act and, in the long term, changing the ownership stmcture of companies. Reacting to the Sarbanes-Oxley Act is hardly controversial. The Commission proposes mies in a number of matters dealt with in the Sarbanes-Oxley Act. As regards the composition of the board and its activities, the Commission proposes modest mies such as mies clarifying the role of non-executive directors. The Commission also recommends minimum Standards applicable to nomination, remuneration and audit committees.
^^ The Action Plan contains the following headings: "Corporate Govemance"; "Enhancing Corporate Govemance disclosure"; "Strengthening shareholders' rights"; "Modemising the board of directors"; "Co-ordinating corporate govemance efforts of Member States"; "Capital Maintenance and Alteration"; "Groups & Pyramids"; Corporate Restmcturing and Mobility"; "The European Private Company"; "The European Co-operative Society and other EU legal forms of enterprise"; and "Enhancing the transparency of national legal forms of enterprise".
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The second higher-level objective of the Action Plan is perhaps more controversial. In the Action Plan, the Commission proposes new disclosure obligations to major shareholders and institutional investors. In addition, the Commission favours "a real shareholder democracy" and says that it would undertake a study on the consequences of adopting the one share / one vote principle.
3.2.3 The Effect of the Sarbanes-Oxiey Act If a European Company wants to be in the US capital markets, it must comply with the Sarbanes-Oxley Act. The Sarbanes-Oxley Act expands corporate govemance and accounting requirements for SEC-registered non-US companies. Extra-territorial effect. The international scope of the Sarbanes-Oxley Act is wide for several reasons. For example, the interpretation of the "interstate commerce clause" of the US Constitution is very wide;^^ the legislator did not find conflicts with foreign companies' home country regulation as important as effective oversight over the fmancial reporting process for listed securities of any issuer, regardless of its domicile; and Clements of the Act were hastily drafted. The Act makes generally no distinction between US and non-US issuers and it does not provide any specific authority to exempt non-US issuers from its reach. The Act leaves it to the SEC to determine where and how to apply the Act's provisions to foreign companies. Shiftfrom disclosure to Substantive regulation. The Sarbanes-Oxley Act creates new Problems for foreign companies listed in the US because it imposes new Substantive requirements that may conflict with foreign companies' home country laws.^^ The Act reflects a potential shift in the philosophy underlying the US securities laws. Firstly, the Sarbanes-Oxley Act represents an incursion of the US federal govemment into the corporate govemance area. Under the federal System, State govemments, rather than the central govemment, enact most corporate laws. The basic philosophy is for the states and the stock exchanges to determine their corporate govemance requirements. Secondly, the Sarbanes-Oxley Act reflects a potential shift fi*om disclosure to Substantive regulation of corporate govemance. Main areas of concern. Although the European Commission Supports the objectives of the Sarbanes-Oxley Act to enhance corporate govemance, audit and accounting Standards in the US, the Commission wants to avoid its undesirable extra-territorial effects.
^^ US Constitution, Article I, Section 8: "The Congress shall have power ... To regulate commerce with foreign nations, and among the several states, and with the Indian tribes ..." See also Kersting C, Auswirkungen des Sarbanes-Oxley-Gesetzes in Deutschland: Können deutsche Unternehmen das Gesetz befolgen? ZIP 2003 p 235; Coffee JC, The Future as History: The Prospects for Global Convergence in Corporate Govemance and Its ImpHcations, Nw U L Rev 93 (1999) pp 690-691. ^^ See for example Ribstein LE, International ImpHcations of Sarbanes-Oxley: Raising the Rent on U.S. Law, JCLS 3 (2003) p 306.
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The Commission has identified seven broad areas of concem, namely: the registration of audit firms with the new Public Company Accounting Oversight Board; the direct US access to EU audit working papers; the audit committee requirements; the rules on auditor independence; the issue of loans to directors and executive officers (notably for banks); the certification of financial reports; and the certification of internal control. Certification. The Sarbanes-Oxley Act provides that the chief executive officer (CEO) and chief financial officer (CFO) of an issuer must certify the quarterly financial Statements filed with the SEC.^"^ They must certify that the periodic report containing the financial Statements complies with the Securities Exchange Act of 1934^^ and that information contained in the periodic report fairly presents, in all material respects, the financial condition and results of Operations of the issuer. In addition, the CEO and CFO must certify the internal controls of the issuer.^^ The SEC has already brought the first civil fraud charges against the CEO of a non-US Company for alleged breaches of the Sarbanes-Oxley provisions on certification."*^ One of the most burdensome parts of the Sarbanes-Oxley Act is Section 404 that came into effect on 15 November 2004. It requires the management and the Company's extemal auditor to appraise the internal controls over fmancial transactions and to report any weaknesses. While the Sarbanes-Oxley Act Covers the evaluation of the effectiveness of internal controls, the Act does not cover the evaluation of board Performance. The Act is nevertheless complemented by the corporate govemance rules of the New York Stock Exchange (NYSE) and similar rules."*^ The corporate govemance rules of the NYSE require companies to adopt and disclosure corporate govemance guidelines, and these guidelines must "address" annual Performance evaluation of the board. This falls short of a mandatory requirement, but it would be difficult for a Company to address the issue and declare it had decided against doing anything about it. Audit Committees. The Sarbanes-Oxley Act expands the role and responsibilities of the audit committee of the board of directors.'*^ Sarbanes-Oxley requires the audit committee to be responsible for the outside auditor relationship, including the responsibility for the appointment, compensation, and oversight of a Company's outside auditor. The Act requires that members of the audit committee be "independent" from Company management (in addition, the corporate govemance
^•7 The United States Code, title 18, Chapter 63, § 1350. ^^ In particular, section 13(a) or 15(d) of the Securities Exchange Act of 1934. Section 302(a) of the Sarbanes-Oxley Act of 2002. 40 See Authers J, Silver S, *It's absurd for the SEC to use a Mexican Company and Mexican Citizens to try to impose US regulations...' Financial Times, 20 January 2005 p 11. For the effect of the NYSE rules on German companies see Schäfer A, Der Prüfungsausschuss - Arbeitsteilung im Aufsichtsrat, ZGR 2004 pp 416-431. Section 301 of the Sarbanes-Oxley Act of 2002; see further Kersting C, Auswirkungen des Sarbanes-Oxley-Gesetzes in Deutschland: Können deutsche Unternehmen das Gesetz befolgen? ZIP 2003 p 234.
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mies of the NYSE set out a cooling-off period of three years for former employees43)^
The SBC has made exemptions for the needs of other countries' practices.'^'^ For example, the SEC incorporated changes to accommodate the German requirement of non-management employees' serving as members of a Company's audit or supervisory board. If a non-US issuer utilises an exemption to audit committee independence, this information must be disclosed to US investors. In addition, audit committee requirements do not affect the appUcation of the provisions of an issuer's governing law, which require that instead of an audit committee, the matter must be decided on by shareholders."^^ The SEC has no authority to make exemptions conceming the Obligation of foreign issuers to appoint an audit committee and the Obligation of audit committees to take care of their responsibilities. Financial experts. The Sarbanes-Oxley Act and the SEC mies provide that every issuer, including a non-US issuer, must disclose whether or not there is at least one "fmancial expert" in the audit committee of the board of directors"^^ and whether the fmancial expert is independent from management. If the answer is negative, the issuer must disclose the reasons for it. The SEC has decided to delay the disclosure requirement as far as non-US issuers are concemed."^"^ Public Company Accounting Oversight Board. The Act provides that a new Public Company Accounting Oversight Board shall oversee the accounting profession and public Company audits."^^ The Act requires foreign public accounting firms that audit SEC-registered issuers, including non-US issuers, to register with the Oversight Board and be subject to its oversight. There are also mies on direct US access to audit working papers. According to the express provisions of the Act, foreign accounting firms are deemed to have consented to these obligations."^^ The USA have so far refused the EU's request for an exemption and the Commission has threatened with retaliation. Lawyers. The SEC was directed by the Sarbanes-Oxley Act to adopt mies regarding minimum Standards of professional conduct for lawyers.^^ Foreign lawyers seem to have been fully exempted from the SEC mle imposing reporting duties on lawyers, provided that they are "non-appearing foreign attomeys", that is,
43 NYSE Listed Company Manual § 303 A.02. "^ Section 301 of the Sarbanes-Oxley Act of 2002; Section 10A(m)(3)(c) of the Securities Exchange Act of 1934; Standards Relating to Listed Company Audit Committees, Securities Act Release No. 33-8220. ^^ See also Kersting C, Auswirkungen des Sarbanes-Oxley-Gesetzes in Deutschland: Können deutsche Unternehmen das Gesetz befolgen? ZIP 2003 p 239. 46 Section 407 of the Sarbanes-Oxley Act of 2002. 4^ Standards Relating to Listed Company Audit Committees, Securities Act Release No. 33-8220. 48 Section 101 of the Sarbanes-Oxley Act of 2002. 49 Section 106 of the Sarbanes-Oxley Act of 2002. 50 Section 307 of the Sarbanes-Oxley Act of 2002.
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lawyers who are not admitted in the United States and do not advise clients regarding US law.^^
3.2.4 The Present Approach to Harmonisation One could say that there are two main models for the regulation of the govemance of public limited-liability companies: the US model and the Continental European model.^^ In both cases companies are regulated by a mix of: (a) either securities markets rules or traditional Company law rules; and (b) either mandatory rules or rules that are dispositive or non-binding. The weight given to different factors depends on the legislator's choice of the default form of raising finance. The General Model The approximation of corporate govemance mies by the institutions of the EU seems to follow the US model. According to the US model, companies are assumed to raise finance in the capital markets. In order to protect investors and the efficiency of capital markets, capital market transactions are regulated by federal securities laws that lay down mandatory mles.^^ These mies contain in particular mandatory disclosure requirements that enhance market transparency. As regards traditional Company law matters, State Company laws only set out the most fundamental mies. Mandatory mies are necessary where disclosure requirements would not prevent expropriation by the management. Party autonomy can cover many traditional Company law matters. According to the traditional Continental European model, companies are assumed to raise finance privately. In order to protect minority shareholders and creditors, companies are to a large extent regulated by mandatory provisions of Company law. Existing EU legislation has so far focused on key areas such as: the maintenance and alteration of capital; the representation of the Company in its dealings Implementation of Standards of Professional Conduct for Attomeys, Securities Act Release No. 33-8185; Groskaufmanis KA, Climbing 'up the ladder': corporate counsel and the SEC's reporting requirement for lawyers, Comell L Rev 89 (2004) p 516. Merkt H, Zum Verhältnis von Kapitalmarktrecht und Gesellschaflsrecht in der Diskussion um die Corporate Govemance, AG 2003 p 127. See also Hopt KJ, Gestaltungsfreiheit im Gesellschaftsrecht in Europa - Generalbericht. ZGR Sonderheft 13 (1998) pp 123-147. Section 14 of the Securities Act of 1933 (15 USC Section 77n): "Any condition, stipulation, or Provision binding any person acquiring any security to waive compliance with any provision of this subchapter or of the rules and regulations of the Commission shall be void." Section 29(a) of the Securities Exchange Act of 1934 (15 USC Section 78cc(a)): "Any condition, stipulation, or provision binding any person to waive compliance with any provision of this chapter or of any rule or regulation thereunder, or of any rule of an exchange required thereby shall be void."
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with third parties; financial reporting; and disclosure of information to Investors. While some of these rules belong to the traditional area of Company law, others belong to the field of securities markets law. Coro Company Law Matters The EU has acted with some sensitivity in the area of Company law. The Company Law Action Plan is thus considerably less Interventionist than the Financial Services Action Plan. For example, the maintenance and alteration of capital is govemed by the Second Company Law Directive (77/91/EEC). The Second Directive is one of the comerstones of EU Company law. It imposes a minimum legal capital to public limited liability companies and contains a number of detailed provisions aiming at protecting shareholders and creditors. These provisions apply for example to the formation stage, to distributions to shareholders, to acquisitions of own shares, to increases in capital and to reductions in capital. The Second Directive also provides for the equal treatment of shareholders who are in the same position (Article 42). The Commission regards a simplification of the Second Directive as a priority and has presented a proposal for a Directive to simplify measures related to capital. The representation of limited-liability companies is govemed by the First Company Law Directive (68/151/EEC). The First Directive co-ordinates the validity of obligations entered into by companies and the disclosure of basic information about the Company, especially particulars of the persons who are authorised to bind the Company. On the other hand, there is little legislation at EU level on the internal Organisation of companies. The Commission presented a proposal for a Fifth Directive on the structure of public limited liability companies in 1972, but this proposal has now been dropped. In October 2004, the Commission adopted two non-binding Commission Recommendations on the role and remuneration of directors.^"* The Commission also proposed a Directive that would provide for the coUective responsibility of board members to the Company for the financial and other key information that they publish; the Directive would also require a corporate govemance Statement in annual reports. A consultation on shareholders' rights was launched by the Commission in September 2004.^^ i^ addition, the Transparency Directive (2004/109/EC) was Commission Recommendation of 15 February 2005 on the role of non-executive or supervisory directors and on the committees of the (supervisory) board (2005/162/EC); Commission Recommendation of 14 December 2004 fostering an appropriate regime for the remuneration of directors of listed companies (2004/419/EC); Proposal for a Directive amending Directives 78/660/EEC and 83/349/EEC conceming the annual accounts of certain types of companies and Consolidated accounts. Fostering an appropriate regime for shareholders' rights, Internal Market Directorate General, 16 September 2004.
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adopted in December 2004. The Transparency Directive Updates existing EU law on the inforaiation provided to shareholders and bondholders at a general meeting through proxies and by electronic means. However, a European corporate govemance code is not part of the Action Plan. In 2001, the Commission launched a review of the main corporate govemance Codes relevant to the EU. The füll comparative study was finalised in March 2002 and concluded that the EU should not devote time and effort to the development of a European code. The High Level Group of Company Law Experts confirmed this result in its Final Report. The Commission does not think that the development of a European code would offer significant added value. The Commission is of the opinion that "the adoption of such a code, if it were even possible, would be an inevitable and possibly messy political compromise, which would be unlikely to achieve füll Information for investors about the key corporate govemance mies." The basis of codes of corporate govemance should therefore "come from the markets and/or national legislation".^^ There is no general directive on the govemance of groups. The Commission is of the opinion that there is no need to revive the old draft Ninth Directive on group relations.^^ The Commission thinks that particular problems should be addressed through specific provisions in three areas: disclosure, the Implementation of a coordinated group policy, and the risks associated with chains of holding companies ("pyramids"). The draft Ninth Directive was influenced by German and French law. Its main features were: (a) a definition of a "subsidiary undertaking" which would oblige Member States to provide for "control contracts", (b) mies about the disclosure of shareholdings in public limited-liability companies, (c) mies as to the conduct of a "parent undertaking" towards a public limited-liability subsidiary (including the liability of the parent undertaking for loss sustained by subsidiary, and for its debts), (d) mies applicable when the parent undertaking had entered into a "control contract" with a public limited-liability Company, or when it had made a "unilateral declaration instituting a vertical group". Disclosure The piece-meal measures in the traditional area of Company law can be contrasted with the extensive harmonisation of disclosure requirements. The purpose of the Accounting Directives is to improve the quality, comparability and transparency of the financial Information provided by companies. The Fourth Company Law Directive (78/660/EEC) is complemented by the Seventh Directive (83/349/EEC) that appHes to Consolidated accounts. One of the purposes ^^ The Speech of Charlie McCreevy, European Commissioner for Internal Market and Services, Corporate Govemance in Europe, European Corporate Govemance Forum, Brüssels, 20 January 2005. ^'^ Ninth Company Law Directive on the Conduct of Groups containing a Public Limited Company as a Subsidiary. A draft was circulated by the Commission in December 1984 for consultation.
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of EU legislation in this area is to ensure compatibility with international Standards. The lAS Regulation (1606/2002/EC) thus requires that all listed companies prepare their Consolidated accounts in accordance with IFRS from 2005 onwards. There is a package of Financial Services Action Plan measures to establish a common financial disclosure regime across the EU for issuers of listed securities. The "disclosure and transparency agenda" consists of the following legislative projects: the lAS Regulation (1606/2002/EC); the Directive on Market Abuse (2003/6/EC) v^hich requires issuers to publish inside information;^^ the Prospectus Directive (2003/71/EC) which deals v^ith initial disclosure requirements at the point of public offer of securities/its admission to trading on a regulated market;^^ and the Transparency Directive (2004/109/EC). In addition to these legislative projects, the Financial Services Action Plan contains the proposed Directive on statutory audit.^^ The Takeover Directive (2004/25/EC) sets out both disclosure requirements and conduct rules relating to mandatory or voluntary bids.^^ For example, the Takeover Directive contains a "breakthrough rule" which limits the effect of restrictions on voting rights provided for in the articles of association of the target Company or in contractual agreements. The Main Disclosure Obligations Although Information and disclosure requirements are at the intersection of Company law and securities markets law, there are more disclosure rules in EU securities markets law than in EU Company law. Periodic information. EU Company law contains rules on the publication of annual accounts (the Fourth Directive) and Consolidated accounts (the Seventh Directive).^^ Current EU law requires only annual and semi-annual reports. There is no Obligation to publish quarterly reports. The Financial Services Action Plan and the disclosure and transparency agenda also have a big impact on the disclosure of periodic information. The Transparency Directive (2004/109/EC) will revise and replace provisions of the Listing Directive (2001/34/EC). The Transparency Directive is less demanding than the highest existing national Standards on quarterly reporting. For example, quarterly reporting is required in the UK, and by the operator of the Frankfurt stock exchange.
^^ Article 6. The Member States shall bring into force the laws, regulations and administrative provisions necessary to comply with the Market Abuse Directive not later than 12 October 2004 (Article 18). 59 Article 3.
^^ Proposal for a Directive of the European parliament and the Council on statutory audit of annual accounts and consolidtated accounts and amending Council Directives 78/660/EEC and 83/349/EEC. ^^ Member States shall implement the Takeover Directive by 20 May 2006. ^2 See also Article 62 of the SE Regulation; Directive 2000/12/EC (credit institutions) and Directive 91/674/EEC (insurance undertakings).
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The Transparency Directive provides for annual and half-yearly financial reports.^^ These reports are in effect mini-prospectuses. They must contain the audited (annual) or Condensed (half-yearly) financial Statements of the Company, a management report and Statements. These Statements are made by the "persons responsible within the issuer" to the effect that, to the best of their knowledge, the financial Statements prepared in accordance with the applicable set of accounting Standards give a true and fair view. The Transparency Directive also lays down a minimum Standard of liability for the breach of these rules.^"^ Somebody - at least the issuer or its administrative, management or supervisory bodies - must be responsible for the information to be drawn up and to be made public in accordance with the provisions of the Directive. Somebody - either the issuer, its administrative, management or supervisory bodies or "persons responsible within the issuer" - must also be liable for failure to do so. Member States are free to determine the extent of this liability.^^ The Commission has proposed a new Directive in order to make the monitoring of the Company more objective: the Directive on statutory audit in the EU.^^ At the moment, the Accounting Directives require that the annual accounts or Consolidated accounts are audited by one or more persons entitled to carry out such audits, and the Eighth Directive (84/253/EEC) deals primarily with the approval of statutory auditors in Member States. But these Directives do not contain requirements on how a statutory audit should be conducted. In the past, the Commission has issued a Recommendation on quality assurance for the statutory auditor in the EU (November 2000)^"^ and a Recommendation on Statutory Auditors' Independence in the EU (May 2002).^^ The proposed new Directive on statutory audit in the EU would now clarify the duties of statutory auditors and set out certain ethical principles to ensure their objectivity and independence. For example, the proposed Directive contains provisions on: the introduction of an annual transparency report for audit firms; auditor rotation; audit quality reviews; the appointment of the statutory auditor or audit firm on the basis of a selection by the audit committee; and contacts between the statutory auditor and the audit committee. Ad-hoc disclosure, Ad-hoc disclosure is regulated by EU securities markets law. The most important rules are contained in the new Market Abuse Directive (2003/6/EC) and in the new Transparency Directive. The Listing Directive (2001/34/EC) contains further rules on ad-hoc disclosure. The new Market Abuse Directive not only prohibits abuse but also requires issuers to publish information.^^ (a) There is an Obligation to disclose inside infor-
^^ Articles 4, 5 and 6. ^"^ Article 7. See also Article 24 . 65 Recital 10. 66 Proposal for a Directive o f the European parliament and the Council on statutory audit of annual accounts a n d consolidtated accounts a n d amending Council Directives 78/660/EEC and 83/349/EEC. 6^ Commission Recommendation 2002/590/EC. 6^ Commission Recommendation 2001/256/EC. 69 See Articles 2, 3 and 6 of the Market Abuse Directive (2003/6/EC).
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mation to the public (Article 6(1)).^^ Under some circumstances, disclosure of inside information may be delayed, provided that the delay would not be likely to mislead the public and the issuer is able to ensure the confidentiality of that information (Article 6(2)). There is a new rule on selective disclosure: "Member States shall require that, whenever an issuer, or a person acting on his behalf or for his account, discloses any inside information to any third party in the normal exercise of his employment, profession or duties ... he must make complete and effective public disclosure of that information, simultaneously in the case of an intentional disclosure and promptly in the case of a non-intentional disclosure" (Article 6(3)). (b) Primary insiders^^ are prohibited from disclosing inside information to any other person unless such disclosure is made in the normal course of the exercise of his employment, profession or duties (Article 3(a)). (c) They are also prohibited from recommending or inducing another person, on the basis of inside information, to acquire or dispose of financial instruments to which that information relates (Article 3(b)). The Listing Directive contains regulations on the information that must be published in the listing particulars and on continuing obligations. Like the new Market Abuse Directive, the Listing Directive provides that "[t]he Company must inform the public as soon as possible of any major new developments in its sphere of activity which are not public knowledge and which may, by virtue of their effect on its assets and liabilities or financial position or on the general course of its business, lead to substantial movements in the prices of its shares" (Article 68(1)). The Transparency Directive provides that a person acquiring or disposing of shares so that its holding with a publicly traded Company reaches, exceeds or falls below certain thresholds informs the Company, which is in its tum responsible for disclosing this information to the public (Article 9(1)). The Transparency Directive also lays down a general Obligation of the issuer to "ensure that all the facilities and information necessary to enable holders of shares to exercise their rights are available in the home Member State" (Article 13(2)). Like the Second Company Law Directive (Article 42), it also provides for the equal treatment of all holders of shares who are in the same position (Article 13(1)). Transactions. There are several provisions on the disclosure of information relating to transactions. The Second and Third Company Law Directives (77/91/EEC, 78/855/EEC) contain disclosure rules relating to transactions that "^^ Article 1(1) provides that inside information "shall mean information of a precise nature which has not been made public, relating, directly or indirectly, to one or more issuers of financial instruments or to one or more financial instruments and which, if it were made public, would be likely to have a significant effect on the prices of those financial instruments or on the price of related derivative financial instruments ..." ^^ Articles 2(1) and 2(2). Article 2(1)(2): *'The first subparagraph shall apply to any person who possesses that information: (a) by virtue of his membership of the administrative, management or supervisory bodies of the issuer; or (b) by virtue of his holding in the capital of the issuer; or (c) by virtue of his having access to the information through the exercise of his employment, profession or duties; or (d) by virtue of his criminal activities."
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must be approved by the general meeting (see above). The Listing Directive (2001/34/EC) provides that "[t]he listing particulars shall contain the information which, according to the particular nature of the issuer and of the securities for the admission of which application is being made, is necessary to enable investors and their investment advisers to make an informed assessment of the assets and habihties, financial position, profits and losses, and prospects of the issuer and of the rights attaching to such securities" (Article 21(1)). The Takeover Directive (2004/25/EC) provides for disclosure rules in the context of voluntary or mandatory takeover bids.
3.3 Freedom to Choose the Company Form in the EU Freedom to choose the Company form can be regarded as one of the comerstones of the regulation of corporate govemance in the EU. Recognition of Foreign Companies under National Law Each Member State has its own business forms for public hmited-liabiHty companies. The parties are not really free to choose the Company form unless the Company is recognised as such in all other Member States. National Company laws lay down under which circumstances a Company is recognised as a Company, and rules of private international law (conflicts of law rules) designate the national Company law that shall govem the issue. Both rules rules of national Company law and rules of private international law - may vary in different states. As regards the private international law of companies, the Member States apply either the incorporation doctrine (like the United Kingdom, Ireland, the Netherlands and the Nordic Countries) or the real seat doctrine (like Germany, France and most Continental Member States). Some Member States apply a combination of both doctrines (Italy and Portugal). The incorporation doctrine regards the place of registration as the decisive factor connecting the Company to national Company law. According to the real seat doctrine, the central administration or principal place of business is the decisive connecting factor.^^ Thus, if a businessman intends to build up a firm with its centre of administration in Bonn, Germany, traditional German law says that he cannot choose English law to be the governing law for the firm.^^ Traditional German international private law excludes party autonomy by using residence (the real seat) as an objective and mandatory connecting factor. The use of an objective and mandatory 72
For the benefits of the real seat doctrine see Schmidt K, Sitzverlegungsrichtlinie, Freizügigkeit und Gesellschaftsrechtspraxis, ZGR 1999 pp 23-24; Roth WH, From Centros to Ueberseering: Free Movement of Companies, Private International Law, and Community Law, ICLQ 52 (2003) pp 181-182. Roth WH, From Centros to Ueberseering: Free Movement of Companies, Private International Law, and Community Law, ICLQ 52 (2003) p 181.
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connecting factor reflects the fact that German Company law is tainted by mandatory Substantive provisions the purpose of which is to protect creditors and minority shareholders; even the regulations on employee representation presuppose the existence of a Company govemed by German Company law. On the other hand, English law says that the businessman can choose English law to be the governing law for the firm regardless of the fact that the centre of administration of the firm is in Bonn. The basic rule of English international private law of companies is party autonomy. Instead of residence, English law uses domicile as a connecting factor, the domicile being determined by the registered Office in the country under the law of which it has been incorporated.^"* The Company's business may thus be conducted anywhere. Similarly, companies formed under foreign law will be recognised if the law of claimed incorporation confers validity on them. Recognition of Foreign Companies According to tiie ECJ The refusal to recognise the legal capacity of the Company raises questions as to consistency with the freedom of establishment of companies. The real seat doctrine especially prevents companies from moving their business undertakings between states without serious risk of being seriously disabled in law. The real seat doctrine has been under examination by the ECJ in Centros,''^ Überseering,''^ and Inspire Art?'' In Centros, the ECJ confirmed that the right of establishment allows foreign investors to incorporate a business under a more attractive foreign Company Statute and operate that business in another Member State in the form of a branch; the extent to which Member States may enact specific rules to regulate pseudo-foreign companies is severely limited.^^ The Court held that "the fact that a national of a Member State who wishes to set up a Company chooses to form it in the Member State whose rules of Company law seem to him the least restrictive and to set up branches in other Member States cannot, in itself, constitute an abuse of the right of establishment".^^ As a rule, a Company that fulfils the conditions set out in Article 48 of the EC Treaty - a Company or firm formed in accordance with the law of a Member State (that is, any Member State) and having its registered office, central administration or principal place of business within the Community (that is, in the same or any other Member State) - does not have to conduct any business in the Member State in which it has its registered office and is not prohibited fi*om pursuing its activities only in the Member State where its branch is established.^^ Roth WH, From Centros to Ueberseering: Free Movement of Companies, Private International Law, and Community Law, ICLQ 52 (2003) pp 182-183. C-212/97 Centros [1999] ECR1-1459. 76 C-208/00 Überseering [2002] ECR 1-9919. ^^ C-167/01 Inspire Art [2003] ECR 1-10155. ^^ Timmermans CWA, Company Law as lus Commune? First Walter van Gerven Lecture, Leuven Centre for a Common Law of Europe (2002) p 11. ^9 Para27. ^^ Para29.
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This led to fears that the real seat doctrine is contrary to Community law as far as companies established in the EU are concemed. In Überseering, the Court seems to have confirmed this by holding that a "necessary precondition for the exercise of the freedom of establishment is the recognition of those companies by any Member State in which they wish to establish themselves".^^ Centros and Überseering will have an impact not only on the scope of the real seat doctrine of some Member States^^ but also on the regulatory techniques of all Member States.^^ For example, German Company law contains mandatory Substantive provisions, which are meant to protect creditors and minority shareholders, and the German regulations on employee representation presuppose the existence of a Company govemed by German Company law.^"* The German govemment pleaded in Überseering that the application of the real seat principle was justified by the need to enhance legal certainty as well as by the protection of creditors (paragraph 87) and employees (paragraph 89). Germany and other Member States intending to adopt mies for the protection of these interest groups will now have to draft them in a way that accommodates foreign companies incorporated in other Member States.^^ How this can be done is still open. The ruling of the ECJ in Inspire Art was expected to provide some guidance as to which regulatory techniques will be permitted. In Inspire Art, AG Alber was of the opinion that a Company established in Member State A is not fully recognised in Member State B if: (1) the Company is generally govemed by the law of Member State A but (2) Member State B applies its own Company law to specific questions such as minimum capital and the liability of the directors.^^ On the other hand, since the EC Treaty is silent on the matter of the law of which Member State shall govem companies, what is regarded as a matter of Company law is not expressly defined in the EC Treaty. According to traditional mies, the Classification of a matter as one of Company law is determined in accordance with the private international law of lex fori, and different Member States can in practice classify the ^^ Para 59. Further Leible S, Hoffmann J, „Überseering" und das deutsche Gesellschaftskollisionsrecht, ZIP 2003 pp 926 and 929 after footnote 42; Timmermans CWA, Company Law as lus Commune? First Walter van Gerven Lecture, Leuven Centre for a Common Law of Europe (2002) p 13; Zimmer D, Ein Internationales Gesellschaftsrecht für Europa, RabelsZ 67 (2003) p 310; Roth WH, From Centros to Ueberseering: Free Movement of Companies, Private International Law, and Community Law, ICLQ 52 (2003) pp 206-207. ^^ See for example the judgment of the Austrian Oberster Gerichtshof of 15 July 1999 (6 Ob 123/99 b) and the judgment of the German Bundesgerichtshof of 13 March 2003 (VII ZR 370/98); further Leible S, Hoffmann J, „Oberseering" und das deutsche Gesellschaftskollisionsrecht, ZIP 2003 pp 928-930. ^^ Micheler E, Recognition of Companues Incorporated in Other EU Member States, ICLQ vol 52, April 2003 p 529. ^"^ Roth WH, From Centros to Ueberseering: Free Movement of Companies, Private International Law, and Community Law, ICLQ vol 52, January 2003 p. 181. ^^ Micheler E, Recognition of Companues Incorporated in Other EU Member States, ICLQ 52 (2003) p 529. 86 Para 100.
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matter in different ways. The opinion of AG Alber was silent on how Company law should be determined for this purpose. A possible Solution could be that the EC Treaty does not prevent a Member State from applying its own law - laws governing Company matters or other matters - to a foreign Company provided that a Company established in another Member State is recognised and the application of the law of that Member State does not amount to a restriction of the right of establishment. The question should not be, to what extent the host Member State of a Company from another Member State is still allowed to apply its own Company law rules to the foreign Companyj^"^ but to what extent the host Member State of a Company from another Member State is still allowed to apply rules other than the rules of the foreign Company's home Member State (that is, not only Company law rules, but any rules designated by the applicable choice of law rules).^^ - It is of course clear that the application by a host Member State of its own or a third country's law cannot always restrict the right of establishment. For example, the Regulation on insolvency proceedings (1346/2000/EC) provides that the law applicable to a Company's insolvency proceedings and their effects shall, as a rule, be that of the Member State within the territory of which the debtor Company's registered office is situated. However, what is decisive is not the place of the registered office as such but the centre of the debtor Company's main interests, and there is only a rebuttable presumption that these places are the same (Articles 3(1) and 4(1), see also Article 3(2)).^^ Therefore, a Company's insolvency is not always govemed by the law under which the Company has been incorporated. In Inspire Art, the ECJ then held that the registered office, central administration or principal place of business of the Company are "connecting factors" under Article 48 of the EC Treaty.^^ The wording of the judgment is a bit misleading. In light of the wording of Article 48 of the EC Treaty, the ECJ must have meant that the connecting factor is the formation of the Company in accordance with the law of a Member State provided that the Company has its "registered office, central administration or principal place of business within the Community". Although the ECJ did identify the connecting factors, it did not expressly identify the provisions to be connected with a legal System. Regardless of which provisions the ECJ had in mind, the ECJ indicated that they are subject to an autonomous Classification instead of being classified under the Classification rules of
^"^ Compare Timmermans CWA, Company Law as lus Commune? First Walter van Gerven Lecture, Leuven Centre for a Common Law of Europe (2002) pp 12-13. ^^ See also Micheler E, Recognition of Companies Incorporated in Other EU Member States, ICLQ 52 (2003) p 529: "The ruling of the ECJ in Inspire Art will Start to demarcate the boundaries within which Member States may regulate companies incorporated in other Member States." ^^ Recital 13: "The * centre of main interests' should correspond to the place where the debtor conducts the administration of his interests on a regulär basis and is therefore ascertainable by third parties." See also Zimmer D, Ein Internationales Gesellschaftsrecht für Europa, RabelsZ 67 (2003) p 310. 90 Para97.
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Member States' private international law.^^ The ECJ seemed to apply the "connecting factors" based on Article 48 of the EC Treaty to provisions that, in light of their effect, could be classified as "company-law rules".^^ It followed that the application of "company-law rules" other than those designated by Article 48 of the EC Treaty constituted a restriction on freedom of establishment as guaranteed by Articles 43 and 48 of the EC Treaty.^^ The "connecting factors" based on Article 48 of the EC Treaty are connecting factors only for the purposes of Article 43 of the EC Treaty. Article 43 does not automatically replace the Member States' traditional choice of law rules. The ECJ in effect held that the application of Substantive rules designated by Member States' choice of law rules could constitute an impediment to freedom of establishment, not the choice of law rules as such. If the Substantive rules constitute an impediment to freedom of establishment, it must be considered whether they can be justified on one of the grounds set out in Article 46 of the EC Treaty or, failing that, by an overriding reason relating to the public interest.^"^ The application of national law to a Company established in another Member State. Accordingly, the application of Substantive "company-law" rules in Member State A to a Company established in Member State B can constitute a restriction on freedom of establishment as guaranteed by Articles 43 and 48 of the EC Treaty under the Inspire Art principles. The Classification of rules in Member States A and B is not relevant, because the "company-law" nature of rules is determined by EU law.^^ In a Member State, "company-law" rules covered by the Inspire Art principles can belong to other fields of law such as contract law, tort law, insolvency law or criminal law.^^ It is also interesting to note that the SE Regulation seems to establish a presumption of equivalence between national regimes. The Regulation seems to be based on the principle of mutual recognition of national Company laws: (a) An Option is allowed between the one-tier and two-tier board structure, with very few Substantive provisions as to the Organisation and functioning of the board. (b) The rules on workers' participation are based on the "avant-apres" or "before-after" principle meaning that the workers' participation regime is based on the regimes applied to the national companies involved in the formation of a SE: it is basically permissible to create an SE subject to a regime for workers' participation ranging from the German model to none at all. (c) As regards many important Company law matters, the Regulation refers, directly or indirectly, to the national Company law of the Member State of incorporation of the SE.
9^ 92 9^ 94 9^
Para99. ParalOO. Para 104. See also paras 107 and 133 (justification). Paras 107 and 133. See Spindler G, Hemer O, Der Gläubigerschutz im Gesellschaftsrecht nach Inspire Art, RIW 1/2004 p 9. 9^ See Spindler G, Hemer O, Der Gläubigerschutz im Gesellschaftsrecht nach Inspire Art, RIW 1/2004 pp 11-13 and 15; Schön W, Zur "Existenzvemichtung" der juristischen Person, ZHR 168 (2004) pp 290-295.
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SE and the Real Seat Doctrine It may be surprising at first sight that the real seat doctrine, the scope of which has been effectively limited by the case law of the ECJ, has been adopted in the SE Regulation. Article 7 of the SE Regulation sets out that the registered office of an SE shall be located within the Community, in the same Member State as its head office. Both the transfer of the registered office and the transfer of the head office have been expressly regulated - and limited - by the Regulation, (a) The registered office of an SE may be transferred to another Member State without the winding up of the SE or the creation of a new legal person (Article 8(1)). An SE will nevertheless be required to reregister if it moves its registered office from the State of formation (Articles 8(2)-(13)), and this will lead to a change of the law governing the Company (Articles 9(1) and 8(16)). (b) The head office of an SE may not be transferred to another Member State. If it is, and the SE does not either re-establish its head office in the Member State in which its registered office is situated or transfer its registered office, the Company will be liquidated (Article 64). The SE Regulation is based on the assumption that one must distinguish between a Company's freedom to move in and the freedom to move out: Articles 43 and 48 EC are expected to apply to the former but not to the latter, and a Member State has a power to destroy the Company when the Company intends to exercise its right of establishment by moving out. It will be seen whether or not the provisions of the Regulation can be reconciled with the judgments of the ECJ in Centros and Überseering.^'^
3.4. The European Company 3.4.1 Introduction There are at the moment two Company forms based on Community law, namely the European Company or "Societas Europaea" (SE) and the European Economic Interest Grouping (EEIG). Only an SE is regarded as a public limited-liability Company, and other European business forms are not relevant for the purposes of this study. The legal basis of the SE is the European Company Statute adopted by the Member States in October 2001. The Statute consists of a Regulation,^^ which sets
Compare Timmermans CWA, Company Law as lus Commune? First Walter van Gerven Lecture, Leuven Centre for a Common Law of Europe (2002) pp 9-10; Roth WH, From Centros to Ueberseering: Free Movement of Companies, Private International Law, and Community Law, ICLQ 52 (2003) pp 206-207; Zimmer D, Ein Internationales Gesellschaftsrecht für Europa, RabelsZ 67 (2003) p 310; Werlauff E, SE - The Law of the European Company (2003) p 19. Regulation 2157/2001/EC on the Statute for a European Company (SE).
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out the core Company law framework, and a Directive,^^ which Supplements the Regulation with regard to the involvement of employees. The Regulation entered into force with a delay of 3 years on 8 October 2004 (Article 70). What the Regulation tries to achieve is that companies established in more than one Member State would be able to merge and operate throughout the EU on the basis of a single set of rules and a unified management and reporting System. It should be possible to avoid the need to set up a network of subsidiaries govemed by different national laws. The Regulation meets this objective only partly. It does contain some very detailed provisions on the cross-border restructuring of companies. A further benefit of the Regulation is that it enables European firms to use a simple group structure after mergers or acquisitions, foregoing intermediate holding companies.^^^ However, there is no such thing as a genuinely European European Company. Instead of a European European Company, each Member State has its own form of European Company, and some rules applicable to an SE vary depending on the home country of the companies that participated in its founding. In principle, a regulation has general application and is directly applicable in all Member States.^^^ It does not necessarily have to be "implemented" by the Member States. The SE Regulation is different: it includes 31 Member State options, there are requirements in the SE Regulation for Member States to enact certain measures, and new legislation may be required in the Member States to ensure its effective application.^^^ Different Member States have implemented the Regulation in different ways depending on the preferences of each Member State and the contents of national Company law.^^^ In the UK, the European Public Limited-Liability Company Regulations came into force on 8 October 2004. In Germany, a corresponding Act (Gesetz zur Einführung der Europäischen Gesellschaft, SEEG) entered into force on 29 December 2004. This results in different regulation of SEs formed in different Member States. An SE is basically a public limited-liability Company that is formed under the law of a Member State and govemed by the law of the Member State in which it has its registered office. ^^ Directive (2001/86/EC) supplementing the Statute for a European Company with regard to the involvement of employees. ^00 See Wenz M, Einsatzmöglichkeiten einer Europäischen Aktiengesellschaft in der Unternehmenspraxis aus betriebswirtschaftlicher Sicht, AG 2003 pp 185-196. 101 Article 249(2) of the EC Treaty. 10^ See for example the Explanatory Memorandum for the UK Parliament on the European Public Limited-Liability Regulations 2004 (SI2004/2326), para 10. 10^ See Bundesministerium fiir Justiz, Diskussionsentwurf eines Gesetzes zur Einfiihrung der Europäischen Gesellschaft (SEEG); Neye HW, Teichmann C, Der Entwurf für das Ausfiihrungsgesetz zur Europäischen Aktiengesellschaft, AG 2003 pp 169-179; Hommelhoff P, Zum Konzemrecht in der Europäischen Aktiengesellschaft, AG 2003 pp 179-184; DTI, Implementation of the European Company Statute: The European Public Limited-Liability Company Regulations 2004. A Consultative Document (October 2003).
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There are therefore many general questions relating to governing law and corporate govemance. Which mies govem the govemance of an SE? In particular: What is the relationship between the provisions of the Regulation and Member States' laws? How is the governing law determined? To what extent does the Regulation permit party autonomy? How may Member States implement the provisions of the Regulation conceming corporate govemance? The SE Regulation contains relatively few mies on shareholders' powers. Instead of the SE Regulation, these powers are based on Member States' laws applying to public limited-liabihty companies in general.
3.4.2. The Applicable Ruies in General An SE is established by two pieces of legislation, namely a Regulation (directly applicable in Member States) establishing the Company law mies and a Directive (which must be implemented in national law in all Member States) on employee involvement. In addition, Member States' laws and party autonomy play a significant role. An SE is not able to operate on the basis of a single set of European mies, and it is possible that SEs incorporated in the same Member State operate on the basis of different mies. Both the Directive and the Regulation contain mies on corporate govemance, governing law and the extent of party autonomy. The Directive on Employee invoivement The key question delaying the European Company Statute was co-determination. According to Article 1(4) of the SE Regulation, employee involvement in an SE shall be govemed by Directive 2001/86/EC. This makes co-determination mandatory in some cases. On the other hand, these provisions allow a circumvention of German mies on co-determination. Earlier legislation on employee involvement. There is some earlier EU legislation on employee involvement. Hundreds of multinational companies operating across Europe have set up European Works Councils as a result of the 1994 Directive on European Works Councils (94/45/EC). European Works Councils bring together employee representatives from each EU (or EEA) country in which the Company has Operations, for the purposes of the disclosure of information and consultation with group-level management. In 2002, the information and consultation Directive (2002/14/EC) was adopted. The purpose of this Directive is to establish a general framework setting out minimum requirements for the right to information and consultation of employees in undertakings or establishments within the Community. No uniformity. The complex regime under the Directive on employee involvement (2001/86/EC) does not amount to a Substantive uniformity. ^^"^ Instead, the Directive provides for alternative forms of co-determination to be applied in an ^^^ See Timmermans CWA, Company Law as lus Commune? First Walter van Gerven Lecture, Leuven Centre for a Common Law of Europe (2002) p 8.
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SE. The Directive recognises that it is not possible to set up a single European model of employee involvement applicable to all SEs (recital 5). On the other hand, the establishment of an SE should not reduce practices of employee involvement existing within the participating companies (recital 3). This leads to a "before and after" principle: employee rights in force before the establishment of an SE should provide the basis for employee rights of involvement in the SE (recital 18). The Directive on employee involvement determines the law of which country shall govem the co-determination rights of employees and, at least partly, designates the applicable rules. In some cases the so-called Standard rules apply, in some cases not. The underlying principle is that the concrete procedures of codetermination should be defined primarily by means of an agreement between the parties concemed or, in the absence thereof, through the application of a set of subsidiary rules (recital 8). Standard rules. Each Member State must lay down Standard rules on employee involvement. In normal cases, the place of the registered office of the SE will determine the governing law: the Standard rules as laid down by the legislation of the Member State in which the registered office of the SE is to be situated apply from the date of the registration of the SE.^^^ However, Member States must distinguish between 'Information and consultation" and "participation" in the Standard rules. While rules on information and consultation are a factor that must be taken into account when Company representatives exercise their powers on behalf of the company,^^^ rules on participation partly lay down who will be empowered to exercise some of these powers (especially the power to take care of the Company's internal decision-making):^^^ The former can be described as rules on constraints on govemance, but the latter are rules on govemance. The Standard rules on information and consultation apply if the Standard rules apply. It is the purpose of the Directive to ensure information and consultation procedures at transnational level (recital 6). With regard to information and consultation, the competence of the employees' "representative body"^^^ is limited to "questions which concem the SE itself and any of its subsidiaries or establishments situated in another Member State or which exceed the powers of the decision-making organs in a single Member State". The Standard rules on participation will not apply unless there was a sufficient amount of employee participation within the various participating companies (the "before and after" principle).^^^ The "before and after" principle means in practice
^05 Article 7(1) of the Directive. ^^^ See Articles 2(i) and 2(j) of the Directive. ^^'^ Article 2(k) of the Directive. ^^^ Article 2(f) of the Directive. ^^9 Article 7(2) of the Directive.
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that it is potentially permissible to create an SE subject to a regime for workers' participation ranging from the strict German or Dutch model to none at all.^^^ No Standard rules. In some cases the Standard rules are not applicable at all. (a) As Said above, the applicability of the Standard rules on participation is subject to the "before and after" principle. (b) In addition, the employees' "special negotiating body"^" may under some circumstances decide to rely on the normal rules on information and consultation of employees in force in the Member States where the SE has employees.^^^ (c) Furthermore, the Standard rules will not apply if the competent organs of the participating companies and the special negotiating body of the employees have reached an agreement on employee involvement but not an agreement on the application of those Standard terms. The Directive permits freedom of contract and allows for tailor-made Solutions. Application of German co-determination. For an SE established by way of merger, the threshold for the application of German co-determination is 25% of the workforce under the "before-after" principle (Article 7(2) of the Directive). If the participating companies choose a straightforward cross-border merger under the new Directive on cross-border mergers, the threshold will be slightly higher. The final version of the Directive on cross-board mergers says, in effect, that after a merger involving a German Company, the merged entity will have to adopt German co-determination if one-third or more of the workers are German. However, German co-determination can also be circumvented. For example, it is possible to found an SE in another Member State without merging or transforming any existing German Company; such an SE is recognised and may carry on business even in Germany. It may be that this makes German companies less attractive as mergers partners. It is also possible to convert an SE into a public limited-liability Company govemed by the law of the same State (Article 66 of the Regulation). An SE registered in France can thus be converted into a French SA that is not subject to mandatory employee participation of the German kind. The SE Regulation The SE Regulation contains a number of rules on corporate govemance. For example, Article 38 lays down the basic management structure and organs of an SE and Article 1(4) of the Regulation sets out that employee involvement in an SE shall be govemed by the provisions of Directive 2001/86/EC. However, the Regulation contains detailed rules on relatively few issues. For example, the Regulation sets out the legal nature of an SE and how an SE can be set up. These rules are necessary since this Company form is based on Community law; it is not possible to set up an SE on the basis of national Company law only. ^^^ See for example Henssler M, Unternehmerische Mitbestimmung in der Societas Europaea. Neue Denkanstöße für die „Corporate Govemance'-Diskussion. In: Festschrift für Peter Ulmer (2003) pp 199-200; Heinze M, Die Europäische Aktiengesellschaft, ZGR 2002 p 69-70. ^^^ Article 2(g) of the Directive. ^^2 Article 3(6) of the Directive.
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In addition, the rules on the setting up of an SE address several legal problems relating to the cross-border restructuring of Operations. The lack of detailed rules can be explained by the basic legislative technique used in the Regulation and great reliance on Member States' laws. The minimum use of uniform rules is based on the principle of subsidiarity (recital 29).^^^ An SE founded in the UK is thus largely govemed by UK law, and an SE founded in Germany by German law. Basic legislative technique. The basic legislative technique used in the Regulation is, firstly, that the provisions of the Regulation set out some general rules which are directly applicable in the Member States and, secondly, that the modalities of different rights and obligations are based on the provisions of national laws.114
The SE Regulation contains both a general reference (Article 9(1)) to national law - in particular to provisions "which would apply to a public limited-liability Company formed in accordance with the law of the Member State in which the SE has its registered office" - and specific references thereto. Furthermore, Members States are expected to implement the SE Regulation by adopting some specific rules for SEs. This means that the SE Regulation is different from a typical regulation that is binding in its entirety and directly applicable in all Member States^ ^^ and does not need to be implemented by them. But although the SE Regulation can be described as a framework regulation,^ ^^ it should not be described as a directive-like regulation. Its general rules are directly applicable and binding whether the Member States implement them or not. The hierarchy of sources of rules. Because of the legislative technique of the SE Regulation, the rules governing an SE can be based on EU, national and Company sources. Article 9(1) of the Regulation partly lays down their hierarchy. In addition, the hierarchy of rules is govemed by the Substantive provisions of the Regulation, the provisions of Directive 2001/86/EC and the provisions of Member States' laws. To begin with, Article 9(1) provides that "[a]n SE shall be govemed: (a) by this Regulation, (b) where expressly authorised by this Regulation, by the provisions of its Statutes or (c) in the case of matters not regulated by this Regulation or, where matters are partly regulated by it, of those aspects not covered by it, by: (i) the provisions of laws adopted by Member States in implementation of Commu113 See also recital 9; Teichmann C, Die Einführung der Europäischen Gesellschaft. Grundlagen der Ergänzung des europäischen Statuts durch den deutschen Gesetzgeber, ZGR 2002 pp 391-392. 11"^ Kubier F, Leitungsstrukturen der Aktiengesellschaft und die Umsetzung des SE-Statuts, ZHR 167 (2003) p 223: "Die VO gibt nur einen Rahmen vor, der durch die schon bestehenden Aktiengesetze der Mitgliedstaaten und durch die von ihnen zu schaffenden Rechtsvorschriften implementiert wird." 115 Article 249(2) of the EC Treaty. 11^ See Hopt KJ, Company Law in the European Union: Harmonization or Subsidiarity, 31 Saggi, conferenze e seminari del Centro di studi e ricerche di diritto comparato e straniero di Unidroit (1998) pp 11-12 on framework directives.
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nity measures relating specifically to SEs; (ii) the provisions of Member States' laws which would apply to a public limited-liability Company formed in accordance with the law of the Member State in which the SE has its registered Office; ^^^ (iii) the provisions of its Statutes, in the same way as for a public limitedliability Company formed in accordance with the law of the Member State in which the SE has its registered office". These rules are complicated. In any case, the hierarchy of rules governing an SE seems to be as follows:'^^ the applicable provisions of the EC Treaty;^ ^^ provisions of the Regulation, all of which are mandatory in the sense that neither the Member States nor the parties may derogate from them (Article 9(1 )(a)); provisions of Statutes expressly authorised by the Regulation (Article 9(1 )(b)); mandatory provisions of laws adopted by Member States in implementation of Community measures relating specifically to SEs (Article 9(l)(c)(i)); the agreement on arrangements for the involvement of the employees within the SE set out in Article 4 of Directive 2001/86/EC (Articles 1(4) and 12(4));^2o ^^e Standard rules on employee involvement laid down by the Member States (Article 1(4));^^^ other rules according to Member States' hierarchy of rules: these rules must contain at least mandatory or dispositive provisions of Member States' laws applicable to public limited-liability companies (Article 9(l)(c)(ii)), and mandatory or dispositive provisions of Statutes (Article 9(l)(c)(iii)).^^^
3.4.3 Party Autonomy under the SE Regulation The hierarchy of rules affects party autonomy and an SE's internal rule-making. As said above, the hierarchy of rules governing an SE is based on Article 9(1) of the Regulation, the Substantive provisions of the Regulation, the provisions of Directive 2001/86/EC and the provisions of Member States' laws. To what extent is there scope for party autonomy in an SE's internal rule-making? To what extent ^^^ See also Article 9(2): "The provisions of laws adopted by Member States specifically for the SE must be in accordance with Directives applicable to public limited-liability companies referred to in Annex 1.3 ..." Further to Article 9(2) Werlauff E, SE - The Law of the European Company (2003) pp 23-24. '^^ Compare especially Kubier F, Leitungsstrukturen der Aktiengesellschaft und die Umsetzung des SE-Statuts, ZHR 167 (2003) pp 224-225. ^^^ For example, Article 48 of the EC Treaty in light of the case law of the ECJ in Centros and Überseering; Article 12 of the EC Treaty. See Werlauff E, SE - The Law of the European Company (2003) pp 82-83. ^^^ Article 1(4) of the Regulation: "Employee involvement in an SE shall be govemed by the provisions of Directive 2001/86/EC." Article 12(4) of the Regulation: "The Statutes of the SE must not conflict at any time with the arrangements for employee involvement ..." See also Articles 4 and 12 of Directive 2001/86/EC. 121 Article 7(1) of Directive 2001/86/EC. 122 Article 9(1) raises questions such as: the scope of the Regulation, the scope of its specific provisions and the role of gap-filling; the effect of Article 9(1) on private international law; the adoption of provisions either for pubhc limited-liability companies generally or for SEs specifically; and party autonomy.
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may shareholders and other internal rule-makers make internal rules for the Company? Sources of internal rules. An SE may have different kinds of internal rules. The Statutes are not the only source of internal rules. The Statutes of the Company are nevertheless the most important source of an SE's internal rule-making.^^^ Statutes are the only source of an SE's internal rulemaking that the Regulation regulates in a relatively detailed way. But while some provisions of Statutes are expressly authorised by the Regulation (Article 9(1 )(b)), most provisions must comply with Member States' laws applicable to public limited-liability companies (Article 9(l)(c)(iii)). Another regulated source of internal rule-making is related to employee involvement. Article 4 of Directive 2001/86/EC^2'^ provides for an agreement on arrangements for the involvement of the employees within the SE. According to the Regulation, the Statutes of the SE must not conflict at any time with the arrangements for employee involvement (Article 12(4)). The Directive provides that each Member State shall ensure that the obligations laid down by the Directive are not breached (Article 12).i25 In contrast, the effect of internal guidelines and ad-hoc decisions is regulated by the provisions of Member States' laws. The SE Regulation provides for the most fundamental rules only; these rules must be supplemented by Member States' laws laying down the modalities of different rights and obligations.^^6 Statutes. The SE Regulation contains some rules on the Statutes of an SE. The amendment of Statutes requires a majority of at least two thirds of the votes cast (Article 59). According to the wording of Article 9(1) of the Regulation, the provisions of Statutes can be based either on the express provisions of the Regulation or on the law governing the SE.^^'^ If the provisions of the Statutes are "expressly authorised" by the Regulation, they are permitted whether or not they are permitted under national law.
^^^ According to Article 6, "the Statutes of the SE" shall mean both the instrument of incorporation and, where they are the subject of a separate document, the Statutes of the SE. ^'^^ Article 1(4) of the Regulation: "Employee involvement in an SE shall be govemed by the provisions of Directive 2001/86/EC." See also Articles 4 and 12 of Directive 2001/86/EC. ^25 Article 12(1) of Directive 2001/86/EC: " Each Member State shall ensure that the management of establishments of an SE and the supervisory or administrative organs of subsidiaries and of participating companies which are situated within its territory and the employees' representatives or, as the case may be, the employees themselves abide by the obligations laid down by this Directive, regardless of whether or not the SE has its registered office within its territory." See also Article 12(2) of the Directive. ^^^ See also Hommelhoff P, Satzungsstrenge und Gestaltungsfreiheit in der Europäischen Aktiengesellschaft. In: Festschrift fiir Peter Ulmer (2003) p 276. ^^^ See also Kubier F, Leitungsstrukturen der Aktiengesellschaft und die Umsetzung des SE-Statuts, ZHR 167 (2003) pp 224-225; Werlauff E, SE - The Law of the European Company (2003) p 23.
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Some provisions can be adopted in the SE's Statutes because they have been expressly permitted in the Regulation. ^^^ For example, the Statutes must contain a choice between the two-tier System and the one-tier System (Article 38), and the number of members of the management organ or the rules for determining it must be laid down in the SE's Statutes (Article 39(4)). A Member State may also require or permit the Statutes to provide that the member or members of the management organ shall be appointed and removed by shareholders in general meeting under the same conditions as for public limited-liabihty companies (Article 39(2)). As regards these rules, the limits to the discretion available to the parties and Member States vary.^^^ For example, a Member State may stipulate the number of members of the supervisory organ for SEs registered within its territory or a minimum and/or maximum number (Article 40(3)); a Member State may set a minimum and, where necessary, a maximum number of members of the administrative organ (Article 43(2)); members of Company organs shall be appointed for a period laid down in the Statutes not exceeding six years (Article 46(1)); and an SE's Statutes shall list the categories of transactions which require authorisation of the management organ by the supervisory organ in the two-tier System or an express decision by the administrative organ in the one-tier System (Article 48(1)). On the other hand, the administrative organ shall meet at least once every three months at intervals laid down by the Statutes (Article 44(1)); an SE's Statutes may, in accordance with the law applicable to pubhc limited-liability companies in the Member State in which the SE's registered office is situated, lay down special conditions of eligibility for members representing the shareholders (Article 47 (3)); and the Statutes may provide for internal rules relating to quorums and decision-taking in SE organs (Article 50).
3.4.4 The Basic Governance Structure under the SE Regulation The SE Regulation sets out the basic governance structure but leaves some room for interpretation. For example, although the Regulation names the organs of an SE and provides for a choice between a two-tier System and a one-tier System, it is a matter of interpretation whether an SE can have other organs than those listed in the Regulation, what the two-tier System and the one-tier System exactly mean, and whether the managing director must be a board member.
Organs The Regulation provides that "an SE shall comprise: (a) a general meeting of shareholders and (b) either a supervisory organ and a management organ (two-tier ^^^ See Hommelhoff P, Satzungsstrenge und Gestaltungsfreiheit in der Europäischen Aktiengesellschaft. In: Festschrift für Peter Ulmer (2003) pp 274-275. ^^^ Compare Hommelhoff P, ibid p 275: "Ermächtigungen mit Regelungsauftrag an den Satzungsgeber", "Ermächtigungen ohne Regelungsauftrag".
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System) or an administrative organ (one-tier System) depending on the form adopted in the Statutes" (Article 38). These are the organs of the Company as far as the management, supervision and administration of an SE are concemed. As a rule, Member States' laws may not provide for any other management Organs for an SE. The matter as to which organs are empowered to take care of the management, supervision and administration of an SE has been regulated by the Regulation, and the provisions of Member States' laws that would apply to public limited-liability companies will not govem this issue (Article 9(l)(c)(ii)).^^° According to the preamble of the Regulation, the respective responsibilities of those responsible for management and those responsible for supervision should be clearly defined in order for an SE to be efficiently managed and properly supervised (recital 14). There are some exceptions to the rule that Member States' laws may not provide for any other organs as far as the management, supervision and administration of an SE are concemed: (a) The first exception relates to accounts. The Regulation provides that an SE shall be govemed by the rules applicable to public limited-hability companies as regards the preparation of its annual accounts including the accompanying annual report and the auditing and publication of those accounts (Article 61). (b) A similar exception relates to winding up, liquidation, insolvency, cessation of payments and similar procedures (Article 63). In these two cases, it is possible that other bodies are partly empowered to take care of the management, supervision and administration of public limited-liability companies (Article 9(l)(c)(ii)). (c) There is also an exception relating to the representation of the Company in dealings with third parties and in legal proceedings. Article 12(1) of the Regulation provides that every SE shall be registered in accordance with Article 3 of the First Directive (68/151/EEC). Article 3 of the First Directive refers to Article 2 of the same Directive, and Article 2(1 )(d) of the First Directive distinguishes between persons who either as a body constituted pursuant to law or as members of any such body: (i) are authorised to represent the Company in dealings with third parties and in legal proceedings; or (ii) take part in the administration, supervision or control of the Company. This means that in addition to the management organs mentioned in Article 38, an SE and a public limited-liability Company may, under national law, have bodies, which are authorised to represent the Company in dealings with third parties. (d) An SE can have a managing director or managing directors (Articles 39(1) and 43(1)). The role of managing directors is a matter of interpretation. The same can be said of the secretary of a UK Company. As will be discussed below, the wording of the SE Regulation may create Problems for both the UK and Germany.
Choice Between the Two-tier System and the One-tier System The choice between the two-tier System and the one-tier System has been left to the Company. An SE shall have either a two-tier System or a one-tier System depending on the form adopted in the Statutes (Article 38(b), recital 14). This is not a 130
See also Werlauff E, SE - The Law of the European Company (2003) p 73.
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matter for the discretion of Member States, and both Systems must be available in every Member State. Since the laws of many Member States have not offered the choice between these two Company forms in the past, they must be amended accordingly (Articles 39(5), 43(4) and 68(l)).^3i Failure to implement. The fact that a Member State fails to adopt these measures will not prevent the Company from choosing either one of these two Systems (Article 38(b) and recital 14).^^^ £yen in this case, the principles laid down by the Regulation will be complemented by the laws of a Member State under Article 9(1). For example, the modalities of "management" may, in the absence of appropriate legislative measures, have to be determined by applying the general principles of national Company law or by the use of analogy.^^^ Existing Systems and appropriate measures. The Regulation is based on the idea that there are just two main ways to organise the management of public limited-liability companies in Europe: either a one-tier System or a two-tier System in the sense of Article 38(b) of the Regulation with no grey area between the two. This might seem natural from the perspective of German law (an AG has a twotier System, a GmbH can have a one-tier System or a two-tier System) or French law (both Systems available), but not from the perspective of UK law (great flexibihty as regards the internal management of companies) or the law of the Nordic States. May a Member State adopt "appropriate measures" in relation to SEs where there is already a one-tier or two-tier System of some kind but not a System identical to that laid down by the provisions of the Regulation, or where the System adopted by the Member State cannot be regarded as any of these two Systems? The answer must be yes in order not to deprive Article 38(b) - which provides for a right to choose either a two-tier System or a one-tier System in the Statutes of its effectiveness.^^"^ Member States' rights to adopt these measures must then be based either on Articles 39(5) and 43(4) or Article 9(l)(c)(i). Articles 39(5) and 43(4) should be interpreted as in no way restricting the scope of Article
^^^ See also Werlauff E, ibid p 77: "not merely a question of 'appropriate measures', but rather of 'corresponding provisions', which is something rather different and more precise". *^^ See also Teichmann C, Die Einführung der Europäischen Gesellschaft. Grundlagen der Ergänzung des europäischen Statuts durch den deutschen Gesetzgeber, ZGR 2002 p 442. ^33 Compare Teichmann C, ibid pp 442 and 398-399. ^^'^ This matter may have been unclear. See first DTI, Implementation of the European Company Statute, para 3.41: "It is arguable that GB does not have either a 'one-tier' or 'two-tier' System of the same legal nature as those mandated in the Regulation. This would prevent the use in GB of the powers in Articles 39(5) or 43(4)..." Para 3.42: "... the Department proposes not to make use of Articles 39(5) or 43(4)." Compare this with the Explanatory Memorandum for the UK Parliament on the European Public LimitedLiability Regulations 2004 (SI 2004/2326), para 14: "The principal Option in the EU Regulation ... is that set out in Article 39(5) ... Following consultation the regulations have been amended to make clear how the references to directors ... will apply to members of two-tier SEs. These amendments are made by virtue of Article 68 of the EU Regulation ..."
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9(l)(c)(i).^^^ The Obligation of Member States to adopt provisions that are appropriate to ensure the effective application of the Regulation is based on Article 68(1). Party autonomy - choice ofa third System. According to the wording of Article 38(b), one of only two Systems may be chosen. It is probably clear that the System adopted in the Statutes may not differ from the models laid down by the Regulation (Articles 9(1)). But can the Statutes provide that the Company shall have other management, supervision or administrative bodies than those permitted by the Regulation? Is the choice of a management structure at the discretion of the Company so long as its Statutes comply with the provisions of the Regulation? To what extent is the choice of a management structure in the discretion of an SE's internal rule-makers? When answering these questions, one gets little guidance from the wording of the Regulation. It is probably necessary to distinguish between the regulation of the management structure in the Statutes and regulation by means of other internal rule-making. It could be argued that the Statutes cannot provide for management, supervision or administrative bodies not expressly authorised by the provisions of the Regulation. This is because this matter is regulated by the Regulation, that is, covered by Article 38(b). If Member States' laws do not govem an SB in this respect in the first place (Article 9(1 )(c)), party autonomy cannot be based on Member States' laws. To this extent, Article 38(b) could be mandatory law as far as an SE's internal rule-making is concemed. On the other hand, this does not necessarily apply to an SE's other internal rulemaking. Since Article 38(b) does not provide for the modalities of an SE's management, supervision or administration, the matter of delegation of these powers could be govemed by Member States' laws (Article 9(l)(c)(ii)). It is unclear to what extent Article 38(b) restricts delegation of the management function to subboard bodies. The Basic Characteristics ofthe Two Systems The Regulation contains mies specifically for the two-tier System, rules specifically for the one-tier System, and rules common to both Systems. The special rules governing either the two-tier System or the one-tier System set out an SE's management organs, the division of powers between these organs and the number and appointment of organ members. In addition, the Regulation contains provisions on managing directors (Articles 39(1) and 43(1), see below). The two-tier System. The two-tier System consists of a supervisory organ and a management organ. No member may serve on both the management board and the supervisory board at the same time (Article 39(3)).
^35 But compare Teichmann C, Die Einfuhrung der Europäischen Gesellschaft. Grundlagen der Ergänzung des europäischen Statuts durch den deutschen Gesetzgeber, ZGR 2002 p 443.
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The role of the supervisory organ is to "supervise" the work of the management Organ, that is, to check and monitor the management organ. The supervisory board may not itself exercise the power to "manage" the SE, that is, to engage in management tasks or represent the Company in transactions with third parties (Article 40). The members of the supervisory organ are normally appointed by shareholders in general meeting. However, this is without prejudice to any employee participation arrangements determined pursuant to Directive 2001/86/EC (Articles 40(2) and 47(4)). The management organ is responsible for "managing" the SE (Article 39(1)). In addition, the management organ must report to the supervisory organ on a regulär basis, pass information promptly on events likely to have an appreciable effect on the SE and respond to enquiries (Article 41). The member or members of the management organ are appointed and removed by the supervisory organ. A Member State may, however, require or permit the Statutes to provide that the member or members of the management organ shall be appointed and removed by the general meeting under the same conditions as for public limited-liability companies that have registered offices within its territory (Article 39(2)). One of the benefits of the two-tier System is that it can create an institutional and personal Separation of monitoring and management organs and help realise a distinct distribution of responsibilities and powers within the Company. The one-tier System. Under the single-tier structure, the SE is managed by an administrative organ instead of a supervisory organ and a management organ (Article 43). Members of an administrative organ are normally appointed and removed by shareholders in general meeting unless the rules on employee participation provide otherwise (Articles 43(3) and 47(4)). Management and supervision and Member States' laws. It is not easy to draw a line between "management" and "supervision". Although the supervisory organ is not supposed to exercise the power to manage an SE (Article 40(1)), the Regulation does not prevent the supervisory organ from exercising some fundamental management powers: the supervisory organ may appoint and remove members of the management organ (Article 39(2)) and authorise or refuse to authorise transactions (Article 48(1)). It is also clear that "management" includes even supervision such as the maintaining of internal controls: financial, operational and compliance Controls and risk management Systems.^^^ This means that a two-tier System can be "genuinely" two-tier for the purposes of the Regulation although the supervisory organ has some powers that in real life could just as well be said to belong to management. ^^^ ^^^ Compare for example the Combined Code of Corporate Govemance, provision C.2.1. ^^'^ But compare Werlauff E, SE - The Law of the European Company (2003) p 77: "[Article 40(1) of the Regulation] ensures that the two-tier System is genuinely two-tier, and not as in Denmark, where the board of directors both has supervisory tasks and takes part in the management of the Company, even if not in the daily management, but only the ' Overall' management."
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As the exact duties of an SE's supervisory, management and administrative Organs - the modalities of "management" and "supervision" - have not been defined in the Regulation (see nevertheless Article 41 on reporting), they must be govemed Member States' laws (Article 9(l)(c)(ii)). Rules common to both Systems. The provisions setting out rules common to both Systems cover some fundamental matters relating to organ membership and voting (such as the term of organ membership, conditions of eligibility for organ members and quorums)^^^ as well as certain matters preventing expropriation by Company insiders of the Company and its shareholders (such as decision-making on important transactions, the duty of confidentiality, and liability).^^^ The Managing Director There is room for a managing director or managing directors under both Systems. According to the wording of Articles 39(1) and 43(1), a Member State "may provide that a managing director or managing directors shall be responsible for the current management under the same conditions as for public limited-liability companies". An SE can thus have one or more managing directors depending on the implementation of the Regulation in the Member States. The wording of the Regulation raises some questions. Is the managing director or the body of managing directors an organ of the Company? Must a managing director be a member of the management organ or the administrative organ? Can an SE appoint a managing director if the position of managing directors has not been regulated by laws that apply to public limited-liability companies generally? There are differences between Member States' existing laws. Germany. A German AG does not have a "managing director" although the chairman or "Speaker" of the management board is often perceived as "CEO" by foreigners dealing with German companies. The business of an AG is managed by a management board (Vorstand) the members of which are executives who actually run the Company's affairs in their capacity as board members. A management board may not delegate its powers to lower ranking officers. If a German SE chooses the two-tier structure, it cannot appoint managing directors. The board structure will be that of an AG. However, a German SE must appoint one or more managing directors (Geschäftsführende Direktoren) under the one-tier structure. These managing directors can but do not have to be members of the administrative organ. Even other persons can be appointed.*"^^ The role of managing directors resembles the role of management board members (Vorstand) under the statutory two-tier structure of a German AG. In effect, a German SE that appoints one or more managing directors
^^^ Articles 46, 47 and 50, respectively. ^^^ Articles 48,49 and 51, respectively. 140 § 40(1) SEEG.
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will end up with a board structure that resembles that of an AG.^"*^ The supposedly one-tier structure looks like a two-tier structure. ^"^^ 77?^ United Kingdom. Whether a UK Company can appoint one or more managing directors depends on the wording of its articles of associaton. According to a regulation in model articles (Table A), a board member can be appointed as a managing director.^'*^ Most companies have adopted this regulation. A managing director is thus an executive board member who takes care of the day-to-day management of the Company and who has been appointed as a managing director by the board. The European Public Limited-Liability Regulations 2004 are silent on managing directors. The UK legislator did not make use of the Member State options under Articles 39(1) and 43(1) of the SE Regulation. On the other hand, it was believed that there was nothing in previous law that prevented a public limitedliability Company from regulating its board structure in articles of association, and it was obviously assumed that the SE Regulation did not change the law that applies to managing directors.^"^"^ There is therefore no Statute in the UK that would say that an SE incorporated in the UK might appoint a managing director. A UK Company must have a Company secretary,^"*^ A Company secretary has been described as "an officer of the Company with substantial authority in the administrative sphere and with powers and duties derived directly from the articles and the Companies Act".^"^^ A Company secretary is "the chief administrative officer of the Company". ^"^^ For example, a Company secretary regularly "enters into contracts ... which come within the day-to-day running of the Company's business".^"^^ A Company secretary is arguably a person who is to some extent "responsible for the current management" of the Company in the sense of the Regulation. The European PubHc Limited-Liability Regulations 2004 are silent on the Company secretary as well. The DTI had earlier indicated that the SE Regulation does not require an SE registered in the UK to appoint any Company secretary. Duties that would normally fall to the Company secretary (for example the filing of documents at Companies House) would need to be undertaken by one of the board ^"^^ There are some exceptions. For example, managing directors must follow directions given by the administrative organ under § 44(2) SEEG. ^^'^ See for example Hoffmann-Becking M, Organe: Strukturen und Verantwortlichkeiten, insbesondere im monistischen System, ZGR 2004 pp 371-372. ^^^ Section 8 of the Companies Act 1985. Table A, regulation 84 allows directors to "appoint one or more of their number to the office of managing director or to any other executive Office under the Company". Table A, regulation 72 provides that directors may "delegate to any managing director or any director holding any other executive office such of their powers as they consider desirable to be exercised by him". ^^^ See the Explanatory Memorandum for the Parliament on the European Public LimitedLiability Regulations 2004 (SI2004/2326), para 14 and Annex A. ^^^5 Section 283(1) of the Companies Act 1985. 14^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 298. ^"^^ Salmon LJ in Panorama Developments (Guildford) Ltd v Fidelis Fumishing Fabrics Ltd [1971] 2 QB 711, [1971] 3 All ER 16 (Court of Appeal). ^^^ Lord Denning MR in Panorama Developments.
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members of the SE.^"^^ However, the Consultation Document published by the DTI contained no express proposals to this effect. On the contrary, the DTI was of the opinion that "[pjrovisions in GB Company law that apply to PLCs will also apply to SEs ... and will apply equally to one-tier and two-tier boards unless specific different provision is made in respect of the latter under Article 39(5)".^^^ Organ. Therefore, the position of managing directors can be different in different Member States. It is probably not relevant whether the managing director is or is not regarded as an organ under Member States' laws governing public limitedliability companies. It is clear that a managing director will not be regarded as an independent organ under the SE Regulation because the management organs of the Company are those listed in Article 38; this matter is not govemed by Member States' laws (Article 9(l)(c)(ii)). The fact that the managing director is or is not regarded as an organ under national law will not affect the effectiveness of the SE Regulation's provisions as such. But whether the managing director is regarded as an organ under Member States' law can affect the managing director's rights and obligations under the governing law. It is not the objective of the SE Regulation to change these rights and obligations; Articles 39(1) and 43(1) set out expressly that a managing director or managing directors shall be responsible for the current management "under the same conditions as for public limited-liability companies". Member. It seems more interesting to ask whether the managing director must be a board member under the Regulation. One alternative could be to assume that since the Regulation does not lay down any express rules on the matter, the appointment and activities of managing directors are govemed by national law only. A better view could nevertheless be that only a member of the management organ or the administrative organ can be appointed as a managing director.^^^ This conclusion can be based on the objectives and the internal structure of the Regulation and it can be supported by the regulation of public limited-liability companies in UK and German law. According to the preamble, an SE must be "efficiently managed and properly supervised" and "the respective responsibilities of those responsible for management and those responsible for supervision should be clearly defined" (recital 14). While the Regulation contains some provisions on the responsibilities of organ members, it is silent on this matter as far as managing directors are concemed, although current management constitutes the most visible part of an SE's management.
^^9 Source: Mr. Peter Brower, DTI. 150 j)ji^ Implementation of the European Company Statute, para 3.39. See also para 3.41. ^^^ See also Hommelhoff P, Einige Bemerkungen zur Organisationsverfassung der Europäischen Aktiengesellschaft, AG 2001 p 284 (a managing director is a member). For another view see Neye HW, Teichmann C, Der Entwurf für das Ausfuhrungsgesetz zur Europäischen Aktiengesellschaft, AG 2003 p 179 (a managing director can be a member).
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This means that a managing director must be a member of the management Organ or the administrative organ, as the case may be. The provisions of the Regulation seem to be based on this idea: (a) Under a two-tier System (the same principles apply under a one-tier System), the management organ shall be responsible for managing the SE. According to the wording of the Regulation, a Member State may provide that a managing director or managing directors shall be responsible for the current management of the SE (Article 39(1)), which could imply that a managing director is a member of the management organ. (b) The members of the management organ shall be appointed and removed by the supervisory organ (Article 39(2)), but there are no express provisions on the appointment and removal of a managing director. Such provisions are not necessary if the managing director is a member of the management organ. (c) The number of members of the management organ or the rules for determining it shall be laid down in the SE's Statutes (Article 39(4)), and the same rule should probably apply to the number of managing directors. (d) No person may at the same time be a member of both the management organ and the supervisory organ of the same SE (Article 39(3)). It is probably clear that a managing director should not be a member of the supervisory organ of the same SE. (e) The supervisory organ shall supervise the work of the management organ (Article 40(1)), but there are no express rules on the supervision of the work of a managing director. Such rules are not necessary if the managing director is a member of the management organ. (f) The management organ shall report to the supervisory organ at least once every three months on the progress and foreseeable development of the SE's business (Article 41(1)). It is not necessary to have express rules on the managing directors' duty to report if the managing directors are members of the management organ and the management organ reports collectively to the supervisory organ. The same can be said of the duty of the management organ to promptly pass the supervisory organ any information on events likely to have an appreciable effect on the SE (Article 41(2)) and the right of the supervisory organ to require the management organ to provide Information of any kind which it needs to exercise supervision (Article 41(3)). (g) Members of Company organs shall be appointed for a period laid down in the Statutes not exceeding six years (Article 46(1)). It would be contrary to the objectives of this Provision not to apply it to managing directors. The same can be said of the eligibility of organ members (Article 47(2)), the duty of confidentiality (Article 49), and the liability for breach of duty (Article 51). (h) An SE's Statutes shall list the categories of transactions which require authorisation of the management organ by the supervisory organ in the two-tier System or an express decision by the administrative organ in the one-tier System (Article 48(1)), but there is no express Provision on authorisation of the managing director or managing directors by the management organ in the two-tier System. Even this implies that a managing director is a member of the management organ or the administrative organ. Same conditions. According to the wording of the Regulation, a Member State "may provide" that a managing director or managing directors shall be responsible for the current management "under the same conditions as for public limitedliability companies". On the other hand, Article 9(l)(c)(ii) provides that an SE shall be govemed by the provisions of Member States' laws that would apply to a
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public limited-liability Company. Is the reference to "the same conditions" meaningless in light of the fact that an SE is govemed by the provisions applicable to public limited-liabiHty companies anyway?^^^ This is not the case. A managing director either is or is not regarded as an organ, or an organ member, under Member States' laws applicable to public limited-liability companies, but a managing director is definitely not regarded as an organ under the Regulation. The reference to "the same conditions" could therefore mean the following things: (a) The managing director of an SE and the managing director of a public limited-liability Company are basically not the same thing because the rules governing them are not the same (provisions of the Regulation v. provisions of Member States' laws). (b) Basically, the rules applicable to the managing director of a public limited-liability Company do not govem an SE under Article 9(l)(c)(ii) because this matter is regulated by Articles 38, 39(1) and 43(1) of the Regulation, (c) If a Member State provides that a managing director or managing directors shall be responsible for current management, a managing director must, because of the reference to "same terms", nevertheless have the powers, rights and obligations conceming current management that a managing director would have in a public limited-liability Company (Articles 39(1) and 43(1)). (d) While the appointment and remuneration of members of a management organ or an administrative organ are covered by the provisions of the Regulation (Articles 39(2) and 43(3)), the appointment and remuneration of a managing director are not. In this respect, the "same terms" will apply (Articles 39(1) and 43(1)). (e) Different terms are permitted at least where they are appropriate to ensure the effective application of the Regulation (Articles 68(1) and 9(l)(c)(i)). For example, they may be necessary in light of the managing director's Status as member of the management organ or administrative organ of an SE. (f) The term "current management" does not have to be defined independently and given a Community meaning because the distribution of powers within a management organ or an administrative organ does not have to regulated by the Regulation (recitals 14^^^ and 29) and is generally not covered by its specific provisions. Can the laws of a Member State provide for a managing director or managing directors under Article 39(1) or 43(1) although there are - like in Germany^^"^ - no provisions on managing directors for public limited-liability companies in this Member State? The answer must be yes. The organs of an SE are regulated in Article 38, and the right of Member States to provide for a managing director or managing directors in implementing legislation is regulated in Articles 39(1) and 43(1). A managing director in the sense of the Regulation is not a body whose existence is based on Member States' provisions on public limited-liability compa'^2 See Neye HW, Teichmann C, Der Entwurf für das Ausfuhrungsgesetz zur Europäischen Aktiengesellschaft, AG 2003 p 176 at footnote 38. ^^^ According to the wording of recital 14, "the respective responsibilities ofthose responsible for management and those responsible for supervision should be clearly defined", but the distribution of powers within the management organ or the administrative organ has not been mentioned. ^^"^ See Neye HW, Teichmann C, Der Entwurf für das Ausführungsgesetz zur Europäischen Aktiengesellschaft, AG 2003 p 176.
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nies. It is arguable that it would amount to discrimination on grounds of nationality^^^ to allow some Member States to adopt provisions on managing directors for SEs but prohibit other Member States from doing so. Furthermore, the different treatment of Member States on this point cannot be justified by the need to protect third parties or employees or to enable restructuring and Cooperation Operations involving companies from different Member States, it would go beyond what is necessary to attain the objectives of the Regulation (see recital 29), and it would be contrary to its objectives (see especially recital 7). If this analysis is correct, a Member State like Germany may provide that a managing director or managing directors shall be responsible for the day-to-day management without changing the provisions that govem pubhc limited-liability companies generally^^^ or copying the rules that govem the Vorstand. Germany has implemented the Regulation in effect by doing the latter. It is clear that a managing director cannot be responsible for day-to-day management under the same conditions as in a public limited-liability Company if there is no legislation setting out those conditions in the first place. A Member State must then adopt such provisions as is appropriate under Article 68(1) and may do so under Article 9(l)(c)(i). The General Meeting An SE must have a general meeting of shareholders (Article 38). The Regulation contains some provisions on the powers of the general meeting (Article 52). However, the legal nature of the general meeting has been left open in the Regulation. For example, the Regulation does not say that the general meeting of shareholders is an "organ" of the Company (see Chap. 5.2.2 below).^^"^ Powers. The powers of the general meeting are generally govemed by the provisions of the law of the Member State in which the SE's registered office is situated. In this case, the governing law is determined not by Article 9(l)(c)(ii) and the applicable rules of private international law but by an express rule in the SE Regulation. The general meeting shall also decide on matters for which responsibility is given to the general meeting by the SE's Statutes in accordance with that law. In addition, the general meeting shall decide on matters for which it is given sole responsibility either by the Regulation^^^ or the rules on employee involve-
^^^ Article 12(1) of the Treaty establishing the European Community. ^^^ Compare Neye HW, Teichmann C, Der Entwurf für das Ausfuhrungsgesetz zur Europäischen Aktiengesellschaft, AG 2003 p 176. ^57 See also Werlauff E, SE - The Law of the European Company (2003) pp 95-96. ^58 See especially Article 8(4) (transfer of registered office); Article 23(1) (approval of the draft terms of merger); Article 32(6) (formation of a holding SE); Articles 37(5)-37(7) (conversion of an existing public limited-liability Company into an SE, approval of the draft terms of conversion); Article 39(2) (appointment and removal of a member or members of the management organ); Article 40(2) (appointment of the members of the supervisory organ); 43(3) (appointment of the member or members of the administrative
3.5 Conclusion
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ment supplementing its provisions (that is, the legislation of the Member State in which the SE's registered office is situated adopted in implementation of Directive 2001/86/EC). For example, amendment of an SE's Statutes shall require a decision by the general meeting taken by a majority which may not be less than two thirds of the votes cast, unless the law apphcable to public limited-liabihty companies in the Member State in which an SE's registered office is situated requires or permits a larger majority (Article 59(1)). Voting. The Regulation contains some provisions on the Organisation and conduct of general meetings and on voting procedures (Article 53), on majorities (Article 57) and the amendment of an SE's Statutes (Article 59). These provisions are dispositive in that: the general meeting's decisions shall be taken by a majority of the votes validly cast unless Member States' laws require a larger majority (Article 57); the amendment of an SE's Statutes requires a majority not less than two thirds of the votes cast, unless Member States' laws provide otherwise (Article 59); and the matter of Organisation and conduct of general meetings and voting procedures is govemed by Member States' laws (Article 53). The Regulation contains even some provisions on decision-making in the event that an SE has two or more classes of shares.^^^ Constraints on the exercise of voting rights are generally covered by Member States' laws in the absence of specific provisions in the Regulation (Article 9(l)(c)(ii)).
3.5 Conclusion The possible powers of shareholders to make the rules according to which a public limited-liability Company is run are, with some exceptions, govemed by the provisions of Member States' laws rather than the derivative EU Company or securities markets law. The regulation of the govemance of companies has been a sensitive issue in the EU. EU Company law Directives have relied on a piece-meal approach and the harmonisation of a few core issues. For example, shareholders in general meeting decide on measures relating to share capital and structural change. On the other hand, there is extensive harmonisation of securities markets laws in the EU. Rules governing the disclosure of information to shareholders and investors have largely been harmonised by securities markets Directives.
organ); Article 59 (amendment of an SE's Statutes); Articles 66{A)-66{6) (conversion of an SE into a public limited-liability Company, approval of the draft terms of conversion). ^^^ Where an SE has two or more classes of shares, every decision by the general meeting shall be subject to a separate vote by each dass of shareholders whose dass rights are affected thereby (Article 60(1)). Where a decision by the general meeting requires the majority of votes specified in Article 59(1) or (2), that majority shall also be required for the separate vote by each dass of shareholders whose dassrightsare affected by the decision (Article 60(2)).
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For many reasons, there is likely to be more piece-meal harmonisation regarding the govemance of public limited-hability companies in the future. In the long run, the legislative developments in the USA and the stated objective of setting international Standards based on EU law may make it necessary to codify core corporate govemance principles in the EU. The lack of detailed mies means that the SE Regulation can hardly be used as a model for the regulation of corporate govemance or the power of shareholders to act as a mle-maker. With this in mind, one would assume that the SE Regulation could only to a limited extent lead to the convergence of mies that govem shareholders' rights in Europe. It is nevertheless possible that the SE Regulation leads to some convergence, because some of its provisions may act as legal irritants and force Member States to amend laws that govem public limited-liabihty companies in general, and the fear of competition between Company forms or between Member States can have the same effect. For example, the SE Regulation can make it more difficult for Germany not to change its co-determination laws.
4 The United Kingdom
4.1 General Remarks 4.1.1 Introduction UK law and the work carried out by the Cadbury, Greenbury and Hampel Committees have had an effect on the corporate govemance debate in other European countries. Many think that the corporate govemance framework adopted in the UK is more stringent and highly developed than those in other European markets. But Problems related to the regulation of corporate govemance in the past have led to wide-reaching reforms in recent years. It is interesting to note that although the legal powers of shareholders to influence management are quite limited, UK shareholders might be more powerful than their US counterparts.^ Environment. A distinctive feature of the corporate govemance System in the UK is that the environment in which its public companies operate strongly resembles that which exists in the USA.^ Common features in the UK and the USA include the presence of welldeveloped equity markets, relatively dispersed share ownership,^ and the important role played by institutional Investors who prefer a highly diversified portfolio of shares and freedom to seil their shares (an "exit Option")."^ The stmcture of ownership and control in the UK and the USA has been characterised as an "outsider" or "arm's-length" System.^ Institutional Investors have given executives significant managerial discretion in the past.
See Bebchuk LA, The Case for Increasing Shareholder Power, Harv L Rev 118 (2005) pp 847-850. For differences see Armour J, Cheffins BR, Skeel DA, Corporate Ownership Stmcture and the Evolution of Bankruptcy Law: Lessons from the United Kingdom, Vand L Rev 55 (2002) pp 1714-20. See La Porta R, Löpez-de-Silanes F, Shleifer A, Vishny RW, Law and Finance, J Polit Economy 106 (1998) p 1146 and Table 7: in the world as a whole, dispersed ownership in large public companies is "simply a myth". Schmidt RH, Tyrell M, What Constitutes a Financial System in General and the German Financial System in Particular? In: Krahnen JP, Schmidt RH (eds) The German Financial System (2004) p 58. See for example Cheffins BR, Law as Bedrock: The Foundations of an Economy Dominated by Widely Held Public Companies, OJLS 23 (2003) pp 3-4.
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In addition, both countries are said to have a "shareholder economy", where private enterprise is about maximising profits for those who invest, and where shareholders occupy the central position with respect to companies.^ In the UK, the tolerance of inequality is higher than in Germany. For example, London is the economic, financial and political center of the country. Britain is perceived as a class-oriented society and the distribution of income is slightly less equal than in Germany;'^ the UK can generally be regarded as less committed to a Cluster of European social values called "social democracy" than Germany.^ On the other hand, Britain is usually associated with a sense of "fair play" and pragmatism. Traditionally, the position of the State has been weak in comparison to the rest of Europe. On the other hand, the key relationship that established and maintained the City of London's pre-eminence in the UK economy was its connection with the Crown and central govemment.^ A further factor that should not be forgotten here is legal costs. In the UK, the general "loser pays" principle applies. The court has discretion as to whether and when costs are payable, but the general rule is that the loser pays the winner's costs to an extent that reflects the success of the winner, taking into account the conduct of the parties before and during proceedings and any payment into court or offers to settle. Contingency fee agreements are not allowed in the UK. The use of Conditional Fee Arrangements (no win/no fee) and After the Event insurance policies (insurance against the costs of unsuccessflil litigation) is on the increase, although their legal Status is uncertain. Regulation, This environment is reflected also in the regulation of corporate govemance. To begin with, the regulation of markets is path dependent, and all UK markets have firm, long-held traditions of self-regulation: "They are legally grounded in the law merchant and common law, and have at their heart the belief that commerce is a domain of private transactions. The private regulatory structures of the
See Armour J, Cheffms ER, Skeel DA, Corporate Ownership Structure and the Evolution of Bankruptcy Law: Lessons from the United Kingdom, Vand L Rev 55 (2002) p 1715. See for example The Economist 4 September 2003, Inequality. Would you like your dass war shaken or stirred, sir? Hopt KJ, The German Two-Tier Board: Experience, Theories, Reforms. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) Comparative Corporate Govemance - The State of the Art and Emerging Research (1998) p 252. See Mark J. Roe, Political Preconditions to Separating Ownership from Corporate Control, Stan L Rev 53 (2000) pp 573-577; Coffee JC, The Rise of Dispersed Ownership: The Roles of Law and the State in the Separation of Ownership and Control, Yale L J 111 (2001) pp 15-16; Armour J, Cheffms BR, Skeel DA, Corporate Ownership Structure and the Evolution of Bankruptcy Law: Lessons from the United Kingdom, Vand L Rev 55 (2002) p 1717. Gilligan GP, The Origins of UK Financial Services Regulation, Comp Lawyer 18 (1997) pl69.
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City's markets therefore reflect national characteristics and are partially explained by the relative weakness of the central state."^^ What is characteristic of the regulation of the govemance of public limitedliability companies by traditional Company law is that: courts are reluctant to interfere with the internal administration and business decisions of the Company; traditional Company law is flexible; the guiding principle is disclosure; articles of association are the main source of rules on the distribution of powers in the Company; and articles of association usually confer wide powers on the board of directors. But apart from the disclosure principle, this cannot be said of the regulation of UK securities markets. Securities markets laws are not flexible but contain a large number of mandatory provisions. The govemance of listed companies is increasingly being regulated by these rules. The large powers of the board under traditional Company law and articles of association are nowadays limited both by extemal rules, such as listing rules and corporate govemance codes, and by intemal mle-making. It is normal that the acts of executive directors are constrained by the board membership of independent non-executive directors. In addition, the powers of the statutory board to mn the Company are de facto constrained by the delegation of many management functions to sub-board executive bodies. At the same time, some of the mies that govem the activities of statutory board members are applied, either directly or by analogy, to sub-board managers.
4.1.2 The Most Important Legal Forms of Business Organisation In the UK, most companies are registered companies, that is, companies incorporated under the Companies Act 1985. A registered Company can be a Company limited by shares,*' a Company limited by guarantee^^ QJ. ^n unlimited Company. ^^ The registered Company is not the only Company form in the UK. For historical reasons, there are even chartered companies (companies whose existence is based on a charter granted by the Crown) and statutory companies (companies incorporated by Statute). These Company forms are not govemed by the Companies Act 1985. The Limited Liability Partnerships Act 2000 introduced the LLP, a British Version of the US limited liability Company (LLC). A hybrid between a Company and a partnership, an LLP offers limited liability protection to its members and the flexibility of management and the taxation stmcture of a partnership. The openended investment Company (OEIC) is also a new Company form,^"^ and Part 2 of the Companies (Audit, Investigations and Community Enterprise) Act 2004 makes
Gilligan GP, ibid p 169. Section l(2)(a) of the Companies Act 1985. See also Table A. Section l(2)(b) of the Companies Act 1985. Section l(2)(c) of the Companies Act 1985. See section 262 of the FSMA 2000 and the Open-Ended Investment Companies Regulations2001.
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Provision for the establishment of a new corporate vehicle, the Community interest Company (CIC), in order to promote the development of social enterprise. Like the Company laws of other Member States of the EU, the Companies Act 1985 distinguishes between private companies and public limited companies.^^ This distinction is nowadays based on the provisions of the Second Company Law Directive. The regulations governing public companies are more extensive than those governing private companies: ownership and management are normally separated in a public Company, but in a private Company they are often in the same hands. In many areas, however, no distinction is made between these two types of Company. While the form of the Companies Act 1985 reflects the needs of large companies, most companies incorporated in the UK are registered as private companies. In its Final Report,'^ the Steering Group of the Company Law Review made a ränge of recommendations that are intended to change the framework of Company law for small firms. In particular, the Final Report recommends measures that would simplify the administration of private companies.
4.1.3 Sources UK Company law is only partly codified. The regulation of the govemance of public companies is based on statutory law and uncodified common law, Standards and practices that are in effect binding, and market self-regulation. This makes it difficult and time-consuming to find out about the governing rules. The Companies Act 1985 applies both to private companies and to public companies. The Companies Act 1989 and the Companies (Audit, Investigations and Community Enterprise) Act 2004^^ are two of the important Acts amending the 1985 Act. In the following, references to the provisions of the Companies Act 1985 include also references to provisions amended or inserted by other Acts. In July 2002, the Department of Trade and Industry (DTI) published its White Paper on Company law reform.^^ It was the Government's first official response to the Final Report and Recommendations of the Company Law Review (CLR) exercise, which was published in July 2001.^^ The White Paper not only set out the Government's intentions for the shape of the planned Companies Bill but also set out around 200 draft clauses of the Bill for comment by interested parties.
^5 Section 1(3) of the Companies Act 1985. ^^ Modem Company Law for a Competitive Economy: Final Report (July 2001). ^'' There is also a commencement order which brings the 2004 Act's provisions into effect. The Companies (Audit, Investigations and Community Enterprise) Act 2004 (Commencement) and Companies Act 1989 (Commencement No 18) Order 2004. ^^ Modemising Company Law White Paper Cm 5553 (July 2002). '^ Modem Company Law for a Competitive Economy: Final Report (July 2001).
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Specialist Acts contain some of the material that was formerly contained within the Companies Act 1985 or previous Companies Acts. In particular, matters relating to financial Services and insolvency are regulated by specialist Acts.^^ Common law is based on case law. This is regarded as both good and bad. Carnwath LI has said: "One of the curses of the common law method in the 2Ist Century is unlimited accessibiUty to authorities, reported and unreported, and apparently unlimited resources for copying them ... On the other hand, one of the blessings is the availability of up to date and authoritative textbooks^^ on almost every relevant subject, in which the material cases have been sorted out and digested." Carnwath U described his own method in a recent case as follows: "For my part, at least where I am concemed with common law rather than Statute, I find it most helpful to Start by looking for a succinct Statement of the relevant principle: either in a recent binding decision of the higher courts, if there is one; or, if not, in a leading textbook (or, where available, a Law Commission report). Of course, that is only the starting point. Authorities may be needed to qualify, expand, or merely illustrate the basic principle. However, it is important to be clear for which of those purposes any case is being advanced. Furthermore, where the purpose is to qualify or expand, it is not enough simply to cite an authority, without being able to articulate with reasonable precision the proposition which it is said to Support. Occasionally, and exceptionally, the uncertainty of the law in a particular area may require a detailed examination of cases going back over a long period. In such cases, for my part, I welcome all the help I can get. In most disputed areas of the law, it is possible to identify a recent, informed academic treatment of the subject by a recognised authority, with a füll discussion of the relevant cases. Proliferation of academic articles is no more welcome than proliferation of authorities. However, an objective academic review can often provide the best framework for the discussion in court, and a useful corrective to the necessarily partisan viewpointofcounsel."22 The Practice Direction on the Citation of Authorities^^ seeks to limit the citation of previous authority to cases that are relevant and useful to the court. It may nevertheless be difficult to define the applicable rule. The works of academic writers are cited relatively seldom by courts. In the past, counsel were not entitled to quote living authors as authorities.^"*
^^ Insolvency Act 1986, Company Directors Disquahfication Act 1986, Financial Services and Markets Act 2000. 2^ Cheffins BR, Using Theory fo Study Law: A Company Law Perspective, CLJ 58(1) (1999) p 199: "A classic example familiär to British Company lawyers is Gower's Principles of Modem Company Law." 22 GEL Group Ltd v Nedlloyd Lines UK Ltd & another [2003] EWCA Civ 1716. 2^ Signed by the Lord Chief Justice of England and Wales on 9 April 2001. Referred to in Harvey Shopfitters Ltd v ADI Ltd [2003] EWCA Civ 1757 at [22], [23]. 2"* See Kötz H, Die Zitierpraxis der Gerichte. Eine vergleichende Skizze, RabelsZ 52 (1988) pp 649-653.
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A factor that contributes to the "uncertainty of the law" is the role of equitable considerations. Equitable considerations are an important part of traditional UK Company law and courts often try to avoid clear-cut rules.^^ The corporate Constitution of a Company is composed of two documents: the memorandum of association and articles of association.^^ The Companies Act 1985 is supplemented by Tables A to F 1985^'^ made under sections 3 and 8 of the Act. These Tables contain a model Constitution. A Company limited by shares may for its articles adopt the whole or any part of Table A. The Final Report of the Company Law Review and the Government's White Paper have recommended a Single constitutional document which would replace the memorandum and articles. A new Table A would then become necessary. Companies must comply with accounting Standards set by the Accounting Standards Board ASB). The ASB is a subsidiary of the Financial Reporting Council (FRC), an independent regulator.^^ The Financial Services and Markets Act 2000 (FSMA 2000), which replaced the Financial Services Act 1986, provides a statutory framework for the regulation of investment business. It sets out the obligations of issuers of hsted securities and makes provision for the making of listing rules. The specific activities regulated by the FSMA 2000 include also market abuse and the making of misleading Statements. Companies that are listed on the London Stock Exchange are required to comply with the Listing Rules approved by the UK Listing Authority; it says in the Listing Rules that issuers must comply with them (paragraph 1.1). The Financial Services Authority (FSA) is the UK Listing Authority. The Listing Rules contain a reference to the Combined Code of Corporate Govemance (paragraph 12A3A)}^ Listed companies must therefore adhere to the Combined Code as well. The Combined Code focuses on principles and rules conceming the board. It is a set of main principles, supporting principles and provi^^ In the past, the were courts of equity and law courts. ^^ A Single constitutional document has been proposed, to replace the articles and memorandum of association. See Modem Company Law: Final Report, para 9.4. 27 Companies (Tables A to F) Regulations 1985 (S.I. 1985 No. 805). 2^ The first Part of the Companies (Audit, Investigations and Community Enterprise) Act 2004 gave the subsidiary bodies of the FRC new powers to exercise statutory functions in relation to accounting and auditing. 2^ The Listing Rules, 12.43A: "In the case of a Company incorporated in the United Kingdom, the foUowing additional items must be included in its annual report and accounts: (a) a narrative Statement of how it has applied the principles set out in Section 1 of the Combined Code, providing explanation which enables its shareholders to evaluate how the principles have been applied; (b) a Statement as to whether or not it has complied throughout the accounting period with the Code provisions set out in Section 1 of the Combined Code. A Company that has not complied with the Code provisions, or complied with only some of the Code provisions or (in the case of provisions whose requirements are of a continuing nature) complied for only part of an accounting period, must specify the Code provisions with which it has not complied, and (where relevant) for what part of the period such non-compliance continued, and give reasons for any non-compliance."
4.1 General Remarks
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sions. The Combined Code is not binding, but an issuer must: (a) apply the principles set out in Section P^ of the Combined Code and explain how they have been apphed; and (b) either comply with the provisions set out in Section 1 of the Code provisions or give reasons for any non-compliance. The purpose of this "comply or explain" principle is to secure sufficient disclosure so that investors and others can assess a listed Company's corporate govemance practices and respond in an informed manner. In addition, the Listing Rules require companies to report to shareholders on directors' remuneration.^^ While the previous Combined Code embraced work carried out by the Cadbury, Greenbury and Hampel Committees, the new Combined Code of Corporate Govemance is to a large extent based on the draft revision of the previous Code that Derek Higgs suggested in his report on non-executive directors published in January 2003. The Code was approved by the Financial Reporting Council on 23 July 2003.32 The City Code on Takeovers and Mergers (the City Code) and the Rules Governing Substantial Acquisitions of Shares (the SARs) apply to the acquisition of shares. Both the City Code and the SARs are administered by the Panel on Takeovers and Mergers.33 They have also been endorsed by the Financial Services Authority (FSA).3'* The purpose of endorsing the City Code and the SARs is to provide them with statutory support.^^ Statutory support means, for example, that there are administrative sanctions for breach of these rules.^^ The City Code and the SARs do not form part of the listing rules although they have been endorsed by the FSA and are supported by the UK Listing Authority (the FSA).^^ There is overlap between regulators. For example, corporate finance activities or transactions may give rise to the involvement of more than one regulator at a time. A public Company takeover offer involving the issue of securities to be listed on the Official List as consideration for the offer will thus be regulated by the FSA, UKLA, the Stock Exchange and the Takeover Panel simultaneously: the FSA and UKLA because of the promotion of and listing of securities, the Stock
3^ Section 1 applies to companies and Section 2 to institutional shareholders. Companies are not required to report on whether and how they have complied with the provisions set out in Section 2 of the Code. 31 The Listing Rules, 12.43A(c). 32 The Financial Reporting Council (FRC) with its subsidiaries, the Accounting Standards Board (ASB) a n d the Financial Reporting Review Panel (FRRP) together m a k e u p an Organisation whose purpose is to promote and secure good financial reporting.
33 See FSA Handbook, Market conduct, Endorsement of the Takeover Code, para 4.2.4. 34 Section 143 o f the F S M A 2000; F S A Handbook, Market conduct, Endorsement of the Takeover Code, paras 4.2.1 and 4.2.2. 3^ F S A Handbook, Market conduct, Endorsement of the Takeover Code, para 4.1.3. 36 Section 143 o f the F S M A 2000; F S A Handbook, Market conduct, Endorsement o f the Takeover Code, paras 4.2.3 and 4.3.1. 3*^ The Listing Rules, Chapter 10, Scope of chapter.
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Exchange for admission of securities to trading and the Takeover Panel because of the takeover offer.^^
4.1.4 The Extent of Party Autonomy in Ruie-making What is the general approach of UK law to party autonomy in the law of public limited-liability companies? How much extemal rule-making is there? To what extent are the extemal provisions mandatory? Which matters are left to the discretion of shareholders? It is necessary to look at both Company law and securities markets law to answer these questions. General approach in Company law. UK Company law is regarded as flexible. It has been said in the UK that UK Company law "gives greater flexibility to the founders and Controllers of companies to design and structure their businesses to suit their needs than any other legal System". This has been viewed as "a great strength, which is likely to prove a major competitive advantage".^^ Flexibility is complemented by disclosure. Sealy has said that disclosure is "one key Word which more than any other sums up the underlying principles of [UK] Company law". He has also observed that "when it comes down to a choice between having a fixed rule about something on the one hand and having no fixed rule as to what a Company must do but saying that whatever it does has to be openly disclosed, the natural choice within the traditions of English Company law has always been to opt for the second approach"."*^ According to the Final Report of the Steering Group of the Company Law Review, freedom and transparency must go hand in hand: "the basic framework of [UK Company] law should provide the maximum possible freedom to the participants, but combined with the necessary supporting transparency to empower the effective exercise ofthat freedom"."*^ Regulatory Intervention in Company law, The Company Law Review listed some justifications for regulatory intervention.'^^ Four justifications were given, with the qualification added that "[w]hen intervention is necessary it should be designed, so far as possible, to avoid inhibiting freedom of choice and flexibility for development"."*^ According to the Company Law Review, justification arises where: legal provision is required to achieve an outcome that is otherwise unobtainable (for example, obtaining the company's separate legal personality); the desired outcome is predictable and the law can supply the parties with default rules ^^ See Slorach S, Corporate Finance, Mergers & Acquisitions 2004. Legal Practice Course Guides (2004) pp 4-5. ^^ Modem Company Law: Final Report, para 1.26; see also Goddard R, Modemising Company Law: The Govemment's White Paper, MLR 66 (2003) p 408. ^^ Sealy LS, Company Law and Commercial Reality (1984) p 21; see also Goddard R, Modemising Company Law: The Govemment's White Paper, MLR 66 (2003) pp 408409. "^^ Modem Company Law: Final Report, para 1.15; see also Goddard R, op cit p 409. ^'^ For an analysis of the justifications see Goddard R, op cit pp 402-424. ^^ Modem Company Law for a Competitive Economy: Developing the Framework, para 2.6.
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87
thereby reducing transaction costs (for example, a model Constitution); individuals are unable to protect their interests (for example, because of market failure); or the public interest intrudes upon the activity in question."^"^ The first two justifications reflect a narrow role for the State in corporate affairs. Significant emphasis is placed upon the value of party autonomy. The third and fourth justifications show that there can be a legitimate interest for mandatory rules. For example, a public interest mentioned in the fourth justification already exists in the State's provision of a structure for corporate activity. The fourth justification is also illustrated by rules without which confidence in the process of private ordering would be undermined: mandatory disclosure provisions facilitate the flow of information to the market, and rules prohibiting fraud and dishonesty protect the process of private ordering from abuse. The role of mandatory provisions in Company law. In Company law, the traditional approach has been to leave the making of rules on the govemance of companies to the discretion of shareholders and Company bodies. The numbers of statutory provisions and mandatory provisions have nevertheless increased over the years. The mandatory provisions of the Companies Act 1985 relate especially to disclosure and the duties and accountability of directors or officers. There are also an increasing number of criminal offences related to these duties. It is worth noting that the interests of the workforce are not directly protected by mandatory rules in the companies legislation,"^^ but can be protected by provisions of labour law. For example, it has been recognised that contracts of employment are not equated with commercial contracts, and implied terms can protect employees from the "harsh and unacceptable employment practices" to which they could otherwise be exposed."^^ Express contract terms nevertheless take precedence over implied terms. As regards the rights of shareholders to "opt out" of extemal regulation, it is necessary to distinguish between four things: (a) Company law and rules such as the Combined Code of Corporate Govemance on one hand; and (b) party autonomy when the Company is founded and party autonomy during the life of the Company on the other.^"^ When the Company is founded, the founders and shareholders have plenty of discretion as far as the Constitution of the Company is concemed. But the discretion available to shareholders is limited during the life of the Company by statutory and common law rules on the distribution of powers, internal decision-making, and amendment of the Constitution. One could say that part of the discretion available to shareholders is consumed when shareholders make use of it by founding a Company or deciding on its con^^ Modem Company Law: Final Report, para 1.11. ^^ See Wedderbum A, Employees, Partnership and Company Law, ILJ 31 (2002) pp 99111. 46 Lord Steyn in Johnson v Unisys Limited [2001] UKHL 13; [2001] 2 All ER 801; [2001] 2 WLR 1076. See especially paras 19 and 20. ^'^ See also Rajak H, Gestaltungsfreiheit im Gesellschaftsrecht des Vereinigten Königreichs, ZGR-Sonderheft 13 (1998) p 191.
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stitution. After that, Company law makes it difficult for shareholders to change things but gives the board of directors and management relatively free hands. Formation. The founders of a Company draft the memorandum of association and articles of association for the Company. Both the number of provisions and the Contents of Substantive provisions have largely been left to the discretion of founding members. The articles of association of a UK Company typically contain both more regulations and more detailed regulations than the articles of association of a German Company; many matters that would be regulated by mandatory statutory rules in Germany are thus regulated by articles of association in the UK. In the UK, a Company must have a memorandum of association to specify its Constitution and objects."*^ In principle, the Registrar will not register a company's memorandum unless he is satisfied that all the statutory requirements have been complied with."*^ In practice, the memorandum of association is a simple document that contains only very fundamental Information. The memorandum of a Company limited by shares must State:^^ (a) the name of the Company;^^ (b) whether the company's registered office is to be situated in England and Wales or in Scotland; (c) the objects of the Company; (d) that the liability of the members is limited; and (e) the maximum amount of capital the Company may raise and its division into shares of a fixed amount. The memorandum of a public Company must State that it is to be public company.^2 Precedents for the memorandum of association for a public Company are set out in Table F (SI 1985 No 805). In practice the Contents of a memorandum will be more elaborate than the suggested form. The Companies Act 1985 contains some important restrictions relating to capital that must be observed in the memorandum. These provisions are based on the Second Company Law Directive, which contains a number of detailed provisions aiming at protecting shareholders and creditors. For example, the authorised minimum capital ofa public Company is £50,000.^^ A public Company may not allot a share except as paid up at least as to one-quarter of its nominal value and the whole of any premium of it.^"^ There are detailed rules on the transfer to a public Company of non-cash assets,^^ and a public Company may not accept, in payment ^^ Section 1(1) of the Companies Act 1985: "Any two or more persons associated for a lawful purpose may, by subscribing to a memorandum of association and otherwise complying with the requirements of this Act in respect of registration, form an incorporated Company, with or without limited liability." ^^ Section 12 of the Companies Act 1985. ^^ Section 2 of the Companies Act 1985. ^^ The choice ofa name for a Company is subject to a number of restrictions. See sections 25 and 26 of the Companies Act 1985. ^^ Section l(3)(a) of the Companies Act 1985. In a public Company, each subscriber to the memorandum must take at least one share in the Company, section 2(5) of the Companies Act 1985. 5^ Section 118(1) of the Companies Act 1985. ^4 Section 101(1) of the Companies Act 1985. 55 Sections 104-195 of the Companies Act 1985.
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up of its shares, an undertaking given by any person that he should do work or perform Services. ^^ In addition to a compulsory memorandum of association, a Company limited by shares may have articles of association.^^ The contents of the articles of association are in most cases at the discretion of the shareholders because they are not compulsorily laid down by the Companies Act. Table A attached to the Act becomes the articles of association of a Company limited by shares if no articles are registered, or if the articles that are registered do not exclude or modify Table A.^^ In addition, the Companies Act merely forbids the inclusion of certain clauses or makes them of no effect if they do appear.^^ Life of the Company. During the life of the Company, the role of mandatory Company law is different. Statutory law is basically mandatory.^^ In the event of a conflict between the Constitution of the Company and statutory law, statutory law will prevail. Statutory law also affects shareholders legal powers to influence management. For example, the provisions of Companies Act 1985 on the alteration of the memorandum and articles of association are mandatory: the articles of association can be altered by special resolution,^^ and the memorandum can be altered by special resolution with respect to the Statement of the Company's objects.^^ Like these provisions, the provisions of Companies Act 1985 protecting creditors or minorities are mandatory. There is nevertheless plenty of case law on how binding the provisions of the Companies Act are, and the principle of unanimous consent is an exception to this main rule. According to this principle, "the Company is bound in a matter intra vires by the unanimous agreement of its members".^^ Because the informal consent of the members must be unanimous,^"^ this principle cannot be applied in a public Company with plenty of shareholders, but it can be applied in a subsidiary Company or private Company with few shareholders. It is therefore important in Company groups. ^^ Section 99 of the Companies Act 1985, see also section 102. ^'' Section 7 of the Companies Act 1985. ^^ Section 8 of the Companies Act 1985. ^^ For example, section 310 of the Companies 1985. ^^ Parts of statutory law can also be merely enabling. For example, provisions on the acquisition of separate legal personality or the conferring of limited liability are enabling. See Rajak H, op cit pp 208-209; Easterbrook FH, Fischel DR, The Economic Structure of Corporate Law (1991) p 2: "An enabling Statute allows managers and investors to write their own tickets, to establish Systems of govemance without Substantive scrutiny from a regulator." ^^ Section 9 of the Companies Act 1985. ^2 Section 4 of the Companies Act 1985. ^^ Lord Davey in Salomon v Salomon & Co [1897] AC 22, cited in Re Express Engineering Works Ltd [1920] 1 Ch 466. See also Parker & Cooper Ltd v. Reading [1926] Ch 975; Re Horsley & Weight [1982] Ch 442; [1982] 3 All ER 1045 (ratification of an act done by directors); Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical Services Ltd [1983] Ch 258 (effect on directors' liability). 64 EBM Co Ltd V Dominion Bank [1937] 3 All ER 555.
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The scope of this principle as well as the binding nature of Company law and the Company's Constitution have varied in the past. In Scott v Frank F Scott (London) Ltd^^ the Court of Appeal took a strict approach to formalities. In this case it was held that the court had no Jurisdiction to rectify the memorandum or articles of association: "It seems to us that there is no room in the case of a Company incorporated under the appropriate Statute or Statutes for the application to either the memorandum or articles of association of the principles upon which a court of equity permits rectification of documents whether inter partes or not." In Cane v Jones^^ the principle of informal assent was nevertheless applied to special and extraordinary resolutions. The High Court judge argued that an informal unanimous shareholders' agreement may be as effective as an extraordinary or special resolution: "In my judgment, [the section of the Companies Act on the alteration of articles by special resolution^^] is merely laying down a procedure whereby only some of the shareholders can validly alter the articles: and if, as I believe to be the case, it is a basic principle of Company law that all the corporators, acting together, can do anything which is intra vires the Company, then I see nothing in [this section] to undermine this principle ..." This case was followed in Re Home Treat Ltd.^^ The Company, which was in administration, had carried on the business of a nursing home for many years without having power to do so under its objects clause. The administrator wished to continue to run the business with a view to selling it as a going concem. Harman J held that, since the Company's only shareholders had agreed to the change of activity, it must be deemed to have changed its memorandum under section 4 of the Companies Act 1985. Cane v Jones has been criticised. It has been argued that it is difficult to reconcile the lax view taken of the importance of formalities in Cane v Jones with the stricter approach of Scott v Frank v Scott (London) Ltd,^^ In any case, the principle in Cane v Jones'^^ seems to be an established principle of Company law: all the corporators of a Company acting together may do anything which is intra vires the Company. One of the illustrations of this principle is the principle in Re DuomaticP^ In Re Duomatic, Buckley J held that where it could be shown that all shareholders with the right to attend and vote at a general meeting (not necessarily all shareholders) had assented to some matter, which a general meeting of the Company could carry into effect, such assent was as binding as a resolution in general meeting. The Duomatic principle has been adopted in Table A, regulation 53."^^
^5 Scott V Frank F Scott (London) Ltd [1940] Ch 794. See also Bratton Seymour Service Co Ltd v Oxborough [1992] BCLC 693. 66 Cane v Jones [1981] 1 All ER 533. 6"^ Now sections 9 and 378 of the Companies Act 1985. 68 Re Home Treat Ltd [1991] BCLC 705. 6^ Sealy LS, Cases and Materials in Company Law, Sixth Edition (1996) p. 194; see also Rajak H, op cit pp 208-209. 70 Cane v Jones [1981] 1 All ER 533 at 537c-538a. ^^ Re Duomatic [1969] 2 Ch 365. ^2 See also Table A, regulation 93 (proceedings of directors).
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The Duomatic principle originally covered the authorisation of, and assent to, acts by a Company that were intra vires the Company and involved simply a failure to observe the provisions of the articles of the Company. This principle has nevertheless been applied to a failure to observe even other procedural requirements. It has been applied to a failure to observe procedural requirements laid down by Statute such as statutory requirements as to notice,''^ and Monecor (London) Limited V Euro Brokers Holdings Limited''^ implies that the Duomatic principle can be applied to all kinds of procedural requirements: "It is a sound and sensible principle of Company law allowing the members of the Company to reach an agreement without the need for strict compliance with formal procedures, where they exist only for the benefit ofthose who have agreed not comply with them. What matters is the unanimous assent of those who ultimately exercise power over the affairs of the Company through their right to attend and vote at a general meeting. It does not matter whether the formal procedures in question are stipulated for in the Articles of Association, in the Companies Acts or in a separate contract between the members of the Company concemed. What matters is that all the members have reached an agreement. If they have, they cannot be heard to say that they are not bound by it because the formal procedure was not followed." Whether the Duomatic principle can be applied is dependent on the purpose and underlying rationale of the particular formality in question. Failure to comply with statutory requirements cannot always be remedied by waiver of the formalities or assent to the transaction by a Company's shareholders. But can the Duomatic principle be applied even where the rules as to procedure are not merely procedural and do not exist for the benefit of current members only? The case law seems to be changing in this direction. In Re RWPeak (Kings Lynn) Limited^^ the court still took a narrow view. The shares of a shareholder had been sold to the Company. A shareholder argued that the agreement was void for failure to comply with the provisions of the Companies Act 1985, because the Company was not authorised to purchase its own shares by its articles^^ and no special resolution had been proposed or passed authorising the contract before it was entered into."^^ The Company argued that the formalities required by the Companies Act did not have to be strictly complied with, because the shareholders had unanimously assented to the transaction. Lindsay J held that the Duomatic principle could not operate to eure the failure. He said that section 164(2) required the terms of the agreement to be approved by a special resolution of shareholders before the agreement was entered into. Lindsay J additionally founded his decision upon policy considerations: "In the circumstances it is not possible, in my view, to regard the provisions of ss 162 and 164 which ensure that Re Oxted Motor Company Ltd [1921] 3 KB 32. See also In Re Express Engineering Works Limited [1920] 1 Ch 466; Atlas Wright (Europe) Ltd v George Peter Wright and Ann Wright [1999] EWCA Civ 669. Monecor (London) Limited v Euro Brokers Holdings Limited, [2003] EWCA Civ 105 at 62 (per Mummery LJ). 75 Re RW Peak (Kings Lynn) Limited [1998] IBCLC 193. "^^ As required by section 162 of the Companies Act 1985. "^^ As required by sections 164(1) and (2) of the Companies Act 1985.
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time is afforded for a measured and informed consideration by members of the wisdom or propriety of any proposed purchase, as merely procedural and for the benefit only of current members."^^ This can be contrasted with Atlas Wright (Europe) Ltd v Wrighf"^ in which the court took a wider view. Potter LJ said in this case that the reasoning m Re RW Peak did not apply to the requirements of section 319 of the Companies Act 1985. But section 319 deals with directors' long-term employment contracts and it contains rules that are not merely procedural. For example, section 319(6) sets out that "[a] term incorporated in contravention of this section is, to the extent that it contravenes the section, void". General approach in securities markets law. While UK Company law leaves the govemance of companies largely to the discretion of shareholders and Company bodies, this is not the approach adopted in UK securities markets law. The obligations of issuers of listed securities and their managers are subject to extensive regulation under the FSMA 2000 and the Listing Rules. The nature of the regime under the FSMA 2000 and the Listing Rules is mandatory. Compliance with these largely mandatory provisions is safeguarded by penal or administrative sanctions in addition to civil liability. The FSA has wide supervisory powers, and market participants place much reliance on interpretative guidance published by it. Issuers must comply with all listing rules applicable to them.^^ If the UK Listing Authority (the FSA) considers that an issuer has breached any provision of the listing rules it may impose on the issuer a financial penalty or publish a Statement censuring the issuer subject to the provisions of the FSMA 2000.^^ Even directors may be punished. If a person, who was at the material time a director of the issuer, was knowingly concemed in the breach, the UK Listing Authority may impose on that person a financial penalty or publish a Statement censuring that person under the FSMA 2000.«^ The Combined Code of Corporate Govemance. While statutory law is basically mandatory, the Combined Code is not. The revised Combined Code of Corporate Govemance is a recommendation, and companies may opt out of it. However, companies cannot opt out of a "comply or explain" Obligation. The Listing Rules require listed companies to make a disclosure Statement which Covers the principles and provisions in the Code.^^ Although the Combined Code is a recommendation only, non-compliance with this disclosure Obligation and the Listing Rules can have consequences for companies that are perhaps even more serious than those arising from breaches of the Companies Act.^"^ 78 At205(d)-(f). "^^ Atlas Wright (Europe) Ltd v George Peter Wright and Ann Wright [1999] EWCA Civ 669. 80 The Listing Rules, 1.1. 81 The Listing Rules, 1.8. The Listing Rules, 1.9. 83 The Listing Rules, 12.43A. 8"* See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 322323. Those consequences includefinancialpenalties of an unlimited amount on both de-
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The disclosure Statement must be made in two parts: 1) In the first part of the Statement, the Company has to report on how it appHes the principles set out in Section 1 of the Code. The form and content of the first part of the Statement are not prescribed; companies have a free hand to explain their govemance pohcies in light of the principles, including any special circumstances applying to them that have led to a particular approach. 2) In the second part of the Statement the Company has either to confirm that it complies with the Code's provisions or to provide an explanation if it does not.
4.2 Basic Govemance Structure 4.2.1 Introduction The main organs recognised by Company law are the board of directors and the shareholders' meeting. At first sight, the Companies Act 1985 seems to provide for a one-tier board, but UK Company law is very flexible and does not prohibit two-tier board structures.^^ There is nothing in law to prevent public companies incorporated in the UK from adopting a structure under their articles under which the powers granted to directors are divided between two tiers of directors, one exercising management functions and the other exercising a supervisory role in relation to these functions.^^ Furthermore, the law does not prevent the delegation of management powers to a non-statutory body below board level. For example, the day-to-day management of the Company can be conducted through a sub-board executive committee. The Company Law Review found some evidence that the practice of delegating dayto-day management and major operational questions to a "management board" is becoming increasingly common in the UK.^^
faulting companies and defaulting directors, actions by the PSA to obtain an injunction or restitution, and, ultimately, de-listing of the Company. ^^ See for example DTI, Implementation of the European Company Statute, para 3.41. ^^ See DTI, Implementation of the European Company Statute, para 3.39; Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 317. ^^ Modem Company Law for a Competitive Economy: Developing the Framework, para 3.139; Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 317.
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4.2.2 General Meeting of Shareholders There are two types of general meetings of shareholders.^^ Every Company must every year hold a general meeting as its annual general meeting.^^ A Company can also hold extraordinary general meetings.^^ Ordinary, extraordinary and special resolutions. There are three different kinds of resolutions in a public limited-liability Company: ordinary resolutions, extraordinary resolutions^^ and special resolutions.^^ An ordinary resolution is passed by a simple majority of members who vote on it. As only extraordinary and special resolutions have been defined in the Companies Act 1985, a resolution is "ordinary" when it is not an extraordinary or special resolution.^3 For example, a resolution to remove a director can be passed by an ordinary resolution.^"* In some cases the Companies Act provides that an ordinary resolution is not sufficient. A resolution is an extraordinary resolution when it can be passed "by a majority of not less than three-fourths of such members as (being entitled to do so) vote in person or, where proxies are allowed, by proxy, at a general meeting of which notice specifying the intention to propose the resolution as an extraordinary resolution has been duly given".^^ For example, the Variation of dass rights^^ and the voluntary winding up of the company^^ require the passing of an extraordinary resolution. Special resolutions are important from a corporate govemance perspective because the alteration of articles^^ and the alteration of the Company's objects^^ require a special resolution. Shareholders in general meeting can also give directions to the board by special resolution. A special resolution is like an extraordinary resolution but requires 21 days' notice. In other words, a resolution is a special resolution when it can be passed "by such a majority as is required for the passing of an extraordinary resolution [that is, three-fourths]) and at a general meeting of which not less than 21 days' notice, specifying the intention to propose the resolution as a special resolution, has been duly given".^^^
^^ Generally, sections 366-383 of the Companies Act 1985 and regulations 36-63 of Table A. ^^ Section 366 of the Companies Act 1985. 90 Section 368 of the Companies Act 1985. ^' Section 378(1) Companies Act. See also s. 125 Companies Act 1985; ss. 84, 165 Insolvency Act 1986. 92 Section 378(2) Companies Act 1985. 93 Table A, regulations 64, 78, 82 and 96 . 9^ Section 303 of the Companies Act 1985. 95 Section 378(1) of the Companies Act 1985. 96 Section 125(2)(b) of the Companies Act 1985.
97 Section 84(1) of the Insolvency Act 1986. 9^ Section 9 of the Companies Act 1985. 99 Section 4 of the Companies Act 1985. O ' ö Section 378(2) of the Companies Act 1985.
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Powers. The articles of association normally vest few management and monitoring powers in shareholders in general meeting. For example, articles of association can give, but do not always give, shareholders the power to choose who sits on the board.
4.2.3 Board of Directors Every public Company must have at least two directors.^^^ The legal obligations placed on directors arise by virtue of a combination of case law principles and statutory provisions, but their powers are to a very large extent regulated by articles of association. ^^^ Powers. Articles of association normally vest the authority to manage the business in the hands of the board of directors. Table A, regulation 70 gives directors the power to manage the business of the Company and exercise all the powers of the Company. ^^^ For this reason, the powers of the board of directors are normally very wide. Lord Wilberforce said in Ampol^^^ that "[t]he Constitution of a limited Company normally provides for directors, with powers of management, and shareholders, with defined voting powers having power to appoint the directors, and to take, in general meeting, by majority vote, decisions on matters not reserved for management". He said also that "directors, within their management powers, may take decisions against the wishes of the majority of shareholders", and that "the majority of shareholders cannot control them in the exercise of these powers while they remain in office". There are detailed statutory provisions laying down what directors may not do. The Companies Act 1985 provides for more than 200 punishable offences for directors, and directors can also face sanctions under a wide ränge of other Statutes such as the Insolvency Act 1986. However, there are only very general principles about what directors should do, that is, how directors should manage the Company. For example, directors should act "bona fide in the interests of the Company as a whole". The Combined Code ^^^ Section 282 of the Companies Act 1985; regulation 64 of Table A. See also sections 291 (share qualification), 292 (voting), 293 (age limit) and 741(2) (shadow directors). For shadow directors see even section 214(7)) of the Insolvency Act 1986. ^^^ See for example Davies PL, Struktur der Untemehmensführung in Großbritannien und Deutschland: Konvergenz oder fortbestehende Divergenz? ZGR 2001 p 276. ^^^ Table A, regulation 70: "Subject to the provisions of the Act, the memorandum and the articles and to any directions given by special resolution, the business of the Company shall be managed by the directors who may exercise all the powers of the Company. No alteration of the memorandum or articles and no such direction shall invalidate any prior act of the directors which would have been valid if that alteration had not been made or that direction had not been given. The powers given by this regulation shall not be limited by any special power given to the directors by the articles and a meeting of directors at which a quorum is present may exercise all powers exercisable by the directors." 104 Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821.
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says that every listed Company should be headed by an "effective board" which should "lead and control the Company". Where powers are conferred on the directors under the Company's articles, they are conferred upon the directors collectively as a board.^^^ According to Table A, "the business of the Company shall be managed by the directors who may exercise all the powers of the Company".^^^ According to Mitchell & Hobbs (UK) v Mill,^^'^ this means that the power to manage the Company can be exercised by the board of directors, but not by a Single director. In principle, all directors owe the same legal duties and are equally responsible for decisions taken by the entire board. In practice, the carrying out of director's duties is dependent on the knowledge and experience of each director, and directors may have different functions in the Company. The different functions of different directors have been recognised in Table A. Table A, regulation 72 sets out that "[t]he directors may delegate any of their powers to any committee consisting of one or more directors". The Company may also have one or more managing directors. However, the board will not be entitled to delegate its powers without an express authorisation in the articles, and the individual director or managing director may not have any powers unless and to the extent that the board has exercised its authority to delegate.^^^ Chairman ofthe board. In the UK, the functions of the chairman of the board are expanding due to the new monitoring role played by non-executive directors. A listed Company normally has a dual corporate leadership consisting of a parttime non-executive chairman ofthe board and a full-time chief executive.^^^ The role of chairman ofthe board is partly based on articles of association. According to Table A, regulation 91, "directors may appoint one of their number to be the chairman ofthe board of directors and at any time remove him from that Office". Table A, regulation 88, provides that the chairman shall have a second or Casting vote in the case of an equality of votes. The role of the chairman nevertheless varies depending on the Company. In some companies the chairman is "some sort of overlord and remunerated as such", in other companies "merely an omamental figurehead".^^^ The chairman could be expected to act as a link to shareholders and Company executives and pass information to other board members. According to the Combined Code, the board should be supplied in a timely manner with information in a form and of a quality appropriate to enable it to discharge its duties,^^^ and the ^^^ See also Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 320. ^^^ Table A, regulation 70. 107 Mitchell & Hobbs (UK) v Mill [1996] 2 BCLC 102. 10^ See also Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 320. 10^ In the USA, the chief executive is typically also the chairman. See The Economist 9 January 2003, Corporate boards. The way we govem now. i'o Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 160 footnote 62. 111 Principle A.5.
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chairman is responsible for ensuring that the directors receive accurate, timely and clear information.^^^ It is not prohibited to combine the posts of chairman and chief executive in one person, but a decision to combine the posts of chairman and chief executive in one person should be publicly justified.^^^ The Combined Code points out that the running of the board and the executive responsibility for the running of the Company's business are two key tasks at the top of every pubhc Company and that there should be a clear division of responsibility at the head of the Company. ^^"^ In the majority of listed companies, the posts are held by different people. Executive and non-executive directors. Some board members are usually executive directors. The Combined Code provides that "[t]he board should include a balance of executive and non-executive directors (including independent nonexecutives) such that no individual or small group of individuals can dominate the board's decision taking". This means that "[n]on-executive directors should comprise not less than one third of the board". It is Standard practice to appoint non-executive directors in larger companies. Non-executive directors can be for example former executives or members of the founding family. The Combined Code nevertheless provides that the majority of them should be independent, that is, "independent of management and free from any business or other relationship which would materially interfere with the exercise of their independent judgment". In principle, Company law does not recognise non-executives as a separate dass of director: all directors owe the same legal duties and are equally responsible for decisions taken by the entire board. Independent non-executive directors are nevertheless expected to fulfil two key flinctions: (a) The first is monitoring management. Due to the lack of a statutory two-tier board, executive directors are not effectively accountable to other organs of the Company in large public companies. Outside directors add, at least in theory, a supervisory dement to the board structure.^^^ (b) The second is advisory. Outside directors are thought to bring in their expertise and links with other organisations. In practice however, non-executive directors are often "expected to do little or nothing other than to attend a reasonable number of board meetings and, perhaps, some of the committees that the board may establish. As such they will be modestly rewarded by directors' fees resolved upon by the Company in general meeting."^^^ The role and ejfectiveness of non-executive directors. In any case, nonexecutive directors are expected to play a central role in corporate govemance. The Company Law Review noted "a growing body of evidence from the US sug^i2prindpleA.2. ^^^ Provision A.2.2. ii4PrindpleA.2. '^^ See also Leyens PC, Deutscher Aufsichtsrat und U.S.-Board: ein- oder zweistufiges Verwaltungssystem? Zum Stand der rechtsvergleichenden Corporate GovemanceDebatte, RabelsZ 67 (2003) p 76. '^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 319.
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gesting that companies with a strong contingent of non-executives produce superior Performance". In April 2002, building on the work of the Company Law Review and other reviews, the Government commissioned Derek Higgs to lead an independent review of the role and effectiveness of non-executive directors in the UK.^^^ The preferred starting-point of the Government in this area was an approach based on best practice, not regulation or legislation. Derek Higgs pubHshed his report on 20 January 2003. The report included guidance for non-executive directors, guidance for chairmen and a proposal for a revised combined code. While institutional investors mostly supported the Higgs proposals, companies were critical about them. For example, the provisions conceming the designation of a senior non-executive director and the chairing of the committee nominating new directors seemed problematic. Although the chairman was generally made responsible for communicating with shareholders, the proposal called for a senior independent director to join regulär management meetings with big shareholders and report back to the board. And although the chairman was allowed to sit on the nomination committee, the proposal required the nomination committee to be chaired by an independent non-executive instead of the chairman of the board. Companies worried that the role of the chairman would be undermined if the senior independent director was required to hold separate regulär meetings with investors. The revised Combined Code of Corporate Govemance gives companies more flexibility to opt out of the recommendation. The language of the recommendation has been tempered to make it less prescriptive. In the revised Code, the role of the senior non-executive director has been watered down.^^^ A Company chairman can chair its board nomination committee.^^^ The provisions relating to the senior nonexecutive director highlight the role of the chairman in any meetings with shareholders. ^^^ A Chief executive can become chairman. If the board of directors feels that a Chief executive should become a chairman, then it should consult shareholders and State its reasons.^^^ Remuneration. The remuneration of directors may be based on articles of association or contract. Mere appointment to a directorship does not entitle a director to remuneration^^^ but the articles of association may provide for a director's pay. Table A, regulation 82 provides that the "directors shall be entitled to such remuneration as the Company may by ordinary resolution determine". The right to re-
'^^ The reviewer was asked to assess: the population of non-executive directors in the UK; their "independence"; their effectiveness; their accountability; their relationship with institutional investors; issues relating to non-executive directors' remuneration; the role of the Combined Code; and what, if anything, could be done to strengthen the quality, independence and effectiveness of non-executive directors. "^ See for example provision A.1.3. 119 Provision A.4.1. 120 Provision A.B.3; principle A.2.
121 Provisions A.2.1 and A.2.2. ^22 Re George Newman and Co. [1895] 1 Ch 674.
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muneration may also arise from a Service contractu ^^ or a contract of employment made with the Company. ^^^^ Removal ofa director. Shareholders can at least in theory oust board members even if they have not elected them. The Companies Act 1985 provides that "[a] Company may by ordinary resolution remove a director before the expiration of his period of Office, notwithstanding anything in the articles or in any agreement between it and him".^^^ It should nevertheless be distinguished between Company law and the law of contract. The fact that a Company may remove a director does not mean that the Company cannot at the same time be made liable for breach of contract for doing so. A resolution to remove a director does not deprive the director removed of compensation or damages payable to him.^^^ Delegation of functions. In theory, the board of directors could manage the Company as a collegiate body. Table A, regulations 70 and 88 set out that "the business of the Company shall be managed by the directors" who may, subject to the provisions of the articles, "regulate their proceedings as they think fit". In practice, much authority is delegated to a managing director and other executives who manage the Company full-time. The Company Law Review found evidence that the practice of delegating day-to-day management and major operational questions to a "management board" is becoming increasingly common in the UK.127 The board will not be entitled to delegate its powers without an express authorisation in the articles of association, but Table A allows directors to "appoint one or more of their number to the office of managing director or to any other executive Office under the company"^^^ and lets them "appoint any person to be the agent of the Company for such purposes and on such conditions as they determine".i29 The board may not delegate the exercise of its discretion (delegatus non potest delegare). Even when the directors in fact do not manage the Company, control of management will always rest with the board. For example, all directors should
^^^ See section 318 of the Companies Act 1985. ^2^ See section 319 of the Companies Act 1985. 125 Section 303(1) of the Companies Act 1985. 12^ Section 303(5) of the Companies Act 1985. This principle can be found in Stirling v. Maitland (1864) 5 B&S 840 where Cockbum LJ said: "if a party enters into an arrangement which can only take effect by the continuance of a certain existing set of circumstances, there is an implied engagement on his part that he shall do nothing of his own motion to put an end to that State of circumstances under which alone the arrangement can be operative". 12*^ Modem Company Law for a Competitive Economy: Developing the Framework, para 3.139; Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 317. 128 Table A, regulation 84A. 129 Table A, regulation 71.
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monitor the functioning of a sub-board "management board" or "executive committee" in order to avoid risking breach of their common law duties.^^^ In Re Barings plc (No. 5),^^^ Jonathan Parker J (as he then was) summed up the mies on the delegation of fünctions as follows: "(0 Directors have, both collectively and individually, a continuing duty to acquire and maintain a sufficient knowledge and understanding of the Company's business to enable them properly to discharge their duties as directors. (ii) Whilst directors are entitled (subject to the articles of association of the Company) to delegate particular fünctions to those below them in the management chain, and to trust their competence and integrity to a reasonable extent, the exercise of the power of delegation does not absolve a director from the duty to supervise the discharge of the delegated fünctions. (iii) No rule of universal application can be formulated as to the duty referred to in (ii) above. The extent of the duty, and the question whether it has been discharged, must depend on the facts of each particular case, including the director's role in the management of the Company."
4.2.4 Managing Director A listed Company usually has a chief executive. The chief executive reports to the board, which usually has a non-executive chairman.^^^ As discussed above, the main rule governing the power to manage a Company is based on Table A, regulation 70. This regulation provides that "the business of the Company shall be managed by the directors who may exercise all the powers of the Company". In Mitchell & Hobbs (UK) v Mill,^^^ it was held that these powers could be exercised by the board of directors, but not by a single director. However, the Company can have a managing director, who acts as the chief executive, and other executive directors. Table A allows directors to "appoint one or more of their number to the office of managing director or to any other executive Office under the company".^^"^ The fünctions of a managing director are not fixed by law, but depend on the particular terms of his appointment.^^^ The powers ofa managing director are thus based on delegation by the board. Table A, regulation 72 provides that directors may "delegate to any managing director or any director holding any other executive Office such of their powers as they consider desirable to be exercised by him". These powers were considered in Mitchell & Hobbs (UK) v Mill}^^ The court held that Table A, regulation 72 did not give any powers to a managing director
^^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 317. ^31 Re Barings plc (No. 5) [1999] 1 BCLC 433, upheld in the Court of Appeal on 25 February 2000. ^^^ The Economist 9 January 2003, Corporate boards. The way we govem now. 133 Mitchell & Hobbs (UK) v. Mill [1996] 2 BCLC 102. 134 Table A, regulation 84A. 135 Holdsworth & Co (Wakefield) Ltd v Caddies [1955] 1 WLR 352. 136 Mitchell & Hobbs (UK) v Mill [1996] 2 BCLC 102.
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over and above those held by the other directors unless such powers had been delegated by the board.
4.2.5 Company Secretary A Company can have a managing director but it must have a secretary. ^^"^ A board member can be appointed as a Company secretary unless he is a sole director.^^^ The role of Company secretary is interesting because the Company secretary sometimes acts in effect as the chief administrative officer of the Company. In the past, a Company secretary was not regarded as a management organ of the Company. It was argued that "the secretary's functions are purely ministerial and administrative and he is not, as secretary, charged with the exercise of any managerial powers".^^^ In Re Maidstone Buildings Provisions Ltd,^^^ it was said that "[s]o far as the position of a secretary as such is concemed, it is established beyond all question that a secretary, while performing the duties appropriate to the Office of secretary, is not concemed in the management of the Company", and that "he is not concemed in carrying on the business of the Company". In reality however, a Company secretary is often responsible for parts of the management of the Company although his role varies according to the size of the Company. A Company secretary is not a mere servant whose position is that he is to do what he is told.^"^^ The duties of the secretary have only to some extent been regulated by the Companies Act 1985 and Table A. There are common law principles on the duties of a Company secretary, and some provisions in the Combined Code. Some duties are based on self-regulation by the professional body of Company secretaries. The same can be said of his powers. The secretary does not automatically have any powers or rights under the Companies Act 1985. The Companies Act 1985 merely allows the secretary to sign certain forms and documents.^"*^ His rights depend on the terms of his contract with the Company. Internal administration. A Company secretary takes care of parts of the Company's basic intemal administration.^"^^ In particular, the secretary ensures that the ^^^ Section 283 of the Companies Act 1985. A draft Companies Bill would allow private companies to appoint a Company secretary if they want to but would remove the requirement to do so. 1^^ Section 283(2) of the Companies Act 1985. ^^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 296-298. 140 Re Maidstone Buildings Provisions Ltd [1971] 1 WLR 1085 at 1092; cited in Gower and Davies' Principles of Modem Company Law. ^^^ Panorama Developments (Guildford) Ltd v FideHs Fumishing Fabrics Ltd [1971] 2 QB 711, [1971] 3 All ER 16. 142 Sections 49(4), 51(4), 53(l)(b) and 43(3) of the Companies Act 1985. 143 See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 297. See also Modem Company Law: Final Report, para 15.41: "... we consider that certain aspects of basic administration should be the responsibility of the secretary as well as the directors, for example, maintenance of registers of members etc ..."
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documentation of the Company is in order, that the requisite retums are made to Companies' House,^"^"^ and that the Company's registers are properly maintained.^"*^ For example, the secretary may prepare resolutions of the Company in general meeting and decisions of the board of directors. Normally, the Companies Act 1985 does not require acts to be done only by the secretary; a common formula is to require an act to be done "by a director and the secretary of the Company or by two directors"^"^^ or "by a director of the Company or by the Company secretary".^"^^ The Combined Code contains some rules on the responsibilities and position of a Company secretary. The Company secretary is responsible to the board for ensuring that board procedures are complied with.^"^^ Under the direction of the chairman, the Company secretary's responsibihties include ensuring good information flows within the board and its committees and between senior management and non-executive directors, as well as facilitating induction and assisting with professional development as required. The Company secretary should be responsible for advising the board through the chairman on all govemance matters.^"^^ All directors should have access to the advice and Services of the Company secretary.^^^ The Institute of Chartered Secretaries and Administrators (ICSA), the professional body for chartered secretaries, has published a guide to the duties of the Company secretary in UK public and private registered companies.^^^ Representation of the Company. A Company secretary can represent the Company in its dealings with third parties. This power is based on common law principles and not on statutory law. The role of the Company secretary varies according to the size of the Company, but he has normally quite extensive powers as its agent. In Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd,^^^ Lord Salmon distinguished between matters concemed with administration and the commercial man^^^ Documents to be registered with Registrar of Companies at Companies' House include: the memorandum of association (section 10(1)); the articles of association (section 10(1)); Statements (sections 10(2) and 12(3)); and particulars of directors and secretary (section 10(3)). ^"^^ The following documents (the "statutory books") must be kept at the Company's registered Office and be available for inspection: register of members (sections 352-362); register of charges (sections 395-424); copies of instruments creating charges (section 406); minute book of General Meetings (section 383); register of debenture holders (sections 190-191); register of directors and secretary (sections 288-190); register of directors' share and debenture holdings in the Company (sections 324-325); copies of directors' Service contracts (section 318). ^46 Section 36A(4) of the Companies Act 1985. ^^^ Section 382A(2) of the Companies Act 1985, See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 298. ^4« Provision A.5.3. 149 Principle A.5. 1^^ Provision A.5.3. 1^1 Duties of a Company secretary - best practice guide (1998). 1^^ Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd [1971] 2 QB 711, [1971] 3 All ER 16.
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agement of the Company. As regards matters concemed with administration, the secretary has ostensible authority to sign contracts on behalf of the Company. Management. One could say that the Company secretary is to some extent responsible for the current management of the Company. Lord Denning MR said in Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd^^^ that the secretary "is an officer of the Company with extensive duties and responsibilities. This appears not only in the modern Companies Acts, but also by the role which he plays in the day-to-day business of companies." The secretary has also been described as "an officer of the Company with substantial authority in the administrative sphere and with powers and duties derived directly from the articles and the Companies Act".^^"^ The secretary is "the chief administrative officer of the Company".^^^ For example, the secretary regularly "enters into contracts ... which come within the day-to-day running of the Company's business". ^^^ Differences to board ofdirectors. A Company secretary differs from the board of directors or the managing director in many ways. The Company secretary has no responsibility for corporate policy, as opposed to playing an administrative role in ensuring that the policy decisions are implemented.^^"^ In addition, the secretary can be appointed with less formality than a director. The secretary is appointed by the board of directors. In the articles of association, it is common to adopt regulation 99 of Table A which provides that: "Subject to the provisions of the Act, the secretary shall be appointed by the directors for such term, at such remuneration and upon such conditions as they may think fit; and any secretary so appointed may be removed by them". In the absence of a formally appointed secretary, any officer of the Company may be authorised by the board to act.^^^ Both the appointment and removal of the Company secretary should be a matter for the board as a whole.^^^ A Corporation can be appointed as a secretary. ^^^ For example, a separate professional firm is sometimes appointed to act as registrar to maintain the registers of members and debenture-holders.^^^ In National Westminster Bank Plc v Breeds,^^^ the company's solicitor and the Company secretary were the same person. ^^^ Panorama Developments (Guildford) Ltd v Fidehs Furnishing Fabrics Ltd [1971] 2 QB 711, [1971] 3 All ER 16. ^^"^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 298. ^^^ Salmon LJ in Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd [1971] 2 QB 711, [1971] 3 All ER 16. ^^^ Lord Denning MR in Panorama Developments. ^^'^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 298. ^^^ Section 283(3) of the Companies Act 1985. 159 Provision A.5.3. ^^ö See section 283(4) of the Companies Act 1985. ^^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 297. ^^2 National Westminster Bank Plc v Breeds [2001] EWHC Ch 21.
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In the case of a public Company, the secretary must be professionally qualified or suitably experienced. The Companies Act 1985 provides that it is the duty of directors to take all reasonable steps to secure that the secretary or each Joint secretary of such a Company "is a person who appears to them to have the requisite knowledge and experience to discharge the functions of secretary of the Company" and who, in addition, fulfils requirements regarding previous experience or membership of specified professions or professional bodies.^^^ This shows the rising professional Status of the secretary in public companies. ^^"^
4.2.6 The Location of Management The location of top management is not based on law. The allocation of powers is largely a matter for the articles of association, and different companies can have regulated their top management in different ways. But since even articles of association are vague on this, one should look at the actual management of the Company. There are many reasons for this. To begin with, Table A, regulation 70 suggests that shareholders keep few matters for themselves, beyond what the law or other regulation requires, and that management powers have been delegated to the board of directors.^^^ Since the wording of Table A also curtails the rights of the general meeting to interfere, the general meeting does not really monitor management. The Combined Code then suggests that there can be a distinction between management and supervision within a single-tier board with executive directors having a management role and independent non-executive directors a monitoring role.^^^ In principle, a public Company could be run by its chairman and board of directors. But although the wording of Table A vests wide powers in the board of directors, the board is often a body that monitors management instead of actually running the Company. At least the board has the power to monitor management: "Somewhat like British monarchs, directors have the right to be consulted, the right to encourage and the right to warn. But they do not usually exercise control."i67
In practice, a public Company is to a very large extent run by its managing director and sub-board managers.^^^ The wording of Table A has legitimated centralised management below board level. Much authority is delegated to the managing director and other executives. The Combined Code provides that the annual report should include "a high level Statement of which types of decisions are to be taken
^^3 Section 286 of the Companies Act 1985. ^^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 297. '^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 299. ^^^ See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 325326. ^^^ The Economist 13 January 2005, Corporate directors. Stick *em up. 168 See for example Davies PL, Stmktur der Untemehmensfühmng in Großbritannien und Deutschland: Konvergenz oder fortbestehende Divergenz? ZGR 2001 p 271.
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by the board and which are to be delegated to management".^^^ Furthermore, a Company secretary has substantial authority in the administrative sphere.
4.3 The Importance of Articles of Association 4.3.1 Introduction The Contents of articles of association are important for shareholders who want to have a say in the Company, because the division of powers between shareholders in general meeting and the board is to a very large extent left by the law to be determined by the Company's articles. In normal cases, almost all management powers have been delegated to the board of directors. If a Company has adopted Table A, its shareholders cannot normally interfere in the day-to-day running of the Company; only a majority of not less than 75% of shares can do so.^^^ Furthermore, it is difficult to amend articles, because it requires a special resolution at a general meeting. This makes it important to find out how binding articles of association are and how they penetrate the hierarchy of the Organisation. The effect of articles of association is not quite clear. There are several reasons for this. Firstly, articles are regarded as a statutory contract, and the use of contractual concepts makes it more difficult to interpret the scope of rules contained in them. Secondly, the fact that articles constitute a statutory contract for the benefit of shareholders does not mean that shareholders would be able to enforce this contract. Thirdly, articles can in effect be binding even on board members, the Company secretary, and senior executives, who are not regarded as party to the statutory contract.
4.3.2 Parties Bound by the Memorandum and Articles Main Principles The main rule is that the memorandum and articles of association (the Constitution of the Company) constitute a "contract" binding on its parties. However, the main rule answers only partially the question on whom the Constitution of the Company is binding. Although this rule helps to limit the parties who may bring proceedings in the event that articles are breached to those who can sue for "breach of contract", breach of contract is not the only cause of action available. Contract. The legal effect of the memorandum and articles of association is set out in section 14 of the Companies Act 1985. When registered, they "bind the Company and its members to the same extent as if they respectively had been ^^^ Provision A. 1.1. ^"^^ Regulation 70 of Table A, section 378 of the Companies Act 1985.
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signed and sealed by each member, and contained covenants on the part of each member to observe all the provisions of the memorandum and of the articles". The legal effect of these documents is nevertheless controversial. The traditional view is that section 14 creates a contract, which forais the basis of legal relations between the Company and its members and between the members inter se.^^^ This view has its roots in the law of partnerships. Prior to the Joint Stock Companies Act 1856, companies were formed on the basis of a deed of settlement that was an elaborate form of partnership deed. In principle, the benefit of regarding articles of association as a contract could be flexibility in the stmcturing of the corporate Constitution. Statutory contract. What makes the interpretation of section 14 of the Companies Act so difficult is the fact that unlike a partnership, a Company is a separate legal person distinct from its shareholders. For many reasons the memorandum and articles of association do not constitute a normal contract based on the provisions of contract law. Section 14 of the Companies Act 1985 creates a "statutory contract" only. In Bratton Seymour Services Co Ltd v Oxborough,^'^^ it was noted that articles of association are "a statutory contract of a special nature with its own distinctive features. It derives its binding force not from a bargain Struck between parties but from the terms of the Statute". Section 14 is subject to other provisions of the Companies Act 1985. This means that party autonomy is limited by these other provisions, and the Company may alter the "contract" by special resolution.*^^ The extent of party autonomy in the articles is therefore dependent on the true construction of the provisions of the Companies Act 1985.^"^"^ For example, in Re Feveril Gold Mines Ltd,^'^^ it was held that a Company's articles could not prevent a shareholder from petitioning for the winding up of the Company because a shareholder may do so under the provisions of the Companies Act. Furthermore, section 310 of the Companies Act 1985 declares provisions exempting officers and auditors form liability void, and so forth.
^^^ Shareholders Remedies, Law Commission Report 246 (1997), para 7.2, footnote 2: "The precise nature of this statutory contract has been the subject of much academic debate. See, for example: K W Wedderbum, * Shareholders Rights and the Rule in Foss v Harbottle" [1957] CLJ 194; G D Goldberg, 'The Enforcement of Outsider Rights under Section 20 of the Companies Act 1948' (1972) 35 MLR 362; G N Prentice, *The Enforcement of Outsider Rights' (1980) 1 Co Law 179; R Gregory, *The Section 20 Contract' (1981) 44 MLR 526; G D Goldberg, 'The Controversy on the Section 20 Contract Revisited' (1985) 48 MLR 158; R Drury, 'The Relative Nature of a Shareholders Right to Enforce the Company Contract' [1986] CLJ 219." ^"^^ Steyn LJ (as he then was) in Bratton Seymour Services Co Ltd v Oxborough [1992] BCLC 693. ^''^ Section 9 of the Companies Act 1985. 174 See for example Bushell v Faith [1970] AC 1099, [1970] 1 All ER 53 (House of Lords) on what is now section 303 of the Companies Act 1985. 175 Re Peveril Gold Mines Ltd [1898] 1 Ch 122.
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The extent of party autonomy is in effect restricted also by the Listing Rules. For example, it was observed in Bushell v Faith that companies with a listing on the Stock Exchange may in practice not circumvent what is now section 303 of the Companies Act by provisions in their articles, for this is forbidden by the Listing Rules; there is in effect one regime for listed companies and another for all other companies.^^^ Many of the normal rules of contract such as rules on implication or remedies for breach do not apply to this "statutory contract": (a) The articles cannot be supplemented by additional terms implied from extrinsic circumstances. In Bratton Seymour Services Co Ltd v Oxborough,^'''' it was said that it is permitted to interpret articles of association on the basis of any language found therein and it is possible to imply a term purely from the language of the document itself, but "it is quite another matter to seek to imply a term into articles association from extrinsic circumstances". In Equitable Life v Hyman,^'^^ it was distinguished between the processes of interpretation and implication: "The purpose of interpretation is to assign to the language of the text the most appropriate meaning which the words can legitimately bear ... If a term is to be implied, it could only be a term implied from the language of [the relevant provision in the articles] read in its particular commercial setting. Such implied terms operate as ad hoc gap fillers ... The process 'is one of construction of the agreement as a whole in its commercial setting'^"^^ ... This principle is sparingly and cautiously used and may never be employed to imply a term in conflict with the express terms of the text." (b) The courts will not Order rectification of the statutory contract. In Scott v Frank F Scott (London) Ltd,^^^ it was held that courts have no Jurisdiction to rectify articles of association, although they do not accord with what is proved to have been the concurrent intention of all the signatories therein at the moment of signature. (c) The courts will not rescind the "statutory contract" for misrepresentation. In Bratton Seymour Service Co Ltd v Oxborough,^^^ it was held that "the Company or an individual member cannot seek to defeat the statutory contract by reason of special circumstances such as misrepresentation, mistake, undue influence and duress". (d) And lastly, rules on the right of a third party to enforce a term of a contract in some Situation under the Contracts (Rights of Third parties) Act 1999 do not apply to the memorandum and articles of association.^^^
1^6 Sealy LS, Cases and Materials in Company Law; Bushell v Faith [1970] AC 1099, [1970] 1 All ER 53 (House of Lords). ^"^^ Bratton Seymour Services Co Ltd v Oxborough [1992] BCLC 693. ^''^ Lord Steyn in Equitable Life v Hyman [2000] 3 All ER 961 (House of Lords). ^''^ Citing Lord Hoffmann in Banque Bruxelles Lambert S.A. v Eagle Star Insurance Co. Ltd. [1997] AC 191. 180 Scott v Frank F Scott (London) Ltd [1940] Ch 794. 181 Bratton Seymour Service Co Ltd v Oxborough [1992] BCLC 693. 182 Section 6(2); Unfair Contract Terms Act 1977; see G. H. Treitel, The Law of Contract, Eleventh Edition (2003) p 662.
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Effect on Shareholders and the Company The articles constitute a statutory contract only between individual members and between the Company and its members. Shareholders. This means that shareholders can be bound by the articles. In Rayfield v Hands,^^^ it was held that one member may sue another on the contract created by the articles. In Hickman's case,^^"* Ashbury J said that "a Company is entitled as against its members to enforce and restrain breaches of its regulations" and that "shareholders as against their Company can enforce and restrain breaches of its regulations". The Company. The Company is bound by articles of association. Although section 14 does not expressly State that the Company is bound by its own articles, it is regarded as clear on the wording of section 14 that this section gives rise to a contract binding the Company to the members on which it can sue and be sued.^^^ In Wood V Odessa Waterworks Co^^^ and Quin & Axtens Ltd v Salmon,^^'^ a shareholder could seek an injunction restraining the Company from acting on a shareholders' resolution that was inconsistent with the articles. Outsiders. The position of Outsiders differs from that of shareholders and the Company. The articles do not per se constitute an enforceable contract between a Company and an outsider. Even shareholders can sometimes be regarded as Outsiders. The articles bind members in their capacity as members, but the articles do not bind members in their other capacity. ^^^ Since the articles do not confer rights on a member in his capacity as an Outsider, it is necessary to distinguish between "personal and individual rights" of members in their capacity of members and their outsider-rights. For example, in Pender v Lushington,^^^ a shareholder, whose vote had not been recorded, had an individual right in respect of which he had a right to sue. This can be contrasted with Eley v Positive Government Security Life Assurance Co Ltd, ^^^ where the articles contained an Obligation to employ Eley as the Company's solicitor. It was held that the articles did not create any contract between Eley and the Company. The principle was formulated in Hickman's case,^^^ where it was said: "An Outsider to whom rights purport to be given by the articles in his capacity as such Outsider, whether he is or subsequently becomes a member, cannot sue on those articles treating them as contracts between himself and the Company to enforce those rights". This principle was applied to directors in Beattie v E & F Beattie Ltd,^^^ 183 Rayfield v Hands [1960] Ch 1, [1958] 2 All ER 194. 18"^ Hickman v Kent & Romney Marsh Sheep-Breeders' Association [1915] 1 Ch 881. 18^ Shareholders Remedies, Law Commission Report 246 (1997), para 7.3. 186 Wood V Odessa Waterworks Co (1889) 42 Ch D 636. 187 Quin & Axtens Ltd v Salmon [1909] AC 442 (House of Lords). 188 Shareholders Remedies, Law Commission Report 246 (1997), para 7.6. 189 Pender v Lushington (1877) 6 Ch D 70 (Court of Chancery (Master of the Rolls)). 190 Eley V Positive Government Security Life Assurance Co Ltd, [1876] 1 Ex D 88. 191 Hickman v Kent or Romney Marsh Sheep Breeders' Association [1915] 1 Ch 881. 192 Beattie v E & F Beattie Ltd [1938] Ch 708, [1938] 3 All ER 214.
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where a director, who was sued in his capacity as a director and not as a member, could not rely on the statutory contract. In Newtherapeutics Ltd v Katz,^^^ it was held that the appointment of a person to the office of director did not of itself establish a contractual relationship between him and the Company. Border-line cases. What could make the effect of the articles of association unclear is the existence of cases where the articles of association were held to be binding on directors who also happened to be members of the Company. In Pulbrook v Richmond Consolidated Mining,^^"^ every director was a shareholder because the Company's articles fixed the holding of shares as the qualification of a director. It was held that a director could bring a personal action against his fellow directors to restrain them from wrongfully excluding him from board meetings. In Rayfield v Hands,^^^ the articles of association contained an article entitling every member to seil his shares to the directors of the Company at fair valuation.^^^ In effect, the members enjoyed 'put' options exercisable against the directors. The directors happened to be shareholders. It was held that the obligations imposed by the article on the directors for the time being were enforceable against them on grounds that the obligations were imposed on the directors in their capacity as members of the Company. This case was approved in the Cumbrian Newspapers case.^^"^ Effect on the Board and Individual Board Members Although the memorandum and articles of association are not regarded as a "contract" between board members and the Company, they can de facto be binding on board members. Effect on individual board members. Directors must act in accordance with the Company's Constitution. The directors are under a duty to acquaint themselves with the terms of the Company's memorandum and articles and to remain within their constitutional powers.^^^ These duties are based partly on common law principles and trust analogy, partly on the provisions of the Companies Act 1985. In Regal (Hastings) v Gulliver,^^^ it was held that directors are not trustees, but they occupy a fiduciary position towards the Company whose board they form. In Belmont Finance Corp. v Williams Furniture Ltd (No. 2),^^^ it was concluded that although directors are not accurately described as trustees of the Company's assets ^93 Newtherapeutics Ltd v Katz [1991] Ch 226; [1991] 2 All ER 151. 194 Pulbrook V Richmond Consolidated Mining [1878] 9 Ch D 610. 195 Rayfield v Hands [1960] Ch 1, [1958] 2 All ER 194. 196 "Every member who intends to transfer shares shall inform the directors who will take the Said shares equally between them at fair value." i^*^ Cumbrian Newspapers Group Ltd v Cumberland and Westmoreland Herald Newspaper and Printing Co Ltd [1987] Ch 1, [1986] 2 All ER 816. 198 Davies PL, G o w e r and Davies' Principles of M o d e m C o m p a n y L a w (2003) p 383. 199 Regal (Hastings) v Gulliver (1942) [1967] 2 A C 134n, 159. 200 Belmont Finance Corp. v Williams Furniture Ltd (No. 2) [1980] 1 All E R 393.
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(the assets being vested in the Company), they have always been treated as trustees of assets which are in their hands or under their control. This principle was recently applied in Bairstow v Queens Moat Houses plc,^^^ where it was held: "There is ample authority ... establishing that although Company directors are not strictly speaking trustees, they are in a closely analogous position because of the fiduciary duties which they owe to the Company." Section 35(3) of the Companies Act 1985 provides that "[i]t remains the duty of the directors to observe any limitations on their powers flowing from the Company's memorandum". Section 35(2) empowers a member of a Company to bring proceedings to restrain the doing of an act that is contrary to limitations in the memorandum. According to section 35(3), such action by the directors may only be ratified by the Company by special resolution. The law will be clarified in the future, because the duty to act in accordance with the Company's Constitution has been adopted in a new draft Companies Bill published in July 2002.202 Effect on the board of directors. At common law, an act or decision of the directors which is outside the Company's Constitution is void and of no effect.2<^3 If the breach of Constitution has involved the improper distribution of the Company's assets, the directors are liable to replace the assets, whether or not they were the recipients of them. In Leeds Estate, Building and Investment Company v Shepherd,^^^ the directors were required to repay their remuneration, the payment of which was objectionable because it was done in breach of the Company's articles.205
Effect on Other Members ofthe Company's Management The traditional view is that the company's Constitution is a "contract" between the Company and its members and between the members inter se. The Constitution confers no rights on a third party, e.g. the company's auditor or solicitor.20^ A third party may neither sue nor be sued for breach of this "contract".
201 Bairstow v Queens Moat Houses plc [2000] 1 BCLC 549. 202 Section 19(1): "Schedule 2 sets out - (a) the general principles applying to a director of a Company in the Performance of his flinctions as a director ... and has effect in place o f the corresponding equitable and c o m m o n law rules." Schedule 2, para l(a): " A director o f a Company must act in accordance with - (a) the c o m p a n y ' s Constitution, and (b) decisions taken under the Constitution (or by the Company, or any d a s s of members, under any enactment or rule of law as to means of taking Company or d a s s decisions), a n d must exercise his powers for their proper purpose." See also section 322A(8) of the Companies Act 1985.
203 See, for example, Boschoek Pty Ltd v Fluke [1906] 1 Ch 148. 204 Leeds Estate, Building and Investment C o m p a n y v Shepherd, (1887) 36 C h D 787; see also R e Oxford Benefit Building Society (1886) 35 Ch D 502. 205 Davies PL, G o w e r and Davies' Principles o f M o d e m C o m p a n y L a w (2003) p 383 foot-
note 59. 206 See also section 6(2) o f t h e Contract (Rights of Third Parties) Act 1999.
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The memorandum and articles of association can nevertheless have an effect on the management of the Company. The Constitution can influence the management of the Company even when it is not binding, but to some extent it does bind the management. Company secretary. A Company secretary has a duty to ensure that the Company complies with its memorandum and articles of association. The Companies Act 1985 imposes numerous obligations on companies regarding the conduct of their affairs. Most of these requirements are backed up by penal sanctions so that, in the event of a breach, the Company and every officer of it who is in default is liable to a fine and, in some cases, imprisonment. As an officer of the Company,2^^ the Company secretary can be prosecuted for most of these offences. The duties of Company secretary are usually contained in an employment contract. At common law, the fiduciary duties of directors can apply equally to executives occupying senior management positions in the Company and authorised to act on its behalf ^^^ This usually includes the Company secretary who has the following fundamental duties as an officer of the Company: to act in good faith in the interests of the Company; not to act for any coUateral purpose; to avoid conflicts of interest; and not to make secret profits from dealings for or on behalf of the company.2ö9 ^he Company Law Review recommended that the test for liability of Company secretaries should be the same as that for directors.^^^ The core duties of Company secretaries include the duty to ensure that the Company complies with its memorandum and articles of association. The Institute of Chartered Secretaries and Administrators (ICSA) distinguishes between the duties that all Company Secretaries should perform (core duties) and those which they often perform (additional duties). Core duties are defined as those for which the Company secretary is responsible as an officer of the Company. In its Best Practice Guide, the ICSA has listed several core duties on the basis of Statute, common law and good practice.^^^ According to the Best Practice Guide, Company secretaries should, for example, ensure compliance with all relevant statutory and regulatory requirements; ensure that the Company complies with its memorandum and articles of association; and ensure that an annual general meeting is held in accordance with the requirements of the Companies Act 1985 and the articles of association. Other managers. Even senior managers are considered as normal workers and therefore protected by the ordinary provisions applicable to the duties of the workforce.
207 Section 744 of the Companies Act 1985. 208 Canadian Aero Service v O'Malley [1973] 40 DLR. 209 The Institute of Chartered Secretaries and Administrators, ICSA's Duties ofa Company Secretary - Best Practice Guide (1998). 2^0 Modem Company Law for a Competitive Economy, Final Report (June 2001), para 15.41. 2^^ The Institute of Chartered Secretaries and Administrators, ICSA's Duties ofa Company Secretary - Best Practice Guide (1998).
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Nevertheless, the fiduciary duties of directors can apply equally to executives occupying senior management positions in the Company and authorised to act on its behalf. For example, in Canadian Aero Service v O'Malley^^^ it was held that directors or senior officers could not usurp for themselves or divert to another person or Company a maturing business opportunity which their Company is actively pursuing. The duties of senior managers are usually contained in an employment contract. The duty of senior managers to ensure that the memorandum and articles of association are complied with is dependent on the position of the manager in question. Auditors. The scope of auditors' duties is based on contract. Like all who render professional Services for reward, a Company's auditor owes the Company an implied duty of care in and about the manner in which they perform those Services. An auditor must exercise reasonable care and skill in making inquiries and investigations and take reasonable care and skill before he believes that what he certifies is true.^^^ As the liability of professional advisers, including auditors, can be based on a failure to provide accurate information, breach of a Company's articles of association by somebody eise can in principle be caused by, or lead to, an auditor breaching his own duties. For example, in Leeds Estate, Building and Investment Company V Shepherd^^^ the court ordered a negligent auditor to repay to the Company the bonuses paid to a manager; according to the Company's articles of association, the bonuses were only properly payable if the Company paid a dividend of 5%.^^^
4.3.3 Enforcement by Shareholders There are restrictions on shareholders' rights to enforce the memorandum and articles of association. Although the memorandum and articles of association bind the shareholders and the Company, there are restrictions on a shareholder's ability to bring a personal action to enforce their provisions.^^^ Properplaintiff. The rule in Foss v Harbottle^^'^ restricts shareholders' rights to sue for wrongs done to the Company. According to the rule in Foss and Harbottle, as interpreted through the years, duties owed to a Company may only be enforced through an action by the Company itself; where it is alleged that a wrong has been done to a Company, prima facie the only proper plaintiff is the Company itself In principle, shareholders can sue for wrongs done to them, but it can sometimes be difficult to identify enforceable personal rights conferred by the articles.
2^2 Canadian Aero Service v O'Malley [1973] 40 DLR. 213 Re London and General Bank No 2) [1895] 2 Ch. 21"^ Leeds Estate, Building and Investment Company v Shepherd (1887) 36 Ch D 787; cited recently in Equitable Life Assurance Society v Ernst & Young [2003] EWCA Civ 1114. 21^ See also Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 383 footnote 59. 21^ Shareholders Remedies, Law Commission Report 246 (24 October 1997), paras 7.5-7.8. 21*^ Foss V Harbottle (1843) 2 Hare 461 (Court of Chancery, Vice-Chancellor).
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Internal irregularities. The courts have classified breaches of certain constitutional provisions as "internal irregularities" for which no personal action will lie. This restriction stems from the "majority rule" and "proper plaintiff principles. The courts have held that if the internal affairs of the Company are not being properly managed, then the Company is the proper person to complain; there is no use in having litigation "the ultimate end of which is only that a meeting has to be called and then ultimately the majority gets its wishes".^^^ The majority rule principle developed as a result of the courts' historical reluctance to become involved in disputes over the internal management of business ventures. The proper plaintiff principle has been described as "the elementary principle that A cannot, as a general rule, bring an action against B to recover damages or secure other relief on behalf ofC for an injury done by B to C'?^^ Personal rights. There are nevertheless membership rights to which the "internal irregularities" restriction does not apply: shareholders have been entitled to bring Claims based on irregularities in voting procedures and in cases involving defective notices of meetings, or inadequate notice of some resolutions.^^^ In practice, the distinction between "internal irregularities" to which the restriction applies and those to which it does not apply has not caused many problems. This is partly because actions to enforce personal rights can be covered by proceedings under section 459 of the Companies Act 1985.^^^ This will change in the future. According to the Final Report of the Company Law Review, "all obligations imposed by the Constitution should be enforceable by individual members both against the Company and other members unless the contrary was provided in the Constitution, unless the breach in question was trivial or the remedy fruitless".^^^ Powers of the board. As duties owed to a Company may only be enforced through an action by the Company itself, the Constitution of the Company can be enforced by the board of directors acting as a collegiate body. It is unclear to what extent the right of enforcement can be extended to individual directors or other officers. For example, some aspects of the relationship between directors and a Company have been regulated in Table A,^^^ but it is unclear whether these regulations create a legal relationship between directors and a company.224
218 MacDougall v Gardiner (1875) 1 Ch D 13, 2 5 . 219 Prudential Assurance C o Ltd v N e w m a n Industries Ltd ( N o 2 ) [1982] C h 204, 2 1 0 . See also Shareholders Remedies, L a w Commission Report 246 (1997), paras 6.1 and 7.7. 220 Shareholders Remedies, L a w Commission Report 246 (1997), para 7.7.
221 Shareholders Remedies, Law Commission Report 246 (1997), paras 7.10 and 7.11. 222 M o d e m C o m p a n y L a w for a Competitive Economy, Final Report, para 7.34. The C o n tract (Rights o f Third parties) A c t 1999 reforms the rule o f "privity o f contract" under which a person can only enforce a contract if he is a party to it. See nevertheless section
6(2). 223 For example Table A, regulations 82, 85 and 87. 22"^ The Law Society, response to Company Formation and Capital Maintenance (10 January 2000): "We do not consider it possible at this stage to express an opinion on whether a right to enforce the Constitution of the Company should be extended to directors or
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4.4 The General Meeting and Internal Management 4.4.1 Introduction There are many forms of shareholder activism. In principle, shareholders can make rules in many ways. (a) Shareholders may be able to make rules either at a general meeting of shareholders or otherwise. (b) In addition, some rules can be made by the Company in general meeting, some powers can be exercised by a group of shareholders or one or more shareholders holding a certain number of shares or votes, and some rights are vested in individual shareholders. (c) One can distinguish between direct and indirect rule-making. Direct rule-making can include, for example, decisions on the Constitution of the Company, directions given to the board, decisions on management matters, and agreements. Indirect rulemaking can consist of the use of shareholders' rights to disclosure of information and the use of remedies against managers. (d) Many of these powers can also be described as monitoring powers. While direct rule-making is in effect a form of ex ante monitoring, indirect rule-making can contain Clements of both ex ante and ex post monitoring. In the UK, shareholders in general meeting can make rules in most of these ways. As regards the internal management of the Company, they may decide on the Constitution of the Company and vote on measures relating to share capital and structural change. They may oust persons who monitor management. They may also give directions by special resolution and vote on certain substantial transactions and takeover defences. But apart from these powers, the formal powers of shareholders in general meeting to act as a rule-maker in a listed Company are rather limited. In smaller companies and other companies with concentrated ownership, powerful shareholders can often teil managers how the Company should be run regardless of the formal regulation of corporate govemance.
4.4.2 Division of Powers: General Remarks According to a common nineteenth-century view, shareholders in general meeting were regarded as constituting the Company and the board of directors were regarded as their agents.^^^ The question of division of powers between the shareholders and the board was related to the nature of a Company. The modern view is that the board of directors is an independent organ of the Company. Directors are not agents of shareholders, but there is a relationship akin to agency as between directors and the Company, and decisions of the majority of shareholders at a general meeting are regarded as the acts of the Company.^^^ other officers. A company's Constitution already creates legal relationships between directors and a Company (e.g. Regulations 82, 85 and 87 of Table A) and we assume that there is a proposal to alter this feature of a company's Constitution." 225 See Isle of Wight Railway C o m p a n y v Tahourdin (1883) 25 Ch D 320. 226 See Davies PL, G o w e r and D a v i e s ' Principles of M o d e m C o m p a n y L a w (2003) p 300.
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The relationship between shareholders in general meeting and the board of directors is regulated by the Companies Act 1985, common law, and articles of association. There seems to be no limit on the business that may be transacted at a general meeting, provided that all the formalities are fulfilled.^^'^ Companies Act 1985. The Companies Act 1985 reserves a number of decisions for shareholders in general meeting. The Companies Act 1985 provides, for example, that a Company may by special resolution alter its articles (section 9) and, with respect to the Statement of the Company's objects, its memorandum (section 4^228
Most other matters, which fall within the powers of the general meeting, relate either to the Company's share capital (in accordance with EU Company law directives) or directors and include: decisions to issue shares (section 80); alteration of share capital (section 121); reduction of share capital (section 135); consultation on serious loss of capital in a public Company (section 142); purchase by the Company of its own shares (sections 164-166); removal of any director by ordinary resolution (section 303);^^^ approval of a director's contract of employment for more than five years (section 319); approval of a director's golden handshake (section 312); approval of substantial property transactions involving directors (section 320); and decisions to wind the Company up voluntarily (section 84 of the Insolvency Act 1986). Furthermore, the Companies Act 1985 sets out that shareholders in general meeting may, by special resolution, ratify an ultra vires unauthorised action by directors (that is, an act which is beyond the capacity of the company).^^^ At common law, the shareholders may also, by ordinary resolution in general meeting, ratify an intra vires unauthorised act of directors (that is, an act which is within the capacity of the Company but beyond the authority or competence of the directors).23i
Articles of association. In most cases, the division of power between directors and shareholders will be settled by the company's articles of association.^^^ If a Company has adopted Table A, the board of directors may exercise all management powers in the Company and shareholders cannot normally interfere in the
22"^ Principle D.2; Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 346-347. ^^^ Respectively, sections 9 and 4 of the Companies Act 1985. Further to the mandatory involvement of shareholders see, for example, Gower and Davies' Principles of Modem Company Law (2003) pp 294-295. 229 Bushell v Faith [1970] A C 1099, [1970] 1 All E R 53 (House of Lords): "It enacts that this can be done b y the Company b y ordinary resolution. Furthermore, it may be a c h i e ved notwithstanding anything in the company's articles, or in a n y agreement between the Company and the director." 230 Section 35(3) of the Companies Act 1985.
231 Re Horsley & Weight [1982] Ch 442, [1982] 3 All ER 1045. 232 See Davies PL, Gower and Davies' Principles of M o d e m Company L a w (2003) p p 3 1 6 317.
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day-to-day running of the Company; only a majority of not less than 75% of shares can do so.^^^ Table A reserves few powers for shareholders in general meeting. Firstly, the general meeting may give directions to the board of directors by special resolution.^^"* These directions can be given ex ante only. There is a long line of cases which assert that an exercise of management powers by the directors cannot be "overruled" by a resolution of shareholders in general meeting,^^^ and the wording in Table A provides that no direction given by special resolution may invalidate any prior act of the directors which would have been valid if that direction had not been given. Secondly, the power of directors to exercise all the powers of the Company is subject to anything in the articles. Other powers reserved for shareholders in general meeting include, for example, the power to determine the remuneration of directors by ordinary resolution.^^^ In addition, Table A provides that the Company may by ordinary resolution declare dividends payable to shareholders.237
The Listing Rules and the City Code. The Listing Rules and the City Code contain some special rules on the power to decide on substantial transactions and takeover defences. Common law. At common law, the absence of an effective board of directors can result in management powers reverting to the shareholders. They may thus act where the board of directors is unable to perform the functions conferred upon it (deadlock).^^^ Breckland Group Holdings Ltd v London & Suffolk Properties LtdP"^ exemplifies that where there is an effective board, the Company in general meeting cannot usurp its powers, but if the board is ineffective, the power which in effect has been delegated by the articles to the directors reverts to the person or persons who delegated, namely the Company in general meeting.
4.4.3 Procedure of Decision-making In normal cases, the annual general meeting is the only yearly occasion during which the general body of shareholders is given the opportunity to consider, to criticise and to comment upon the conduct by the board of the Company's affairs, to vote upon the directors' recommendation as to dividends, to approve or disap233 Regulation 70 of Table A, section 378 of the Companies Act 1985. ^^"^ Table A, regulation 70. 235 See in particular Scott v Scott [1943] 1 All ER 582; Shaw v Shaw [1935] 2 KB 113; and Mitchell & Hobbs (UK) Ltd v Mill [1996] 2 BCLC 102. 23^ Respectively, regulations 82 and 102 of Table A. 23^ Table A, regulation 102. No dividend shall exceed the amount recommended by the directors. 238 Warrington J in Barron v Potter [1914] 1 C h 895: "If directors having certain powers are unable or unwilling to exercise them - are in fact a non-existent body for the purpose there must be some power in the Company to d o itself that which under other circumstances would be otherwise done." See also Foster v Foster [1916] 1 Ch 632. 239 Breckland Group Holdings Ltd v London & Suffolk Properties Ltd [1989] B C L C 100.
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prove the directors' remuneration, and, if thought desirable, to remove and replace all or any of the directors.^^o The fundamental questions affecting the value of general meetings as a rulemaking vehicle include: the power to call a general meeting; the power to get items onto the agenda; the power to vote and proxy voting; the quorum; and the required majority. For example, the shareholders' meeting is not of much value as a vehicle of shareholder control if the meeting cannot easily be convened^"^^ or if the management is able to call meetings only when it suits them,^'*^ and it is of no use to shareholders simply to be able to convene a shareholders' meeting unless it is possible for them to have some influence on the agenda for that meeting.^"^^ In practice, general meetings are to a large extent controlled by directors. Power to call a general meeting. If the Company has adopted Table A, its directors have a general power to call general meetings.^'*'* Sometimes directors must call a general meeting. The court has a reserve power to call a meeting if "for any reason it is impracticable" to call the meeting otherwise.^"*^ The directors must call annual general meetings.^^^ in the case of default in holding an annual general meeting, the Company and every officer of it who is in default is liable to a fine^'*^ and the Secretary of State may, on application of any member of the Company, call the general meeting.^"^^ The Companies Act 1985 does not prescribe the business that has to be transacted at an annual general meeting. For example, it does not say that the annual directors' report and the accounts must be laid before the annual general meeting or that the directors due for re-election must be considered then, although it is in practice normal for these matters to be taken at the annual general meeting.^"*^ On the other hand, the Act does not limit the business that may be transacted at an annual general meeting.^^^ In the case of listed companies, the business to be transacted at the annual general meeting is also determined by the Listing Rules and the Combined Code. For example, the Listing Rules sets out which items must be included in the annual accounts and reports.^^^ The Combined Code recommends for example that "[a]ll directors should be subject to election by shareholders at the first annual general meeting after their appointment, and to re-election thereafter at intervals of no more than three years".^^^ According to the Combined Code, the board "should 240 See Caparo Industries Plc v Dickman [1990] 2 A C 605 (House of Lords, Lord Oliver).
241 Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 346. 242 Davies PL, G o w e r and Davies' Principles of M o d e m C o m p a n y L a w (2003) pp 3 4 7 - 3 4 8 .
243 Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 350-351. 244 Table A, regulation 37. 245 Section 371 of the Companies Act 1985. 246 Section 366(1) of the Companies Act 1985. For private companies see section 366A. 247 Section 366(4) of the Companies Act 1985. 248 Section 367(1) of the Companies Act 1985. 249 Davies PL, G o w e r and Davies' Principles of M o d e m C o m p a n y L a w (2003) p 346. 250 Davies PL, G o w e r and Davies' Principles of M o d e m C o m p a n y L a w (2003) p 346.
251 The Listing Rules, 12.41-12.43A. 252 Provision A.7.1.
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use the [annual general meeting] to communicate with Investors and to encourage their participation".^^^ The directors must convene an extraordinary general meeting of the Company on a members' requisition, unless the articles provide otherwise.^^"^ The holders of one-tenth of the voting power at a general meeting may require the directors to convene such a meeting within twenty-one days. The requisition must State the objects of the meeting.^^^ A members' requisition must be signed by shareholders representing not less than one-tenth of total voting rights.^^^ If the directors fail to convene the meeting, the requisitionists may do so themselves.^^'^ A Company's articles commonly provide that any meeting other than the annual general meeting (an extraordinary general meeting) may be convened by the directors whenever they think fit.^^^ Getting items onto the agenda, It is easier for the board of directors than for shareholders to get items onto the agenda. The annual general meeting is normally convened by the board and, as part of that process, the board will be able to stipulate the items which it wishes to have discussed at the meeting.^^^ Shareholders can put their items onto the agenda or make their views known to other shareholders in advance of the meeting provided that the conditions laid down in the Companies Act have been met.^^^ If shareholders do so, they will bear the costs, unless the Company otherwise resolves.^^^ In practice, these provisions have not been sufficient to counteract the advantage enjoyed by the management.^^^ Like annual general meetings, extraordinary general meetings are usually convened by the board. If the conditions set out in the Companies Act 1985 have been met, shareholders may in this case circulate to other members a short Statement "with respect to the matter referred to in any proposed resolution or the business to be dealt with at that meeting".^^^ Shareholders may get items onto the agenda of an extraordinary general meeting if it is a meeting convened on shareholders' requisition.264
253 Principle D.2. 254 Section 368(1) of the Companies Act 1985. Note regulation 3 7 o f Table A : " T h e directors m a y call general meetings and, on the requisition of m e m b e r s pursuant to the provisions of the Act, shall fortwith proceed to convene an extraordinary general meeting ..." 255 Section 368(3) of the Companies Act 1985. 256 Section 368(2) of the Companies Act 1985. 257 Section 368(4) of the Companies Act 1985. 258 Davies PL, G o w e r and Davies' Principles of M o d e m Company L a w (2003) pp 3 4 7 - 3 4 8 . 259 Davies PL, G o w e r and Davies' Principles of M o d e m C o m p a n y L a w (2003) p 350. 260 See sections 376 and 377 of the Companies Act 1985.
261 Section 376(1) of the Companies Act 1985. 262 Davies PL, G o w e r and D a v i e s ' Principles of M o d e m C o m p a n y L a w (2003) p 352.
263 Section 376 of the Companies Act 1985. 264 Section 368 of the Companies Act 1985.
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Notices. The Companies Act 1985 contains some ruies on notices.^^^ In Hessen V Henderson, it was also held that the notice convening a meeting must be sufficiently füll and specific to enable the shareholder receiving it to decide whether or not he ought in his own interest to attend.^^^ Proxy voting. At common law, a corporate body may act by a majority vote given at a meeting duly summoned.^^^ According to Table A, voting will normally be carried out by a show of hands unless a poll is demanded.^^^ The Companies Act 1985 sets out that a provision contained in a Company's articles is normally void in so far as it would have the effect of excluding the right to demand a poll at a general meeting.^^^ Proxy voting is a key dement in shareholder decision-making. A shareholder does not have to appear at the meeting in person. According to the Companies Act 1985, "[a]ny member of a Company entitled to attend and vote at a meeting of it is entitled to appoint another person (whether a member or not) as his proxy to attend and vote instead of him".^"^^ It is therefore possible for directors of companies, or other interested individuals, to seek support from shareholders by requesting them to appoint a particular person as their proxy, either generally or in relation to particular proposals. Since few shareholders of listed companies tum up at general meetings, control by the board of the proxy machinery is likely to strengthen the strong position of the board of directors. Directors are not prohibited from soliciting proxies at the Company's expense. For example, in Peel v London and North Western Railway Company, the Court of Appeal held: "The Company may legitimately do and may defray out of its assets the reasonable expenses of doing all such acts as are reasonably necessary for calling the meeting and obtaining the best expression of the corporators' views on the questions to be brought before it."^*^^ The position of shareholders is weaker. The Companies Act 1985 provides that shareholders wanting to circulate their resolutions or Statements will normally bear the costs thereof (unless the Company otherwise resolves).^'^^ The Listing Rules provide that a listed Company should nevertheless send out two-way proxies giving shareholders an equal opportunity to vote for or against the resolution.^*^^ This forces the directors at least to some extent to give effect to
^^^ For the length of notice see section 369 and regulation 38 of Table A. For special notice see sections 379, 293(5) and 303(2). 266 Tiessen v Henderson [1899] 1 Ch 861). 267 A G V Davy (1741) 2 Atk 212 (Lord Chancellor). 268 Table A, regulation 46. 269 Section 373(1) of the Companies Act 1985; see also regulation 46 of Table A. 270 Section 372(1) of the Companies Act 1985. 271 Peel V London and North Western Railway Company [1907] 1 Ch 5 at 19. 272 Section 376(1) of the Companies Act 1985. 273 Para 9.26 of the Listing Rules (Financial Services and Markets Act 2000 Amendment) Instrument 2001: "A proxy form must be sent with the notice convening the meeting of holders of listed securities to each person entitled to vote at the meeting, and must comply with the other requirements set out in paragraphs 13.28 and 13.29." See also para
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the wishes of individual shareholders. If directors are appointed proxies and instructed how to vote they must obey these instructions.^'^'^ Voting by electronic means. It is possible to appoint proxies by electronic means. The Companies Act 1985 generally allows many of the most important Communications between companies and their shareholders to be made electronically. All types of electronic communication covered by the Electronic Communications Act 2000 are permitted, where there is agreement between the Company and the shareholder. However, direct electronic voting from a distance is not yet possible. The Company Law Review proposed that the law should permit electronic voting by shareholders. ^^^
4.4.4 The Memorandum and Articies of Association The memorandum and articies of association cover both the internal decisionmaking of the Company and the representation of the Company in its dealings with third parties (for the representation of the Company in its dealings with third parties see Chap. 4.5 below). As discussed above, the memorandum contains only a small number of mies, one of which is the Statement of the Company's objects. The articies of association are in practice far more important, and they are relatively long and detailed. The Companies Act 1985 leaves considerable flexibility for companies to decide on the contents of their articies. Table A attached to the Companies Act 1985 nevertheless provides for some standardisation, because Table A attached to the Act becomes the articies of association if no articies are registered, or if the articies that are registered do not exclude or modify Table A. Furthermore, compliance with the recommendations of the Combined Code requires in practice the adoption of many regulations in the articies of association. The ejfect ofthe articies on the division and exercise of powers. The division of powers between the directors and the shareholders and the ränge of business decisions to be conferred upon the board is left by the law to be determined by the Company's articies of association.^^^ Again, Table A and the Combined Code provide for some standardisation. Derogation from the articies of association. Articies of association are regarded as a statutory contract that is binding on its parties. In Automatic SelfCleansing Filter Syndicate Co Ltd v Cuninghame,^'^'^ it was held that the delegation in the articies of association of managerial powers to the board of directors deprived the 13.28: "A proxy form must provide for two-way voting on all resolutions intended to be proposed..." '^'^^ See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 362. ^'^^ See Modem Company Law for a Competitive Economy: Developing the Framework, para 4.59; Completing the Stmcture, para 5.39. ^^^ See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 294. 2'^'^ Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame [1906] 2 Ch 34.
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shareholders of all management rights. Directors, within their management powers, may thus take decisions against the wishes of the majority of shareholders, and the majority of shareholders cannot control them in the exercise of these powers while they remain in office. Articles of association can in effect be binding on other parties as well, because non-compliance with articles of association can amount to breach of duty. For example, board members, the Company secretary, and the Company's auditor have in effect a duty to comply with articles although they are not regarded as parties to this statutory contract. It is sometimes possible to derogate from articles of association. Firstly, a Company is bound in a matter intra vires by the unanimous agreement of its members. Secondly, derogation can in effect be possible due to the fact that shareholders have only limited rights to enforce the articles; the proper plaintiff mle and the doctrine that some breaches are internal irregularities only make it difficult for shareholders to bring proceedings in the event that the articles have been breached. Articles of association may be altered by special resolution.^*^^ Provisions in articles which prohibit the alteration of articles are invalid. In Russell v Northern Bank,^^^ Lord Jauncey said: "while a provision in a Company's articles which restricts its statutory power to alter those articles is invalid an agreement dehors the articles between shareholders as to how they shall exercise their voting rights on a resolution to alter the articles is not necessarily so". Thus, in that case, an agreement by the Company not to use its statutory powers was not valid, but an agreement by shareholders as to how they would exercise their voting powers was valid. On the other hand, shareholders may on the formation of the Company make a constitutional provision unalterable by including it in the memorandum.^^*^ The Company Law Review proposed entrenchment provisions in the Constitution, that is, provisions stating that other specified provisions may not be altered except by a resolution passed by (at least) a specified percentage of members greater than that needed for a special resolution.^^^ Power of shareholders to enforce the articles of association. The enforcement of the articles of association has been discussed above (Chap. 4.3.3). Shareholders have only limited rights to enforce articles of association because of the proper
^^^ Section 9 of the Companies Act 1985. For "special resolutions" see section 378(2). Articles may only be altered "subject to the provisions of this Act". See sections 16-18 (effect on members, registration etc); section 125 (Variation of dass rights); sections 177(4) and (5) (powers of court); and sections 461(3), (4) and (5) (court order). Articles may only be altered subject to the conditions contained in the memorandum. See section 17(2)(b). ^^^ Russell v Northern Bank Russell v Northern Bank Development Corporation Ltd [1992] 3 All R 161; [1992] 1 WLR 588 (House of Lords). ^^^ See section 4 of the Companies Act 1985. ^^^ Modem Company Law: Final Report, paras 7.28 and 16.68-16.70. See also clause 21 of the proposed Companies Bill.
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plaintiff rule and the doctrine that certain constitutional provisions are "internal irregularities" for which no personal action will lie.
4.4.5 Decisions on Management Matters The general management of the Company is normally vested in the board of directors, which may nevertheless delegate its powers. Some powers are, or can be, reserved for shareholders in general meeting. Since the Companies Act 1985 does not State that the management has to be vested in the directors, the articles can set limits within which these powers are to be exercised; an Obligation to obey decisions properly taken by shareholders in general meeting will thus not be incompatible with the Act.^^^ The most important powers that are usually or by law reserved for shareholders in general meeting include the power to give directions; the power to give or not to give approval to major transactions; the power to ratify irregulär acts by directors; and the power to decide on some major transactions and measures relating to share capital. Sometimes shareholders in the general meeting have a power to appoint directors (see Chap. 4.4.6 below). Directions The articles of association may reserve some powers for shareholders in general meeting. Shareholders in general meeting may give directions if Table A applies. Table A, regulation 70 provides that "the business of the Company shall be managed by the directors who may exercise all the powers of the Company", but these powers are "[sjubject to the provisions of the Act, the memorandum and the articles and to any directions given by special resolution". Scope. According to the wording of Table A, the right to give directions is unlimited and not restricted to certain matters. The directions are potentially flexible tools with which the management can be told how to run the Company. For example, it may be decided at the general meeting that the directors must enter into a transaction even though a decision on this matter belongs to the general management of the Company's business.^^^ At the general meeting it may also be decided that the directors may not enter into such a transaction. Table A, regulation 70 provides that "no such direction shall invalidate any prior act of the directors which would have been valid if that alteration had not been made or that direction had not been given". If the directors have already entered into a binding contract on behalf of the Company, the special resolution cannot invalidate that. On the other hand, shareholders in general meeting may direct that the directors should not act upon an earlier resolution of the board of direc-
^^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 303. 382-384. 283 Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 303.
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tors; the earlier resolution will remain valid but the directors may not act upon it.284 The wording in Table A, regulation 70 does not prevent shareholders in general meeting from giving directions on board procedures. The Companies Act 1985 does not regulate the proceedings of the board in detail and Table A permits the directors to settle their own procedure.^^^ For example, Table A, regulation 88 provides that "[sjubject to the provisions of the articles, the directors may regulate their proceedings as they think fit". But where the Company has adopted Table A, regulation 70, the shareholders may teil the board to comply with certain corporate govemance guidelines or adopt the Combined Code on Corporate Govemance. Effect on the board of directors. The directors have a duty to obey directions. The duty to act in accordance with decisions taken under the Constitution has been expressly adopted in the draft clauses of a new Companies Bill published in July 2002.286 Effect on sub-board managers. It is unclear to what extent sub-board managers should obey directions. The duties of sub-board managers are based on contract. It could be that the duty of sub-board managers is dependent on the position of the manager in question (see Chap. 4.3.2 above).
Decisions on Major Transactions As discussed above, the main source of distribution of powers between different Organs is the Company's Constitution. The articles of association normally confer unlimited management powers on the directors. The same principles apply to major transactions. However, there are some exceptions to this main rule in listed companies. Decisions having a major impact. According to the Listing Rules, shareholder approval must be obtained for decisions which are likely to have a major impact on the Company's business. The Listing Rules provide that in the case of "a Class 1 transaction ... an explanatory circular must be despatched to the Company's shareholders and the Company must obtain the prior approval of its shareholders in general meeting, and any transaction must be conditional upon such approval being obtained''.^^*^ A transaction is classified by assessing its size relative to that of 28"* Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 303-304. 285 See Table A, regulations 88-98; Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 320. 286 Section 19(1): "Schedule 2 sets out - (a) the general principles applying to a director of a Company in the Performance of his flinctions as a director ... and has effect in place of the corresponding equitable and common law m i e s . " Schedule 2, para l(a): " A director of a Company must act in accordance with - (a) the Company's Constitution, and (b) decisions taken under the Constitution (or by the Company, or any class o f members, under any enactment or m l e of law as to means of taking Company or class decisions), and must exercise his powers for their proper purpose." See also section 322A(8) of the Companies Act 1985; Davies P L , Gower and Davies' Principles of M o d e m Company
Law (2003) pp 382-384. 287 The Listing Rules, 10.37.
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the listed Company proposing to make it.^^^ A Class 1 transaction is a transaction where any "percentage ratio" is 25 % or more.^^^ The "percentage ratios" are calculated on the basis of the listed Company's assets, profits, tumover, market capitalisation or gross capital.^^^ This rule prevents the board from carrying through a transaction of this size without the shareholders' approval, but it does not permit the shareholders to initiate such a transaction.^^^ Issues by major subsidiary undertakings. The Listing Rules contain a similar rule on the issue of shares by major subsidiary undertakings. According to the Listing Rules, "[a] Company must obtain the consent of shareholders before any major subsidiary undertaking of the Company makes any issue for cash of equity securities so as materially to dilute the Company's percentage interest in equity shares of that subsidiary undertaking ... a subsidiary undertaking which represents 25% or more of the aggregate of the share capital and reserves or profits ... of the group will be regarded as a major subsidiary undertaking".^^2 Acceptance oftakeover bids in the target Company, It is clear that the board of directors of the target Company cannot decide on the sale of the shares of the Company's shareholders to a bidder. Each shareholder either accepts the bid on his own behalf or rejects it by holding onto his shares. On the other hand, some decisions that normally do fall within the powers of the board of directors are govemed by takeover rules, and there are rules on a squeeze-out right and a sell-out right. The City Code on Takeovers and Mergers and the Rules Governing Substantial Acquisitions of Shares (the S ARs) set out the general principles and some detailed rules relating to the conduct and timing of takeovers. The purpose of these rules is to ensure the fair and equal treatment of all shareholders in relation to takeovers. The City Code and the SARs apply to takeovers of public companies. The SARs apply broadly where: the offeree is a UK listed Company; the acquirer will go to 15% or more of voting rights but makes no offer under the City Code; and the acquisition will not result in 30% or more of voting rights. The City Code applies where: the offeree is a UK plc (listed or unlisted); and the transaction involves the acquisition of shares where 30% or more of voting rights are to be obtained. The powers of the board of directors to recommend the bid or reject it have been constrained by the City Code. According to the City Code, the board of the offeree Company must obtain competent independent advice on the offer and teil its shareholders about that advice.^^^ When doing so, the directors should consider "the shareholders' interests taken as a whole, together with those of employees and creditors", instead of 288 The Listing Rules, 10.3. 289 The Listing Rules, 10.4. 290 The Listing Rules, 10.5.
291 Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 299. 292 The Listing Rules, 9.22. For listed subsidiaries, see para 9.23. 293 The City Code, Rule 3 .
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"their personal or family shareholdings" or "their personal relationships with the companies''.^^"* There are restrictions on the powers of the board of directors to frustrate the bid. General Principle 7 of the City Code vests powers in the general meeting of shareholders in order to prevent the board of the target Company from doing so: "At no time after a bona fide offer has been communicated to the board of the offeree Company, or after the board of the offeree Company has reason to believe that a bona fide offer might be imminent, may action be taken by the board of the offeree Company in relation to the affairs of the Company, without the approval of the shareholders in general meeting, which could effectively result in any bona fide offer being fmstrated or in the shareholders being denied an opportunity to decide on its merits". Rule 21.1 expands on this General Principle. It provides certain exemptions to the general restriction including the ability of the board of the target Company to seek shareholder approval. This General Principle was used as a model when drafting Article 9 of the Takeover Directive (2004/25/EC). On the other hand, the City Code does not prohibit the target Company's board from seeking a white knight to make an offer for the target,^^^ provided that the directors act in what they believe to be good faith and in the best interests of the Company and for a proper purpose. The City Code also permits an action to persuade shareholders to reject a takeover bid under such circumstances. In order to comply with the City Code, the directors^^^ must then present all information accurately and fairly and must meet prospectus Standards in all documents that are sent to shareholders.^^^ The board of the target Company must obtain competent independent advice on any offer the substance of which it has to disclose to shareholders.^^^ The Companies Act provides for both a squeeze-out right and a sell-out right in the context of takeover offers. Where the takeover offeror has acquired at least 90% of the shares to which the offer relates, he may require the remaining minority shareholders to seil him their shares.^^^ A similar threshold applies to the right of minority shareholders to be bought out by the offeror. ^^^ The Takeover Directive now requires both a squeeze-out right and a sell-out right,^^^ and proposed changes to the Second Directive would include the introduction of these rights (that is, the right of the majority shareholder, under certain conditions, to buy out minority shareholders at a fair price and the complementary right of minority shareholders to compel the majority shareholder to buy their shares). Corporate transactions. The terms "acquisitions", "mergers" and "takeovers" are often used interchangeably; the same transaction may be referred to as a merger, a takeover and an acquisition. However, mergers and divisions may take 294 The City Code, General Principle 9. 295 See Rule 21.1 of the City Code. 296 The City Code, General Principles, Introduction; and Appendix 3.1. 297 The City Code, General Principle 5; the Listing Rules, 14.1 and 14.2. 298 Rules 3.1 and 25.1 of the City Code. 299 Section 429(1) of the Companies Act 1985. ^^ Section 4 3 0 A of the Companies Act 1985. 30^ Articles 15(2) and 16(2) of the Takeover Directive (2004/25/EC).
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place in the UK by means of compromises or arrangements govemed by sections 425 to 427 of the Companies Act 1985. These transactions involve the transfer of the undertaking or property of a Company (transferor Company) to another Company (transferee Company) in exchange for shares in the transferee Company receivable by shareholders of the transferor Company with or without an additional cash payment. The Merger Directive (the Third Company Law Directive 78/855/EEC) and the Directive conceming the division of public limited liability companies (the Sixth Directive 82/891/EEC) have been implemented by the Companies (Mergers and Divisions) Regulations 1987. These Regulations amended the Companies Act 1985 by inserting a new section 427A which provides that sections 425 to 427 shall have effect in the case of mergers and divisions. The Regulations also inserted a new Schedule 15B. According to the Companies Act 1985, a court may not sanction a compromise or arrangement unless a majority of three-fourths (75%) has given its consent thereto. Depending on the type of compromise or arrangement, the majority of three-fourths relates to shareholders, a dass of shareholders, creditors, or a dass of creditors.^^2 Schedule 15B provides, in particular, that the court may only sanction a compromise or arrangement under section 425 of the Companies Act 1985 if: (i) threefourths of each dass of the shareholders of the transferee companies involved present at a meeting agree (section 425 already provides that three-fourths of the shareholders of the transferor companies must so agree) (paragraph 1); (ii) the draft terms of the merger or division were drawn up by the directors of the companies involved and published by the registrar of companies (paragraph 2); (iii) directors' reports containing specified information were drawn up (paragraphs 3 and 4); (iv) expert's reports containing specified information were drawn up by independent experts (paragraphs 3 and 5); and (v) the above documents, the relevant Company accounts and, if no recent accounts are available, accounting Statements, were made available to shareholders (paragraphs 3 and 6). The provisions of section 427A and Schedule 15B do not apply where the Company in respect of which the compromise or arrangement is proposed is being wound up.^^^ Transactions with directors or substantial shareholders. The Companies Act 1985 and the Listing Rules also contain regulations which prevent self-dealing by directors or abuse by major shareholders by reserving powers to shareholders in general meeting. Under Part X of the Companies Act 1985, gratuitous pay-offs to directors must be approved,^^"* and substantial property transactions between a Company and its directors must be prospectively authorised by shareholders.^^^
302 Section 425(2) of the Companies Act 1985.
303 Section 427A(4) of the Companies Act 1985. 304 Sections 312 and 313 of the Companies Act 1985. 305 Sections 320 and 322 of the Companies Act 1985.
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Further regulations are set out in Chapter 11 of the Listing Rules ("transactions with related parties"). Where a Company proposes to enter into a transaction with certain related parties, such as a director, a substantial shareholder (that is, a shareholder holding 10% or more of the voting power of the Company), or their "associates", the transaction must, whatever its size, be first approved by the shareholders in general meeting.^^^ The UK Listing Authority (the FSA) will normally require a circular to be sent to shareholders and require the relevant related party to abstain from voting.^^"^
Decisions on Share Issues The rules on the allocation of power to decide on share issues have partly been coordinated by the Second Company Law Directive (77/91/EEC). In the UK, shareholders play a smaller role and the board of directors a bigger role than might be expected from the wording of the Directive. For example, the UK provisions relating to pre-emptive rights have been described as "complicated and confusing - and also controversial".^^^ The Second Directive. The Second Directive sets out the powers of Company bodies to decide on any increase in share capital and provides for the pre-emptive rights of shareholders. According to the Second Directive, any increase in capital must be decided upon by shareholders in general meeting (Article 25(1)). The Statutes or instrument of incorporation or shareholders in general meeting may nevertheless authorise an increase in the subscribed capital up to a maximum amount which they shall fix with due regard for any maximum amount provided for by law. The power of such body in this respect shall be for a maximum period of five years that may be renewed (Article 25(2)). The Second Directive also provides that existing shareholders have pre-emptive rights to new shares: "Whenever the capital is increased by consideration in cash, the shares must be offered on a pre-emptive basis to shareholders in proportion to the capital represented by their shares" (Article 29(1)). According to the Second Directive, the right of pre-emption "may not be restricted or withdrawn by the Statutes or instrument of incorporation" (Article 29(4)).^^^ On the other hand, pre-emptive rights may be waived under the Second Directive "by a decision of the general meeting" (Article 29(4)). In this case, the "administrative or management body shall be required to present to such a meeting a written report indicating the reasons for restriction or withdrawal of the right of pre-emption, and justifying the proposed issue price". A resolution to waive preemptive rights requires at least "a majority of not less than two-thirds of the votes attaching to the securities or the subscribed capital represented" (Article 40(1)). 306 The Listing Rules, 11.4. 307 The Listing Rules, 11.5. 308 Davies PL, G o w e r and Davies' Principles of M o d e m Company L a w (2003) p 6 3 1 . 309 See also Schwarz G C , Europäisches Gesellschaftsrecht (2000) p p 3 9 2 - 3 9 3 ; Werlauff E, E U C o m p a n y L a w (2003) p 2 4 1 .
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In addition, the laws of a Member State may provide that "the Statutes ... or the general meeting, acting in accordance with ... paragraph 4, may give the power to restrict or withdraw the right of pre-emption to the Company body which is empowered to decide on an increase in subscribed capital within the limits of the authorized capital". There is a renewable maximum period of five years (Article 29(5)). Decisions on the increase ofshare capital. In the UK, a Company should think about three things before going ahead with a share issue: whether it is necessary to increase the amount of its authorised capital to cover the new shares to be issued; whether directors have authority to exercise the power to allot new shares; and the pre-emptive rights of shareholders. In addition, it is important for listed companies to comply with the Listing Rules and the Pre-emption Guidelines. According to the Companies Act 1985, shareholders in general meeting decide on the alteration of share capital.^^^ The articles of association normally provide that share capital may be increased by ordinary resolution.^^* Section 80 of the Companies Act 1985 also provides that the directors of the Company shall not exercise any power of the Company to allot shares, unless they are authorised to do so by the Company in general meeting or the Company's articles.^^2 For a public Company the maximum duration of this authority is five years.^^^ At the general meeting, this authority is given by an ordinary resolution.314
An allotment of shares that is not covered by an appropriate authority is not invalid for that reason^^^ but the responsible directors are liable to a fine.^^^ If, in addition to failing to comply with section 80, the directors have acted in breach of their fiduciary duties in making the allotment, it may be liable to be set aside on that ground. Directors must generally exercise their powers for a "proper" purpose, that is, the purpose for which those powers are conferred. This common law principle has most frequently been applied in relation to the power to allot shares. For example, in Hogg V Cramphorn LimitecP^'' the directors had used their powers to issue shares for the purpose of forestalling a takeover bid in breach of the proper purposes principle. A minority shareholder brought a derivative action to have the issue set aside. The exercise of power for this purpose was regarded as a breach of fiduciary duty, but the court held that the allotment could be cured by ratification. It is possible that directors have breached the duty to use their powers for a proper purpose although they have acted in good faith. In Hogg v Cramphorn Limited, it was held that the honest belief that the act was for the good of the Company did not prevent the motive for issuing the shares from being improper. In Howard 31^ Section 121 of the Companies Act 1985. ^^^ Table A, regulation 32. 312 Section 80(1) of the Companies Act 1985.
313 Section 80(4) of the Companies Act 1985. 314 Section 80(8) of the Companies Act 1985. 315 Section 80(10) of the Companies Act 1985. 316 Section 80(9) of the Companies Act 1985.
317 H o g g V Cramphorn Limited [1967] Ch 254; [1966] 3 All E R 420.
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Smith Ltd v Ampol Petroleum Ltd,^^^ the Privy Council held that the court must first investigate the purpose for which the fiduciary power might be exercised and then decide whether the directors have exercised the power for this purpose. Decisions to disapply pre-emptive rights. The three most important sources of rules on the disapplication of pre-emptive rights by a listed Company are the Companies Act 1985, the Listing Rules and the Pre-emption Guidelines of the Preemption Group. There was no common law rule recognising shareholders' pre-emptive rights although it was open to a Company to include such a provision in its articles.^^^ The power of directors to allot shares was constrained by the proper purpose rule.320
The Companies Act 1985 now provides for the pre-emptive rights of existing shareholders.^^^ In CAS (nominees) Ltd v Nottingham Forest FC PLC,^^^ Hart J pointed out that "[t]he significance of Howard Smith v Ampol in English law has been reduced as a result of the enactment (in 1980) of what is now Section 89 of the Companies Act 1985. That section (which was enacted to give effect to provisions in the second EC Directive on Company Law, 77/91/EEC) requires a Company proposing to allot equity securities to make an offer to each existing shareholder to allot to him on the same or more favourable terms a rateable proportion of those securities".^^^ The pre-emptive rights of shareholders do not apply to noncash issues or to employee shares.^^"* Pre-emptive rights do not always mean equal treatment. Firstly, the Companies Act 1985 provides that shareholders must be given terms which are "as nearly as practicable equal".^^^ Sometimes equal treatment is not "practicable". Secondly, the pre-emptive rights of shareholders are "without prejudice to any enactment by virtue of which a Company is prohibited (whether generally or in specified circumstances) from offering or allotting equity securities to any person".^^^ Thirdly, there is a common law rule that the directors cannot treat different shareholders differently unless the directors act in the best interests of the Company and there is no unfaimess between different groups of shareholders. In Mutual Life Insurance
^18 Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821 (Privy Council). 319 See MacNeil I, Shareholders' Pre-emptive Rights, JBL 2002 p 78. 320 See MacNeil I, Shareholders' Pre-emptive Rights, JBL 2002 p p 9 0 - 9 5 .
321 Section 89(1) of the Companies Act 1985. 322 C A S (nominees) Ltd v Nottingham Forest FC P L C [2002] B C C 145. 323 Contravention of section 89 o f the Companies Act 1985 gives rise to a statutory claim for damages against the Company and its responsible officers (section 92). Directors m a y be given power to make an allotment as if Section 89(1) did not apply, if they are so authorised b y the articles of association or b y special resolution. Such a special resolution has to b e preceded b y a recommendation of the directors and the provision to shareholders of specified financial information (section 95). 324 Section 89(4) of the Companies Act 1985.
325 Section 89(l)(a) of the Companies Act 1985. 326 Section 93(1) of the Companies Act 1985.
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V Rank Organisation Ltd}'^'^ the directors of Rank had given shareholders, other than North American shareholders, the right to subscribe for new shares of the same dass. There was evidence that the North Americans had been excluded because the Company did not wish to comply with the requirements for registration of the SEC and comparable commissions in Canada. The directors had received advice from merchant bankers that to register with the SEC would not be in the interests of the Company. The North American plaintiffs claimed that their shares entitled them to equal treatment. According to Goulding J, there was no such rule. He Said that the rule was, firstly, "that the directors' powers are to be exercised in good faith in the interests of the Company, and secondly, that they must be exercised fairly as between different shareholders". On the facts of the case, Goulding J held that the directors had acted in the best interests of Rank and that there had been no unfaimess between the two groups of shareholders.^^^ The pre-emptive rights under the Companies Act 1985 can be waived. Where the directors of a public limited-liability Company are generally authorised to allot shares,^^^ they may also be given power by the articles, or by a special resolution, to allot shares pursuant to that authority as if the pre-emptive rights of existing shareholders did not apply to the allotment.^^^ In practice, the pre-emptive rights under the Companies Act 1985 can be waived with relative ease. Public companies commonly pass a special resolution at their annual general meetings to that effect.^^^ Sufficiently large shareholders can of course block the passing of a special resolution, which requires a majority of not less than three-fourths of votes.^^^ The Companies Act 1985 is complemented by the Listing Rules. The Listing Rules provide for pre-emptive rights that resemble those under the Companies Act
^^"^ Mutual Life Insurance Co of New York v Rank Organisation Limited [1985] BCLC 11; Re BSB Holdings Ltd (No.2) [1996] 1 BCLC 155. ^^^ See also the Law Commission, Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties, Consultation Paper 153 (1998), paras 11.1911.20; Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 637. ^^^ They may be authorised either by the articles of association or an ordinary resolution of the general meeting by virtue of sections 80(1) and 80(8) of the Companies Act 1985. ^^^ The wording of section 95(1) of the Act is as follows: "Where the directors of a Company are generally authorised for purposes of section 80, they may be given power by the articles, or by a special resolution of the Company, to allot equity securities pursuant to that authority as if- (a) section 89(1) did not apply to the allotment, or (b) that subsection applied to the allotment with such modifications as the directors may determine; and where the directors make an allotment under this subsection, sections 89 to 94 have effect accordingly." For private companies see section 91 of the Companies Act 1985. ^^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 635; Ferran E, Company Law and Corporate Finance (1999) p 617. See also MacNeil I, Shareholders' Pre-emptive Rights, JBL 2002 pp 86-87. 332 Section 378 of the Companies Act 1985.
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1985.^^^ The pre-emptive rights under the Listing Rules do not apply when they have been disapphed under the Companies Act 1985.^^"* There are nevertheless some differences between the Listing Rules and the Companies Act.^^^ (a) One of the major differences between the Companies Act 1985 and the Listing Rules is that the latter even regulate issues by major subsidiary undertakings (see above).^^^ These rights are not waived by the disapplication of pre-emptive rights under the Companies Act 1985. (b) A further difference is that the Company does not have to comply with the pre-emptive rights in a rights issue or open offer with respect to "securities which the directors of the Company consider necessary or expedient to exclude from the offer on account of either legal Problems under the laws of any territory, or the requirements of any regulatory body".^^'^ On the other hand, the Companies Act 1985 does not always require equal treatment (see above). The relative ease with which the pre-emptive rights of shareholders can be waived forced institutional investors to act in order to restrict the dilution of their Position. This led to the Pre-emption Guidelines. The Pre-emption Guidelines differ from the Companies Act 1985 and the Listing Rules in that they are not based on any action by the State. The Pre-emption Guidelines were introduced in 1988 by the Pre-emption Group, a group comprising representatives of listed companies, Investment institutions and corporate finance practitioners. The Guidelines are not legally binding rules, but in real life they can be perceived as binding because many institutional shareholders are strongly opposed to dilution of their position without their individual consent. The Guidelines relate to issues of equity securities for cash other than on a pro rata rights issue basis. The members of the Pre-emption Group have committed themselves to vote in favour of disapplication proposals on certain conditions only. (a) According to the Guidelines, the London Stock Exchange will continue to require listed companies to obtain shareholders' approval annually for a special resolution to disapply pre-emptiverights.^^^Members of the Group are advised to approve a resolution for an annual disapplication, provided it is restricted to an amount of shares "not exceeding 5% of issued ordinary share capital shown by the latest published annual accounts".^^^ In addition, the Guidelines provide for cumulative limits. Although the füll annual disapplication entitlement may be sanctioned each year at the annual general meeting, a Company should not without prior consultation with the Investment Committees of the Association of British Insurers and the National Association of Pension Funds make use of "more than 7 1/2% of issued ordinary share capital shown by the latest published annual ac333 The Listing Rules, 9.18. 334 The Listing Rules, 9.20.
335 See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 636637. Compare Ferran E, Company Law and Corporate Finance (1999) p 617. 336 The 337 The 338 The 339 The
Listing Rules, 9.22 and 9.23. Listing Rules, 9.19. Pre-emption Guidelines, 1.1. Pre-emption Guidelines, 1.2.
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counts by way of non pre-emptive issues for cash in any rolling three year pe340 Yhe Guidelines also seek to limit the amount of the discount, at which equity is issued for cash other than to shareholders.^"^^ (b) Issues beyond the annual disapplication of pre-emption rights will always require an extraordinary general meeting, and there are prior consultation procedures available to determine the likely reaction of institutional shareholders to specific proposals.^'*^ Prior consultation with the Investment Committees of the Association of British Insurers and the National Association of Pension Funds is not necessary if the disapplication to be considered at the extraordinary general meeting is within the limits of the Guidelines.343 J-|Q(^"
Decisions on the Distribution of Profits The statutory rules on the distribution of profits and assets to shareholders have been heavily influenced by the Second Company Law Directive. While the provisions of the Companies Act 1985 focus on the limits of these distributions, the power to decide on these distributions is normally regulated by the Company's articles of association. The board of directors usually controls the amount distributed to shareholders. Power to decide on the distribution of profits. The Companies Act 1985 is silent on who may declare a dividend and thus does not require the dividend to be declared by shareholders in general meeting, The articles usually distinguish between final dividends and interim dividends. (a) The articles usually provide that final dividends shall be declared by the shareholders in general meeting, but let the board of directors determine the maximum amount. According to Table A, "the Company may by ordinary resolution declare dividends in accordance with the respective rights of the members, but no dividend shall exceed the amount recommended by the directors".^"*"* (b) On the other hand, interim dividends may normally be paid by the directors from time to time.^"*^ Before declaring an interim dividend, the directors must satisfy themselves that the financial position of the Company Warrants the payment of such a dividend out of profits available for distribution.^"^^ Where the power to pay interim dividends is vested in the board of directors, shareholders in general meeting cannot interfere with the directors' exercise of this power. Profits available for distribution. The Second Directive limits the amount of flinds available for distribution.^"**^ There is a common law principle that dividends must not be paid out of capital, but this principle has largely been replaced by the ^^ö The Pre-emption Guidelines, 2.1. '^^^ The Pre-emption Guidelines, 3. ^^^ The Pre-emption Guidelines, 6.1. ^^'^ The Pre-emption Guidelines, 6.2. ^"^^ Table A, regulation 102. ^^^ Table A, regulation 103. 346 Table A, regulation 103.
347 See Articles 15, 16 and 23 of the Second Directive (77/91/EEC).
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detailed provisions of the Companies Act 1985. The Companies Act 1985 generally provides that a Company cannot make a distribution to its shareholders except out of its Profits available for this purpose.^"^^ Public companies are subject to further restrictions.^"^^ Accounts. All calculations for profits available for distribution must be taken from the "accounts which are relevant", that is, the latest annual accounts laid before the Company in general meeting.^^^ There is a specific provision on Interim accounts.^^^ Failure to comply with these requirements means that the distribution is unlawful.^^2 Unlawful distributions. According to the Companies Act 1985, a recipient shareholder who knows or has reasonable grounds to believe that a distribution or part of it is unlawful is hable to repay it or that part of it to the company.^^^ No such liability exists in respect of a shareholder who is an innocent recipient,^^'^ for example, a shareholder in a listed Company who cannot be expected to have detailed knowledge of the day to day running of the Company. While this statutory remedy is available only to the Company, and only against a shareholder with actual or constructive knowledge of the unlawfulness of this dividend, it is without prejudice to any other Obligation to repay an unlawful dividend.^^^ The shareholders cannot agree to waive these requirements of the Companies Act 1985. The requirements are mandatory. For example, if a distribution is made in breach of these requirements it is no excuse to say that the Company could have drawn up accounts which complied with the requirements.^^^
Ratification In addition to giving directions by special resolution, shareholders in general meeting may ratify irregulerar acts by directors at common law. In Bamford v Bamford,^^'^ the directors had used their powers to issue shares in breach of the proper purposes principle. A minority shareholder brought a derivative action to have the issue set aside but ratification defeated the actions. Harman LJ said: "directors can, by making a füll and frank disclosure and calling together the general body of the shareholders, obtain absolution and forgiveness of their sins; and provided the acts are not ultra vires the Company as a whole everything will go on as if it had been done all right from the beginning." 3^8 Section 263(1) of the Companies Act 1985. ^"^^ Section 264 of the Companies Act 1985. ^^^ Section 270(3) of the Companies Act 1985; see also section 271 and Article 15(1) of the Second Directive (77/91/EEC). 35^ Section 272 of the Companies Act 1985. 352 Section 270(5) of the Companies Act 1985.
353 Section 277 of the Companies Act 1985; see also Article 16 of the Second Directive (77/91/EEC). 354 See Re D e n h a m & Co (1883) 25 C h D 752.
355 Moxham v Grant [1900] 1 QB 88. 356 Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] 1 Ch 447. 357 Bamford v Bamford [1970] 1 Ch 212.
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An ordinary resolution will normally be enough. For example, if the directors have acted contrary to the articles of association, it is not necessary to pass a special resolution altering the article.^^^ Under the Companies Act 1985, a special resolution will nowadays be necessary if the directors acted outside the objects of the company.^^^ In some cases, ratification is not permitted. Ratification of irregulär acts is generally not possible if it would unfairly prejudice a third party.^^^ For example, purported ratification will not prevent a minority shareholder from bringing a derivative action, if the shareholder can show fraud and wrongdoer control. Where the directors have committed a fraud on the minority, that fraud on the minority is challengeable by the minority regardless of whether the majority have approved it or not.^^^ Although it is clear that shareholders in general meeting may ratify irregulerar acts by directors, it is less clear whether the board can initially refer the matter to a general meeting for a decision there. This might depend on the terms of the memorandum and articles of the Company concemed. However, where the general management of the Company is vested in the board of directors under Table A, regulation 70, it is probably permissible for the directors to resolve on action "subject to ratification by the Company in general meeting".^^^ In a listed Company, the directors are under a duty to do so in the case of major transactions.^^^ Ratification and ratifiability influence the remedies available to the shareholders. If a wrong has been effectively ratified by the Company, there is no cause of action in respect of which the Company can bring proceedings; this will also be a complete bar to a derivative action. If a wrong is ratifiable (that is, capable of being ratified), it is not possible for a minority shareholder to bring a derivative action even if there has been no formal ratification. In MacDougall v Gardiner,^^^ Mellish LJ emphasised that if the action complained of is something that the majority is entitled to do, then only the majority can complain that it has not been done properly. A resolution that no action should be taken to remedy a wrong done to the Company is not regarded as ratification of the wrongful act. Such a resolution will not eure the wrong. If made in good faith and what the majority consider to be for the benefit of the Company, it will bind the minority. In Taylor v National Union of Mineworkers (Derbyshire Area),^^^ Vinelott J made it clear that such a resolution could be effective even if the wrong could not be ratified by any majority of the members. On the other hand, a minimum requirement is that the shareholders 358 Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 305. 35^ Section 35(3) of the Companies Act 1985. 360 PQJ. ratification and its limits generally see the principles which are set out in paras 2047 and 2-087 of the 17* edition of Bowstead and Reynolds on Agency. 3^^ Section 459 of the Companies Act 1985. ^^^ See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 305. 363 The Listing Rules, 10.37. 364 MacDougall v Gardiner (1875) L R 10 Ch App 606.
365 Taylor v National Union of Mineworkers (Derbyshire Area) [1985] BCLC 237; see also Smith v Croft (No 3) [1987] BCLC 355.
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were aware of the nature of the act. In a Scottish case it was said: "While it may be that shareholders of a Company may, by a majority, determine that a remedy available to the Company in respect of a past ultra vires act should not in the interests of the Company be pursued, such a determination would at least require that the members, when making such a determination, were aware that the act had been ultra vires but had nonetheless, bona fide and in the best interests, as they saw it, of the Company, so determined."^^^
4.4.6 The Appointment, Remuneration and Removal of Managers As the general management of the Company is normally vested in the board of directors or managers to whom these powers have been delegated, it is not unimportant who may decide on the appointment, remuneration and removal of these directors and sub-board managers. The main source of distribution of these powers is again the Company's Constitution. And once again, these matters are not always decided on by shareholders in general meeting. The shareholders may, however, decide on the removal of directors.
Board Members While the Companies Act 1985 contains some mandatory rules on the removal of board members, rules on board structure and composition and the appointment and remuneration of directors have been left by the Companies Act to be determined by the Company's articles of association. On the other hand, the Combined Code recommends rules for listed companies in this area; instead of statutory law, many questions are thus regulated by "soft law".^^^ Appointment of directors. The Companies Act 1985 contains few rules on the appointment of directors.^^^ For example, the Act provides that a public Company must have at least two directors,^^^ but the Act requires neither that directors be elected by the shareholders in general meeting nor that they submit themselves periodically to re-election by the shareholders.^''^ However, directors may be, and indeed usually are, appointed at annual general meetings. While the board has the power to fill casual vacancies, such an appointment is held only until the next following annual general meeting when the appointee can be re-elected.^'^^ The appointment of directors is govemed mainly by the Company's articles of association. According to Table A, directors may be appointed either by the board ^^^ Opinion of Lord Hamilton in Clydebank Football Club Limited v Charles Alexander Steedman and others [2000] ScotCS 250 (29th September, 2000), para 85. ^^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 316-317. ^^^ See sections 282, 291 (share qualification), 292 (appointment of directors to be voted on individually) and 293 (age limit). ^^^ Section 282 of the Companies Act 1985. Not less than two under regulation 64 of Table A. ^^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 307. ^''^ See Brenda Hannigan, Company Law (2003) p 136.
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of directors or at the general meeting of shareholders.^'^^ In the latter case, Table A does not prevent a member holding 51 per cent of the voting shares from electing the whole of the board.^"^^ The Combined Code on Corporate Govemance is based on the assumption that the board of directors appoints its own members. The Combined Code contains some principles on appointments to the board. There should be a "formal, rigorous and transparent procedure for the appointment of new directors to the board".^^"* Appointments to the board should be made "on merit and against objective criteria" and care should be taken to ensure that "appointees have enough time available to devote to the job".^*^^ According to the Combined Code, there should be a nomination committee. This committee should lead the process for board appointments and make recommendations to the board. A majority of members of the nomination committee should be independent non-executive directors.^*^^ The board should not agree to a füll time executive director taking on more than one non-executive directorship in a FTSE 100 Company nor the chairmanship of such a Company.^"^"^ Directors' remuneration and employment contracts. The Companies Act 1985 contains few rules on the power to decide on directors' remuneration and their employment contracts. The Companies Act does not provide for remuneration. Neither does the Companies Act set out that the matter of directors' remuneration would always have to be decided on by shareholders in general meeting. These matters are mainly govemed by the articles of association. The Companies Act 1985 and Table A distinguish between directors' ordinary duties and duties outside the scope of the ordinary duties of a director. Remuneration of ordinary duties. As regards the ordinary duties, the law maintains a presumption that directors are expected to work for nothing, (a) At common law, directors are fiduciaries who are not entitled to any remuneration unless duly authorised. Hutton v West Cork Railway Co^''^ is a leading authority for the traditional rule that directors have no right to be paid for their Services, unless payment is authorised by the Company's articles. (b) Any contract providing for payment will be an example of "self-dealing". Part X of the Companies Act 1985 sets out the procedure for permitting self-dealing by directors in a number of specific cases^^^ and regulates self-dealing in different ways: by imposing an obliga-
^^^ Table A, regulations 77 and 78. ^^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 307. ^''^ Principle A.4. See also Davies PL, Struktur der Untemehmensführung in Großbritannien und Deutschland: Konvergenz oder fortbestehende Divergenz? ZGR 2001 p 279. 375 Principle A.4. ^"^^ Provision A.4.1. 377 Provision A.4.5. 378 Hutton V West Cork Railway Co (1883) 23 Ch D 654. 37^ See sections 3 1 2 - 3 1 6 (payments to directors for loss o f office, etc); section 317 (disclosure b y directors to their board); sections 3 1 8 - 3 1 9 (directors' service contracts); sections 3 2 0 - 3 2 2 (substantial property transactions involving directors etc); section 322A (transactions beyond the directors' powers); section 322B (contracts with sole member direc-
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tion to make disclosure to the shareholders or the board, an Obligation to obtain approval of the shareholders as well, or an absolute prohibition. However, the articles of association can provide for directors' remuneration. The common law rule is ordinarily displaced by a provision in the articles which authorises the Company in general meeting to determine the rate of payment.^^^ If the Company has adopted Table A, the directors shall be entitled to "such remuneration as the Company may by ordinary resolution determine"^^^ and to reimbursement for expenses incurred by them.^^^ The remuneration of the managing and other executive directors is typically left to the directors to determine.^^^ There are actually two sets of mies, one for companies generally and additional rules for listed companies. The Combined Code provides for a remuneration committee for listed companies.^^"^ According to the Combined Code, the remuneration committee should have delegated responsibility for setting remuneration for all executive directors and the chairman.^^^ The board itself or, where required by the articles of association, the shareholders should determine the remuneration of the non-executive directors.^^^ Remuneration ofduties outside the scope of ordinary duties. Employment contracts outside the scope of the ordinary duties of a director are govemed by other rules. If the Company adopts Table A, the principle that the directors may normally exercise all the powers of the company^^^ apphes even to directors' employment contracts and remuneration for directors' Services under these contracts. (a) Table A provides that "the directors ... may enter into an agreement or arrangement with any director for his employment by the Company or for the provision by him of any Services outside the scope of the ordinary duties of a director. Any such appointment, agreement or arrangement may be made upon such terms as the directors determine and they may remunerate any such director for his Services as they think fit."^^^ In Guinness plc v Saunders,^^^ the House of Lords held that where the power to pay directors' remuneration is conferred by the articles of association upon the directors themselves, the terms of the articles must be strictly observed. (b) It is worth noting that a regulation in the articles of association is not a contract between the Company and directors. On the other hand, a contract may be inferred from the conduct of the parties. In Re New British Iron Co, ex parte Beckwith,^^^ it tors); sections 323 and 327 (prohibition of Option dealing by directors and their near families). 3^^ See Table A, regulation 82. 3^1 Table A, regulation 82. ^^2 Table A, regulation 83. 3^3 See Table A, regulation 84. 384 Provision B.2.1. 385 Provision B.2.2. 386 Provision B.2.3. 387 Table A, regulation 70. 388 Table A, regulation 84. 389 Guinness plc v Saunders [1990] 2 A C 663; [1990] 1 All E R 652 (House of Lords). 390 R e N e w British Iron Co, ex parte Beckwith [1898] 1 C h 324.
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was held that an article which fixes the remuneration of the directors "is not in itself a contract between the Company and the directors ... But where on the footing of that article the directors are employed by the Company and accept office the terms of [that article] ... form part of the contract between the Company and the directors". There is an exception to the main rule that the board decides on directors' Service contracts. The Companies Act 1985 provides that certain long-term contracts of employment must first be approved by a resolution of the Company in general meeting.^^^ In addition, directors' Service contracts shall be kept open to inspection,^^2 and there is an obhgation to disclose related information in notes to a company's annual accounts.^^^ The Act also prohibits tax-free payments to directors^^"* as well as provisions which exempt a director from liability.^^^ Remuneration levels. In practice, the remuneration of executive directors is a controversial issue in England.^^^ Executive directors are highly-paid. Their remuneration packages can consist of a base salary, performance-related pay, benefitsin-kind, and pension benefits. Listed companies are required by the Listing Rules to make available for inspection by any person füll particulars of each director's remuneration including salary and other benefits.^^"^ The Combined Code also contains rules on disclosure, remuneration committees and the level of remuneration. Remuneration committees are a way for listed companies to control the levels of remuneration. According to the Combined Code, the board should establish a remuneration committee the members of which should all be independent nonexecutive directors.^^^ The powers of the remuneration committee depend on its terms of reference, that is, the authority delegated to it by the board and the articles of association. The Combined Code provides that: "The remuneration committee should have delegated responsibility for setting remuneration for all executive directors and the chairman, including pension rights and any compensation payments. The committee should also recommend and monitor the level and structure of remuneration for senior management. The definition of 'senior management' for this purpose should be determined by the board but should normally in^^* Section 319 of the Companies Act 1985 (Directors' contracts of employment for more than 5 years). See also Atlas Wright (Europe) Ltd v George Peter Wright and Ann Wright [1999] EWCA Civ 669 (shareholder unanimous consent accepted where procedures not complied with) and Re Duomatic [1969] 2 Ch 365. ^^^ Section 318 of the Companies Act 1985 (directors' Service contracts to be open to inspection). 3^3 Section 232 of the Companies Act 1985; Part I of Schedule 6. 394 Section 311 of the Companies Act 1985.
395 Section 310 of the Companies Act 1985. 396 For more information see the documents of the Company L a w Review and the Governm e n t ' s response, for example the following: Final Report, paras 6.10-6.14; White Paper, Part II, paras 3.21-3.22. See also The Directors' Remuneration Report Re-gulations 2002, S.I. 2002 No.1986. 397 The Listing Rules, 16.9. 398 Provision B.2.1.
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clude the first layer of management below board level."^^^ In addition, there is a special rule on the remuneration of non-executive directors: "The board itself or, where required by the Articles of Association, the shareholders should determine the remuneration of the non-executive directors within the limits set in the Articles of Association. Where permitted by the Articles, the board may however delegate this responsibility to a committee, which might include the chief executive.""^^^ The Combined Code also contains rules on the levels of remuneration. The levels of remuneration should be "sufficient to attract, retain and motivate directors of the quality required to run the Company successfully, but a Company should avoid paying more than is necessary for this purpose". In addition, a "significant Proportion of executive directors' remuneration should be structured so as to link rewards to corporate and individual Performance"."*^^ The remuneration committee should judge where to position their Company relative to other companies.'*^^ According to the Combined Code, the performance-related Clements of remuneration should form a significant proportion of the total remuneration package of executive directors;'*^^ on the other hand, levels of remuneration for non-executive directors should reflect the time commitment and responsibilities of the role, and remuneration for non-executive directors should not include share options.'*^'* Removal of directors, While rules on the appointment and remuneration of directors have largely been left to the discretion of the Company, there are more binding extemal rules on the removal of directors. The Companies Act 1985 does not require that directors submit themselves periodically to re-election by the shareholders. This is nevertheless often a consequence of the provisions of the Company's articles and the Combined Code. Table A provides for retirement by rotation of a certain proportion and for the filling of the vacancies at each annual general meeting;"*^^ the same can be said of the Combined Code."*^^ However, a managing director and a director holding any other executive Office shall not be subject to retirement by rotation according to Table A.407
In addition, the Combined Code recommends that "[a]ll directors should be subject to election by shareholders at the first annual general meeting after their appointment, and to re-election thereafler at intervals of no more than three years".408 Section 303 of the Companies Act 1985 provides that "[a] Company may by ordinary resolution remove a director before the expiration of his period of office, 399 Provision B.2.2. 400 Provision B.2.3.
^oiprincipleB.l. 402principleB.l. 403 Provision B . 1.1. 404 Provision B . 1.3. 405 Table A, regulations 7 3 - 7 6 ; see also Davies PL, Gower and Davies' Principles of M o d e m Company Law (2003) p 307. 406 Principle A.7. See also provisions A.7.1 (directors) and A.7.2 (non-executive directors). 407 Table A, regulation 84. 408 Provision A.7.1.
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notwithstanding anything in its articles or in any agreement between it and j^jj^" 409 jiijs means that the articles of association may provide additional grounds for the removal of directors, the most common being a request from fellow directors, but cannot override section 303."^^^ Removal and the contractual relationship. The right to remove a director under section 303 of the Companies Act or the Company's articles of association must be distinguished from the contractual relationship between the director and the Company and the matter of compensation or damages payable to the director if the Company exercises these powers. According to the Companies Act 1985, section 303 "is not to be taken as depriving a person removed under it of compensation or damages payable to him in respect of the termination of his appointment as director or of any appointment terminating with that as director, or as derogating from any power to remove a director which may exist apart from this section"."^^^ Table A is based on the same principle. Table A provides that "[a]ny appointment of a director to an executive office shall terminate if he ceases to be a director but without prejudice to any claim to damages for breach of contract of Service between the director and the company"/^^ As discussed above, the articles of association alone do not constitute a contract between the Company and a director; to what extent the contents of the contract between the director and the Company should be interpreted with reference to the articles of association is dependent on the circumstances. For example, in Nelson v James Nelson & Sons Ltd^^^ the express terms of a written contract were interpreted without reference to the articles, but in Read v Astoria Garages (Streatham) Ltd^^"^ a director was held to have been appointed as a managing director on terms set out in the articles of association. In Southern Foundries (1926) Ltd v Shirlaw,^^^ it was held that an article on the removal of a director by the Company is not automatically a breach of contract but to act upon it can be contrary to the director's agreement. For example, the contract may be lawfully terminable only on giving reasonable notice or the notice specified in the contract."^^^ The Combined Code provides that the remuneration committee should carefully consider what compensation commitments (including pension contributions and all other Clements) their directors' terms of appointment would entail in the event of early termination. According to the Code, the aim should be "to avoid rewarding poor Performance" and the remuneration committee should take a "robust line ^^^ Section 303(1) of the Companies Act 1985; see also regulation 81 of Table A. ^^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 310. 411 Section 303(5) of the Companies Act 1985. 412 Table A, regulation 84. 413 Nelson v James Nelson & Sons Ltd [1914] 2 K B 770. See also Davies PL, Gower and Davies' Principles of M o d e m Company Law (2003) p 313. 414 Read V Astoria Garages (Streatham) Ltd [1952] C h 637, [1952] 2 All ER 292. 415 Southem Foundries (1926) Ltd v Shirlaw [1940] A C 7 0 1 , [1940] 2 All E R 445 (House of Lords). See also Davies PL, Gower and Davies' Principles of M o d e m Company L a w ( 2 0 0 3 ) p 312. 41^ Davies PL, Gower and Davies' Principles of M o d e m Company L a w (2003) p 313.
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on reducing compensation to reflect departing directors' obligations to mitigate l0SS".417
Right to nominate candidates to the board. The right to nominate candidates for election to the board is determined by the Company's articles of association. Table A and the Combined Code suggest that the rights of shareholders to nominate candidates are subject to restrictions. According to Table A, no person (other than a director retiring by rotation) shall be appointed or reappointed a director at any general meeting unless (a) he is recommended by the directors or (b) a shareholder has, in advance, notified the Company of his intention to propose that person for appointment or reappointment; shareholders who wish to nominate candidates for election to the board must therefore adhere to the dates and and follow the procedures set out in the articles."^^^ The Combined Code is silent on the rights of shareholders to nominate candidates. Other Managers While the Companies Act 1985, Table A and the Combined Code regulate the appointment, remuneration and removal of members of the board of directors, these mies do not apply to sub-board managers. The appointment, remuneration and removal of other managers are govemed by the general rules applicable to distribution of powers within the Company. The articles of association normally confer unlimited management powers on the directors. The Combined Code provides that the remuneration committee should recommend and monitor the level and structure of remuneration for senior management. The definition of senior management for this purpose should be determined by the board of directors but should normally include the first layer of management below board level."^^^ Auditors The appointment of auditors is regulated partly by the Companies Act 1985 (as amended) and partly by the Combined Code. Appointment. In normal cases,'*^^ auditors are appointed at each general meeting at which accounts are laid. The appointment must be from the conclusion of that meeting until the conclusion of the next general meeting at which accounts are laid."^^^ This is designed also to enhance the independence of auditors' from directors.422
^^7 Provision B.1.5. 4'^ Table A, regulations 76, 77 and 78. See also Branch v Bagley & Ors [2004] E W H C 426 (Ch). 419 Provision B.2.2. 420 See section 385(1) of the Companies Act 1985. 421 Section 385(2) of the Companies Act 1985. 422 Davies PL, Gower and Davies' Principles of M o d e m Company Law (2003) p 569.
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Remuneration. Shareholders in general meeting may decide on the remuneration of auditors. The remuneration of auditors appointed at the general meeting is fixed either by the shareholders or in such manner as they may determine."*^^ In practice, shareholders normally adopt a resolution proposed by directors to the effect that the remuneration shall be agreed by the directors. This is true although the statutory rule has a good purpose - it is "intended to emphasise that the auditors are the members' watchdogs rather than the directors' lapdogs"/^"^ Disclosure. The Companies (Audit, Investigations and Community Enterprise) Act 2004 made a number of amendments to the Companies Act 1985. One of the aims of the new Act was to enable more detailed disclosure requirements which allow stakeholders and others to identify particular features of the company/auditor relationship that may raise concems over the auditor's independence. For example, Part 1 of the Act extends the Secretary of State's power to require detailed disclosure of non-audit Services provided by auditors to companies."^^^ Removal. Shareholders in general meeting may decide on the removal of auditors. They may by ordinary resolution at any time remove an auditor from office, notwithstanding anything in any agreement between the Company and the auditor.'*^^ On the other hand, this would not deprive an auditor of compensation or damages payable to him in respect of the termination of his appointment as auditor, or of any appointment terminating with that as auditor,'*^'^ and an auditor removed would not lose all his rights immediately.'^^^ This means that "a Company cannot remove an auditor against his will without facing a serious risk of a row at the general meeting (and, in the case of a listed Company, adverse press publicity) and, probably, payment of compensation"."^^^ Rotation. There are some mies on the regulär rotation of auditors. There is no regulatory requirement for listed companies to change auditors after a number of years in office. However, although there is no requirement for rotation at the level of the firm, the audit engagement partner (lead partner on an audit) must rotate at least every 7 years and cannot retum to that role for a further five years."^^^ ^2^ Section 390A(1) of the Companies Act 1985. ^'^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 570. ^^^ See the new section 390B of the Companies Act 1985 inserted by the Companies (Audit, Investigations and Community Enterprise) Act 2004. ^26 Section 391(1) of the Companies Act 1985. 427 Section 391(3) of the Companies Act 1985. ^'^^ Section 391(4) of the Companies Act 1985: "An auditor of a Company who has been removed has, notwithstanding his removal, the rights conferred by section 390 in relation to any general meeting of the Company - (a) at which his term of office would otherwise have expired, or (b) at which it is proposed to fill the vacancy caused by his removal ..." Section 390 sets out what a Company's auditors are entitled to. 42^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 572. 43^ The Institute of Chartered Accountants in England & Wales (ICAEW), Statement 1.201 (Integrity, Objectivity and Independence), para 4.80. The European Commission has issued a Recommendation Statutory Auditors' Independence in the EU: A Set of Fundamental Principles on 16 May 2002. The Recommendation requires mandatory partner rotation on listed clients after seven years but allows a retum already after two years. See also para 3.3(d) of the Listing Rules.
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Audit committee. According to the Combined Code, the board should establish an audit committee, the members of which should all be independent nonexecutive directors."*^^ The audit committee is expected "to make recommendations to the board, for it to put to the shareholders for their approval in general meeting, in relation to the appointment, re-appointment and removal of the external auditor and to approve the remuneration and terms of engagement of the extemal auditor".'*^^ The audit committee should have primary responsibility for making a recommendation on the appointment, reappointment and removal of the extemal auditors/^^ If the board does not accept the audit committee's recommendation, the Statement in the annual report relating to compliance with the Code should include the audit committee's Statement explaining the recommendation and the reasons why the board has taken a different position.'^^^ The audit committee should also approve the terms of engagement and the remuneration to be paid to the extemal auditor in respect of audit Services provided.435
4.5 Agreements and Internal Management 4.5.1 Introduction One or more shareholders can act as a rule-maker also outside the general meeting of shareholders. In particular, the Constitution of the Company and resolutions of the Company in general meeting can be supplemented by agreements. Agreements can have the advantage of flexibility. The most important forms of contracts are the unanimous consent of shareholders, shareholders' agreements, and shareholders' agreements with the Company.
4.5.2 Unanimous Consent There are two kinds of rules on the unanimous consent of shareholders. The common law rules on unanimous consent apply to public as well as private companies. The provisions of the Companies Act 1985 on written resolutions and elective resolutions apply only to private companies. Unanimous consent at common law. Although the common law rules on unanimous consent apply even to public companies, it is in practice impossible to obtain the assent of all shareholders in a listed Company. This principle is never-
431 Provision C.3.1. See also the Smith Guidance. ^32 Provision C.3.2. 433 Provision C.3.6. "^34 Schedule C. See also the Smith Guidance, para 4.14. 435 The Smith Guidance, para 4.18.
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theless useflil where the listed Company is the parent that makes rules in a subsidiary. According to the principle in Re Duomatic,^^^ the unanimous consent of all shareholders who have a right to attend and vote at a general meeting of the Company can override formal requirements in relation to the passing of resolutions at such meetings. In Cane v Jones,"^^"^ it was held that the informal assent of all shareholders of a Company has the effect of binding the Company even if a special or other resolution or alteration of articles is thereby affected. This common law rule does not require consent to any written resolution. Even wholly informal consent may bind the Company, provided that it is given by all the members entitled to vote. The shareholders can give their consent without any form of meeting."^^^ For example, in Wright v Atlas Wright (Europe) Ltd^^^ the managing director of a Company had negotiated with the managing director of its wholly owned subsidiary the terms of a consultancy agreement which the latter was proposing to enter into with the subsidiary. This was found to amount to informal unanimous consent on the part of the parent. On the other hand, there are post-decision formalities applicable to some informal agreements. Some agreements must be forwarded to the Registrar of companies and recorded.'*'^^ The principle of unanimous consent applies whether the general meeting is required by the Companies Act 1985 or the Company's articles of association. The Courts must nevertheless draw a line between the common law principle of unanimous consent and the procedural formalities required by the Companies Act 1985 to be observed in many cases where the Act requires a shareholder resolution."^"^^ For example, in Wright v Atlas Wright (Europe) Ltd the Court of Appeal had to consider whether the term in the consultancy agreement was rendered void by the procedural formalities of the Companies Act^'^^ or whether it might be enforceable by the principle of unanimous consent as set out in Re Duomatic. According to the courts, reference has to be made both to the purpose of the procedural requirement and to the matter of whom the prescribed procedure is supposed to Protect. The principle of unanimous consent can operate to waive formalities required for the protection of shareholders, but not those required for 436 R e Duomatic [1969] 2 Ch 365. 437 [1981] 1 All E R 533. 438 Davies PL, Gower and Davies' Principles of M o d e m Company L a w (2003) p p 3 3 4 - 3 3 7 . 439 Wright and another v Atlas Wright (Europe) Ltd [1999] 2 B C L C 3 0 1 , [1999] B C C 163. 440 Davies P L , Gower and Davies' Principles o f M o d e m Company L a w (2003) p 3 3 6 : "There seems to b e n o reason for exempting informal agreements from these requirements. Indeed, the Obligation to notify the Registrar m a y already apply [section 380(4)(c)], but the requirement as to recording in the minute book seems not to [sections 382 and 382A]". 44^ See Davies PL, Gower and Davies' Principles of M o d e m Company Law (2003) p p 3 3 5 336. 442 B y section 319(6) o f the Companies Act 1985 to the extent that the formalities laid down in section 319(1) had not been compHed with (resolution of Company in general meeting and prior laying of memorandum for inspection).
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the protection of other parties such as creditors. For example, in Precision Dippings Ltd V Precision Dippings Marketing Ltd^^^ it was held that no distribution of Profits could be made in breach of the statutory requirements; these requirements are mandatory. Effect on the board ofdirectors and sub-board managers. It is to be noted that none of the decided cases clearly present the Situation of the shareholders unanimously taking a decision which had been allocated by the Constitution to the board.444
The common law principle of unanimous consent operates on the basis that the shareholders have by their assent waived the need for compliance with procedural requirements which are for their benefit. This means that the effect of the unanimous consent on the board ofdirectors and sub-board managers is indirect: the act done by the shareholders is regarded as sufficient and valid. In other words, "where that which has been done informally could ... have been done formally and was assented to by 100% of those who could have participated in the formal act if one had been carried out, then it would be idle to insist upon formality as a pre-condition to the validity of the act which all those competent to effect it had agreed should be effected"."^^ Written resolutions and elective resolutions. For private companies, the formalities relating to resolutions have been relaxed by provisions on written resolutions and elective resolutions."^"^^ The provisions on written resolutions and elective resolutions do not yet apply to public companies, but this may change. The Final Report of the Steering Group of the Company Law Review recommends that legislation should expressly State that any decision, which the Company has the power to make, may be made without observing any of the formalities of the Companies Act or the Company's Constitution where the members unanimously agree.'*'^'^ The Final Report further recommends that written resolutions may be effected in private companies without the need for unanimity. Instead, written resolutions may be passed with 75 % and 50 % majorities of those eligible to vote for special and ordinary resolutions, respectively."^"^^
^^^ Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] Ch 447. ^^ See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 306. 445 Oliver J in Re N e w Cedos Engineering Co Limited [1994] 1 B C L C 797. 446 Sections 3 8 1 A - 3 8 1 C and section 379A of the Companies Act 1985, respectively. These provisions were inserted b y Companies Act 1989. The Company L a w Review proposed a further deregulation o f formalities for private companies. 447 M o d e m Company Law for a Competitive Economy, Final Report, para 2.14. 448 M o d e m Company Law for a Competitive Economy, Final Report, para 2.15.
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4.5.3 Shareholders' Agreements Agreements between the shareholders inter se can have the advantage of flexibility and privacy/"*^ These "real" agreements must be distinguished from articles of association. Shareholders' agreements are govemed by the ordinary principles of contract law."*^^ Although articles of association are also regarded as a contract/^^ articles of association are regarded only as a unique statutory form of contract and not as a normal contract. It is not quite clear to what extent the Company can be made party to shareholders' agreements. For example, a Company cannot with impunity break its contracts, but a Company cannot contract out its statutory power to alter its articles by special resolution.'*^^ It is necessary to distinguish between the effect of shareholders' agreements on the shareholders and their effect on the Company. Effect on shareholders. The main rule is that agreements concluded between shareholders are valid and binding."^^^ A shareholders' agreement may also be enforced by injunction in the same way as any other contract."^^"* On the other hand, shareholders' agreements are binding on their parties only. The main principle applicable to the effect of shareholder agreements is formulated in Welton v Saffery,^^'^ where Lord Davey said: "Of course, individual shareholders may deal with their own interests by contract in such way as they may think fit. But such contracts, whether made by all or some only of the shareholders, would create personal obligations, or an exceptio personalis against themselves only, and would not become a regulation of the Company, or be binding on the transferees of the parties to it, or upon new or non-assenting shareholders." An agreement between the shareholders as to how they will exercise the voting rights attached to their shares is not caught by the principle that a Company cannot contract out of its statutory powers to alter its articles or memorandum."^^^ In Russell V Northern Bank Development Corpn Ltd,^^'^ Lord Jauncy said, after citing '^^ Section 10 of the Companies Act 1985; Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 506; the Law Commission, Shareholder Remedies, Law Commission Consultation Paper 142 (1996) para 3.4. ^^^ See the Law Commission, Shareholder Remedies, Law Commission Consultation Paper 142 (1996) para 3.3. ^5^ Section 14(1) of the Companies Act 1985. ^^^ Section 9 of the Companies Act 1985; Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 506-507. 4" See Russell v Northem Bank Development Corpn Ltd [1992] 3 All ER 161, [1992] 1 WLR 588 (House of Lords); the Law Commission, Shareholder Remedies, Law Commission Consultation Paper 142 (1996) para 3.16. ^^^ See the Law Commission, Shareholder Remedies, Law Commission Consultation Paper 142 (1996) para 3.10. 455 Welton V Saffery [1897] AC 229. "^56 Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 508. 457 Russell V Northem Bank Development Corpn Ltd [1992] 3 All ER 161, [1992] 1 WLR 588 (House of Lords).
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Welton V Saffery,^^^ that "shareholders may lawfully agree inter se to exercise their voting rights in a manner which, if it were dictated by the articles, and were thereby binding on the Company, would be unlawful". Effect on the Company. The effect of shareholders' agreements on the Company can to some extent be dependent on the contents of the Company's articles of association. Under Table A, regulation 70, shareholders cannot normally interfere in the exercise of the directors' powers;"^^^ directions can be given only by special resolution by shareholders in general meeting. However, the Companies Act 1985 does not seem to prevent articles which provide that directions can be given by shareholders' agreements. What is less clear is to what extent a shareholder can generally force the Company to act in accordance with the terms of a shareholders' agreement.'*^^ What was at issue in some cases was the availability of an injunction against the Company to prevent it from adopting new articles contrary to a shareholders' agreement. For example, while in Southern Foundries (1926) Limited v Shirlaw^^^ Lord Porter said that an injunction cannot be granted to prevent the adoption of new articles, Scott J said in the Cumbrian Newspapers case"^^^ that he could "see no reason why [the Company] should not, in a suitable case, be injuncted from initiating the calling ofa general meeting with a view to the alteration of the articles." In legal literature, a distinction has been made between injunctive relief to prevent the adoption of new articles (the former case, relief not granted) and injunctive relief merely to prevent an action upon the new articles (relief granted)."^^^ In practice, injunctive relief against the Company has been available to a shareholder seeking to enforce his contractual rights and there are cases where an express or implied shareholders' agreement has in effect been held to be binding on the company."^^"* In Pennell Securities Ltd v Venida Investments Ltd,^^^ an agreement had been made tacitly between the members of the Company on its formation that the plain458 Welton v Saffery [1897] A C 229. 459 John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 K B 113; Quin & Axtens Ltd v Salmon [1909] A C 442; Automatic Self-Cleansing Filter Syndicate C o Ltd v Cunningham [1906] 2 Chapter 34; Alexander Ward and C o Ltd v Samyang Navigation C o Ltd [1975] 2 All E R 424; Scott v Scott [1943] 1 All E R 582; and Breckland Group Holdings Ltd v London & Suffolk Properties Ltd [1989] B C L C 100. 460 See also Davies PL, Gower and Davies' Principles of M o d e m Company Law (2003) p p
507-508. 461 Shirlaw v Southern foundries (1926) Ltd [1939] 2 KB 206. 462 Cumbrian Newspapers Group Ltd v Cumberland & Westmorland Herald Newspaper & Printing Company Ltd [1987] C h . l .
463 Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 507-508: "injunctive relief merely to prevent an acting upon the new articles would not fall foul of [the] principle [in Shirlaw]". 4^4 See also Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 507-508. 465 Noted in Sealy LS, Cases and Materials in Company Law.
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tiffs' minority stake should remain at 49% unless they agreed otherwise. Because of this implied agreement, Templeman J granted the plaintiffs injunctions to prevent the directors from proceeding with resolutions the effect of which would have been to cut the plaintiffs' minority holding under 10%. On the other hand, sometimes relief can have been granted on a basis other than a shareholders' agreement. In Breckland Group Holdings Ltd v London and Suffolk Properties Ltd^^^^ a shareholders' agreement set out that no decision on the institution of legal proceedings could be taken by the board of the Company without the affirmative Support of two directors, each representing one of the two major shareholders. Legal proceedings had nevertheless been commenced in the name of the Company. The solicitors had acted on the instructions of a shareholder Controlling 51%o of the votes at a general meeting. Harman J held that the procedure laid down in the shareholders' agreement could not be by-passed. Shareholders in general meeting had no competence to interfere in the matter. On the other hand, the ruling in Breckland was based in part on the terms of the shareholders' agreement and in part on the wording of an article which was similar in terms to Table A, regulation 70 which vests the power to manage the Company in the directors. It was in other words held that the Company in general meeting could not intervene to adopt unauthorised proceedings; the only organ that could do so was the board. \xvRe A & BC Chewing Gum Ltd,^^'^ a shareholders' agreement provided that a certain corporate investor, who had put up one-third of the share capital, should enjoy a fifty-fifty say in management despite its minority shareholding. This did not happen. The Company was therefore wound up on a just and equitable ground (although a direct remedy to enforce the contract by injunction might have been available). In Harman v BML Group Ltd,^^^ the Company had a share capital consisting of 290,000 A shares and 210,000 B shares. There were four A shareholders but only one B shareholder, a Mr Blumenthal. A shareholders' agreement provided that Mr Blumenthal should be entitled to remain in office as director so long as he, or any family Company of his, should be the owner of the B shares, and that a general meeting should be inquorate unless the B shareholder, or his proxy or representative, attended. According to the Court of Appeal, there was a dass right attached to a dass of shares, which the convening of a general meeting was designed to override. The court held that this could not be done. Dillon LJ made it clear that it was not for the court to make a new shareholders' agreement and impose it on the parties. This dass right could not be overridden by section 371 of the Companies Act 1985 (power of the court to order a meeting). However, in Union Music Limited and Arias Limited v Russell Watson and Blacknight Limited,^^^ a provision in a shareholders' agreement which required the 4^^ Breckland Group Holdings Ltd v London and Suffolk Properties Ltd [1989] BCLC 100. 467 Re A & BC Chewing Gum Ltd [1975] 1 All ER 1017, [1975] 1 WLR 579. 46« Harman v BML Group Ltd [1994] 1 WLR 893. 469 Union Music Limited and Arias Limited v Russell Watson and Blacknight Limited [2003] EWCACiv 180.
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consent of all shareholders before a shareholders' meeting could be held did not prevent the court from convening a meeting under section 371 of the Companies Act 1985, nor from determining that the meeting could be held with only one shareholder present. Gibson LJ distinguished this case from Harman v BML Group Ltd: "The present case is not one with entrenched or any dass rights, as it seems to me. There is nothing in the Agreement or in the memorandum and articles of Arias which confers any right on Mr Watson as shareholder which is not also conferred on Union as shareholder." Gibson LJ went on to say interestingly that there is no major difference between shareholders' agreements and articles of association."^*^^ Effect on directors and sub-board managers. Whether a shareholders' agreement is in effect binding on directors in their capacity as members of the board of directors could be dependent on whether it is binding on the Company. A shareholders' agreement can hardly be binding on directors unless it is binding on the Company. For example, it could be binding on the Company under the common law rules on unanimous consent or due to an express regulation in the articles of association conferring on the shareholders a power to give directions by shareholders' agreement.'^'^^ These matters have been discussed above in the context of unanimous consent.
4.5.4 Shareholders' Agreements with the Company Sometimes the Company is joined as a party to an agreement between the shareholders. Shareholders' agreements with the Company must be distinguished from agreements between shareholders inter se. Effect on the Company, Shareholders' agreements with the Company are not always invalid. For example, a Law Commission Consultation Paper pointed out that the Company can become a party and it may "agree to take or not to take certain action, or to consult the parties to the agreement before entering into certain ^'^^ Gibson LJ: "In this context it is to be bome in mind that by section 14(1) of the Act, the memorandum and articles bind the Company and its members to the same extent as if they respectively had been signed and sealed by each member, and contained covenants on the part of each member to observe all the provisions of the memorandum and articles. For my part, I have difficulty in seeing how an agreement constituted by the statutory deeming provision is to be treated in any way differently from an express agreement, such as a shareholders' agreement, containing a quorum provision. Both have effect as contractual agreements as between the shareholders." ^'^^ See also sections 35(3), 35A(1) and 35A(3)(b) of the Companies Act 1985. Section 35(3): "It remains the duty of the directors to observe any limitations on their powers flowing from the company's memorandum ..." Section 35A(1): "In favour of a person dealing with a Company in good faith, the power of the board of directors to bind the Company, or authorise others to do so, shall be deemed to befreeof any limitation under the company's Constitution." Section 35A(3): "The references above to limitations on the directors' powers under the company's Constitution include limitations deriving ... (b) from any agreement between the members of the Company or of any dass of shareholders." See also sections 322A(1) and 322A(8)(b).
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transactions, for example, a secured loan or a contract for the sale of its business." In addition, a shareholders' agreement may also "give a member a right to receive certain Information from the Company"."^"^^ Sometimes shareholders' agreements with the Company are invalid. Shareholders' agreements with the Company are void if they fetter the Company's statutory powers. Section 9 of the Companies Act 1985 provides that a Company may alter its articles of association by special resolution. According to a principle applied in Russell v Northern Bank Development Corpn Ltdf'^ an agreement is not valid, if it would in effect become a regulation of the Company. In Russell, an agreement by shareholders as to how they would exercise their voting powers was valid, but the agreement by the Company not to use its statutory powers (to create or issue shares) was not. The principle of invalidity is subject to the qualification that a validly made agreement does not become invalid just because the Company later amends its articles and to act upon the altered articles would amount to breach of contract."^^"^ In Southern Foundries (1926) Limited v Shirlaw,'^'^^ Lord Porter said: "A Company cannot be precluded from altering its articles thereby giving itself power to act upon the provisions of the altered articles - but so to act may nevertheless be a breach of contract if it is contrary to a stipulation in a contract validly made before the alteration." It is also necessary to distinguish between the obligations of the Company and the obligations of shareholders or third parties. While the principle of invalidity can apply to agreements which lay down obligations on the Company, it does not have to be applied in the same way to agreements which lay down obligations on others who are party to the agreement. For example, in Re Peveril Gold Mines Ltd^'^^ the articles of association of the Company purported to forbid members from petitioning for the winding up of the Company unless certain conditions were satisfied. Lord Lindley MR said: "Any article contrary to [the winding up] sections ... would be an attempt to enforce on all the shareholders that which is at variance with the statutory conditions and is invalid ... I do not intend to decide whether a valid contract may or may not be made between the Company and an individual shareholder that he shall not petition for the winding up of the Company." In Re Colt Telecom Group Plc,'^'''^ the notes of bondholders contained a no-action clause according to which a holder could not pursue any remedy with respect to the notes unless certain conditions were fulfilled. It was held that the no-action clause in no way fettered the rights of the Company; it was restrictive of noteholders' rights only. "^^^ The Law Commission, Shareholder Remedies, Law Commission Consultation Paper 142 (1996) para 3.6. 473 Russell v Northern Bank Development Corpn Ltd [1992] 3 All ER 161, [1992] 1 WLR 588 (House of Lords, Lord Jauncey). ^"^^ See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 507. 475 Southern Foundries (1926) Limited v Shirlaw [1940] A C 7 0 1 , [1940] 2 All E R 4 4 3 (House of Lords). 476 Re Peveril Gold Mines Ltd [1898] 1 C h 122. 477 Re Colt Telecom Group Plc [2002] E W H C 2815 (Ch).
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Effect on directors and sub-board managers. There is little material on whether shareholders' agreements with the Company are in some way - in the strict legal sense or merely de facto - binding on directors and sub-board managers. It can probably be assumed that they cannot be legally binding on directors and subboard managers unless they are binding on the Company. If they are binding on the Company, they probably affect the duties of directors and sub-board managers like any other contracts binding on the Company. In order to comply with his duty of care, a director or sub-board manager may need to take the contract into account. The effect of the contract depends probably on the nature of the contract and the role and position of the director or sub-board manager in question.
4.6 Disclosure, Remedies and IVIanagement Duties 4.6.1 Introduction As discussed above, there are many forms of shareholder activism. Shareholders have sometimes formal powers to make mies directly. In smaller companies and companies with concentrated ownership, large shareholders have de facto powers to influence management regardless of the formal regulation of corporate govemance. On the other hand, there are also rules that give shareholders an opportunity to act as a rule-maker indirectly. The rights of shareholders to monitor the board can create indirect rule-making powers. This is because the exercise of board members' powers can be consträined by: (a) the disclosure of Information and the "outrage constraint'V^^ that is, how angry shareholders and the public at large get about their actions; (b) board members' duties and the remedies available to shareholders for breach of duty; and (c) the remedies available to shareholders without any breach of duty being necessary. These matters can influence the board if board members are aware of the risk of future sanctions related to their actions. Shareholders' rights to information. Disclosure is one of the fundamental principles of UK Company law. New legislation has nevertheless been necessary after the recent US and European corporate scandals in order to restore Investor confidence in corporate govemance, accounting and Company auditors."^^^ Duties ofthe management. Board members' and sub-board managers' acts can be constrained both by their duties and by remedies for breach of duty. To what extent these duties are "hard law" or "soft law" (or "mandatory", "dispositive" or "non-binding", see Chap. 2.3.8 above) in fact is dependent not only on the duties as such but even on the remedies for their breach and how effectively these remedies are enforced. (a) Shareholders can influence management at least indirectly by actively using the remedies available to them. On the other hand, shareholders ^^^ See Bebchuk LA, Fried JM, Walker D, Managerial Power and Rent Extraction in the Design of Executive Compensation, U Chicago L Rev 69 (2002) pp 751-846. ^'^^ See for example the first Part of the Companies (Audit, Investigations and Community Enterprise) Act 2004.
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do not always need to do this. (b) Some duties can be enforced by other parties. (c) It is also possible that some duties are followed as generally acceptable practices or social norais regardless of the lack of effective legal remedies for their breach or the failure to enforce these remedies. It is probably reasonable to assume that most managers in the UK want to do their job. Remedies. In any case, there are different kinds of remedies. While some remedies available to shareholders are linked to a breach of duty, other remedies do not require any such breach. For example, shareholders in general meeting can in principle decide on the removal of directors and sometimes on their appointment. This remedy, which does not have to be linked to any breach of duty, enables Controlling shareholders to change underperforming board members. A shareholder who holds a majority of the voting rights will not usually need to resort to other remedies. In principle, breach of duty is often coupled with liability for loss caused thereby. In light of difficulties facing shareholders contemplating civil litigation, penal or administrative sanctions can be an important means of ensuring that board members and sub-board managers comply with their obligations."*^^
4.6.2 Disciosure of Information The disciosure of information is necessary for two main reasons. Firstly, shareholders cannot use their limited powers in a rational way without sufficient information. Secondly, the capital market cannot function effectively without accurate and timely information available, at least in principle, to all Investors. Disciosure requirements are therefore part of both Company law and capital markets law."^^^ Shareholders can obtain information from the Company either passively or actively. They can wait until information about the Company is disclosed to them (passive shareholders) or ask the representatives of the Company for information not yet disclosed to them (active shareholders). The passive strategy is complemented by the Company's or its management's active duty of disciosure. The active strategy can lead to selective disciosure, general disciosure, or no disciosure at all, depending among other things on the rights and obligations (in particular the right to disclose information, the duty to disclose information, or the duty not to divulge information) of the Company representatives in question (in
"^^^ Modem Company Law for a Competitive Economy: Completing the Structure, para 13.7. 481 See also Completing the Structure, para 13.26. Lord Oliver said in Caparo Industries v Dickman [1990] 2 AC 605 (House of Lords) that "the history of the legislation is one of an increasing availability of information regarding the financial affairs of the Company to those having an interest in its progress and stability" and that "[i]t cannot fairly be said that the purpose of making such information available is solely to assist those interested in attending general meetings of the Company to an informed supervision and appraisal of the stewardship of the Company's directors".
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particular the board of directors, Company secretary, managing director, sub-board managers, or auditor).
Unrequested Information The main rules on compulsory disclosure can be found in the Companies Act 1985 and in the Listing Rules. The former apply to public companies generally and the latter to listed companies. These rules are supplemented by other requirements. Companies Act 1985. Disclosure is the fundamental principle underlying the Companies Act 1985. Publicity is maintained in many ways, for example by the compulsory disclosure of the financial position in the Company's annual published accounts and by attempting to ensure their accuracy through a professional audit.482
The rules on annual accounts are based on the provisions of the Fourth and Seventh Company Law Directives. These Directives adopted both the "true and fair" test from UK law and the Continental European practice of dealing with matters of form and content of annual accounts in legislation."^^^ Like before, the Companies Act requires that the accounts give a true and fair view of the financial affairs of the Company.'*^'* Schedules 4 and 4A of the Act deal with matters of form and content of individual Company and group accounts. Accounting Standards. The provisions of the Companies Act 1985 and Schedules 4 and 4A are complemented by accounting Standards which are developed nowadays by the Accounting Standards Board (ASB). The accounting Standards are important because neither the Fourth and Seventh Directives nor Schedules 4 and 4A of the Companies Act deal with all matters that have to be covered in the accounts. The Schedules lay down a "comply or explain" rule relating to accounting Standards: "It shall be stated whether the accounts have been prepared in accordance with applicable accounting Standards and particulars of any material departure from those Standards and the reasons for it shall be given"."*^^ Reform. In order to prevent Enron-style frauds and to restore Investor confidence, the Companies (Audit, Investigations and Community Enterprise) Act 2004 amending the Companies Act 1985 gives auditors greater powers to get information they need"*^^ and provides that directors have to State that they have not withheld any relevant information from auditors."^^^ The Act provides that directors can be prosecuted and fined for concealing relevant information from auditors. In this
"^^^ See Modem Company Law for a Competitive Economy: Developing the Framework, Chapter 5; Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 533. ^^'^ See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 543. ^^^ Sections 226(2) and 227(3) of the Companies Act 1985. See also Article 2 of the Fourth Directive. ^^5 Schedule 4, para 36A. See also sections 226(3)-(5) of the Companies Act 1985. ^86 Sections 389A(1) and 389A(2) of the Companies Act 1985. ^^^ Section 234(2A) of the Companies Act 1985.
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respect the duty of care of directors is objective."^^^ Also failure to comply with information requests is an offence (offence relating to the provision of information to auditors)."^^^ The powers of auditors extend even to subsidiaries."^^^ The Companies (Audit, Investigations and Community Enterprise) Act 2004 also provides for independent monitoring of audits of listed and other major companies."^^^ In addition, the new Act makes changes in relation to authorising a person to apply to the court to correct defective accounts.'^^^ Listing Rules. The main disclosure obligations under the Listing Rules are set out in Chapter 9 which deals with continuing obligations. These rules are complemented by the UKLA's Continuing Obligations Guide. Chapters 5 and 6 of the Listing Rules set out requirements relating to prospectuses and listing particulars. There are two underlying principles behind all continuing obligations in the Listing Rules, namely: (a) timely disclosure of all relevant information;"*^^ and (b) equal treatment of shareholders."*^"* These principles seek to protect investors by achieving an orderly market and they are supposed to ensure that all users have simultaneous access to the same relevant information/^^ but they do not prevent the Combined Code from recommending close contacts with major shareholders and institutional shareholders."*^^ In addition to several detailed obligations, the Listing Rules require companies to comply with two main disclosure obligations. Firstly, a Company must ensure that all the necessary facilities and information are available to enable shareholders to exercise their rights (prescribed information to shareholders)."*^^ In particular, such information must include notice of meetings, dividends, new issues, and information on redemption or repayment. Secondly, the Listing Rules impose a general statutory Obligation for all listed companies to disclose such information as is necessary to enable an Investor to make an informed decision on the Performance of the companies. The Listing Rules and the UKLA's Continuing Obligations Guide contain for example the following obligations: (a) The principal disclosure Obligation for listed companies is to ensure that the information emanating from it, its advisers or
4^^ Section 234ZA of the Companies Act 1985. 489 Section 389B of the Companies Act 1985. "*90 Sections 389A(3) and 389A(4) of the Companies Act 1985. 491 Sections lOA and 12A of the Companies Act 1985 and Part 3 of Schedule 11 to the Companies Act 1989. 492 T h e person w h o is currently authorised to d o so under section 245 C of the Companies Act 1985 is the Financial Reporting Review Panel (FRRP). The Act provides the F R R P with a statutory power to require a Company and its officers, employees and auditors to provide documents and information. See Section 245F of the Companies Act 1985. 493 T h e Listing Rules, 9.1, 9.2 and 9.3A. 494 T h e Listing Rules, 9.16; the Continuing Obligations Guide, 1.4. 495 T h e Continuing Obligations Guide, 1.5. 496 Combined Code, principle D . I . 497 T h e Listing Rules, 9.24. See also Articles 65(2) and 78(2) of the Listing Directive (2001/34/EC).
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agents is given to the market as a whole and is timely, sufficient and relevant.'*^^ (b) Listed companies must publish a half-yearly report without delay after board approval and in any event within 90 days of the end of the period to which it relates."^^^ (c) Listed companies are required to publish their annual report and accounts as soon as possible after the accounts have been approved but no later than six months after the end of the financial period.^^^ (d) The annual accounts must be independently audited, in Consolidated form and, if they do not give a true and fair view of the State of the Company's or group's affairs and profit and loss, provide detailed additional information.^^^ (e) Listed companies must notify of major new developments that are not in public knowledge and which may be price sensitive, without delay.^^^ Where the continuing obligations are not met and the UKLA considers it appropriate, one ofa ränge of sanctions set out in Chapter 1 of the Listing Rules may be imposed.^^^ Periodic disclosure. Periodic disclosure is govemed by a number of rules that complement each other. Annual disclosure is govemed by the provisions of the Companies Act 1985 and Schedules 4 and 4A. The Listing Rules require that listed companies prepare half-yearly reports in addition to annual reports.^^"* Section 226(1) of the Companies Act 1985 requires the directors ofa Company to prepare, for each financial year of the Company, a balance sheet as at the last day of the year. According to sub-section (2), the balance sheet shall give "a true and fair view of the State of affairs of the Company as at the end of the financial year". Section 233(1) requires that the Company's annual accounts, prepared in accordance with section 226(1), be approved by the board of directors. If annual accounts are approved which do not comply with requirements of the Act - including the true and fair view requirement - every director of the Company who is party to their approval and who knows that they do not comply or is reckless as to whether they comply is guilty of an offence and liable to a fine under section 233(5). Section 235(1) of the Companies Act 1985 requires the Company's auditors to make a report to shareholders on the annual accounts. Section 235(2) requires that the auditors' report shall State whether in the auditors' opinion the balance sheet of the Company does show a true and fair view of the Company's affairs at the end of the fmancial year. Although it might appear from these sections of the Companies Act 1985 that the preparation, approval, and audit of annual accounts are a series of distinct and sequential steps, this would not reflect ordinary practice. It would be most unusual ^'^^ The Continuing Obligations Guide, 1.8. See also the Listing Rules, 9.1 and 9.2. 499 The Listing Rules, 12.46 and 12.49; Article 70 of the Listing Directive (2001/34/EC). For the report of auditors see the Listing Rules, 12.54; and the Continuing Obligations Guide, 6.15. ^^ The Listing Rules, 12.42; the Continuing ObHgations Guide, 6.1. ^^^ The Listing Rules, 12.42; the Continuing ObHgations Guide, 6.7. ^^^ The Continuing Obligations Guide, 2.2. ^^^ The Continuing Obligations Guide, 1.8. 504 The Listing Rules, 12.41 and 12.46; Article 70 of the Listing Directive (2001/34/EC).
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for directors to approve annual accounts without having first satisfied themselves, by consultation with the auditors, as to the form of report which the auditors would expect to make in relation to those accounts. Discussions between directors and auditors as to the proper treatment in the balance sheet of any item Hkely to be controversial will, almost invariably, take place before the accounts are approved and the audit report signed. These discussions do not absolve the directors, or the auditors, from their own independent duties. It is nevertheless in the interests of both that any issue as to the proper treatment of an item should be identified, and if possible resolved, before the accounts are fmalised.^^^ Compliance with accounting requirements is also monitored by the Financial Reporting Review Panel (FRRP, the Panel). The Panel considers whether the annual accounts of public companies and large private companies comply with the requirements of the Companies Act 1985 including applicable accounting Standards. Although the powers of the Panel derive from the Companies Act 1985,^^^ they are rather limited because the Panel is not a public authority. Failing voluntary correction, the Panel can exercise its powers to secure the necessary revision of the original accounts through a court order. The Panel can also make press notices. Self-evaluation of board Performance. The Combined Code provides for the evaluation of board Performance. The board should undertake "a formal and rigorous annual evaluation of its own Performance and that of its committees and individual directors".^^'^ The board should also State in the annual report how Performance evaluation of the board, its committees and its individual directors has been conducted. The non-executive directors, led by the senior independent director, should be responsible for Performance evaluation of the chairman, taking into account the views of executive directors.^^^ On the other hand, the Combined Code is silent on whether that calls for external or internal assessment and what, if anything, should be disclosed about the outcome. In practice, most FTSE 100 companies prefer self-assessment. So far, reporting on board evaluation in the annual report tends to be bland, with little information on responses to findings.^^^ Ad-hoc disclosure. As regards ad-hoc disclosure, the most important rules can be found in the Listing Rules. They are supplemented by the Continuing Obligations Guide. The most important rule is that listed companies must notify without delay of major new developments that are not public knowledge and which may be price sensitive.^^^
505 Coulthard v Neville Russell [1997] EWCA Civ 2837; [1998] 1 BCLC 143. ^^^ Section 245C of the Companies Act 1985; the Companies (Defective Accounts) (Authorised Person) Order 1991, SI 1991/13, authorising the Financial Reporting Review Panel Limited for the purposes of Section 245B. 50"^ Principle A.6. ^^^ Provision A.6.1. ^^^ Plender J, How to bring the board to book, Financial Times 20 January 2005 p 8. ^^^ The Listing Rules, 9.1 and 9.2; the Continuing Obligations Guide, 2.2.
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Transactions. The disclosure of information relating to transactions is govemed by the general mies on ad-hoc disclosure and special rules dealing with transactions. These disclosure rules can be found in different sources. Some important disclosure rules relate to equity transactions. The Companies Act 1985 and also the Listing Rules lay down some disclosure requirements that belong to the traditional area of Company law: (a) Some transactions require Communications to shareholders because they must be approved by shareholders in general meeting under the Companies Act 1985 or otherwise.^^^ The Companies Act 1985 says little about the content of the notice convening a general meeting,^^^ but there is a common law rule according to which the notice must be sufficiently füll and specific to enable the shareholder receiving it to decide whether or not he ought in his own interest to attend.^^^ The Listing Rules provide that any circular sent by a Company to holders of its listed securities must contain certain information.^^^ Where voting is required, it must for example "contain all information necessary to allow the holders of securities to make a properly informed decision" and a "recommendation from the directors as to the voting action shareholders should take, indicating whether or not the proposal described in the circular is, in the opinion of the directors, in the best interests of the shareholders as a whole". (b) In addition, some measures relating to share capital require specific Communications to shareholders. For example, the Listing Rules set out what a number of circulars must contain.^^^ The Companies Act 1985 provides that pre-emption offers must be communicated to shareholders.^^^ The Pre-emption Guidelines of the Pre-emption Group contain de facto binding rules on prior consultation and monitoring where the Company wants to disapply pre-emption rights. As regards the allotment of shares for a non-cash consideration, the Companies Act 1985 provides that the Company must send a valuation report to the Registrar at the same time that it flies the retum of the allotments ofthose shares.^^"^ Some disclosure rules relate to listing particulars. The Financial Services and Markets Act 2000 (FSMA 2000) provides that listing particulars must contain "all such information as investors and their professional advisers would reasonably require, and reasonably expect to find there, for the purpose of making an informed assessment of (a) the assets and liabilities, financial position, profits and losses, and prospects of the issuer of the securities; and (b) the rights attaching to the securities".^^^ This information is required in addition to any information required by ^^^ See for example general principle 7 of the City Code on Takeovers and Mergers and Article 9(2) of the Takeover Directive (2004/25/EC). ^^^ See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 357. For the length of notice see section 369 and regulation 38 of Table A. For special notice see sections 379, 293(5) and 303(2). 513 Tiessen v Henderson [1899] 1 Ch 861. 51^ The Listing Rules, 14.1. 515 The Listing Rules, 14.5-14.26. 516 Section 9 0 o f the Companies A c t 1985; Articles 29(1) and 29(3) of the Second Directive.
517 Section 111(1) of the Companies Act 1985; Article 10(3) of the Second Directive. 518 Section 80(1) of the FSMA 2000.
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the Listing Rules or the FSA.^^^ Chapter 6 of the Listing Rules lays down more detailed rules on the contents of the listing particulars. Some disclosure rules relate to takeovers. The conduct and timing of takeovers of UK public companies are govemed by the City Code on Takeovers and Mergers and the Rules Governing Substantial Acquisitions of Shares (SARs). According to the City Code, shareholders must be given sufficient information and advice to enable them to reach a properly informed decision and must have sufficient time to do so. No relevant information should be withheld from them.^^^ During the course of an offer, neither an offeror nor the offeree Company may fumish information to some shareholders which is not made available to all shareholders.^^^ The City Code also contains rules on the accuracy of the information provided to shareholders^^^ as well as on the fiduciary duties of directors.^^^ Furthermore, any major transaction may trigger off the duty to disclose information to the shareholders of a listed Company. The Listing Rules and the Continuing Obligations Guide are designed to ensure that shareholders are informed of and, in the case of larger transactions, have the opportunity to vote on transactions which have an impact on the company.^^'* There are four categories or classes of transaction under these rules, the category being determined by a series of calculations known as percentage ratios. Essentially the larger the transaction the more disclosure is required and the greater the need for shareholder approval.^^^ Chapter 11 of the Listing Rules also contains regulations for transactions with "related parties" such as a director.
Information Made Available at the Request of Shareholders Disclosure to active shareholders is govemed by the general rules that constrain board members' and sub-board managers' freedom of action (for example, duty of care and fiduciary duties). There are also specific rules that limit disclosure and selective disclosure in a listed Company. Disclosure of information at the general meeting, The Combined Code contains a principle that the board should use the annual general meeting to communicate with investors and to encourage their participation.^^e However, the Companies Act 1985 gives shareholders limited rights to request information at the general meeting apart from the information that must be made available to shareholders generally. For example, directors do not have any general Obligation to address the requests of all shareholders for information and clarification at the general meeting, 519 Section 80(2) of the FSMA 2000. 5^^ City Code, general principle 4. See also Article 9(5) of the Takeover Directive (2004/25/EC). 5^1 City Code, general principle 2. 5^^ City Code, general principles 5 and 6. 5-^^ City Code, general principle 9. ^'^^ The Continuing Obligations Guide, 7.1. 5^5 The Continuing Obligations Guide, 7.3. 5^^ Combined Code, principle D.2.
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and they do not have any general Obligation to answer the questions of individual shareholders. The main statutory remedy for failure to provide Information is section 459 of the Companies Act 1985. Selective disclosure. According to the Listing Rules and the Continuing Obligations Guide, selective disclosure of price sensitive information, without making it public, is not generally permissible.^^^ Recipients of price sensitive information may not deal in the Company's securities before the information is made public.^^^ Individuais should also have regard to the insider dealing provisions set out in the Criminal Justice Act 1993. Listed companies that are, or may become, involved in a take-over must also abide by the City Code on Take-overs and Mergers in relation to secrecy and the content and timing of announcements.^^^ On the other hand, the Combined Code recommends a dialogue with institutional shareholders. There should be "sufficient contact" with major shareholders "to understand their issues and concems". The chairman should "discuss govemance and strategy with major shareholders. Furthermore, the board should State in the annual report "the steps they have taken to ensure that the members of the board, and in particular the non-executive directors, develop an understanding of the views of major shareholders about their Company, for example through direct face-to-face contact, analysts' or brokers' briefings and surveys of shareholders' opinion".^^^ 4.6.3 Shareholder Remedies The exercise of board members' and sub-board managers' powers can be constrained by their duties and the remedies available to shareholders for breach of duty or otherwise. Legal duties and remedies often go hand in hand, but some duties can actually be effective although they are not coupled with any effective sanctions for their breach. There is a wide variety of different shareholder profiles. Some shareholders may be able to teil the management how the Company despite the formal allocation of power. These shareholders do not normally need to resort to legal remedies. On the other hand, not all institutional shareholders want to use the legal remedies available to them. For example, institutional shareholders might only manage the fiinds of others and would therefore not be provided by their clients with funds for litigation purposes. Some active shareholders may want to use the remedies available to them. ^^^
^^'^ The Continuing Obligations Guide, 2.1. ^^^ The Continuing Obligations Guide, 2.3. ^^^ City Code, Section D, rule 2.1; the Continuing Obligations Guide, 2.15. 530 City Code, D.I.
^^^ The Law Commission, Shareholder Remedies, Law Commission Consultation Paper 142(1996), 1.11.
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In any case, the existence of legal duties and legally enforceable sanctions can flinction as a constraint and make board members and managers act in the desired way. Sanctions. Legally enforceable sanctions for any rule are a package which can consist of civil remedies and criminal sanctions.^^^ Different remedial actions may be available for different kinds of defauk by board members or sub-board managers. For example, these remedies could include: fines and criminal penalties; court injunctions; damages or compensation; rescission of contracts made by a Company in breach of directors' duties; and termination of any Services contract for grave misconduct. Civil remedies designed for shareholders. There are considerable procedural difficulties facing shareholders who contemplate civil litigation against directors. In practice a distinction must be made between remedies available to a Controlling shareholder and those available to minority shareholders. In addition, it is necessary to distinguish between wrongs alleged to be done to the Company and wrongs alleged to be done to the shareholders. The latter distinction is fundamental as far as the availability of remedies is concemed, and it effectively restricts the power of shareholders to bring proceedings against the management. A shareholder who holds a majority of the voting rights will not usually need to resort to other remedies than the right to remove and appoint directors. The appointment and removal of directors by shareholders having the necessary majority has been discussed above. On the other hand, a majority shareholder may not be able to resort to some remedies because of the so-called proper plaintiff rule. The proper plaintiff rule effectively restricts even minority shareholders' rights to bring proceedings against defaulting directors. There are nevertheless some civil remedies available to minority shareholders. Minority shareholders' dissatisfaction with the manner in which a Company is run frequently revolves around allegations that: there has been a breach of duty owed by the directors to the Company; the majority shareholders have used their voting power to cause the Company to act in a way which unfairly prejudices the interest of the minority shareholder; or the Company has not complied with the requirements of its Constitution. There are three main minority shareholder remedies in the UK: the 'unfair prejudice' remedy in which a member seeks redress for action by the Company which injures his interest as a member; the derivative action, in which a member
^^^ See Modem Company Law for a Competitive Economy: Completing the Structure, para 13.10: "For example, where a Company fails to file annual accounts, the directors may commit a criminal offence under section 242, the Company may be liable to a civil penalty under section 242A, members may have a remedy under section 459 or 713, and if there is a persistent default the Company may be Struck off and the directors disqualified under section 3 of the Company Directors Disqualification Act 1986 (CDDA). Members also have rights to requisition meetings and remove directors. (These rights do not depend on the directors' default, but members may well seek to remove directors who fail to produce accounts.)" See also Completing the Structure, 13.44 and 13.70.
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seeks to enforce a claim belonging to his Company; and action to enforce the Company's Constitution. ^^^ The unfair prejudice remedy and the derivative action are specialist remedies. The unfair prejudice remedy is a statutory remedy under section 459 of the Companies Act 1985. It is far more common than the derivative action but is most commonly used in private companies. The derivative action is of much less importance in practical terms than the statutory remedy under section 459. It is nevertheless regarded as an important mechanism of shareholder control of corporate wrongs. Other civil remedies. There is a large number of other civil remedies. For example, there are common law remedies in contract and tort and under the law of restitution. A shareholder may also have rights as a result of misstatements made at the time he acquired his shares. Penal sanctions. There are hundreds of offences applicable to directors. Some important offences are contained in the Companies Act 1985, the Financial Services and Markets Act 2000 (FSMA 2000), the Listing Rules and the Criminal Justice Act 1993. It is well estabhshed that there is no criminal penalty for a breach without express provisions.^^"^ In addition to criminal penalties, there are civil penalties which run parallel to criminal penalties. Duties. Directors' duties have not been codified. There are different kinds of duties. Many duties are based on common law principles. Some duties follow from the need to avoid penal or civil sanctions. The Company Law Review proposed that directors' duties should be codified in broad Statements of principle and that there should also be a codification of civil remedies for breach of directors' duties.^^^ The Company Law Review went on to propose that Company law should, as a general principle, State clearly in relation to every rule what the consequences of breach are to be.^^^ In the UK, there is plenty of case law on to whom directors' duties are owed. This question can mean at least two things. (a) One of the purposes of this question is to limit the number of parties who have a cause of action for breach of these duties. If the duties are owed to A, only A may sue for their breach. (b) Sometimes the purpose of this question is different. It can be that directors have a duty to take into account the interests of certain parties although these parties have no cause of action for breach of duty. But if the duties are owed to A, only A can sue, although the director has breached his Obligation to take into account the interests ofB.
^^^ The Department of Trade and Industry published its Consultative Document on shareholder remedies in November 1998. It follows the publication in October 1997 by the Law Commission of its Report on shareholder remedies. Consultation Paper No 142; Remedies, Report No 246. See also Modem Company Law for a Competitive Economy: Completing the Structure, Chapter 13; and Final Report, Chapter 15. ^^^ Completing the Structure, para 13.9. ^^^ Modem Company Law for a Competitive Economy: Final Report, para 15.28; Completing the Stmcture, para 13.71. ^^^ Final Report, para 15.3.
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Sub-board managers. As a rule, shareholders cannot bring proceedings against defaulting sub-board managers or a defaulting Company secretary. The scope of rules applicable to directors is often extended to sub-board managers by applying them either directly or by analogy. The duties of sub-board managers are less clear than those of directors. Some of sub-board managers' duties are based on the same common law principles as the duties of Company directors. Some duties are contained in the Companies Act 1985. The Act lays down a number of duties for the Company secretary, and some statutory duties can apply even to other sub-board managers. Some criminal sanctions can apply even to sub-board managers. The offences set out in the Companies Act 1985 typically apply to "officers", and the FSMA 2000 extended the liability for an offence committed by a Company under the FSMA 2000 to its "officers".
Penal Sanctions Penal sanctions are regarded as an important means of ensuring that board members comply with their obligations.^^'^ For example, the main argument for penal sanctions used for enforcing compliance with accountability and disclosure rules is cost-effectiveness: no one eise is likely to enforce them, and it is relatively cheap and easy for a public authority systematically to do so.^^^ The Company Law Review proposed the placing of all companies under an Obligation to include in their annual reports disclosure of convictions for criminal breaches of Companies Act requirements on the part of the Company or its officers or key employees. The purpose of this Obligation would be to embarrass wrongdoers and help to maximise compliance.^^^ The requirement to disclose would apply only to criminal convictions under the Companies Act 1985, not to any other failure to comply which had not resulted in a successful prosecution, nor to civil action.540
The Companies Act 1985. The Companies Act 1985 imposes numerous obhgations on companies regarding the conduct of their affairs. Most of these requirements are backed up by sanctions so that, in the event of a breach, the Company and every officer of it who is in default is liable to a fine and, in some cases, imprisonment.^'^^ The Companies Act 1985 contains more than 200 offences.^'*^ For example, Part VII of the Companies Act 1985 regulates the form, content and publicity of
^^^ Modem Company Law for a Competitive Economy: Final Report, para 13.7. ^^^ Completing the Structure, para 13.44. ^^^ Final Report, para 15.31. ^^^ Final Report, para 15.34. ^^^ The Institute of Chartered Secretaries and Administrators, ICSA's Duties of a Company Secretary - Best Practice Guide (1998) p 5. ^"^2 See Completing the Structure, para 13.25. A list of offences under the Companies Act 1985 has been published by the DTI; see Classification of Offences under the Companies Act 1985 and Associated Legislation.
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Company accounts, and Part X regulates fair dealing by directors. Both Parts contain penalties for failure to comply with their provisions. The Company Law Review put forward a categorisation of criminal offences, using the categories of: offences of dishonesty; intermediate offences; and regulatory offences."^"^^ Offences of dishonesty include especially fraudulent trading.^"^"^ Fraudulent trading is in effect a general offence of fraud in relation to the Operation of registered companies.^"^^ The purpose of this offence is to counter corporate crime.^"*^ The Company Law Review defmed the intermediate offence as one relating to Company management which depends on proving an act or Omission, without exploring the motive, and where dishonesty is difficult to establish but strong suspicions arise.^'^'^ A typical example of intermediate offences is provided by the offences relating to breach of the primary disclosure obligations that enforce fair dealing by directors.^"^^ The matters covered by these provisions include: disclosure by directors of interests in contracts;^"*^ Company failing to keep accounting records;^^^ making false Statements to auditors;^^^ and financial assistance for the purchase of shares.^^^ The Company Law Review also proposed a new offence relating to the preparation of accounts.^^^ This offence has now been inserted in the Companies Act 1985 by the Companies (Audit, Investigations and Community Enterprise) Act 2004. Directors therefore have a duty to State that they have not withheld any relevant information from auditors.^^"*
^"^^ Modem Company Law for a Competitive Economy: Final Report, para 15.5; Computing the Structure, para 13.19. ^^ Part XVI and section 458 of the Companies Act 1985: "If any business of a Company is carried on with intent to defraud creditors of the Company, or creditors of any other person, or for any fraudulent purpose, every person who was knowingly a party to the carrying on of the business in that manner is liable to imprisonment or a fme or both. This applies whether or not the Company has been, or is in the course of being, wound up." ^^^ Completing the Structure, para 13.30. ^"^^ Completing the Structure, para 13.31. ^"^^ Final Report, para 15.6. 548 For example, Part X, sections 317, 324 and 328 of the Companies Act 1985. See Completing the Structure, para 13.35. ^^^ Section 317 of the Companies Act 1985; see Completing the Structure, para 13.37. 55^ Section 221(6) of the Companies Act 1985; see Modem Company Law for a Competitive Economy: Completing the Stmcture, para 13.38. 55^ Section 389A(2) of the Companies Act 1985; see Completing the Stmcture, para 13.39. 5^^ Section 151 of the Companies Act 1985; see Completing the Stmcture, para 13.42. 55^ Completing the Stmcture, para 13.43: "In paragraph 5.69 of Developing the Framework we proposed that an additional offence should be added to that under section 233 of knowingly or recklessly approving accounts which failed to give a tme and fair view of the matters required under section 226 where the failure was dishonest, in the sense that the directors knew that they were likely to deceive or mislead." 55^ Section 234ZA of the Companies Act 1985.
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The vast majority of offences under the Companies Act 1985 are regulatory.^^^ Minor criminal sanctions are extensively used for enforcing compliance with accountability and disclosure rules. There are dozens of such technical offences.^^^ According to the Company Law Review, the purpose of these provisions is to ensure proper disclosure: in a large Company, Information is the only means to check on the Performance of directors; directors may be unwilling to disclose where not effectively obliged to do so; Information is relevant to the market valuation of the Company; and failure to supply accurate Information on time can distort the market.^^^ Criminal sanctions for regulatory offences are regarded as highly efficient and it is believed that they enable high compliance levels without specific enforcement action.^^^ Misstatements, the FSMA 2000. The FSMA 2000 contains more than 20 offences. These offences relate for example to listing particulars, disclosure requirements, and liability for misleading Statements. A person who knowingly or recklessly makes a misleading, false or deceptive Statement is, under some circumstances, guilty of a criminal offence under section 397 of the FSMA 2000. This section applies not only to Statements in prospectuses but also to other Statements such as oral Statements and forecasts. In addition, section 397 of the FSMA 2000 sets out that any person who creates a false or misleading Impression is, under some circumstances, guilty of an offence. Section 400 of the FSMA 2000 extends the liability for an offence committed by a Company under this Act to its directors and sub-board managers. Like in the Companies Act 1985, the term used in the FSMA 2000 is "officer". This term is defined widely to mean, in relation to a body corporate, "a director, member of the committee of management, chief executive, manager, secretary or other similar officer of the body, or a person purporting to act in any such capacity" and "an individual who is a Controller of the body".^^^ An officer is guilty of an offence under the FSMA 2000 where an offence committed by a body corporate is shown either (a) to have been committed with the consent or connivance of the officer, or (b) to be attributable to any neglect on his part. In such a case, he is "liable to be proceeded against and punished accordingly".560 Insider trading and market abuse. Part V of the Criminal Justice Act 1993 makes insider dealing a criminal offence. Part VIII of the FSMA 2000 creates a civil regime which operates parallel to the insider provisions of the Criminal Justice Act 1993 (see below). The FSMA 2000 contains penalties for market abuse.^^^
^^^ Completing the Structure, para 13.23. ^^^ Completing the Structure, para 13.44. ^^"^ Completing the Structure, para 13.26. ^^^ Completing the Structure, paras 13.29 and 13.46. 559 Section 400(1) of the F S M A 2000. The term manager is defined in section 4 2 3 . 560 Section 400(5) of the F S M A 2000. 56^ Section 118 o f the F S M A 2000. Slorach S, Corporate Finance, Mergers & Acquisitions 2004. Legal Practice Course Guides (2004) p 7.
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Regulatory Civil Sanctions Under some circumstances, a public authority may bring civil proceedings to safeguard the wider public interest.^^^ j ^ e most important bodies include the DTI and the FSA. The DTI. The powers of intervention most frequently invoked by the DTI are the issuing of a petition to wind up the Company under section 124A of the Insolvency Act 1986 and an application to disqualify directors under sections 6 or 8 of the Company Directors DisquaUfication Act 1986 (CDDA).^^^ The majority of Orders to disqualify directors are sought in respect of directors of insolvent companies, whose activities have come to light in insolvency proceedings.^^"* In addition, the Secretary of State has power to bring civil proceedings on a Company's behalf under section 438 of the Companies Act 1985 if it appears to him on the basis of information or a report arising from an investigation to be in the public interest to do so.^^^ Market abuse, the FSMA 2000. The FSMA 2000 creates civil penalties for market abuse which run parallel to the criminal offences.^^^ The FSA is required to issue a code of practice, The Code of Market Conduct, to help market participants decide what types of behaviour are market abuse.^^"^ The civil disciplinary regime allows for a wide ränge of penalties to be imposed. The FSA may impose a financial penalty or make a public Statement about the behaviour. The FSA can also apply for an injunction restraining market abuse or an order for restitution. According to the FSMA 2000, penalties may be imposed on "a person".^^^ The Listing Rules. The Listing Rules are binding on issuers, and issuers must comply with them.^^^ In the event of breach, the UK Listing Authority (UKLA) may impose on the issuer a financial penalty or publish a statement.^^^ In addition, some sanctions apply to directors. If the UKLA considers that an issuer has breached any provision of the listing rules and that a person who was at the material time a director of the issuer was knowingly concemed in the breach, the UKLA may impose on that person a financial penalty or publish a Statement.^"^^ There are no similar sanctions for non-compliance with the Combined Code or the City Code. Failure by companies to comply with the disclosure provisions of the Combined Code is a breach of the Listing Rules. The sanctions available to the UKLA are public censure or the imposition of a financial penalty on the Company. ^^^ See Completing the Structure, paras 13.54 and 13.56. ^^^ See Completing the Structure, para 13.55. ^^^ Completing the Structure, para 13.57. ^^^ See Completing the Structure, para 13.59: "We find it difficult to envisage circumstances where the Company's interest and the public interest could coincide so as to justify such intervention." 566 Section 118 of the F S M A 2000. 567 Section 119 of the F S M A 2000. 568 Section 123 of the F S M A 2000. 569Rulel.l.
570Rulel.8. 571 Rule 1.9.
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Monitoring the quality of companies' compliance is a matter for the shareholders. The City Code is not incorporated into Listing Rules for which reason there are no similar sanctions for non-compUance.
4.6.4 Right to Sue: General Remarks The Proper Plaintiff As discussed above, it is necessary to distinguish between wrongs alleged to be done to the Company and wrongs alleged to be done to the shareholders. The shareholders have only limited powers to sue when the wrong is alleged to be done to the Company. This is because of the "proper plaintiff and "majority rule" principles, also called the rule in Foss v HarbottleP'^ The proper plaintiff in an action in respect of a wrong alleged to be done to a Company is, prima facie, the Company. The power to decide whether to bring proceedings on behalf of the Company is normally vested in the board of directors who may exercise all the powers of the Company under the Company's articles of association.^*^^ The power to sue on behalf of the Company can be delegated to an agent of the company.^^"* The shareholders may normally give, by special resolution, directions to the board of directors to sue. ^"^^ If the directors refuse to sue, a shareholder can act for the Company only under exceptional circumstances.^^^ The majority rule principle developed as a result of the courts' historical reluctance to become involved in disputes over the internal management of business ventures.^^^ According to the principle of majority rule, no individual member of the Company is allowed to maintain an action in respect of the matter where the alleged wrong is a transaction which might be made binding on the Company and on ^^^ Foss V Harbottle (1843) 2 Hare 461. The rule in Foss v Harbottle was restated in Edwards V Halliwell [1950] 2 All ER 1064 as foUows: "First, the proper plaintiff in an action in respect of a wrong alleged to be done to a Company ... is prima facie the Company ... itself Secondly, where the alleged wrong is a transaction which might be made binding on the Company ... on all its members by a simple majority of the members, no individual member of the Company is allowed to maintain an action in respect of that matter for the simple reason that, if a mere majority of the members of the Company ... is in favour of what has been done, then cadit quaestio." Cadit quaestio means that the question is at an end. ^"^^ Table A, regulation 70; see also the Law Commission, Shareholders Remedies, Law Commission Report 246 (1997), para 6.34. ^'^^ Table A, regulation 71. ^^5 Table A, regulation 70. 576 por example, if the directors breach their duty in deciding not to pursue the claim then a derivative claim can be brought against them; the Law Commission, Shareholders Remedies, Law Commission Report 246 (1997), para 6.34. 5'^'^ The principle is based on the doctrine of separate corporate personality and on the early partnership principle that courts would not interfere between partners except to dissolve the partnership; see the Law Commission, Shareholders Remedies, Law Commission Report 246 (1997), para 6.1.
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all its members by a simple majority of the members. If the majority confirms the transaction, there is no wrong done to the Company. If the majority challenges the transaction, there is no valid reason why the Company should not sue. Individual shareholders are not allowed to sue for härm done to their Company unless they can carry with them the majority at a general meeting.
To Whom are Directors' Duties Owed? Which wrongs are done to the Company? The most important wrongs done to the Company are probably the breach of duty of care and the breach of fiduciary duty. According to common law principles, a director owes a duty of care and a fiduciary duty to the Company of which he is a director. These duties are owed to "the Company as a whole" and not to individual shareholders.^"^^ The meaning of this phrase is nevertheless flexible. The Company. It has been recognised that a duty owed to the Company is in effect owed to the corporators as a general body^"^^ (including the long-term interests of present members and the interests of fliture members). This definition is not without difficulty due to the fact that different types of shareholders have different interests.^^^ In the context of a takeover bid, the interests of current shareholders are regarded as the interests of the company.^^^ Shareholders. Under exceptional circumstances, the duties of directors can be owed to the shareholders (as distinct to the Company). In Peskin v Anderson,^^^ the Court of Appeal confirmed that directors would not owe fiduciary duties to shareholders (as distinct to the Company) unless there is a special factual relationship between the directors and the shareholders which is capable of generating fiduciary obligations. For example, in Platt v Platt^^^ it was held that a director did owe a fiduciary duty to a shareholder when he persuaded the shareholder to transfer his shares to him. Outsiders. The fact that the duties are owed to "the Company as a whole" does not exclude the duty to take account of the interests of Outsiders where to do so is in the best interests of the Company. Directors can therefore owe a duty to the Company to have regard to the interests of the creditors of the company^^"* or the Company's employees,^^^ but duties owed to the Company cannot be enforced by creditors or employees. The Companies Act 1985 now contains such a provision in relation to the interests of employees.^^^ The Act also contains a provision on 578 Percival v Wright [1902] 2 Ch 421. 579 Greenhalgh v A r d e m e Cinemas Ltd [1951] Ch 286, [1950] 2 All E R 1120. 580 See W e d d e r b u m A, Employees, Partnership and C o m p a n y Law, ILJ 31 (2002) p 108.
581 Heron International Ltd v Lord Grade [1983] BCLC 244. 582 Peskin v Anderson [2001] B C C 874. 583 Platt V Platt [1999] 2 B C L C 7 4 5 . 584 Winkworth v Edward Baron Development Co Ltd [1986] 1 W L R 1512.
585 Bowen LJ in Hutton v West Cork Railway Co (1883) 23 Ch D 654. 586 Section 3 0 9 o f the Companies Act 1985: " ( I ) T h e matters to which the directors o f a Company are to have regard in the Performance of their functions include the interests o f the company's employees in general, as well as the interests o f its members. (2) Accord-
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the power of a Company to make voluntary payments to employees on the cessation or transfer of its business "notwithstanding that its exercise is not in the best interests of the company".^^^ In the correct circumstances, the duty to the Company can actually mean a duty to its creditors, but enforceable only by the company.^^^ The City Code on Takeovers and Mergers requires directors of an offeree Company to have regard to the interests of employees as well as shareholders and creditors when advising shareholders on the merits of a bid.^^^ There are related duties under the Takeover Directive (2004/25/EC). The Takeover Directive provides that the offer document must State for example the offeror's intentions with regard to Jobs (Article 6(3)(i)), and the the board of the offeree Company must give its views on the effects of implementation of the bid on employment, conditions of employment and the locations of the company's places of business (Article 3(1 )(b)). The Takeover Directive further provides that the disclosure of Information to and the consultation of representatives of the employees of the offeror and the offeree Company are govemed by the relevant national provisions and other EU Directives (Article H).^^« The interests of creditors are also protected by making certain breaches of duty, fraudulent trading, and wrongful trading a criminal offence under the Insolvency Act 1986^91 and the Companies Act 1985.^92 Employees. The directors do not owe duties to employees. Although the Companies Act 1985 provides that the matters to which the directors of a Company are to have regard in the Performance of their functions also include the interests of the company's employees,^^^ there is no civil remedy for the employees.^^"^ In the "General Principles by which Directors are Bound" attached to the draft Compaingly, the duty imposed by this section on the directors 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. (3) This section appHes to shadow directors as it does to directors." There is doubt as to what section 309 means. See the Law Commission, Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties, Consultation Paper 153 (1998), para 11.28. ^^^ Section 719 of the Companies Act 1985. Because of this section, Parke v Daily News [1962] Ch 927, [1962] 2 All ER 929 is no more good law. See also section 187 of the Insolvency Act 1986. 5^^ Facia Footwear Ltd v Hinchcliffe [1998] BCLC 218 and Yukong Line Ltd v Rendsburg Investments Corporation (no 2) [1998] 1 WLR 294. ^^^ General Principle 9 of the City Code states that: "Directors of the offeree Company should give careful consideration before they enter into any commitment with an offeror (or anyone eise) which would restrict theirfreedomto advise their shareholders in the fiiture. Such commitments may give rise to conflicts of interest or result in a breach of directors' fiduciary duties." 590 See in particular 94/45/EC, 98/59/EC, 2001/86/EC and 2002/14/EC. See also recital 23. 59^ Sections 212-215 of the Insolvency Act 1986. 592 Section 458 of the Companies Act 1985. 59^ Section 309 of the Companies Act 1985. This section reversed Parke v Daily News [1962] Ch 927. See also section 719. ^^^ See Wedderbum A, Employees, Partnership and Company Law, ILJ 31 (2002) pp 99111.
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nies Bill published in July 2002, employees - suppliers of labour - are treated like suppliers of any other commodity.^^^
4.6.5 Proceedings Brought by Shareholders for Breach of Duty The proper plaintiff in an action in respect of a wrong alleged to be done to a Company is, prima facie, the Company. Where the alleged wrong is a transaction which might be made binding on the Company and on all its members by a simple majority of the members, no individual member of the Company is allowed to maintain an action in respect ofthat matter. A shareholder can nevertheless bring proceedings when the majority rule and proper plaintiff principles do not apply. They do not apply when the wrong is done to a shareholder. Sometimes the shareholder can bring a derivative action although the wrong is done to the Company. There are also other shareholder remedies such as remedies based on section 122 of the Insolvency Act 1986 or section 459 of the Companies Act 1985. Derivative Actions - Actions on Belialf of tlie Company In some cases a shareholder can bring a derivative action on behalf of the Company (an action to enforce the Company's cause of action). Any compensation will then be paid to the Company. In Prudential Assurance Co Ltd v Newman Industries Ltd (No 2),^^^ the Court of Appeal pointed out that a derivative action is "an exception to the elementary principle that A cannot, as a general rule, bring an action against B to recover damages or secure other relief on behalf ofC for an injury done by B to C. C is the proper plaintiff because C is the party injured, and, therefore, the person in whom the cause of action is vested." There are established exceptions to the rule in Foss v Harbottler'^'' However, the law relating to the ability of a shareholder to bring a derivative action has been described as "rigid, old fashioned and unclear".^^^ The majority rule and proper plaintiff principles do not apply, if:^^^ the alleged wrong is ultra vires the Corporation (the majority of members cannot confirm the transaction, a shareholder can bring a personal action); or the transaction complained of could be validly done or sanctioned only by a special resolution or the ^^^ See Wedderbum A, Employees, Partnership and Company Law, ILJ 31 (2002) pp 109111. See also Easterbrook FH, Fischel DR, The Economic Structure of Corporate Law (1991) p 50: "Employees, consumers, trade creditors, and lenders are voluntary creditors. The compensation they demand will be a function of theriskthey face." ^^^ Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch. 204. 597 Foss V Harbottle (1843) 2 Hare 4 6 1 ; 67 ER. 598 The L a w Commission, Shareholders Remedies, L a w Commission Report 2 4 6 (1997),
para 1.4. 599 Prudential Assurance C o Ltd v N e w m a n Industries (No 2) [1982] C h 204, [1982] 1 All E R 354; see also Shareholder Remedies, L a w Commission Report 246 (1997) para 6.2.
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like (a simple majority cannot confirm a transaction which requires the concurrence of a greater majority, a shareholder can bring a personal action); or what has been done amounts to fraud and the wrongdoers are themselves in control of the Company (a shareholder can bring a derivative action). Section 35(2) of the Companies Act 1985 provides that a shareholder may bring proceedings to restrain the doing of an act which would be beyond the Company's capacity.^^^ The most important of these situations is fraud on the minority. Fraud on the minority. "Fraud on the minority" is a technical term that refers to a number of possible situations. "Fraud" does not refer to a criminal fraud in the sense of obtaining money or a financial benefit by deception but rather to an abuse of power. The categories that might constitute "fraud" have been left open by the courts but some commonly recognised are: expropriation of Company property; mala fides breaches of duty;^^^ uses of powers for improper purposes;^^^ and negligent acts which bring some benefit to the wrongdoer.^^^ For example, negligence as such is not sufficient. A derivative action based on negligence may only be brought if it can be shown that the wrongdoers have profited by the negligence.^^"^ A "fraud on the minority" involves two Clements. The first is a cause of action in the Company that can be characterised as an equitable fraud. Fraud includes all cases where the wrongdoers are endeavouring, directly or indirectly, to appropriate themselves money, property or advantages, which belong to the Company or in which the other shareholders are entitled to participate.^^^ The second dement is control of the Company by the wrongdoers. Wrongdoer control. Fraud on the minority requires wrongdoer control. The principle that underlines this exception to the rule in Foss v Harbottle is that those in control of the Company have manipulated their position so as to ensure that the action is not brought against the company.^^^ However, the courts have restricted the rights of a shareholder to bring a derivative action in the sense that the shareholder now has to carry the majority of the aggrieved minority shareholders in Order to go on with the action. The meaning of the concept of "wrongdoer control" is unclear. The Court of Appeal has acknowledged that "control embraces a broad spectrum extending from an overall absolute majority of votes at one end, to a majority of votes at the ^^^ Section 35(1) of the Companies Act 1985: "The validity of an act done by a Company shall not be called into question on the ground of lack of capacity by reason of anything in the company's memorandum." Section 35(2): "A member of a Company may bring proceedings to restrain the doing of an act which but for subsection (1) would be beyond the company's capacity; but no such proceedings shall lie in respect of an act to be done in flilfilment ofa legal obHgation arisingfroma previous act of the Company." ^^^ For example Cook v Deeds [1916] 1 AC 554 (Privy Council). 602 For example H o g g v C r a m p h o m Ltd [1967] Ch 254, [1966] 3 All ER 420.
603 For example Daniels v Daniels [1978] Ch 406, [1978] 2 All ER 89. 604 T h e L a w Commission, Shareholders Remedies, L a w Commission Report 246 (1997), para6.38. 605 Burland v Earle [1902] A C 8 3 . 606 Vinelott J in Prudential Assurance Co v N e w m a n Industries (No 2) [1981] Ch 257.
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other end, made up of those likely to be cast by the delinquent himself plus those voting with him as a result of influence or apathy".^^^ Wrongdoer control may be established by proof that the wrongdoers own a majority of the shares carrying votes, but the essential question is whether the Company is being prevented from pursuing a claim which the Company legitimately has, as was pointed out by Knox J in Smith v Croft:^^^ "'Is the plaintiff^^^ being improperly prevented from bringing these proceedings on behalf of the Company?' If it is an expression of the corporate will of the Company by an appropriate independent organ that is preventing the plaintiff from prosecuting the action he is not improperly but properly prevented and so the answer to the question is 'No'." Availability ofthe derivative action generally. The derivative action is available in respect of breaches of duty by directors and Covers even claims against third parties as a result of such breaches. The derivative action is not available where the majority abuse their position in a manner that affects the running of the Company. For example, in Estmanco (Kilner House) Ltd v Greater London Council,^^^ the derivative action was not available because the fraud found by the court was the majority shareholders' conduct and not that of the directors. It is nevertheless possible that instead of a derivative action on behalf of the Company, the appropriate remedy for the shareholder is a claim under section 459 ofthe Companies Act 1985 (which is in practice more likely) or a personal action under the articles of association (which is less likely).^^^ Availability in respect of breaches of duty by sub-board Managers and other employees. The derivative action is in practice not available in respect of breaches of duty by sub-board managers and other employees. It would be unusual for situations involving breaches of duty by employees to come within the common law exceptions. The decision on what action to take against employees is a management decision for the board of directors. It would thus not be possible for a shareholder in a public Company to bring proceedings against sub-board managers where the shareholder is unhappy with particular management decisions.^^^ Requirements in respect ofthe claimant. The derivative action is not available unless the claimant fulfils certain requirements. In Nurcombe v Nurcombe,^^^ it was held that: the court will not allow a derivative action to be used in an inequitable manner so as to produce an injustice (the bringing of the derivative claim requires the exercise of the equitable Jurisdiction of the court on the grounds that the interests of justice require it); the claimant must not have participated in the wrong
^^^ Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204. ^08 Smith V Croft (No 2) [1988] Ch 114. ^^^ Or perhaps more accurately, the Company. ^^0 Estmanco (Kilner House) Ltd v Greater London Council [1982] 1 WLR 2. ^^^ The Law Commission, Shareholders Remedies, Law Commission Report 246 (1997), paras 6.28-6.30. ^^^ The Law Commission, Shareholders Remedies, Law Commission Report 246 (1997), paras 6.42-6.46. 613 Nurcombe v Nurcombe [1984] BCLC 557.
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of which the complaint is made; and the claimant must be acting bona fide for the benefit of the Company. The Position ofthe Company in the proceedings. A derivative action is brought by a shareholder in his own name on behalf of the Company. The Company is rather curiously - joined as a defendant in order for it to be bound by any judgment and to receive the fruits (if any) of the judgment, and because the action has not been authorised by its board or shareholders in general meeting.^^"* Sometimes the Company seeks to strike out the action. In Prudential Assurance Co Ltd V Newman Industries Ltd (No 2),^^^ the Court of Appeal considered what course was to be taken by the court if the court was confronted by such a motion. The Court of Appeal held that "the plaintiff ought at least to be required before proceeding with his action to establish a prima facie case (i) that the Company is entitled to the relief claimed and (ii) that the action falls within the proper boundaries of the exception to the rule in Foss v Harbottle. In the latter issue it may well be right for the judge trying the preliminary issue to grant a sufficient adjoumment to enable a meeting of shareholders to be convened by the board, so that he can reach a conclusion in the light ofthe conduct of and proceedings at, that meeting." In Smith v Croft (No 2),^^^ Knox J said that the purpose ofthe adjoumment was not to discem whether the defendants had control, but was to secure for the benefit ofthe judge, who was deciding whether to allow the minority shareholder's action on behalf of the Company to go forward, the commercial assessment whether the prosecution ofthe action was likely to do more härm than good or, the phrase used in argument in Prudential Assurance, "kill the Company by kindness." He said that the whole tenor of the Court of Appeal's judgment was directed at securing that a realistic assessment of the practical desirability of the action going forward should be made by the organ that has the power and ability to take decisions on behalf of the company.^^"^ Costs. The court has a wide power to determine by whom and to what extent costs are to be paid,^*^ but the discretion must be exercised in accordance with the mies of court and established principles.^^^ The general rule under the Civil Procedure Rules (CPR) is that the unsuccessful party will be ordered to pay the costs of the successful party.^^o jj^^ ^Q^J.^ nevertheless has plenty of discretion.^^i
6^^ Spokes V Grosvenor and West End Railway Terminals Hotel Co. Ltd. [1897] 2 QB 124; See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 454. See also CPC 19.9. ^^5 Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204. 616 Smith V Croft (No 2) [1988] Ch 114 (20 December 2001). 61 "^ Lawrence Collins J in Konamaneni v Rolls Royce Industrial Power (India) Ltd [2001] EWHC Ch 470. 618 Section 51 ofthe Supreme Court Act 1981. 619 M c D o n a l d v H o m [1995] 1 All E R 961 at 969. 620 C P R 44.3(2).
621 CPR 44.3(1).
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The availability of indemnification in respect of costs has made the derivative action look more attractive to shareholders than proceedings under section 459 of the Companies Act 1985. Where a shareholder brings a derivative action, the court is able to indemnify him in respect of bis costs by means of a pre-emptive cost order (also called prospective cost order). A pre-emptive cost order is an order that irrespective of the outcome of the case (and which party is successfül), a party will be entitled to its costs (and also any costs ordered to be paid by them in favour of the winning party). The modern practice in pre-emptive costs Orders is derived from a number of sources which are related to the right of a fiduciary such as a trustee or agent to be indemnified. An agent normally has a right to be indemnified by a principal. In Wallersteiner v Moir,^'^^ Lord Denning MR said that a minority shareholder bringing a derivative action on behalf of a Company against its directors was an agent who was entitled to be indemnified by the Company against all costs and expenses reasonably incurred. The indemnity was analogous to the indemnity to which a trustee was entitled from a cestui que trust. But in order to be entitled to the indemnity, the minority shareholder should apply for the sanction of the court to continue the proceedings.^^^ On such an application by a minority shareholder, the court should simply consider whether there was a reasonable case for the minority shareholder to bring at the expense of the Company. The Courts can thus indemnify a shareholder in respect of his costs in the form of a Wallersteiner order where it is reasonable. For example, Arden LJ said in Clark V Cutland:^'^^ "As to costs, in a derivative action it is open to the court to Order the Company, for whose benefit the action was brought, to indemnify the claimant against the costs reasonably incurred by it.. ."^^s But although the courts can grant a Wallersteiner order, there are few cases where an indemnity from the Company might be available.^^^ Some of the restrictions are based on trust cases.^^^ It is possible that courts might offer an indemnity at least in a test case. In the insurance Company case oiRe Axa Equity and Law Life Assurance Society plc,^^^ a "pre-emptive costs order" was granted in favour of a policyholder in litigation conceming a scheme of reorganisation. 622 Wallersteiner v Moir [1975] Q B 3 7 3 .
623 By analogy with the practice of a trustee making a Beddoe application for the sanction of the court to bring proceedings. Re Beddoe, Downes v. Cottam [1893] 1 Ch 547. 624 Clark V Cutland [2003] E W C A Civ 810. 625 Citing Buckley on the Companies Acts, para 127.12. 626 In Halle v Trax B W Ltd [2000] B C C 1020, such an indemnity from the Company w a s deemed to be inappropriate in a dispute involving 50/50 shareholders. 62*7 R e Buckton [1907] 2 C h 406; cited b y Hoffinann LJ in the pension scheme case of McDonald v H o m [1995] 1 All E R 9 6 1 . 628 Compare R e A X A Equity and L a w Life Assurance Society plc (Evans-Lombe J 11 January 2001), The Times 19 December 2000. In this case, a policyholder w h o w a s performing a service b y bringing a test case to clarify the effect of a proposed scheme of reorganisation.
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Adlons on the Shareholder's Own Behalf The proper plaintiff in an action in respect of a wrong alleged to be done to a Company is, prima facie, the Company. Where the alleged wrong is a transaction which might be made binding on the Company and on all its members by a simple majority of the members, no individual member of the Company is allowed to maintain an action in respect of that matter. But the rule in Foss v Harbottle does not prevent a shareholder from bringing an action where the wrong is alleged to be done to that shareholder. In this case, the proper plaintiff is the shareholder. Personal action. A shareholder can bring either a personal action or a representative action. A personal action may be brought under certain circumstances. In addition to claims in respect of transactions requiring a special majority (in this case a simple majority cannot confirm a transaction which requires the concurrence of a greater majority), a personal action may be brought to restrain an ultra vires or illegal act (in this case the majority of members cannot confirm the transaction). A personal action can be brought in respect of breaches of personal rights arising under a shareholders' agreement. This was the case in Russell v Northern Bank Development Corporation Ltd,^'^'^ where a shareholder obtained a declaration that a shareholders' agreement was binding on the other shareholders. A personal action may also be brought in respect of breaches of personal rights arising under the Company's Constitution. The legal effect of the memorandum of association and the articles of association is set out in section 14 of the Companies Act 1985 which provides that, when registered, they bind the Company and its members "to the same extent as if they respectively had been signed and sealed by each member and contained covenants on the part of each member to observe all the provisions of the memorandum and of the articles". It is not always necessary to join the Company as a party,^^^ but it is possible to bring proceedings against the Company. In Quin & Axtens Ltd v Salmon,^^^ the House of Lords held that the shareholders' resolutions were inconsistent with the articles and granted an injunction restraining the Company from acting on them. It is difficult to identify enforceable personal rights conferred by the articles. There are restrictions on a shareholder's ability to bring a personal action to enforce the provisions of the articles of association. Firstly, the statutory contract only confers rights on a shareholder in his capacity as shareholder, not in any "Outsider" capacity. Secondly, the courts have classified breaches of certain constitutional provisions as "internal irregularities" for which no personal action will lie. This restriction stems from the majority rule and proper plaintiff principles discussed above. The courts have held that if the internal affairs of the Company are not being properly managed, then the Company is the proper person to complain; there is no use in having litigation "the ultimate end of which is only that a meeting has to be ^29 Russell V Northern Bank Development Corporation Ltd [1992] 3 All ER 161, 630 Rayfield v Hands [1960] C h 1, [1958] 2 All E R 194.
631 Quin & Axtens Ltd v Salmon [1909] AC 442 (House of Lords).
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called and then ultimately the majority gets its wishes". For example, in Smith v Croft (No 2)^^^ Knox J distinguished between a shareholder's right to object to an ultra vires transaction (personal right) and his right to enforce a right of the Company to Claim compensation for a past ultra vires transaction (majority rule): "Ultimately the question which has to be answered in order to determine whether the rule in Foss v Harbottle applies to prevent a minority shareholder seeking relief as plaintiff for the benefit of the Company is 'Is the plaintiff being improperly prevented from bringing these proceedings on behalf of the Company?' If it is an expression of the corporate will of the Company by an appropriate independent organ that is preventing the plaintiff from prosecuting the action he is not improperly but properly prevented and so the answer to the question is 'No'. The appropriate independent organ will vary according to the Constitution of the Company concemed and the identity of the defendants who will in most cases be disqualified from participating by voting in expressing the corporate will". But there are cases where shareholders have been entitled to bring claims based on irregularities in voting procedures, such as the wrongful exclusion of proxy votes which would otherwise have resulted in the defeat of a resolution. Similarly, in cases involving defective notices of meetings, or inadequate notice of certain resolutions, the courts have allowed personal actions to proceed. Representative action. In addition, the Rules of the Supreme Court provide that "[wjhere numerous persons have the same interest in any proceedings, the proceedings may be begun ... by or against any one or more of them as representing all ... of them".^^^ Some of the provisions of the Companies Act 1985 are based on the same principle as this rule. While the effect of the Company's Constitution on the validity of acts done by the Company is restricted,^^"* a shareholder may bring proceedings to restrain the doing of an act which is in conflict with the company's constitution.^^^ In addition, a shareholder may bring proceedings because of unfair prejudice.^^^
632 Smith v Croft (No 2) [1988] C h 114, [1987] 3 All E R 909. 633 Rules of the Supreme Court, Order 15, Rule 12(1). 634 Section 35(1) o f the Companies Act 1985: " The validity o f an act done b y a Company shall not b e called into question on the ground of lack of capacity b y reason of anything in the c o m p a n y ' s m e m o r a n d u m . " 635 Section 35(2) o f the Companies Act 1985: " A m e m b e r o f a Company m a y bring p r o c e e dings to restrain the doing o f an act which but for subsection (1) would b e beyond the c o m p a n y ' s capacity; but n o such proceedings shall h e in respect of an act to b e done in fulfilment of a legal Obligation arising from a previous act of the Company." 636 Section 459(1) o f the Companies Act 1985: " A m e m b e r of a Company m a y apply to the court by petition for an order under this part on the ground that the c o m p a n y ' s affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of its members generally or o f some part o f its members (including at least himself) or that any actual or proposed act or Omission of the Company (including an act or Omission on its behalf) is or would b e so prejudicial)." See also section 4 6 1 ( 2 ) ( c ) : "... the court's order m a y (c) authorise civil proceedings to b e brought in the n a m e and on behalf o f the Company by such person or persons and on such terms as the court m a y direct".
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Shareholders' claimsfor reflective loss. As a rule, a shareholder cannot recover damages merely because the Company in which he is interested has suffered loss. On the other hand, the shareholder can recover damages for personal loss. This leads to the problem of the recoverabihty of reflective loss. In UK law, reflective loss is a personal loss suffered by the shareholder as a result of "the diminution of the value of the shares ... the loss of dividends ... and all other payments which the shareholder might have obtained from the Company if it had not been deprived of its fUnds".^^^ Although reflective loss is personal loss, in some situations there are policy reasons why a shareholder is debarred from claiming it.^^^ In Johnson v Gore Wood & Co,^^'^ Lord Bingham argued: (1) Where a Company suffers loss caused by a breach of duty owed to it, only the Company may sue in respect of that loss. No action lies at the suit of a shareholder suing in that capacity and no other to make good a diminution in the value of the shareholder's shareholding where that merely reflects the loss suffered by the Company. (2) Where a Company suffers loss but has no cause of action to sue to recover that loss, the shareholder in the Company may sue in respect of it (if the shareholder has a cause of action to do so), even though the loss is a diminution in the value of the shareholding. (3) Where a Company suffers loss by reason of a breach of duty owed to the Company, and a shareholder suffers a loss separate and distinct from that suffered by the Company caused by breach of a duty independently owed to the shareholder, each may sue to recover the loss caused to it by breach of the duty owed to it but neither may recover loss caused to the other by breach of the duty owed to that other. The result of Johnson is that claimants now try to argue that they have suffered a personal loss "separate and distinct from any loss suffered by the company".^"^^ Class Adlons Class actions against directors are still far from common in the UK. The rise in the number of class actions by groups of shareholders in the USA is a particular concem for directors of UK companies with a US listing. Changes to the civil litigation System have made US-style class actions more viable in the UK. The courts now have express powers to facilitate and manage multiparty actions where claims give rise to "common or related issues of fact and law".^"^^ In addition, representative action is possible (see above).
637 Johnson v Gore W o o d & Co [2000] U K H L 65; [2001] 1 All E R 4 8 1 ; [2001] 2 W L R 72
(LordMillett). 638 Mitchell C, Shareholders' Claims for Reflective Loss, L Q R 120 (2004) p 460. 639 Johnson v Gore W o o d & Co [2000] U K H L 65; [2001] 1 All ER 4 8 1 ; [2001] 2 W L R 72. 640 See also Mitchell C, Shareholders' Claims for Reflective Loss, L Q R 120 (2004) p 4 6 1 . 6"*' See section 5 of the Community Legal Service (Funding) Order 2000.
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LIabllity for Löss Caused by the Breach of Disclosure Requirements in ttie Capital Market Generally, there are many different legal remedies available to shareholders in the event that managers breach disclosure requirements in the capital markets. The remedies available to shareholders include: (a) remedies against the Company, offeror or seller of the securities; (b) civil remedies against persons responsible; and (c) criminal liability of persons responsible and administrative penalties.^'*^ Civil remedies are relatively rare in practice. Civil remedies against persons responsible. The civil remedies available to shareholders against persons responsible contain in particular: (a) damages for deceit; (b) damages for negligent misstatements at common law; and (c) compensation under the FSMA 2000 and the Pubhc Offers of Securities Regulations 1995 (the POS Regulations) for inaccurate or misleading Statements made in listing particulars or a prospectus, or omissions from the Information which must be disclosed.^"^^ The FSMA 2000 does not affect any civil (or criminal liability) which a person may incur under the general law. As regards civil remedies, it is in theory easier for an investor to have recourse to the remedies provided by FSMA 2000 than to seek common law and equitable remedies. There are several reasons for this. Firstly, the older specialist case law on damages for misrepresentation has largely been made redundant by the Misrepresentation Act 1967^44 and Hedley Byrne & Co Ltd v Heller & Partners Ltd,^^ the leading case on misrepresentation and tort of negligence. Secondly, the Misrepresentation Act 1967 gives rights to a contract party only. Thirdly, where the principles laid down by Hedley Byrne v Heller are applied, the practical problems of establishing liability on the facts of a particular case can be quite formidable.^"*^ The Hedley Byrne v Heller principles were restated by the House of Lords in Caparo Industriesplc v Dichnan.^^'^ The position established in Caparo is that the law of England does not impose any general duty of care to avoid negligent misstatements or to avoid causing pure economic loss even if economic damage to the plaintiff is foreseeable. However, such a duty of care will arise if there is a special relationship between the parties.^"^^ The prerequisites for liability are: (a) a state^'^^ See especially section 397 of the FSMA 2000 on misleading Statements and practices; section 346 on the provision of false or misleading information to auditor or actuary; sections 118, 123 and 129 on market abuse. ^^^ See section 90 of the FSMA 2000 on the liability for any person responsible for false or misleading hsting particulars to pay compensation and section. See also section 150. ^^ See sections 2(1) and 2(2) of the Misrepresentation Act 1967. Liability under these subsections falls only on a contract party and can hardly be applied to Claims of shareholders against directors or managers. 645 Hedley Byrne & Co Ltd v Heller & Partners Ltd [1964] AC 465, [1963] 2 All ER 575 (House of Lords). ^^^ See Fisher J, Bewsey J, The Law of Investor Protection (1997) 29-029. 64^ Caparo Industries v Dickman [1990] 2 AC 605. 648 White v Jones [1995] 2 AC 287 (House of Lords, Lord Browne-Wilkinson).
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ment which is inaccurate or failure to State a material fact which renders a Statement misleading; (b) reliance on the material misstatement; (c) a sufficiently proximate relationship between the parties (proximity or a special relationship);^"*^ (d) foreseeability of financial loss caused by the misleading Statement; and (e) that it is just and reasonable to impose the liability. However, although it is in theory easier for an investor to have recourse to the remedies provided by FSMA 2000, civil liability under FSMA 2000 is relatively rare in practice. Firstly, the investor has to establish that the loss was caused by the misleading Statement, which can be difficult. Secondly, the responsible person has the benefit of Schedule 10 of the FSMA 2000, which relieves him from liability if, when the particulars were submitted to the UK Listing Authority, he reasonably believed the Statement to be true and not misleading. Civil remedies against the Company. Shareholders can in principle have remedies not only against directors or other managers but also against the Company. The Companies Act 1985 does not prevent a person from obtaining damages or other compensation from a Company by reason only of his holding or having held shares in the company.^^^ For example, the liability of the issuer can be based on: the FSMA 2000 (the issuer is a person responsible for listing particulars under the FSMA 2000);^^^ breach of a contractual duty (the prospectus forms the basis of a contract between the Company and investors);^^^ and the Misrepresentation Act 1967 (which applies to negligent misstatements).^^^ Prospectuses. The most important statutory requirement relating to the contents of a prospectus is the general duty of disclosure set out in section 80 of the FSMA 2000. Listing particulars must contain "all such information as investors and their professional advisers would reasonably require, and reasonably expect to find there, for the purpose of making an informed assessment of (a) the assets and liabilities, financial position, profits and losses, and prospects of the issuer of the securities; and (b) the rights attaching to the securities."
^^ Lord Bridge in Caparo v Dickman [1990] 2 AC 605 at 621: "The Situation is entirely different where a Statement is put into more or less general circulation and may foreseeably be relied on by strangers to the maker of the Statement for any one of a variety of different purposes which the maker of the Statement has no specific reason to anticipate. To hold the maker of the Statement to be under a duty of care in respect of the accuracy of the Statement to all and sundry for any purpose for which they may choose to rely on it is, not only to subject him, in the classic words of Cardozo CJ to iiability in an indeterminate amount for an indeterminate time to an indeterminate dass' see Ultramares Corporation v Touche 1931, 174 NE 441, 444; it is also to confer on the world at large a quite unwarranted entitlement to appropriate for their own purposes the benefit of expert knowledge or professional expertise attributed to the maker of the Statement." ^50 Section 111A of the Companies Act 1985. 65^ See section 90 of the FSMA 2000; regulation 13(1) of the POS Regulations 1995. ^^^ No civil remedy lies against the Company at common law for the Omission of information required to be included in the listing particulars or prospectus. Re South of England Natural Gas and Petroleum Co Ltd [1911] 1 Ch 573. ^53 Sections 2(1) and 2(2) of the Misrepresentation Act 1967.
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Section 90 of the FSMA 2000 provides for compensation for false or misleading particulars. Any person responsible for listing particulars is potentially liable to pay compensation to a person who has acquired securities to which the particulars apply.^^"* The FSMA 2000 is complemented by regulation 14 of the POS Regulations which imposes civil liability on persons responsible for a false or misleading prospectus.^^^ To bring an action under section 90 or regulation 14, an Investor must show that he has suffered loss as a result of false or misleading information in the document, or as a result of the Omission of any matter required to be included in it. There is no need for the injured party to show that he actually relied on the Statement or Omission in question. These statutory remedies are in addition to any other available statutory or common law remedy. According to the POS Regulations 1995, the persons responsible for a prospectus or supplementary prospectus include, for example, the issuer, each person who is a director of the issuer, each person who is stated in the prospectus or supplementary prospectus as accepting responsibility for any part of the prospectus, and each person who has authorised the contents of any part of the prospectus.^^^ The Listing Rules provide that the directors of the issuer must sign a Statement confirming that the listing particulars include all required information.^^^ The responsibility Statement is thought to place a duty of care on anyone accepting responsibility as against persons who acquire shares on the basis of the contents of the prospectus. Breach of this duty can give rise to civil liability in tort for misstatements in a prospectus under the principles ofHedley Byrne v Heller. Continuing obligations. As regards continuing obligations, the requirements are set out in the Listing Rules and the Combined Code. These requirements are supplemented by the City Code on Takeovers and Mergers, the SARs and the FSMA 2000. The civil liability for loss sustained by Investors by reason of breach of these requirements may again arise under the principles of Hedley Byrne v Heller that govem negligent or fraudulent misstatements.
4.6.6 Other Shareholder Remedies Some important remedies are based on section 122 of the Insolvency Act 1986 or section 459 of the Companies Act 1985. The latter are in practice the most important minority shareholder remedy under the Companies Act 1985.
^^^ Section 90(1) of the FSMA 2000: "Any person responsible for listing particulars is liable to pay compensation to a person who has (a) acquired securities to which the particulars apply; and (b) suffered loss in respect of them as a result of (i) any untrue or misleading Statement in the particulars; or (ii) the Omission from the particulars of any matter required to be included by section 80 or 81." 655 Regulation 14 of the POS Regulations 1995. ^^^ Regulation 13 of of the POS Regulations 1995; section 79(3) of the FSMA 2000. 657 The Listing Rules, 5.5, 6.A.3, 16.1 and 16.2.
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Winding up. Section 122 of the Insolvency Act 1986 provides that a Company may be wound up on a just and equitable ground.^^^ Unfair prejudice. According to section 459 of the Companies Act 1985, a shareholder may apply to the court by petition for an order on the ground that the Company's affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of its members generally or of some part of its members.659
The remedies a shareholder can obtain through a section 459 action are at the discretion of the court. The most common is a buy out order usually by the majority. Although the powers given to the court are very wide,^^^ they do not include the power to order the Company to be wound up.^^^ A shareholder seeking a winding up order must pursue a claim under section 122(l)(g) of the Insolvency Act 1986. In principle, this may be done in the same petition although a practice direction discourages the practice of pleading the two petitions in the alternative.^^^ This would also be complicated because of certain differences between these two sections. In particular, facts which satisfy the test under section 459 may not necessarily satisfy the test under section 122(l)(g) of the Insolvency Act 1986 and vice versa.^^^ The statutory remedy contained in section 459 is seen as a more direct way for an aggrieved shareholder to defend his rights than the derivative action which is brought on behalf of the Company. The conduct of management must be both unfair and prejudicial to come under section 459.^^"^ A course of conduct by those who control the Company will be unfairly prejudicial if it diminishes or seriously threatens the value of the member's shareholding.^^^ The application of this section is not restricted to strict legal rights but has a broader meaning. In the ordinary case where the shares carry equal voting rights a majority shareholder will generally have the power to stop unfairly prejudicial conduct of ^^^ Section 122(l)(g) of the Insolvency Act 1986: "A Company may be wound up by the court if the court is of the opinion that it is just and equitable that the Company should be wound up." ^59 Section 459(1) of the Companies Act 1985. See also section 461(2). ^^^ Section 461(2) of the Companies Act 1985. The specific powers Hsted in section 461(2) are without prejudice to the terms of section 461(1) which gives the court a discretion "to make such order as it thinks fit for giving rehef in respect of the matters complained of. ^^^ The Law Commission, Shareholders Remedies, Law Commission Report 246 (1997), para 4.24. ^^^ Practice Direction (Chancery Division) (Companies Court: Contributory's Petition) [1990] 1 WLR 490; see the Law Commission, Shareholders Remedies, Law Commission Report 246 (1997), para 4.29. ^^^ The Law Commission, Shareholders Remedies, Law Commission Report 246 (1997), para 4.24. 6^4 Re Saul D Harrison & Sons plc [1995] 1 BCLC 14. See also O'Neill v Phillips [1999] UKHL 24; [1999] 1 WLR 1092. For the distinction between breach of duty, or illegahty, and unfairly prejudicial conduct see Hoffmann LJ in Re Saul D Harrison & Sons plc. 665 Slade J in Re RA Noble & Son (Clothing) Ltd [1983] BCLC 273.
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the company's affairs or any unfairly prejudicial act or Omission of the Company. In Re Baltic Real Estate Ltd (No 2),^^^ Knox J indicated that prejudice will not be unfair to the petitioner's interests where the petitioner had available to him a method of bringing that prejudicial State of affairs to an end. Costs. The wide wording of section 459 results in costly and cumbersome litigation.^^"^ The matter of costs is thus important. There is a fundamental difference between the derivative action and relief under section 459. Where a shareholder brings a derivative action, the court is able to indemnify the shareholder in respect of his costs by a Wallersteiner order.^^^ This has not been the case where the shareholder has sought relief under section 459. For example, in Clark v Cutland Arden LJ said:^^^ "As to costs, in a derivative action it is open to the court to order the Company, for whose benefit the action was brought, to indemnify the claimant against the costs reasonably incurred by it »670 ßy contrast, the Company is not usually ordered to pay any of the costs in section 459 proceedings.^"^^ This fundamental difference may be disappearing. In Clark v Cutland, the difference between the derivative action and section 459 proceedings was downplayed by Arden LJ who said that even relief under section 461 "is sought for the benefit of the Company". In such a case, it is open to the shareholder "to seek an Order against the Company for payment to him of any costs incurred by him". In the past, the main attraction of the derivative action was the availability of indemnification in respect of the shareholder's costs in the form of a Wallersteiner order.^'^^ It has been suggested that the judgment of Arden LJ in Clark v Cutland may result in section 459 substantially replacing the derivative action.^'^^ 4.6.7 The Duties of Board Members As discussed above, the proper plaintiff rule and the principle that many of directors' duties are owed to the Company limit shareholders' rights to bring proceedings against defaulting directors. The proper plaintiff for wrongs alleged to be done to the Company is the Company. There are nevertheless a number of duties that must be complied with by the directors. Some of these duties are backed up by civil remedies, other by criminal sanctions.
666 Re Baltic Real Estate (No 2) [1993] BCLC 503. 66*7 The Law Commission, Shareholders Remedies, Law Commission Report 246 (1997), para2.1. 668 Wallersteiner v Moir [1975] Q B 373. 669 Clark v Cutland [2003] E W C A Civ 810. 6*^^ Citing Buckley on the Companies Acts, para 127.12. 6"^^ Citing Buckley on the Companies Acts, para 459.33. 672 Wallersteiner v M o i r [1975] Q B 373.
673 See Prentice D, Payne J, The Corporate Opportunity Doctrine, LQR 120 (2004) pp 198, 202.
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Directors' duties have not yet been codified. The Company Law Review proposed that directors' duties should be codified in broad Statements of principle in Order to make them clearer and more accessible.^'^'^ There are both common law duties and statutory duties. Some general duties can be based on recommendations in the Combined Code. Important duties such as the duty of care and fiduciary duties are based on common law principles and backed up by civil sanctions. No criminal penalties are imposed on directors who are in breach of their common law duties. The enforcement of these duties is a matter for the Company and its organs.^"^^ The most important statutory duties are based on the Companies Act 1985 and the Financial Services and Markets Act 2000. The duties under these Acts are supplemented by many different sanctions including criminal sanctions. Duty of Care While the new approach to directors' common law duty of care is objective, the traditional approach was subjective. In older cases, the duty of a director to participate in the management of a Company was stated in very undemanding terms. The traditional line culminated in the case of Re City Equitable Fire Insurance Co where Romer J summarised the old authorities.^"^^ Under common law principles based on Re City Equitable Fire Insurance Co, a director may normally rely on his co-directors and officers of the Company. The emphasis is largely on the exercise of proper judgment in selection of matters which it is proper for directors to leave to some only of their number, or some other individual or Organisation, rather than on any monitoring which should be undertaken once a delegation has been properly made.^"^"^ Romer J said in Re City Equitable Fire Insurance Co that "[i]n respect of all duties that, having regard to the exigencies of a business, and the articles of association, may properly be left to some other official, a director is, in the absence of grounds for suspicion, justified in trusting that official to perform such duties honestly". A director may thus rely on a co-director appointed to the board by reason of his expertise in a particular ^"^^ Modem Company Law for a Competitive Economy: Completing the Structure, paras 13.71 and 13.74; Developing the Framework, Chapter 3. ^^^ Completing the Structure, para 13.36. ^"^^ Re City Equitable Fire Insurance Co[1925] Ch 407:" (1) A director need not exhibit in the Performance of his duties a greater degree of skill than may reasonably be expected from a person with his knowledge and experience ... (2) A director is not bound to give continuous attention to the affairs of his Company. His duties are of an intermittent nature to be performed at periodical board meetings ... He is not, however, bound to attend all such meetings ... (3) In respect of all duties that, having regard to the exigencies of a business, and the articles of association, may properly be left to some other official, a director is, in the absence of grounds for suspicion, justified in trusting that official to perform such duties honestly." ^^^ See the Law Commission, Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties, Consultation Paper 153 (1998), paras 12.13-12.16.
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area, and is entitled to rely upon the advice of his fellow directors in matters in which they are, or should be, experts.^^^ As regards sub-board managers, Lord Halsbury stated in Dovey v Corey:^"^^ "I cannot think it can be expected of a director that he should be watching either the inferior officers ... or verifying the calculations of the auditor himself. The business of hfe could not go on if people could not trust those who are put into a position of trust for the express purpose of attending to details of management." In the 1990s, it was accepted by Hoffmann LJ first in Norman v Theodore Goddard^^^ (as Hoffmann J) and then in Re D 'Jan of London Ltd^^^ that a director's duty of care could be defined by reference to section 214(4) of the Insolvency Act 1986; that is, as the conduct of "a reasonably diligent person having both (a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the Company, and (b) the general knowledge, skill and experience that that director has". This principle has been adopted even in the draft Companies Bill published in July 2002.^82 In Bishopsgate Investment Management Ltd (in liq) v MaxweW^^ Hoffmann LJ went on to suggest, obiter, an objective approach: "The law may be evolving in response to changes in public attitudes to corporate govemance ... Even so, the existence of a duty to participate must depend upon how the particular business is organised and the part which the director could be reasonably expected to play." In Re Barings plc (No. 5),^^^ Jonathan Parker J then said: "Directors have, both collectively and individually, a continuing duty to acquire and maintain a sufficient knowledge and understanding of the Company's business to enable them properly to discharge their duties as directors." Under the new objective approach, directors must become more active than was the case under the old common law principles based on Re City Equitable Fire Insurance Co. For example, Jonathan Parker J said in Re Barings plc (No. 5): "Whilst directors are entitled (subject to the articles of association of the Company) to delegate particular functions to those below them in the management chain, and to trust in their competence and integrity to a reasonable extent, the exercise of the power of delegation does not absolve a director from the duty to supervise the discharge of the delegated functions." This was also the approach
^^^ See the Law Commission, Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties, Consultation Paper 153 (1998), para 12.13. ^^^ Dovey v Corey [1901] AC 477. 680 N o r m a n v Theodore Goddard [1992] B C C 14; [1992] B C L C 1028.
681 Re D'Jan of London Ltd [1993] BCC 646; [1994] 1 BCLC 561. 682 See the proposed 234ZA(3): "... a director ought to k n o w a matter if it would b e k n o w n by a reasonably diligent person having both (a) the knowledge, skill and experience that m a y reasonably b e expected o f a person carrying out the same functions as are carried out b y the director in relation to the Company, and (b) the knowledge, skill and experience that the director has". 683 Bishopsgate Investment M a n a g e m e n t Ltd (in liq) v Maxwell [1993] B C L C 1282. 684 Re Barings plc (No 5) [1999] 1 B C L C 433.
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taken by Thomas J in the New Zealand case of Dairy Containers v NZI Bank :^^^ "... it is the fundamental task of the directors to manage the business of the Company. Theirs is the power and the responsibility of that management. To manage the Company effectively, of course, they must necessarily delegate much of their power to executives of the Company, especially in respect of its day to day Operations. Although constantly referred to as 'the management', the executives' powers are delegated powers, subject to the scrutiny and supervision of the directors. Responsibility to manage the Company in this primary sense remains firmly with the directors ... The directors may delegate powers and functions, using that term in a broad sense, but they cannot delegate the management flinction itself ... If a director negligently disregards the Obligation to oversee the conduct of the Company's business, he or she has manifestly failed to perform that flinction with reasonable care." It is clear from Baringsplc v Coopers & Lybrand that where a default occurs as a result of a failure by a director to monitor the activity of a person to whom the board has delegated its management functions, he should not escape liability unless it was reasonable for him not to have monitored it.^^^ The new active approach has been adopted in a number of corporate govemance rules such as the Companies (Audit, Investigations and Community Enterprise) Act 2004, the Combined Code, the Listing Rules, and the TumbuU guidance. As discussed above, the new section 234ZA of the Companies Act 1985, inserted by the 2004 Act, provides for a directors' Statement on the disclosure of information. Section 1 of the Combined Code requires that the board should maintain a sound System of internal control to safeguard shareholders' Investment and the company's assets (C.2). According to the Code, the board should, at least annually, conduct a review of the effectiveness of the group's System of internal Controls and should report to shareholders that they have done so. The review should Cover all material controls, including financial, operational and compliance controls and risk management Systems (C.2.1). The Combined Code thus requires companies to evaluate the effectiveness of their controls. This is complemented by the Listing Rules which set out a comply or explain duty and a duty to explain how the Company has complied with these Code principles. Paragraph 12.43A of the Listing Rules states that "in the case of a Company incorporated in the United Kingdom, the following additional items must be included in its annual report and accounts: (a) narrative Statement of how it has applied the principles set out in Section 1 of the Combined Code, providing explanation which enables its shareholders to evaluate how the principles have been applied; (b) a Statement as to whether or not it has complied throughout the ^85 Dairy Containers v NZI Bank [1995] 2 NZLR 30, cited in Barings Plc v Coopers & Lybrand (a firm) [2003] EWHC 1319. ^^^ Barings plc v Coopers & Lybrand [1997] 1 BCLC 427 (Court or Appeal); see also Modem Company Law: Final Report, para 15.41.
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accounting period with the Code provisions set out in Section 1 of the Combined Code. A Company that has not complied with the Code provisions, or complied with only some of the Code provisions or (in the case of provisions whose requirements are of a continuing nature) complied for only part of an accounting period, must specify the Code provisions with which it has not complied, and (where relevant) for what part of the period such non-compliance continued, and give reasons for any non-compliance." While the Combined Code requires companies to evaluate the effectiveness of their controls, the Tumbull guidance explains how to do this. This guidance should be followed by boards of listed companies in: assessing how the Company has applied Code principle C.2; implementing the requirements of Code provision C.2.1; and reporting on these matters to shareholders in the annual report and accounts. In respect of the Company's property a director may come under the same liabilities as a trustee.^^"^ In Re Lands Allotment Co,^^^ Lindley LJ said: "Although directors are not properly speaking trustees, yet they have always been considered and treated as trustees of money which comes to their hands or which is actually under their control; and ever since Joint stock companies were invented directors have been held liable to make good moneys which they have misapplied upon the same footing as if they were trustees ..." Fiduciary Duty A traditional common law principle based on cases like Re Smith & Fawcett Ltd^^^ provides that directors must exercise their powers "bona fide in the interests of the Company" and "not for any collateral purpose". This phrase restates the general principle applicable to fiduciary powers.^^^ What is a fiduciary duty? In Bristol & West Building Society v Mothew,^^^ Millett LJ distinguished between the duty of care and the fiduciary duty and defined the latter: "A fiduciary is someone who has undertaken to act for or on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence. The distinguishing Obligation of a fiduciary is the Obligation of loyalty. The principal is entitled to the single-minded loyalty of his fiduciary. This core liability has several facets. A fiduciary must act in good faith; he must not make a profit out of his trust; he must not place himself in a position where his duty and his interest may conflict; he may not act for his own benefit or the benefit of a third person without the informed consent of his principal.. ."^^^ ^^^ See the Law Commission, Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties, Consultation Paper 153 (1998), paras 12.20-12-25. 688 Re Lands Allotment Co [1894] 1 Ch 616; [1891-94] All ER 1032. 689 R e Smith & Fawcett Ltd [1942] C h 304, [1942] 1 All E R 542. 690 Lord Wilberforce in Howard Smith v Ampol Petroleum [1974] A C 8 2 1 , [1974] 1 All E R 1126 (Privy Council).
691 Bristol and West Building Society v Mothew [1998] Ch 1. 692 John V Price Waterhouse [2001] E W H C C h 438 (11 April 2001) where Ferris J said: "I am not sure that it is helpful to attempt to divide the duties of a director into separate
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A number of fiduciary duties of directors were listed in a consultation paper issued by the Law Commission in 1998:^^^ the duty of loyalty (directors must act bona fide in what they consider is in the best interests of the company);^^"* the duty to exercise powers for a proper purpose (directors must exercise their powers for the purpose for which those powers are conferred);^^^ the duty not to fetter their discretion (directors must not enter into an agreement with a third party as to how they will exercise their discretion);^^^ the duty to act in accordance with the Company's Constitution; and the duty to deal fairly as between different shareholders (the directors must exercise their powers in good faith in the interests of the Company and fairly as between different shareholders).^^^ In addition, there are the duties under the no-conflict rule (certain consequences can flow if directors place themselves in a position where their personal interests or duties to other persons are liable to coniflict with their duties to the Company of which they are directors unless the Company gives its informed consent) and the no-profit rule (directors cannot retain secret profits which they make by using information or property or opportunities which belong to their Company).^^^ One of the fiduciary duties is based on the corporate opportunity doctrine.^^^ The corporate opportunity doctrine proscribes a director from diverting to his own advantage a commercial opportunity that could have been exploited by the com-
categories of fiduciary duties and duties of care. That is not the basis on which such duties were discussed in the Speech of Lord Browne-Wilkinson in Henderson v Merrett Syndicates Ltd ... or the judgment of Millett LJ in Bristol and West Building Society v Mothew..." ^^^ The Law Commission, Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties, Consultation Paper 153 (1998). ^^4 Lord Greene MR in Re Smith and Fawcett Ltd [1942] Ch 304. 69^ Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821 (Privy Council). 696 Fulham Football Club Ltd v Cabra Estates plc [1994] 1 B C L C 363: "It is trite law that directors are under a duty to act bona fide in the interests of their Company. However, it does not foUow fi'om that proposition that directors can never m a k e a contract b y which they bind themselves to the future exercise o f their powers in a particular manner, even though the contract taken as a whole is manifestly for the benefit of the Company. Such a rule could well prevent companies fi'om entering into contracts which were commercially beneficial to them ... If, w h e n a contract is negotiated on behalf o f a Company, the directors bona fide think it in the interests of the Company as a whole that the transaction should b e entered into and carried into effect they m a y bind themselves b y the contract to do whatever is necessary to effectuate it." 697 Mutual Life Insurance v Rank Organisation Ltd [1985] B C L C 11; R e B S B Holdings Ltd
(No2)[1996] 1 BCLC 155. 698 Regal (Hastings) Ltd v Gulliver [1967] A C 134 (House of Lords). There is a recent analysis o f the law in the judgment of Lawrence CoUins J in C M S Dolphin Ltd v Simonet (unreported, 23 M a y 2 0 0 1 , at paras 84-97); see also In Plus Group Ltd v Pyke [2002] E W C A C i v 370; G w e m b e Valley Development Company Ltd v Koshy [2003]
EWCACivl048. 699 See Prentice D, Payne J, The Corporate Opportunity Doctrine, L Q R 120 (2004) p p 1 9 8 202.
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pany. In Bhullar v Bhullar,'^^^ it was held that the breach of duty arises from the failure to pass relevant information to the Company: "the existence of the opportunity was Information which it was relevant for the Company to know, and it follows that the appellants were under a duty to communicate it to the Company." In light of Bhullar a director could not carry on a competing business with his Company unless there was consent.'^^^ The same principles can now be applied to a director who sets up a competing business or serves on the board of a competitor.^^^ Many leading cases on the fiduciary duty of directors deal with the purpose of the issue of shares. Directors must generally exercise their powers for a "proper" purpose, that is, for the purpose for which those powers are conferred. In Howard Smith Ltd v Ampol Petroleum Ltd,''^^ the Privy Council held that the court must first investigate the purpose for which the fiduciary power might be exercised and decide then whether the directors have exercised the power for this purpose. Reform Inspired by the Company Law Review, the Draft Companies Bill published in June 2002 contains a Statement of directors' duties. The principles set out in Schedule 2 of the Draft Companies Bill would replace the corresponding equitable and common law rules."^^"* The headings of these principles are: "Obeying the Constitution and other lawful decisions"; "Promotion of Company's objectives"; "Delegation and independence of judgement"; "Care, skill and diligence"; "Transactions involving conflict of interest"; "Personal use of the Company's property, information or opportunity"; and "Benefits from third parties".
700 Bhullar v Bhullar [2003] E W C A Civ 424; [2003] 2 B C L C 2 4 1 . Prior to Bhullar t w o distinct tests o f a corporate opportunity had emerged, the "maturing business opportunity" test and the "line of business" test. The Court o f Appeal in Bhullar rejected the maturing business opportunity test. See Prentice D , Payne J, T h e Corporate Opportunity Doctrine, L Q R 120 (2004) p 199.
701 Prentice D, Payne J, The Corporate Opportunity Doctrine, LQR 120 (2004) p 202. 702 One of the implications of Bhullar is that the Mashonaland case must be put to rest. A c cording to the Mashonaland case, the no-conflict rule imposed not a duty but a disability, that is, the directors did not have a duty not to place themselves in a position of conflict. London & Mashonaland Exploration C o v N e w Mashonaland Exploration C o [1891] W N 165. EarHer case law w a s critisised. See Christie M , T h e director's fiduciary duty not to compete, M L R 55 (1992) p 506; Lower M , Good faith and the partly-owned subsidiary, J B L 2000 p p 2 3 8 - 2 3 9 . See also Movitex Ltd v Bulfield [1988] B C L C 104 and the remarks of Sedley L J in Plus Group Ltd v Pyke [2002] E W C A Civ 370. 703 H o w a r d Smith Ltd v A m p o l Petroleum Ltd [1974] A C 8 2 1 , [1974] 1 All E R 1126 (Privy Council). 704 Clause 19 of the Draft Companies Bill.
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Duties under the Companies Act 1985 The provisions of the Companies Act 1985 impose several duties on the directors of companiesJ^^ These duties relate to two main areas, the production of the annual financial Statements and the regulär administration of the Company, in particular its Communications with Companies House^^^ For example, the Companies (Audit, Investigations and Community Enterprise) Act 2004 gave additional powers to auditors to obtain Information and required directors to State that they have not withheld relevant Information from their auditors7^"^ There are also numerous administrative requirements laid down by the Companies Act 1985. As discussed above, these duties are supplemented by a large number of offences in the Companies Act 1985.^08 Duties under Securities Markets Legislation A number of duties of directors are contained in the securities markets legislation. These duties relate in particular to disclosure^^^ and takeovers or substantial property transactions. The FSMA 2000 and the POS Regulations 1995 set out duties with respect to the publication of prospectuses. Directors are "persons responsible" for an issuer's listing particulars under the FSMA 2000. Directors are also responsible for ensuring that the Company complies with the Listing Rules. The Listing Rules provide for general disclosure obligations. The Combined Code is part of the Listing Rules, but only the failure to comply with the disclosure provisions of the Combined Code is a breach of the Listing Rules. The monitoring of the quality of companies' compliance is a matter for the shareholders. The City Code, although endorsed by the UKLA, is not part of the Listing Rules. Contracting out of Directors' Duties It is not possible to contract out of directors' duties under securities markets rules contained in the FSMA 2000 and the Listing Rules. It is to some extent unclear to what extent it is possible to contract out of directors' duties under Company law or the liabiHty for breach of these duties.
"^^^ See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 295296. 7^^ Sections 226,234,234A, 241 and 242 of the Companies Act 1985. '^^'^ See sections 389A, 389B and 234ZA of the Companies Act 1985. "^^^ See Modem Company Law for a Competitive Economy: Completing the Stmcture, para 13.25. A Hst of offences under the Companies Act 1985 has been pubUshed on the DTI Website. See Classification of Offences under the Companies Act 1985 and Associated Legislation, http://www.dti.gov.uk/cld/class_offences.pdf ^^^ See also the disclosure requirements under section 317 and the provisions on annual reports in section 234 of the Companies Act 1985.
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Provisions exempting a director front liability under Company law. According to the wording in section 310 of the Companies Act 1985, a provision which exempts a director from liability is void. In the old case oiRe City Equitable Fire Insurance Co Ltd,''^^ the directors and auditors escaped liability because the articles of the Company limited their liability for breach of duty. However, the new rule applies to "any provision, whether contained in a Company's articles or in any contract with the Company or otherwise, for exempting any officer of the Company ... from, or indemnifying him against, any liability which by virtue of any rule of law would otherwise attach to him in respect of any negligence, default, breach of duty or breach of trust of which he may be guilty in relation to the Company"."^^^ Not all provisions which at first sight might be of this type are necessarily void. For example. Table A sets out that after prior disclosure of the matter to fellow directors, a director may do certain acts which he normally would not be allowed to do."^^^ The Companies Act 1985 sets out expressly that insurance policies taken out against directors' possible liability for negligence are not prohibited,"^^^ and the Combined Code provides that the Company should arrange appropriate D&O Cover for Claims against its directors."^^"^ There is a great deal of academic debate as to how section 310 interrelates with articles of association which modify directors' fiduciary duties."^^^ The courts have accepted that directors' duties can be limited by the articles. The Companies Act does not seem to prevent shareholders from contracting out of directors' duties in the articles of association.^^^ In the absence of a duty, there will be neither breach of duty nor any liability for breach of this duty. On the other hand, at least in Movitex Ltd v Bulfield^^'^ the court did not distinguish clearly between the existence of a duty and the liability for breach of that duty. Instead, Vinelott J distinguished between duties and disabilities by holding that the rule against self-dealing by a trustee or a director is properly seen as a disability or restriction on the conduct of a fiduciary and not as a duty: articles which exclude or modify the application of this rule do not, therefore, infringe section 310 of the Companies Act 1985. 7^0 Re City Equitable Fire Insurance Co Ltd [1925] Ch 409. 7" Section 310(1) of the Companies Act 1985. "^^2 See Table A, Regulation 85. "^^3 Section 310(3) of the Companies Act 1985. ^'"^ Provision A. 1.5. ''^^ See the Law Commission, Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties, Copsultation Paper 153 (1998), para 11.49. 7*6 The High Court of AustraUa in Fürs Ltd v Tomkies (1936) 54 CLR 583: "... the inflexible rule that, except under the authority of a provision in the articles of association, no director shall obtain for himself a profit by means of a transaction in which he is concemed on behalf of the Company unless all the material facts are disclosed to the shareholders and by resolution a general meeting approves of his doing so or all the shareholders acquiesce." Cited in Gwembe Valley Development Company Ltd v Koshy [2003] EWCA Civ 1048. ^^'^ Movitex Ltd v Bulfield [1988] BCLC 104; see also Gwembe Valley Development Company Ltd v Koshy [2003] EWCA Civ 1048.
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Ratification ofwrongs. Actions by the directors that are breaches of their duties or go beyond their powers may be subject to ratification.'^^^ Under common law, the subsequent ordinary resolution of the Company in general meeting can eure a breach by directors. In Hogg v Cramphorti^^^ and Barnford V Bamford,''^^ this principle was applied to matters capable of waiver by a bare majority.^^^ The Companies Act 1985 now contains an express provision on the ratification of actions by the directors which exceed the Company's capacity but are binding on it. Such actions may only be ratified by the Company in general meeting by special resolution. This will not absolve the directors from liability unless there is a further special majority vote to that end.^^^ According to the Duomatic principle, so called because of its formulation by Buckley J in Re Duomatic,'^^^ a resolution in general meeting is not always necessary. As Oliver J said in Re New Cedos Engineering Co Ltd-P"^ "the ratio of Buckley J's decision is that where that which has been done informally could, but for an oversight, have been done formally and was assented to by 100% ofthose who could have participated in the formal act, if one had been carried out, then it would be idle to insist upon formality as a pre-condition to the validity of the act which all those competent to effect it had agreed should be effected". The common law principle is subject to limitations. The Company cannot ratify an act that is outside its powers and not binding on it or an illegal act by a director. For example, the majority cannot ratify fraud on the minority or expropriation of the Company's assets.^^^ The Company in general meeting cannot ratify a breach of duty if the Company is insolvent or may thereby become unable to pay its creditors.726
''^^ See the Law Commission, Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties, Consultation Paper 153 (1998), para 11.31-11.38. 719 H o g g V C r a m p h o m [1967] 1 C h 254, [1966] 3 All E R 420. 720 Bamford v Bamford [1970] 1 C h 212, [1969] 1 All E R 969.
721 See also CAS (nominees) Ltd v Nottingham Forest FC PLC [2002] BCC 145. 722 Sections 35(1) and 35(3) of the Companies A c t 1985.
723 Re Duomatic [1969] 2 Ch 365. 724 R e N e w Cedos Engineering C o Ltd [1994] 1 B C L C 797. 725 Cook V Deeks [1916] 1 A C 554 (Privy Council). 726 In West Mercia Safetywear Ltd v Dodd [1988] B C L C 2 5 0 , D i l l o n L J cited with a p proval a Statement b y Street C J in Kinsela v Russell Kinsela Pty Ltd (in liq) (1986) 4 N S W L R 7 2 2 where h e said: " I n a solvent Company the proprietary interests o f the shareholders entitle them as a general body to b e regarded as the Company w h e n questions o f the duty o f directors arises. If, as a general body, they authorise or ratify a particular action of the directors, there can be n o challenge to the validity of what the directors have done. But where a Company is insolvent the interests of the creditors intrude. They b e c o m e prospectively entitled, through the mechanism of liquidation, to displace the power o f the shareholders and directors to deal with the company's assets. It is in a practical sense their assets and not the shareholders' assets that, through the m e d i u m of the Company, are under the management o f the directors pending either liquidation, ret u m to solvency, or the imposition of some ahemative administration."
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Relieffrom liability under section 727. Section 727 of the Companies Act 1985 provides that a court may in some cases relieve an officer of a Company or a person employed by a Company as auditor from his liability on such terms as the court thinks fit. However, the person must have acted "honestly and reasonably". A director can have acted "honestly and reasonably" although he has been negligent. A number of judges have had to consider how a negligent defendant can be found to have acted reasonably .^^"^ In Re D 'Jan of London Ltd, Hoffmann LJ held that conduct could be reasonable for the purposes of section 727 despite amounting to a lack of reasonable care at common law. In any case, Re Duckwariplc (No 1)'^^^ shows that relief under this section is not lightly given. Approval of actions. The Company cannot complain about commercial decisions which have been made by the directors with the approval of the shareholders.^29
4.6.8 The Duties of Sub-board Managers As discussed above, the derivative action is in practice not available in respect of breaches of duty by sub-board managers and employees. It would thus not be possible for a shareholder in a public Company to bring proceedings against managers where the shareholder is unhappy with particular management decisions.^^^ Although the shareholders cannot bring proceedings themselves, they could in principle cause the Company to do so by giving directions to the board by special resolution."^^^ Which are the duties of sub-board managers and employees? Duties under the Companies Act 1985. Some duties are based on criminal sanctions for their breach. In some cases the Companies Act 1985 can impose criminal liability on sub-board managers. The allocation of criminal liability for default is dependent on the nature of the offence. Different classes of person will be liable in relation to different offences. The majority of the offences in the Companies Act 1985 fall within the regulatory category and are aimed at securing compliance with procedural or reporting requirements imposed on companies. The approach adopted is almost invariably to provide that if the Company breaches such a requirement it is guilty of an offence, as is "every officer who is in default".'^^^ ^ s regards offences in the dishonesty category in general, "a director" or (occasionally) "an officer" is liable. As regards dishonesty offences, which are so serious that the conduct in question will be
•727 See Barings Plc v Coopers & Lybrand (a firm) [2003] EWHC 1319. 728 Re Duckwari plc (No 1) [1997] 2 B C L C 713. 729 Multinational G a s and Petrochemical C o Ltd v Multinational G a s and Petrochemical Services Ltd [1983] Ch 258, [1983] 2 All E R 563. 7^^ The L a w Commission, Shareholders Remedies, L a w Commission Report 246 (1997),
paras 6.42-6.46. 731 Provided that the Company has adopted Table A, regulation 70. 732 M o d e m C o m p a n y L a w for a Competitive Economy: Completing the Structure, para 13.84.
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criminal in character whoever engages in it, "a person" is liable.^^^ In many instances it is not clear who is covered^^"^ In light of Meridian Global v Securities Commission,''^^ it is possible that reference will be made to who should be treated as the "directing mind and will of the Company" for the purpose. Therefore, in some cases the Obligation is laid not only on the director,^^^ but also upon any "officer" of the Company, and the sanction for non-compliance, normally a minor criminal sanction, is laid on any "officer who is in default".''^'' Who will be regarded as an officer of the Company? The Act defines officer"^^^ as including "a director, manager or secretary". It is still unclear who is intended to be included in the definition of "manager". In practice, the prosecution of sub-board managers is rarely attempted because the uncertainty as to the interpretation of the term "every officer who is in default" is thought to make action against anyone other than a director or secretary virtually impossible; this formulation is perceived as "vague and uncertain".^^^ The main uncertainty in the meaning of officer in the Act derives from the difficulty in pinning down the meaning of "manager"7"^^ The Company Law Review recommended that the definition of manager should be restricted normally to a person who "under the immediate authority of a director or secretary is charged with managerial functions which include the relevant function".'^'^^ In addition, for all those covered by the definition of officer, default should be taken to have occurred only where the person had authorised, actively participated in, knowingly permitted or knowingly failed to take active steps to prevent the action in question.742
"^^^ Completing the Structure, para 13.83. '^^^ Completing the Structure, para 13.97. ^^^ Meridian Global v Securities Commission [1995] 3 All ER 918 (Privy Council), a case about attribution of knowledge, rather than attribution of responsibility, to the Company; see Completing the Structure, para 13.98. ''^^ See, for example, sections 226,234,234A, 241 and 242 of the Companies Act 1985. "^^"^ See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 295296 and for example sections 238 and 352 of the Companies Act 1985. Modem Company Law: Final Report, para 15.40: "... there are a few offences which even now apply only to directors or to the directors and secretary, for example sections 242 (delivery of report and accounts to the Registrar) and 363 (delivery of annual retum to the Registrar). In the former case every director, and in the latter every director or secretary, may be liable unless in either instance they can show that they took *all reasonable steps' to avoid the default." "^^^ Section 744 of the Companies Act 1985. •^^^ Modem Company Law: Final Report, paras 15.38, 15.45 and 15.42, note 296. Para 15.38: "We proposed a more targeted approach, attributing criminal liability to a particular individual or dass of individuals according to the nature of the requirement and who ought to be responsible for ensuring compliance." ^^^ Modem Company Law: Final Report, para 15.44. ''^^ Final Report, para 15.54 and para 15.46. The suggested definition is based on section 119(1) of the Building Societies Act 1986. "^^2 Final Report, para 15.54.
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Duties under securities markets legislation. Some of the duties and liabilities under the FSMA 2000 apply to "persons responsible" or "officers". These terms Cover even sub-board managers. Section 400 of the FSMA 2000 extends the üabihty for an offence committed by a Company under this Act to its officers. In addition to a director, this term means a "member of the committee of management, chief executive, manager, secretary or other similar officer of the body, or a person purporting to act in any such capacity" and "an individual who is a Controller of the body".'''*^ Any "person responsible" is liable under section 90 of the FSMA 2000 for false or misleading listing particulars. The FSMA 2000 is complemented by regulation 14 of the POS Regulations which imposes civil UabiUty on persons responsible for a false or misleading prospectus."^"*^ According to the POS Regulations 1995, the persons responsible for a prospectus or supplementary prospectus include each person who is stated in the prospectus or supplementary prospectus as accepting responsibility for any part of the prospectus and each person who has authorised the Contents of any part of the prospectus.*^"^^ Under the common law principles of Hedley Byrne v Heller, sub-board managers can be liable at least in theory if not in practice. The responsibilites under the City Code on Takeovers and Mergers are regarded by the Panel as applying to directors of companies which are subject to the Code and to "persons or groups of persons ... who participate in, or are connected with, transactions to which the Code applies".^"*^ Duties under the employment contract. The question of the exact duties of subboard managers and employees is one of construction of the particular employment contract in light of its surrounding circumstances. It is also a question of the Status of the relevant employee. While in most other Member States of the EU which are civil law Systems, labour law is codified into one source; labour law in the UK is based on two major sources of law, common law and Statute law. This has given rise to problems of interpretation.^"*"^ Duties under the contract of employment are based on express terms of the contract and implied terms."^"^^ In addition to individualised terms, the contract of employment also consists of standardised terms implied by law. These standardised •^43 Section 400(1) of the FSMA 2000. The term manager is defmed in section 423. '''^'^ Regulation 14 of the POS Regulations 1995. ^45 Regulation 13 of of the POS Regulations 1995; section 79(3) of the FSMA 2000. ^46 The City Code, Introduction l(b). ^"^^ See Anderman S, The Interpretation of Protective Employment Statutes and Contracts of Employment, ILJ 29 (2000) p 223. ^"^^ See, for example, CoUins H, Regulating the employment relation for competitiveness, ILJ 30 (2001) pp 25-26; Lindsay J, The ImpHed Term of Trust and Confidence, ILJ 30 (2001) pp 1-16; Clarke L, Breach of Confidence and the Employment Relationship, ILJ 31 (2002) pp 353-360; Anderman S, The Interpretation of Protective Employment Statutes and Contracts of Employment, ILJ 29 (2000) pp 223-242; Wedderbum A, Employees, Partnership and Company Law, ILJ 31 (2002) pp 99-111.
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terms are said to be an incident of all contracts of employment. Since the parties are at least to some extent free to exclude or modify them,'^'*^ implied terms operate as default rules. On the other hand, it is "no longer right to equate a contract of employment with commercial contracts"; there is a "need for implied terms in contracts of employment protecting employees from harsh and unacceptable employment practices"; and the "need for protection of employees through their contractual rights, express and implied by law, is markedly greater than in the past"7^^ Some of the implied terms can include a duty of care and fiduciary duties. Duty ofcare, Senior employees have a duty of care. To what extent employees need to ensure that the Company complies with relevant statutory and regulatory requirements and its memorandum and articles of association depends on the terms of the contract. For example, senior employees are obliged to help the directors or the person or persons to whom the management powers have been delegated."^^^ Employees have some discretion in the course of their employment (the employee's prerogative)."^^^ Fiduciary duties, The contract of employment can also involve a fiduciary element.^^^ Senior employees can have fiduciary duties similar to those of directors.^^"^ These duties include: the duty to act in good faith in the interests of the Company; duty not to act for any collateral purpose; duty to avoid conflicts of interest; and duty not to make secret profits from dealings for or on behalf of the Company. The scope of fiduciary duties is dependent on the position of the employee. For example, it is a general principle that servants must behave honestly. To some extent, employees are bound to act in a manner consonant with good faith. However, the duty of fidelity flowing fi'om the relationship of master and servant imposes lesser obligations than the füll duty of good faith owed by a director or other fiduciary agent.^^^ An employee's duty of fidelity is more limited than a director's fi-
^49 Lord Steyn in Malik v Bank of Credit; Mahmud v Bank of Credit [1997] UKHL 23; [1998] AC 20; [1997] 3 All ER 1; [1997] IRLR 462; [1997] 3 WLR 95; [1997] ICR 606. See also Scally v Southern Health and Social Services Board [1992] 1 AC 294, 307B. 750 Steyn LJ in Johnson v Unisys Limited [2001] UKHL 13; [2001] 2 All ER 801; [2001] 2 WLR 1076. See also Walker v Northumberland County Council [1995] ICR 702 HC; Gogay v Hertfordshire County Council [2000] IRLR 703. "^^^ See also Shierson v Rastogi [2002] EWCA Civ 1624 on the interpretation of sections 235 (headed "Duty to cooperate with office-holder") and 236 of the Insolvency Act 1986. '^^^ See Brodie D, Beyond Exchange: The New Contract of Employment, ILJ 27 (1998) p 98. 75^ See Clarke L, Breach of Confidence and the Employment Relationship, ILJ 31 (2002) pp 356-359. "^54 Canadian Aero Service v O'Malley [1973] 40 DLR. See also Tesco Stores Ltd v Simon Pook [2003] EWHC 823 (Ch). ''^^ See In Plus Group Ltd v Pyke [2002] EWCA Civ 370. Sedley LJ cited in this case Gower's Company Law, 6th Edition p 622.
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duciary duty, but there can be circumstances in which employees owe such duties and are liable to account for any profit made by breach thereof^^^ It is an "implied term to serve the employer faithfuUy within the requirements of the contract".^^^ An employee thus has implied obligations to serve his employer loyally and not to act contrary to his employer's interests."^^^ There is also an implied Obligation of "mutual trust and confidence"^^^ As discussed above, employees will have some discretion in the course of their employment (the employee's prerogative).^^^ A manager who is given discretion to give instructions to others and to supervise their work must exercise that discretion "faithfully in the interests of the employers"."^^^ In general, employees must interpret the terms of the contract in a similar fashion^^^ In implementing the Orders of the employer the employee must not "seek to obey them in a wholly unreasonably way which has the effect of disrupting the system".'^^^ In many workplaces, these legal reinforcements for contractual restraints on possible abuse of managerial discretion are supplemented by union pressures in Support of collective agreements or custom and practice^^"^ "Dishonest assisting" of directors in a breach offiduciary duty. Dishonest assisting of directors in a breach of fiduciary duty can lead to liability under common law principles laid down by the Privy Council in Royal Brunei Airlines Sdn Bhd V TanJ^^ In the Royal Brunei case, Lord NichoUs said that an honest person does not "deliberately close his eyes and ears, or deliberately not ask questions, lest he leam something he would rather not know, and then proceed regardless". He stated the general principle that dishonesty is a necessary ingredient of accessory liability and that knowledge is not an appropriate test."^^^ In Twinsectra Lim-
''^^ See Reading v Attomey-General [1951] AC 507; Nottingham University v Fishel [2000] IRLR 471; Attomey-General v Blake [2001] IRLR 36. ^5^ Buckley LJ in Secretary of State for Employment v ASLEF (No 2) [1972] ICR 19 at 62. ^58 Malik V Bank of Credit; Mahmud v Bank of Credit [1997] UKHL 23; [1998] AC 20; [1997] 3 All ER 1; [1997] IRLR 462; [1997] 3 WLR 95; [1997] ICR 606. ^59 Johnson v Unisys Limited [2001] UKHL 13; [2001] 2 All ER 801; [2001] 2 WLR 1076. ^^ö See Brodie D, Beyond Exchange: The New Contract of Employment, ILJ 27 (1998) p 98. ^^^ Ralph Gibson LJ, Ticehurst and Thomson v British Telecommunications plc [1992] IRLR 219 at 225. See also Collins H, Regulating the employment relation for competitiveness, ILJ 30 (2001) p 24. 762 Secretary o f State v A S L E F (No 2) [1972] 2 All E R 949.
763 ibid at 980 (Roskill LJ). 76"^ Collins H, Regulating the employment relation for competitiveness, ILJ 30 (2001) pp 25-26. 765 Royal Brunei Airlines Sdn B h d v Tan [1995] 2 A C 378, [1995] 3 All E R 97. 766 "... dishonesty is a necessary ingredient o f accessory liability. It is also a sufficient ingredient. A liability in equity to m a k e good resulting loss attaches to a person w h o dishonestly procures or assists in a breach o f trust or fiduciary Obligation. It is not necessary that, in addition, the trustee or fiduciary w a s acting dishonestly, although this will usually b e so where the third party w h o is assisting him is acting dishonestly. ' K n o w ingly' is better avoided as a defining ingredient of the principle ..."
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ited V Yardley,''^'^ Lord Hutton considered that this was a Statement of a general principle. Lord Hoffmann was of the opinion that "those principles require more than knowledge of the facts which make the conduct wrongful. They require a dishonest State of mind, that is to say, consciousness that one is transgressing ordinary Standards of honest behaviour". Contracting out ofmanagers' duties. There are some limitations on the right to contract out ofmanagers' duties. Section 310 of the Companies Act 1985 Covers even provisions exempting any person employed by the Company as auditor or "officer" from liability.
4.6.9 The Duties of Company Secretary Like the duties of sub-board managers, the duties of a Company secretary are owed to the Company and not to any shareholder. The proper plaintiff in an action against a Company secretary is therefore the Company. As a rule, shareholders cannot bring proceedings against defaulting Company secretaries.
Duties under the Companies Act 1985 Company secretaries have a large number of duties. The duties of the secretary are usually contained in an employment contract. Many duties are in practice based on sanctions for non-compliance with statutory requirements. The Companies Act 1985, Business Names Act 1985, Insolvency Act 1986, and Company Directors Disqualification Act 1986 detail a large number of potential criminal offences by directors or "officers" of the Company, and there are many statutory procedures and filing requirements to be observed. As the secretary is an "officer" of the Company under section 744 of the Companies Act 1985, he may be criminally liable for breach of these duties. In light of sanctions for non-compHance under the Companies Act 1985, the duties of the secretary may be divided into three main areas: maintaining statutory registers; completing and filing statutory forms; and meetings and resolutions. The Companies (Audit Investigations and Community Enterprise) Act 2004 introduced a fourth main duty, the duty to provide information to auditors."^^^ The secretary usually maintains statutory registers (register of members, register of directors and secretaries, register of directors' interests in shares and debentures, register of charges);^^^ ensures that statutory forms are completed and filed promptly (for example, the annual accounts, the annual retum, changes in directors and secretaries, allotments of shares, and an amendment to the memorandum and articles of association); ensure that proper notice of meetings is given to those 767 Twinsectra Limited v Yardley [2002] U K H L 12, [2002] 2 All E R 377 (House of Lords). 768 Section 389A of the Companies Act 1985. 769 Section 352 (the register of members); section 288 (the register of directors and secretaries); section 325 (the register of directors' interests); section 4 0 7 (the register of charges); and section 211 (for public companies, the register o f interests in shares).
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who are entitled to attend; sends the Registrar copies of resolutions and agreements; supplies a copy of the accounts to every member of the company;'^'^^ keeps, or arranges for the keeping, of minutes of directors' meetings and general meetings; and ensures that people entitled to do so can inspect Company records. The Companies (Audit Investigations and Community Enterprise) Act 2004 gives an auditor a right of access at all times to the Company's books and a right to require any of the Company's officers, for example the secretary, to provide him with such Information or explanations as he thinks necessary for the Performance of his duties as auditor.*^^^ Common Law Duties The common law principles of fiduciary duty and duty of care apply both to directors and Company secretaries. Fiduciary duty. The fiduciary duties of directors can apply equally to executives occupying senior management positions in the Company and authorised to act on its behalf. For example, in Canadian Aero Service v O'Malley''''^ it was held that directors or senior officers could not usurp for themselves or divert to another person or Company a maturing business opportunity which their Company is actively pursuing. As an officer of the Company, the secretary has the following fundamental common law duties: duty to act in good faith in the interests of the Company; duty not to act for any collateral purpose; duty to avoid conflicts of interest; and duty not to make secret profits from dealings for or on behalf of the Company. ^"^^ Duty ofcare. The Institute of Chartered Secretaries and Administrators (ICSA) has published a best practice guide on the duties of the secretary. The guide is intended to be authoritative. Its purpose is to distinguish between the duties which all Company secretaries should perform (core duties) and those that they often perform (additional duties). Core duties are defmed as those for which the secretary is responsible as an officer of the Company. The list of core duties is therefore a distillation of Statute, common law and good practice.^"^"^ According to the guide, Company secretaries "should ensure compliance with all relevant statutory and regulatory requirements".'''^^ This does not mean compliance with the requirements of the Companies Act 1985 only. For example, a Provision of the Pensions Act 1995 sets out that if a corporate body commits an offence, officers of the Company are implicated by consent, connivance or neglect; and a provision of the Money Laundering Regulations 1993 states that when an
'^''^ Sections 238 and 239 of the Companies Act 1985. "^71 Section 389A, "Rights to information". See also Section 389B, "Offences relating to the Provision of information to auditors". "^^2 Canadian Aero Service v O'Malley [1973] 40 DLR. ^^^ The Institute of Chartered Secretaries and Administrators, ICSA's Duties of a Company Secretary - Best Practice Guide (1998) pp 5-6. ^"7^ Best Practice Guide (1998) p 3. ^^5 Best Practice Guide (1998) p 4.
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offence has been committed, the secretary can be held liable^"^^ Even requirements which are not based on statutory law can be covered. For example, ensuring compliance with Stock Exchange rules and regulations as well as the City Code is regarded as a core duty.*^"^^ The guide goes on to list several duties that the secretary will need to fulfil. For example, the secretary will need to ensure that the Company complies with its memorandum and articles of association and that annual general meetings are held in accordance with the requirements of the Companies Act and the articles of association^^^ Reform The Company Law Review considered the duties and liability of Company secretaries. According to the Company Law Review, certain aspects of basic administration should be the responsibility of the secretary as well as the directors, for example the maintenance of registers. The Company Law Review recommended that the test for the liability of the secretary should be the same as that for directors, where directors have properly charged the secretary with the function. The secretary should be liable for example where the secretary can fulfil filing requirements without assistance from the directors or the directors have done their part in providing the document and the secretary has failed to file it."^^^
4.6.10 Auditors' Duties Like the duties and liability of sub-board managers, employees and the Company secretary, the duties of auditors and the remedies available to shareholders for breach of auditors' duties are two different things. Auditors normally owe their duties to their audit dient only. Auditors are thus only rarely liable to shareholders for breach of duty. In practice the shareholders' interests can be protected by the Company which will have a claim against its auditor in the event that the auditor breaches duties owed to the Company.^^^ General duties. The scope of the general duties of the Company's auditor is based on the express terms of the auditor's engagement and its implied terms. The common law duties of auditors were considered by the House of Lords in Caparo Industries plc v Dickman'^^^ where Lord Oliver said: "It is the auditors' function to ensure, so far as possible, that the financial information as to the Company's affairs prepared by the directors accurately reflects the Company's position ^^^ Section 115 of Part I of the Pensions Act 1995; sections 5 and 6 of The Money Laundering Regulations 1993; see Best Practice Guide (1998) pp 6-7. ^^^ Best Practice Guide (1998) pp 6-7. ^^8 Best Practice Guide (1998) pp 7-8. "^"^^ Modem Company Law: Final Report, para 15.41. ''^^ See Lord Bridge of Harwich in Caparo Industries Plc v Dickman [1990] 2 AC 605 at 626D-F. ^^^ Caparo Industries Plc v Dickman and others [1990] 2 AC 605.
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in Order, firstly, to protect the Company itself from the consequences of undetected errors or, possibly, wrongdoing (by, for instance, declaring dividends out of capital) and, secondly, to provide shareholders with reliable intelligence for the purpose of enabling them to scrutinise the conduct of the Company's affairs and to exercise their collective powers to reward or control or remove those to whom that conduct has been confided." Like all who render professional Services for reward, the Company's auditor owes the Company an implied duty of care in and about the manner in which he performs these Services7^^ The limits of this implied duty of care were discussed in Bank of Credit and Commerce International (Overseas) Ltd (in liquidation) v Price Waterhouse,''^^ where Laddie J Struck out BCCI's claims against its auditors in contract and tort to recover losses made on bad investments. Laddie J said: "The skill [the auditor] offers and for which he is paid is the skill in looking at the Company's accounts and the underlying information on which they are or should be based and telling the shareholders whether the accounts give a true and fair view of the company's financial position. He is not in possession of facts nor qualified to express a view as to how the business should be run, in the sense of what investments to make, what business to undertake, what prices to charge, what lines of credit to extend and so on. Not only does he not normally have the necessary expertise but those are areas in respect of which his advice is not sought. When the Company engages an auditor, it is not seeking his help in steering the management into making better management decisions." The duties of an auditor must be distinguished from those of an accountant. For example, auditors do not have a common law duty to advise the directors. In Coulthard v Neville Russell (afirm),''^^ Chadwick LJ said: "The auditors ... are not engaged, as auditors, to advise the directors as to the way in which the directors should fulfil the director's duties; but they may properly be expected to inform the directors, in advance of the approval of the accounts, how they, as auditors, will regard the treatment of any controversial item in the accounts when performing their own duties under section 235 of the Act." It is thus normal that discussions between directors and auditors as to the proper treatment in the balance sheet of any item likely to be controversial take place before the accounts are approved and the audit report signed. Duty to comply with accounting Standards. Auditors have a duty to carry out their audits in accordance with auditing Standards. It is well established that nonlegal Standards can be used to determine the Standard of care required at common law of professional persons. The courts are likely to accept professional Standards such as auditing Standards as best evidence of the Standard of care required by the law of negligence of auditors in the discharge of their professional duties.^^^ On "^^2 Equitable Life Assurance Society v Ernst & Young [2003] EWCA Civ 1114. ^^^ Bank of Credit and Commerce International (Overseas) Ltd (in liquidation) v Price Waterhouse [1999] BCC 351. ^^^ Coulthard v Neville Russell (afirm)[1998] 1 BCLC 143; [1997] EWCA Civ 2837. "7^5 Sections 226(2) and 227(3) of the Companies Act 1985. See for example Lloyd Cheyman & Co v Littlejohn & Co [1987] BCLC 303.
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the other hand, courts are not bound by professionally developed Standards. In Bolitho V City and Hackney Health Authority,''^^ Lord Browne-Wilkinson said: "if, in a rare case, it can be demonstrated that the professional opinion is not capable of withstanding logical analysis, the Judge is entitled to hold that the body of opinion is not reasonable or responsible". Liability to shareholders, Auditors are seldom liable to shareholders for breach of duty. A shareholder relies on the audit report at his own risk. This is because a plaintiff who sues for breach of duty imposed by the law (whether in contract or tort or under Statute) must do more than prove that the defendant has failed to comply. He must show that the duty was owed to him and that it was a duty in respect of the kind of loss that he has suffered^^^ Most of the duties of the Company's auditors are owed to the Company. The leading case is Caparo Industries Pia v Dickman,''^^ where the House of Lords applied the principles set out in Hedley Byrne v HellerJ^^ The fundamental Clements of these principles are reasonable foreseeability, reliance, and assumption of responsibility.'^^^ The House of Lords held in Caparo that the purpose of preparing audited accounts was to assist Company members to conduct business. On the other hand, the purpose of preparing audited accounts was not to assist those making Investment decisions, whether existing or new investors in the Company, and the auditors did not owe a duty of care to them. The House of Lords further held that liability for economic loss for neghgent misstatement should be limited to situations where the Statement was made to a known recipient for a specific purpose of which the maker was aware and upon which the recipient had relied and acted upon to his detriment. In other words, it was true that the auditors' failure to use reasonable care in auditing the Company's statutory accounts was a breach of their duty of care. But "^^^Bolitho V City and Hackney Health Authority [1998] AC 232. Bolitho was a medical negligence case but the approach taken by the House of Lords is not limited only to cases of medical negligence. ^^^ Hoffmann LJ in Banque Bruxelles SA v Eagle Star [1997] AC 191. "^^^ Caparo Industries Plc v Dickman and others [1990] 2 AC 605 (House of Lords). ^89 Hedley Byrne & Co Ltd v Heller & Partners Ltd [1964] AC 465 (House of Lords). ''^^ In Caparo Industries v Dickman [1990] 2 AC 605 Oliver LJ said, at page 638: "What can be deduced from the Hedley Byrne case, therefore, is that the necessary relationship between the maker of a Statement or giver of advice (*the adviser') and the recipient who acts in reliance upon it (*the advisee') may typically be held to exist where - (1) The advice is required for a purpose, whether particularly specified or generally described, which is made known, either actually or inferentially to the adviser at the time when the advice is given; (2) The adviser knows either actually or inferentially that his advice will be communicated to the advisee, either specifically or as a member of an ascertainable dass, in order that it should be used by the advisee for that purpose; (3) It is known either actually or inferentially that the advice so communicated is likely to be acted upon by the advisee for that purpose without independent inquiry; and (4) It is so acted upon by the advisee to his detriment. That is not, of course, to suggest that these conditions are either conclusive or exclusive but merely that the actual decision in the case does not Warrant broader propositions."
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they were not liable to an outside take-over bidder because the duty was not owed to him. Nor were they liable to shareholders who had bought more shares in reliance on the accounts. Although shareholders were owed a duty of care, they were not owed a duty of care in their capacity of potential buyers of its shares. The liability of auditors to shareholders is thus very limited. In Caparo, Lord Jauncey said: "Only where the auditor was aware that the individual shareholder was likely to rely on the accounts for a particular purpose such as his present or fliture investment in or lending to the Company would a duty of care arise." The same principle has been applied to the liability of auditors to takeover bidders. In Galoo Limited v Bright Graham Murray,'''^^ Glidewell LJ said: "Mere foreseeability that a potential bidder may rely on the audited accounts does not impose on the auditor a duty of care to the bidder, but if the auditor is expressly made aware that a particular identified bidder will rely on the audited accounts or other Statements approved by the auditor, and intends that the bidder should so rely, the auditor will be under a duty of care to the bidder for the breach of which he may be liable." The liability of auditors for failure to provide accurate information is nevertheless in a State of development.'^^^ In the Bannerman case,*^^^ the Scottish Court of Session held that the auditors owed a duty of care to a third party due to the auditors' knowledge of the third party's involvement.'^^'* Although this decision is only of persuasive weight in England, the Bannerman case has in practice made it necessary for auditors to change the wording of the audit report. The audit report will now be explicit on for whom it is intended and for whom it is not, and it will (unless submitted to the SEC, see below) contain a disclaimer of responsibility to any third party.*^^^ Contracting out of auditors' duties. Section 310 of the Companies Act 1985 prohibits provisions exempting auditors from liability to the Company. The duties of auditors are nevertheless based on the terms of engagement, and auditors can agree on these terms within the limits of the duty to carry out audits in accordance with auditing Standards. There are no similar restrictions as regards the duties and liability of auditors to shareholders and other third parties. The view of the courts is that the interest of the shareholders in the proper management of the Company's affairs is indistinguishable from the interest of the Company itself and that any loss suffered by the '^^^ Galoo Limited v Bright Graham Murray [1994] 1 WLR 1360. See also Morgan Crucible Co plc V Hill Samuel Bank Ltd [1991] Ch 295; [1991] BCLC 178. ^92 Chadwick LJ in Coulthard v Neville Russell (a firm) [1998] 1 BCLC 143; [1997] EWCA Civ 2837. ^' ^^ Royal Bank of Scotland v Bannerman Johnstone Maclay (a firm) [2003] SC 125. ''^^ Lord MacFadyen said: "It seems to me to be reasonably clear that ... for a relationship of proximity to be held to exist the adviser must at the time when the advice is given know: (1) the identity of the person to whom the advice or information is to be communicated, (2) the purpose for which that person is to be provided with the advice or information, and (3) that the person to whom the advice or information is communicated is likely to rely on it for the known purpose." ^' ^^ The Institute of Chartered Accountants, The Audit Report and Auditors' Duty of Care to Third Parties, Audit 01/03.
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shareholders by the negligent failure of the auditor to discover and expose a misappropriation of funds by a director of the Company will be recouped by a claim against the auditors in the name of the Company.^^^ On the other hand, the SEC does not permit the inclusion of disclaimers in audited financial Statements submitted to the SEC, for which reason the 20-F filings of UK companies do not contain disclaimers.
4.6.11 Shareholders' Duties Although board members and managers owe a duty of care and a fiduciary duty to the Company, the position of shareholders is different. In a partnership, a partner has a fiduciary duty under the Partnership Act 1890. In a Company, however, there is no similar duty. For example, a majority shareholder which competes with the Company or which controls a rival business or which diverts corporate opportunities to itself is not in breach of any duty.*^^"^ It has nevertheless been argued that where shareholders exercise management powers they should be subject roughly to the same type of constraints as are imposed on directors.'^^^ Shareholders - especially minority shareholders - are to some extent protected under section 122 of the Insolvency Act (winding up on a just and equitable ground) and section 459 of the Companies Act 1985 (unfairly prejudical conduct). These questions will be discussed in Chaps. 4.8 and 4.9 below.
4.7 Shareholders and Dealings with Third Parties 4.7.1 Introduction In the UK, shareholders have very limited powers to decide to which extent acts done on behalf of the Company in its dealings with third parties are binding on the Company. In the articles of association, authority to bind the Company to contracts is primarily reserved for the board of directors and not for shareholders.^^^ In the vast majority of transactions it would nevertheless be impossible for the board of directors to represent the Company, and doing so would not be compatible with the role of the board of directors as a monitoring body. Most powers to represent the Company are in practice delegated to the managing director and sub-board managers under the articles of association. ^^^Lord Bridge of Harwich in Caparo Industries Plc v Dickman and others [1990] 2 AC 605. "^^^ See Lower M, Good faith and the partly-owned subsidiary, JBL 2000 pp 238-239. ^' ^^ See Lower M, Good faith and the partly-owned subsidiary JBL 2000 pp 238-239, citing Prentice D, The closely-held Company and minority oppression, OJLS 3 (1983) p 417 at p419. 799 Table A, regulation 70.
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Different rules apply to representation of the Company by its board of directors and to representation by other persons. Board of directors, The main rule is that the Company is bound where it has been represented by its board of directors. Limitations under the Company's Constitution cannot normally be invoked against a person who has dealt with the Company through its board of directors or anyone authorised by the board.^^^ Individual board members and sub-board managers. In most cases the Company is not represented by its board of directors but officers such as sub-board managers, the managing director, individual board members or the Company secretary. The indoor management rule (sometimes called the rule in Turquand's case^^^) allows persons dealing with a Company to assume that all required acts of a Company's internal management have been fulfilled, but the rule does not allow a third party to assume that the person with whom he is dealing has authority to bind the Company. The authority to bind the Company can nevertheless be based on the principles of actual or ostensible (or apparent) authority. Liability. Breach of these limitations can nevertheless result in liability for loss caused to the Company. 4.7.2 Representation of the Company: General Remarks It is possible to distinguish between authority to bind the Company under the Companies Act 1985 and common law authority. The authority to bind a Company has not been regulated by the provisions of the Companies Act 1985. Instead, it is conferred by the articles of association either directly or by delegation under a power contained in them.^^^ The general power to manage is usually conferred on the board which may delegate it.^^^ What the Companies Act 1985 does is that it provides that most transactions entered into by the Company through its board of directors or a person authorised by the board are binding on the Company. At common law (but subject to the statutory provisions and the general agency principles), a contract which is entered into by the Company's officers without authority (for example because it exceeds a restriction in the articles, or because the directors are acting in breach of their fiduciary duties to the Company), may be set aside by the Company unless it is ratified by the Company by ordinary resolution in general meeting.
^00 Section 35(1) of the Companies Act 1985. ^^^ Royal British Bank v Turquand (1856) 6 E & B 327 (Exchequer Chamber). ^^^ See for example The Law Commission, The Execution of Deeds and Documents by or on behalf ofBodies Corporate, Consultation Paper No 143 (1996), para 5.7. 8^3 Table A, regulations 70 and 72.
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4.7.3 Company Acting through its Board of Directors Where the Company has acted through its directors, the validity of transactions, which are contrary to limitations under the Company's Constitution, is govemed either by specific provisions of the Companies Act 1985 or common law mies. Companies Act 1985. The specific provisions of the Companies Act 1985 apply where somebody deals with the Company through its board of directors or an agent authorised by the board. A third party might have dealings with the Company through its board where the Company is very small or the transaction is very large. The most important provisions can be found in sections 35, 35A and 35B as well as section 322A. According to the main rule, a transaction carried out with a third party will bind the Company if it is effected on behalf of the Company by the board of directors and the third party was in good faith. This main rule is based on the wording of sections 35A and 35B. Sections 35A and 35B benefit a third party who deals with the Company through its board of directors. Section 35A protects third parties who deal with the Company in good faith by deeming the directors' powers to be free of any limitation under the Company's Constitution.^^"* In addition, section 35B provides that third parties are not put into enquiry as to the capacity of the Company or the authority of its directors.805
Section 35B expressly excludes the old common law doctrine of constructive notice of the contents of a Company's memorandum and articles. Under section 35B, failure to make enquiries does not constitute bad faith. If a third party, who has not in fact read the constitutional documents of the Company and does not otherwise know of restrictions therein, contracts with the Company through its board of directors, he will be protected by section 35A. Even the actual knowledge of a lack of authority does not necessarily take the third party out of the category of one who has acted in good faith. The courts are reluctant to construe section 35B "in such a way as to reintroduce, through the back door, any requirement that a third party acting in good faith must still investigate the regulating documents of a Company". ^^^ This means that the constitutional documents of the Company are not an appropriate mechanism for communicating to third parties limits on the authority of the board of directors as far as dealings of the Company with Outsiders are concemed. On the other hand, section 35A is not applicable in all situations. ^^"^ Section 35A(1) of the Companies Act 1985: "In favour of a person dealing with a Company in good faith, the power of the board of directors to bind the Company, or authorise others to do so, shall be deemed to be free of any limitation under the Company's Constitution." ^^^ Section 35B of the Companies Act 1985: "A party to a transaction with a Company is not bound to enquire as to whether it is permitted by the Company's memorandum or as to any limitation on the powers of the board of directors to bind the Company or authorise others to do so." ^06 Sir Nicolas Browne-Wilkinson V-C in TCB Ltd v Gray [1986] Ch 621 on the effect of section 9(1) of the European Communities Act 1972 (at p 635).
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Section 35A is limited to the Company's Constitution and, in particular, to the breach of a constitutional limitation on the powers of the board of directors. For example, in Smith v Henniker-Major^^'' it was held that quorum requirements as to board meetings constituted limitations in the Constitution on the board's authority. Section 35A does not protect third parties who are not in good faith. (a) Section 35A does not protect a third party where the third party is on notice that the members of the board have breached the provisions of the Companies Act. In Rolled Steel Products (Holdings) Ltd v British Steel Corporation,^^^ Browne-Wilkinson LJ said: "A third party who has notice - actual or constructive - that a transaction, although intra vires the Company was entered into in excess or abuse of the powers of the Company, cannot enforce such a transaction against the Company and will be accountable as constructive trustee for any money or property of the Company received by the third party." (b) In addition, a third party can be informed in some other way of limitations on the authority of the board of directors. Such a third party would be at risk of being held not to have acted in good faith for the purposes of section 35 A. The main rule is complemented by section 322A of the Companies Act 1985. Section 322A protects the Company when the party who enters into transactions with the Company is a director, a connected person of a director or a Company with which he is associated.^^^ If the transaction is contrary to limitations under the Company's Constitution,^ ^^ the transaction is voidable at the instance of the Company.^^' This means that where the transaction passes the first filter of section 35A but is caught by the second filter of section 322A, the transaction is voidable, not void. Common law rules. The common law mies complement sections 35, 35A and 35B as well as section 322A of the Companies Act 1985. Where the agent of the Company exceeds his authority, the transaction is not binding on the Company unless it is ratified by the Company. The transaction is 807 Smith V Henniker-Major [2002] E W C A Civ 762, [2003] C h 182. 808 Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1986] Ch 246; [1985] 2 WLR 908. 80^ Section 322A(1) of the Companies Act 1985: "This section appHes where a Company enters into a transaction to which the parties include (a) a director of the Company or of its holding Company, or (b) a person connected with such a director or a Company with whom such a director is associated, and the board of directors, in connection with the transaction, exceed any limitation on their powers under the company's Constitution." 8^0 Section 322A(1) of the Companies Act 1985: "This section appHes where ... the board of directors, in connection with the transaction, exceed any limitation on their powers under the company's Constitution." See also section 322A(8) of the Companies Act 1985: "In this section ^transaction' includes any act; and the reference in subsection (1) to limitations under the company's Constitution includes limitations deriving (a) from a resolution of the Company in general meeting or a meeting of any dass of shareholders, or (b) from any agreement between the members of the Company or of any dass of shareholders." 8^^ Section 322A(2) of the Companies Act 1985.
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ratified either when it is approved by the body that does have authority to approve such transactions on behalf of the Company or it is approved by ordinary resolution of the shareholders. If the transaction is also beyond the Company's capacity (ultra vires the Company), it can be made binding on the Company only by a special resolution of the shareholders under section 35(3) of the Companies Act 1985.812
4.7.4 Company Acting through Other Representatives It would, however, be unusual for a third party to have dealings with the Company through its board of directors. It would be normal for a third party to deal with the Company through its executives or employees and have no knowledge of the internal administration of the Company. ^^^ Where the Company has acted not through its board of directors as a collegiate body but through other representatives, the validity of transactions, which are contrary to limitations under the Company's Constitution, is govemed either by the specific provisions of the Companies Act 1985 or the complicated common law principles of agency, depending on whether the Company has acted through "persons authorised by the board" or other persons. These mies are applied also where the Company has acted through its managing director or other managers, or through the Company secretary or companies belonging to the same group of companies. Company acting through persons authorised by the board. Section 35A govems even transactions performed by a person who is in fact authorised by the board to act on behalf of the company.^^'* Such a transaction will bind the Company if the third party is in good faith (see above). The interpretation of section 35A is far from clear. For example, section 35A does not say that the board shall be deemed to have exercised its power to authorise other persons to bind the Company under the Company's articles of association.815
The common law doctrine of constructive notice has been abolished under section 35B of the Companies Act 1985 where the Company is represented by a person authorised by the board (see below).
812 Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 145. 813 Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 156. ^^^ Section 35A(1) of the Companies Act 1985: "In favour ofa person dealing with a Company in good faith, the power of the board of directors to bind the Company, or authorise others to do so, shall be deemed to be free of any Hmitation under the company's Constitution." 81^ See Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 149: *Tt is unclear whether the section operates automatically to override the limitations in the company's Constitution, whenever the board confers authority on an agent, or whether the board must expressly or by necessary implication make an appointment which is inconsistent with the provisions in the company's Constitution."
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Company acting through other persons. It would, however, be unusual for a third party to know whether the representative of the Company has actually been authorised by the board. In this case, the complicated common law rules on agency will apply. To begin with, the common law principles of agency provide that a principal is bound to a contract made by an agent having actual or apparent authority to bind the company.^^^ According to the principles of the law of agency, "actual" authority is "a legal relationship between principal and agent created by a consensual agreement to which they alone are parties".^^"^ "Apparent" or "ostensible" authority is the "authority of an agent as it appears to others".^^^ For example, where a Company appoints an agent to a certain position and agents in that position normally have a certain scope of authority, the agent has that much authority to bind the Company. Even if the particular agent's actual authority is less than what is usual, the third party can rely upon what is usually the case.^^^ This means that a principal is bound to a contract purportedly made by an agent without, or in excess of, actual authority if the principal has held out the agent as having authority and the promisee knew of, and relied on, that holding out. The Company will not be bound where the third party knew that the representative lacked authority or exceeded it. In Rolled Steel Products (Holdings) Ltd v British Steel Corporation,^'^^ the Court of Appeal held that a person, who enters with a Company into a transaction to which its representatives, to the knowledge of that person, have no authority to commit it, can acquire no rights under the transaction.^2^ The leading judgment was given by Slade LJ who said:^^^ "If... a person dealing with a Company is on notice that the directors are exercising the relevant power for purposes other than the purposes of the Company, he cannot rely on the
^^^ See also Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 129 footnote 1: "Actual authority may be conferred expressly or impliedly. Authority to perform acts which are reasonably incidental to the proper Performance of an agent's duties will be implied unless expressly exclude and an agent who, on previous occasions, has been allowed to exceed the actual authority originally conferred upon him may thereby have acquired actual authority to continue so to act. Ratification of a contract entered into by an agent in excess of his authority enables the principal to sue the other party if the agent had disclosed that he was acting for an identifiable principal." Footnote 2: ["Apparenf or "ostensible" authority] consists of (i) the authority which a person in his position and in the type of business concemed can reasonably be expected to have and (ii) the authority which the particular agent has been held out by the principal as having unless, in either case, the other party knows or ought to have known that the agent was not actually authorised." ^^'^ Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480 at p 502. 8^8 Hely-Hutchinson v Brayhead Ltd [1968] 1 QB 549 at p 583. ^'^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 143-144. ^20 Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1986] Ch 246. ^^' See Nourse LJ in Jyske Bank (Gibraltar) Limited v Spjeldnaes [1999] Lloyds Rep. (Banking) 511. 822Atp295H.
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ostensible authority of the directors and, on ordinary principles of agency, cannot hold the Company to the transaction." The third party can have actual notice of the agent exceeding his authority. For example, if the third party has read the Company's Constitution and so knows of the limitations on the agents' actual authority, the common law does not regard it as appropriate to give the third party the protection of the doctrine of ostensible authority. ^^^ In addition to actual notice, the third party can have constructive notice of the agent exceeding his authority. In Rolled Steel Products (Holdings) Ltd v British Steel Corporation,^^'^ Browne-Wilkinson LJ said: "A third party who has notice actual or constructive - that a transaction, although intra vires the Company was entered into in excess or abuse of the powers of the Company, cannot enforce such transaction against the Company and will be accountable as constructive trustee for any money or property of the Company received by the third party." In principle, the "indoor management rule" - also called the rule in Royal British Bank v Turquand or the rule in Turquand's case^^^ - allows Outsiders dealing with a Company to assume that acts of internal management have been properly carried out. Outsiders are not expected to look into the internal affairs of the Company. Company acting through individual directors. The same common law principles apply to acts done by individual directors. In Rolled Steel Products (Holdings) Ltd V British Steel Corporation,^^^ Browne-Wilkinson LJ described the relationship between the rule in Turquand'^ case, the common law principles of "ostensible" authority and the rule on the effect of third party's notice as follows: "Apart from questions of ostensible authority, directors like any other agents can only bind the Company by acts done in accordance with the formal requirements of their agency, eg, by resolution of the board at a properly constituted meeting. Acts done otherwise than in accordance with these formal requirements will not be the acts of the Company. However, the principles of ostensible authority apply to the acts of directors acting as agents of the Company and the rule in Turquand's case ... establishes that a third party dealing in good faith with directors is entitled to assume that the internal steps requisite for the formal validity of the directors' acts have been duly carried through. If, however, the third party has actual or constructive notice that such steps [have] not been taken, he will not be able to rely on any ostensible authority of the directors and their acts, being in excess of their actual authority, will not be the acts of the Company." The Company acting through its managing director and other managers. The common law rules of agency apply even where a third party deals with the Company through its managing director or sub-board managers,^^^ ^^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 143-144. ^24 Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1986] Ch 246. 825 Royal British Bank v Turquand (1856) 6 E&B 327. 826 Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1986] Ch 2 4 6 . 82'^ See Davies PL, G o w e r and Davies' Principles of M o d e m C o m p a n y L a w (2003) p p 1 5 9 161.
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Therefore, if the person acting for the Company is its chief executive or managing director, he may be assumed to be authorised under the common law rules, unless there are suspicious circumstances or the transaction is of such magnitude as to imply the need for board approval. If the person acting for the Company is its fmance director, he cannot be assumed to have authority outside that area. On the other hand, when the third party deals with an officer or employee below the level of member of the board of directors the position is more problematic.^2^ In many older cases,^^^ the courts have been reluctant to recognise any ostensible authority of a manager below the level of director. But these cases were distinguished in Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd on the ground that they were examples of unusual transactions.^^^ It can therefore be assumed that a manager, even if he does not have actual authority, will generally have ostensible authority to undertake everyday transactions relating to the branch of business which he is managing (though probably not if they are really major transactions) and that the secretary will similarly have such authority in relation to administrative matters.^^^ The Company acting through a person acting as managing director. Where the articles of association contain a regulation that gives a power to delegate powers to a managing director,^^^ ^ third party may rely on the ostensible authority of a person who is acting as managing director of the Company even if he has not read the articles.^^^ While it is unnecessary to show that the third party has actually read the articles in Order for him to rely on principles of ostensible authority, it is also clear that the articles do not amount to a "holding-out".^^"^ Company secretary. A Company secretary can represent the Company in its dealings with third parties. This power is based on common law principles and not on statutory law. For example. Table A only provides that, unless determined otherwise by the board of directors, instruments to which the Company's seal is af-
^^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 160. 829 See also Houghton & Co v Nothard, Lowe & Wills Ltd [1927] 1 KB 246; Kreditbank Cassel GmbH v Schenkers Ltd [1927] 1 KB 826; Rama Corporation Ltd v Proved Tin & General Investments Ltd [1952] 2 QB 147. 8^0 Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480: "The cases where the contractor's claim failed, namely Houghton & Co v Nothard, Lowe & Wills Ltd, Kreditbank Cassel GmbH v Schenkers Ltd and the Rama Corporation case, were all cases where the contract sought to be enforced was not one which a person occupying the position in relation to the Company's business which the contractor knew that the agent occupied, would normally be authorised to enter into on behalf of the Company." 8^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 160. 832 See Table A, regulation 72.
833 Freeman & Lockyer v Buckhurst Park Properties [1964] 2 QB 480. 834 See The L a w Commission, The Execution o f Deeds and Documents b y or on behalf of Bodies Corporate, Consultation Paper N o 143 (1996), para 5.19.
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fixed should be signed by a director and by the secretary or by a second director.835
The role of the secretary varies according to the size of the Company, but he will normally have quite extensive powers as its agent. In Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd,^^^ Lord Denning MR said that the secretary: "regularly makes representations on behalf of the Company";^^"^ "enters into contracts on its behalf which come within the day-to-day running of the company's business"; and is "entitled to sign contracts connected with the administrative side of a company's affairs, such as employing staff, and ordering cars and so forth". These powers are normally limited to matters concemed with administration and the commercial management of the Company. In Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd, Lord Salmon said: "As regards matters concemed with administration ... the secretary has ostensible authority to sign contracts on behalf of the Company ... Whether the secretary would have any authority to sign a contract relating to the commercial management of the Company, for example, a contract for the sale or purchase of goods in which the Company deals, does not arise for decision in the present case". The Company acting through companies belonging to the same group. Common law principles will be applied even when acts are done on behalf of the Company by companies belonging to the same group of companies or by its shareholders. In this case, the authority of the representatives of the Company can normally be based on actual authority only.
4.7.5 Shareholders as a Rule-maker In the past, the contents of the constitutional documents of the Company used to be a more powerful constraint on the representation of the Company in its dealings with third parties. Nowadays, the memorandum and articles of association can seldom be invoked against third parties. Their effect is largely internal. The constitutional documents of the Company are not an appropriate mechanism for communicating to third parties limits on the authority of the board of directors as far as dealings of the Company with Outsiders are concemed, and they are in practice not very important as regards acts done by individual directors or sub-board managers. However, although the memorandum and articles can seldom be invoked against third parties in order to make contracts allegedly concluded by the Company not binding, they can sometimes be invoked intemally in order to punish the persons who breached them (see Chap. 4.3.2 above). ^^5 Table A, regulation 101. ^^^ Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd [1971] 2 QB 711, [1971] 3 All ER 16. ^^'^ The secretary will in practice be referred to in order to obtain authenticated copies of contracts and resolutions decided upon the board. Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 297.
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Ultra vires. In UK Company law, the capacity of the Company has traditionally been restricted by the doctrine of ultra vires, but the law has been substantially changed foUowing the Companies Act 1989. The ultra vires doctrine used to restrict the powers of the Company to matters covered by its stated objects. Any act which was outside those objects was a nullity, having no effect whatsoever. Even if an action was within the capacity of the Company, it may have been outside the powers of the individuals who were involved in the transaction. On the other hand, persons outside a Company were entitled to assume that internal procedures had been complied with (the rule in Turquand's case).^^^ The doctrine of ultra vires was partially abolished by the Companies Act 1989 so far as the liability of the Company to Outsiders is concemed.^^^ Acting ultra vires nevertheless remained a breach of directors' duties,^"^^ a shareholder who discovers in advance that the directors are going to act outside the objects clause is entitled to ask for an injunction to restrain them from such action,^"^^ and the ultra vires doctrine may still affect the validity of a contract concluded between the Company and a director.^"*^ At common law, the memorandum and articles of association can have an effect on the validity of transactions performed by the Company. The effect ofthe Constitution on the capacity ofthe Company. It is necessary to distinguish between the capacity of a Company and the authority of its representatives. In principle, the Constitution govems the capacity of a company.^"*^ At common law, any act beyond the capacity of a Company is treated as ultra vires and void. It cannot be ratified by the members of the Company. According to the common law rule, the capacity of a Company registered under Companies Act 1985 is determined by the objects set out in the memorandum of association, and by the implied powers to do any act reasonably incidental to the attainment or pursuit ofthose express objects.^"^"* The common law rule has been abolished by section 35(1) of the Companies Act 1985 which provides that a Company's capacity is not limited by its memorandum. ^"^^ A shareholder of a Company may nevertheless bring proceedings to restrain the doing of an act which but for section 35(1) would be beyond the com-
838 Royal British Bank v. Turquand (1856) 6 E & B 327.
839 Section 35(1) ofthe Companies Act 1985. 840 Section 35(3) o f t h e Companies Act 1985.
841 Section 35(2) ofthe Companies Act 1985. 842 Section 322A(4) ofthe Companies Act 1985. 843 See for example The Law Commission, The Execution of Deeds and Documents by or on behalf ofBodies Corporate, Consultation Paper No 143 (1996), para 5.4. 844 Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1986] C h 246; [1985] 2 W L R 908.
845 Section 35(1) ofthe Companies Act 1985: "The validity of an act done by a Company shall not be called into question on the ground of lack of capacity by reason of anything in the Company's memorandum."
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pany's capacity,^"^^ and Section 322A (invalidity of certain transactions to which directors or their associates are parties) has effect notwithstanding section 35. The capacity of a Company and the authority of its representatives are not the same thing. For example, so long as an act is capable of falling within the Company's objects and powers, it will not be ultra vires and void merely because the directors have exceeded their authority.^"^^ The effect ofthe Constitution on the authority of Company representatives generally. The Constitution has more effect on the authority of Company representatives. The memorandum and articles of association can affect the validity of transactions, which are contrary to limitations under the Company's Constitution, by affecting the authority of its representatives. The validity of these transactions depends on (1) through whom the Company has acted and (2) whether the matter is govemed by specific provisions ofthe Companies Act 1985 or common law rules. This is regardless of the fact that parties to the Constitution of the Company are only the shareholders and the Company and the shareholders inter se.^"^^ At common law (but subject to the statutory provisions and the general agency principles), a contract which is entered into by the Company's officers without authority (for example because it exceeds a restriction in the articles, or because the directors are acting in breach of their fiduciary duties to the Company) may be set aside by the Company unless it is ratified by the Company in general meeting by ordinary resolution. In practice, provisions in the Company's Constitution are more likely to restrict the actual authority of Company representatives instead of their apparent (or ostensible) authority. Restrictive provisions in the Company's Constitution limit the agent's actual authority. But if an agent has been permitted in the past to act in breach of restrictions in the Constitution, the courts will probably hold that he or she has acquired actual authority to continue to act in the permitted way. It is more difficult to determine the impact of provisions in the Constitution on ostensible authority. This is because the doctrine of ostensible authority permits the third party to treat the agent as acting within his authority and therefore to hold the Company bound by the transaction even though in fact the agent was acting outside the scope of his actual authority. The effect of the indoor management rule. It is worth noting that the indoor management rule does not Hmit the effect of restrictive provisions in the company's memorandum and articles of association. This is because: (a) the indoor management rule does not benefit a third party who knows that the agent does not have authority or a third party who has been put on inquiry as to whether the agent is duly authorised; (b) representatives such as directors cannot rely on the indoor
8^6 Section 35(2) ofthe Companies Act 1985. ^^•7 Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1986] Ch 246; [1985] 2 WLR 908. ^48 Section 14 ofthe Companies Act 1985.
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management rule for their own benefit;^"*^ (c) it does not restrict the scope of the doctrine of constructive notice (see below); and (d) the indoor management rule does not allow Outsiders to assume that the person with whom they are dealing has authority to bind the Company because this matter is govemed by the common law rules on "actual" and "apparent" or "ostensible" authority. The effect of the doctrine of constructive notice. Are third parties deemed to have constructive notice of restrictive provisions in the Constitution? According to the common law doctrine of constructive notice, anyone dealing with a registered Company is deemed to have notice of the contents of its "public documents". These documents include at least its memorandum and articles of association. When applying this doctrine it is again necessary to distinguish between the representation of the Company by its board of directors and the representation of the Company by other agents. The common law doctrine of constructive notice has been abolished under section 35B of the Companies Act 1985 where the Company is represented by its board of directors or a person authorised by the board, and the courts are reluctant to "construe it in such a way as to reintroduce, through the back door, any requirement that a third party acting in good faith must still investigate the regulating documents of a company".^^^ The doctrine of constructive notice will still apply to the common law rule that govems the representation of the Company by other agents. A third party might thus lose the protection of the doctrine of ostensible authority on the basis of a piece of knowledge that the third party does not in fact possess. The third party must either run this risk or carefully examine the Company's Constitution before contracting with its agent.^^^ Section 71 lA of the Companies Act 1985^^^ was expected to generally abolish the doctrine of deemed notice (constructive notice) of the contents of the memorandum and articles of association. But although section 711A is applied to LLPs, it has not yet been brought into force for companies. The wording of existing section 71 lA would not completely abolish the need to study the Company's Constitution. Section 711 A(l) does provide that "[a] person shall not be taken to have notice of any matter merely because of its being disclosed in any document kept by the registrar of companies (and thus available for inspection) or made available by the Company for inspection". But section 711A(2) qualifies the abohtion of deemed notice to an uncertain extent by setting out that "[t]his does not affect the question whether a person is affected by notice of any matter by reason of a failure to make such inquiries as ought reasonably to be made". For example, it is accepted practice in mergers and acquisitions that a purchaser has deemed notice of matters disclosed in documents kept by the registrar of companies. The Company
849 Morris V Kanssen [1946] AC 459 (House of Lords). 85^ Sir Nicolas Browne-Wilkinson V-C in TCB Ltd v Gray [1986] Ch 621 on the effect of section 9(1) of the European Communities Act 1972 (at p 635). 85^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 143-144. 852 Inserted by section 142 of the 1989 Act.
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Law Review has recommended that section 711A(2) should not be brought into force. The third party can, under some circumstances, use knowledge of the provisions of the Company's Constitution as a part of the third party's claim against the Company. This is regardless of the fact that a third party is not party to the "statutory contract" under section 14 of the Companies Act. (a) This is true at least where the third party had actual knowledge of the memorandum and articles and had relied on some provision in them. However, the claim of the third party can never be based on constructive notice of the company's Constitution. Constructive notice is a negative doctrine curtailing what might otherwise be the apparent scope of the authority and not a positive doctrine increasing it.^^^ (b) The third party does not always have to show that he has actually read the articles of association in Order to rely on principles of ostensible authority.^^'^ For example, where there is a power in the articles to delegate powers to a managing director, a third party may rely on the ostensible authority of a person who is acting as managing director of the Company even if he has not read the articles.^^^ The mere fact, however, that there is such a power in the articles will not in itself amount to a "holding-out", nor will a power to delegate to an officer assist if the relevant act is beyond the usual authority of a person holding such office. The effect of the Constitution on the authority of the board of directors. The Constitution of the Company must have some effect on the actual authority of the board of directors because the Companies Act of 1985 does not say what the powers of directors are. This is left to the company's Constitution. However, this does not mean that the breach of the company's Constitution could be invoked against third parties where the Company has been represented by its board. Section 35A(1) of the Companies Act restricts the right of the Company to use limitations under the company's Constitution as a defence: "In favour of a person dealing with a Company in good faith, the power of the board of directors to bind the Company, or authorise others to do so, shall be deemed to be free of any limitation under the company's Constitution." In principle, the powers of directors are limited by the capacity of a Company, but section 35(1) provides that "[t]he validity of an act done by a Company shall not be called into question on the ground of lack of capacity by reason of anything in the company's memorandum". Although restrictive provisions in the Constitution cannot normally be invoked against third parties, they can still be invoked against the directors intemally. The effect of articles on the terms andfulfilment ofcontracts. The articles of association can to some extent affect the terms and fulfilment of contracts, and contracts can affect the articles. The main rule is that the articles are regarded as a "statutory contract" between the Company and its shareholders and that the articles alone do not constitute a contract between the Company and Outsiders. For example, the regulations of the ^^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 162-163. ^^^ See The Law Commission, The Execution of Deeds and Documents by or on behalf of Bodies Corporate, Consultation Paper No 143 (1996), para 5.19. 855 Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480.
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articles on board members do not form a contract with a director. The party invoking the contract will have to show that there is a separate contract of Service or for Services, whether formal or informal.^^^ In Nelson v James Nelson & Son Ltd,^^^ it was held that no term could be incorporated by implication from the articles into the contract so as to override its express terms. On the other hand, sometimes the contract is based on or incorporates the articles of association. In Re New British Iron Co, ex p Beckwith,^^^ article 62 of the Company's articles of association provided that the remuneration of the board should be an annual sum of £1,000. Wright J said: "That article is not in itself a contract between the Company and the directors; it is only part of the contract constituted by the articles of association between the members of the Company inter se. But where on the footing ofthat article the directors are employed by the Company and accept office the terms of article 62 are embodied in and form part of the contract between the Company and the directors." And in Read v Astoria Garage (Streatham) Ltd,^^^ Jenkins LJ said: "In my view, it is really clear beyond argument that the directors must be taken to have been making [the appointment of a managing director] with reference to the provisions of Article 68 ... - it was only under that article that they could make the appointment." The other side of the coin is that the Company cannot evade the terms of its contract by altering its articles of association. Whether the alteration of articles constitutes a breach of contract depends on the terms of the contract. There is no breach where the Company has contracted on the basis that the terms of the contract will change automatically if the articles are altered. In Shuttleworth v Cox Bros (Maidenhead) Ltd^^^ it was held that where the contract is made upon the terms of an alterable article, neither of the contracting parties could can complain if the article is altered.^^^ The alteration of articles can nevertheless only be altered as to the future, that is, not retrospectively.^^^ Sometimes there can nevertheless be a breach. In Southern Foundries (1926) Limited v Shirlaw,^^^ it was said that there is "a positive rule of the law of contract that conduct of either the promisor or promisee which can be said to amount to himself 'of his own motion' bringing about the impossibihty of Performance is in itself a breach".
856 See for example Davies PL, G o w e r and Davies' Principles of M o d e m C o m p a n y Law (2003) p 312. 857 Nelson v James Nelson & Son Ltd [1914] 2 K B 770.
858 Re New British Iron Co, ex p Beckwith [1898] 1 Ch 324. 859 Read V Astoria Garage (Streatham) Ltd [1952] C h 637, [1952] 2 All E R 292. 860 Shuttleworth v Cox Bros (Maidenhead) Ltd [1927] 2 K B 9; Sealy L S , Cases and Materials in C o m p a n y Law. 86^ See for example Davies PL, G o w e r and Davies' Principles of M o d e m C o m p a n y L a w
(2003) p 312. 862 Swabey v Port Darwin Gold Mining C o (1889) 1 M e g 385.
863 Southem Foundries (1926) Limited v Shirlaw [1940] AC 701, [1940] 2 All ER 443 (House of Lords).
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This can be the case where a contract is based on or incorporates the articles of association. In British Equitable Assurance Co Ltd v Baily,^^"^ the contracts of policyholders contained a reference to the "deed of settlement and by-laws of the Company". It was indicated that in some cases, an alteration of the alteration of the Company's Constitution could infringe the rights of the policyholders.
4.8 The Governance of Croups in the UK 4.8.1 Introduction Instead of organising on a divisional basis within a single legal entity, large businesses are often established as a parent Company with a number of legally distinct subsidiaries. Some companies may be less than 100 per cent-owned but still be managed as an integral part of the group.^^^ The parent Company can run a subsidiary Company in many ways. (a) Sometimes the parent Company exercises its powers conferred to it or its representatives by law. The parent Company can act in the capacity of a shareholder in the subsidiary Company, or the parent Company's nominees can take decisions at the subsidiary's board meetings. (b) Sometimes the control of a subsidiary company's affairs is vested in its parent Company and exercised by the parent Company outside the confines of the board or general meeting of the subsidiary.^^^ The parent company's employees can perform many important management flinctions under a matrix management System, or individuals can be allocated functions in the management of the subsidiary without regard to which Company belonging to the same group employs them. (c) Sometimes decisions are taken at board meetings or by sub-board managers for the benefit of the parent Company or the group as a whole without the parent Company actively participating in the decision-making. This raises two issues: (a) the scope of general rules designed with a single individual Company in mind; and (b) the existence of special rules designed with the governance of corporate groups in mind. In principle, these special rules could include for example rules on the identification of a subsidiary with its holding Company, rules on the role of nominee directors or sub-board managers, and rules on the liability of the appointor (parent Company) for acts done by a nominee director or sub-board manager (in the subsidiary).^^^ There are few special rules dealing with the governance of groups in the UK.
^^^ British Equitable Assurance Co Ltd v Baily [1906] AC 35 (House of Lords). ^^^ Modem Company Law: Completing the Structure, para 10.2. ^^^ Lower M, Good faith and the partly-owned subsidiary, JBL 2000 p 243. ^^'^ See also Dine J, The Governance of Corporate Groups (2000) p 44: "The governance of groups ... depends on the way in which regulations made to deal with general Company law issues impact on groups. The most important rules in this category are: (i) the capacity of the court to 'lift the veil' in cases offraudand the failure to develop a *law of the enterprise'; (ii) protection of creditors and the issue of interdependent Company liability;
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4.8.2 Legislation on Croups The main principle is that the statutory and common law rules governing the govemance of a Single independent Company govem even the govemance of parent companies and subsidiary companies. Parents are linked to subsidiaries merely as shareholders.^^^ General rules, Ordinarily a parent Company and its subsidiary are treated as distinct persons.^^^ The Company Law Review stated this principle as follows: "The basic current position is that each Company in a group is ... a separate legal entity with its own rights, liabihties and assets: each Company has a distinct legal Personality, with separate rights and obligations, regardless of ownership; shareholders of each Company have limited liability, regardless of who they are; creditors of each Company have Claims only against the Company; and a director of a Company must act in its interests."^^^ According to the mies that govem Single independent companies, a majority shareholder does not have any fiduciary duty to the Company. A shareholder is not prevented from competing with the Company or Controlling a rival business or diverting corporate opportunities to itself While the board members and sub-board managers of a subsidiary Company are under such a duty, the parent Company is not, although the real power over the subsidiary lies with the parent.^^^ Special rules. There is no law on groups as such but there are many laws that affect groups. For example, for many tax and accounting purposes groups of companies are treated as one unit.^'^^ There are also some special mies on the govemance of groups. They relate in particular to disclosure. For example, section 227 of the Companies Act 1985 requires a parent Company to prepare group accounts on a Consolidated basis.^^^ The Combined Code on Corporate Govemance, which applies to UK listed companies, and related guidances contain few mies on the govemance of groups,^^"* but the most important of the few mies that do exist relate to disclosure. For example, the (iii) directors' duties and the oppression of minority shareholders; (iv) Consolidated accounts and taxation." ^^^ See Dine J, The Govemance of Corporate Groups (2000) p 43. 869 Adams v Cape Industries plc [1990] Ch 433. 8"^^ Completing the Structure, para 10.4. 8"^^ See Lower M, Good faith and the partly-owned subsidiary, JBL 2000 pp 238-239. 8*^^ See Dine J, The Govemance of Corporate Groups (2000) p 44. ^'^^ Completing the Stmcture, para 10.5. ^''^ See Provision A.3.1 (independency of non-executive directors); principle B.l (sensitivity to pay and employment conditions elsewhere in the group) complemented by Higgs suggestions for good practice (Suggestions for good practice from the Higgs report, January 2003); provision C.2.1 (review of the effectiveness of the group's System of intemal controls, report to shareholders) complemented by the TumbuU Guidance (Guidance on Internal Control, September 1999), paras 3 and 14 (the review and report should be from the perspective of the group as a whole) and para 41; the Smith Guidance (Guidance on Audit Committees, July 2003), para 1.12 (necessary for the audit committee of the parent Company to review issues that relate to particular subsidiaries or activities carried on by the group).
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board should, at least annually, conduct a review of the effectiveness of the group's System of internal controls and should report to shareholders that they have done so. The review should cover all material controls, including financial, operational and compliance controls and risk management systems.^^^ For groups of companies, the review of effectiveness of internal control and the report to the shareholders should be from the perspective of the group as a whole.^^^ Furthermore, it will usually be necessary for the audit committee of the parent Company to review issues that relate to particular subsidiaries or activities carried out by the group. The board of a UK listed parent Company should ensure that there is adequate Cooperation within the group (and with internal and extemal auditors of individual companies within the group) to enable the parent Company audit committee to discharge its responsibilities effectively.^^^ The Companies (Audit, Investigations and Community Enterprise) Act 2004 contains some rules on groups. According to section 389A(1) of the Companies Act 1985, as amended by the 2004 Act, an auditor of a Company has a right of access to the Company's books and accounts and can require certain persons to provide him with such Information or explanations as he thinks necessary for the Performance of his duties as auditor. According to section 389(2), these persons include, for example: "... (c) any subsidiary undertaking of the Company which is a body corporate incorporated in Great Britain; (d) any officer, employee or auditor of any such subsidiary undertaking or any person holding or accountable for any books, accounts or vouchers of any such subsidiary undertaking ..." According to section 389(3), the auditor of the parent Company could require information relating to a subsidiary undertaking which is not a body corporate incorporated in Great Britain.
4.8.3 The Effect of the Group Structure on the Scope of Rules The starting point is that Company law rules apply to a Single independent Company and that the group structure will not affect their scope. This means that a group structure can prevent the penetration of in the Organisation of the group. Main rule. Therefore, according to the main rule, the group structure will not affect the scope of rules governing the govemance ofa Company. There have been movements for treatment of groups of companies as a single economic entity in Company law, but they have not been successful in courts. In Company law, courts have assumed that the treatment of a group of companies as a Single economic entity is excluded by the principle of separate corporate personality laid down by Salomon v Salomon}'^^ ^"^5 Provision C.2.1. 876 xhe Tumbull Guidance, paras 3 and 14. ^^^ The Smith Guidance, para 1.12. ^'^^ Salomon v A Salomon & Co Limited [1897] AC 22 (House of Lords). See also Gramophone and Typewriter Co Ltd v Stanley [1908] 2 KB 89 where the Court of Appeal declined to "lift the veil" of separate corporate personality, partly on the ground that the control of the affairs of the subsidiary was confided to its directors.
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The group theory was clearly rejected in Adams v Cape Industries plc^'^^ after which the concept of a Single economic unit in Company law has been described as "extremely limited indeed".^^^ The fundamental rule in UK law remains that laid down in Salomon v Salomon,^^^ This means that a subsidiary will not be identified with its parent Company. The fact that the relationship between two companies is one of parent and subsidiary does not mean that the subsidiary would not be an entity with its own business. For example, in one of the cases resulting from the collapse of Barings,^^^ it was held that Baring Futures (Singapore), a subsidiary, was not just one of the corporate vehicles for the parent's securities business; BFS was a functioning corporate entity both in reality as well as in theory. The non-identification of a subsidiary with its parent means that the rules on the distribution of powers, distribution of risk and distribution of information within the firm apply as if each Company were a single independent Company. Exceptions to the main rule. There can nevertheless be exceptions to the main rule. These exceptions seem to be more relevant for the distribution of risk, that is, the liability in tort or contract. Exceptions to the main rule can be based on a Statute or special facts or on the flexible use of the concept of contract or tort liabilAccording to one view, courts can "pierce the corporate veil" when it is established that the Company is an authorised agent of its Controllers or its members, corporate or individuals,^^"^ but although the end-result is that these persons are liable, this Situation can hardly be described as an exception to the principle of separate corporate personahty: these persons are liable for their own obligations and not for those of the Company. In any case, sometimes the shareholder or parent can be made liable. One of the possibilities of seeing through the corporate form is afforded by the concept of agency. In Zabaxe Limited v Nicklin,^^^ the employees provided Services to Northminster Publishing Group Limited but were paid through Northminster Holdings Limited. The Employment Appeals Tribunal ^^9 Adams v Cape Industries plc [1990] Ch 433 at p 536. 880 Hobhouse LJ in Ord v Belhaven Pubs Ltd [1998] 2 B C L C 447 at p 457.
881 See for example Peter Cibson LJ in Pirelli Cable Holding NV v Inland Revenue [2003] EWCACivl849. 882 Barings Plc & another v Coopers & Lybrand (a firm) & others [2003] EWHC 1319 (Ch). 883 Modem Company Law: Completing the Structure, para 10.6: "The courts have been willing from time to time directly to *pierce the corporate veil' by imposing Company liabilities on the real Controllers of the enterprise. Gower concludes that there are three circumstances in which the court may do so: i when construing a Statute, contract or other document; ii when the Company is a mere fa9ade, concealing the true facts; and iii when it can be established that the Company is an authorised agent of its Controllers or its members, corporate or individuals." 88"* See Modem Company Law: Completing the Stmcture, para 10.6. 885 EAT 123/89; see also Duncan Web Offset (Maidstone) Limited v Cooper [1995] IRLR 633; McMuUen J, Atypical Transfers, Atypical Workers and Atypical Employment Stmctures, ILJ 25 (1996) p 302.
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(EAT) remarked that Northminster Holdings Limited could be called an invoicing Company and that Holdings were merely agents for Northminster Publishing Group Limited. The parent is not automatically liable for the obligations of the subsidiary: (a) For example, in Kodak Ltd v Clark it was held that a 98% Controlling interest in a Company does not in itself give rise to an agency relationship.^^^ (b) In Kleinwort Benson Limited v Malaysia Mining Corporation Berhad,^^'^ a parent Company was not liable for the liabilities of a subsidiary even though it had written a "letter of comfort" indicating that it was its policy to support the subsidiary. In Re Augustus Barnett & Son Ltd,^^^ the parent Company was not liable, although it had repeatedly issued Statements that it would continue to support the subsidiary, it had failed to do so, and the subsidiary had gone into liquidation. (c) As far as liability in tort is concemed. British courts are said to be unwilling to "lift the veil" and make parent companies responsible for subsidiary corporations.^^^ Anyway, sometimes the exception is based on a Statute. In Adams v Cape Industries plc, Slade LJ said that there could be cases "where the wording of a particular Statute or contract has been held to justify the treatment of parent and subsidiary as one unit, at least for some purposes".^^^ For example, the undercapitalisation of subsidiaries, and their Operation in a way which creates undue risks of insolvency, are matters that can be dealt with by insolvency law.^^^ The exception can also be based on special facts. Any departure from corporate Personality has apparently been on special facts. For example, in DHN Food Distributors V Tower Hamlets London Borough CounciF^^ Lord Denning treated a group of companies as a Single economic entity. However, the circumstances were special, no other judge has gone as far as Lord Denning went in the DHN case, major doubts have been expressed about Lord Denning'sjudgment, and the case is
^^^ Kodak Ltd v Clark [1905] 1 KB 505; see also Dine J, The Govemance of Corporate Croups (2000) p 45. ^^'^ Kleinwort Benson Limited v Malaysia Mining Corporation Berhad [1989] 1 WLR 379; see Modem Company Law: Completing the Structure, para 10.6. ^^^ Re Augustus Bamett & Son Ltd [1986] BCLC 170; see Dine J, The Govemance of Corporate Croups (2000) pp 44-45. ^^^ See Modem Company Law: Completing the Stmcture, para 10.58, citing Hofstetter K, Parent Responsibility for Subsidiary Corporations, ICLQ 39 (1990) p 576; Adams v Cape Industries [1991] 1 All ER 929. ^90 Adams v Cape Industries plc [1990] Ch 433 at 536. ^^^ See Completing the Stmcture, para 10.59. ^92 DHN Food Distributors v Tower Hamlets London Borough Council [1976] 1 WLR 852. The Council compulsorily purchased land owned by the subsidiary of DHN. Lord Denning treated DHN as the owners ofthat land. Neither DHN nor the subsidiary would have been entitled to payment of compensation otherwise. See, for example, McMullen J, Atypical Transfers, Atypical Workers and Atypical Employment Stmctures, ILJ 25 (1996) pp 299-300.
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not regarded as authority for any general proposition that parent companies and subsidiaries should be treated as one.^^^ Shadow directors. In principle, a holding Company can be regarded as a "shadow director" under some circumstances. Many of the provisions of the Companies Act 1985 are extended to shadow directors. For example, shadow directors have a duty to have regard to the interests of the Company's employees,^^"* and shadow directors must declare an interest in a contract or proposed contract with the company.^^^ Shadow directors can also be found liable for wrongful trading under the Insolvency Act 1986.^^^ "Director" and "shadow director" have been defined in the Companies Act 1985. "Director" includes any person occupying the position of a director.^^^ A "shadow director" means a person in accordance with whose directions or instructions the directors of the Company are accustomed to act.^^^ A shadow director does not claim or purport to act as a director. On the contrary, he claims not to be a director.^^^ Where a board of directors is made up of more than one person, there must be at least a working majority of directors who customarily act on the alleged shadow director's directions or instructions. The Companies Act 1985 lists sections in which a body corporate is not to be treated as a shadow director of any of its subsidiary companies by reason only that the directors of the subsidiary are accustomed to act in accordance with its directions or instructions.^^^ It is nevertheless clear that a holding Company can become a shadow director of its subsidiary. Directors of the holding Company are not automatically regarded as shadow directors. It must be found that the director's actions constitute him as a shadow director. 4.8.4 The Parent Company as a Ruie-maker in the Subsidiary The rules governing the parent company's powers to run the subsidiary are the rules that govem shareholders' powers to run the Company in general. There are
893 Park J in Pirelli Gable Holding NV v Commissioners of Inland Revenue [2003] EWHC 32 (Ch), citing Lord Keith in Woolfson v Strathclyde Regional Council (1978) SLT 159 at 161 (House of Lords). ^^^ Section 309 of the Companies Act 1985. 895 Section 317(8) of the Companies Act 1985. 896 Section 214 of the Insolvency Act 1986. 897 Section 741(1) of the Companies Act 1985. 898 Section 741(2) of the Companies Act 1985. 899 Millett J in R e Hydrodan ( C o r b y ) [1994] B C C 161. It was also distinguished between a shadow director and a de facto director. A de facto director is one w h o claims to act and purports to act as a director, although not validly appointed as such. See for example Malcolm Huntley Potier and Secretary of State for Trade and Industry Secretary of State for Trade and Industry and John Douglas Solly [1997] E W C A Civ 2 8 6 1 . 900 Section 741(3) of the Companies Act 1985. See also sections 3 2 0 - 3 2 2 .
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no special mies on the powers of the parent to run the subsidiary. Such mies have not been regarded as necessary.^^^ In addition to the powers conferred to shareholders (the parent Company) by the subsidiary's articles of association, the parent Company has some powers under common law principles. For this reason, the Company Law Review saw no case for adjusting the directors' duties of subsidiaries: "The directors will be bound to promote the success of the subsidiary for the benefit of its members - i.e. the parent. If there is doubt the parent may amend the Constitution to subject the directors to its direction, subject to the general law ..." The Company Law Review therefore did not think that it was necessary, for example, that the directors of a subsidiary should, by law, act in accordance with directions given by the parent.^^^ Directions. If the subsidiary Company has adopted Table A, its shareholders in general meeting (in practice, the representatives of the parent) can give binding directions to the subsidiary's board by special resolution.^^^ Unanimous consent. The principle of unanimous consent can be useflil in groups. Under the principle in Re Duomatic,^^'^ the unanimous consent of all shareholders who have a right to attend and vote at a general meeting of the Company can override formal requirements in relation to the passing of resolutions at such meetings. For example, in Wright v Atlas Wright (Europe) LtcP^^ the managing director of a Company negotiated with the managing director of its wholly owned subsidiary the terms of a consultancy agreement that the latter was proposing to enter into with the subsidiary. This was found to amount to informal unanimous consent on the part of the parent. Consent and the liability of directors. A Company cannot complain about commercial decisions, alleged to be negligent, which the directors have made with the approval of the shareholders. This is tme although individual shareholders owe no duty to the Company .^^^
4.8.5 Duties of the Board of the Subsidiary Company A major shareholder may be able to nominate a board member to protect its interests in the Company. In a group of companies, directors of a subsidiary are in practice expected to promote the interests of the group as a whole or the holding Company. This raises several questions. May a nominee director protect the interests of his nominator? To whom do nominee directors owe their fiduciary duties? Again, there are no special mies for Company groups. ^^^ See for example Completing the Structure, para 10.38. 9^2 Completing the Structure, para 10.38. 903 Table A, regulation 70. 904 R e Duomatic [1969] 2 Ch 365. 905 Atlas Wright (Europe) Ltd v Wright [1999] E W C A Civ 669 (28 January 1999). See also Davies PL, G o w e r and Davies' Principles of M o d e m C o m p a n y L a w (2003) p 334. 906 Multinational G a s and Petrochemical C o Ltd v Multinational G a s and Petrochemical Services Ltd [1983] Ch 258, [1983] 2 All E R 563.
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Duty to act in the interests ofthe (subsidiary or parent) Company. At common law, all directors of a Company must act in the interests of that Company, and that Company only. They must do what they honestly and reasonably believe to be in the best interests ofthe Company. In Hutton v West CorkRailway Co,^^'^ Bowen LJ observed famously that "charity cannot sit at the boardroom table" and "there are to be no cakes and ale except for the benefit ofthe Company". Where the Company is a member of a group of companies, the directors may have regard to the interests of the group if, but only if, it is in the interests of the Company to do so. Thus, a director of a subsidiary Company is not in breach of duty if he fails to consider the interests of the subsidiary separately from those of the group, provided that an intelligent and honest man in the same position could reasonably have come to the same conclusion that the transaction was for the benefit ofthe subsidiary.^^^ This means that actions and omissions which may seem to benefit the parent Company at the expense of the subsidiary can sometimes be permissible. On occasions, it might be legitimate for the directors of a subsidiary Company to sacrifice its short-term interests for the good of the group; there will be no breach of duty where this is done with a view to the good ofthe subsidiary in the medium term.^^^ The main rule, however, is that a director may not consider the interests of individual shareholders in making his decisions. This is even where the holding Company has nominated him to protect its interests in the subsidiary. In Scottish Co-operative Wholesale Society Ltd v Meyer,^^^ the co-coperative society appointed three of its own directors of a textile Company. The House of Lords held that the directors were wrong in assuming that as nominees ofthe co-operative society their first duty was to the co-operative society. Lord Denning said: "So long as the interests of all concemed were in harmony, there was no difficulty ... But, so soon as the interests of the two companies were in conflict, the nominee directors were placed in an impossible Situation. It is piain that ... these three gentlemen could not do their duty to both companies, and they did not do so." Directors must in general not fetter their discretion.^^' Directors are generally required to come to any decision with an open mind and to decide according to what is in the Company's interests. This rule is nevertheless not without exceptions.^^^ In Fulham Football Club Ltd v Cabra Estates plc,^^^ the Court of Appeal stated: "It is trite law that directors are under a duty to act bona fide in the interests of their Company. However, it does not follow from that proposition that directors 907 Hutton V West Cork Railway Co (1883) 23 Ch D 654. 908 See the Law Commission, Company Directors: Regulating Conflicts o f Interests and Formulating a Statement of Duties, Consultation Paper 153 (1998), para 11.29; Charterbridge Corporation Ltd v Lloyds Bank [1970] Ch 62. 909 See Lower M, Good faith and the partly-owned subsidiary, JBL 2000 p 245-246. 910 Scottish Co-operative Wholesale Society Ltd v Meyer [1959] A C 324, [1959] 3 All ER 66 (House of Lords). 911 Kregor v Hollins (1913) 109 LT 225. 912 See the Law Commission, Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties, Consultation Paper 153 (1998), para 11.11. 913 Fulham Football Club Ltd v Cabra Estates plc [1992] B C C 863.
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can never make a contract by which they bind themselves to the future exercise of their powers in a particular manner, even though the contract taken as a whole is manifestly for the benefit of the Company. Such a rule could well prevent companies from entering into contracts which were commercially beneficial to them." The Court of Appeal went on to hold: "The true rule was stated by the High Court of Australia in Thorby v Goldberg ... If, when a contract is negotiated on behalf of a Company, the directors bona fide think it in the interests of the Company as a whole that the transaction should be entered into and carried into effect they may bind themselves by the contract to do whatever is necessary to effectuate it." Liability ofparent Company, The rule that directors of the subsidiary Company must act in the interests of the subsidiary is complemented by the rule that individual shareholders such as the holding Company cannot be made liable for the actions of their nominee directors. The liability of a nominee director will not be extended to his appointor. In Kuwait Asia Bank EC v National Mutual Life Nominees Ltd,^^^ it was held: "A substantial shareholder in a Company who appoints a nominee director to its board owes no duty to anybody for the way in which the nominee performs his duties as a director. It makes no difference that the director is an employee of the shareholder who nominates him."
4.8.6 Duties of the Board of the Parent Company In the parent Company, the duties of the board of directors are govemed by the same mies as in the subsidiary. Where the Company is a member of a group of companies, the directors may have regard to the interests of the group if, but only if, it is in the interests of the Company so to do.^^^ Directors of the parent Company are therefore not prevented from taking account of the realities of the group Situation. Directors of the parent Company can sometimes take actions which may seem to benefit the parent Company at the expense of the subsidiary. However, this conduct may not be "unfairly prejudicial".^^^ An example of conduct that has not been held as unfairly prejudicial was the non-payment by a parent Company of debts owing to a subsidiary when this course was considered to be in the interests of the group as a whole. In Nicholas v Soundcraft Electronics Ltd,^^'^ Fox LJ said: "It seems to me that Electronics in a desperate financial Situation was using what as9^4 Kuwait Asia Bank EC v National Mutual Life Nominees Ltd [1990] 1 AC 187, [1990] BCC 567, [1990] 3 All ER 404 (Privy Council). See Lower M, Good faith and the partly-owned subsidiary, JBL 2000 pp 232-244 where the author discusses whether the parent Company in a partly-owned subsidiary owes any fiduciary duty to the minority shareholder. ^^^ See the Law Commission, Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties, Consultation Paper 153 (1998), para 11.29; Charterbridge Corporation Ltd v Lloyds Bank [1970] Ch 62. 9^^ Section 459 of the Companies Act 1985. ^^•7 Nicholas v Soundcraft Electronics Ltd [1993] BCLC 360.
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sets it could lay its hand on to keep the group afloat. To attempt to do so by withholding the debts was not, I think, unfair. It was in the interests of the Company that Electronics should not go into liquidation. The Company had to pay a price to help secure that. It is the fact that the price - withholding of debts - left the Company critically short of money. But the attempts to keep the group afloat by recourse to the assets of both companies was a reasonable commercial judgment in the circumstances which existed, and was not unfair. It no doubt caused härm to the Company, but worse härm would probably have followed from a liquidation of Electronics". 918
4.8.7 Duty of Board Members to Supervise Outsourced Activities Many important management functions are in practice performed by individuals employed by other companies in the group or companies that do not belong to the same group. Do board members have a duty to supervise these activities? In principle, the rules governing the duties of board members are the same regardless of whether management functions are performed by employees of other companies as independent contractors or by individuals employed by other companies in the same group.^^^ Members of the board have a duty to supervise even outsourced activities. In Re Barings plc (No. 5),^^^ Jonathan Parker J said: "Directors have, both collectively and individually, a continuing duty to acquire and maintain a sufficient knowledge and understanding of the Company's business to enable them properly to discharge their duties as directors. Whilst directors are entitled (subject to the articles of association of the Company) to delegate particular functions to those below them in the management chain, and to trust in their competence and integrity to a reasonable extent, the exercise of the power of delegation does not absolve a director from the duty to supervise the discharge of the delegated functions." He cited Thomas J in the New Zealand case ofDairy Containers v NZI Bank:^^^ "... it is the fundamental task of the directors to manage the business of the Company. Theirs is the power and the responsibility of that management. To manage the Company effectively, of course, they must necessarily delegate much of their power to executives of the Company, especially in respect of its day to day Operations. Although constantly referred to as 'the management', the executives' powers are delegated powers, subject to the scrutiny and supervision of the directors. Responsibility to manage the Company in this primary sense remains firmly with the directors." Thomas J continued: "The directors may delegate powers and functions, using that term in a broad sense, but they cannot delegate the management function itself." This means also: "If a director negligently disregards the obliga-
918 See Lower M , Good faith and the partly-owned subsidiary, JBL 2000 pp 2 4 6 - 2 4 7 . 919 Barings Plc v Coopers & Lybrand (a firm) [2003] E W H C 1319 (Ch). 920 Re Barings plc (No. 5) [1999] 1 B C L C p 489, cited in Barings Plc v Coopers & Lybrand (a firm) [2003] E W H C 1319 (Ch).
921 Dairy Containers v NZI Bank [1995] 2 NZLR 30 at p 79.
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tion to oversee the conduct of the Company's business, he or she has manifestly failed to perform that fiinction with reasonable care."
4.8.8 Duties of Outside Managers Many important management functions are in practice performed by individuals employed by other companies to whom management functions have been outsourced. The rules governing the duties of outside managers are those that govem the duties of managers in a single independent Company. The duties of sub-board managers are generally based on a contract of employment and depend on the Position of the manager in question. There are in other words no special rules that would penetrate the independent legal personality of the two companies involved. The Company Law Review proposed the widening of the scope of persons responsible for the Performance of various regulatory obligations under the Companies Act 1985.^2^ The purpose of the proposal was to catch de facto directors, secretaries and managers. The term "manager" would cover those to whom functions have been delegated by a person at board level or by the secretary. Typically the directors or secretary of a Company will, if they do not perform the various regulatory obligations in the legislation themselves, tend to delegate their Performance to others within the Company or group. These persons may be employees of the Company or of another Company in the group. Altematively, the directors or secretary often tum to an independent supplier of the Service such as registrars, accountants and other Professionals properly charged with a compliance function. The Companies (Audit, Investigations and Community Enterprise) Act 2004 gives auditors a power to demand information not only from directors but also from ordinary employees and some persons who are not employed by the company.^2^
4.9 Constraints on the Exercise of Shareholders' Powers 4.9.1 Introduction Constraints on the use of shareholders' powers can be important due to the fact that some shareholders may be more influential than others either because of formal rules or because of their fmancial muscle or position in the Company. In addition, constraints on the alteration of articles are important because of the role played by articles in the govemance of companies. The Protections for minority shareholders in the UK can nevertheless be described as "patchy" or as being "in a confused state''.'^"* This is partly understand^^^ Modem Company Law: Final Report, para 15.47. 923 See sections 389A(2) and 389A(4) of the Companies Act 1985. 92^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 484, 510 and 483-486.
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able in light of the fact that most formal management powers are normally exercised by directors instead of shareholders. General principles. There are few general principles that act as constraints on the exercise of shareholders' powers generally. For example, shareholders do not normally owe fiduciary duties towards the Company or other shareholders. There are nevertheless some general principles that limit the use of Controlling shareholders' powers. Powers ofminority shareholders. Some provisions of the Companies Act 1985 act as constraints on the exercise of majority shareholders' powers by giving rights to minority shareholders. Constraints on the acts of Controlling shareholders. Some constraints apply in practice to the acts of Controlling shareholders (for example to the acts of the parent in a group of companies). In Company law, the main legal constraints on the use of Controlling shareholders' powers consist of the statutory provisions under section 459 of the Companies Act 1985 on unfairiy prejudicial conduct and the Obligation of Controlling shareholders to act in the interests of the members of the Company as a whole. In addition, some constraints can be found in the securities markets legislation. Firstly, Chapter 11 of the Listing Rules provides safeguards against substantial shareholders taking advantage of their position. Where a Company proposes to enter into a transaction with a "related party", that is, a director or a substantial shareholder or an "associate" of a related party»^^^ the transaction must first be approved by the shareholders in general meeting.^^^ The UKLA will normally require a circular to be sent to shareholders and require the relevant related party to abstain from voting.^^? Secondly, the Listing Rules generally provide that a Company having listed shares must ensure equality of treatment of all holders of such shares who are in the same position.^^^ The right to be treated equally with other shareholders of the same dass also appears in the City Code on Takeovers and Mergers. Right to sue. The rules governing minority shareholders' right to sue are complicated.^^^ It is nevertheless clear that the rule in Foss v Harbottle and the distinction between internal irregularities and shareholder's personal rights permit a minority shareholder to sue other shareholders or the Company in rare cases only. Firstly, identifying personal rights is difficult. (a) For the rights to be personal the court must be satisfied that, properly construed, the right has accrued to the shareholder individually and not simply to him in common with other shareholdgj.g 930 PQJ. example, a shareholder has a personal right to vote on a resolution at a general meeting, but he has no personal right to prevent the Company from altering 925 R u l e 1 1 . 1 . 926 R u l e 11.4.
927 Rules 11.5 and 11.10. 928 Rules 9.16 and 9.17. These provisions are based on Articles 65(1) and 78(1) of the L i s ting Directive (2001/34/EC). 929 Davies PL, Gower and Davies' Principles of M o d e m Company L a w (2003) p 484. 9^^ See the Law Commission, Shareholder Remedies, L a w Commission Consultation Paper 142 (1996) para 2.39.
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its articles to make some uniform amendment to all the voting rights of shareholders. (b) On the other hand, the courts have allowed personal actions to proceed in several cases involving defective notices of meetings or inadequate notice of certain resolutions. For example, the courts have upheld a shareholder's personal right to challenge a special resolution where the shareholder did not receive adequate notice of the resolution in connection with the reconstruction of a Company or an increase in the company's capital.^^^ Secondly, the rule in Foss v Harbottle means that some breaches are classified as "internal irregularities" for which no personal action will lie. The courts have held that where the alleged wrong is a transaction that might be made binding on the Company and on all its shareholders by a simple majority of the shareholders, no individual shareholder may sue.^^^ The Company is the proper person to complain; there is no use in having litigation "the ultimate end of which is only that a meeting has to be called and then ultimately the majority gets its wishes".^^^ In Prudential Assurance Co Ltd v Newman Industries Ltd (No 2)^^^ it was restated that this restriction does not apply where: the alleged wrong is ultra vires the company;^^^ the transaction complained of could be validly done or sanctioned only by a special resolution;^^^ or what has been done amounts to fraud and the wrongdoers are themselves in control of the Company. A special resolution is required for example for the alteration of articles. The matter of wrongdoer control has been discussed in Chap. 4.6.5 above. 4.9.2 Constraints on Voting The main principle is that a shareholder's vote is a property right which the shareholder may exercise in his own interest. There are nevertheless some constraints. Voting rights ofminority shareholders, Some provisions of the Companies Act 1985 act as constraints on the exercise of majority shareholders' powers by giving rights to minority shareholders. Different levels of shareholding give minority shareholders different rights. For example, even one share gives some rights in the Company. 5% gives the right to Petition the court to prevent the passing of a special resolution Converting a public Company into a private Company. 10% gives the ability to requisition an extraordinary general meeting of the Company.^^^ More than 10% excludes the ^^^ See the Law Commission, Shareholder Remedies, Law Commission Consultation Paper 142 (1996) paras 2.24—2.25; The Law Commission, Shareholders Remedies, Law Commission Report 246 (1997) para 7.7. ^32 Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204. 933 MacDougall v Gardiner (1875) 1 Ch D 13,25. 934 Prudential Assurance Co Ltd v N e w m a n Industries Ltd (No 2) [1982] Ch 204. 935 See Smith v Croft (No 2) [1988] C h 114. 936 See section 9 of the Companies Act 1985 (alteration of articles of association). 93^ In a private Company, it gives also the ability to object to a special resolution approving the giving o f financial assistance according to the whitewash provisions in sections 155 to 158 of the Companies Act 1985.
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right of the person making a takeover offer to squeeze out minority shareholders by acquiring their shares compulsorily under the Companies Act 1985 because only nine-tenths (90%) give the offeror the ability to acquire the remaining shares compulsorily.^^^ More than one-fourth (25%) of votes gives the abihty to block actions which can be carried out only by a special resolution (taking target private, financial assistance, voluntary liquidation, change of articles, change of name, and so forth) and which therefore require three-fourths (75%o) of votes. Main rule: lack offiduciary duties. Fiduciary duties do not normally act as a constraint.^^^ A shareholder voting as such is under no fiduciary duty to the Company: "When a shareholder is voting for or against a particular resolution he is voting as a person owing no fiduciary duty to the Company and who is exercising his own right of property to vote as he thinks fit."^'^^ The same principle applies even where a director is voting as a shareholder.^"*^ Shareholders do not owe any fiduciary duties to each other. When exercising voting rights, a shareholder need not consider anyone's interest but his own. Exceptions to the main rule. There are nevertheless exceptions to this main rule. The most important of them are: "unfairly prejudicial conduct"; winding up on the just and equitable ground; the equitable principles which are applicable to all powers conferred on majorities and enabling them to bind minorities; and the equitable principles that govem the relations between members of the type of Company that can be described as a quasi-partnership. These kinds of principles apply also to the enforcement of the Company's Constitution. The remedy for unfairly prejudicial conduct under section 459 of the Companies Act 1985 is the main remedy of minority shareholders in the event of unsatisfactory conduct of Company business. It is often combined with the threat of winding up on the just and equitable ground under section 122(l)(g) of the Insolvency Act 1986. In most cases what can be achieved by the equitable principles can nowadays be achieved by a petition under section 459 of the Companies Act 1985. These equitable principles have therefore been described as meaningless in relation to activities by shareholders.^"^^ One of the factors that makes it difficult to apply these equitable principles is their equitable nature. For example, Foster J asked in Clemens v Clemens Bros LtcP"^^ whether there is any restraint on shareholders exercising their powers as members at general meetings. He came to the conclusion that it would be unwise to try to produce a principle, since the circumstances of each case are infmitely varied.
938 Sections 428^30F of the Companies Act 1985. 939 See Davies PL, Gower and Davies' Principles of M o d e m C o m p a n y L a w (2003) p 486. 940 Northern Counties Securities Ltd v Jackson & Steeple Ltd [1974] 2 All E R 625.
941 North-West Transportation Co Ltd v Beatty (1887) 12 App Cas 589 (Privy Council). 942 Davies PL, G o w e r and Davies' Principles of M o d e m Company L a w (2003) p 494.
943 Clemens v Clemens Bros Ltd [1976] 2 All ER 268.
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Right to sue. The right of a shareholder to sue depends on the cause of action. Where the rights of an individual member have been infringed, he may sue in his own name. For example, in Pender v Lushington it was held that a member of the Company is "entitled to have his vote recorded - an individual right in respect of which he has a right to sue".^"^"^ As regards the two equitable principles, a shareholder may bring proceedings in his own name but only subject to the rule in Foss v Harbottle. When this is combined with the fact that the law relating to derivative actions is in many respects unclear,^"*^ it is understandable that a minority shareholder often resorts to section 459 of the Companies Act 1985 instead. One of the purposes of section 459 of the Companies Act 1985 was to outflank the rule in Foss v Harbottle.^"^^ An individual shareholder has therefore wider rights to sue in his own name under section 459. The same can be said of section 122(l)(g) of the Insolvency Act 1986. Unfairly prejudicial conduct. Section 459 of the Companies Act 1985 allows any shareholder to petition the court for relief on the grounds that the affairs of the Company are being, have been or are about to be conducted in a manner which is unfairly prejudicial to the interests of some of its shareholders (including at least the petitioner). Such conduct occurs most frequently in smaller companies in which most of the shareholders are involved in management.^"^"^ In re Saul D Harrison & Sons plc,^"^^ Hoffmann LJ (as he then was) reviewed the factors to be taken into account when deciding whether a Company's affairs have been conducted in an unfairly prejudicial manner. Often it is simply a case of whether the terms of the articles of association have been complied with and whether the directors have observed their fiduciary duties. In these cases, section 459 is a mechanism for outflanking the rule in Foss v Harbottle where this is desirable.949 On the other hand, it is possible that no particular act can be identified as having caused prejudice to the claimant. The prejudice can arise because of the cumulative effect of a series of incidents and be a result of a course of conduct. Winding up on the just and equitable ground. The remedy for unfairly prejudicial conduct under section 459 of the Companies Act 1985 and winding up under section 122(l)(g) of the Insolvency Act 1986 are commonly pleaded in the alternative.^^^ 94^ Pender v Lushington (1877) 6 Ch D 70 (Court of Chancery (Master of the Rolls)). '^^^ See Smith v Croft (No 2) [1988] Ch 114; Davies PL, Gower and Davies' Principles of Modem Company Law (2003) p 462. 946 Re Saul D Harrison & Sons plc [1995] 1 BCLC 14. ^4*7 The Law Commission, Shareholder Remedies, Law Commission Consultation Paper 142 (1996) para 1.7. 948 Re Saul D Harrison & Sons plc [1995] 1 BCLC 14. ^49 See Lower M, Good faith and the partly-owned subsidiary, JBL 2000 pp 239-240. 9^^ The leading case on winding up on a just and equitable ground is Ebrahimi v Westboume Galleries Ltd [1973] AC 360. See also Hoffmann LJ (as he then was) in Re Saul D Harrison & Sons plc [1995] 1 BCLC 14,19.
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Like protection against unfairly prejudical conduct, winding up on the just and equitable ground under section 122(l)(g) of the Insolvency Act 1986 is one of the exceptions to the proper plaintiff rule. A minority shareholder is not prohibited from suing on this ground. Equitable principles applicable to majorities. The rights of majority shareholders to exercise their voting rights are also constrained by some common law principles. In UK Company law, there are "general principles of law and equity which are applicable to all powers conferred on majorities and enabling them to bind minorities".^^^ These principles apply at least when the majority vote in favour of a resolution to alter the articles of association. Although section 9 of the Companies Act 1985 provides that articles of association may be altered by special resolution,^^^ it does not give unlimited powers to do so. The current law on special resolutions altering the Constitution is the "Greenhalgh rule".^^^ According to this rule, the relevant decision must be taken in the best interest of the members of the Company as a whole. The "Greenhalgh rule" even govems resolutions that alter dassrights.^^"*In this case, the relevant decision must be taken in the best interest of the members of the dass as a whole. Class rights have been defined both in the Companies Act 1985 and by the courts. Resolutions on the Variation of class rights are govemed by provisions of the Companies Act 1985. Different rules apply depending on four things: whether rights are attached to a class of shares by the memorandum or by the articles, and whether they contain provision with respect to the Variation of those rights or do not do so.^^^ The way courts have defined dass rights can be described as flexible or uncertain. It is clear that a class right cannot exist where there is only one type of share in issue and the rights of the shareholders are the same.^^^ On the other hand, in the Cumbrian Newspapers case,^^*^ Scott J was of the opinion that class rights might include cases where rights are enjoyed by a particular member or category of members but no specific shares are designated to which those rights are refer951 Lindley MR in Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656. See Lower M, Good faith and the partly-owned subsidiary, JBL 2000 pp 236-237. 95^ For "special resolutions" see section 378(2). Articles may only be altered "subject to the provisions of this Act". See sections 16-18 (effect on members, registration etc); section 125 (Variation of class rights); sections 177(4) and (5) (powers of court); and sections 461(3), (4) and (5) (court order). Articles may only be altered subject to the conditions contained in the memorandum. See section 17(2)(b). 953 Greenhalgh v Ardene Cinemas Ltd [1951] C h 286; [1950] 2 All E R 1120. See also
Modem Company Law: Final Report, para 7.53. 954 R e Holders Investment Trust [1971] 1 W L R 583; [1971] 2 All E R 289.
955 See sections 125(5), 17, 125(4), 125(2), 125(3), 80, and 135. For shareholder's right to object to Variation see section 127. 956 Gibson L J in Union Music Ltd & another v Watson & another [2003] E W C A Civ 180. 95*7 Cumbrian Newspapers Group Ltd v Cumberland & Westmorland Herald Newspaper & Printing C o m p a n y Ltd [1987] C h 1.
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able. He said that rights or benefits which may be contained in articles can be divided into three different categories: rights or benefits which are annexed to particular shares (dass rights; classic examples of rights of this character are dividend rights); rights or benefits conferred on individuals not in the capacity of members or shareholders of the Company but connected with the administration of the Company's affairs or the conduct of its business (no dass rights); and rights or benefits that, although not attached to any particular shares, are nonetheless conferred on the beneficiary in the capacity of member or shareholder of the Company (dass rights).958 The interests of the members of the Company as a whole and the Greenhalgh rule. Majority shareholders are thus expected to exercise their voting rights not only in their own interest but also in the interests of the shareholders of the Company as a whole. In Allen v Gold Reefs,^^^ Lord Lindley MR said that the power to alter regulations contained in the articles must "be exercised subject to those general principles of law and equity which are applicable to all powers conferred on majorities and enabling them to bind minorities. It must be exercised, not only in the manner required by law, but also bona fide for the benefit of the Company as a whole, and it must not be exceeded." In the leading case Greenhalgh v Arderne Cinemas Ltd,^^^ Evershed MR held that "bona fide for the benefit of the Company as a whole" means that "the shareholder must proceed upon what, in his honest opinion, is for the benefit ot the Company as a whole". According to Evershed MR, the phrase "the Company as a whole" does not mean "the Company as a commercial entity, distinct from the corporators"; instead, it means "the corporators as a general body". Evershed MR used two tests. The first test is to take "an individual hypothetical member" and ask whether what is proposed is, in the honest opinion of those who voted in favour of the resolution, for that person's benefit. The second test is simpler. Evershed MR said that a special resolution "would be liable to be impeached if the effect of it were to discriminate between the majority shareholders and the minority shareholders, so as to give to the former an advantage of which the latter were deprived".96i Equitahle principles applicable to quasi-partnerships. Equitable principles can govem the relations between members of the type of Company that is sometimes described as a quasi-partnership. This was confirmed by the decision of the House of Lords in O 'Neill v Phillips.^^^ The mechanism for enforcing this fiduciary duty is section 459 of the Companies Act 1985.^^^
958 See also Bushell v Faith [1970] A C 1099, [1970] 1 All ER 53 (House of Lords). 959 Allen V Gold Reefs of West Africa Ltd [1900] 1 C h 656. 960 Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286. 9^^ For Problems related to these tests see Davies P L , Gower and Davies' Principles of M o d e m Company L a w (2003) p 492. 962 O'Neill V Phillips [1999] 1 W L R 1092 (House of Lords). 96^ See Lower M , Good faith and the partly-owned subsidiary, JBL 2000 p 232.
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For example, in re Saul D Harrison & Sons plc,^^"^ Hoffmann LJ (as he then was) gave as an example the Standard case in which shareholders have entered into association upon the understanding that each of them who has ventured his capital will also participate in the management of the Company. In such a case it will usually be considered unjust, inequitable or unfair for a majority to use their voting power to exclude a member from participation in the management without giving him the opportunity to remove his capital upon reasonable terms. In O 'Neill v Phillips, Lord Hoffmann said that there would be cases in which equitable considerations make it unfair for those conducting the affairs of the Company to rely upon their strict legal powers. This unfaimess may consist of a breach of the rules or of using the rules in a manner which equity would regard as contrary to good faith.^^^
4.9.3 Enforcement of the Constitution of the Company In the UK, the right to enforce the Constitution of the Company is potentially important because the articles of association are the most important source of rules on the govemance of the Company that can be altered by shareholders. As the memorandum and articles of association constitute a contract between the Company and its shareholders and the shareholders inter se,^^^ one might assume that shareholders can enforce them against the Company and each other. This is nevertheless not always the case because the Constitution of the Company is a statutory contract only and differs from a Standard contract. Although the Company can enforce this statutory contract against shareholders and shareholders can enforce it against each other, there are limitations on the rights that shareholders can enforce. The rules governing the right of shareholders to enforce the Constitution of the Company are very complicated. Firstly, a shareholder cannot enforce rights other than his pure membership rights.^^^ Secondly, the right of an individual shareholder to enforce the Constitution of the Company are subject to the majority rule and proper plaintiff principles discussed above (the rule in Foss v Harbottle).^^^
4.9.4 Constraints on Other Acts A Controlling shareholder can exercise real power over the Company, without having to vote, by exercising management powers either directly or indirectly. These actions can relate to the conduct of the Company's affairs. On the other hand, the 964 R e Saul D Harrison & Sons plc [1995] 1 B C L C 14. 965 See also Lower M , Good faith and the partly-owned subsidiary, JBL 2000 pp 2 3 9 - 2 4 0 . 966 Section 14(1) of the Companies Act 1985. 967 See The L a w Commission, Shareholder Remedies, L a w Commission Consultation Paper 142 (1996), para 2.14. 968 See The L a w Commission, Shareholder Remedies, L a w Commission Consultation Paper 142 (1996), paras 2.21-2.22.
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actions of a Controlling shareholder can be prejudicial even where they do not directly relate to the conduct of this Company's affairs. For example, there is a risk that the Controlling shareholder sets up a rival business. ^^^ A majority shareholder which competes with the Company or which controls a rival business or which diverts corporate opportunities to itself is not in breach of any common law fiduciary duty.^"^^ Minority shareholders aggrieved by the acts of a Controlling shareholder may nevertheless petition for relief under section 459 of the Companies Act 1985 on the grounds that their interests have been unfairly prejudiced.^^^ In light of the decisions in Scottish Co-operative Wholesale Society V Meyer and Nicholas v Soundcraft Electronics,^'^^ section 459 of the Companies Act 1985 does not seem to require that the conduct complained of should arise out of decisions taken by the board of the Company (in practice, the board of the subsidiary Company) or at its general meeting. However, shareholders who exercise management powers are not yet subject to quite the same types of constraints as are imposed on directors. ^^^
4.9.5 Fraud on the Minority Minority shareholders may bring an action on behalf of the Company where it is alleged that a fraud has been committed against the Company by those in control. In Burland v Earle, it was held: "It is an elementary principle of the law relating to Joint stock companies that the court will not interfere with the internal management of companies acting within their powers, and in fact has no Jurisdiction to do so. Again, it is clear law that in order to redress a wrong done to the Company, the action should prima facie be brought by the Company itself... But an exception is made to the second rule, where the persons against whom the relief is sought themselves hold and control the majority of shares in the Company. In that case the courts allow the shareholders complaining to bring an action in their own names ... The cases in which the minority can maintain such an action are ... confined to those in which the acts complained of are of a fraudulent character or beyond the powers of the company."^'^'*
4.9.6 Croups The same principles can be applied in groups of companies. Although shareholders are not usually thought to be fiduciaries for the Company or for each other, the ^^^ See Lower M, Good faith and the partly-owned subsidiary, JBL 2000 pp 242-243. ^'^0 Lower M, Good faith and the partly-owned subsidiary, JBL 2000 pp 238-239. ^"^^ Lower M, Good faith and the partly-owned subsidiary, JBL 2000 p 239. ^"^^ Scottish Co-operative Wholesale Society v Meyer (1959) AC 324 (House of Lords); Nicholas v Soundcraft Electronics Ltd [1993] BCLC 360. ^"^^ See Lower M, Good faith and the partly-owned subsidiary, JBL 2000 pp 238-239, citing Prentice D, The closely-held Company and minority oppression, OJLS 3 (1983) p 419. 974 Buriand v Earle [1902] AC 83 (Privy Council).
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parent Company and the minority shareholders are at least under some circumstances in a fiduciary relationship. The mechanism for enforcing the parent company's duties is section 459 of the Companies Act 1985.^^^ Powers infact. In reality, the parent Company can exercise its powers either directly or directly, and its unilateral actions can affect the conduct of the affairs of the subsidiary. The parent Company can exercise its powers directly in many ways. The parent Company can act in the capacity of a shareholder in the subsidiary Company. The parent Company's nominees can take decisions at the board meeting of the subsidiary. The control of a subsidiary Company's affairs is sometimes vested in its parent Company and exercised by the parent Company outside the confines of the board or general meeting of the subsidiary.^^^ The parent Company's employees can perform many important management functions under matrix management, or individuals can be allocated functions in the management of the subsidiary without regard to which Company belonging to the same group employs them. The parent Company can exercise its powers even indirectly. In the subsidiary Company, decisions are often taken at board meetings or by sub-board managers for the benefit of the parent Company or the group as a whole. Even unilateral actions by the parent Company can affect the conduct of the affairs of the subsidiary. A parent Company can sometimes run its own affairs in a manner that is harmful to the interests of its subsidiary. For example, in Nicholas v Soundcraft Electronics LtcP'''' Fox LJ explained: "Electronics was, in effect, treating the financial affairs of the two companies as that of a single enterprise over which it had control ... We are not, therefore, dealing with a case of a Company which is simply running its own affairs in a manner which is harmful to the interests of its subsidiary. It seems to me that Electronics, when it withheld payments from the Company, was doing so as part of general control of the fmancial affairs of the Company. It exercised that general control by deciding how much the Company should receive (by withholding sums due to the Company) and restricting the Company's ability to spend money (by the signature requirements on cheques drawn by the Company." And in Scottish Co-operative Wholesale Society v Meyer,^''^ the majority shareholder in a Joint venture Company exercised control over its subsidiary through its power to decide whether to allow it access to raw materials at a fair price.^^^ Constraints. In principle, section 459 of the Companies Act 1985 can under some circumstances be applied to all these three forms of actions. To begin with, section 459 requires that the conduct complained of be in substance and reality the conduct of the affairs of the Company in question: it does not expressly require that the conduct complained of be that of the majority shareholder in its capacity as member. Therefore, resolutions passed at a general meet^^^ Lower M, Good faith and the partly-owned subsidiary, JBL 2000 p 232. ^^^ Lower M, Good faith and the partly-owned subsidiary, JBL 2000 p 243. 9^^ Nicholas v Soundcraft Electronics Ltd [1993] BCLC 360. ^"^^ Scottish Co-operative Wholesale Society v Meyer (1959) AC 324 (House of Lords). ^"^^ See Lower M, Good faith and the partly-owned subsidiary, JBL 2000 p 244.
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ing are acts of the Company to which section 459 of the Companies Act 1985 can apply,^^^ and misfeasance in the management of a Company at board level is capable of constituting unfairly prejudicial conduct.^^^ Furthermore, the courts took a broad approach to unfairly prejudicial conduct in Nicholas v Soundcraft Electronics LtcP^^ and Scottish Co-operative Wholesale Society V Meyer.^^^ Both cases show that the exercise by a parent Company of de facto control over the allocation of corporate assets or opportunities can amount to conduct of the subsidiary's affairs.^^"^ For example, the facts oi Nicholas v Soundcraft Electronics Ltd show the scope of the parent Company's fiduciary duty is modified to take account of the realities of the group situation.^^^ In this case, Fox LJ Said: "It seems to me that Electronics in a desperate financial Situation was using what assets it could lay its hand on to keep the group afloat. To attempt to do so by withholding the debts was not, I think, unfair. It was in the interests of the Company that Electronics should not go into liquidation. The Company had to pay a price to help secure that. It is the fact that the price - withholding of debts - left the Company critically short of money. But the attempts to keep the group afloat by recourse to the assets of both companies was a reasonable commercial judgment in the circumstances that existed, and was not unfair. It no doubt caused härm to the Company, but worse härm would probably have followed from a liquidation of Electronics". Directors' duties. The duties of directors have been discussed above. The general principle is that the courts do not Substitute their judgment for that of the directors made in good faith; on the other hand, the court could reject the view of the directors for instance because they have acted for an irrelevant purpose.^^^ According to this principle, actions and omissions that may seem to benefit the parent Company at the expense of the partly-owned subsidiary can sometimes be permissible. Where the Company is a member of a group of companies, the directors may have regard to the interests of the group if, but only if, it is in the interests of the Company so to do. It might be legitimate for the directors of a subsidiary Company to sacrifice its short-term interests for the good of the group; there will be no breach of duty where this is done with a view to the good of the subsidiary in the medium term.^^*^ A director of a subsidiary Company is not in breach of duty if he fails to consider the interests of the subsidiary separately from those of the group, ^^ORe Kenyon Swansea Ltd [1987] BCLC 514; see Lower M, Good faith and the partlyowned subsidiary, JBL 2000 p 243. See nevertheless Re Blackwood Hodge plc [1997] 2 BCLC where Jonathan Parker J states that the conduct of a parent Company does not amount to conduct of the affairs of the subsidiary. Further Lower M, Good faith and the partly-owned subsidiary, JBL 2000 p 245. 981 See Hoffmann LJ in Re Saul D Harrison [1995] 1 BCLC 14. 982 Nicholas v Soundcraft Electronics Ltd [1993] B C L C 360. 983 Scottish Co-operative Wholesale Society v Meyer (1959) A C 324 (House of Lords). 984 See Lower M , Good faith and the partly-owned subsidiary, JBL 2000 p 2 4 3 . 985 Lower M , Good faith and the partly-owned subsidiary, J B L 2000 p 2 4 6 - 2 4 7 . 986 Charterbridge Corporation Ltd v Lloyds B a n k Ltd [1970] C h 62. 987 See Lower M , Good faith and the partly-owned subsidiary, J B L 2000 p 2 4 5 - 2 4 6 .
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provided that an intelligent and honest man in the same position could reasonably have come to the same conclusion that the transaction was for the benefit of the subsidiary.
4.9.7 Sanctions Against Shareholders In the UK, there are few sanctions against shareholders related to rule-making in the Company. Some of the main sanctions against shareholders include remedies under section 461 of the Companies Act 1985. These sanctions apply in practice to majority shareholders of quasi-partnership companies. A further remedy that is in practice applied to majority shareholders is the doctrine of piercing the corporate veil. Sanctions for unfairly prejudicial conduct. Section 461 sets out the relief that the court may give in order to protect a shareholder against unfair prejudice. The Companies Act leaves the court plenty of discretion. The main rule is that the court "may make such order as it thinks fit for giving relief in respect of the matters complained o f .^^^ For example, the court may "provide for the purchase of shares of any members of the Company by other members or by the Company itself .^^^ Piercing the corporate veil. The common law doctrine of piercing the corporate veil or lifting the veil is regarded as an exception to the limited liability of shareholders and a departure from the rule in Salomon's case. It means that the liabilities of the Company are imposed on its real Controllers. There are three circumstances in which courts may pierce the veil: when construing a Statute, contract or other document; when the Company is a mere fa9ade, concealing the true facts; and when it can be established that the Company is an authorised agent of its Controllers or its members, corporate or individuals.^^^ As a rule, the courts are reluctant to do so, and companies are allowed to take advantage of the principle of hmited liability by forming subsidiaries.^^^ The leading case is Adams v Cape Industries?^'^ In this case, Slade LJ said that "the court is not free to disregard the principles of Salomon v A Salomon & Co Ltd ... merely because it considers that justice so requires. Our law, for better or worse, recognises the creation of subsidiary companies, which though in one sense the creatures of their parent companies, will nevertheless under the general law fall to be treated as separate legal entities with all the rights and liabilities which would normally attach to separate legal entities". On the other hand, there can be cases "where the wording of a particular Statute or contract has been held to justify the treatment of parent and subsidiary as one unit, at least for some purposes". According to Adams v Cape Industries, companies forming a group are entitled to ^^^ Section 461(1) of the Companies Act 1985. 989 Section 461(2)(d) of the Companies Act 1985. 99^ Modem Company Law: Completing the Stmcture, para 10.6, citing Gower. 99^ Completing the Stmcture, paras 10.58 and 10.59. 992 Adams v Cape Industries [1991] 1 All ER 929.
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structure their activities so as to avoid a liability that might arise if they were not treated as separate entities, so long as there is no "deception" or "sham". In some cases it has been held that a Company is the agent of its shareholders. In these situations the shareholders are actually liable for their own obligations and not of those of the Company; where the activities of the Company are attributed to its shareholders, the corporate veil does not need to be "pierced". In any case, this Situation is relatively rare even in Company groups. In Lonrho v Shell Petroleum,^'^'^ Shaw LJ said that "[tjhere are no doubt situations ... where on the established facts a Company is so utterly subservient or subordinated to the will and the wishes of some other person (whether an individual or a parent Company) that compliance with that other person's demands can be regarded as assured. Each case must depend upon its own facts and also upon the nature, degree and context of the control ..." The doctrine of piercing the corporate veil has partly been made redundant by statutory provisions that make shareholders or other persons liable for Company debts in the case of insolvency or abuse. For example, section 214 of the Insolvency Act 1986 applies to directors or shadow directors who are guilty of "wrongful trading", and section 213 of the same Act applies to any person guilty of "fraudulent trading". Parent-company liability in tort. A shareholder can thus be liable for his own actions without any "piercing" of the corporate veil. There is a series of cases where Claims have been made in the parent Company's Jurisdiction that it is liable in tort directly to the claimant by reason of its de facto control of the Operations of the subsidiary.^^"*
993 Lonrho Ltd v Shell Petroleum Co Ltd [1980] QB 358, affirmed [1980] 1 WLR 627 (House of Lords). 99"^ See McLachlan C, International Litigation and the Reworking of the Conflict of Laws, LQR 120 (2004) pp 587-588.
5 Germany
5.1 General Remarks 5.1.1 Introduction Laws written in German had heavy influence on the laws of many other countries outside the German language area before World War IL For example, there has been wide reception of German law in Greece and Japan. In the field of civil law, the German Civil Code (Bürgerliches Gesetzbuch, BGB) has been used as a model especially in Central and Eastem Europe as well as in the Nordic countries and the Baltic States. The influence of German law is complemented by Austrian and Swiss law. The influence of laws written in German was not limited to the BGB, because jurists accustomed to use German language sources had the technical skills to look for Inspiration even in other areas of German law. For example, it is not Strange to refer to German legal sources in Nordic Company law textbooks, although this practice is not as common as it used to be in the past. While the influence of German Company law on EU Company law is well known, the convergence of Company laws towards the German model is rarely discussed nowadays. But as will be discussed in Chap. 6, there is some convergence towards the German model even in the UK. Environment. In corporate govemance literature, German society is described as more "social democratic" than the British.^ On the other hand, German society is also built on Christian social ideals, and not all things social are caused by left of centre politics.^ The idea of the social market economy seems to be generally accepted. According to this concept, the economy is govemed by market forces but the State retains an important role. There is extensive social protection and relatively harmonious labour relations. The tolerance for inequality is lower than in the UK.^ Judged by the distribution of income, Germany looks a slightly less unequal country than the UK.
Roe MJ, Political Preconditions to Separating Ownership from Corporate Control, Stan L Rev (2000) p 550. For the origins of labour co-determination see for example Hopt KJ, The German TwoTier Board: Experience, Theories, Reforms. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit pp 236-237. Roe MJ, Political Preconditions to Separating Ownership from Corporate Control, Stan L Rev (2000) p 564.
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Big political decisions generally require relatively broad consensus. The political and legislative power is divided between many different organs."^ Germany is also a federal State with each State having its own parliament, judiciary and administration. It is perhaps an Understatement to say that the State has traditionally played a powerflil role in Germany. There is a well-developed bureaucracy both in the Society in general and inside companies. The traditional business culture is formalistic, and laws are taken seriously.^ The regulation of business is extensive and overregulation is a constant topic in German and foreign media. Big reforms are difficult to carry out due to the nature of the political decision-making process and the lack of consensus.^ German economy is geographically less centralised than British economy. There is no one centre, although Frankfurt is the main financial hub. The German financial System has not yet transformed into a UK and US-style market-based System, although there is a gradual evolution towards a marketoriented equity culture.^ Banks play a powerful role in German business. The largest deposit banks are still independent and predominandy controlled by Germans, although traditional German investment banks are losing out increasingly to foreign competitors. Bank financing has traditionally been the dominant source of long-term extemal financing for large German companies/ and the market capitalisation of listed German firms is low in comparison to countries like the UK and the USA.^ In addition, the largest German banks own shares in many public companies^^ and form the most important distribution Channel for mutual flinds.^^ Banks could at least in principle For the history of the decentraUsation of legislative power in Germany see Zweigert K, Kötz H, Einführung in die Rechtsvergleichung (1996) § 10 IL See also La Porta R, Löpez-de-Silanes F, Shleifer A, Vishny RW, Law and Finance, 106 J Polit Economy (1998) p 1141. A recent example is the failure of the Independent FederaHsm Committee (Kommission von Bundestag und Bundesrat zur Modernisierung der bundesstaatlichen Ordnung, "FöderaUsmuskommission") in 2004. Nowak E, Investor Protection and Capital Market Regulation in Germany. In: Krahnen JP, Schmidt RH (eds) The German Financial System (2004) p 427. Hackethal A, German Banks and Banking Structure. In: Krahnen JP, Schmidt RH (eds) The German Financial System (2004) pp 94-95; Reinhard H. Schmidt, Corporate Govemance in Germany: An Economic Perspective. In: Krahnen JP, Schmidt RH (eds) p 411; Cheffins BR, Mergers and Corporate Ownership Structure: The United States and Germany at the Tum of the 20th Century, American Journal of Comparative Law 51 (2003) p 497. Theissen E, Organized Equity Markets. In: Krahnen JP, Schmidt RH (eds) The German Financial System (2004) pp 140-141. See Deutsches Aktieninstitut, DAI Factbook 2003; Hopt KJ, The German Two-Tier Board: Experience, Theories, Reforms. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit p 253. Maurer R, Institutional Investors in Germany: Insurance Companies and Investment Funds. In: Krahnen JP, Schmidt RH (eds) The German Financial System (2004) pp 126127.
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influence public companies by using their position as lender, by voting with their own shares, by Controlling the proxy machinery and through supervisory board memberships.^^ It is also normal for banks to have an advisory role. There is a high level of ownership concentration. Public companies often have a large family or corporate shareholder.^^ In 1992, 85% of the 694 largest German companies still had a majority shareholder;^"* a few years ago, 89% of all listed companies still had a Single shareholder Controlling more than 25% of their equity.^^ Unlike in the USA, the position of Controlling family shareholders was not diluted at the tum of the 20* century,^^ and a new founder generation emerged after World War II. Furthermore, a high capital gains tax used to lock financial institutions into a web of cross-shareholdings because any attempt to liquidate these blocks would have been punitively taxed.^'^ This tax was eliminated as from 1 January 2002.^^ Although the role of institutional investors is gradually increasing, UK and UStype Pension funds for extemally funded occupational pension schemes are still of minor importance as institutional investment schemes in Germany.^^ As regards legal costs, the loser pays principle applies. On the other hand, the legal costs are largely determined on the basis of the value of the disputed case (Gegenstandswert) and the Lawyers' Remuneration Act (Rechtsanwaltsver-
^^ Elsas R, Krahnen JP, Universal Banks and Relationships with Firms. In: Krahnen JP, Schmidt RH (eds) The German Financial System (2004) pp 199-202 and 227-228; Donald DC, The Nomination of Directors under U.S. and German Law, Institute for Law and Finance, Johann Wolfgang Goethe-Universität Frankfurt, Working Paper SeriesNo.21(2004)p5. ^^ See Deutsches Aktieninstitut, DAI Factbook 2003; Theissen E, Organized Equity Markets. In: Krahnen JP, Schmidt RH (eds) p 142; La Porta R, Löpez-de-Silanes F, Shleifer A, Vishny RW, Law and Finance, 106 J Polit Economy (1998) p 1146 and Table 7; Hopt KJ, The German Two-Tier Board: Experience, Theories, Reforms. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit p 232; Teichmann C, Corporate Govemance in Europa, ZGR 2001 pp 654-655. ^"^ See Roth GH, Wörle U, Die Unabhängigkeit des Aufsichtsrats - Recht und Wirklichkeit, ZGR 2004 pp 594-595; Netzwettbewerb durch Regulierung, Vierzehntes Hauptgutachten der Monopolkommission gemäß § 44 Abs. 1 Satz 1 GWB - 2000/2001 Kurzfassung (2002) pp 21-22. ^^ Coffee JC, The Rise of Dispersed Ownership: The Roles of Law and the State in the Separation of Ownership and Control, Yale Law Journal 111 (2001) p 23, citing Christopher Swann, The Weak Will Become Frey, Financial Times, June 30,2000. ^^ See Cheffins BR, Mergers and Corporate Ownership Structure: The United States and Germany at the Tum of the 20th Century, AJCL 51 (2003) p 494. ^'' See Coffee JC, The Rise of Dispersed Ownership: The Roles of Law and the State in the Separation of Ownership and Control, Yale L J 111 (2001) pp 15-16. ^^ The amended § 8b of the Corporate Tax Act (Untemehmenssteuergesetz) states that public companies' capital gains on the sale of shareholdings are generally tax-free. ^^ Maurer R, Institutional Investors in Germany: Insurance Companies and Investment Funds. In: Krahnen JP, Schmidt RH (eds) The German Financial System (2004) p 107; Coffee JC, The Future as History: The Prospects for Global Convergence in Corporate Govemance and Its ImpHcations, Nw U L Rev 93 (1999) p 671.
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gütungsgesetz, RWG).^° Lawyers' fees are therefore significantly lower than in the UK. Regulation. What is characteristic of the German model is not only the two-tier board structure of public Hmited-Hability companies, but also the important role played by statutory and mandatory rules in the govemance of these companies, the fact that a public limited-liability Company is actually run by one of the two statutory boards, and that some of the members of the supervisory board are appointed by the workforce. The German model rehes on consensus-based decision-making and mixed monitoring. In addition, there are special rules on the govemance of corporate groups (Konzemrecht) and a flexible Company form for subsidiaries (GmbH).
5.1.2 The Most Important Legal Forms of Business Organisation In German law, the two main forms of limited-liability companies distinct from their shareholders are the public limited Company (Aktiengesellschaft, AG) and the private limited Company (Gesellschaft mit beschränkter Haftung, GmbH). The GmbH is a Corporation whose shares may not be quoted on a stock exchange. The stated capital of a GmbH consists of shares (Geschäftsanteile) that are not negotiable. The assignment of shares requires a notarised deed. The transferabihty of GmbH shares may be limited by the Company's articles of association. For example, the articles may set out that the assignment of shares requires a shareholders' resolution or provide for rights of first refusal of existing shareholders. The AG is a legal entity the shares of which are freely negotiable. Shares in an AG can be listed and traded on a stock exchange. Even non-quoted shares can easily be transferred through contracts of sale. The distinction between the AG and the GmbH is not based on the Company's size. There are both large firms operating as a GmbH and small family-owned corporations operating as an AG. The overwhelming majority of limited-liability companies operate nevertheless as a GmbH with currently more than 800,000 private limited companies (GmbH) and more than 15,000 public limited companies (AG)^^ of which only a small minority are listed companies.^^ This means also that most limited-liability companies are privately owned. Apart from the ownership of companies, a factor contributing to the popularity of the GmbH is the flexibility of GmbH legislation. The articles of association of a GmbH can be more specifically tailored to the requirements of the shareholder(s). ^^ § 2(1) RVG: "Die Gebühren werden, soweit dieses Gesetz nichts anderes bestimmt, nach dem Wert berechnet, den der Gegenstand der anwaltlichen Tätigkeit hat (Gegenstandswert)." ^^ Deutsches Aktieninstitut. See also Ulmer P, Aktienrecht im Wandel, AcP 2002 p 143; Lutter M, Hommelhoff P, GmbH-Gesetz (2000), Einleitung, 1; Hommelhoff P, Gestaltungsfreiheit im GmbH-Recht, ZGR-Sonderheft 13 (1998) p 37. ^^ According to the Factbook of Deutsche Börse Group, there were 829 domestic quoted companies at the Frankfurt Stock Exchange on 31 December 2003.
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The German subsidiaries of foreign corporations are typically private limited companies rather than public limited companies. The statutory provisions on the AG, on the other hand, are based on the assumption that the Company has a large number of shareholders who mostly do not actively participate in the administration of the Company.^^ A Company fonn that is becoming increasingly populär with small businesses is the UK limited liability Company. Many German businesses incorporate as a UK Company but carry on business in Germany under the case law of the ECJ. According to a recent estimate, there are 15,000 active UK companies in Germany.^"^ One of the main reasons for this is the cost of limited liability in these two countries. In a German GmbH, limited liability is combined with the relatively high minimum capital requirement of € 25,000.^^ The UK Itd is also regarded as a flexible Company form.
5.1.3 Sources The basic legislation on the AG can be found in the Stock Corporation Act (Aktiengesetz, AktG). The Aktiengesetz is also the primary source of law relating to the govemance of the AG. The most important acts supplementing the Aktiengesetz are the Commercial Code (Handelsgesetzbuch, HGB), the Civil Code (Bürgerliches Gesetzbuch, BGB), the Transformation Act (Umwandlungsgesetz, UmwG), the Co-determination Acts (Mitbestimmungsgesetze),^^ the Securities Acquisition and Takeover Act (Wertpapiererwerbs- und Übemahmegesetz, in short, Wertpapierübemahmegesetz, WpÜG), the Securities Trading Act (Wertpapierhandelsgesetz, WpHG), and regulations amending the Securities Trading Act.^*^ Rules on the commercial register and on accounting issues can be found in the Handelsgesetzbuch (HGB), rules on takeover bids and special duties of the management of the target Company in the Wertpapierübemahmegesetz (WpÜG), and rules on insider dealing in the Wertpapierhandelsgesetz (WpHG).
^^ See Hommelhoff P, Schwab M, Regelungsquellen und Regelungsebenen der Corporate Govemance: Gesetz, Satzung, Codices, untemehmensinteme Grundsätze (2003) p 52. ^^ Jürgens P, Begrenzter Erfolg, Der Spiegel 40/2004 p 106, citing professor Heribert Hirte. ^^ § 5(1) GmbHG. See also Graf von Bemstdorff C, Das Betreiben einer englischen Limited in Deutschland, RIW 7/2004 pp 501-502. ^^ The Iron and Steel Co-determination Act of 1951 (Montan-Mitbestimmungsgesetz), the Works Constitution Act of 1952 (das Betriebsverfassungsgesetz 1952), the Works Constitution Act of 1972 (das Betriebsverfassungsgesetz 1972), the Co-determination Act of 1976 (Mitbestimmungsgesetz 1976) and the Works Constitution Act of 2001 (Reformgesetz zum Betriebsverfassungsgesetz 1972, BetrVReformG). ^^ Especially Stock Exchange Admission Regulation (Verordnung über die Zulassung von Wertpapieren zur amtlichen Notierung an einer Wertpapierbörse, in short, Börsenzulassungs-Verordnung, BörsZulV) and Regulation on the Prospectus for Securities Offered for Säle (Prospectus Regulation) (Verordnung über Wertpapier-Verkaufsprospekte, in Short, Verkaufsprospekt-Verordnung, VerkProspVO).
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5 Germany
The Aktiengesetz and related laws have been amended in recent years by the Act on Control and Transparency of Enterprises (KonTraG),^^ the Act on Registered Shares and on Facilitating the Exercise of the Right to Vote (NaStraG),^^ and the Transparency and Disclosure Act (TransPuG).^^ More reforms are on the way in 2005. In February 2003, the federal govemment presented its 10-point Programme on promoting corporate integrity and investor protection.^^ Part of this Programme, the Act on Corporate Integrity and Modemisation of Rescission Law (UMAG)^2 will reform the liability of Company organs and how resolutions of the general meeting are contested. The UMAG is expected to enter into force on 1 November 2005. In addition to the UMAG, liability matters will be reformed by two or three other Acts: the Capital Investor Precedence Case Act (KapMuG),^^ the Investor Protection Act (AnSVG),^"* and the Capital Market Information Liability Act (KapInHaG).^^ Of these four Acts, the KapInHaG is regarded as politically controversial and its future is still unclear. The purpose of these reforms is generally to make sure that market capital is allocated to sound businesses and that businesses manage this capital properly.^^ The Investor Protection Act (AnSVG)^'' will also implement the provisions of the Market Abuse Directive and related EU legislation; the Market Abuse Directive has more consequences for German companies than for UK companies due to the board structure of German public companies. Post-Enron reforms also include a draft Auditor Supervision Act (APAG)^^ as well as two new Acts on the reform of accounting and statutory audits: the Act on the Introduction of International Accounting Standards and on the Protection of the Quality of Audits (BilReG)^^ and the Act on the Control of Financial Statements (BilKoG).4o Although the AG and the GmbH are govemed by different acts, many basic principles of corporate law apply equally to both types of companies, and GmbH legislation may sometimes be taken into account when interpreting the Aktienge^^ Gesetz zur Kontrolle und Transparenz im Untemehmensbereich (1998). ^^ Gesetz zur Namensaktie und zur Erleichterung der Stimmrechtsausübung (Namensaktiengesetz, 2001). ^^ Transparenz- und PubHzitätsgesetz (2002). This Act was based on the recommendation of the German Corporate Govemance Commission. ^^ See Federal Ministry of Justice, press release of 23 February 2003, Bundesregierung stärkt Anlegerschutz und Untemehmensintegrität. ^^ Das Gesetz zur Untemehmensintegrität und Modernisierung des Anfechtungsrechts. ^^ Kapitalanleger-Musterverfahrensgesetz. ^^ Anlegerschutzverbesserungsgesetz. ^^ Kapitalmarktinformations-Haftungsgesetz. ^^ See Hommelhoff P, Schwab M, Regelungsquellen und Regelungsebenen der Corporate Govemance: Gesetz, Satzung, Codices, untemehmensinteme Gmndsätze (2003) p 52. ^'^ Anlegerschutzverbessemngsgesetz. ^^ Abschlussprüferaufsichtsgesetz. ^^ Gesetz zur Einfühmng intemationaler Rechnungslegungsstandards und zur Sichemng der Qualität der Abschlussprüfung (Bilanzrechtsreformgesetz, BilReG). The BilReG will be applied from 1 January 2005. "^^ Gesetz zur Kontrolle von Untemehmensabschlüssen (Bilanzkontrollgesetz, BilKoG). The BilKoG will enter into force on 1 July 2005.
5.1 General Remarks
245
setz. The GmbH Act (GmbH-Gesetz, GmbHG) is nevertheless closer to legislation on partnerships. Both case law and academic literature play an important role. Germany is a large country with a uniform Company law regime for the whole country. This regime is more than one hundred years old. There is therefore a large body of Company law cases that are cited both by courts and by academics."^^ There is also a very large body of academic literature on any subject, and even these sources are normally cited by courts. German courts cite academic writers more often than the courts of most other countries."*^ The sheer volume of materials makes German Company law more detailed than the Company laws of many other countries. It is also usual to have competing schools of thought. The role of industry self-regulation has traditionally been limited as far as the govemance of German public limited-liability companies is concemed. The govemance of AGs is characterised by mandatory legislation. Nevertheless, a takeover code (Übemahmekodex) was published in 1995 and two different corporate govemance codes, based on private initiatives, were published in 2000."^^ All these codes were later replaced. The takeover code was replaced by the WpÜG that was modelled on the UK City Code on Takeovers and Mergers and entered into force on 1 January 2002. The two corporate govemance codes were replaced by the German Corporate Govemance Code. Adopted by a govemment commission on 26 Febmary 2002, this code is linked directly to action on the part of the State, which is unusual by intemational Standards. It is reviewed yearly by the govemment commission. The German Corporate Govemance Code introduced conduct Standards for management boards (Vorstand) and supervisory boards (Aufsichtsrat) of listed companies. The Code is a recommendation only, but it has a legal basis. Compliance is encouraged by the declaration of conformity pursuant to § 161 of the Aktiengesetz^"^ and the pressure from investors."^^ On the other hand, compliance with the Code is voluntary, companies can freely opt out from it and listed companies cannot be forced to comply with the Code by the mies of a stock exchange."^^ See generally Wagner-Döbler R, Präjudizien in deutschen, englischen und USamerikanischen Gerichtsentscheidungen. Ein quantitativer Vergleich, RabelsZ 59 (1995) pp 113-127. See Kötz H, Die Zitierpraxis der Gerichte. Eine vergleichende Skizze, RabelsZ 52 (1988) pp 657-661. Grundsatzkommission Corporate Govemance, Code of Best Practice (2000); Berliner Initiativkreis German Code of Corporate Govemance (2000). In 1998, Deutsche Schutzvereinigung für Wertpapierbesitz had published its Guidelines (1998). As amended by the Transparency and Disclosure Act (TransPuG). See also § 285 Nr. 16 HGB. See Hommelhoff P, Schwab M, Regelungsquellen und Regelungsebenen der Corporate Govemance: Gesetz, Satzung, Codices, untemehmensinteme Gmndsätze (2003) p 58. See Hommelhoff P, Schwab M, Regelungsquellen und Regelungsebenen der Corporate Govemance: Gesetz, Satzung, Codices, untemehmensinteme Gmndsätze (2003) pp 5758, 68; Ulmer P, Der Deutsche Corporate Govemance Kodex - ein neues Reguliemngsinstmment für börsennotierte Aktiengesellschaften, ZHR 166 (2002) p 172.
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5 Germany
The Aktiengesetz provides for a duty to make a Statement whether the Company complies with the recommendations of the Code and name the recommendations that the Company does not comply with."*^ There is no duty to explain why the Company does not comply with all recommendations. Most of the recommendations of the Code can only repeat the principles of the largely mandatory Aktiengesetz. As most matters are covered by the Aktiengesetz anyway, there is only some room for new genuine recommendations. It could be Said that the German Corporate Govemance Code is for the most part a tool for providing foreign investors with a concise overview of the German corporate goverenance model (in other words, a marketing tool)."^^ In Germany, listing rules do not mandate specific corporate govemance structures or practices. They may nevertheless set out special notification requirements.
5.1.4 The Extent of Party Autonomy in Ruie-making What is the general approach of German law to party autonomy in the law of public limited-liability companies? How much legislation is there? To what extent are these provisions mandatory? Which matters are left to the discretion of the shareholders of a public Company? Which matters are left to the discretion of the management? General approach. In Germany, the rules governing public limited-liability companies have largely been standardised by the statutory rules of the Aktiengesetz. The rules on the govemance of public hmited-liability companies have therefore not been left to the discretion of shareholders. The same can be said of mies made by the management on the govemance of the Company at the level of the two boards. Although there is more discretion at this level, it is constrained by the existence of a large number of statutory mies. The statutory mies of the Aktiengesetz and related case law can be described as prescriptive. The Aktiengesetz often contains a short general mle that has been interpreted by the courts in a large number of cases leading to a large number of detailed mles.^^ Many statutory mies on the govemance of the Company are mandatory. Mandatory mies are regarded as necessary for several reasons. Firstly, they make Investments in securities easier by protecting both shareholders and creditors. For example, there are strict mies preventing the Company from repaying share capital § 161 AktG: "Vorstand und Aufsichtsrat der börsennotierten Gesellschaft erklären jährlich, dass den vom Bundesministerium der Justiz im amtlichen Teil des elektronischen Bundesanzeigers bekannt gemachten Empfehlungen der „Regierungskommission Deutscher Corporate Govemance Kodex" entsprochen wurde und wird oder welche Empfehlungen nicht angewendet wurden oder werden. Die Erklärung ist den Aktionären dauerhaft zugänglich zu machen." See also Roth GH, Die (Ohn-)Macht der Hauptversammlung. Oder: Unlautere Werbung für Aktienrecht, ZIP 2003 p 370. It is sufficient to compare any UK Company law textbook with Hüffer U, Aktiengesetz (2002), a leading short commentary.
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247
contributions to the shareholders irrespective of whether such payment would reduce the company's net assets to a level below its stated share capital. Secondly, mandatory rules are necessary in order to make a two-tier board work and to avoid the concentration of power into the hands of a US-style CEO or chairman. Thirdly, standardised and mandatory rules are necessary because of co-determination; the balance of power between representatives of capital and labour would not survive without mandatory rules on how these powers are exercised.^^ And fourthly, as will be discussed in Chap. 6 below, mandatory rules are generally necessary because of the participation of a large number of stakeholders in the monitoring of the Company. There are few signs of the scope of party autonomy being increased. When approving the Act on Control and Transparency of Enterprises (KonTraG)^^ the German parliament (Bundestag) applied the following basic principles: the adoption of flirther mandatory provisions in German Company law ought to be avoided as far as possible; and instead of strict legal directives, it would be preferable to leave companies to organise themselves and for control to be provided by the existing supervisory bodies and the markets. In reality, however, the KonTrag has already been followed by several legislative initiatives containing new mandatory provisions (see above). Consensus. The autonomy of a Single party or shareholder is to some extent constrained by the fact that the German model of the govemance of public limited-liability companies favours consensus. For example, the amendment of articles of association requires a majority of three-fourths of the registered capital of the Company at a general meeting;^^ both the supervisory board and the management board are collegiate bodies the members of which take decisions collectively; and the rules on co-determination make it unwise to take important decisions without the consent of shareholder representatives, employee representatives and the management. Further examples of the same phenomenom could be said to include the fact that the supervisory board is a way to institutionalise a network (it has been called "a relationship board");^^ the fact that statutory board members are supposed to carry out their duties not only for the benefit of shareholders (see Chap. 5.2.3 below); and the wide scope of the general duty of loyalty (see Chaps. 5.9.2 and 5.10 below). Co-determination. At first sight, co-determination gives the employees a relatively strong position with respect to corporate govemance. The relations between capital and labour are regulated at the Company level by the Co-determination Acts (Mitbestimmungsgesetze). These rules are mandatory.
^^ See Hirte H, Die aktienrechtliche Satzungsstrenge: Kapitalmarkt und sonstige Legitimationen versus Gestaltungsfreiheit, ZGR-Sonderheft 13 (1998) pp 64-67; Hommelhoff P, Schwab M, Regelungsquellen und Regelungsebenen der Corporate Govemance: Gesetz, Satzung, Codices, untemehmensinteme Grundsätze (2003) pp 52-53. ^^ Gesetz zur Kontrolle und Transparenz im Untemehmensbereich (1998). 52 § 179(2) AktG. 5^ Hopt KJ, The German Two-Tier Board: Experience, Theories, Reforms. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit p 234.
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Depending on business size and type, there are different forms of codetermination. As regards corporate govemance, the most striking is the membership of employee representatives in supervisory boards. The membership of employee representatives in supervisory boards is not regarded as politically controversial in Germany, although it is constantly being criticised by German managers. It is to be noted that the co-determination regime applies not only to AGs but also to other companies Umited by shares provided that the latter have more than 500 employees.^"* It does not apply to partnerships. There are three different Systems of membership of employee representatives in supervisory boards. There is a one-third model for companies with more than 500 employees; a full-parity model for coal and steel companies; and quasi-parity codetermination for companies with more than 2,000 employees. In the coal and steel industries, the full-parity System of the Iron and Steel Codetermination Act of 1951 (Montan-Mitbestimmungsgesetz, Montan-MitbestG) will apply. The Montan-MitbestG affects large firms with more than 1,000 employees. It obliges the supervisory boards of companies (Aufsichtsrat) to be made up equally of representatives of the employer and employees' representatives. There is also a "neutral" member. Normally, the supervisory board would consist of 11 members.^^ Five would be appointed by the employees and five by the shareholders. A further "neutral" member would be appointed by the majority of each side of the supervisory board.^^ In large companies, the model described as quasi-parity co-determination will apply. In 1976, co-determination was extended to all large corporations. The 1976 Co-determination Act (MitbestG) applies to companies outside the iron and coal industries with more than 2,000 employees. The number of supervisory board members and the representatives of each side are dependent on the size of the Company. Although the basic provision regarding the composition of the supervisory boards remains equal to that of the Iron and Steel Co-determination Act (Montan-MitbestG), decisive details restrict the influence of the workforce in this law. Firstly, one of the employees' representatives has to be an employee of the management level. In practice, that representative does not necessarily represent the interests of the employees. Furthermore, the chairman of the supervisory board cannot be nominated without the consent of representatives of the employer. The chairman can cast the decisive vote in tied situations. This model is described as "quasi-parity co-determination" because of this slight superiority of shareholders. In smaller and medium-sized companies, the one-third model will apply. This model is based on the Works Constitution Act of 1952 (Betriebsverfassungsgesetz, BetrVG). In public limited-liability companies with up to 2,000 employees, and in any other type of business with 500 - 2,000 employees, the share of work54 § 77 BetrVG 1952. See also § 76(6) BetrVG 1952. The example in Roe MJ, Political Preconditions to Separating Ownership from Corporate Control, Stan L Rev (2000) pp 548-550 was therefore not quite accurate. 55 § 4 Montan-MitbestG. See also § 9 Montan-MitbestG. 56 See § 8 Montan-MitbestG.
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ers' representatives on the Supervisory boards is one third. As two-thirds of the members are appointed by the shareholders, the majority of voting power is held by these members, and the employee representatives have a counselling role. Li smaller businesses, employees do not have any extended influenae on management. Nevertheless, employees can form workers' Councils (Betriebsrat) in any enterprise with more than five employees. These Councils have a voice in social and personnel matters. The law commits workers' Councils to cooperate with companies rather than to seek confrontation. It expHcitly forbids exertion of pressure on companies. The Works Constitution Act ensures representation of both unionised and non-union workers, but because of high levels of unionisation in Germany, Union members dominate most Councils. The Betriebsrat can be seen as a constraint on the govemance of companies rather than a body governing the Company. The Betriebsrat has a right to be consulted. Some actions - especially actions in the social area - require the consent of the Betriebsrat in order to be effective.^'^ But the Betriebsrat cannot take care of the internal decision-making of the Company or represent it in its dealings with third parties and Company insiders.^^ Most of the employees' influenae occurs through the Betriebsrat. Co-determination enhances the effectiveness of the Betriebsrat bodies by giving employee representatives access to Information.^^ There are special provisions relating to senior officers (leitende Angestellte). For example, the Betriebsrat does not have any say in the appointment and removal of senior officers,^^ because the interests of senior officers are safeguarded by a committee called the Sprecherausschuß.^^ In addition, in companies subject to co-determination under the Co-determination Act (MitbestG), one of the members of the Supervisory board must represent senior officers.^^ There are also other statutory bodies. An undertaking with more than 100 employees must have an economic committee (Wirtschaftsausschuß). The Wirtschaftsausschuß must be kept informed of "economic matters" of the Company.^^ It may be that the position of employees is not as strong as the idea of codetermination would suggest at first sight. For example, the representatives of employees in the supervisory board do not outnumber the representatives of shareholders, the supervisory board is not the organ that actually runs the Company, and the powers of the supervisory board are constrained by the mandatory provisions
5^ See especially §§ 87, 94, 95 and 112 BetrVG. 58 See Zöllner W, Loritz KG, Arbeitsrecht (1998) § 46 I. 5^ O'Connor MA, The Human Capital Era: Reconceptualizing Corporate Law to Facilitate Labor-Management Cooperation, Cornell Law Review 78 (1993) p 937. 60 § 5(3) BetrVG. 6^ § 25(1) SprAuG (Gesetz über Sprecherausschüsse der leitenden Angestellten). 62 §15(2)(3) MitbestG. 63 §106 BetrVG.
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of Company law. Furthermore, co-determination does not exclude the de facto influence of a Controlling shareholder or the Company's bank.^"^ It is also worth bearing in mind that firms will be able to avoid the codetermination regime under the SE Regulation.^^
5.2 Basic Governance Structure 5.2.1 Introduction The special features of the governance of a Single independent German public limited-liability Company (AG) include, for example, the role played by mandatory Company law, the statutory two-tier System, co-determination, the principle of collegiality in the representation of the Company intemally and extemally, the lack of a statutory sole managing director, and the formalistic approach to management. 5.2.2 The General Meeting In Germany, shareholders play a limited role in the management of large companies. For example, shareholders do not elect all members of the supervisory board, and it is not the purpose of this organ to represent the interests of shareholders only. The interests of shareholders are nevertheless safeguarded by mandatory mies that protect shareholders in general, minority shareholders,^^ or individual shareholders.^'^ The shareholders vote at general meetings (Hauptversammlung).^^ In most routine cases, a simple majority of the votes actually cast is sufficient.^^ For example, ^ Roe MJ, Political Preconditions to Separating Ownership from Corporate Control, Stan LRev (2000) pp 567-568. ^^ See Kubier F, Leitungsstrukturen der Aktiengesellschaft und die Umsetzung des SEStatuts, ZHR 267 (2003) pp 227-228. 66 For example, a shareholders' meeting must be held at the request of a minority representing one-twentieth (5%) of the share capital. § 122(1) AktG. The same minority can get items on the agenda. § 122(2) AktG. The same minority can also decide on the bringing of proceedings in the event that the management board does not comply with these requests. § 122(3) AktG. A minority representing one-tenth (10%) of the share capital can also decide on the bringing of proceedings against defaulting members of the two statutory boards. § 147 AktG. ^^ For example, any dissenting shareholder can normally bring proceedings against the Company in the event that a resolution of the general meeting is void or voidable. §§ 241, 243 and 249 AktG. According to § 248(1) AktG, even other shareholders benefit from the judgment. A shareholder has a limited right to disclosure at the general meeting and the right to sue in the event that the management board breaches its duty of disclosure. §§ 131 and 132 AktG. Any individual shareholder has also preemptive rights to new shares under § 186(3) AktG and Article 29(1) of the Second Directive. 68 §118 AktG.
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the election of shareholder representatives to the supervisory board requires this majority. Some extraordinary matters require the approval of three-fourths (75%) of the capital represented at the meeting. The amendment of the articles of association belongs to this group.^^ German law imposes no quorum requirement for shareholders' meetings. The general meeting is one of the three "organs" of the Company (the two other being the supervisory board and the management board). According to the organ theory (Organtheorie) developed in the 19* Century by Otto von Gierke, a legal person is capable of acting on its own behalf: it acts through organs that are identified with the legal person itself. The organ theory affects also the language used in Company law. In German law, decisions are taken "by the general meeting" (this refers to the organ);^^ they can also be taken "at the general meeting" (this refers to the meeting). However, the organ theory is not part of UK Company law in this form,'^2 and it is normal to say that decisions are taken "by the Company in general meeting", "by shareholders in general meeting", or "at the general meeting". The general meeting is not regarded as the "highest" or "supreme" organ of an AG, because its powers were restricted in the Aktiengesetz of 1937 in order to make the management of large companies more efficient. The powers of the general meeting are mainly based on the mandatory provisions of the Aktiengesetz. As a rule, the Aktiengesetz lists the categories of matters that the general meeting may decide on. To some extent these categories of matters can be listed in the articles of association. The general meeting may not decide on other matters.^^ The Aktiengesetz lists a number of powers that are vested in the general meeting.^^ There are only three items that will necessarily have to be voted upon at the annual general meeting of shareholders: (a) the amount of annual dividend, if any, that will be authorised; (b) a vote of "approval" with respect to the management board and the supervisory board; and (c) the appointment of the statutory auditor.75
In addition, the general meeting will, among other things: (d) appoint those members of the supervisory board who represent shareholder interests; (e) decide on the amendment of the articles of association; and (f) decide on several matters relating to the share capital of the Company and structural change. The articles of association can in principle vest further powers in the general meeting.^^ In practice, however, this is rarely possible due to the fact that the dis69 § 133 AktG.
70 §179(2) AktG. ''^ See for example § 119(1) AktG: "Die Hauptversammlung beschließt in den im Gesetz und in der Satzung ausdrücklich bestimmten Fällen ..." 7^ See for example Edwards V, Ultra Vires and Directors' Authority - An EC Perspective, Comp. Law. 16(7) (1995) pp 202-206. 73 §119 AktG. 74 See Hüffer U, Aktiengesetz (2002) § 119 R n 6 - 1 0 .
75 §119(1) AktG. 76 § 119(1) AktG.
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tribution of powers between different Company organs is based on the mandatory provisions of the Aktiengesetz and any powers not expressly vested in the general meeting by the provisions of the Aktiengesetz would easily breach the general provisions on the powers of the supervisory board and the management board.^*^ In particular, the general meeting may not decide on management matters unless required to do so by the management board.'^^ 5.2.3 The Two-tier System In an AG, management and the supervision of management have been separated by the mandatory provisions of the Aktiengesetz. The Aktiengesetz requires each Company to have two distinct boards. An AG has both a statutory management board (Vorstand) and a statutory supervisory board (Aufsichtsrat). The statutory management board is the organ that manages the Company's business and represents the company.^^ All members of the management board have an executive role in the Company; there are no non-executive directors in the management board. The statutory supervisory board appoints the members of the management board and supervises the company's management.^^ Members of the supervisory board do not have any executive role in that capacity. Members of the management board cannot serve as members of the supervisory board and vice versa, but the supervisory board may consist of, for example, representatives of the Company's employees and extemal managers. From early on, the statutory two-tier System has been regarded as superior to the one-tier System. In 1926, the idea of introducing a US type board System was discussed by the 34* Conference of German jurists^^ but rejected on the grounds that the dualistic System enabled companies to control powerful chairmen of management boards. In 1998, the Act on Control and Transparency of Enterprises (KonTraG) improved the work of supervisory boards without affecting the basic structure of public limited-liability companies (in particular the two-tier System and co-determination). In Germany, the two-tier System is not designed for the benefit of shareholders only. It is there also to protect the public interest,^^ and it is normal to say that members of the management board do not act in the interests of shareholders only. By law, members of the management board are expected and entitled to carry out their duties for the benefit of shareholders, employees and the society as a whole.^^ 77 See Hüffer U, Aktiengesetz (2002) § 119 Rn 10. '' §119(2). 79 § 76 AktG. 80 §111 AktG. 8^ Der 34. Deutsche Juristentag. 8^ See Hopt KJ, The German Two-Tier Board: Experience, Theories, Reforms. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit p 230. 8^ See Hüffer U, Aktiengesetz (2002) § 76 Rn 12; Leyens PC, Deutscher Aufsichtsrat und U.S.-Board: ein- oder zweistufiges Verwaltungssystem? Zum Stand der rechtsverglei-
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This rule was originally based on the Aktiengesetz of 1937.^'* Although there is no similar express provision in the present Aktiengesetz,^^ this rule applies as a general uncodified principle supported by some provisions of the German Constitution.^^ It is nevertheless worth noting that although statutory board members do not have a duty to act for the benefit of shareholders only, they do have a duty to act in the interests and for the benefit of the Company (Untemehmensinteresse). When doing so, statutory board members are expected to take into account the interests of the Company's stakeholders. The duty to take into account the interests of stakeholders is always subject to the interests of the company.^"^ Furthermore, the primary purpose of an AG is to make a profit because profitability is crucial to the long-term sustainability of its existence.^^ The importance of stakeholder interests should therefore not be exaggerated.
5.2.4 The Management Board The statutory management board is the body that by law runs the Company and represents the Company in its business dealings and legal affairs.^^ One of the most central statutory and mandatory rules on the govemance of a German AG is that the management board "directs the Company under its own responsibility".^^ This rule means many things. Firstly, it vests management powers exclusively in the management board. By law, the management board must take care of the actual management of the Company's affairs and its day-to-day business. Secondly, it limits the powers of other Company bodies. In particular, neither the supervisory board nor the general meeting have any power to take care of the
chenden Corporate Govemance-Debatte, RabelsZ 67 (2003) p 80: "Als Geschäftsführungsorgan har er nicht nur den Wünschen der Anteilseigner, sondern auch allen sonstigen im Unternehmen koalierenden shareholder- und stakeholder-Interessen Rechnung zu tragen (Koalitionsmodell)." ^"^ According to § 70 of the AktG of 1937, the management board had to manage the Company "wie das Wohl des Betriebes und seiner Gefolgschaft und der gemeine Nutzen von Volk und Reich es erfordern". See for example Loewenstein MJ, Stakeholder protection in Germany and Japan, Tul L Rev 16 (2002) p 1676. 85 See § 76 AktG. 8^ Articles 2, 12, 14 and 20 of the Constitution (Grundgesetz). 8^ See for example BGHZ 36, 296, 306 on the duties of nominee supervisory board members: "Entsandte Aufsichtsratsmitglieder haben dieselben Pflichten wie die gewählten Aufsichtsratsmitglieder. Als Angehöriger eines Gesellschaftsorgans haben sie den Belangen der Gesellschaft den Vorzug vor denen des Entsendungsberechtigten zu geben und die Interessen der Gesellschaft wahrzunehmen, ohne an Weisungen des Entsendungsberechtigten gebunden zu sein." 88 See Kuhner C, Untemehmensinteresse vs. Shareholder Value als Leitmaxime kapitalmarktorientierter Aktiengesellschaften, Z G R 2004 pp 2 5 0 - 2 5 1 . 89 §76(1) and §78 AktG. 90 § 76(1) AktG.
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management of the Company. According to the preparatory works, this outcome was intended.^^ Although the Aktiengesetz vests management powers in the management board only, in practice the limited powers conferred on the general meeting and the supervisory board do enable these two bodies to participate in the management of the Company in the broad sense. For example, the general meeting can take some fundamental decisions affecting the management of the Company, and it may decide on regulär management issues at the request of the management board.^^ xhe supervisory function of the supervisory board can be regarded as a category of the general management of the Company and includes decisions on a number of management matters. Chairman ofthe management board. The management board can have a chairman.^^ The chairman ofthe management board coordinates its work.^"* However, the chairman of the management board is basically one of many board members with one vote only. He cannot decide against the majority of the management board's members, and he has no power to give directions to other board members.^^ Some companies like large banks have decided against appointing any "chairman". Instead, they name a "spokesman" (Sprecher). The purpose of this practice is to emphasise the spokesman's role as primus inter pares in a collective decisionmaking body. For example, while Dresdner Bank AG has a chairman of the management board, Deutsche Bank AG and Commerzbank AG have a spokesman. Number. The number of management board members - either the exact number or the minimum and maximum number - is laid down by the articles of association. For a small AG with a statutory capital not exceeding € 3 million and to which co-determination is not applicable, the minimum number is one.^^ For an AG falling within the scope of the Co-determination Act, the minimum number is two due to the fact that the Company must have a director of human resources (Arbeitsdirektor). Sole managing director. Due to the statutory and mandatory rules on the management of the Company, a large AG cannot have a sole "managing director". By law, none of the members of the management board can have a position formally comparable to the position of the CEO of an Anglo-American Company (see below).
^^ The preparatory works ofthe Aktiengesetz 1937. See Amtliche Bergündung, Vorbemerkung zu den §§ 70-124. See also Fleischer H, Zur Leitungsaufgabe des Vorstands im Aktienrecht, ZIP 2003 p 3. 92 §119(2) Akte. 93 § 84(2) Akte. 9^ See also the German Corporate Govemance Code, Foreword. 95 See von Hein J, Vom Vorstandvorsitzenden zum CEO? ZHR 166 (2002) pp 489, 499, 501; Fleischer H, Zur Leitungsaufgabe des Vorstands im Aktienrecht, ZIP 2003 p 8. 96 § 76(2) AktG.
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Appointment. Members of the management board are appointed by the supervisory board for a period not exceeding five xcars.^*^ They may be reappointed. The supervisory board also decides on their remuneration. The chairman of the management board is appointed by the supervisory board like the other members of the management board.^^ Removal The supervisory board may oust members of the management board or the chairman of the management board prematurely for "important reasons" (wichtiger Grund).^^ Employment contracts and remuneration. In Germany, it is necessary to distinguish between the position of management board members in that capacity and their position in the capacity of a contract party. The termination of board membership does not necessarily end the contractual relationship. When drafting board members' contracts of employment, it is thus necessary to keep in mind the fliture expiry of the board membership.^^^ The supervisory board both decides on the employment contracts (Anstellungsvertrag) and remuneration of management board members and represents the Company in its dealings with management board members.^^^ According to a mandatory rule of the Aktiengesetz, the remuneration of each management board member must be reasonable in light of the functions of the member in question and the Situation of the Company. ^^^ It can be noted that members of the management board are not treated as employees. Labour laws do not apply to members of the management board because they are deemed to represent the interests of the employer.^^^ Independence, Management board members cannot be "independent" since the management board is the body that is expected to run the Company and each member of the management board is a senior executive. There are nevertheless statutory provisions that seek to prevent them from acting in their own interest only, and many internal rules have the same effect.^^"^ The provisions of the Aktiengesetz lay down for example the following mandatory duties: members of the management board have a duty to take into account the interests of shareholders, employees and creditors and also the public interest; members of the management board have a duty of care to the company;^^^ no management board member may vote on a matter that concems the formal approval of his own acts or in which he has a material interest;^^^ they may not grant
97 §84(l)AktG. 98 § 84(2) AktG. 99 § 84(3) AktG. ^00 Senne in Kasseler Handbuch (1997) 4.1 .Rz 11-14. ^01 See § 112 AktG. 102 § 87(1) AktG. See also the German Corporate G o v e m a n c e Code, item 4.2.2. ^^^ See for example Zöllner W , Loritz K G , Arbeitsrecht (1998) p 4 6 - 4 7 ; Kasseler Hand-
buch (1997) 4.1.Rz 2-5. 104 See § 82(2) AktG. 105 § 93 AktG. 106 See also § 181 BGB.
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loans from the Company to each other;^^'^ and they may not compete with the Company. ^^^ Delegation of powers. As a rule, the management board may not delegate its power to run the Company. It is therefore necessary in German law to determine many concepts related to the running of the Company.^'^^ There are still different views on the core duties that may not be delegated to sub-board executives.^^^ Some functions may nevertheless be delegated for example to a sub-board "executive committee". The wording of the Aktiengesetz implies that for the purposes of this Act, the management board shall "lead" the Company (Leitung)^ ^^ by taking care of its "management" (Geschäftsführung)*^^ and by "representing" the Company in its dealings with other parties extemally and intemally (Vertretung)."^ The interpretation of the first two concepts is still unclear. In older sources, the focus is on to what extent these powers can or cannot be delegated in the articles of association. Modem studies tend to discuss various details of the running of the Company but not the main principles of delegating or outsourcing the management functions.**"^ In any case, the specific provisions of the Aktiengesetz indicate that there are at least some things that belong to the core duties of the management board and therefore cannot be delegated: the BGH uses the term "management decisions" (Leitungsentscheidungen)."^ Some of the duties that cannot be delegated relate to the internal Organisation of the Company as a legal person, are in the public interest, or Protect the interests of creditors.**^ For example, they include: the duty to ^^'^ According to § 89 AktG, the supervisory board will decide on loans to management board members. 108 § 88 AktG. 109 See Hüffer U, Aktiengesetz (2002) § 76 Rn 7-8. 110 See Fleischer H, Zur Leitungsaufgabe des Vorstands im Aktienrecht, ZIP 2003 p 2; Götz J, Corporate Govemance multinationaler Konzerne und deutsches Untemehmensrecht, ZGR 2003 p 11. 1" § 76(1) AktG: "Der Vorstand hat unter eigener Verantwortung die Gesellschaft zu leiten." 112 § 77(1) AktG: "Besteht der Vorstand aus mehreren Personen, so sind sämtliche Vorstandsmitglieder nur gemeinschaftlich zur Geschäftsführung befugt." 113 § 78(1) AktG: "Der Vorstand vertritt die Gesellschaft gerichthch und außergerichtUch." 11^ See Fleischer H, Zur Leitungsaufgabe des Vorstands im Aktienrecht, ZIP 2003 p 2. "5 BGHZ 149, 158. See also Semler J, Die Rechte und Pflichten des Vorstands einer Holdinggesellschaft im Lichte der Corporate Govemance-Diskussion, ZGR 2004 p 639. ^^^ Fleischer H, Zur Leitungsaufgabe des Vorstands im Aktienrecht, ZIP 2003 p 6: "Vorstandspflichten, die der verbandsintemen Funktionsfähigkeit dienen, ihm in öffentlichen Interesse aufgeben sind oder vornehmlich Gläubigerinteressen sichern, zählen zu den organschaftlichen Mindestzuständigkeiten, die nicht delegierbar sind." See also Art. 716a(2) Nr. 6 and 7 OR (Obligationenrecht, the Swiss Civil Code) about the duties of the administrative organ that may not be delegated: "Der Verwaltungsrat hat folgende unübertragbare und unentziehbare Aufgaben: 1. die Oberleitung der Gesellschaft und die Erteilung der nötigen Weisungen; 2. die Festlegung der Organisation; 3. die Ausgestaltung des Rechnungswesens, der Finanzkontrolle sowie der Finanzplanung, sofern diese für die Führung der Gesellschaft notwendig ist; 4. die Ernennung und Abberufung der
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see that accounts are kept and that there is a control System;'^"^ the duty to call a general meeting due to losses and to file for insolvency;"^ the general duty to call a general meeting; ^^^ the duty to prepare and enforce resolutions of the general meeting;^^^ the duty to submit proposals for each question on the agenda ofa general meeting;^^^ the right to refer management matters to the general meeting;^^^ the duty to report to the supervisory board;^^^ and the duty to submit the annual accounts and the annual report to the supervisory board.^^"^ These specific provisions are complemented by § 76(1) AktG that lays down an important rule on the general responsibilities of the management board. There are thus even other matters the delegation of which is subject to restrictions. When interpreting this general rule, it is probably possible to distinguish between decision-taking on one hand and the preparation and technical execution of the decision on the other.^^^ While the power and duty of the management board to take a decision cannot be delegated, the preparation and technical execution of the decision can. For example, the management board should put an effective control System into place by deciding on this System and appointing sub-board officers to operate it, but the details of the System can be left to sub-board officers. ^^^ The management board being a collegiate organj^^"^ the Aktiengesetz restricts the delegation of powers to individual management board members. Members of the management board are jointly responsible for running the Company There are some exceptions to this rule, and some intemaP^s QJ. extemaP^^ powers may be delegated to individual board members. The Aktiengesetz does not permit the delegation to sub-board executives of the power to take management decisions, but the Act does permit the delegation of management functions; in particular, sub-board executives can be authorised to mit der Geschäftsführung und der Vertretung betrauten Personen; 5. die Oberaufsicht über die mit der Geschäftsführung betrauten Personen, namentlich im Hinblick auf die Befolgung der Gesetze, Statuten, Reglemente und Weisungen; 6. die Erstellung des Geschäftsberichtes sowie die Vorbereitung der Generalversammlung und die Ausführung ihrer Beschlüsse; 7. die Benachrichtigung des Richters im Falle der Oberschuldung." 1^7 §91 AktG. 1^8 §92 AktG. 119 §121(2) AktG. 120 § 83 AktG. 121 § 124(3) AktG. 122 §119(2) AktG. 123 § 90 AktG. 124 § 170 AktG. 12^ Fleischer H, Zur Leitungsaufgabe des Vorstands im Aktienrecht, ZIP 2003 p 6. 12^ See Fleischer H, Zur Leitungsaufgabe des Vorstands im Aktienrecht, ZIP 2003 p 6. 127 §§ 76(1) and 77(1) AktG. 128 § 77(1) AktG: "... Die Satzung oder die Geschäftsordnung des Vorstands kann Abweichendes bestimmen; es kann jedoch nicht bestimmt werden, daß ein oder mehrere Vorstandsmitglieder Meinungsverschiedenheiten im Vorstand gegen die Mehrheit seiner Mitglieder entscheiden." 129 § 78(3) AktG.
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prepare and execute management decisions.^^^ These are actually acts regulated by labour laws. What happens when the management board delegates management functions to sub-board exeecutives is that the employer represented by the management board gives directions (Weisungen) under labour laws.^^^ Many duties remain even after the management board has delegated management functions to sub-board officers. The remaining duties of the management board relate to supervision, direction and control.^^^ The management board may also to some extent delegate management functions to extemal parties, because the Aktiengesetz does not prohibit the outsourcing of management functions as regards non-core activities (obvious examples could include cleaning or security). On the other hand, the outsourcing of these activities is permitted only provided that: the Company does not choose its contract party without being satisfied that the supervision of these activities is appropriate; the contract gives the management board a right to obtain Information conceming the outsourced activities; and the management board still can, on a contractual basis, give directions on the running of the outsourced function.^^^ In banking law, there is a specific provision that permits the outsourcing of IT but specifies risk management principles.^^"^ The permissibility of contracts for the outsourcing of management and the permissibility of the delegation of powers in corporate groups will be discussed in Chap. 5.9.5 below. The fettering of discretion will be discussed in Chap. 5.5 below.
^30 See Fleischer H, Zur Leitungsaufgabe des Vorstands im Aktienrecht, ZIP 2003 p 8; Götz J, Corporate Govemance multinationaler Konzerne und deutsches Untemehmensrecht, ZGR2003pp 13 and 17-18. ^^^ See Fleischer H, Zur Leitungsaufgabe des Vorstands im Aktienrecht, ZIP 2003 p 8. ^^^ Fleischer H, Zur Leitungsaufgabe des Vorstands im Aktienrecht, ZIP 2003 p 8. Interestingly, when discussing the management duties of German board members, Fleischer mentions the Delaware case Grimes v. Donald, 20 Del J Corp L 757 (Del. Ch. 1995). In this case it was said: "Absent specific restriction in the certificate of incorporation, the board of directors certainly has very broad discretion in fashioning a managerial structure appropriate in its judgment to moving the Corporation toward the achievement of corporate goals and purposes." Furthermore, "while a board may delegate powers subject to possible review, it may not abdicate them". Compare also Cahall v. Longland, 114 A. 224, 229 (Del. Ch. 1921): "The duties of directors are administrative, and relate to supervision, direction and control, the details of the business being delegated to inferior officers, agents and employees. This is what is meant by management." 133 BGH NJW 1982, 1817 (Holiday Inn). See Fleischer H, Zur Leitungsaufgabe des Vorstands im Aktienrecht, ZIP 2003 p 10; Paefgen WG, Unternehmerische Entscheidungen und Rechtsbindung der Organe in der Aktiengesellschaft (2002) p 20. 134 § 25a(2) KWG (Banking Act); see also § 5(3) Nr. 4 VAG (Insurance Supervision Act) and § 1(3) BörsG (Stock Exchange Act).
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The Lack ofa Sole Managing Director (CEO) The present legislation does not provide for a sole managing director although it is possible for small companies to have a management board consisting of one board member only. In practice, foreigners often consider the chairman of the management board (or, especially in German banks, the spokesman for the management board, Sprecher des Vorstandes) equivalent to the CEO within the structures of other countries. This is however not quite correct due to the principle of collegiality. Whether to introduce a sole managing director (CEO) or not has been discussed in Germany since the Weimar repubhc. The Handelsgesetzbuch of 1897 set out that the management board consisted of one or more persons^^^ but was silent on the management board's internal Organisation. In practice, companies chose either the principle of having a powerful chairman who authorised the acts of other board members (Generaldirektorsprinzip) or the principle of equality meaning that the chairman was no more than primus inter pares having no more powers than any other member (Gleichberechtigungsprinzip). In the 1920s, it was decided not to follow US Company law and not to introduce a sole managing director as it was feared that this would further increase the power of the chairman. ^^^ The Aktiengesetz of 1937 combined the idea of a US-type CEO with the national socialist principle of one dominant leader (Führerprinzip). The management board as a whole was dominant as regards the distribution of power between different organs of the Company. Furthermore, the chairman was dominant as regards the internal Organisation of the management board. The Aktiengesetz of 1937 gave the chairman the power to decide alone, if the members were not unanimous and this power had not been excluded in the company's articles of association.^^*^ According to the Aktiengesetz of 1937, the chairman could be empowered to sign for the Company alone.^^^ In 1965, these special powers of the chairman, which had in fact been inspired by the role of the CEO in US companies, were abolished as part of the remnants of the national socialist ideology. The new Aktiengesetz of 1965 set forth that in a management board consisting of several members, the members could manage the Company only collectively.^^^ The dominant role of the management board was nevertheless not abolished. In some German companies, the role of the chairman can in practice be close to the role of the CEO in the USA. The explanation can be sought in the internal culture of the Company (for example, the Americanization of corporate govemance Systems) or the personality of the chairman rather than the extemal regulation of corporate govemance in Germany. ^^^ § 231(2) HOB of 1897: "Der Vorstand kann aus einer oder mehreren Personen bestehen." 136 Verhandlungen des 34. Deutschen Juristentags (Köln 1926); cited in von Hein J, Vom Vorstandvorsitzenden zum CEO? ZHR 166 (2002) pp 473-474. 137 §70(2)(2) Akte of 1937. 138 § 71(2) AktGof 1937. 139 §77(1)(1) Akte.
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Distribution of Management Responsibiiities within tiie Management Board Instead of a sole statutory managing director, all members of the management board (Vorstand) are senior executives each with his own management responsibiiities. The management board could just as well be called (and sometimes is called) the board of managing directors. There are no mandatory management board committees, but the Aktiengesetz permits the distribution of responsibiiities within the management board to be organised in many ways.^^^ Each management board member is normally responsible for a different function in the Company (Ressortprinzip). These functions can consist of centralised functions (Zentralbereiche) or divisions (Sparten). For example, the management board of DaimlerChrysler AG could consist of executives responsible for the following divisions or centralised functions: Mercedes Gar Group; Chrysler Group; Commercial Vehicles; Human Resources & Labour Relations; Global Procurement & Supply; Finance & Controlling; Services; Research & Technology; and Corporate Development. On the other hand, the Aktiengesetz permits very un-German executive structures like that of Deutsche Bank AG.^"^^ The four members of the management board of Deutsche Bank are senior executives coUectively responsible for the management of the whole Company, the chairman acting in effect as a CEO. In addition to the statutory management board, there is a non-statutory Group Executive Committee made up of the members of the management board and the business heads from the group divisions.^"^^ The Group Executive Committee reviews the development of the businesses, discusses matters of group strategy and prepares recommendations for final decision by the board of managing directors. The management and organisational structure of HVB Group, a bank, attempts to draw a line between Strategie management of the Group and operative responsibility for individual business segments. The management board of the parent, Bayerische Hypo- und Vereinsbank AG, is the group board in Charge of the Strategie development of the business segment portfolio, resource and capital allocation, and business segment Controlling. Operational decisions are made by the board for the respective business segment under the chairmanship of the management board member responsible. The bank is divided into three business segments: Germany, Austria & Central and Eastem Europe, and Corporates & Markets. The management board of the parent thus consists of a spokesman, a Chief Risk Officer (CRO), a Chief Financial Officer (CFO), a member responsible for the business segment Germany, a member responsible for the business segment Corporates &
^40 See Fleischer H, Zur Leitungsaufgabe des Vorstands im Aktienrecht, ZIP 2003 p 7. ^^^ The Deutsche Bank model has been discussed in German literature. See Götz J, Corporate Govemance multinationaler Konzerne und deutsches Untemehmensrecht, ZGR 2003 pp 9-10. ^^^ See Götz J, Corporate Govemance multinationaler Konzerne und deutsches Untemehmensrecht, ZGR 2003 p 11-12.
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Markets, and a Chief Operating Officer (COO) who is also responsible for the business segment Austria & CEE. Companies with more than 2,000 employees must normally have a director of human resources (Arbeitsdirektor)^"^^ as set out in the Co-determination Acts.^"^"* The management board can take decisions only as a collegiate organ.^"^^ Although the management responsibilities have been distributed between different management board members, each member of the management board is under a duty to control the acts of other management board members and, if necessary, intervene. The position of the chairman of the management board is basically the same. 5.2.5 The Supervisory Board The statutory supervisory board (Aufsichtsrat) is an institutionalised way to control management.^"^^ The supervisory board is mandatory for an AG.^"^"^ The principal functions of the supervisory board have been set out in the Aktiengesetz. Independence. Unlike in the UK and US, the focus is not on the independence of individual supervisory board members. It is generally accepted that members of the supervisory body can represent different constituencies, for example the Company's employees orbank. Under German law, the focus is on the independence of the supervisory board as a Company body. The independence of the supervisory board is safeguarded by institutional measures, in particular by mandatory provisions of the Aktiengesetz on: the two-tier board structure; the composition of the supervisory board; the distribution of powers between different Company organs; and the duties of supervisory board members. The most important rule safeguarding the independence of the supervisory board is that a member of one of the two statutory boards cannot simultaneously be member of the other. This means that the supervisory board is at least not directly dominated by the company's own executives because members of the body responsible for the running of the Company (the management board) are excluded from supervisory board membership. In addition, there is no formal way for the management board or its individual members to make nominations for the supervisory board. Formally, most nominations for supervisory board positions emanate from the supervisory board itself. On the other hand, some factors often make the supervisory board look less independent in foreign eyes.
^43 76(2) AktG. ^^ §§ 1 and 33(1) MitbestG 1976. See also § 13(1) Montan-MitbestG. 145 §77(1)(1) AktG. i46§ 111 AktG. ^'^'^ For GmbHs it is either optional under § 52(1) GmbHG or mandatory under the codetermination regime, see § 77(1) BetrVG 1952 and § 25(1) MitbestG.
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Up to half of the supervisory board members must be representatives of Company employees. Some of these representatives can be trade union representatives, and some Company employees. Under German law, all employee representatives are considered to be sufficiently independent because of the focus on the independence of the supervisory board as a whole. However, the independence of employee representatives is safeguarded also by statutory and mandatory rules prohibiting both discrimination against them and their preferential treatment. For example, under the case law of the Federal Supreme Court (Bundesgerichtshof, BGH), employee representatives may not be excluded from the committees of the supervisory board without an important reason because doing so would violate the mandatory provisions of German law prohibiting discrimination.^"*^ Employee representatives who continue to be on the Company's payroll are not considered to be less independent than the trade union representatives on the supervisory board who do not receive any such payments from the Company. - The employee members would not technically meet the independence requirements of the US Sarbanes-Oxley Act. It is not yet clear to what extent a German AG may exclude employees from the supervisory board's audit committee to flilfil the independence requirements of the Sarbanes-Oxley Act without violating German law.^'*^ In practice, the membership of employee representatives in the supervisory board under the co-determination regime has often been criticised as a factor that prevents the supervisory board from acting as a real collegiate organ that controls management.^^^ It is also quite usual that the previous chairman of the management board is appointed more or less automatically as chairman of the supervisory board. Even this practice has been criticised, although the independence of the supervisory board as a whole is more important than the independence of its individual members or chairman under German law. The close contacts between the supervisory board (especially its chairman, see below) and the management board help the supervisory board to take care of its supervisory and advisory role in the Company, but may also make the supervisory board less likely to criticise actions the supervisory board has been involved in. Multiple supervisory board memberships are permitted. One person may be a supervisory board member in up to ten other companies, although this would be very rare and most supervisory board members are members of one supervisory
148 BGHZ 122, 342. 1"*^ See Scheffler E, Aufgaben und Zusammensetzung von Prüfungsausschüssen (Audit Committees), ZGR 2003 pp 260-261; Kersting C, Auswirkungen des Sarbanes-OxleyGesetzes in Deutschland: Können deutsche Unternehmen das Gesetz befolgen? ZIP 2003 pp 238-239. According to these authors, employee membership can be excluded. 150 See for example Roe MJ, Political Preconditions to Separating Ownership from Corporate Control, Stan L Rev (2000) p 568.
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board only.^^^ After the KonTraG, the chairmanship of a supervisory board is counted as two memberships.^^^ The German Code on Corporate Govemance addressed the matter of independence of supervisory boards. Inadequate independence was perceived as a problem. According to the Code, the supervisory board as a whole should be sufficiently independent to advise and supervise the management board. ^^^ This requires that supervisory board members have the required knowledge, abilities and expert experience to properly complete their tasks.^^"* The members should also be sufficiently independent^^^ in the sense that "not more than two former members of the Management Board shall be members of the Supervisory Board and Supervisory Board members shall not exercise directorships or similar positions or advisory tasks for important competitors of the enterprise".^^^ In addition, each member of the supervisory board should have sufficient time to perform his mandate.^^"^ Powers. The main rule is that the supervisory board may not take decisions that belong to the operative management of the Company (Geschäftsführung).^^^ It is not the purpose of the supervisory board to interfere with the Company's day-today business. The main flinctions of the supervisory board are to supervise the management board (Aufsicht) and to provide independent advice to it (Rat).^^^ The supervisory board monitors the management board both ex ante and ex post. For this reason, the supervisory board also has a right to comprehensive information from the management board.^^^ In addition, the supervisory board has several other powers.^^^ Many of these relate to the duty to disclose information to shareholders (see Chap. 5.6.2 below). Supervision. Some of the powers of the supervisory board could be classified as de facto management powers. The supervisory board is responsible for the appointment, supervision, and removal of members of the management board (Vorstand), that is, the company's most senior executive officers.^^^ Some of these powers extend to other companies. If an AG owns at least 25% of shares in another Company and both companies are subject to the co^^^ Hopt KJ, The German Two-Tier Board: Experience, Theories, Reforms. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit pp 242-243. ^^^ See also the German Corporate Govemance Code, item 5.4.3: "... Members of the Management Board of a listed Company shall not accept more than a total of five Supervisory Board mandates in non-group listed companies." ^53 See item 5.4.2. 154 See item 5.4.1. 155 See item 5.4.1. 156 Item 5.4.2.
i5Mtem 5.4.3. 158 § lll(4)AktG. 159 § lll(l)AktG. 160 § 9 0 AktG.
161 See Hüffer U, Aktiengesetz (2002) § 111 Rn 1. 162 §§ 84, 111 and 77(1) AktG. See also § 246(2) AktG (Anfechtungsklage) and § 249(1) AktG (Nichtigkeitsklage).
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determination regime, the supervisoiy board of the AG also decides on the appointment and removal of the board members of the other Company.^^^ In these cases, only employer representatives may vote. The supervisory board is usually involved in major corporate transactions and the development of long-range Company goals. The articles of association of the Company may provide that certain categories of transactions require the supervisory board's prior consent. In addition, the supervisory board may decide that certain categories of transactions are subject to its prior consent. If the consent is refused, the management board may appeal the decision to the general meeting.^^ Key management board decisions - such as major acquisitions, divestments, and financial transactions - regularly require supervisory board approval. The German Code on Corporate Govemance recommends that the consent of the supervisory board should be required for transactions of fundamental importance, such as "measures which fundamentally change the asset, financial or eamings situations of the enterprise".^^^ The extent of these de facto management powers vested in the supervisory board depends on the extent of discretion that is has. The supervisory board has business discretion in business decisions (Geschäftsführungsentscheidungen), but the extent of this discretion varies. While some of the powers of the supervisory board are veto rights, others can be desbribed as initiation rights, (a) The supervisory board has more discretion as regards the Contents of the decision, if the supervisory may take the decision without the management board having submitted any proposal. For example, the supervisory board may choose whom to appoint as a management board member. (c) In most cases, however, the supervisory board has little discretion as regards the contents of the decision. The supervisory board may either approve the proposal submitted by the management board or refuse its consent. ^^^ (c) If the decision is a decision on the supervision of the management board (Überwachungsentscheidung), the powers of the supervisory board are limited by the powers and business discretion of the management board. If members of the management board breach the law, the supervisory board must prevent it and has no discretion in this respect; on the other hand, the supervisory board has discretion to choose the methods. Generally, the supervisory board has business discretion to choose whether to (1) give advice or (2) decide that certain categories of transactions are subject to its prior consent (and then refuse the consent). If the management board fails to comply with the latter decision, the supervisory board
^63 § 32(2) MitbestG. ^^"^ § 111(4) AktG. For example, § 13(4) of the articles of association of Siemens AG provides that "[t]he supervisory board may require that certain kinds of action taken by the Managing Board shall be subjected to its approval". ^^^ The German Corporate Govemance Code, 3.3. 166 See for example Semler J, Entscheidungen und Ermessen im Aktienrecht. In: Festschrift für Peter Ulmer (2003) p 629.
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must react and again has no discretion in this respect; on the other hand, the superisory board has business discretion as regards the proper method.^^'^ The supervisory board has extensive rights to information. The management board must keep the supervisory board informed of important matters on a regulär basis. The Aktiengesetz provides that the management board shall report to the supervisory board on: the intended business poHcy and other fundamental matters regarding the future conduct of the Company's business (especially conceming budgeting, investments and personnel); the profitability of the Company, in particular the retum on equity; the State of business, in particular revenues and the condition of the Company; and transactions which may have a material impact upon the profitability or liquidity of the Company. ^^^ In addition, the chairman of the supervisory board must be notified of other signiflcant developments as soon as they they occur. Such significant developments also include circumstances conceming the business of an affiliated enterprise which become known to the management board and which may have a material impact upon the condition of the Company. ^^^ The supervisory board reviews the Company's quarterly reports, annual report, and Consolidated financial Statements, as well as audits performed by independent auditors.^*^^ The supervisory board may inspect and examine the books and records of the Company; the supervisory board may also commission individual members or, with respect to specific assignments, special experts to carry out such inspection and examination.^"^^ The supervisory board also has a large number of other supervisory powers. For example, the supervisory board represents the Company in its dealings with management board members and decides whether to sue them.^'^^ other supervisory powers include the power to decide on loans to managers. A Company may not grant credit to its management board members without the consent of the supervisory board;^^^ the same mies apply to holders of a general commercial power of attomey (Prokuristen).^'^'* There are specific provisions on the granting of credits to the managers of connected companies.^^^ Advice. As the supervisory board monitors the management board ex ante, the giving of independent advice is an important supervisory tool.^*^^
^^^ See Semler J, Entscheidungen und Ermessen im Aktienrecht. In: Festschrift für Peter Ulmer (2003) pp 630-631; Roth GH, Worte U, Die Unabhängigkeit des Aufsichtsrats Recht und WirkHchkeit, ZGR 2004 p 568. 168 § 90(1) AktG. 16^ § 90(1)(4) AktG. i7o§§lll(2)andl71 AktG. 171 § 111(2) AktG. 172 §112 AktG. 173 § 89(1) AktG. 174 § 89(2) AktG. 175 § 89(2) AktG. 176 See Hüffer U, Aktiengesetz (2002) § 111 Rn 5.
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The supervision ofsub-board managers. As discussed above, the Aktiengesetz provides that the supervisory board supervises the management board and that the latter keeps the supervisory board informed of the management of the Company. In principle, even other persons (Sachverständige, Auskunftspersonen) can report to the supervisory board on individual matters.^^^ As a rule, however, the approach of the Aktiengesetz is that the management board has an exclusive right inside the Company to disclose information to the supervisory board regarding management matters.^"^^ The supervisory board may not supervise sub-board managers.^"^^ Neither have sub-board managers any statutory duty to disclose information to or be supervised by the supervisory board; these duties can only be based on an employment contract.^^^ On the other hand, the power of the supervisory board to appoint members of the management board^^^ means that the supervisory board must contact even subboard managers in order to evaluate them and follow the career of potential management board candidates.^^^ There are no provisions on direct contacts between the supervisory board and sub-board managers in the German Corporate Govemance Code.^^^ Chairman ofthe supervisory board. In practice, the chairman of the supervisory board holds an influential position. The provisions of the Aktiengesetz normally lead to close contacts between the chairman and the management board. ^^"^ Firstly, the chairman of the supervisory board has the normal responsibilities of the chairman of a collegiate body (coordinating work within the supervisory board, preparing meetings, chairing meetings and so forth). Like chairmen of other collegiate bodies, the chairman of the supervisory board can influence the information available to members of this body and set its agenda.^^^ Secondly, the chairman of the supervisory board is the representative of the supervisory board in its contacts with the management board and individual management board members. For example, the management board notifies the chairman of the supervisory board of significant developments both in the Company and in affiliated companies (conceming such developments in the latter provided that they have a material impact on the Company).^^^ There are also regulär reports made to the supervisory board. i'77§§ 109(1) and 111(2) AktG. 178 § 90 AktG. i*^^ Dreher M, Direktkontakte des Aufsichtsrats in der Aktiengesellschaft zu dem Vorstand nachgeordneten Mitarbeitern. In: Festschrift für Peter Ulmer (2003) pp 87-88. 180 Dreher M,ibidp 98. 181 § 84 AktG. 182 Dreher M, Direktkontakte des Aufsichtsrats in der Aktiengesellschaft zu dem Vorstand nachgeordneten Mitarbeitern. In: Festschrift fiir Peter Ulmer (2003) pp 100-101. 183 See also Dreher M, ibid p 91. 184 See Hüffer U, Aktiengesetz (2002) § 107 Rn 5; Hopt KJ, The German Two-Tier Board: Experience, Theories, Reforms. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit p 245. See also the German Corporate Govemance Code, item 5.2. 185 See Hüffer U, Aktiengesetz (2002) § 107 Rn 5. 186 § 90(1)(4) AktG.
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In addition, the articles of association can provide that the chairman has a tiebreaking vote.^^"^ This makes the position of the chairman particularly important in large public limited-liability companies where the model described as quasi-parity co-determination applies under the Co-determination Act of 1976. Decision-making. For a quorum, the majority of all members must be present.^^^ Most decisions require basically the majority of votes cast at the meeting,^^^ unless the articles of association provide otherwise. Statutory law can provide for special majority rules.^^^ Some have been set out in the Co-determination Act. Some special majority rules are necessary because of co-determination and the membership of employee representatives in the supervisory boards of many companies belonging to the same group. The Co-determination Act provides that members of the management board are appointed by a majority of two-thirds of all members of the supervisory board;^^^ if such a majority cannot be reached, a committee of the supervisory board will submit a new proposal which will be decided on by a simple majority votes cast.'^^ According to the Co-determination Act, the same majority is required for the appointment of the chairman of the supervisory board. A similar procedure is applied in the event that this majority cannot be reached.^^^ In groups of companies, some decisions will be taken by the votes of employer representatives in order to balance the cumulative effect of the membership of employee representatives in the supervisory boards of companies belonging to the same group.^^^ Committees. As a rule, there are no mandatory supervisory board committees. The only exception is the mediation committee required by the Co-determination Act. This committee will act in the rare case that a member of the management board cannot be elected on the first attempt.^^^ The supervisory board may form committees although there is no legal Obligation to do so. The formation of committees is at the supervisory board's discretion. The duties and powers of a supervisory board committee are normally determined by the supervisory board in a committee regulation (Ausschuss-Ordnung).^^^ Because of the statutory two-tier board structure, a supervisory board committee does not have a supervisory function within the board itself ^^^ The purpose of these committees is to prepare the meetings of the supervisory board and submit proposals that the supervisory board will decide on.^^^ The su187 See Hüffer U, Aktiengesetz (2002) § 108 Rn 8. 188 § 108(2) AktG. 189 See Hüffer U, Aktiengesetz (2002) § 108 Rn 6. 190 See Hüffer U, Aktiengesetz (2002) § 108 Rn 7. i9i§31(2)MitbestG 192 § 31(3) MitbestG. 193 § 27 MitbestG. 194 §§ 32(1) and 32(2) MitbestG." 195 §§ 31(3) and 27(3) MitbestG. 19^ Schefflet E, Aufgaben und Zusammensetzung von Prüfungsausschüssen (Audit Committees), ZGR 2003 p 247. 197 See Scheffler E, ibid p 237.
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pervisory board may also delegate decision-making powers to committees to the extent that it has not expressly been prohibited in the Aktiengesetz.^^^ For example, a committee might prepare the election of the chairman of the supervisory board, the appointment of members of the management board, and the appointment of the chairman of the management board, but the committee would not be able to decide on these matters. A supervisory board committee must have at least three members.^^^ The System of co-determination also affects the composition of committees of the supervisory board. The German Federal Supreme Court of Justice (Bundesgerichtshof, BGH) has held that employee representatives must not be excluded from committees.^^^ For example, the audit committee of Siemens AG comprises three shareholder representatives and two employee representatives. Of the latter, one is a trade union representative, the other an employee of the Company. According to the German Code of Corporate Govemance, the use of committees should be increased; committees "serve to increase the efficiency of the supervisory board's work and the handling of complex issues''.^^^ JI^Q Code provides that the supervisory board should set up an audit committee which, in particular, handles "issues of accounting and risk management,^^^ the necessary independence required of the auditor, the issuing of the audit mandate to the auditor, the determination of auditing focal points and the fee agreement''.^^"* In addition to an audit committee, the supervisory board could delegate other matters to be handled by one or several committees. These matters include "the strategy of the enterprise, the compensation of the members of the management board, investments and financing".^^^ The supervisory board could also arrange for committees "to prepare supervisory board meetings and to take decisions in place of the supervisory board".^^^ The supervisory board of DaimlerChrysler AG has formed three committees in accordance with its articles of association: the Presidential Committee (Präsidialausschuss), the Audit Committee (Prüfungsausschuss), and the Mediation Committee (Vermittlungsausschuss). The Presidential Committee is responsible for deciding on Service contracts and other contractual matters in relation to the 198 § 107(3) AktG. 199 § 107(3) A k t G prohibits the delegation o f powers mentioned in §§ 107(1)(1), 59(3), 77(2)(1), 84(1)(1), 84(1)(3), 84(2), 84(3)(1), 111(3), 171, 314(2), 314(3) as well as the power o f the supervisory board to decide on matters that belong to a certain category. For matters that can b e delegated see Hüffer U , Aktiengesetz (2002) § 107 R n 18. 200 § 108(2) AktG; see for example Hüffer U , Aktiengesetz (2002) § 84 R n 13.
201 BGHZ 122, 342. See also Hoffmann D, Preu P, Der Aufsichtsrat (2003) p 40. 202 Item 5.3.1.
203 See also § 91(2) AktG on the duties of the management board: "Der Vorstand hat geeignete Maßnahmen zu treffen, insbesondere ein Überwachungssystem einzurichten, damit den Fortbestand der Gesellschaft gefährdende Entwicklungen früh erkannt werden." 204 Item 5.3.2. T h e chairman o f the audit committee should not b e a former m e m b e r of the management board of the Company. 205 Item 5.3.3. 206 Item 5.3.4.
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management board and the supervisory board. It also assists the chairman and vice chairman of the supervisory board. The Audit Committee is responsible for deliberating the interim accounts as well as the annual financial Statements and the Consolidated financial Statements of DaimlerChrysler. The Audit Committee is entitled to instruct the independent auditor and to determine the emphasis of the auditing. In addition, the Audit Committee gives recommendations to the supervisory board on the appropriation of net profits. The Mediation Committee was established by the supervisory board pursuant to its obligations under the Codetermination Act.^^^ Meetings ofthe supervisory board. Any member of the management board may ask the chairman to call a meeting ofthe supervisory board.^^^ The supervisory board is expected to meet at regulär intervals. However, the supervisory board must meet only a minimum of four times per year.^^^ Supervisory board committees will normally convene more frequently. Appointment. The supervisory board must have at least three but no more than 21 members. According to the Aktiengesetz, the number of members must be divisible by three and is dependent on the Company's registered capital, and the maximum number of members permissible in an AG with a share capital of more than € 10 million would be 21.^'^ However, this is without prejudice to codetermination. In practice, the number of supervisory board members in large companies is determined by legislation on co-determination.^^^ As stipulated by the mandatory provisions ofthe 1976 Co-determination Act (MitbestG), up to one half of the members of the supervisory board represent Company employees and the rest shareholders. Members of the supervisory board must therefore be elected in two different ways. While shareholders' representatives are elected at the annual general meeting,2^2 employee representatives are elected by a Conference of employee delegates. The modalities of the appointment of employee representatives have been set out in quite detailed federal regulations issued in 2002 by virtue of the Codetermination Act (MitbestG).^^^
207 §§ 31(3) and 27(3) MitbestG. 208 § 1 1 0 ( 1 ) AktG. 209 § 110(3) AktG. See also Andre TJ, Cultural Hegemony: T h e Exportation of AngloSaxon Corporate G o v e m a n c e Ideologies to Germany, Tul L R e v 73 (1998) p p 158-159. 210 § 95 AktG.
211 § 95 AktG; § 7 MitbestG; § 4 MontanMitbestG; § 5 MontanMitbestErgG. See Hüffer U, Aktiengesetz (2002) § 95 Rn 6. For the average size of supervisory boards see Prigge S, A Survey of German Corporate Govemance. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit p 955. 212 § 101 AktG.
213 § 39 MitbestG. Erste Wahlordnung zum Mitbestimmungsgesetz (1. WOMitbestG); zweite Wahlordnung zum Mitbestimmungsgesetz (2. WOMitbestG); dritte Wahlordnung zum Mitbestimmungsgesetz (3. WOMitbestG).
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The employee representatives have to be employees of the Company, with the exception of two or three trade union representatives.^^"* At least one employee representative has to be recruited from the group of officers of the Company.^^^ German law prohibits both discrimination and any preferential treatment of these employee representatives.^^^ The AktG also provides for liability of those persons who abuse their influence on members of the supervisory board to induce them to act to the disadvantage of the Company or its shareholders.^^^ Although employee representatives on the supervisory board are solely elected by the employees, they have to act in the interests of the Company as a whole (Untemehmensinteresse). They are in other words not elected to only fürther the employees' interests. Appointment ofthe chairman ofthe supervisory board. The supervisory board elects one of its members as chairman.^^^ The Aktiengesetz requires only the simple majority of votes cast or the majority set out in the articles of association. However, the Co-determination Act both requires a majority of two-thirds of all members and lays down the procedure to be followed when this majority cannot be reached.^'^ Term, The maximum term of office of supervisory board members is approximately five years. The Aktiengesetz lays down the maximum term,^^^ and the articles of association can provide for a shorter term. Within these limits, the body electing supervisory board members can at the same time regulate their term of office.221 Removal. Supervisory board members appointed by the general meeting may be removed by the general meeting before the expiry of this term. Such a decision requires a majority of three-fourths unless the articles of association provide for a smaller or larger majority. ^^^ The removal of employee representatives appointed by virtue of the Codetermination Acts is govemed by the provisions ofthose acts. The employee representatives may be removed by the employees who elected them with a majority of three-fourths of votes cast.^^^ The court may, at the request of the supervisory board, remove a supervisory board member - both an employer representative and an employee representative - for important reasons relating to the person ofthat member. ^^4 Remuneration. The remuneration of supervisory board members can be regulated by the articles of association or decided on by the general meeting.^^s For ex2^4 § 7(2) MitbestG. 215 § 15(1) MitbestG. 216 § 2 6 MitbestG.
217 §117 AktG. 218 §107(1) AktG. 219 § 27 MitbestG. 220 § 102(1) AktG.
221 See Hüffer, Aktiengesetz (2002) § 102 Rn 3. 222 §103(1) AktG. 223 See for example § 23(1) MitbestG. 224 § 103(3) AktG.
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ample, each member of the supervisory board might receive an annual compensation and reimbursement of his actual out-of-pocket expenses. Employee representatives employed by the Company still receive their ordinary salary during their period on the supervisory board. This is because employee representatives on the supervisory board must not be hindered in carrying out their duties and not disadvantaged as a result of their activities. The same applies to their career development.^^^ On the other hand, as German law prohibits both discrimination and any preferential treatment of employee representatives on the supervisory board, employee representatives employed by the Company receive their ordinary salary only. They do not receive any extra compensation compared to other employees. The trade union representatives on the supervisory board do not receive any payments from the Company apart from the compensation granted to all members of the supervisory board. According to a mandatory rule of the Aktiengesetz, the remuneration of supervisory board members must be reasonable in light of the functions of the supervisory board members and the Situation of the Company.^^T
5.2.6 Prokurist A German AG can employ holders of a general commercial power of attomey (Prokurist, in plural Prokuristen). This power of attomey (Prokura) gives wide powers to bind the Company in its dealings with third parties,^^^ but a Prokurist is not an organ. A Prokurist is normally an employee of the Company or its "servant" (Handlungsgehilfe).22^ A person is not regarded as a Prokurist by reason of his employment or position only.
5.2.7 The Location of Management In a German public limited-liability Company, it is relatively easy to determine the location of top management. This is because the distribution of powers between different Company organs is regulated by the mandatory provisions of the Aktiengesetz. The allocation of decision-making over the Company's business policy is basically not a matter to be regulated by the articles of association. Management board. The Aktiengesetz provides that an AG shall be managed by the management board acting as collegiate body. The management board may not delegate this core duty to other Company bodies. All members of the manage-
225 226 227 228 229
§ llSAktG. § 26 MitbestG. §113(1) AktG. § 49 HGB. § 59 HGB.
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ment board are senior executives, and there are no non-executive management board members with a monitoring role only. Although the management board may not delegate its own core duties to other bodies, it can delegate other duties. Since the management board is responsible for the "management of the Company" (Leitung der Gesellschaft), it is necessary to interpret this term in order to find out which duties cannot be delegated. One could say that it is clear that the management board is the corporate body that runs a German AG, but it is rather unclear what running the Company means.^^^ Unlike a British public limited-liability Company, a German AG cannot formally have a "managing director", that is, an executive board member or the most senior executive to whom the power to take care of the day-to-day management of the Company has been delegated. Sometimes the role of the chairman can in practice resemble that of the CEO in USAJK companies for other than strictly legal reasons. Board members and sub-board managers. Although the delegation of matters that belong to the "management of the Company" is as a rule prohibited, most management functions can be and are delegated to individual management board members or sub-board managers. Prokurist. Below management board level, a German AG typically employs several Prokuristen. The Company is not run by its Prokuristen. On the other hand, the Prokura normally identifies persons who are regarded as senior managers of the Company and being given a Prokura is regarded as a step up on the career ladder. Instead of a Prokura, the Company can give a general power of attomey (Handlungsvollmacht) .2^ ^
5.3 The Importance of Statutory Ruies 5.3.1 Introduction The two most important sources of rules on the management of a German AG are the Aktiengesetz and labour law. The role of contracts is limited. The Aktiengesetz is the most important source of specific rules on the management of a German AG at the highest management level. The provisions of the Aktiengesetz are largely mandatory. The scope of these provisions goes hand in hand with the fact that the Company is actually run by its statutory organs. The provisions of the Aktiengesetz do not directly regulate the activities of sub-board managers or employees. The statutory rules of the Aktiengesetz govem both the internal decisionmaking of the Company and the representation of the Company in its dealings with third parties. There are both penal sanctions and civil sanctions for their breach. These rules can be binding either directly or indirectly. They can be said to be in230 See Fleischer H, Zur Leitungsaufgabe des Vorstands im Aktienrecht, ZIP 2003 p 2.
231 §54(1) HOB.
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directly binding for example where non-compliance in effect leads to the breach of other rules. In principle, shareholders are protected by these statutory and mandatory rules. Although the rights of shareholders in general meeting and the rights of individual shareholders to enforce them are limited, the limited rights left to shareholders are an important means for them to monitor management. Labour law is the most important source of rules on management below the level of the two statutory boards. The provisions of statutory labour law are largely mandatory. They are complemented by 57,000 collective agreements regulating the terms and conditions of employment with direct and mandatory effect under the Collective Agreements Act (Tarifvertragsgesetz, TVG) for the individuals bound by the collective agreement.^^^ One could therefore say that statutory labour law is flexible, but these collective agreements are not.^^^ On the other hand, collective agreements can be tailor-made for individual firms with the consent of the relevant union: both employers' associations and individual employers can conclude collective agreements, but only trade unions and their central organisations (Spitzenorganisationen) have capacity to conclude collective agreements on behalf of employees.^^"^ It is clear that contracts are an important in the govemance of a Company. However, it is also clear that there is less room for party autonomy if laws are both mandatory and prescriptive. As both the Aktiengesetz and labour laws are largely mandatory and detailed, this affects contract practice (for enterprise contracts see Chap. 5.9.5 below).
5.3.2 Effect on Board Members and the Statutory Auditor In addition to the Company, the statutory rules laid down by the Aktiengesetz are binding, either directly or de facto, on the members of its two statutory boards and on its auditor. They cannot be said to be binding on sub-board managers. In Germany, subboard managers are basically treated as employees. Like the activities of other employees, the activities of sub-board managers are govemed by labour laws. German labour law consists of a large body of statutory and other rules that are typically protective of employees, mandatory, and very detailed. There would thus be little room for the direct or analogous application of Company law rules below the level of the two statutory boards. It is perhaps not surprising that it is difficult to find any evidence of the penetration of Company law rules below this level of Company hierarchy. 232 § 3 TVG. 233 Frankfurter Allgemeine Zeitung 25 February 2005, „Das deutsche Arbeitsrecht ist ungeheuer flexibel". D i e künftige Präsidentin des Bundesgerichts, Ingrid Schmidt, i m Gespräch. 234 g 2 T V G . Graft trades associations and guilds also possess the capacity to conclude collective agreements under the Graft Trades Gode.
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Members of the management board are not treated as employees. Labour laws do not apply to members of the management board because members of the management board have no duty to comply with any specific directions given by the supervisory board^^^ (but can apply to managing directors of a GmbH who have a duty to comply with specific directions given by the shareholders). Management board members are thus deemed to represent the interests of the employer rather than be employees themselves.^^^ Penal Sanctions for Breach The Aktiengesetz contains some penal sanctions designed to help enforce its mandatory rules. The penal sanctions set out in the Aktiengesetz^^^ are normally imposed on members of the two statutory boards of the Company. In some cases, they also cover the activities of the founder, liquidator or statutory auditor of the Company and in exceptional cases the activities of shareholders or other persons. The penal sanctions set out in the Aktiengesetz are not imposed on sub-board managers. This may be understandable because one of the fundamental principles of the Aktiengesetz is that an AG is run by its management board. Civil Sanctions for Breacti There are civil sanctions for the breach of the Aktiengesetz. The same rules provide for civil sanctions for the breach of the company's articles of association. Civil sanctions are applied to breaches by the Company, members of the two statutory boards and shareholders, and they are indirectly applied to breaches by the company's auditor of his own duties. The mandatory distribution of powers within the Company makes it difficult for shareholders to bring proceedings against defaulting board members. In this case, the Company will normally be represented by one of its two statutory boards. Members ofthe management board. According to the Aktiengesetz, members of the management board owe a duty of care to the company.^^^ Compliance with the provisions of the Aktiengesetz and the articles of association is covered by this duty. In addition, the members must comply with the terms of their employment contracts.2^^ As this duty is owed to the Company, shareholders are not entitled to claim compensation for the breach of the Aktiengesetz or the articles of association. The Aktiengesetz nevertheless provides for liability for any loss sustained by the Company as a result of breach of duty. 2^^ § 76(1) AktG; see Mankowski P, Organpersonen und Internationales Arbeitsrecht, RIW 3/2004 p 169. 236 See for example Zöllner W, Loritz K G , Arbeitsrecht (1998) p 4 6 - 4 7 ; Senne in Kasseler Handbuch (1997) 4.l.Rz 2. 237 See §§399-408 AktG. 238 § 93 AktG. 239 See Hüffer U, Aktiengesetz (2002) § 93 Rn 13.
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As a rule, shareholders may not bring proceedings against members of the management board for breach of duty. In its dealings with management board members, the Company is represented by its supervisory board.^"*^ In some cases, the shareholders may bring proceedings against management board members for the breach of other rules. The shareholders may base their action on the general rules for tort liability, provided that they are within the protective ambit of the breached rule.^"^^ These rules relate, for example, to economic crime.^"^^ Even in this case, any compensation for the loss of the value of shares (Doppelschaden) will be paid to the company.^"*^ Members of the supervisory board. The provisions of the Aktiengesetz are binding on members of the supervisory board. The liability of supervisory board members is govemed by the same rules as the liability of management board members.^"*"* In proceedings against members of the supervisory board, the Company is normally represented by the management board and not by its shareholders.245
Shareholders. The provisions of the Aktiengesetz are binding on the shareholders. A resolution by shareholders in general meeting that violates the provisions of the Aktiengesetz is generally voidable,^'*^ and some resolutions are automatically void and of no effect.^'*'' For example, if a resolution on the disapplication of preemptive rights of is not carefully drafted, it may end up being found void (nichtig) or voidable (anfechtbar) by a court if contested by shareholder activists or the management board. In addition, the Aktiengesetz contains a general rule on the equal treatment of shareholders,^"^^ and this rule is complemented by case law on fiduciary duties that shareholders owe to the Company and other shareholders.^^^^ Breach of these duties can lead to a resolution being declared void or, in rare cases, liability for any loss sustained by the Company or the other shareholders.^^^ Shareholders and even third parties can be made liable, if they abuse their influence over the Company by causing a management board or supervisory board member to act to the detriment of the company.^^^ 240 § 112AktG. 241 § 823(2) BGB. See also § 826 BGB. 242 For example § 266 StGB and §§ 399 and 400 AktG; see Hüffer U , Aktiengesetz (2002) § 93 R n 19. 243 Hüffer, Aktiengesetz (2002) § 93 R n 19. 244 § 116 AktG.
245 § 78 AktG. 246 § 243 AktG. 247 § 241 AktG. 248 § 53a AktG. 249 See especially B G H Z 103, 184 at p 194 (Linotype), B G H Z 129, 136 at p 142 (Girmes) and B G H Z 142, 167 (Hilgers); Hüffer U, Aktiengesetz (2002) § 53a Rn 2. 250 See Hüffer U, Aktiengesetz (2002) § 53a Rn 19-22.
251 § 117(1) AktG. See also Hüffer U, Aktiengesetz (2002) § 117 Rn 3: "In Frage kommen zB: Aktienbesitz, Kredit- oder Lieferbeziehungen, Mitgliedschaft in Gesellschaftsorganen oder in AN-Vertretungen ..."
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The Company. The provisions of the Aktiengesetz are binding on the Company. For example, it is possible to sue the Company if its organs do not comply with the provisions of the Aktiengesetz that regulate the internal decision-making of the company,^^^ and transactions carried out by the Company are not necessarily binding on the Company where provisions of the Aktiengesetz have been breached.^^^ Auditors. The provisions of the Aktiengesetz do not bind the statutory auditors directly, but they do influence auditors' duties. For example, statutory auditors have a duty to inspect whether members of the management board have complied with the provisions of the Aktiengesetz on annual accounts^^"^ and Controlling Systems.^^^ 5.3.3 Effect on Sub-board Managers and Employees The Aktiengesetz does not regulate the management of the Company at all levels of Company hierarchy. The most important groups whose activities are not directly regulated by the Aktiengesetz are sub-board managers, other employees with management powers, and holders ofa Prokura. The provisions of the Aktiengesetz are not directly binding on sub-board managers and employees. The duties of a sub-board manager are based on an employment contract and labour laws that contain both mandatory and dispositive regulations. Contracts are complemented by directions (Weisungen) given by the employer.^^^ These directions are important because all modalities of employees' duties cannot be regulated in advance. The Aktiengesetz is not directly binding on "senior officers". German labour laws make a distinction between employees and senior officers (leitende Angestellte). The most important definition of senior officers can be found in the Betriebsverfassungsgesetz. Basically, senior officers are employees who manage the business.^^^ The Aktiengesetz is not directly binding on Prokuristen. The duties of a Prokurist are not regulated by the Aktiengesetz. A Prokurist is normally an employee and offen a senior officer (leitender Angestellte) according to German labour laws.^^^
5.3.4 Derogation from the Aktiengesetz In principle, it is not permitted to derogate from the provisions of the Aktiengesetz in the articles of association or by other internal rules.
252 See for example §§ 241 and 243 AktG.
253 See for example § 78 AktG. 254 § 317(1) H G B ; § 91(1) A k t G . 255 § 317(4) H G B ; § 91(2) AktG. 256 See for example H r o m a d k a W , Maschmann F, Arbeitsrecht, 2. Aufl. (2002) pp 1 7 5 - 1 8 1 . 257 § 5(3) BetrVG. § 5(4) BetrVG. 258 § 5(3) BetrVG. See also Senne in Kasseler Handbuch (1997) 4.1.Rz 28.
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Because of the principle of Satzungsstrenge,^^^ regulations in articles of association may not violate the provisions of the Aktiengesetz. However, regulations in articles of association that do so are not automatically void and of no effect.^^^ Where the articles of association are amended and the new regulations violate the provisions of the Aktiengesetz, the resolution to amend the articles is in most cases voidable^^^ (instead of void).^^^ Where no proceedings are brought within one month from the resolution, the resolution and the regulations in the articles of association cannot be contested and the breach is cured.^^^ Where the resolution is void, it and the regulations in the articles of association cannot be contested after the expiry of three years from the entering of the resolution in the trade register.^^^ Similar principles apply where the original articles of association violate the provisions of Aktiengesetz.2^^
5.4 The General Meeting and Internal Management 5.4.1 Introduction Like in the UK, there are many forms of shareholder activism. In principle, shareholders can influence the management of a public limited-liability Company either at a general meeting or otherwise. It is characteristic of AGs that shareholders have relatively limited formal powers to decide on general management matters. On the other hand, they have relatively large formal powers to decide on measures related to share capital or structural change. They also have meaningful powers to monitor management ex post (in addition to the usual monitoring powers ex ante), and relatively liberal rights to bring things on the agenda of a general meeting. In addition to the decision-making powers of the general meeting, shareholders have a number of rights both individually and together with other shareholders. (a) For example, each shareholder may: participate and express his opinion at a general meeting; vote at a general meeting;^^^ request verbal information from the management board at a general meeting;^^*^ enforce thisright;^^^contest the valid259 § 23(5) AktG. 2^^ See Hommelhoff P, Schwab M, Regelungsquellen und Regelungsebenen der Corporate Govemance: Gesetz, Satzung, Codices, untemehmensinteme Grundsätze (2003) p 53. 261 § 243(1) AktG: "Ein Beschluß der Hauptversammlung kann wegen Verletzung des Gesetzes oder der Satzung durch Klage angefochten werden." 262 § 241 AktG. 263 § 246(1) AktG: "Die Klage m u ß innerhalb eines Monats n a c h der Beschlußfassung erhoben w e r d e n . " 264 § 242(2) AktG: "Ist ein Hauptversammlungsbeschluß nach § 241 Nr. 1,3 oder 4 nichtig, so kann die Nichtigkeit nicht mehr geltend gemacht werden, wenn der Beschluß in das Handelsregister eingetragen worden ist und seitdem drei Jahre verstrichen sind ..." See also § § 2 4 2 ( 1 ) and 130 AktG.
265 § 242(2) AktG; BGHZ 144,365. 266 § 134 AktG. 267 § 131 AktG.
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ity of resolutions of the general meeting;^^^ nominate persons for election to the supervisory board; contest the validity of the composition of the supervisory board;^*^^ ask a court to appoint a member of the supervisory board;^^' and ask a court to determine the compensation payable under a profit transfer agreement.^^^ (b) Shareholders holding 5% (one-twentieth) of the shares have further rights in the Company. Typically, this group of shareholders may demand a general meeting and items to be put on the agenda. (c) Shareholders holding more than 25% (onefourth) of the shares have a right of veto with regard to many important resolutions. In particular, resolutions relating to share capital often require a majority of at least 75% (three-fourths) of the shares represented and a simple majority of the votes cast at the general meeting. For the same reason, shareholders holding more than 25%) (one-fourth) of the shares can block resolutions to amend the articles of association. As regards the rule-making powers of the general meeting, the most important pieces of direct shareholder rule-making include: the articles of association; decisions relating to share capital, structural change and "fundamental matters" (Grundlagenentscheidungen); and decisions on the appointment and removal of those supervisory board members who represent shareholders and of the statutory auditor. It is nevertheless important to keep in mind that the direct rule-making powers of the general meeting are quite limited in management matters. The statutory and mandatory division of powers between different Company organs and the statutory and mandatory co-determination are the most important factors that restrict the powers of the general meeting.^^^
5.4.2 General Remarks on the Division of Powers The general meeting, the supervisory board and the management board do not form a hierarchical chain of organs, and the general meeting is not the "highest" or "supreme" organ of the company.^^"* The powers of the general meeting are in practice the powers that have been specifically vested in it by the provisions of the Aktiengesetz^"^^ and related acts such as the Transformation Act (Umwandlungsgesetz, UmwG). The most important tasks of the general meeting listed in the Aktiengesetz are: the appointment of members of the supervisory board (or the members represent268 §§ 131, 132(2) and 326 AktG. 269 §§ 243 and 245 AktG as well as §§ 241 and 249 AktG. 27^ § 98(2)(3) AktG.
271 §104(1) AktG. 272 § 304 AktG. 273 See for example Hommelhoff P, Schwab M , Regelungsquellen u n d Regelungsebenen der Corporate G o v e m a n c e : Gesetz, Satzung, Codices, u n t e m e h m e n s i n t e m e Grundsätze ( 2 0 0 3 ) p 52. 274 See Hüffer U, Aktiengesetz (2002) § 118 Rn 4 .
275 § 119 AktG. See also Hüffer U, Aktiengesetz (2002) § 119 Rn 7-9.
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ing shareholder or employer interests in companies to which the Co-determination Act applies);^'^^ the appointment of auditors;^^^ the approval of the amount and number of profit distributions;^^^ decisions on any change of the Company's share capital;^'^^ and decisions on the amendment of the articles of association.^^^ Measures that relate to share capital and must be decided on by the general meeting include, for example, decisions not to apply the pre-emptive rights of existing shareholders to a certain allotment of shares,^^^ the increase of the share capital for the purpose of issuing stock options to the management board, and the approval of share buybacks. The Umwandlungsgesetz provides for a number of ways to carry out structural change. It applies to the merger of two or more businesses (Verschmelzung), the Splitting of a whole or parts of a business (Spaltung), and, the change of the legal form without transferring assets or liabilities to another entity (Formwechsel). These transactions typically require the consent of shareholders in general meeting. This means that many fundamental matters require the prior consent of shareholders in general meeting. These specific provisions of the Aktiengesetz and the Umwandlungsgesets are complemented by the Holzmüller principle that applies to decisions on "fundamental matters" (Grundsatzentscheidungen).^^^ In addition, shareholders have an opportunity at the annual general meeting to approve or disapprove of the actions that members of each board have taken during the past financial year (Entlastung).^^^ According to the wording of the Aktiengesetz, additional powers could in principle be conferred on the general meeting in the articles of association, but this is seldom possible. The powers of the supervisory board and the management board are based on mandatory provisions, and these powers are wide due to the generality of the wording of the relevant provisions of the Act.^^'* 5.4.3 Procedure of Decision-making Shareholders exercise their voting rights at annual general meetings or extraordinary general meetings. Although general meetings are to a large extent controlled by the management board, large shareholders may call a general meeting and get items onto the agenda, and any shareholder may submit counter proposals.
276§§ioiandll9(l)(l)AktG. 277 §§ 119(1)(4) and 119(1)(7) AktG. 278§119(l)(2)AktG. 279 §119(1)(6) AktG. 280 §119(1)(5) AktG. 281 § 186(3) AktG. 282 B G H Z 83, 122.
283 § 120 AktG. 284 See Hüffer U, Aktiengesetz (2002) § 119 R n 10.
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Power to call a general meeting. A general meeting is normally called by the management board. The management board may always call a general meeting.^^^ The management board must call a general meeting under the Aktiengesetz or the company's articles of association "when the good of the Company so requires".^^^ For example, the management board must call a general meeting when a matter arises which, according to the provisions on the distribution of powers between different Company organs, must be decided on by the general meeting.^^"^ The management board must call annual general meetings. The annual general meeting must be held each year within eight months of the end of the financial year. The meeting is normally held in Germany at the place where the AG has its registered office. In addition, the supervisory board must call a general meeting "when the good of the Company so requires".^^^ Large shareholders holding in the aggregate at least one-twentieth of the share capital (5%) are permitted to ask the management board to call a general meeting of shareholders. The shareholders must have held this stake for more than three months. These shareholders must notify the management board of the purpose of the meeting and the reasons why a meeting is necessary.^^^ If the management board falls to call the meeting, a court may empower these shareholders themselves to call the meeting.^^^ The shareholders can hold a general meeting any time without observing the general rules on how to call the meeting, provided that all shareholders are present or represented at the meeting and no shareholder objects to holding the meeting.^^i This would be unlikely in a listed Company. Getting items onto the agenda. The bodies that may cause a general meeting to be called can also get items onto the agenda. The management board can thus always get items onto the agenda. There are four formal ways for shareholders to do the same. Large shareholders may ask the management board to call a general meeting (see above). In addition, large shareholders can get items onto the agenda although the meeting has been called by another body. The threshold for getting items onto the agenda is lower than the threshold for asking a general meeting to be called. Shareholders holding in the aggregate at least one-twentieth (5%) or € 500,000 of the share capital may submit a proposal and ask the Company to notify the other shareholders in advance that the proposal has been made.^^^ Furthermore, any shareholder may submit a counter proposal (Gegenantrag). A counter proposal is a proposal that Supplements or opposes that of the manage285 §121(2) Akte. 286 § 121(1) AktG. 287 See Hüffer U, Aktiengesetz (2002) § 121 R n 3 .
288§lll(3)AktG. 289 § 122(1) AktG. See also the reference to § 147(1) AktG. 290 § 122(3) AktG.
291 §121(6) AktG. 292 § 122(2) AktG.
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ment.^^^ Such proposals are frequent in widely held companies, because: they may be submitted by any shareholder regardless of the number of shares held; there is no limit on the number of proposals that may be submitted by any particular shareholder; and companies have little control over the subject matter of counter proposals that appear on their agendas. In practice however, a formal vote on the shareholders' proposal is normally not taken because the management's own proposals tend to prevail. Shareholders may also nominate candidates to the supervisory board.^^"^ Both the management board and the supervisory board must normally submit separate proposals relating to each item on the agenda. For example, when a shareholder gets his proposal onto the agenda, the management board and the supervisory board will each submit its ov^n proposal.^^^ These proposals do not need to be identical. Costsfor the meeting. As a rule, all costs for a general meeting are paid by the Company. This includes costs for the preparation and distribution of the call to the meeting, agenda, and proposals.^^^ The purpose of this rule is to protect minority shareholders. Quorum. German lav^ imposes no quorum requirement for general meetings. Attendance at German annual meetings is traditionally quite lov^, and a relatively small percentage of the outstanding shares could in principle carry a vote v^hen the matters to be considered are relatively less important.^^*^ Resolutions. As a rule, each share carries one vote.^^^ Multiple voting rights are not permitted. There may nevertheless be different classes of shares. An AG can issue both common shares (Stammaktien) and preferred shares (Vorzugsaktien). These shares can be issued either as bearer shares (Inhaberaktien) or registered shares (Namensaktien). Preferred shares may be non-voting. Only half of the registered share capital may be composed of preferred shares without voting rights.^^^ At a general meeting, decisions are made by a simple majority of votes unless: mandatory law requires a greater majority (normally three-fourths); the law requires the consent of certain shareholders; or the articles provide otherwise. Most routine matters require a majority of the votes actually cast at the shareholders' meeting, unless the articles of association provide for a larger majority.^^^
^^^ § 126 AktG. See also Andre TJ, Cultural Hegemony: The Exportation of Anglo-Saxon Corporate Govemance Ideologies to Germany, Tul L Rev 73 (1998) pp 93-94. 294 §§ 126 and 127 AktG. See also Donald D C , The Nomination of Directors under U.S. and German Law, Institute for L a w and Finance, Johann Wolfgang Goethe-Universität Frankfurt, Working Paper Series N o . 21 (2004) p 35. 295 § 124(3) AktG. 296 § 122(4) AktG; see Hüffer U, Aktiengesetz (2002) § 122 R n 13. 297 See Andre TJ, Cultural Hegemony: The Exportation o f Anglo-Saxon Corporate G o v e m ance Ideologies to Germany, Tul L Rev 73 (1998) p 90. 298 § 12 AktG. 299 § 139(2) AktG. 300 § 133 AktG; see Hüffer U , Aktiengesetz (2002) § 133 R n 15.
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Sometimes the Aktiengesetz also requires the majority of the outstanding capital.301 The amendment of the articles of association requires normally a majority of three-fourths (25%) of the share capital represented at a general meeting^^^ in addition to a simple majority of votes cast.^^^ Matters affecting the capital structure of the Company - such as change of share capital, issue of convertible bonds, mergers and the liquidation of the Company - normally require the same majority.^^"* This majority is also required for a resolution to disapply the pre-emptive rights of existing shareholders to a certain allotment of shares.^^^ The consent of individual shareholders affected by the decision is required for example where the rights of preferred shareholders are affected or where the resolution is in breach of the principle of equal treatment of shareholders.^^^ Procedure. The Aktiengesetz contains several rules on the procedure of a general meeting. For example, there are rules on: the notice of calling a general meeting;^^*^ the Obligation of members of the two statutory boards and the auditor to participate;^^^ the list of participants;^^^ the drafting of minutes;^^^ the disclosure of information to shareholders;^" and the use of voting rights.^^^ The articles of association can contain more detailed rules on the modalities of these matters,^^^ and in most cases they do. For example, the Aktiengesetz only provides that a general meeting should have a chairman,^^"^ but is silent on how the chairman should be designated. It is also possible for shareholders in general meeting to complement these rules by internal guidelines. The general meeting may issue guidelines that are in force for future general meetings (Geschäftsordnung),^^^ or guidelines only for that particular meeting. The possibility to issue internal guidelines was introduced by the KonTraG in order to revitalise general meetings. However, internal guidelines, which were in fact possible even before the KonTraG,^^^ are so far rare and have little practical importance.^^^ One of the reasons could be that the guidelines would
301 See Hüffer U , Aktiengesetz (2002) § 133 Rn 13. 302 § 179(2) AktG. 303 § 133(1) AktG. See Hüffer U, Aktiengesetz (2002) § 179 R n 14. 304 § 182 AktG. See Hüffer U, Aktiengesetz (2002) § 182 R n 7. 305 § 186(3) AktG. See Hüffer U, Aktiengesetz (2002) § 186 Rn 2 1 . 306 See Hüffer U, Aktiengesetz (2002) § 179 Rn 2 1 . 307 §121 AktG. 308 §§ 118(2) and 176(2) AktG. 309 § 129(1) AktG. 310 § 130 AktG.
311 §§ 131, 175(2), 175(3), 176(1) AktG. 312 § 133 AktG. 313 See §§ § 118(2), 121(2), 121(5), 123, 134(3) and 134(4) AktG. 314 § 130(2) AktG. 315 § 129(1) AktG. 316 See Hüffer U, Aktiengesetz (2002) § 129 Rn 17. 317 See Hüffer U, Aktiengesetz (2002) § 129 R n 1 a and b.
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largely describe what is already binding under the Aktiengesetz and the articles of association. Voting and proxy voting. Shareholders may participate in a general meeting provided that they are listed in the share register^^^ and the possible requirements laid down by the articles of association have been met. The articles of association can provide for the prior notification of attendance or the deposit of bearer shares.^^^ According to the German Corporate Govemance Code, each shareholder should nevertheless be entitled "to participate in the general meeting, to take the floor on matters on the agenda and to submit materially relevant questions and proposals".^^^ The Aktiengesetz permits proxy voting.^^^ The Aktiengesetz also provides that shareholders must be made aware of the possibility of proxy voting.^^^ According to the German Corporate Govemance Code, the Company should both "facilitate the personal exercising of shareholders' voting rights" and "assist the shareholders in the use of proxies".^^^ Most votes in large companies are cast by proxy. A shareholder thus does not have to appear at the meeting in person. There are different ways to use proxies in Germany. Two of the most important groups of proxies are banks and the management. In 1998, new legislation was passed in order to reduce the influence that banks could exercise over the shares of beneficial owners held in their custody accounts: the KonTraG enabled shareholders' associations (Vereinigungen von Aktionären) to act as competing proxy agents.^^"* In practice, however, the role of shareholders' associations is still limited. The Aktiengesetz contains specific provisions on banks as proxies.^^^ A depository bank holding shares in custody normally owes a duty to its customers to act as a proxy if the customer instructs the bank so to do.^^^ The bank must also suggest how the customer's voting rights could be used and ask for the customer's directions.^^^ Banks owe fiduciary duties to their customers.^^^ According to the Ak-
318 § 67(2) Akte. 319 § 123(2) Akte. 32^ The German Corporate Govemance Code, 2.2.3. 321 § 134(3) AktG. 322 §§ 125(1) and (2) AktG. See Hüffer U, Aktiengesetz (2002) § 125 R n 3: "Regelung wird nichts bewirken, ist aber auch nicht schädlich."
323 The German Corporate Govemance Code, 2.3.3. 324 §§ 125(1), 128(5) and 135(9) AktG; see Roth G H , D i e (Ohn-)Macht der Hauptversammlung. Oder: Unlautere Werbung für Aktienrecht, Z I P 2003 p p 3 7 3 - 3 7 4 ; Donald D C , The Nomination o f Directors under U . S . and German Law, Institute for L a w and Finance, Johann Wolfgang Goethe-Universität Frankfurt, Working Paper Series N o . 21 (2004) p 37.
325 § 135 AktG. 326 § 135(10) AktG. 327 § 128(2) AktG. See also § 135(8) AktG. 328 See Donald D C , The Nomination of Directors under U.S. and German Law, Institute for L a w and Finance, Johann Wolfgang Goethe-Universität Frankfurt, Working Paper Series N o . 21 (2004) p 39.
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tiengesetz, a bank must vote according to the directions given by each customer,^^^ and it is liable for loss sustained by a customer by reason of a breach of duty.^^^ In addition, banks have extensive disclosure obligations.^^^ Normally, banks back the proposals submitted by the two statutory boards.^^^ Few shareholders instruct banks to vote against the management.^^^ The Aktiengesetz also contains specific provisions on the management as proxy. According to the Aktiengesetz, the Company can arrange for the appointment of a representative to exercise shareholders' voting rights in accordance with their instructions.^^"* In this case, the proposals submitted by the two statutory boards would not be filtered by banks.^^^ The German Corporate Govemance Code recommends that the management board should arrange for these representatives.^^^ Voting by electronic means, The NaStraG allowed companies to offer proxy voting via the Internet. It is at the moment not possible for shareholders to vote by electronic means without being physically present at a general meeting or without being represented by a proxy. While Communications to shareholders can be sent by electronic means and the articles of association or the internal guidelines of the Company (Geschäftsordnung) can provide that a general meeting is transmitted audiovisually,^^"^ the legislator has not taken the final step to permit voting via the Intemet.^^^ According to the German Corporate Govemance Code, the Company should make it possible for shareholders to follow a general meeting by using modern communication media (such as the Intemet).^^^
5.4.4 Articles of Association The articles of association (Satzung) cover the relationship between the Company and its founders and shareholders, the internal decision-making of the Company and the representation of the Company in its dealings with third parties. 329 § 135(5) AktG. See also § 135(8) AktG.
330 § 135(1 l)AktG. 33^ See also Donald DC, The Nomination of Directors under U.S. and German Law, Institute for Law and Finance, Johann Wolfgang Goethe-Universität Frankfurt, Working Paper Series No. 21 (2004) pp 37-38. 332 See § 124(3) AktG; Donald D C , The Nomination o f Directors under U.S. and German Law, Institute for L a w and Finance, Johann Wolfgang Goethe-Universität Frankfurt, Working Paper Series N o . 21 (2004) p 37. 333 Roth G H , Die (Ohn-)Macht der Hauptversammlung. Oder: Unlautere W e r b u n g für Ak-
tienrecht, ZIP 2003 p 373. 334 §134(3) AktG. 335 See Roth GH, Die (Ohn-)Macht der Hauptversammlung. Oder: Unlautere Werbung für Aktienrecht, ZIP 2003 p 374. 336 j i i e German Corporate Govemance Code, 2.3.3.
337 §118(3) AktG. 338 See Roth G H , Die (Ohn-)Macht der Hauptversammlung. Oder: Unlautere Werbung für Aktienrecht, ZIP 2003 p 375. 339 The German Corporate Govemance Code, 2.3.4.
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Compared with the articles of association of a UK Company, the articles of a German Company are rather short and not very detailed. The articles of association of Siemens AG, a large German Company, contain 13 pages and 25 short paragraphs. The articles of association of BMW AG contain 12 pages and 25 short paragraphs, and the articles of association of DaimlerChrysler AG, a Company that has its roots in both Germany and the USA, 15 pages and 24 short paragraphs. The autonomy of the shareholders is effectively limited by the principle of Satzungsstrenge set out in § 23(5) of the Aktiengesetz. According to this principle, the articles of association may deviate from the provisions of the Aktiengesetz only where the Act expressly permits it, and the articles of association may contain additional regulations only on condition that the matter has not been fliUy regulated by the provisions of this Act.^"^^ In light of the amount of rules laid down by the Aktiengesetz and related case law and the prescriptive nature of these rules, there is little room for additional regulations in the articles. The Contents of the articles of association are therefore quite predictable. The articles of association: (a) must contain certain mandatory regulations; (b) normally contain some non-mandatory regulations which would not be enforceable otherwise; and (c) may contain additional regulations if expressly permitted by the Act. The articles of association must set out at least the name and registered seat of the Company, its purpose, the amount of its share capital, the par values of shares, the classes of shares (one or more classes), number of shares allocatable to each dass (if there is more than one dass), whether the shares are registered shares or shares issued to bearer, and the number of board members or how their number shall be determined.^"^^ The Aktiengesetz sets out that many internal rules of the Company, in order to be enforceable, must form part of the articles. These regulations include, for example, the Obligation of shareholders to make contributions other than payment of capitaP"^^ and the power of members of the management board to represent the Company not only collectively but also solely.^"^^ There are some additional regulations not prohibited by the principle of Satzungsstrenge.^"*"* For example, the articles of association can provide for: the personal and professional qualifications of management board members; the maximum age of supervisory board members and the requirement that members must belong to the family that owns the Company; extended rights of Company
340 § 23(5) AktG.: "Die Satzung kann von den Vorschriften dieses Gesetzes nur abweichen, wenn es ausdrücklich zugelassen ist. Ergänzende Bestimmungen der Satzung sind zulässig, es sei denn, daß dieses Gesetz eine abschließende Regelung enthält." In English: "The articles m a y make different provisions from the provisions of this Act only if this Act explicitly so permits. T h e articles m a y contain additional provisions, except as to matters that are conclusively dealt with in this Act."
341 § 23(3) AktG. 342 § 55 AktG.
343 § 78(3) AktG. 344 § 23(5) AktG.
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bodies to information; the position of a honorary chairman of the supervisory board; and the position of a spokesman of the management board (Sprecher).^"^^ Some of the regulations prohibited^"^^ by the principle of Satzungsstrenge include regulations changing the following things: the grounds that make resolutions at a general meeting invalid;^'^'^ the right of shareholders to ask a court to declare a resolution void;^"^^ and the right of the supervisory board to form committees.^"^^ All these regulations are prohibited because these matters have already been conclusively regulated by the provisions of the Aktiengesetz.
Articies of Association and the Distribution of Powers The articies of association have little effect on the distribution of powers between the general meeting and the two boards. The distribution of pow^ers between these three organs is based on the mandatory provisions of the Aktiengesetz and there is little room for party autonomy. In some cases the articies can nevertheless have an effect on how these pov^ers are exercised. The articies of association can provide that transactions or matters belonging to a certain category require the consent of the supervisory board.^^^ In addition, the articies of association can provide for additional bodies such as committees to the extent that the statutory distribution of powers is not affected.^^^ The articies of association can also set out that in its dealings with third parties, the Company does not have to be represented by members of the management board acting collectively; for example, the articies of association can set out that the Company can be represented by: a sole management board member; a management board member and a Prokurist together; or by two management board members together.^^^
^^^ See Hüffer U, Aktiengesetz (2002) § 23 Rn 38. Hüffer lists the following regulations: "Aufstellung persönlicher Voraussetzungen für Vorstandsmitglieder (zB Mindestalter, Höchstalter, Staatsangehörigkeit, berufliche Qualifikation), wenn auch unter Wahrung des Auswahlermessens des AR"; "Höchsalter für AR-Mitglieder; desgleichen ihre Zugehörigkeit zur Familie"; "Erweiterung des Auskunftsrechts der Aktionäre ... aber nur unter Beachtung des § 53 a"; "Bildung fakultativer Gremien, zB Beiräte, Verwaltungsräte ... jedoch ohne Änderung der ges Zuständigkeitsverteilung"; "Bestellung eines Ehrenvorsitzenden des AR, Schaffung des Amts eines Vorstandssprechers". 346 See Hüffer U, Aktiengesetz (2002) § 23 Rn 38. ^'^'^ § 241 AktG (Nichtigkeitsgründe). 348 § 275 A k t G (Klage auf Nichtigerklärung). 349 § 107(3) A k t G (Innere Ordnung des Aufsichtsrats). 350 § 111(4) AktG. See Hüffer U, Aktiengesetz (2002) R n 18. 35^ Hüffer, Aktiengesetz (2002) § 2 3 R n 38: "Bildung fakultativer Gremien, z B Beiräte, Verwaltungsräte". See also Hüffer U , Aktiengesetz (2002) § 119 R n 10: "Zulässig ist auch die Bildung v o n Ausschüssen u n d sonstigen Gremien durch HV-Beschluß auf Satzungsgrundlage, soweit dadurch nicht in ges Organkompetenzen eingegriffen wird." 352 § 78(3) AktG.
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Derogation from the Articies of Association In principle, case law and legal literature would permit shareholders in general meeting to derogate from the articies of association under some circumstances, but it is in practice impossible for a public Company with widely dispersed shareholding to legally do so. Firstly, a resolution to derogate from articies of association is voidable unless it has been passed by the votes of all shareholders in the company.^^^ Secondly, derogation from the articies of association is possible only provided that its effects expire ad hoc (punktuelle Satzungsdurchbrechung) and do not continue after the resolution (no Dauerwirkung).^^"* Riglit of Siiareiioiders to Enforce ttie Articies of Association As the govemance of a German AG is basically regulated by mandatory and statutory rules, the right to enforce the articies of association is less important than the right to enforce the provisions of the Aktiengesetz. In any case, the same rules apply to both.
5.4.5 Decisions on Management Matters The powers of shareholders in general meeting to participate in the general management of the Company have been set out in the Aktiengesetz. As a rule, shareholders in general meeting are not empowered to decide on management matters in general. As discussed above, a large number of powers have nevertheless been vested in the general meeting by the specific provisions of this Act. Referral of Management Matters to ttie Generai Meeting The general meeting does not have any general power to give directions to the two statutory boards. On the other hand, the Aktiengesetz provides that the management board can refer management matters to a general meeting.^^^ In practice, such a referral can bring many benefits. The downside is that shareholders may at least in theory contest any resolution of the general meeting (Anfechtungsklage).^^^ The upside is that injunctions (Unterlassungsklage, einstweilige Verfügung) against actions, which are alleged to restrict shareholder's rights on the grounds that a resolution at a general meeting would have been necessary, do not prevent the management board from acting upon this resolution.^^^ If valid, the
^^^ See also Henze H, Aktienrecht. Höchstrichterliche Rechtsprechung (2000) pp 15-16. 354 See Hüffer U, Aktiengesetz (2002) § 179 R n 7 - 8 .
355 § 119(2) AktG. See also § 111(4) AktG. 356 § 241 Nr. 5 AktG, §§ 243 and 246 AktG. 35"^ See Hüffer U , Z u r Holzmüller-Problematik: Reduktion des Vorstandsermessens oder Grundlagenkompetenz oder Hauptversammlung? In: Festschrift für Peter Ulmer (2003)
p290.
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resolution will also restrict the liability of management board members and supervisory board members.^^^
Decisions on Major Transactions As a rule, major transactions do not normally require the consent of shareholders in general meeting. Some transactions do. It is clear that the general meeting must decide on some matters relating to the share capital, but there are also other fundamental matters that fall within its powers. While some of the powers of the general meeting are based on specific statutory and mandatory rules, others - especially the Holzmüller principle - have been developed by the courts interpreting these rules.^^^ Amendments to the articles of association, Many major transactions would not be possible without amending the articles of association. Resolutions of this kind require a majority of three-fourths (75%) of the share capital represented at the general meeting.^^^ The articles of association can require a larger majority or a smaller majority, but the majority may not be less than a simple majority of votes cast.^^^ This is because the specific requirement of a three-fourths majority does not limit the scope of the main rule that all decisions taken by the general meeting require (at least) a simple majority (50%) of votes cast.^^^ The Holzmüller principle. According to the judgment of the Federal Supreme Court (Bundesgerichtshof, BGH) in Holzmüller,^^^ the management board must obtain the prior consent of the general meeting for the transfer of the most valuable part of the Company's business to a subsidiary founded for this purpose.^^"^ The Holzmüller principle used to be very controversial.^^^ The BGH said in Holzmüller that the matter must be referred to the general meeting if it severely affects the rights and interests of the shareholders (bei schwerwiegenden Eingriffen in die Rechte und Interessen der Aktionäre). On the other hand, the facts were special and the wording of the Aktiengesetz is quite clear: the general meeting may not decide on matters of management unless the matter is referred to the general meeting by the management board.^^^ The main rule is therefore that the general meeting has no general power to decide on fundamental matters, but it has the powers specifically vested in it by the provisions of the Aktiengesetz.
35« § 93(4) AktG. See also § 116 AktG. 359 See Hüffer U, Aktiengesetz (2002) § 119 Rn 6. 360 §179(2) AktG. 36^ §133(2) AktG. 362 See also Hüffer U , Aktiengesetz (2002) § 179 R n 19.
363 BGHZ 83,122. See also §§ 119(2) and 179a AktG. 364 § 133(1) AktG. See also Hüffer U , Z u r Holzmüller-Problematik: Reduktion des Vorstandsermessens oder Gmndlagenkompetenz oder Hauptversammlung? In: Festschrift für Peter Ulmer (2003) p p 2 9 7 - 2 9 8 .
365 See Hüffer U, ibid pp 284-285 and 289-291. 366 § 119(2) AktG: "Über Fragen der Geschäftsführung kann die Hauptversammlung n u r entscheiden, w e n n der Vorstand es verlangt."
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Now, if interpreted broadly, the Holzmüller principle might affect Company groups. (a) The Holzmüller principle restricts the powers of the Company's management to found a group. It does so by vesting in the general meeting the power to decide on the transfer of the Company's assets to a subsidiary (Konzembildungskontrolle). (b) Because of this, it also restricts the allocation of some fundamental powers (such as the power to decide on changes in share capital) to the Company's two statutory boards. The transfer of assets to a subsidiary would in effect dilute shareholders' powers. The Holzmüller principle makes it more difficult for the Company to become a parent Company, the statutory boards to become Organs of a parent Company, and the statutory boards to take decisions in a subsidiary as representatives of the parent Company (Konzemleitungskontrolle).^^'^ In two Gelatine cases,^^^ the BGH interpreted the Holzmüller principle in a narrow way and rejected this form of control of Company groups (Konzembildungskontrolle, Konzemleitungskontrolle). The BGH confirmed that significant business decisions only require shareholder approval if they affect at least 80% of the Company's assets. The scope of this principle is thus dependent on quantitative factors. On the other hand, the BGH mied that the approval requires a majority of at least 75% of the capital represented at the shareholder meeting. Before these two judgments, it was assumed that a simple majority of votes would be sufficient. It is regarded as clear that the scope of the Holzmüller principle depends on qualitative factors. It can be applied to delisting (in Macrotron, the BGH made delisting subject to more stringent requirements than before)^^^ and possibly to some takeover defences that affect the rights and interests of the shareholders in a similar way.^^^ However, it is still unclear whether this principle also applies to purchases. Corporate transactions, Although the scope and Contents of the Holzmüller principle are unclear, what is clear is that corporate transactions such as mergers and acquisitions often require the consent of shareholders. The powers of shareholders Vary depending on the corporate transaction. For example, a shareholder holding more than 95% of the registered share capital can pass a resolution at a general meeting to squeeze out minority shareholders for a fair cash compensation ("gegen angemessenen Barabfindung").^^^ Minority shares are then transferred by law to the principal shareholder. Minority shareholders cannot contest the resolution to squeeze them out by arguing that the cash
^^'^ See Hüffer U, Zur Holzmüller-Problematik: Reduktion des Vorstandsermessens oder Grundlagenkompetenz oder Hauptversammlung? In: Festschrift für Peter Ulmer (2003) p282. 368 B G H , judgments of 26 April 2004 - I I Z R 154/02 and I I Z R 155/02 (Gelatine). 369 B G H , j u d g m e n t of 25 N o v e m b e r 2002 - II Z R 133/01 (Macrotron). 3'7o See Hüffer U, Aktiengesetz (2002) § 119 R n 24; Hüffer U, Zur Holzmüller-Problematik: Reduktion des Vorstandsermessens oder Grundlagenkompetenz oder Hauptversammlung? In: Festschrift für Peter U l m e r (2003) pp 2 9 3 - 2 9 6 . 371 § 327a AktG.
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compensation is unfair. Instead, they may bring a claim for additional cash payments.^^2 According to the provisions of the Aktiengesetz and the Umwandlungsgesetz, the consent of the general meeting is necessary for the restructuring of the Company, that is, for acts hke mergers (Verschmelzung), the transfer of the Company's assets (Vermögensübertragung) or the change of Company form (Unwandlung).^''^ The same can be said for the liquidation of the Company. A statutory merger requires the consent of three-fourths (75%) of the registered share capital represented at the general meeting (in addition to a simple majority of votes cast).^^"^ Minority shareholders holding more than one-fourth (25%) may therefore impede the planned merger if they are active. Each shareholder may delay the registration and carrying out of the transaction by challenging its validity. An agreement to transfer all assets of the Company to another Company requires the same majority as the amendment of articles of association and a statutory merger, that is, three-fourths (75%)) of the capital represented at the meeting.^*^^ Control and profit transfer agreements. The Aktiengesetz contains specific provisions on so-called control and profit transfer agreements (Beherrschungsvertrag, Gewinnabführungsvertrag).^"^^ These inter-company agreements are normally used in groups of companies and enable an AG to control another AG. Resolutions of this kind require a majority of three-fourths (15%) of the share capital represented at the meeting.^"^^ Acceptance of takeover bids in the target Company. In the event of a public takeover bid, shareholders of the target Company "vote" not by passing a formal resolution but by holding on to their shares or selling them. The Securities Acquisition and Takeover Act (Wertpapierübemahmegesetz, WpÜG) provides that both the management board and the supervisory board of the target Company must submit their comments on the bid.^^^ The works Council of the target Company is notified of the bid^*^^ and may also give its comments.^^^ But these comments do not have to lead to a formal resolution. Shareholders do not have a general power to decide on takeover defences. The most important defensive measures against hostile bids are those that fall within the general powers of the management board. ^^^ On the other hand, some defen-
372 § 327f Akte. 373 §§ 274(1), 274(2), 293(1), 293(2), 295(1), 319(1), 319(2), 320(1) AktG. See also §§ 65 and 73 UmwG, § 179a(l) AktG and § 174 UmwG, § 226 UmwG. Hüffer, Aktiengesetz (2002) § 119Rn7. 374 § 65(1) U m w G , see also § 62(1) U m w G .
375 § 179a(l) AktG. See Hüffer U, Aktiengesetz (2002) § 179a Rn 3, 11. 376 § 293 AktG. 377 §§ 293 and 295 AktG. See Hüffer U, Aktiengesetz (2002) § 293 R n 8. 378 § 2 7 W p Ü G . 379 §§ 10(5) and 14(4) W p Ü G . 380 § 27(2) W p Ü G .
381 §§76(1) and 111(4) AktG.
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sive measures require the consent of the supervisory board^^^ and many defensive measures are corporate transactions, which require also a resolution by shareholders in general meeting under the general provisions of the Aktiengesetz. According to the wording of the Wertpapierübemahmegesetz, the consent of the supervisory board is not required for: actions commenced before the bid was made pubHc;^^^ actions in the course of the company's normal business;^^"^ and the search of a white knight.^^^ Due to the wide powers of the management board, actions in the course of the company's normal business can include major transactions such as acquisitions under some circumstances.^^^ Some defensive measures require the consent of the supervisory board.^^^ Under some circumstances, the Wertpapierübemahmegesetz restricts the power of the management board of the target Company to take defensive measures that fall within its general powers but could frustrate the bid.^^^ The consent of the supervisory board is required for takeover defences that fall within the general powers of the management board but are not covered by the above exceptions. Many of the measures that require the consent of the supervisiory board are transactions that also require a resolution by shareholders in general meeting under the general provisions of the Aktiengesetz. For example, shareholders must decide on the issuing of new shares (see below) and the acquisition of the company's own shares. Many important takeover defences are nevertheless possible without the consent of shareholders. For example, the target Company may seil assets and make itself thus less attractive to the bidder (the Crown Jewels defence), acquire another Company, or make a bid for the shares of the offeror (the Pac Man defence). It is nevertheless possible that the Holzmüller principle applies in some ofthesecases. Shareholders of the target Company thus do have some powers to vote on takeover defences under the Aktiengesetz. For example, shareholders may vote on the issuing of new shares both before the commencement of the bid and during the bid. The Wertpapierübemahmegesetz makes it easier to convene a general meeting to decide on matters relating to the bid.^^^ The Wertpapierübemahmegesetz also restricts the powers of shareholders in some respects. According to the general provisions of the Aktiengesetz, the gen^^^ § 33(1) WpÜG: "... Dies gilt nicht für ... Handlungen, denen der Aufsichtsrat der Zielgesellschaft zugestimmt hat." ^^^ § 33(1) WpÜG: "Nach Veröffentlichung der Entscheidung zur Abgabe eines Angebots bis zur Veröffentlichung des Ergebnisses ..." ^^"^ § 33(1) WpÜG: "... Dies gilt nicht für Handlungen, die auch ein ordentlicher und gewissenhafter Geschäftsleiter einer Gesellschaft, die nicht von einem Übemahmeangebot betroffen ist, vorgenommen hätte ..." ^^^ § 33(1) WpÜG: "... Dies gilt nicht... für die Suche nach einem konkurrierenden Angebot..." 3^^ See Beckmann R, Kersting MO, Mielke W, Das neue Übemahmerecht (2003) C 38. ^^^ § 33(1) WpÜG: "... Dies gilt nicht für ... Handlungen, denen der Aufsichtsrat der Zielgesellschaft zugestimmt hat." 388 § 33(1) W p Ü G . 389 §§ 16(3) and 16(4) W p Ü G .
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eral meeting may authorise, in advance, the management board to take some measures that can be used as takeover defences (for example, the issue of new shares and share buy-backs).^^^ The Wertpapierübemahmegesetz now states that shareholders in general meeting have a power to authorise, in advance, the use of takeover defences that fall within the powers of the general meeting. But such authorisation is valid only for 18 months and requires a qualified majority of threefourths (75%) of the registered share capital represented at the general meeting. In addition, the management board may not take these actions without the consent of the supervisory board.^^^ Waiver ofthe liability ofstatutory board members to the Company. The liability of statutory board members under the Aktiengesetz cannot be waived without the consent ofthe general meeting (see Chap. 5.6.5 below).^^^
Decisions on Share Issues Like in the UK, the rules on the allocation of power to decide on share issues are partly based on the Second Directive (77/91/EEC). But in Germany, shareholders have traditionally enjoyed extensive protection in matters relating to share capital. The level of protection has now gradually been decreased in order to give German public limited-liability companies the same financial tools that are being used by their UKAJS competitors. The mandatory rules of the Aktiengesetz provide that many matters relating to the share capital of the Company require the consent of the general meeting. For example, the consent of the general meeting is necessary for the increase or reduction of the share capital, the waiver of shareholders' pre-emptive rights to new shares, a merger involving the Company, any other form of transformation of the Company, and the liquidation of the Company. The shareholders decide on the issuing of new shares. Decisions on the increase of capital. A resolution to change the share capital requires the majority of three-fourths (75%) ofthe share capital represented at the meeting and a simple majority of votes cast.^^^ Shareholders holding more than 25% of the shares have thus a right of veto as far as any important decisions relating to share capital are concemed. Decisions to disapply pre-emptive rights. Existing shareholders have preemptive rights to new shares.^^"^ A resolution to disapply the pre-emptive rights of shareholders requires the majority of at least 75% of the share capital represented at the meeting.^^^
^^^ See §§ 202 AktG and 71 AktG; Beckmann/Kersting/Mielke, Das neue Übemahmerecht (2003) C 31-32. 391 § 33(2) WpÜG. 392 §§ 50, 52(1) and 93(4) AktG.
393 § 179(2) AktG. See Hüffer U, Aktiengesetz (2002) § 179 Rn 35. 394 See also Article 29(1) o f t h e Second Directive (77/91/EEC).
395 §186(3) AktG.
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The Aktiengesetz allows companies to disapply pre-emptive rights in connection with capital increases in limited circumstances only, and only in the same shareholders' resolution that authorises the capital increase. For example, it is necessary to obtain shareholders' prior consent for the issuing of share options to members of the management board. The resolution disapplying shareholders' pre-emptive rights must be specific as to the nature, purpose and timing of the transaction.^^^ In addition to being approved by the shareholders, any disapplication of pre-emptive rights requires a justification that the management board must set forth in a written report to shareholders.^^"^ According to the principles developed by the BGH in Kali & Salz,^^^ the disapplication of pre-emptive rights is permitted only where: the Company has a compelling need (dringendes Interesse) served by the disapplication; the disapplication is proportionate to that purpose (Erforderlichkeit des Bezugsrechtsausschlusses); it must also be useful for that purpose (Eignung des Bezugsrechtsausschlusses); and the interest of the Company in doing so outweighs the shareholders' interest in exercising their pre-emptive rights (Grundsatz der Verhältnismäßigkeit von Mittel und Zweck, Grundsatz der Angemessenheit). The BGH has recently given the management board more discretion in order to ensure that it is possible to disapply pre-emptive rights not only in theory but also in practice. The most authoritative cases include judgments of the BGH in Deutsche Bank^^^ and Siemens/Nold^^^ In Deutsche Bank, the BGH emphasised that Courts cannot require too detailed justifications in the management boards' reports because to do so would make it impossible to disapply pre-emptive rights in practice.'*^^ At the same time, the case law of the BGH has made the resolution to disapply pre-emptive rights less important as a mechanism that controls management."*^^
396 § 186(4) AktG. 397 § 186(4) AktG. 398 B G H Z 7 1 , 40, 4 6 - 4 7 . According to this case, the exclusion of pre-emptive rights is permitted only where he Company "nach vernünftigen kaufmännischen Überlegungen ein dringendes Interesse [daran] hat und zu erwarten ist, der damit angestrebte und allen Aktionären zugute kommende Nutzen werde den verhältnismäßigen Beteiligungs- und Stimmrechtsverlust der vom Bezugsrecht ausgeschlossenen Aktionäre aufwiegen". The principles of Kali + Salz were appHed in the important case B G H Z 83, 319 (Holzmann). 399 B G H Z 125,239. 400 B G H Z 1 3 6 , 1 3 3 . ^^^ B G H Z 125, 239, 246: "Werden solche detaiUierten, ins einzelne gehenden, prognostisch kaum ergründbaren Angaben für die sachliche Rechtfertigung einer Ermächtigung unter Ausschluß des Bezugsrechts verlangt, beschränkt man das unternehmerische Ermessen in einem Umfange, der die sachgemäße Planung und Durchführung einer Maßnahme ... unter angemessener Berücksichtigung der Gegebenheiten und Entwicklungen auf dem Kapitalmarkt und im Börsenhandel praktisch nicht mehr möglich macht." "^02 Cahn A, Ansprüche und Klagemöglichkeiten der Aktionäre wegen Pflichtverletzungen der Verwaltung beim genehmigten Kapital, Z H R 164 (2000) p 116.
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Decisions on the Distribution of Profits The statutory rules on the distribution of profits to shareholders have been influenced by the Second Directive. Although the general meeting decides on the distribution of profits, the two statutory boards can in practice determine the distributable amount. Profits availablefi)r distribution. The Company can declare and pay dividends only from annual net profits as they are shown in the annual financial Statements. For each fiscal year, the management board approves the annual financial Statements and submits them to the supervisory board with its proposal as to the appropriation of the annual net profit.^^^ The proposal sets forth what amounts of the annual net profit should be paid out as dividends, but the net profit is determined only after certain amounts have been transferred to capital reserves or carried forward to the next fiscal year."^^"^ According to the Aktiengesetz, the two statutory boards may not allocate more than one half of the annual surplus to profit reserves, unless the articles of association provide otherwise."^^^ There are even other specific provisions dealing with the allocation of the annual surplus to reserves."^^^ Upon approval by the supervisory board,"^^"^ the management board and the supervisory board submit their combined proposal to the shareholders at the annual general meeting. Power to decide on the distribution of profits. The general meeting decides on the distribution of profits,"*^^ but it is bound by the proposal as regards the determination of the amount of annual net profits."^^^ This means that the management board and the supervisory board normally have the final say in the dividend policy.'^^ö The wording of the German Corporate Govemance Code is misleading in this respect."^^^
403§l70AktG;§264HGB. 404 § 158(1) AktG; §§ 275(2) Nr. 20 and 275(3) Nr. 19 H G B . 405 § 58(2) AktG. 406 See especially §§ 58(2a) and 58(3) AktG. 407 §172 AktG. 408 § 119(1) AktG. See also § 174(1) AktG. 409 AktG § 174(1) AktG. 4^0 See also Roth GH, Die (Ohn-)Macht der Hauptversammlung. Oder: Unlautere Werbung für Aktienrecht, ZIP 2003 p p 3 7 0 - 3 7 1 : "Nun ist es freilich nicht so, als ob diese grundsätzliche Kompetenzzuweisung des deutschen AktG im internationalen Vergleich etwas Ungewöhnliches wäre, sondern die deutsche Besonderheit ist gerade umgekehrt die quotenmäßige Restriktion der Rücklagenbildung von Gesetzes wegen mit ihrer wiederholt abgewandelten Dispositivität." 4^^ See the German Corporate Govemance Code, 2.2.1: "The Management Board submits to the General Meeting the Annual Financial Statements and the Consolidated Financial Statements. The General Meeting resolves on the appropriation of net income ..." Compare Austrian Working Group for Corporate Govemance, Austrian Code of Corporate Govemance (November 2002) p 32.
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Decisions on Corporate Governance Guidelines The main rule is that the general meeting is not empowered to decide on corporate governance guidelines or the internal work of the two statutory boards."^^^ The supervisory board organises its own work. The supervisory board decides on its internal work by a simple majority."*^^ There are some statutory rules on formal matters such as the preparation and conduct of meetings and the passing of resolutions."^^"* Committees are permitted."^^^ There is also an increasing tendency to form committees in major corporations due to the large size of supervisory boards."*^^ According to the German Corporate Governance Code, the supervisory board should set up an audit committee"^^^ and form even other committees in Order to increase the efficiency of the supervisory board's work."^^^ The Code also recommends that the representatives of shareholders and the representatives of the workforce should prepare the supervisory board meetings separately."^^^ The management board can organise its own work.^^o jj^ j^Qg^ companies there are rules of procedure for the management board as well as rules on the allocation of responsibilities (Geschäftsordnung).'*^! jf tj^gge rules are approved by the management board itself, they must be approved unanimously.'*^^ Even the change of such guidelines or derogations from them require the consent of all members.'*^^ On the other hand, the supervisory board can decide on internal guidelines for the management board either by virtue of the articles of association or otherwise."*^"* Where the supervisory board has done so, the guidelines are binding on the management board provided that the guidelines do not interfere with what be-
^^'^ See Ulmer P, Der Deutsche Corporate Governance Kodex - ein neues Regulierungsinstrument für börsennotierte Aktiengesellschaften, ZHR 166 (2002) pp 174-175. 413 § 133(1) AktG and § 32(1) BGB. See Hommelhoff P, Schwab M, Regelungsquellen und Regelungsebenen der Corporate Governance: Gesetz, Satzung, Codices, untemehmensinteme Grundsätze (2003) p 81. ^i'* See especially §§107 and 108 AktG. 415 § 107(3) AktG. 41^ Semler J, The Practice of the German Aufsichtsrat. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit p 270. 4iMtem 5.3.2. 418 Item 5.3.1. 419 Item 3.6. 420 § 77(2) AktG. 421 Semler J, The Practice of the German Aufsichtsrat. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit p 2 7 1 . 422 § 77(2) AktG. 423 See Hommelhoff P, Schwab M, Regelungsquellen und Regelungsebenen der Corporate Governance: Gesetz, Satzung, Codices, untemehmensinteme Grundsätze (2003) p 8 1 . 424 § 77(2) AktG: "Der Vorstand kann sich eine Geschäftsordnung geben, wenn nicht die Satzung den Erlaß der Geschäftsordnung dem Aufsichtsrat übertragen hat oder der Aufsichtsrat eine Geschäftsordnung für den Vorstand erläßt. Die Satzung kann Einzelfi-agen der Geschäftsordnung bindend regeln. Beschlüsse des Vorstands über die Geschäftsordnung müssen einstimmig gefaßt werden."
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longs to the management function of the management board."*^^ In practice, the supervisory board decides on these guidelines in medium-sized and small companies. In large companies, these rules are usually approved by the management board itself.^^ö There are no specific rules on the power to decide on whether to comply with the recommendations of the German Corporate Govemance Code or derogate from them. In the absence of specific rules, the general rules on the allocation of power between different Company organs apply. The fact that the management board and the statutory board have a statutory duty to make a Statement on compliance or non-compliance with these recommendations'^^^ says nothing about the power to decide on compliance intemally. For this reason, the power to decide on compliance with the recommendations of the Code is not vested in one statutory board only. For example, the power to decide on compliance with these recommendations depends on the recommendation in question and the decisions of the supervisory board."*^^
5.4.6 The Appointment, Removal and Remuneration of Managers In a German AG, shareholders cannot run the Company by appointing its managers. The statutory and mandatory rules do not confer the power to appoint senior managers to shareholders. In a large Company, shareholders in general meeting can only appoint part of the supervisory board members who supervise management. Shareholders also appoint the Company's statutory auditors. Members ofthe Supervisory Board Members of the supervisory board represent either shareholders or employees."^^^ The number of supervisory board members representing employees is set out in the Co-determination Acts. Appointment. All shareholders' representatives are elected at the annual general meeting,"*^^ unless the articles of association provide that certain shareholders may elect a certain number of the supervisory board members (up to one third of all supervisory board members. Entsendungsrecht)."^^^ The employee representatives
^'^^ See Hommelhoff P, Schwab M, Regelungsquellen und Regelungsebenen der Corporate Govemance: Gesetz, Satzung, Codices, untemehmensinteme Grundsätze (2003) pp 8081. ^^^ Semler J, The Practice of the German Aufsichtsrat. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit p 271. 427§161 AktG. ^'^^ See Ulmer P, Der Deutsche Corporate Govemance Kodex - ein neues Reguliemngsinstmment für börsennotierte Aktiengesellschaften, ZHR 166 (2002) pp 173-174. "^^^ § 96 AktG. See also § 7 ofthe Co-determination Act of 1976 (Mitbestimmungsgesetz). ^30 § 101(1) AktG. 431 § 101(2) AktG.
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are elected by a Conference of employee delegates."^^^ The chairman of the supervisory board is elected by the supervisory board itself."^^^ Candidates are formally nominated in different ways. The supervisory board must nominate candidates, because it has a duty to submit proposals for each question on the agenda of the general meeting.'*^'* The general meeting is usually not bound by this proposal,"*^^ and any shareholder may nominate other candidates at the meeting.'^^^ Germany thus has a very liberal System of shareholder proposals and nominations. The voting procedure is to a large extent in the discretion of the chairman of the general meeting, but the general meeting may also regulate this question by a resolution (Geschäftsordnungsbeschluß)."^^^ In large companies with dispersed ownership, the proposal submitted by the supervisory board is usually supported by more than 99% of votes cast. It looks as if the supervisory board in effect elected its nev^ members."^^^ On the other hand, this formal appointment process is preceded by an informal one. In companies with a clearly defined shareholder structure, the nominations come mostly from the shareholders. In large companies with dispersed ownership, candidates are most often nominated by the chairman and a few influential members of the supervisory board, or by the chairman of the supervisory board who has consulted with the management board. Occasionally, the management board even takes the initiative completely in nominating candidates. The relationship of these two boards is in practice close and it is not unimportant from the management boards' view by whom the work of the management board will be supervised. The management board can in practice be active in this matter regardless of the fact that there is no formal way for the management board to nominate candidates.439
It is also very common to elect a member who represents the Company's house bank, because most companies have a close relationship with one bank (Hausbank).'^'^^ However, the role of bank representatives should not be exaggerated. Banks have limited resources and filling the supervisory boards of German AGs ^^2 Erste Wahlordnung zum Mitbestimmungsgesetz (1. WOMitbestG); zweite Wahlordnung zum Mitbestimmungsgesetz (2. WOMitbestG); dritte Wahlordnung zum Mitbestimmungsgesetz (3. WOMitbestG). 433 § 107(1) AktG. 434 § 124(3) AktG. The decision to nominate candidates to the supervisory board requires a majority o f shareholder representatives. 435 See § 101(1) AktG. 436 § 124(4) AktG; see also Roth G H , Wörle U , D i e Unabhängigkeit des Aufsichtsrats Recht und Wirklichkeit, Z G R 2004 p 577. 437 See Hüffer U, Aktiengesetz (2002) § 101 Rn 4. 438 See Roth G H , Wörle U , Die Unabhängigkeit des Aufsichtsrats - Recht u n d Wirklichkeit, Z G R 2004 p p 5 7 7 - 5 7 8 . 439 See Roth G H , Wörle U , D i e Unabhängigkeit d e s Aufsichtsrats - Recht und Wirklichkeit, Z G R 2004 p p 5 7 8 - 5 8 1 ; Semler J, T h e Practice o f the G e r m a n Aufsichtsrat. In: Hopt KJ, K a n d a H, Roe MJ, Wymeersch E, Prigge S (eds) o p cit p 269. "^^^ For the concept of housebank see Elsas R, Krahnen JP, Universal Banks and Relationships with Firms. In: Krahnen J P , Schmidt R H (eds) T h e German Financial System (2004) p p 2 1 1 - 2 1 2 and 227.
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with bank representatives "simply does not pay"."^"*^ Supervisory board memberships can also make banks look bad in takeover situations because banks sometimes provide Services to different parties with conflicting interests. The need to be able to provide Services without restrictions combined with problems relating to the legal effect of Chinese walls have made banks rethink supervisory board memberships.'^'^^ Most supervisory boards nevertheless contain a member who represents the Company's house bank."^"^^ In the largest Hsted companies (Dax 30, March 2003), approximately 58% of shareholder representatives are management board members of other large companies (36% are management present or former board members of non-finance companies, and 22% come from banking or insurance), 15% are experts (for example scientists or lawyers), and 5% are former management board members of the Company. The former chairman of the management board usually acts as chairman of the supervisory board."^"^"^ The German Corporate Govemance Code is silent on who should be responsible for recommendations for nominations for the election of members of the supervisory board,"^^ because the supervisory board has a statutory duty to nominate candidates. Term. The maximum term of office is also the normal term of office for supervisory board members. Supervisory board members are usually elected for approximately five-year terms.'*'*^ However, staggered boards are possible, because either the articles of association or the shareholder resolution electing a given member may specify a shorter period."*"*^ Removal. Supervisory board members can be removed by the body that appointed them. Shareholders' representatives can be removed by the general meeting at any time by a majority of three-fourths of votes cast, unless the articles of association provide for another majority."^^ In addition, a court can remove any
'^^ Hopt KJ, The German Two-Tier Board: Experience, Theories, Reforms. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit p 252. ^^ See Hopt KJ, Übernahmen, Geheimhaltung und Interessenkonflikte: Probleme für Vorstände, Aufsichtsräte und Banken, ZGR 2002 p 368. ^^ Elsas R, Krahnen JP, Universal Banks and Relationships with Firms. In: Krahnen JP, Schmidt RH (eds) The German Financial System (2004) p 201: "70 per cent of all sample firms have a bank representative as a member of the supervisory board, and in 41.6 per cent of all cases, bank representatives constitute more than 25 per cent of board members representing capital (i.e. excluding co-determination)." See also Hopt KJ, The German Two-Tier Board: Experience, Theories, Reforms. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit pp 242-243. ^"^ Roth GH, Wörle U, Die Unabhängigkeit des Aufsichtsrats - Recht und Wirklichkeit, ZGR 2004 pp 584-586. 445 See item 5.4.1. 44^ See Andre TJ, Cultural Hegemony: The Exportation of Anglo-Saxon Corporate Govemance Ideologies to Germany, Tul L Rev 73 (1998) pp 156-157. 447 See Hüffer U, Aktiengesetz (2002) § 102 Rn 4. 448 § 103(1) AktG.
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member of the supervisory board at the request of the supervisory board for important reasons relating to the person of the member in question.'^'^^ Although German law provides formal methods for removing individual members of the supervisory board or the entire board, and active shareholders occasionally seek the removal of one or more specific supervisory board members, removal attempts succeed very rarely. In this sense, German supervisory board members seem to be quite resistant to outside shareholder pressure for resignation.450 However, voluntary or involuntary resignations of supervisory board members prior to the normal expiration of their term are more frequent than their involuntary removals. Each year, shareholders have an opportunity at the armual general meeting to approve or disapprove of the actions that members of each board have taken during the past financial year (Entlastung)."^^^ A disapproval of a board member's actions during the year amounts to a vote of no confidence, and although it does not automatically remove the board member from office or create liability, it does focus significant media attention on the relevant board member.'*^^ Remuneration. The general meeting decides on the remuneration of supervisory board members. This matter can be regulated either in the articles of association or by a resolution."^^^ The Aktiengesetz provides that the amount of remuneration must be reasonable."^^"^ In practice, the remuneration of supervisory board members is quite low. This is partly due to the principle of equal treatment of all supervisory board members who are in the same position.'*^^ The chairman of the supevisory board and chairmen of supervisory board committees may receive more than ordinary members. According to the wording of the Aktiengesetz, share options may not be granted to supervisory board members because the supervisory board is not a management organ."^^^ In Mobilcom,^^'' the BGH affirmed the main rule that members of the supervisory board could not be compensated with share options. 449 §103(3) Akte. 4^^ See Andre TJ, Cultural Hegemony: The Exportation of Anglo-Saxon Corporate Govemance Ideologies to Germany, Tul L Rev 73 (1998) pp 147-149. 451 § 120 AktG. 452 See Donald D C , The Nomination of Directors under U.S. and German Law, Institute for L a w and Finance, Johann Wolfgang Goethe-Universität Frankfurt, Working Paper Se-
riesNo.21(2004)p32. 453 §113(1) AktG. 454 § 113(1) AktG: " . . . S i e soll in einem angemessenen Verhältnis zu d e n Aufgaben der Aufsichtsratsmitglieder und zur Lage der Gesellschaft stehen ..." 455 B G H Z 83, 151; Lutter M , Corporate govemance - Die deutsche Sicht, Z G R 2001 p p
230-231. 456 § 192(2) AktG: " D i e bedingte Kapitalerhöhung soll n u r z u folgenden Zwecken beschlossen werden: ... 3 . zur Gewährung v o n Bezugsrechten an Arbeitnehmer u n d Mitglieder der Geschäftsführung der Gesellschaft..." See Hüffer, Aktiengesetz (2002) § 192 R n 2 1 . Compare Andre TJ, Cultural Hegemony: T h e Exportation of Anglo-Saxon Corporate G o v e m a n c e Ideologies to Germany, Tul L Rev 73 (1998) pp 163-164. 457 B G H , judgment of 16 February 2004, I I Z R 316/02.
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On the other hand, the Aktiengesetz does not generally prohibit performancerelated compensation. According to the German Corporate Govemance Code, members of the supervisory board should receive "fixed as well as performancerelated compensation. Performance-related compensation should also contain components based on the long-term Performance of the enterprise.'"^^^ Although shareholders in general meeting decide on the appointment and remuneration of supervisory board members, shareholders in general meeting do not represent the Company in its dealings with them. The Company is represented by its management board."^^^ Some special Service contracts of supervisory board members require the consent of the supervisory board in order to be valid."^^^
Members ofthe Management Board The general meeting cannot elect members of the management board. However, the general meeting can define the number, or minimum and maximum number, of management board members in the articles of association."^^^ Within these limits, the supervisory board can freely decide on the appointment, removal and remuneration of management board members."^^^ Shareholders in general meeting nevertheless decide on several matters relating to share Option plans. Appointment. Members ofthe management board are elected by the supervisory board. In practice, recommendations by existing members of the management board can be important in the selection of new management board members."^^^ This is so regardless of the fact that the power to decide on the appointment of new members is formally vested in the supervisory board."*^"* The mandatory provisions ofthe Aktiengesetz do not prevent the management board from submitting proposals either independently or at the request ofthe supervisory board."^^^ Appointment committee. A Company subject to the co-determination regime must have a supervisory board committee to prepare appointments to the management board."*^^ The appointment committee is normally combined with another committee and it does not seem to be very influential."^^^ A possible explanation is that the committee can only submit proposals and competing proposals are not excluded."*^^ 458 Item 5.4.5. 459 § 78(1) AktG. 460 §114(1) AktG. 461 §§ 23(3)(6) and 76(2) AktG 462 § 84 AktG. 463 Semler J, The Practice of the German Aufsichtsrat. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit p 2 7 1 . 464 § 84 AktG. 465 See Hüffer U, Aktiengesetz (2002) § 84 Rn 5. 466 § 27(3) MitbestG. 46"^ Semler J, The Practice o f the German Aufsichtsrat. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit p 270: "These committees as such have absolutely no importance. I have never experienced that such a committee has met, even though I have belonged and, in some cases, still belong to such committees. However, such
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The German Code on Corporate Govemance neither requires nor prohibits an appointment committee. The Code repeats the statutory requirement that members of the management board are appointed and removed by the supervisory board/^^ The Code also mentions that the supervisory board can delegate the preparing of the appointment of members of the management board to a committee. Company groups. The supervisory board of the parent does not appoint managers of a subsidiary. According to the main rule, the Company is represented by its management board in these cases. On the other hand, the articles of association of the parent may provide that the appointment of managers of a subsidiary requires the consent of the parent's supervisory board. The supervisory board may also decide that such a matter is subject to its consent."^"^^ Term ofoffice. The supervisory board will decide on the term of office of management board members. The most common term of office is the maximum term of office permitted by the Aktiengesetz, and five-year terms are deeply embedded at most major German companies."^^^ Remuneration. The supervisory board will also decide on the remuneration of management board members and enter into employment contracts with them. These matters can nevertheless be delegated to a committee."^^^ According to the Code, the supervisory board shall discuss and regularly review the structure of the management board compensation System at the request of the committee dealing with management board contracts."^^^ The Code provides that the chairman of the supervisory board should also chair the committees that handle contracts with members of the management board."^^"^ The employment contracts of management board members are usually prepared according to widely used Standard contracts. They govem their remuneration and retirement benefits and supplementary benefits, and contain clauses restricting competition."*^^ According to a mandatory rule of the Aktiengesetz, the remuneration of each management board member must be reasonable in light of the functions of the member in question and the Situation of the Company."^^^ The German Corporate
committees are very often identical with the executive committee, which is also responsible for personnel matters of the board of managing directors." 468 § 31(3) MitbestG. 469 Item 5.1.2. 470 § 111(4) AktG.
471 See Hüffer U, Aktiengesetz (2002) § 84 P^ 15; Andre TJ, Cultural Hegemony: The Exportation of Anglo-Saxon Corporate Govemance Ideologies to Germany, Tul L Rev 73 (1998) pp 156-157. 472 See Hüffer U, Aktiengesetz (2002) § 84 R n 12. See also the German Code of Corporate G o v e m a n c e , Item 5.1.2. 473 Item 4.2.2. 474 Item 5.2. 475 Semler J, T h e Practice of the German Aufsichtsrat. In: Hopt K J , Kanda H, R o e M J , Wymeersch E, Prigge S (eds) op cit pp 2 7 1 - 2 7 2 . 476 § 87(1) AktG.
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Govemance Code repeats this statutory requirement.'*^^ In addition, the Code recommends that the overall compensation for the members of the management board should comprise a fixed salary and variable components: "Variable compensation should include one-time and annually-payable components linked to the business Performance as well as long-term incentives containing risk Clements.'"^"^^ This was common practice already before the Code."*^^ By US/UK Standards, German executives have been modestly paid."^^^ The reasons could include the moderating influence of German society, the moderating influence of ownership concentration,"^^^ the moderating influence of employee representatives on the supervisory board,'^^^ monitoring in general (see Chap. 6 below), and restrictions on the use of share options in the past. The Mannesmann case (see Chap. 5.6.4 below) not only caused public outrage but put the statutory requirement that board remuneration must be reasonable into the Spotlight. Share options. Several restrictions on the use of share options were abolished by the KonTraG in 1998."*^^ Before the KonTraG, it was not legally possible to issue share options unless they were based on convertible bonds, and even these Option plans were often contested by shareholders.'^^'* The KonTraG made it possible to grant options to subscribe for new shares without any loan component,"^^^ and the changes to the Aktiengesetz are expected to lead to a larger variable component. As said above, the Code contains recommendations on the structuring of variable compensation. The Code also contains recommendations for the structuring of share Option Systems. For example, the share options and comparable instruments should be related to "demanding, relevant comparison parameters", and the
"^^^ The German Corporate Govemance Code, 4.2.2: "... Compensation of the members of the Management Board is determined by the Supervisory Board at an appropriate amount based on a Performance assessment in considering any payments by group companies. Criteria for determining the appropriateness of compensation are, in particular, the tasks of the respective member of the Management Board, his personal Performance, the Performance of the Management Board as well as the economic Situation, the Performance and outlook of the enterprise taking into account its peer companies." '^^^ The German Corporate Govemance Code, 4.2.3. "^^^ Semler J, The Practice of the German Aufsichtsrat. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit pp 271-272. 480 See for example Loewenstein MJ, Stakeholder protection in Germany and Japan, Tul L Rev 76 (2002) pp 1680-1681. ^^^ See Bebchuk LA, Fried JM, Executive Compensation as an Agency Problem, J Econ Perspectl7(2003)p78. ^^^ See Andre TJ, Cultural Hegemony: The Exportation of Anglo-Saxon Corporate Governance Ideologies to Germany, Tul L Rev 73 (1998) pp 161-162. ^^'^ Gesetz zur Kontrolle und Transparenz im Untemehmensbereich. 484§221 AktG. 485 See especially §§192 and 193 AktG. For the effect of the KonTraG on share options see for example Feddersen D, Pohl M, Die Praxis der Mitarbeiterbeteiligung seit Einfühmng des KonTraG, AG 2001 pp 26-33.
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Code prohibits "[c]hanging such Performance targets or the comparison Parameters retroactively"."^^^ Shareholders in general meeting decide on capital increases and the waiver of pre-emptive rights to new shares"^^^ by a majority of three-fourths (75%) of the shares represented at the general meeting"^^^ in addition to a simple majority of votes cast."^^^ Disclosure of remuneration. One of the objectives of the German Corporate Govemance Code was to make the remuneration of board members transparent to investors. According to the Code, both the compensation System and the remuneration of individual members of the management board should be disclosed to shareholders.^^^ The Code provides that compensation for members of the management board should be reported in the Notes of the Consolidated Financial Statements subdivided according to fixed, performance-related and long-term incentive components. The disclosure of information on individual members of the management board was regarded as controversial in the business Community. Previously, the disclosure Standards relating to compensation issues were low.'*^^ What is new and what has been criticised by many management board members is the recommendation that these figures should be individualised.'^^^ It is usual for large listed companies not to comply with the disclosure of individual pay of senior executives for reasons of privacy."^^^ In 2002, only six out of the Dax 30 companies did so."^^"* "^^^Item 4.2.3: "... Variable compensation should include one-time and annually-payable components linked to the business Performance as well as long-term incentives containing risk Clements. All compensation components must be appropriate, both individually and in total. - In particular, Company Stocks with a multi-year blocking period, stock options or comparable instruments (e.g. phantom Stocks) serve as variable compensation components with long-term incentive effect and risk Clements. Stock options and comparable instruments shall be related to demanding, relevant comparison parameters. Changing such Performance targets or the comparison parameters retroactively shall be excluded. For extraordinary, unforeseen developments a possibility of limitation (Cap) shall be agreed for by the Supervisory Board ..." 487 §§ 192(1) and 192(2) Nr. 3 AktG. 488 § 193(1) AktG.
489 §133(1) AktG. 49^ The German Corporate Govemance Code, 4.2.3 and 4.2.4. 491 For example, it was argued that the Data Protection Act (Datenschutzgesetz) prohibits the answering of questions about the remuneration of individual members of the management board. See, for example. Semler J, The Practice of the German Aufsichtsrat. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit p 279; Andre TJ, Cultural Hegemony: The Exportation of Anglo-Saxon Corporate Govemance Ideologies to Germany, Tul L Rev 73 (1998) pp 158-161. 492 Item 4.2.4.
493 Ringleb HM in Ringleb HM, Kremer T, Lutter M, von Werder A, Kommentar zum Deutschen Corporate Govemance Kodex (2003) 4.2.4 Rn 553; Khoudja S, Corporate Govemance in Germany - The recent changes. Luiss Guido Carli, Centro di ricerca per il diritto d'impresa (2003) p 35.
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Auditors The appointment of statutory auditors requires both a decision to elect a certain auditor and an agreement"^^^ with him. Statutory auditors are formally elected by the general meeting."^^^ In reality, the statutory auditor is appointed before the general meeting, because the supervisory board must submit a proposal and cannot do so without first reaching an understanding with a candidate.'^^'' The independence of statutory auditors is regulated by the provisions of the Handelsgesetzbuch."^^^ The German Corporate Govemance Code provides that prior to submitting a proposal for election, the supervisory board, or the audit committee if the Company has one, should obtain from the proposed auditor a Statement on the relationships that could jeopardize his independence."^^^ As shareholders in general meeting cannot represent the Company in its dealings with third parties, they cannot be responsible for any contracts with the Company's auditors. In its dealings with auditors, the Company is represented by its supervisory board,^^^ that is, by an independent organ responsible for the supervision of management. The supervisory board can delegate this matter to a supervisory board committee such as an audit committee.^^^ Although the supervisory board cannot formally elect statutory auditors, the supervisory board is empowered to decide on their remuneration and other contract terms. While the supervisory board (or a supervisory board committee) decides on these matters as a collegiate organ, it would not be feasible to require the supervisory board to enter into negotiations as a collegiate organ. In negotiations with the Company's auditors, the supervisory board is represented by its chairman.^^^ The general meeting can also elect a special auditor (Sonderprüfer) in some cases.^^^ A court may elect a special auditor at the request of a minority representing one-tenth (10%) or € 1 million of the share capital.^^"* During a general meeting it is in principle possible that the Company is represented by this organ, but after the general meeting the Company must probably be represented by its management board.^^^
"^^"^ Deutsche Schutzvereinigung für Wertpapierbesitz e.V. (DSW) regularly publishes a survey on the development of the board members' pay in DAX 30 companies. 495 § 675 BGB. 496§119(l)(4)AktG. 49^ § 124(3) AktG. See also Altmeppen H, Der Prüfungsausschuss - Arbeitsteilung im Aufsichtsrat, ZGR 2004 p 405. 498 See § § 3 1 8 and 319 H G B . 499 Item 7.2.1.
500 §111(2) AktG. 501 § 107(3) AktG. See also Altmeppen H, Der Prüfungsausschuss - Arbeitsteilung im Aufsichtsrat, ZGR 2004 p 405. 502 See Hüffer U, Aktiengesetz (2002) § 111 R n 12a-12d. 503 § 142(1) AktG. 504 § 142(2) AktG; see also § 142(4) AktG. 505 See Hüffer U, Aktiengesetz (2002) § 142 R n 11.
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Prokurist A Prokura is granted by the management board. The general meeting can neither grant nor cancel any Prokura, but the articles of association can provide that the management board may not grant any Prokura without the prior consent of the supervisory board.^^^ A Prokura cannot be granted by a Prokurist or assigned by him.507 A Prokura cannot be granted to a statutory board member due to the mandatory nature of the provisions on the distribution of powers in the Company.^^^ A Prokura can only be granted expressly.^^^ It cannot be granted silently, but it is possible to regard an alleged Prokura that has not been granted expressly as a general power of attomey (Handlungsvollmacht).^^^ Like other powers of attomey, the Prokura can be terminated at any time^^^ and it is terminated at the expiry of the contractual relationship between the Prokurist and the company.^^^ For example, the Prokura of a person who is employed by the Company is terminated automatically when the employment relationship ends. The Prokura is recorded in the commercial register.^^^ The entry of the Prokura in the commercial registar is declaratory only, and its purpose is to protect third parties. Third parties are legally entitled to rely on the authorisation of management board members and the Prokuristen listed in the commercial register to act in the Company's name.^^"^ The articles of association typically provide that the Company may be represented in transactions with third parties by two members of the management board acting jointly or by one member of the management board together with a Prokurist.^^^
5.5 Agreements and Internal Management Sometimes shareholders can also act as a rule-maker outside general meetings. In particular, the articles of association and resolutions of the general meeting can be supplemented by agreements. Agreements can have the advantage of flexibility. The most important forms of contracts are shareholders' agreements. The unanimous consent of shareholders hardly plays any role in the govemance of AGs.
506 §§111(4) and 82(2) AktG. 507 § 52(2) H O B . 508 § 78(2) AktG. 509 § 48(1) H G B . 510 §§ 140 B G B (Umdeutung) and 54 H G B (Handlungsvollmacht). 5 " § 52(1) H G B . See also § 168 B G B .
512 § 168 BGB. 513 §53(1) HGB. 514 §15 HGB. 515 § 78(3) AktG.
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Shareholders' agreements inter se. Shareholders' agreements are basically permitted. As agreements between the shareholders inter se are distinguished from articles of association, their contents are not Umited by the principle of Satzungsstrenge. It is nevertheless possible that some matters such as the duty to subscribe for shares must be regulated by the articles of association and cannot be validly regulated by any shareholders' agreement.^^^ Shareholders' agreements are binding on their parties and can be amended with their unanimous consent only. Sanctions for breach of shareholders' agreements include the normal sanctions for the breach of contractual obligations. Shareholders' agreements are not binding on the Company, and sanctions for their breach cannot be enforced against it. For example, a resolution passed at a general meeting cannot be contested and declared void for the breach of a shareholders' agreement even where all shareholders are party to the agreement.^^^ Shareholders' agreements with the Company. Another undertaking, in particular the parent, can in some cases enter into contracts with the Company in order to be able to manage it (Beherrschungsvertrag) or dispose of its profits (Gewinnabfuhrungsvertrag).^^^ These types of agreements are used especially in Company groups (see Chap. 5.9 below). Apart from this exception, contracts with the Company cannot be used to fetter the discretion of the management board. The management board may not fetter its discretion by agreeing to act in a certain way in the future. Such contracts would violate the principles of the Aktiengesetz in a number of ways.^^^ Firstly, they would be contrary to the Obligation of the management board to "direct the Company under its own responsibility".^^^ Secondly, the management board may not take decisions a long time in advance and thereby restrict the discretion of future management board members. Thirdly, the management board may not subject itself to the will of any third party. On the other hand, the management board may enter into long-term contracts for the benefit of the Company.
5.6 Disciosure, Remedies and Management Duties 5.6.1 Introduction As discussed above, shareholders can sometimes decide on management matters and directly make the rules according to which the Company is run. Sometimes the monitoring rights vested in the shareholders give them an opportunity to influence management. ^^^ See Henze H, Aktienrecht. Höchstrichterliche Rechtsprechung (2000) p 10; Hüffer, Aktiengesetz (2002) § 23 Rn 47. 51^ See Hüffer U, Aktiengesetz (2002) § 23 Rn 47. 518 § 291(1) AktG. 51^ See Fleischer H, Zur Leitungsaufgabe des Vorstands im Aktienrecht, ZIP 2003 pp 1011. 520 § 76(1) AktG.
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In Germany, the rights of shareholders to sue board members are limited due to the statutory and mandatory distribution of powers between different Company Organs and the fact that management is monitored by the supervisory board.^^^ On the other hand, shareholders have traditionally enjoyed relatively extensive rights to sue where the provisions of the Aktiengesetz or the articles of association have been breached at a general meeting. Apart from disclosure, the right to contest resolutions at the general meeting is probably the most important regulated means for shareholders to control management. As this remedy has become increasingly populär in recent years, the legislator has limited its use in order to prevent possible abuse. On the other hand, the post-Enron reforms also include the estabhshment of an independent enforcement authority to examine financial Statements.
5.6.2 The Rights of Shareholders to Disclosure of Information It is possible to make a distinction between the rights of passive shareholders to disclosure of Information and the rights of active shareholders. Sometimes information should be made available to shareholders whether they actively request disclosure or not, but sometimes information is not made available to shareholders unless one or more shareholders have requested it. Unrequested Information The Aktiengesetz and related Statutes mandate the disclosure of information to shareholders. In addition to the disclosure of financial and other information at or before general meetings, the management board has a number of duties to disclose information to shareholders generally without the shareholders having to ask for it.522
Disclosure of periodic information. Firstly, information is disclosed at the annual general meeting in the annual accounts. This information reaches shareholders late. Like in the UK, the rules on financial reporting and annual accounts are based on the Fourth Company Law Directive (78/660/EEC) and the Seventh Directive (83/349/EEC). Under German law, the annual financial Statements of the Company must comply with the provisions of the Commercial Code (Handelsgesetzbuch, HGB). These Statements form the basis for taxation. According to the HGB, the annual financial Statements should provide a true and fair overview of the net assets, financial position and eamings Situation of the Company in accordance with generally accepted accounting principles.^^^
521 §111(1) AktG. 5^^ See for example Baums T, Haftung wegen Falschinformation des Sekundärmarktes, ZHR 167 (2003) pp 144-145. 523 § 264(2) HGB.
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The management board of the parent is responsible for preparing the annual Consolidated financial Statements (Konzemabschlüsse) and Consolidated management reports (Konzemlageberichte) as well as the non-consolidated Statements and reports of the Company.^^"^ These documents are examined by the auditor and the supervisory board. They must be made publicly accessible. It is normally not necessary to seek the general meeting's approval.^^^ The new Act on the Control of Financial Statements (Bilanzkontrollgesetz, BilKoG) provides that an independent enforcement authority (in practice, Deutsche Prüfstelle für Rechnungslegung, DPR) will examine the financial Statements of listed companies.^^^ Members of the management board and a number of other persons have a duty to co-operate with the enforcement authority. If the authority detects accounting irregularities it will try to find an amicable solution.^^^ If a Company fails to cooperate, the Federal Authority for the Supervision of Financial Services (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin) may force the Company to disclose the irregularities.^^^ Disclosure of periodic information in interim reports, Secondly, some information is disclosed in interim reports. These provisions are partly based on the Listing Directive (2001/34/EC). The statutory rules can be found in the Exchange Act (Börsengesetz, BörsG), which sets out that the issuer of admitted shares must publish regularly at least one interim report during each fiscal year,^^^ and in the regulations adopted by the Frankfurt Stock Exchange, which require the disclosure of quarterly reports.^^^ Interestingly, Dr. Ing. b.c. F. Porsche AG has refused to file quarterly reports but has reported its results on a half-yearly basis. Porsche has also sued Deutsche Börse AG, the operator of the Frankfurt Stock Exchange, in order to get its stock listed on the blue-chip MDAX index despite the refusal to release results quarterly. The Frankfurt Stock Exchange lists on its premium segment only companies that publish quarterly reports. Self-evaluation of board Performance, The Aktiengesetz does not require any self-evaluation of board Performance. While the German Corporate Govemance Code provides that "the supervisory board shall examine the efficiency of its activities on a regulär basis'V^^ the Code is silent on how the supervisory board
524 g 91(1) AktG: "Der Vorstand hat dafür zu sorgen, daß die erforderlichen Handelsbücher geführt werden." See also § 238(1) H O B as well as § 264 H O B .
525 § 173(1) AktG. 526 § 342b(2) H G B inserted by the BilKoG. 527 § 342b(5) H G B inserted b y the BilKoG. See Müller W , Prüfverfahren u n d Jahresabschlussnichtigkeit nach d e m Bilanzkontrollgesetz, Z H R 168 (2004) p p 4 2 0 - 4 2 1 . 528 §§ 37p and 37q W p H G inserted by the BilKoG. 529 § 40(1) BörsG. 5^^ §§ 6 3 and 78 o f the Börsenordnung für die Frankfurter Wertpapierbörse. 5^^ The German Corporate G o v e m a n c e Code, 5.6.
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should go about this task. For example, there is no Obligation to disclose the outcome of this examination.^^^ Ad-hoc disclosure. Like the mies on regulär disclosure, the rules on the ongoing duty to disclose price-sensitive information are partly based on EU law.^^^ In Germany, the ongoing duty to disclose information is generally govemed by three types of statutory provisions: the Securities Trading Act (Wertpapierhandelsgesetz, WpHG); the general provisions of the law of obligations (which apply in particular to liabihty in tort); and the Securities Acquisition and Takeover Act (Wertpapierübemahmegesetz, WpÜG, see below).^^"^ The Wertpapierhandelsgesetz lays down a duty of the issuer of securities to disclose price-sensitive information,^^^ and the management board as the organ representing the Company is responsible for compliance with this duty.^^^ The duty to disclose price-sensitive information also Covers "all new facts made known to financial analysts and similar addressees" as well as "any information which the Company discloses abroad in line with corresponding capital market law provisions".^^^ Disclosure ofstructural change. Some transactions require both the consent of shareholders in general meeting and the Submission by the management board of a report to shareholders in advance. These transactions include, for example, capital increases combined with the exclusion of existing shareholders' pre-emptive rights,^^^ the conclusion of enterprise contracts,^^^ the redemption of minority shares (squeeze-out),^"^^ and mergers.^"^^ Disclosure as regards takeovers. The new Wertpapierübemahmegesetz provides for additional reporting requirements regarding planned takeovers of listed companies having a registered office in Germany.^"^^ The offeror must disclose its decision to make a public offer as soon as it has been made.^"^^ 532 See YQji Werder A in Ringleb HM, Kremer T, Lutter M, von Werder A, Kommentar zum Deutschen Corporate Govemance Kodex (2003) 5.6 Rn 817. 5^^ See nowadays Article 6(1) of the new Market Abuse Directive (2003/6/EC). 5^"^ See Hom N, Zur Haftung der AG und ihrer Organmitglieder fiir unrichtige oder unterlassene Ad-hoc-Informationen. In: Festschrift fiir Peter Ulmer (2003) p 818. 535 §15(1) WpHG. 53^ See also the German Corporate Govemance Code, 6.1. 53^ The German Corporate Govemance Code, 6.3 and 6.5. 538 § 186(3) AktG. 539 § 293a A k t G . 540 § 327c(2) AktG. 541 § 8 UmwG.
542 §§ 10 (Veröffentlichung der Entscheidung zur Abgabe eines Angebots), 2 7 (Stellungn a h m e des Vorstands und Aufsichtsrats der Zielgesellschaft) and 35 (Verpflichtung zur Veröffentlichung u n d z u r Abgabe eines Angebots) W p Ü G . T h e W p Ü G is applicable w h e n these companies' shares are listed in the official trading or regulated market Segment, or have been admitted for trading on any organised market in another m e m b e r country o f the European Economic Area. See Assmann H D , Ü b e m a h m e a n g e b o t e im Gefiige des Kapitalmarktrechts, insbesondere i m Lichte des Insiderrechts, der A d hocpublizität und des Manipulationsverbots, Z G R 2002 p p 7 1 1 - 7 1 6 .
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Unlike Rule 2.2 of the City Code, the Wertpapierübemahmegesetz does not say that the target Company would have a similar duty. For example, the Act does not say that the management board of the target Company would have any specific duty to disclose any public offer made by the offeror or the matter that the management board of the target Company has permitted due diligence.^'^'^ On the other hand, the management board of the target Company does have a general duty to disclose price-sensitive information under the Wertpapierhandelsgesetz. ^"^^ The Wertpapierübemahmegesetz also provides that in the event of a takeover offer, the management board and supervisory board of the target Company must submit a Statement of their reasoned position so that the shareholders can make an informed decision.^"^^ There is a similar rule in the German Corporate Govemance Code.547 Disclosure of shareholdings. At the time the Wertpapierübemahmegesetz was passed, some of the provisions of the Wertpapierhandelsgesetz were changed. The disclosure requirements for shareholders and companies were significantly expanded (threshold disclosure)^"^^ due to EU law. EU law provides that a person acquiring or disposing of shares so that its holding with a publicly traded Company reaches, exceeds or falls below certain thresholds informs the Company, which is in its tum responsible for disclosing this information to the public.^"^^ Primary market information. German laws on prospectuses incorporate the general Standards laid down by EU Directives.^^^ The Act on the Prospectus for Securities Offered for Säle (Wertpapier-Verkaufsprospektgesetz, VerkProspG) sets out that the securities prospectus should give the investing public all material information regarding the financial condition and result of Operations of the Company that they require to make a reasoned Investment decision.^^^ Principle of equal treatment of investors. All Investors should be treated equally as far as disclosure of information to investors is concemed. This general principle of EU capital markets law^^^ is codified in the duty of issuers to treat all holders of listed securities equally in similar circumstances^^^ and 543 § 10(1) WpÜG. ^^^ See also Assmann HD, Übemahmeangebote im Gefuge des Kapitalmarktrechts, insbesondere im Lichte des Insiderrechts, der Ad hoc-publizität und des Manipulationsverbots, ZGR 2002 pp 714-715. ^"^5 § 15(1) WpHG. See Hopt KJ, Übernahmen, Geheimhaltung und Interessenkonflikte: Probleme für Vorstände, Aufsichtsräte und Banken, ZGR 2002 pp 345-347. 546 § 2 7 W p Ü G . 547 Item 3.7. See also Article 9(5) of the Takeover Directive (2004/25/EC). 548 See § 21 in connection with § 25 W p H G . See also the G e r m a n Corporate G o v e m a n c e Code, 6.2. 549 See also Article 9(1) of the Transparency Directive (2004/109/EC). 550 See the Prospectus Directive (2003/71/EC).
551 See §§ 1 (scope, general rule), 5 (contents of the prospectus), 7 (contents of the prospectus) VerkProspG. 552 See also Article 13 of the Transparency Directive (2004/109/EC): "... The issuer shall ensure equal treatment for all holders of shares who are in the same position ..."
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the general prohibition to abuse insider information.^^'^ It is also based on the German Corporate Govemance Code. The Code provides that all new facts made known to financial analysts and similar addressees should be disclosed by the Company to shareholders without delay.^^^ The Aktiengesetz also provides that where information has been disclosed to a shareholder otherwise than at a general meeting, this information must, at the request of another shareholder, be disclosed to other shareholders at a general meetjj^g 556
Information Made Available at the Request of Shareholders Apart from the more or less automatic disclosure of information to all shareholders, shareholders have limited rights to disclosure of information. For example, shareholders do not have a general right to view the books and documents of the Company. Reporting. As a rule, the management board reports to the supervisory board and not to shareholders.^^"^ The shareholders nevertheless are entitled to disclosure of information in some cases. Disclosure of information at a general meeting, At a general meeting, shareholders should be given an opportunity to take informed decisions. A shareholder has a subjective right to request verbal information from the management board regarding any item on the agenda (Auskunftsrecht). This right Covers all information regarding the Company, and in the parent Company all information regarding the group, without which it would not be possible to assess the agenda of the meeting.^^^ The management board has a duty to disclose the information provided, for example, that disclosure would not be detrimental to the Company or to an affiliated undertaking.^^^ Where information has been disclosed to a shareholder outside a general meeting, other shareholders are usually entitled to disclosure of the same information at the general meeting.^^^ These personal rights may be enforced by personal legal action. (a) The main legal remedy of an individual shareholder is to contest resolutions passed at a general meeting. The court can declare a voidable or void resolution invalid at the request of a shareholder.^^^ (b) The shareholder may also sue the Company for disclosure before contesting the resolution.^^^ 553 § 39(1) BörsG. 554 § 14 W p H G . 555 Item 6.3.
556§i31(4)AktG. 557 § 90 AktG. 558 § 131(1) AktG.
559 §131(3) AktG. 560 § 131(4) AktG.
561 See especially § 243(4) AktG. 562 §132(2) AktG.
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The power to contest resolutions has sometimes been abused.^^^ The UMAG will therefore limit the right to contest resolutions on this ground.^^"* The UMAG will also restrict the right to request verbal information in order to prevent shareholders from abusing their right to contest resolutions for alleged breach of disclosure rules.^^^ For example, the proposed UMAG would make it possible to refuse to answer a question that has already been answered on the Company website.^^^ Frequently asked questions would therefore not have to be answered anymore at a general meeting. The proposal is based on the idea that the mechanical reading of information could be replaced by more meaningful discussion on the strategy of the Company. Special audit. Any shareholder has the right to propose a special audit (Sonderprüfting) of some aspect of the Company's Operations and, in particular, the activities of members of the management board or the supervisory board. A special auditor (Sonderprüfer) is elected by a simple majority of votes.^^^ Where no such majority is found at the general meeting, the court may appoint the special auditor at the request of minority shareholders.^^^ Proposais seeking special audits are fairly frequent. However, usually they do not carry the endorsement of the management board or the supervisory board, and they succeed only in fairly unusual circumstances.^^^ The UMAG will change these rules. Under the previous rules, a minority of shareholders holding at least one-tenth (10%) or € 1 million of the share capital was necessary.^^^ According to the UMAG, the court will be able to appoint a special auditor at the request of shareholders holding either at least one-hundredth (1%) of the share capital or shares with the market value of at least € 100,000. In addition, the UMAG will require some evidence of gross breaches of duty. Selective disclosure. The right of statutory board members and sub-board managers to disclose information is constrained under the terms of their employment contracts and the general provisions of the Aktiengesetz (see below). In addition, it is restricted by insider trading rules (see below). Unlike Rule 2.1 of the City 563 See Paefgen WO, Unternehmerische Entscheidungen und Rechtsbindung der Organe in der Aktiengesellschaft (2002) p 2. ^^^ The UMAG will probably change the wording in § 243(4) AktG as foUows: "Wegen unrichtiger, unvollständiger oder verweigerter Erteilung von Informationen kann nur angefochten werden, wenn ein objektiv urteilender Aktionär die Erteilung der Information als wesentliche Voraussetzung für die sachgerechte Wahrnehmung seiner Teilnahmeund Mitgliedschaftsrechte angesehen hätte. Auf unrichtige, unvollständige oder unzureichende Informationen in der Hauptversammlung über die Ermittlung, Höhe oder Angemessenheit von Ausgleich, Abfindung, Zuzahlung oder über sonstige Kompensationen kann eine Anfechtungsklage nicht gestützt werden, wenn das Gesetz für Bewertungsrügen ein Spruchverfahren vorsieht." 565 See changes regarding § 131 A k t G in the U M A G . 566 See the n e w § 131(3)(7) A k t G that will be inserted by the U M A G . 567 § 142(1) AktG. 568 § 142(2) AktG. 569 See Andre TJ, Cultural Hegemony: The Exportation of Anglo-Saxon Corporate G o v e m ance Ideologies to Germany, Tul L Rev 73 (1998) p 96. 570 § 142(2) AktG.
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Code, the statutory provisions of the Wertpapierübemahmegesetz do not contain any general prohibition to disclose information in the context of takeover bids. Instead, confidentiality is govemed by other rules.^'^^
Restrictions on the Power or Duty to Disclose Information Sometimes the disclosure of information is prohibited. For example, there are prohibitions to disclose information to shareholders both in the Aktiengesetz and in the Wertpapierhandelsgesetz that lays down insider trading rules. General duty of confidentiality under the Aktiengesetz. Members of the two statutory boards have a duty of confidentiality under the Aktiengesetz.^^^ jj^gy may disclose confidential information and trade secrets if it is in the interests of the Company to do so. Even if they may disclose such information, they may become liable for any loss suffered by the Company where they fail to restrict the use or further disclosure of the information by its recipients although they should have restricted it in the circumstances.^'^^ Breach of duty of confidentiality can be an important reason (wichtiger Grund) to terminate both the board membership and the contract of employment of the management board member in question,^"^"* and the Aktiengesetz also provides for penal sanctions for breach of secrecy.^"^^ The conflict between the duty of confidentiality and the need to disclose confidential information has been discussed in particular in the context of due diligence and takeovers.^^^ Insider trading rules. In Germany, the rules on insider trading are contained in the Wertpapierhandelsgesetz.^'^^ Their application is supervised by the Federal Authority for the Supervision of Financial Services (Bundesanstalt fiir Finanzdienstleistungsaufsicht, BaFin). These rules are based on EU law. The rules on insider trading have an impact on both internal and public disclosure of information. In general, these rules do not hinder the Company from carry^^^ Hopt KJ, Übernahmen, Geheimhaltung und Interessenkonflikte: Probleme für Vorstände, Aufsichtsräte und Banken, ZGR 2002 pp 335-337. 572 §§93(1) and 116 AktG. 573 § 93(1) AktG 574 § 84(3) AktG.
575 § 4 0 4 AktG (Verletzung der Geheimhaltungspflicht). 576 See for example Mertens K, Die Information des Erwerbers einer wesentlichen Untemehmensbeteiligung an einer Aktiengesellschaft durch deren Vorstand, A G 1997 pp 5 4 1 - 5 4 7 ; Schroeder U , Darf der Vorstand der Aktiengesellschaft dem Aktienkäufer eine D u e Diligence gestatten? D B 1997 p p 2 1 6 1 - 2 1 6 6 ; Götze C, Auskunftserteilung durch GmbH-Geschäftsführer im Rahmen der Due Diligence beim Beteiligungserwerb, Z G R 1999 p p 2 0 2 - 2 3 3 ; Hopt KJ, Übernahmen, Geheimhaltung und Interessenkonflikte: Probleme für Vorstände, Aufsichtsräte und Banken, Z G R 2002 p p 356-359,
577 See Articles 2, 3 and 6 of the Market Abuse Directive (2003/6/EC). Article 18: " M e m ber States shall bring into force the laws, regulations and administrative provisions necessary to comply with this Directive not later than 12 October 2004."
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ing out its business in the normal way. However, they affect Communications to shareholders and may require more legal work before the disclosure of information, The mies on insider trading promote public disclosure^^^ and restrict selective disclosure. The Wertpapierhandelsgesetz provides that primary insiders are prohibited from communicating or making available any insider Information to other persons unless the communication is specifically authorised by this Act.^^^ In addition, a primary insider is prohibited from recommending to a third party, on the basis of his knowledge of any insider information, the acquisition or disposal of insider securities.^^^ Primary insiders include not only members of the two statutory boards^^^ but can also include other persons such as senior employees who have access to insider information through the exercise of their employment, profession or duties.^^^ In practice, the insider trading rules of the Wertpapierhandelsgesetz have influenced the internal communication of information within the Company. Normal Communications. The provisions of the Wertpapierhandelsgesetz do not prohibit normal Communications of inside information within the two statutory boards and between these two boards. As a rule, selective disclosure to some Supervisor/ board members is not prohibited by the provisions of the Wertpapierhandelsgesetz, but selective disclosure to shareholder representatives would amount to discrimination of employee representatives prohibited by the provisions of the Co-determination Act.^^^ It is nevertheless possible that sensitive information is first disclosed to the chairman of the supervisory board^^"^ and made public before it is communicated to the members of the supervisory board. The provisions of the Wertpapierhandelsgesetz do not prohibit normal Communications of inside information to statutory employee bodies in the course of codetermination and worker participation. For example, insider rules do not limit the normal disclosure of information to the economic committee (Wirtschaftsausschuß).585 Communications to shareholders, The insider trading rules of the Wertpapierhandelsgesetz have influenced the communication of information by the management board to shareholders. While selective disclosure may violate insider trading rules, it is safer for management board members to disclose information in public and by following the formal procedures set out in the Aktiengesetz. The provisions of the Wertpapierhandelsgesetz also affect the disclosure of insider information to shareholders at a general meeting. The disclosure of insider 578 § 15(1) W p H G . 579 § 14(1)(2) W p H G . 580 § 14(1)(3) W p H G .
581 §13(1)0) WpHG. 582 §13(1)(3) WpHG. 583 § 26 MitbestG. 584 § 90(5) AktG. 585 § 106(2) BetrVG. The most important matters to b e disclosed to the economic committee have been listed in § 106(3) BetrVG. Assmann H D , Gramer P in Assmann H D , Schneider U H (eds) Wertpapierhandelsgesetz (1999) § 14 Rz. 54a.
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information at a general meeting is basically prohibited unless preceded by a formal public disclosure according to the procedura set out in the Wertpapierhandelsgesetz.^^^ Before ad-hoc disclosure of information to the public, the information must be sent in advance and simultaneously to the BaFin and all German exchanges;^^"^ the disclosure must then be made in at least one nationwide newspaper designated for official stock exchange notices or via certain electronic information distribution systems.^^^ Any insider information should therefore be made public prior to disclosure at the general meeting.^^^ In Germany, there is a potential conflict between the duty of management board members under the Aktiengesetz to disclose information at the request of a shareholder at a general meeting,^^^ the duty of management board members under the Wertpapierhandelsgesetz to publicly disclose any pricesensitive information,^^^ and the duty not to disclose information not yet so disclosed.^^2 A possible Solution to a rare problem like this is that the board may reflise to disclose information to shareholders if it has not yet been disclosed pubHcly.593
Communications to major shareholders, due diligence. The provisions of the Wertpapierhandelsgesetz restrict the automatic or systematic disclosure of inside information to major shareholders. It is possible that a major shareholder is in the possession of insider information due to his position; this would make him a primary insider.^^"^ But the prohibition to disclose inside information applies even to disclosure of information to shareholders who may sometimes be regarded as primary insiders. There are exceptions to this main rule. The disclosure of information is not always "unauthorised" (unbefugt), (a) In particular, communication of inside information can be required for the proper functioning of the Company. For example, it can be in the interests of the Company represented by the members of its management board to ask for the opinion of major shareholders in the event that the Company makes plans to increase its share capital.^^^ (b) In Company groups, the insider trading rules do not restrict what can be regarded as the normal flow of
586 § 15 W p H G . See also § 15(3) W p H G . 587 § 15(2) W p H G .
588 §15(3) WpHG. 589 Kumpel S in A s s m a n n H D , Schneider U H (eds) Wertpapierhandelsgesetz (1999) § 15 Rz. 163. 590 § 131 A k t G (Auskunftsrecht des Aktionärs).
591 § 15(1) WpHG (Veröffentlichung und Mitteilung kursbeeinflussender Tatsachen). 592 §15(3) WpHG. 593 See § 131(3)(5) AktG. See also Assmann HD, Gramer P in Assmann HD, Schneider UH (eds) Wertpapierhandelsgesetz (1999) § 14 Rz. 49b-53; Kumpel S ibid § 15 Rz. 164. 594 § 13(1)(2) W p H G . See also Article 2(1)(2) o f the Market Abuse Directive: " T h e first subparagraph shall apply to any person w h o possesses that information: ... (b) b y virtue of his holding in the capital of the issuer ..." 595 A s s m a n n H D , Kumpel S in Assmann H D , Schneider U H (eds) Wertpapierhandelsgesetz
(1999) § 14 Rz. 48c and 54b.
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information within the group.^^^ It is therefore permitted to disclose Information to the Controlling undertaking. (c) It can also be necessary to disclose information in the context of major corporate transactions such as mergers and acquisitions. For example, it is in the interests of the Company to let the buyer of a block of shares conduct due diligence.^^^ It is also possible to let a potential "white knight" conduct due diligence and make a competing bid for the shares of the target Company. ^^^ The information must then be made available to other bidders.^^^ (d) Statutory board members, sub-board managers and employees may disclose inside information if it is "normal" for them to do so.^^^ For example, it is clear that Communications to authorities can be permitted; the same can be said of disclosure of information to lawyers, auditors and extemal Consultants to where disclosure is necessary in light of the Services performed by these parties.^^^ In principle, this exemption does not cover the systematic preferential treatment of a pool of shareholders, normally a pool of family shareholders close to the Company. In practice, members of the management board often disclose information to family shareholders.^^^
5.6.3 Shareholder Remedies The remedies that the Aktiengesetz provides for shareholders are less effective than the informal means available to large shareholders parallel to or in spite of the statutory regulation.^^^ At first sight, the formal powers of individual shareholders to control management are limited. Firstly, top management (the statutory management board) is controlled by the statutory supervisory board. Management board members are appointed and removed by the supervisory board. Secondly, some supervisory board members are not appointed by shareholders in general meeting, and it is difficult for shareholders to remove them. Thirdly, individual shareholders may not normally bring proceedings against top management for breach of duty owed to the Company. The Company is represented by one of its statutory boards. Fourthly, ^^^ Assmann HD, Kumpel S ibid § 14 Rz. 54d: "Insbesondere ist es nicht Sache des Insiderrechts, Informationsweitergaben in unterschiedlichen Konzemierungsformen zu priviligieren oder zu benachteiligen und auf diese Weise Aufgaben des Konzemrechts zu übernehmen." ^^'^ Assmann HD, Kumpel S ibid § 14 Rz. 88b. See also Hopt KJ, Übernahmen, Geheimhaltung und Interessenkonflikte: Probleme für Vorstände, Aufsichtsräte und Banken, ZGR 2002 p 338. 59^ Hopt KJ, ibid pp 356-359. See also note 1 on Rule 20.1 of the City Code. 599 Hopt KJ, ibid p 358. See also Rule 20.2 of the City Code. ^^^ Assmann HD, Kumpel S in Assmann HD, Schneider UH (eds) Wertpapierhandelsgesetz (1999) § 14 Rz. 48a. 601 Assmann HD, Kumpel S ibid § 14 Rz. 56 and 56a. 602 Assmann H D , Kumpel S ibid § 14 Rz. 54b. 603 See Andre TJ, Cultural Hegemony: The Exportation o f Anglo-Saxon Corporate G o v e r -
nance Ideologies to Germany, Tul L Rev 73 (1998) pp 149-150.
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only some statutory duties are owed to shareholders; not all provisions of the Aktiengesetz and related Statutes are deemed to protect shareholders^^'* and give them a right to sue. And lastly, both the management board and the supervisory board have been given some discretion as far as business decisions are concemed. Some powers are nevertheless reserved for shareholders. They include in particular the following: (a) The shareholders may control decision-making at general meetings. Some of the powers of the general meeting are exercised on the basis of actions by the management board or the supervisory board,^^^ and the shareholders can thus have a say on the legality of these actions when they control the legality of resolutions passed at the general meeting. This remedy plays an important role in German Company law (see Chap. 5.7 below). (b) Sometimes a shareholder has individual rights that can be enforced by him. For example, shareholders have a pre-emptive right to new shares issued by the company.^^^ (c) Some powers to decide on the bringing of proceedings against defaulting board members have been vested in the shareholders, because the boards usually do not want to sue defaulting board members. (d) The interests of shareholders are to some extent protected by penal sanctions against statutory board members who abuse their powers. In addition, the independent monitoring of financial information has been made possible by the Bilanzkontrollgesetz. The legal basis of the liability of members of the two statutory boards is largely statutory and mandatory. Therefore, neither the articles of association nor Service contracts contain regulations on the liability of board members. In the following a distinction is firstly made between remedies and duties. There are several remedies available to the Company or its shareholders. Some of these remedies relate to breach of duty. Some - in particular the right not to reappoint a board member - are not related to any breach of duty. Some duties may be effective in fact although they are not coupled with effective sanctions for breach of duty.
Removal of Managers or Refusal to Reappoint Them At least formally, shareholders can have little direct impact on the removal of the persons who actually run the Company, that is, members of the management board or sub-board managers. Shareholders have more impact on the removal of persons who supervise management, that is, members of the supervisory board. But even this power is subject to limitations. Members of the management board. Members of the management board are formally appointed for up to five-year renewable terms, and removed, by the supervisory board.^^^ Members of the management board may be removed prematurely for an important reason (wichtiger Grund),^^^ but whether the employment 60^ In the sense of § 823(2) BGB (Schutzgesetz). 605Seell9AktG. 606§186AktG. 607 § 84(1) AktG. 60« § 84(3) AktG.
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contract of a board member can be terminated at the same time is govemed by the general principles of the law of obligations.^^^ Members of the supervisory board. Members of the supervisory board are elected for up to five-year renewable terms.^^^ Members of the supervisory board or shareholder representatives in companies subject to co-determination - may be removed prior to the end of their term by a vote of three-fourths (75%) of the votes actually cast at the general meeting.^^^ The statutory threshold is quite high, and the articles of association often provide for a lower percentage such as a simple majority of votes cast at the general meeting.^^^ At the request of the supervisory board - but normally not the shareholders - a court may remove a supervisory board member for an important reason relating to his person.^^^ Number ofremovals. The removal of management board members or refusal to reappoint them seem to be used quite often, although shareholders lack a formal power to oust underperfoming managers under the Aktiengesetz and the relationships between management and supervisory boards tend to be close. A study by Booz Allen Hamilton, a consultancy firm, found out that the fluctuation of management board members in Germany is relatively high. The study also found out that top managers (management board members) of German publicly traded companies are forced to leave more frequently than top managers in many other countries.6^4
Compensation for Löss As regards compensation for loss, it is necessary to distinguish between loss sustained by the Company and loss sustained by shareholders. It is also necessary to distinguish between the right to decide on the bringing of proceedings on behalf of the Company and the Standing to sue on behalf of the Company. A shareholder may sue for personal loss. In Germany, a person who is entitled to compensation for loss also has Standing to sue; a subjective right also gives the right to sue. On the other hand, shareholders may normally not sue for loss which reflects the loss sustained by the company.^^^ Only the Company may sue, and the Company is represented intemally and extemally by one of its statutory boards. There are nevertheless exceptions to this main rule. At a general meeting, a group of (minority) shareholders may in some cases ask the Company to institute legal proceedings. In practice, however, the conditions laid down in the Aktienge609 § 84(3) AktG: "... Für die Ansprüche aus d e m Anstellungsvertrag gelten die allgemeinen Vorschriften." 610 § 1 0 1 ( 1 ) and 102(1) AktG.
614103(1) AktG. 612 Andre TJ, Cultural Hegemony: The Exportation o f Anglo-Saxon Corporate Govemance Ideologies to Germany, Tul L R e v 73 (1998) p 87.
613 §103(3) AktG. 61"! CEO Succession Report, see Ehren H, Studie: In Deutschland sitzen Topmanager auf den heißesten Stühlen, Financial Times Deutschland 17 May 2004. 615 See for example § 117(1) AktG.
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setz for these kinds of proceedings against board members are hardly ever met, and shareholders in general meeting cannot cause the Company to sue unless the resolution is supported by a simple majority of votes cast. There are a number of alternative causes of action. (a) The liability of statutory board members for loss sustained by the Company is generally govemed by the specific provisions of the Aktiengesetz.^^^ (b) Their liability can also be based on contract or rules setting out sanctions for breach of contract. (c) The rules on the non-contractual liability of statutory board members are based on a combination of: the general provisions of the BGB setting out the liabiHty for breach of duty (especially § 823(2) BGB);^^"^ other statutory provisions setting out the duties; and the doctrine that the provisions setting out duties protect only some parties or interests thus limiting the right to sue. Statutory provisions are only to a limited extent "protective norms" (Schutzgesetze) in the sense of § 823(2) BGB).^^^
Liability for the Breacli of Board Members' General Duties The liability of board members for loss sustained by the Company by reason of their breach of duty is regulated by the provisions of the Aktiengesetz. Shareholders have only limited formal powers to sue or cause the Company to sue. In court proceedings, the Company is not represented by its shareholders. There are in practice hardly any derivative actions by shareholders against statutory board members. Liability. Each board member is under a statutory duty to employ the care of a diligent and conscientious manager,^^^ and a board member is liable for any loss sustained by the Company by the breach of his duties under the Aktiengesetz.^^^ For example, all management board members and all supervisory board members are responsible for fmancial Statements and can be held accountable.^^^ The Aktiengesetz provides that the plaintiff must only show that a board member has breached his duties, the loss sustained by the Company, and the causation
616 §§93 and 116 Akte 617 § 823(2) B G B . 618
BGH, judgment of 19 July 2004 - II ZR 217/03 (Infomatec): "Schutzgesetz ist eine Rechtsnorm nur dann, wenn sie - sei es auch neben dem Schutz der Allgemeinheit gerade dazu dienen soll, den einzelnen oder einzelne Personenkreise gegen die Verletzung eines Rechtsguts zu schützen. Dabei kommt es nicht auf die Wirkung, sondern auf Inhalt und Zweck des Gesetzes sowie darauf an, ob der Gesetzgeber bei Erlaß des Gesetzes gerade einen Rechtsschutz, wie er wegen der behaupteten Verletzung in Anspruch genommen wird, zugunsten von Einzelpersonen oder bestimmten Personenkreisen gewollt oder zumindest mitgewollt hat (Sen.Urt. v. 21. Oktober 1991 - II ZR 204/90, NJW 1992, 241, 242 m.w.N.)." 619 §§93(1) and 116 AktG. 620 § 93(2) AktG. For duties see §§ 76(1), 83, 90, 92, 93, 111, 117 AktG.
621 The management board: § 91(1) AktG; § 264(1) HGB. The supervisory board: §§ 171(1) and 107(3) AktG. See Fleischer H, Erweiterte Außenhaftung der Organmitglieder im Europäischen Gesellschafts- und Kapitalmarktrecht. Insolvenzverschleppung, fehlerhafte Kapitalmarktinformation, Tätigkeitsverbote, ZGR 2004 pp 470-471.
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between breach of duty and loss. If the use of due care is disputed, the board member bears the bürden of proof that he employed due care.^^^ Decision to sue management board members. The management board decides whether to sue former management board members, and the supervisory board decides whether to sue present ones. As a rule, the decision to bring proceedings against a former member of the management board is a management matter and falls thus within the general powers of the management board.^^^ The supervisory board decides on whether to sue a present member of the management board.^^"* According to the judgment of the BGH in Arag/Garmenbeck,^^^ the supervisory board has a duty to assess: (a) whether there is a claim against a member of the management board; (b) whether the claim is enforceable; and (c) whether it is in the interests of the Company to enforce it. It is not sufficient that the Company has a case. Whether to enforce the claim is a business decision and the supervisory board has some business discretion. In practice, it is easy for the supervisory board to argue that to bring proceedings would be contrary to the interests of the company.^^^ The supervisory board can sometimes come to that conclusion because of the close contacts between these two statutory boards.^^"^ The supervisory board can share the blame. The same can be said of proceedings brought by the management board. To sue a former member of the management board would not be in the interests of other members of the management board because the management board operates as a collegiate organ and existing members can share the blame. For this reason, the general meeting and minority shareholders have been given powers to decide on the bringing of proceedings in some cases. Proceedings must be brought, where shareholders in general meeting so decide by a simple majority of votes cast.^^^ At the request of shareholders in general meeting, the court can appoint an agent to sue on behalf of the company.^^^ Minority shareholders have similar rights under some circumstances; these rights will be increased by the UM AG (see below). In practice however, only large shareholders have been able to cause the Company to sue. The provisions of the Aktiengesetz on the liability of statutory board members have been used quite seldom in the past, and minority shareholders have not really been able to enforce them in listed companies.^^^ 622 § 93(2) AktG.
623 § 76(1) AktG. 624 §112 AktG. 625BGHZ135,244. 626 See Ulmer P, Die Aktionärsklage als Instrument zur Kontrolle des Vorstands- und Aufsichtsratshandelns, ZHR 163 (1999) pp 295-297. 62'7The German Corporate Govemance Code, 3.1: "The Management Board and Supervisory Board cooperate closely to the benefit of the enterprise." See also item 3.5. 628 § 147(1) AktG. 629 § 147(2) AktG. 630 See Leyens P C , Deutscher Aufsichtsrat u n d U.S.-Board: ein- oder zweistufiges Verwaltungssystem? Z u m Stand der rechtsvergleichenden Corporate Govemance-Debatte,
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Decision to sue supervisory Board members. The liability of defaulting supervisoiy board members is govemed by the same provisions as the liability of defaulting management board members.^^^ In this case however, the decision to bring proceedings cannot be taken by the supervisory board. Either the management board or, in some cases, shareholders in general meeting will decide on this matter. Representation ofthe Company. The main rule is that proceedings on behalf of the Company against former members of the management board for loss suffered by the Company are brought by the management board. The Company is generally represented by its management board.^^^ On the other hand, proceedings against present members of the management board for loss sustained by the Company are brought by the supervisory board. The supervisory board represents the Company in its dealings with management board members, and this power Covers even the right to bring proceedings.^^^ In practice, the power to represent the Company (but not the power to decide on matters relating to the proceedings) is often delegated to a supervisory board committee.^^"* In proceedings against defaulting supervisory board members the Company will be represented by the management board.^^^ This is nevertheless likely to cause problems because of the powers of the supervisory board. For example, the management board is unlikely to sue supervisory board members for deciding to pay management board members too much money for their Services.^^^ For this reason, the Aktiengesetz provides that one or more special representatives can be appointed to represent the Company in legal proceedings.^^"^ Number of cases. In Germany, there are few civil lawsuits against members of the supervisory board for violation of the duty to exercise due care, and it is unusual for supervisory board members to pay damages.^^^ The same can be said of management board members. Proceedings against defaulting management board members are rare. In spite of the relatively small number of court cases, the provi-
RabelsZ 67 (2003) p 85: "praktisch nicht vorhandene Haftungswirklichkeit"; Andre TJ, Cultural Hegemony: The Exportation of Anglo-Saxon Corporate Govemance Ideologies to Germany, Tul L Rev 73 (1998) pp 149-150. 631 § 93 AktG. 632 § 78(1) AktG. 633 § 112 AktG. See also Hüffer U, Aktiengesetz (2002) § 112 R n 3 . 634 § 107(3) AktG; B G H Z 12, 327, 334. 635 §§ 77 and 78(1) AktG. 636 Lutter M , Corporate G o v e m a n c e und ihre aktuellen Probleme, vor allem: Vorstands Vergütung u n d ihre Schranken, ZIP 2003 p 7 4 1 . 637 § 147(2) AktG. 638 Semler J, T h e Practice o f the German Aufsichtsrat. In: Hopt K J , K a n d a H , R o e M J , W y m e e r s c h E, Prigge S (eds) o p cit p 279: "Legal provisions with regard to damages are not decisive for the success of entrepreneurs. M u c h more important and, above all, m u c h more effective is the change in the reputation o f an entrepreneur w h o belongs to the supervisory board of a Company which has run into difficulties."
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sions of the Aktiengesetz can still have a preventive effect. It is also possible that some disputes are settled out of court. Derivative action - actio pro socio. One of the factors limiting the number of cases is the main rule that shareholders may not bring proceedings on behalf of the Company.^^^ Where the rights of the Company have been infringed, only the Company may sue. German Company law has only rarely provided for an actio pro socio in the past. Actio pro socio is a derivative action brought by a shareholder on the Company's behalf ^"^^ Neither have shareholders been able to bring proceedings in their own name on behalf of the company.^"*^ The main rule has been that the Claim must be brought on behalf of the Company.^"^^ Minority shareholders' rights. The UMAG will increase minority shareholders' rights. Before the entry into force of the UMAG, minority shareholders will continue to be protected by two provisions. (a) Proceedings must be brought at the request of a shareholders holding one-tenth (10%) of the share capital at a general meeting. These shareholders must have owned their shares three months before the general meeting and still do so.^^ (b) In addition, a court may appoint special representatives (besonderer Vertreter) to bring proceedings on behalf of the Company at the request of shareholders holding one-twentieth (5%) of the share capital or shares the nominal value of which is at least € 500,000 if there are strong grounds to suspect fraud or acts that amount to a gross breach of law or the articles of association.^"^^ This possibility was introduced to the Aktiengesetz by the KonTraG. These provisions have been applied only rarely.^"^^ Firstly, the threshold of onetenth (10%) is often too high for minority shareholders. Secondly, the court cannot appoint any special representative unless it has received sufficient evidence of a gross breach. Thirdly, minority shareholders can be liable for legal costs if the Company loses the case. And if the court appoints a special representative, neither the court nor shareholders will be able to force the special representative to actually sue.^"^^
^^^ See Bamert T, Die Gesellschafterklage im dualistischen System des Gesellschaftsrechts (2003) pp 231 and 233. ^^ See generally Bamert T, ibid p 105. For partnerships see BGHZ 25, 47, 49: "Da die gesellschaftsvertraglichen Verpflichtungen eines jeden Gesellschafters auf dem Gesellschaftsvertrag beruhen und Partner dieses Vertrages sämtliche Gesellschafter sind, steht jedem von ihnen grundsätzlich ein Anspruch darauf zu, daß der andere die von ihm übernommenen Verpflichtungen erfüllt." ^^ See generally Bamert T, ibid p 109. 642§ll7(l)(l)AktG. 643 § 147(1) AktG. 644 § 147(3) AktG. 645 See Ulmer P, Die Aktionärsklage als Instmment zur Kontrolle des Vorstands- und Aufsichtsratshandelns, Z H R 163 (1999) p 293. 646 § 147(3) AktG. See also Hüffer U, Aktiengesetz (2002) § 147 Rn 9a.
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This outcome was partly intended, because the Federal Ministry of Justice feared that shareholders might abuse their rights.^"^^ There will be a number of changes under the UMAG. The thresholds will be lowered and shareholders will be able to bring proceedings in their own name on behalf of the Company. However, they may not do so without the consent of the court, and the liability of statutory board members for business judgments will be clarified or reduced. According to the UMAG, a court will be able to authorise shareholders holding 1% of the share capital to bring proceedings in the name of the Company under some circumstances. The threshold has thus been lowered from 10% to 1%. Shareholders holding shares with the market value of at least € 100,000 will have the same right.^"^^ At the request of the same qualified minority, a special auditor can be appointed by a court to find out whether the Company has a case against its board members.^"^^ As the UMAG will permit shareholders to sue for the Company in their own name, it will no longer be necessary to appoint a representative to sue in the name of the Company. A court will filter the claims by authorising the proceedings (Klagezulassungsverfahren). ^^^ The principle of loser pays will still apply to the Klagezulassungsverfahren,^^^ but the Company will bear the costs of proceedings authorised by the court. ^^2 The UMAG will provide that the liability of statutory board members for loss caused by business judgments requires in effect gross negligence.^^^ Liability to tiie Company for Breacti of Contract In Germany, it is necessary to distinguish between the statutory duties and liabilities of statutory board members on one hand and their contractual duties and liabilities on the other.^^"^ It is usual to regulate the ancillary rights and obligations of statutory board members in a contract of employment (Dienstvertrag). The provisions of the BGB cover this contractual relationship to the extent that the parties have not agreed otherwise. Liability, A number of remedies are available to the injured party. The injured party (the Company) may for example terminate the contract^^^ and claim compen^^'' See Ulmer P, Die Aktionärsklage als Instrument zur Kontrolle des Vorstands- und Aufsichtsratshandelns, ZHR 163 (1999) pp 292-293,299-300. 648 The U M A G will insert a new § 148 AktG. 649 See § 142 AktG. 650 According to the new § 148 AktG (UMAG). 65^ See Ulmer P, Die Aktionärsklage als Instrument zur Kontrolle des Vorstands- und Aufsichtsratshandelns, Z H R 163 (1999) p 339. 652 According to the new § 148 AktG (UMAG). 653 See § 93(1) AktG.
654 See for example Hüffer, Aktiengesetz (2002) § 84 Rn 15. 655 SS 323 and 324 B G B .
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sation for loss caused by breach of contract. In addition to breach of contract (Pflichtverletzung), the liability for loss caused by the breach requires at least negligence (Fahrlässigkeit).^^^ Duties. Board members are not responsible for the result of their actions but only for the quality of their work process.^^*^ For example, a management board member has a contractual duty to act in the interests of the Company and to disclose Information to the supervisory board where the supervisory board requests Information about his actions.^^^ Even in this case, the key question is therefore whether the board member employed the care of a prudent and a diligent manager,^^^ that is, whether the quahty of his work process was adequate. If the answer is yes, the board member is not likely to have caused the breach of contract through negligence, and it is possible that there is no breach of contract in the first place. Right to sue. Only the Company may sue for the breach of contractual duties owed to the Company. The Aktiengesetz does not give shareholders any power to cause the Company to sue its statutory board members for breach of contract.
Liability to Stiaretioiders for Breach ofa Duty Owed to ttie Company In some cases, members of the two statutory boards can be liable for loss suffered by shareholders by the breach of a duty owed to the Company. The liability of board members can be based on certain special provisions of the Aktiengesetz and related Statutes. In the absence of such statutory provisions, the general provisions of tort law apply and board members are not normally liable to shareholders. However, they may in principle become liable for loss caused by the breach of shareholders' personal rights. But even in this case the shareholders are not entitled to compensation for the loss of the value of their shares (Reflexschaden). Liability under special statutory provisions. Some provisions of the Aktiengesetz nevertheless make board members directly liable to shareholders for loss caused by the breach of a duty owed to the Company.^^^ A shareholder is entitled to compensation for loss, where other shareholders or third parties have wilfully caused statutory board members to act to the detriment of the Company (unzulässige Einflussnahme),^^^ that is, contrary to the general Standard of board members' duty of care.^^^ A shareholder who is entitled to compensation for loss also has Standing to sue. The shareholder may sue both the board members and the person or persons who influenced them.^^^
656 §§ 249(1) and § 276(1) B G B . 657 § 675(2) B G B .
658 §§675(1) and 666 BGB. 659 § 675(2) B G B . 660 See Thümmel R C , Persönliche Haftung von Managern und Aufsichtsräten (2003) Rdnr 350.
661 §117(1) AktG. 662 § 93(1) AktG.
663 §117(2) AktG.
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There are nevertheless limitations to the liability of these persons. They are not liable, where the only loss suffered by the shareholder is the loss in the market value of his shares (Reflexschaden). They are Uable only to the extent that the loss does not merely reflect the loss suffered by the company.^^"^ In addition, members of the two statutory boards are not liable, where they had a duty to follow directions given by shareholders in general meeting or by virtue of a formal control agreement (Beherrschungsvertrag).^^^ In these two cases, shareholders are protected by the right to contest void or voidable resolutions^^^ as well as by the special provisions on Company groups (Konzemrecht).^^^ Furthermore, a shareholder may, at least in theory if not in practice, sue under a few special provisions dealing with Company groups (Konzemrecht). There are similar provisions for de facto groups.^^^ (a) The background is that two companies may agree (Beherrschungsvertrag) that one Company is controlled by the other (herrschendes Unternehmen).^^^ It is also possible that one Company is in fact controlled by the other in a "de facto group" (faktischer Konzern) although there is no such formal agreement. (b) The purpose of this exception to the main rule is to protect both the dependent Company and its minority shareholders against wrongdoing by the dominating Company, (c) A shareholder of the dependent Company may bring proceedings on behalf of the dependent company^^^ against the statutory representatives of the Controlling Company.^^^ A shareholder may bring proceedings also against the statutory representatives of the dependent Company.^"^2 jj^ig also means that the majority rules discussed above^"^^ do not prevent a shareholder from bringing proceedings; any minority shareholder may decide to bring proceedings. (d) He may sue, where the statutory representatives of the dominating Company have breached their duty of care when giving directions to the dependent Company and these directions have caused the dependent Company loss.^^"* (e) If he wins, the proceeds will be paid to the dependent company.^^^ (f) In practice, this right exists in theory only. The shareholder would not sue, because he not only lacks the incentive to do so but would also have to carry the risk for legal costs. Furthermore, the shareholder would normally lack Information about the necessary facts of the case.^"^^
664 § 117(l)AktG. 665 § 117(7) AktG. 666 See § 243 AktG.
667 See § 308 AktG. 668 §§ 317(4) and 318(4) AktG. 669 § 308 AktG. 670 § 309(4) AktG.
671 §§ 309(1) and 309(2) AktG. 672 §310(1) AktG. 673 § 147 AktG. 674 §§ 309(1) and 309(2) AktG.
675 § 309(4) AktG. 676 U l m e r P , D i e Aktionärsklage als Instrument zur Kontrolle des Vorstands- u n d Aufsichtsratshandelns, Z H R 163 (1999) p 300.
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At the request of a shareholder, a court may appoint a special representative to sue a board member under special rules relating to formal mergers (Verschmelzung)^"^^ and similar corporate transactions.^*^^ Board members of a Company that merged into another undertaking are liable under the special provisions of the Umwandlungsgesetz for loss caused by breach of duty of care to the merged company^^^ as if the merged Company still existed.^^^ In practice, these special provisions are hardly ever used.^^^ Liability under the general provisions. In the absence of such statutory provisions, the general provisions of tort law apply. For example, it is clear that a person may not cause härm to others with malicious intent (vorsätzliche und sittenwidrige Schädigung).^^^ As regards the liability of defaulting board members for loss sustained by shareholders and the right of shareholders to sue them, the most important provisions of general tort law are § 823(1) BGB and § 823(2) BGB. While § 823(2) BGB gives shareholders under exceptional circumstances only the right to sue board members who have breached their duties under the Aktiengesetz, § 823(1) BGB can be invoked more easily by shareholders whose rights under the Aktiengesetz have been breached. (a) According to the wording of § 823(2) BGB, statutory norms are deemed to Protect a limited number of interests only; a statutory norm is thus a Schutzgesesetz in some respects but not in others as far as liability in tort is concemed. The statutory norms that set out the duties of statutory board members can therefore not always be invoked by shareholders. The liability of statutory board members in tort for loss sustained by shareholders can in principle be based on a combination of § 823(2) BGB that sets out the liability for breach of duty (Schutzgesetzverletzung)^^^ and special provisions of other acts setting out the duties that have been breached. There are many different kinds of duties. These duties can be regulated by different Statutes that are not limited to the activities of companies or Company representatives in particular but govem different activities in general.^^"^ The duties can also be regulated by the Aktiengesetz and related Statutes. For example, the duty of management board members to file for insolvency under the Aktiengesetz^^^ protects the creditors of the Company.
6^7 § 26(1) UmwG. ^•7^ See § 125 UmwG (Spaltung) as well as §§ 205 and 206 UmwG (Formwechsel). 679 §25(1) UmwG. 68Ö § 25(2) UmwG. 6^^ Thümmel RC, Persönliche Haftung von Managern und Aufsichtsräten (2003) Rdnr 354: "Im übrigen werden Schäden bein übertragenden Rechtsträger kaum je entstehen, so dass die Bestimmungen insoweit wenig relevant sind." 682 § 826 B G B .
683 § 823(2) BGB. See also § 823(1) BGB. 68"^ See Thümmel RC, Persönliche Haftung von Managern und Aufsichtsräten (2003) Rdnr 314. 685 § 92(2) AktG.
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The general provisions of the Aktiengesetz setting out the duty of care of statutory board members do not protect shareholders.^^^ Shareholders may therefore not Claim compensation for loss caused by board members who have breached their statutory duty of care owed to the Company. According to the wording of the Aktiengesetz, only the Company may claim compensation for loss caused by the breach of statutory board members' duty of care. The same can be said for example of the provisions relating to capital maintenance, accounting, confidentiality, corporate collapse, and the duty to disclose information to shareholders at a general meeting verbally. Only some of the duties regulated by the Aktiengesetz protect shareholders thus giving them the right to claim compensation for loss. The provisions of the Aktiengesetz that protect shareholders in the sense of § 823(2) BGB relate to punishable acts or acts that are contrary to good morals.^^^ This also means that § 823(2) BGB can only rarely be applied to supervisory board members; it is more likely to be applied to the liability of members of the management board. ^^^ (b) According to the wording of § 823(1) BGB, a person is liable for loss caused by the violation of the personal rights of another person through wilful intent or negligence.^^^ This provision Covers the liability of statutory board members who breach the personal rights of shareholders under the Aktiengesetz.^^^ These rights include, for example, provisions of the Aktiengesetz that vest decision-making powers in shareholders^^^ and the pre-emptive rights of shareholders.692
Assessment ofloss. Shareholders are not entitled to compensation for the loss of the value of their shares. A number of provisions of the Aktiengesetz ensure that shareholders are not entitled to compensation to the extent that the loss merely reflects the loss suffered by the company.^^^ As regards the general liability in tort, the BGH has held that compensation that reflects loss suffered by the Company must be paid to the Company but compensation for any other loss suffered by a
686 § 93(2) AktG. See for example Hüffer U , Aktiengesetz (2002) § 93 R n 19; Henze H , Aktienrecht - Höchstrichterliche Rechtsprechung (2000) R z 4 7 3 ; T h ü m m e l R C , Persönliche Haftung von Managern und Aufsichtsräten (2003) Rdnr 359. 687 For example § 399 A k t G (falsche Angaben), § 2 6 3 StGB (Betrug), § 4 0 4 A k t G (Verletzung d e r Geheimhaltungspflicht). See T h ü m m e l R C , Persönliche Haftung von M a n agern und Aufsichtsräten (2003) Rdnr 359. 688 T h ü m m e l R C , Persönliche Haftung von Managern und Aufsichtsräten (2003) Rdnr 310. 689 § 823(1) B G B . 690 See T h ü m m e l R C , Persönliche Haftung von Managern und Aufsichtsräten (2003) Rdnr 358.
691 See BGHZ 83, 122 (Holzmüller). 692 §§ 202 and 203(2) AktG.
693 See §§ 117(1), 309(4), 310(4), 317(1) and 318(4) AktG. See also Thümmel RC, Persönliche Haftung von Managern und Aufsichtsräten (2003) Rdnr 360.
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shareholder can be paid to the shareholder.^^"^ Shareholders are hardly ever entitled to compensation.^^^ Liability for the Breach of Disciosure Requirements in the Capital Mari^ets In Germany, statutory board members and sub-board managers can potentially be sued on many different grounds for the breach of disciosure requirements in the capital markets. In practice however, statutory board members and sub-board managers can hardly ever be made liable to shareholders. In the past, compliance with disciosure requirements in the capital market used to be safeguarded by administrative sanctions rather than the personal liability of those responsible for their breach. There are nevertheless some new statutory provisions that give investors the right to sue either the issuer or the persons responsible for the breach.^^^ General liability in fort. The general tort law provisions set out in the BGB only Cover these breaches under rare circumstances.^^^ They can be applied where a protective statutory norm (Schutzgesetz) has been breached (§ 823(2) BGB), but the liability of board members and managers can hardly ever be based on this ground.^^^ Altematively, they can be applied where a person has caused loss with malicious intent (§ 826 BGB).^^^ In practice, this provision Covers serious misstatements caused by gross breaches of duty.^^^ In the Infomatec case, the BGH found the chairman of the management board and the vice-chairman liable to shareholders on this ground (see below)."^^^ There is also a doctrine of prospectus liability developed by the courts. (a) Under the case law of the BGH, the prospectus must contain all relevant information regarding the investment.'^^^ A person who is responsible for the prospectus is liable for loss caused by misstatements, provided that third parties are generally as^94 See Hüffer U, Aktiengesetz (2002) § 93 Rn 19; Henze H, Aktienrecht - Höchstrichterliche Rechtsprechung (2000) Rz 524; See Thümmel RC, ibid Rdnr 360. 695 See T h ü m m e l R C , ibid Rdnr 360. 696 H o m N , Zur Haftung der A G und ihrer Organmitglieder für unrichtige oder unterlassene Ad-hoc-Informationen. In: Festschrift für Peter Ulmer (2003) p 822. 69"^ See B a u m s T, Haftung w e g e n Falschinformation des Sekundärmarktes, Z H R 167 (2003)
p 141; HomN, ibidpp 819-821. 698 See T h ü m m e l R C , Persönliche Haftung von Managern und Aufsichtsräten (2003) Rdnr 362. 699 B G H , j u d g m e n t o f 19 July 2004 - II Z R 217/03 (Infomatec): "Für den Vorsatz i m Rahm e n des § 826 B G B genügt ein * Eventualdolus'." "^^^ See H o m N , Zur Haftung der A G und ihrer Organmitglieder fiir unrichtige oder unterlassene Ad-hoc-Informationen. In: Festschrift ftir Peter Ulmer (2003) pp 8 2 0 - 8 2 1 . 701 B G H , j u d g m e n t o f 19 July 2004 - II Z R 217/03 (Infomatec). ^02 B G H Z 79, 337; B G H Z 123, 106. See also B G H , judgment o f 15 December 2003: "Nach den von der Rechtsprechung entwickelten Prospekthaftungsgrundsätzen hat der Prospekt über das Beteiligungsangebot, welcher im Allgemeinen die wesentliche UnterrichtungsmögUchkeit fiir einen Beitrittsinteressenten darstellt, ein zutreffendes u n d vollständiges Bild über sämtliche Umstände zu vermitteln, welche fiir die Anlageentscheidung von Bedeutung sind ..."
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sumed to act on the basis of this information (allgemeine bürgerlich-rechtliche Prospekthaftung).^^^ It is normally presumed that the contents of a prospectus influence investment decisions."^^"^ (b) The liability can also be based on the assumption of liability. The assumption of liability can be made expressly or it can be inferred from the circumstances.^^^ (c) Prospectus liability can only rarely be based on the liability for loss caused with malicious intent (Haftung wegen Sittenverstoßes, § 826 BGB).706 The amount that the injured party can recover in respect of his loss is determined according to the general principle that the injured party must be put in the Position he would have been in, had the other party complied with his duties. For example, in Infomatec the BGH assumed that investors would not have bought shares without their reliance on the misstatement. The BGH held that the plaintiffs were entitled to one of two remedies depending on whether they had already sold their shares or not. Plaintiffs who had not sold their shares were entitled to reclaim the entire money spent on the purchase, in retum for the shares to be delivered to the defendants; plaintiffs who had already sold their shares deducted the selling price from what they had initially paid.''^^ Capital maintenance and the general liability of the issuer in tort. In the rare case that § 826 BGB can be invoked and the loss is caused by one of the issuer's Organs, the issuer is basically liable as the principal (§ 31 BGB) and the organ members are liable under § 826 BGB. On the other hand, the liability may not contravene the strict capital maintenance regime of the Aktiengesetz.^^^ For this
^^^ See Assmann HD, Prospektualisierungspflichten. Aktualisierungs-, Berichtigungs- und Nachtragspflichten im Recht der Haftung fiir Prospekte und Angebotsunterlagen. In: Festschrift fiir Peter Ulmer (2003) p 761. ''^^ BGH, judgment of 15 December 2003: "Nach der ständigen Rechtsprechung des Senats entspricht es der Lebenserfahrung, dass ein Prospektfehler fiir die Anlageentscheidung ursächlich geworden ist..." '^^^ § 311(2) BGB. See also Thümmel RC, Persönliche Haftung von Managern und Aufsichtsräten (2003) Rdnr 366. 706 See Thümmel R C , ibid Rdnr 369. 707 B G H , judgment of 19 July 2004 - I I Z R 217/03 (Infomatec): "Der Inhalt der Pflicht zum Ersatz eines solchen Schadens bestimmt sich nach den §§ 2 4 9 ff B G B . D a im vorliegenden Fall die Ursächlichkeit der von den Beklagten namens der I. A G veranlaßten fehlerhaften beiden Ad-hoc-Mitteilungen fiir den Entschluß der Anleger zum Aktienerwerb als feststehend zu unterstellen ist, sind die in ihrem Vertrauen enttäuschten Anleger grundsätzlich so zu stellen, w i e sie stehen würden, wenn die fiir die Veröffentlichung Verantwortlichen ihrer Pflicht zur wahrheitsgemäßen Mitteilung nachgek o m m e n wären. D a sie dann - wovon ebenfalls auszugehen ist - die Aktien nicht erworben hätten, besteht die nach § 249 Abs. 1 B G B zu leistende Naturalrestitution im Geldersatz in Höhe des fiir den Aktienerwerb aufgewendeten Kaufpreises gegen Übertragung der erworbenen Rechtspositionen auf die Schädiger; soweit die Aktien wegen zwischenzeitlicher Veräußerung nicht mehr vorhanden sind, ist der an ihre Stelle getretene Veräußerungspreis anzurechnen." 708 § 57 AktG.
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reason, a Company is not likely to be liable to its shareholders under § 31 BGB for loss caused by false or misleading Statements in a prospectus.^^^ Statutory prospectus liability. In addition to the general provisions of tort law and the law of obligations, there are special provisions on prospectus liability in securities markets law. German law distinguishes between a prospectus for the listing of securities on a German exchange (Börsenzulassungsprospekt or Untemehmensberichty^^ and a securities sales prospectus (Wertpapier-Verkaufsprospekt)^^^ A prospectus must generally contain all material Information necessary for investors, and the information must be accurate and complete.^*^ The liability for the breach of this disclosure Obligation is generally regulated by the Stock Exchange Act (Börsengesetz, BörsG)7^^ There are complementing rules in related statutes.'^^'* The provisions of the Börsengesetz impose liability on persons who have assumed liability for the prospectus and persons who initiated the issue of the prospectus.^^^ This group of persons can typically contain members of the management board, where they have represented the issuer by certifying the prospectus,^^^ and the arranging banks. According to the Börsengesetz, these persons are jointly and severally liable to purchasers where the prospectus contains incorrect or incomplete Statements that are material to the assessment of the value of the securities^^^ Investors are thus entitled to assume that the prospectus gives a correct view of the securities offered to them7^^ "^^^ See Hom N, Zur Haftung der AG und ihrer Organmitglieder fiir unrichtige oder unterlassene Ad-hoc-Informationen. In: Festschrift fiir Peter Ulmer (2003) pp 826-827. ^^^The Börsenzulassungsprospekt is used in the Official Market. A "company report" (Untemehmensbericht) is used for the purpose of admission to the Regulated Market Segment (Geregelter Markt) of the stock exchange. ^^^ In practice, the sales prospectus and the listing prospectus are usually combined in one document. ''^^ § 7(1) Verkaufsprospektgesetz; § 30(3) BörsG. "^^3 § 13(1) Verkaufsprospektgesetz; § 44 BörsG. ''^^ See § 127 of the Investment Act (Investmentgesetz, InvG) as well as § 12 WpÜG (Haftung für Angebotsunterlage), § 21(3) WpÜG and § 13(3) WpÜG. For § 12 WpÜG see for example Assmann HD, Übemahmeangebote im Gefiige des Kapitalmarktrechts, insbesondere im Lichte des Insiderrechts, der Ad hoc-publizität und des Manipulationsverbots, ZGR 2002 pp 717-720. 7*5 § 44(1) BörsG. 716 g 3 VerkProspVO (Verkaufsprospekt-Verordnung). See Thümmel RC, Persönliche Haftung von Managern und Aufsichtsräten (2003) Rdnr 367. 7*7 § 44(1) BörsG. 7'8 BGH, judgment of 19 July 2004 - IIZR 217/03: "Ein Prospekt stellt in der Regel die fiir den Anlageinteressenten wichtigste und häufigste Informationsquelle dar und bildet im allgemeinen die Grundlage seiner Anlageentscheidung. Nach der Rechtsprechung des Bundesgerichtshofes darf ein Anleger erwarten, daß er ein zutreffendes Bild über das Beteiligungsobjekt erhält, d.h. daß der Prospekt ihn über alle Umstände, die fiir seine Entschließung von wesentlicher Bedeutung sind oder sein können, sachlich richtig und
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The main remedy under the Börsengesetz is the sale of shares to the persons responsible for the prospectus^^^ The statutory prospectus liabihty is Hmited to wilful intent and gross negUgence. The bürden of proof is partly on the persons who are responsible for the prospectus."^^^ Capital maintenance and the statutory prospect liability ofthe issuer. It is not clear whether an AG that has issued shares can be made liable to shareholders under the Börsengesetz for misstatements in a prospectus. According to the wording ofthe Börsengesetz, the issuer is liable for the prospectus. However, the Frankfurt Regional Court (Landgericht Frankfurt am Main) held in one of the EM. TV cases that the liability of the issuer would contravene the strict capital maintenance regime of the Aktiengesetz.'^^^ In this the provisions of the Börsengesetz differ from the provisions of the Wertpapierhandelsgesetz relating to ad-hoc disclosure (see below).722 Reform of ad-hoc disclosure rules. In 2002, the Fourth Financial Market Promotion Act (Finanzmarktförderungsgesetz) started the process of legislative reform intended to give investors better remedies for false or misleading Statements. The Fourth Finanzmarktförderungsgesetz introduced for example new rules regarding the liability of issuers for the breach of ad-hoc disclosure requirements,^^^ new rules on the liability for share price manipulation'^^'* and new requirements for the publication of insider trades and director dealings."'^^ Although the Fourth Finanzmarktförderungsgesetz gave the investors a claim against the issuer,^^^ it did not give them any similar claims against statutory board vollständig unterrichtet (vgl. BGHZ 123, 106, 109 f; Sen.Urt. v. 29. Mai 2000 - II ZR 280/98, NJW 2000, 3346 jew. m.w.N.)." 7^9 § 44(1) BörsG. See also §§ 44(2) and 45(2) BörsG. 720 § 45(1) BörsG.
721 LG Frankfurt am Main, judgment of 17 January 2003 (3-07 O 48/01): "Die Berichtigungspflicht ist durch § 11 VerkProspG und § 52 BörsZulV eindeutig abgegrenzt. AnschUeßend hat nur noch der Emittent, also die Beklagte zu 1., gem. § 44 I Nr. 3 BörsG im Rahmen der Regelpublizität über Quartals-, Halbjahresberichte und Jahresabschlüsse sowie gem. § 15 WpHG durch Ad hoc-Mitteilungen für den Anleger wesentliche Informationen zu veröffentlichen. Eine Prospektberichtigungspflicht sowie eine Haftung gegenüber den Anlegern läßt sich daraus gerade nicht ableiten. Die in § 15 VI WpHG vorgenommene Interessenabwägung, nämlich zugunsten des Emittenten durch einen weitgehenden Haftungsausschluß den Anspruch des Anlegers einzuschränken, würde nicht mehr beachtet, wenn man über die Pflicht zur Aktualisierung doch eine Haftung einfiihren würde. Dadurch würde auch das Verbot der Einlagenrückgewähr (§57 AktG) und des Erwerbs eigener Aktien (§§71 ff AktG) tangiert. Es ist Sache des Gesetzgebers, die Einschränkung dieses Grundsatzes durch das Börsengesetz abzugrenzen." "^^^ See Hom N, Zur Haftung der AG und ihrer Organmitglieder ftir unrichtige oder unterlassene Ad-hoc-Informationen. In: Festschrift ftir Peter Ulmer (2003) pp 826-827. 723 §§ 37b and 37c W p H G . 724 §§ 20a and 20b W p H G . 725 § 15a W p H G . 726 §§ 37b and 37c W p H G .
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members or other managers. If the issuer is liable to Investors, the issuer can sometimes have a right of recourse against its board members or managers under Company law.*^^^ In February 2003, the Federal Ministry of Justice told about its plans to make statutory board members personally liable for loss suffered by investors by reason of misstatements through wilflil intent or gross negligence. These plans have resulted in a draft proposal for an Act on the Liability for Information in the Capital Market (Kapitalmarktinformations-Haftungsgesetz, KapInHaG).'^^^ These changes were also recommended by the Government's Commission on Corporate Govemance.^2^ Statutory liability relating to ad-hoc disclosure, The civil liability relating to ad-hoc disclosure is govemed by the provisions of the Wertpapierhandelsgesetz. Shareholders can hardly ever sue on this ground. To begin with, the Wertpapierhandelsgesetz provides that an issuer of securities admitted to trading on a German stock exchange must immediately publish any information that comes within its sphere of activity where the Information is not publicly known and it is likely to have a significant effect on the price of the securities^^^ Unlike the Börsengesetz, the Wertpapierhandelsgesetz does provide for the liability of the issuer for the breach of this duty. However, the liability of the issuer requires a wilful act or gross negligence, and the issuer can become liable only to persons who bought or sold securities upon the faulty Information.'^^^ It is impossible for shareholders to make statutory board members liable for loss caused by the breach of ad-hoc disclosure obligations under the Wertpapierhandelsgesetz.'^^^ Firstly, the rules on prospectus liability do not apply to ad-hoc disclosure.''^^ Secondly, the rules on ad-hoc disclosure do not cover the liability of members of the two statutory boards. Only the issuer can be liable on this ground.*^^"^ And although members of the two statutory boards could in principle be liable to the Company under the Aktiengesetz,*^^^ they would not be liable to the shareholders. Thirdly, the general liability in tort Covers hardly ever the breach of ad-hoc disclosure obligations under the Wertpapierhandelsgesetz, because the provisions that set out the remedies for the breach of these obligations do not pro'^^'^ See Thümmel RC, Persönliche Haftung von Managern und Aufsichtsräten (2003) Rdnr 363. '^^^ Frankfurter Allgemeine Zeitung 24 August 2004, Vorstände sollen persönlich haften. '^^ Bericht der Regierungskommission Corporate Govemance (2001). ^3o§l5(l)WpHG. "^^^ §§ 37b and 37c WpHG. See also Baums T, Haftung wegen Falschinformation des Sekundärmarktes, ZHR 167 (2003) pp 166-167. "^^2 See also Baums T, Haftung wegen Falschinformation des Sekundärmarktes, ZHR 167 (2003) p 141; Thümmel RC, Persönliche Haftung von Managern und Aufsichtsräten (2003) Rdnr 375. ^33 See especially BGH, judgment of 19 July 2004 - IIZR 217/03 (Infomatec). ''^^ § 15(6) WpHG. See Thümmel RC, Persönliche Haftung von Managern und Aufsichtsräten (2003) Rdnr 374. "735 § 93(2) AktG.
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tect shareholders in the sense of § 823(2) BGB (Schutzgesetz).''^^ According to the judgment of the BGH in Infomatec, the same can be said of the provisions that set out the ad-hoc disclosure obligation.^^^ - The provisions of the Aktiengesetz on misstatements could in principle be thought to protect shareholders, but they can hardly be applied to ad-hoc disclosure."^^^ In theory, the provision that could make statutory board members or other persons liable for loss caused by the breach of ad-hoc disclosure obligations under the Wertpapierhandelsgesetz is § 826 BGB that provides for the liability for loss caused with malicious intent (Haftung wegen Sittenverstoßes). The provisions of the Wertpapierhandelsgesetz on ad-hoc disclosure do not exclude other causes of action.^^^ A number of cases have attracted the attention of the media in recent years. These cases show that shareholders are hardly ever reimbursed for loss caused by misstatements or the failure to make timely disclosure.'^'^^ On the other hand, in the Infomatec case the BGH found the chairman of the management board as well as its vice-chairman liable to shareholders for the breach of ad-hoc disclosure obligations under § 826 BGB.^^^ Capital maintenance and the liability for ad-hoc disclosure, The issuer is liable for the breach of ad-hoc disclosure provisions.^'*^ The wording in the Wertpapierhandelsgesetz has nevertheless received a mixed reception, and many would prefer the strict application of the capital maintenance regime of the Aktiengesetz.'^'^^ 736 §§ 371) and 37c W p H G . See Thümmel RC, Persönliche Haftung von Managern und Aufsichtsräten (2003) Rdnr 376. 737 § 15(1) W p H G . See also § 20a W p H G , formerly § 88 BörsG. B G H , judgment of 19 July 2004 - I I Z R 217/03 (Infomatec). 738 § 400 AktG. See also § 264a StGB. B G H , judgment of 19 July 2004 - II ZR 217/03 (Infomatec). See also Thümmel R C , Persönliche Haftung v o n Managern u n d Aufsichtsräten (2003) Rdnr 377. 739 § 15(6) W p H G . B G H , judgment of 19 July 2004 - II Z R 217/03 (Infomatec): "Unter derartige allgemeine zivilrechtliche Haflungstatbestände fällt insbesondere die sittenwidrige vorsätzliche Schädigung nach § 826 B G B . " 7"^^ See Baums T, Haftung wegen Falschinformation des Sekundärmarktes, Z H R 167 (2003) p 140; H o m N , Zur Haftung der A G und ihrer Organmitglieder fiir unrichtige oder unterlassene Ad-hoc-Informationen. In: Festschrift fiir Peter Ulmer (2003) p 817. See for example A G München, judgment o f 27 August 2001 (EM.TV); L G Frankfiirt am Main, judgments of 20 January 2003 (EM.TV). 741 B G H , judgment o f 19 July 2004 - II Z R 217/03 (Infomatec): "Da beide Beklagten die Bedeutung der konkreten Ad-hoc-Mitteilungen und deren Unrichtigkeit kannten, ist ... schon nach der Lebenserfahrung davon auszugehen, daß die unrichtigen Meldungen keinen anderen Zweck hatten, als dem Börsenpublikum einen gestiegenen Untemehmenswert vorzuspiegeln und den Börsenpreis positiv zu beeinflussen. Von einer bloßen Leichtfertigkeit... kann ersichtlich keine Rede sein." 742 §§ 37b, 37c W p H G . 743 See Hom N, Zur Haftung der AG und ihrer Organmitglieder fiir unrichtige oder unterlassene Ad-hoc-Informationen. In: Festschrift fiir Peter Ulmer (2003) pp 826-827; Baums T, Haftung wegen Falschinformation des Sekundärmarktes, ZHR 167 (2003) pp 166-169.
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Liability relating to misstatements in accounts. The offences of the Aktiengesetz relating to misstatements in accounts also protect shareholders in the sense of § 823(2) BGB (Schutzgesetz).'^'*'* In theory, statutory board members can thus be liable to shareholders on this ground. This offence does not cover ad-hoc disclosure.'''*^ The provisions of the Handelsgesetzbuch on annual financial accounts (§§ 325329 HBG) do not protect shareholders in the sense of § 823(2) BGB. However, offences related to the breach of these provisions also protect shareholders.^'*^ Liability relating to the abuse of inside information or share price manipulation. Statutory board members or sub-board managers are in practice not liable to shareholders for loss caused by the breach of insider rules or share price manipulation. The provisions that prohibit these acts do not protect shareholders in the sense of § 823(2) BGB (Schutzgesetz).^^^ The Company may nevertheless sue statutory board members or sub-board managers for loss sustained by the Company.^"^^ Statutory board members and subboard managers thus owe a fiduciary duty to the Company not to take advantage of inside information in breach of insider rules. For example, insider rules and the potential liability for their breach influence the adoption and exercise of share Option schemes.'^'*^ Share Option schemes generally provide for a waiting period to be observed by the management prior to the exercise of an Option. Right to sue, dass actions. A shareholder has Standing to sue where he is entitled to compensation for loss. As a rule, each shareholder must sue separately and pay his own legal costs. 74^* § 400 AktO; see also § 264a StGB. BGH, judgment of 19 July 2004 - II ZR 217/03 (Infomatec). See also Thümmel RC, Persönliche Haftung von Managern und Aufsichtsräten (2003) Rdnr 377. ^45 BGH, judgment of 19 July 2004 - II ZR 217/03 (Infomatec): "Unter 'Übersichten über den Vermögensstand' sind alle Zusammenstellungen von Zahlenmaterialien, insbesondere alle Arten von Bilanzen zu verstehen, die einen Gesamtüberblick über die wirtschaftliche Situation des Unternehmens ermöglichen ... Darunter fallen ersichtlich nicht Ad-hoc-Mitteilungen ... Soweit in der Literatur vereinzelt die Ansicht vertreten wird, daß sich die 'Darstellungen' i.S. von § 400 Abs. 1 Nr. 1 AktG nicht auf den Vermögensstand beziehen müßten ... kann dem nicht gefolgt werden." 74^ See Merkt H, Untemehmenspublizität (2001) pp 481-482. ^47 §§ 14 and 20a WpHG. See Hom N, Zur Haftung der AG und ihrer Organmitglieder fiir unrichtige oder unterlassene Ad-hoc-Informationen. In: Festschrift fiir Peter Ulmer (2003) p 823; Thümmel RC, PersönHche Haftung von Managern und Aufsichtsräten (2003) Rdnr 371. "^"^^ See Thümmel RC, Persönliche Haftung von Managern und Aufsichtsräten (2003) Rdnr 372. "^^^ See the letter of (what later became) BaFin to the management boards of listed companies: Insiderrechtliche Behandlung von Aktienoptionsprogrammen fiir Führungskräfte, Frankfiirt am Main, 1 October 1997. See also Fürhoff J, Insiderrechtliche Behandlung von Aktienoptionsprogrammen und Management Buy-Outs, AG 1998 pp 83-88; Assmann HD, Kumpel S in Assmann HD, Schneider UH (eds) Wertpapierhandelsgesetz (1999) § 14 Rz. 88h-881.
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Liability for Löss Suffered by Shareholders by a Breach of Shareholders' Rights While it is difficult for shareholders to sue members of the two statutory board or sub-board managers for loss suffered by the Company, a personal action may be brought in respect of breaches of personal rights arising under the Aktiengesetz or the Company's articles of association. In this case, the cause of action could be § 823(2) BGB"^^^ and those provisions of the Aktiengesetz that protect shareholders in the sense of this provision (Schutzgesetz). These provisions have been discussed above. Class Actions Class action suits have in principle not been available to minority shareholders and investors. In practice, however, there are some cases of class action (Sammelklage) in Germany. Class action suits are in effect possible because different suits can be bundled together (objektive Klagehäufung) under the Code of Civil Procedure (Zivilprozeßordnung, ZPO).^^^ The shareholders can co-operate by bundling their cases and choosing the same advocate. The best-known cases relate to Deutsche Telekom AG. Some 15,000 shareholders are participating in the Deutsche Telekom litigation. In the fiiture, class action suits will be made easier. In April 2004, the Federal Ministry of Justice referred to a draft Equity Investor Test Case Act (Kapitalanleger-Musterverfahrensgesetz, KapMuG) that would make it possible to bündle the Claims of many investors in the future.*^^^ In November 2004, the Ministry published the draft Act. Special Ruies for Croups As discussed above, an individual shareholder may normally not sue on behalf of the Company. The special provisions the Aktiengesetz for groups (Konzemrecht) contain an exception to this main rule. A shareholder of the dependent Company may bring proceedings on behalf of the dependent Company against the statutory representatives of the Controlling company,"^^^ or against the statutory representatives of the dependent Company.''^'* There are similar provisions for de facto groups."^^^ The majority rules discussed above^^^ thus do not prevent a shareholder ^^^ § 823(1) BGB does not cover economic loss. See Thümmel RC, Persönliche Haftung von Managern und Aufsichtsräten (2003) Rdnr 311. 751 § 260 ZPO. "^52 Frankftirter Allgemeine Zeitung 8 April 2004, Mehr Rechte für Investoren, neue Risiken für Manager. 753 §§ 309(1), 309(2) and 309(4) AktG. 754 § 310(1) AktG.
755 §§317(4) and 318(4) AktG. 756 § 147 AktG.
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from bringing proceedings; any minority shareholder may decide to bring proceedings.
5.6.4 Penal Sanctions The risk of penal sanctions has influenced corporate govemance in Germany after a number of high profile cases. Managers must generally comply with all applicable laws and the breach of statutory provisions can lead to punishment in many areas. The most common penal sanctions that can be applied to statutory board members and sub-board managers include: the criminal penalties for Untreue; the criminal penalties for misstatements set out in a number of Statutes; and fines for the breach of certain administrative rules (Ordnungswidrigkeiten). In addition, the personal liability of management board members for unpaid taxes is an important administrative sanction for the breach of the duty to file tax declarations. Untreue, The German Criminal Code (Strafgesetzbuch) provides for criminal penalties for Untreue 7^^ A person is guilty of Untreue where he has a duty to manage the property of another person and he causes loss through a gross breach of duty ("gravierende Pflichtverletzung"). In principle, this provision can also be applied to acts done by members of the two statutory boards, because they have a duty to manage the property of the Company and the Aktiengesetz says this property should managed. The crime of Untreue does not require self-dealing, and it is not necessary that a person has benefited from such unlawful acts. For example, the provisions on Untreue can be applied to high-risk transactions that have caused the Company loss, and they Cover acts done by a person who owns all shares in the Company. The Mannesmann case, the Holzmann case, the Bahcock Borsig case, and the WestLB case show that the provisions on Untreue can influence the management of large companies. Mannesmann, In the Mannesmann case,"^^^ six defendants were accused of causing Mannesmann AG loss by approving a total of nearly € 60 million of manager bonuses - including € 15 million for the chairman of the management board - following Mannesmann's takeover by Vodafone. Some of the defendants belonged to the corporate elite of Germany.^^^ According to the Aktiengesetz, all payments to members of the management board must be reasonable. Members of the supervisory board have a duty to comply with this Provision when deciding on the remuneration of, and other payments to, members of the management board.'^^^ ^^^ § 266(1) Strafgesetzbuch. ^^^ See Schmid FA, Wahrenburg M, Mergers and Acquisitions in Germany: Social Setting and Regulatory Framework. In: Krahnen JP, Schmidt RH (eds) The German Financial System (2004) pp 267-269. ^^^ The two most high profile defendants in the case are ex-Mannesmann chief executive, Klaus Esser, and Josef Ackermann, who heads Deutsche Bank. ^6ö§87(l)AktG.
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In this case, the prosecutors argued that members of the supervisory board had failed to do so and had thus committed the crime of Untreue.'^^^ The regional court of Düsseldorf gave its ruling on 22 July 2004. The trial judge^^^ Said that the payments, which had not been made in the interests of the Company, did breach the provisions of the Aktiengesetz. The accused were nevertheless acquitted for the lack ofa gross breach of duty. The Mannesmann case is likely to have implications regarding the remuneration of German managers. The judge mied that the bonuses were illegal under the Aktiengesetz because they were granted retrospectively and did not relate to preset Performance targets. The ruling may mean that bonuses must be written into contracts before they are awarded. Share Option schemes are also expected to become more populär. MisStatements. There are penal sanctions for misstatements in a number of Statutes including the Aktiengesetz, the Commercial Code (Handelsgesetzbuch, HGB), the Criminal Code (Strafgesetzbuch, StGB), and the Securities Trading Act (Wertpapierhandelsgesetz, WpHG). The Aktiengesetz provides for several criminal penalties.*^^^ For example, there are criminal penalties relating to misstatements and breaches of a number of disclosure rules,^^"* breaches of a number of duties when the Company is insolvent,''^^ fraud,"^^^ breach of confidentiality^^'^ as well as breaches relating to shares and rights attached to shares."^^^ The provisions of the Aktiengesetz on penal sanctions do not apply to the extent that the matter is govemed by the provisions of the Handelsgesetzbuch. For example, the Handelsgesetzbuch contains penal sanctions for misstatements in annual accounts and quarterly accounts (unrichtige Darstellung).^^^ These rules were also applied in February 2005 when two former members of the management board of Landesbank Berlin, a well-known state-owned bank, were ordered to pay fines for manipulating the balance sheet.^^^ The Act on the Control of Financial Statements (Bilanzkontrollgesetz, BilKoG) has introduced a new duty to disclose information to an independent enforcement authority. A person who makes negligent misstatements to the enforcement au-
'^^ See for example Frankfurter Allgemeine Zeitung, 31 March 2004, 1 April 2004, 8 April 2004. ^^^ Judge Brigitte Koppenhoefer, Vorsitzende Richterin, Landgericht Düsseldorf. 763 §§ 399-408 Akte. 764 § 399 A k t e (falsche Angaben), § 400 AktG (unrichtige Darstellung), § 403 AktG (Verletzung der Berichtspflicht), § 406 AktG (Ordnungswidrigkeiten). 765 § 401 A k t G (Pflichtverletzung bei Verlust, Überschuldung oder Zahlungsunfähigkeit). 766 § 4 0 2 A k t G (falsche Ausstellung oder Verfälschung v o n Hinterlegungsbescheinigungen). 767 § 404 A k t G (Verietzung der Geheimhaltungspflicht). 768 § 405 A k t G (Ordnungswidrigkeiten).
769 §331 HGB. 770 § 331 N r . 1 and Nr. 4 H G B ; § 340m H G B . Landgericht Beriin, j u d g m e n t of 7 February 2005.
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thority is now guilty of an offence and liable to a fine under the HandelsgesetzThe Strafgesetzbuch contains further penal sanctions for misstatements in prospectuses(Kapitalanlagebetmg).'^'^2 The Wertpapierhandelsgesetz prohibits the manipulation of markets^*^^ and sets out a duty to disclose price-sensitive information.'^^'* These provisions are also complemented by penal sanctions.^^^ Administrative rules. In Germany, members of the management board can be held liable under the Act on Breaches of Administrative Rules (Gesetz über Ordnungswidrigkeiten, OwiG) for breach of duty to supervise officers and employees who have failed to comply with obligations which are imposed on the Company and which are punishable with imprisonment or by a fine^^^ However, this offence usually requires wilful misconduct^^"^ It has therefore been difficult to apply it to misstatements.'^'^^ In principle, this offence might be applied where the Company as a legal person breaches insider trading rules. Liabilityfor unpaid taxes. The Abgabenordnung 1977 provides for the liability for unpaid taxes under some circumstances. Management board members must ensure that the Company keeps books and files its tax declarations. They are personally liable if they fail to do so through wilful intent or gross negligence."^^^ Reform. The current trend is to tighten penal sanctions for misstatements. In July 2002, the Transparency and Disclosure Act (TransPuG) increased the penalties for breaches of confidentiality committed by members of the two statutory boards in listed companies. In March 2003, the Federal Ministry of Justice put forward a catalogue of measures intended to improve investor protection and confidence in the markets. The things that will be reviewed include penal sanctions for misstatements.^^^ The Act on the Introduction of International Accounting Standards and on the Protection of the Quality of Audits (Bilanzrechtsreformgesetz, BilReG) contains some of these new penal sanctions."^^^
''i^ § 342e HGB inserted by the BilKoG. ^^2 § 264a(l) StGB. 773§20aWpHG. 774 § 15(1) W p H G .
775 §§38(1) and 39 WpHG. 77^ § 130 OwiG. See also Schneider UH, Compliance als Aufgabe der Unternehmensleitung, ZIP 2003 p 649. 777§l5StGBand§10OWiG. 778 See Hennrichs J, Fehlerhafte Bilanzen, Enforcement und Aktienrecht, Z H R 168 (2004)
p385. 779 § 34(1) A O 1977 (Abgabenordnung 1977). See also Schneider U H , Compliance als Aufgabe der Unternehmensleitung, ZIP 2003 p 647. 780 In particular §§ 400 and 403 AktG as well as §§ 331 and 332 H G B .
781 See for example § 331 Nr. la HGB inserted by the BilReG and § 334(2) HGB amended by the BilReG.
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5.6.5 The Duties of Management Bodies The duties of statutory board members and sub-board managers are based on many extemal and internal sources. They can be based on statutory provisions or other rules that directly set out the duties; they can also be based on statutory provisions or other rules setting out sanctions for mismanagement or breach of duty. There are duties backed up by effective sanctions and duties without effective sanctions for their breach. The Aktiengesetz and related Acts set out the main duties of members of the two statutory boards. The basic Standard for statutory board members is the Standard of a "prudent and diligent manager" which they they must follow in order not to be held to have acted negligently. The duties of sub-board managers have not been regulated in the Aktiengesetz. Their duties are primarily determined by labour laws and employment contracts. Some of the duties of sub-board managers have already been discussed in the context of sanctions, because some sanctions apply not only to statutory board members but also to persons responsible. Management Duties ofthe Management Board The Aktiengesetz provides in § 76(1) that the management board shall be responsible for the management ofthe Company. § 76(1) AktG is an important provision in two respects. Firstly, it excludes the power of other Company organs to manage the Company. These cannot be conferred on the supervisory board,'^^^ ^nd the general meeting may not decide on management matters unless they have been referred to it by the management board.*^^^ Secondly, § 76(1) AktG confirms that the Company should be run by its management board. On the other hand, the Aktiengesetz does not say how exactly the management board should manage the Company. The Aktiengesetz is flexible in this respect.'^^'^ The provisions ofthe Aktiengesetz lay down duties both directly and indirectly. These duties can be general or specific. The general duties of members of the management board can also be based on other legislation or Service contracts. Direct duties. In addition to a general duty to comply with the provisions of the Aktiengesetz,*^^^ the Aktiengesetz lays down a general duty to comply with: the articles of association; directions given by the supervisory board within its powers; directions given by the general meeting within its powers; and the internal guidelines ofthe board.^^^
782 § 111(4) AktG. 783 §119(2) AktG. 784 See also Semler J, Die Rechte und Pflichten des Vorstands einer Holdinggesellschaft im Lichte der Corporate Govemance-Diskussion, Z G R 2004 p 632.
785 See Paefgen WG, Unternehmerische Entscheidungen und Rechtsbindung der Organe in der Aktiengesellschaft (2002) p 17-18. 786 § 82(2) AktG.
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The basic duty of statutory board members is the general duty to act in the interest and for the benefit of the Company (Untemehmensinteresse or das Wohl des Unternehmens). This duty is a general duty of loyalty of statutory board members to the Company. It has its basis in the contractual relationship between the Company and its board members (Treu und Glauben, § 242 BGB).^^^ Compliance with this duty is also part of the general Standard of care. Breach of this general Standard of care is regarded not only as negligent but also as breach of duty under the Aktiengesetz."^^^ The concept of Untemehmensinteresse can be interpreted in many ways."^^^ In any case, the general duty to act in the interest and for the benefit of the Company contains the duty to act for the purpose of making a profit for the Company within the limits of its objects clause.^^^ According to the German Corporate Govemance Code, the management board should have a duty to "increase the sustainable value of the enterprise"."^^^ The Code also states that all members of the supervisory board have a duty to act in interests of the Company."^^^ Members of the two boards will therefore take the interests of stakeholders into account to the extent that it is proper so to do,^^^ and the flexibility of the concept of Untemehmensinteresse does not prevent managers from creating long term shareholder value. The Aktiengesetz lays down a number of specific management duties.'^^'* For example, the management board is required: to manage the company;^^^ to respect the rights of shareholders to be treated on an equal basis^^^ and receive equal in-
•787 See Hüffer U, Aktiengesetz (2002) § 84 Rn 9 and § 93 Rn 3; Semler J, Entscheidungen und Ermessen im Aktienrecht. In: Festschrift für Peter Ulmer (2003) p 635. "^^^ § 93(1) AktG. See for example Paefgen WG, Unternehmerische Entscheidungen und Rechtsbindung der Organe in der Aktiengesellschaft (2002) p 182; Semler J, Entscheidungen und Ermessen im Aktienrecht. In: Festschrift für Peter Ulmer (2003) p 635. 789 See von Werder A in Ringleb HM, Kremer T, Lutter M, von Werder A, Kommentar zum Deutschen Corporate Govemance Kodex (2003) 3.1 Rn 237-240 as well as Präambel Rn 87; Kuhner C, Untemehmensinteresse vs. Shareholder Value als Leitmaxime kapitalmarktorientierter Aktiengesellschaften, ZGR 2004 pp 247-249. 79^ See Hüffer U, Aktiengesetz (2002) § 82 Rn 9: "Vorstand ist aber selbstverständlich an Gesellschaftszweck gebunden. Ergibt Satzung nichts anderes, liegt er in Gewinnerzielung ... Weiterhin muß sich Vorstand an Satzungsbestimmung über Untemehmensgegenstand halten ..." See also Semler J, Die Rechte und Pflichten des Vorstands einer Holdinggesellschaft im Lichte der Corporate Govemance-Diskussion, ZGR 2004 pp 641-644. ^^^ The German Corporate Govemance Code, 4.1.1. ^^^ The German Corporate Govemance Code, Foreword; 5.5.1. ^^^ See Kuhner C, Untemehmensinteresse vs. Shareholder Value als Leitmaxime kapitalmarktorientierter Aktiengesellschaften, ZGR 2004 p 251. "794 See for example §§ 76(1), 83, 90, 92, 93, 111 and 117 AktG. See also Paefgen WG, Untemehmerische Entscheidungen und Rechtsbindung der Organe in der Aktiengesellschaft (2002) pp 22-23. ^95 §76(1) AktG. 796 § 53a AktG.
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formation;'^^'^ to ensure appropriate risk management within the Company; and to establish an internal monitoring system.^^^ The Aktiengesetz and the general law of obligations also lay down a number of specific fiduciary duties. These duties include, for example: the duty not to divulge Company secrets;*^^^ the duty not to compete with the company;^^^ and the duty not to take advantage of corporate opportunities (the corporate opportunity doctrine, Geschäftschancenlehre).^^^ The German Corporate Govemance Code contains several recommendations clarifying the fiduciary duties of management board members.^^^ For example, members of the management board should disclose conflicts of interest to the supervisory board without delay and inform the other members of the management board thereof ^^^ They should not take on sideline activities such as memberships in supervisory boards without the consent of the supervisory board/^"* and they should not accept payments from third parties.805 Other Statutes can complement the Aktiengesetz. For example, insider trading rules force members of the management board to implement and monitor procedures for the prevention of insider trading by the Company's management and employees. Management board members also owe a fiduciary duty to the Company not to take advantage of inside information in breach of insider rules. Managers generally have to comply with all applicable provisions of law. These provisions can be found outside the area of Company law and may belong to tax law, labour law, environmental law, unfair competition law, administrative law and so forth. In practice, the management board of the Company should set up a compliance Programme. Failure to do so could in practice lead to breach of law and penal or administrative sanctions.^^^ Indirect duties. Most modalities of management are nevertheless determined indirectly by means of duty of care and the liability for loss suffered by the Company by a negligent breach of this duty.^^^ This general duty is necessary because of the generality of the powers vested in the management board. ^^^
797 For example §§ 125(1), 131(1), 131(4) AktG.
798 § 91(2) AktG. 799 § 93(1) AktG. 8^^ § 88 AktG. See also the German Corporate Covemance Code, 4.3.1.
801 See also the German Corporate Covemance Code, 4.3.3. 802 German Corporate C o v e m a n c e Code, 4.3 Conflicts of interest.
803 Item 4.3.4. 804 Item 4.3.5. 805 Item 4.3.2. 80^ Schneider U H , Compliance als Aufgabe der Unternehmensleitung, Z I P 2003 p p 6 4 9 -
650. See in particular § 130 OwiG (Gesetz über Ordnungswidrigkeiten). 807 § 93(1) AktG. 808 See already the preparatory works (Amtliche Begründung) of the Aktiengesetz o f 1937,
§§70 and 71: "Aus dem Recht des Vorstands zur Leitung der Gesellschaft folgt seine Pflicht, für das Wohl der Gesellschaft, zu dem auch die Belange der Aktionäre gehören,
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Liabilityfor negligence. In carrying out their duties, members of the management board must generally exercise the Standard of care of a "pmdent and diligent manager", and they are liable to the Company for loss caused by the breach of this duty.809
The breach of (other) general or specific duties set out in the Aktiengesetz is not enough to make a board member liable on this ground, unless the board member has failed to show the care of a "pmdent and diligent manager". The care of a "prudent and diligent manager" contains many duties related to the process of decision-making. The management board is in principle required to take into account a broad ränge of considerations in its decisions, including the interests of the Company and those of its shareholders, employees and creditors. This rule is based on an uncodified but well-established principle of Company law.^^° The care ofa "prudent and diligent manager" is both an objective Standard and a subjective Standard. The Standard is objective in that it is based on the degree of knowledge and experience that a board member of the Company can be expected to have. The nature and size of the Company and the division of work within the board affect this objective Standard. In addition, a board member should possess the degree of knowledge and experience required ofa board member in his position. The Standard is objective also in that it is not determined on the basis of the personal characteristics of the board member. Lack of knowledge or experience do not limit the liability ofa board member. The Standard is subjective in the sense that a management board member who has special knowledge or experience is expected to make use of it. Discretion as regards management decisions. The liability of management board members for business decisions is govemed by the same rules. According to recent case law of the BGH, members of the two statutory boards have some discretion regarding business decisions. The leading authority is ARAG/Garmenbeck where the BGH held that members of the management board are not liable for loss sustained by the Company by reason of a business decision unless their acts during the decision-making process amounted to breach of duty:^^^ members of the management board must apply the Standard of care of a zu sorgen und sich für dieses Ziel tatkräftig einzusetzen." Cited from Fleischer H, Zur Leitungsaufgabe des Vorstands im Aktienrecht, ZIP 2003 p 2. 809 §§ 93(1) and 93(2) AktG. See also the German Corporate Govemance Code, 3.8: "The Management Board and Supervisory Board comply with the rules of proper corporate management. If they violate the due care and diligence of a prudent and conscientious Managing Director or Supervisory Board member, they are liable to the Company for damages." 8^0 See Hüffer U, Aktiengesetz (2002) § 76 Rn 12. According to § 70 of the AktG of 1937, the management board had to manage the Company "wie das Wohl des Betriebes und seiner Gefolgschaft und der gemeine Nutzen von Volk und Reich es erfordern". See also Articles 2,12,14 and 20 of the German Constitution (Grundgesetz). 811 BGHZ 135, 244 (ARAG/Garmenbeck): "[Eine Schadenersatzpflict des Vorstandes] kann erst in Betracht kommen, wenn die Grenzen, in denen sich ein von Verantwor-
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prudent and diligent manager, and they are liable to the Company for failure to do so. However, they are not liable for the quality of their decision as such. The BGH defined the limits of board members' business discretion with a test that contained five things: the matter must be a business decision; the board members must act in good faith; they must act for the benefit of the Company; they must act on the basis of adequate information; and they must not act for any collateral purpose.^^^ In other judgments such as Kali + Salz and Siemens/Nold, the BGH has continued to give the management board plenty of discretion in order to ensure that it is legally possible to manage companies in a flexible way.^^^ The rules laid down by the BGH in ARÄG/Garmenbeck will be codified by the UMAG. The UMAG will introduce a new rule that is expected to be the core German equivalent of the business judgment rule applied in the US.^^"* The Act will make it easier for minority shareholders to cause the Company to sue defaulting statutory board members. At the same time, the Act will reduce the liability of statutory board members to some extent.^^^ The new rules introduced by the UMAG will distinguish between the result of business decisions and the process of decision-making; this is perhaps not surprising in light of the fact that there is a general distinction between the duty to deliver the agreed result (such a contract is called Werkvertrag)^^^ and the duty to apply due work process (Dienstvertrag)^^"^ in the law of obligations. The new rules will not limit any liability for loss caused by gross negligence. Even this principle mirrors the general principles of German law of obligations.^^^ The new rules will restrict the liability of statutory board members for the result of their business decisions. There will be no breach of duty if the board member can, without being grossly negligent, assume that he is acting on the basis of sufficient information to the benefit of the company.^^^
tungsbewußtsein getragenes, ausschließlich an Untemehmenswohl orientiertes, auf sorgfältiger Ermittlung der Entscheidungsgrundlagen beruhendes unternehmerisches Handeln bewegen muß, deutlich überschritten sind, die Bereitschaft, unternehmerische Risiken einzugehen, in unverantwortlicher Weise überspannt worden ist oder das Verhalten des Vorstandes aus anderen Gründen als pflichtwidrig gelten muß." 8^2 BGHZ 135, 244, 253; Ulmer P, Die Aktionärsklage als Instrument zur Kontrolle des Vorstands- und Aufsichtsratshandelns, ZHR 163 (1999) p 298. 813 BGHZ 71, 40 (KaH + Salz); BGHZ 136, 133 (Siemens/Nold). ^^^ The UMAG, Begründung: "Dies entspricht Vorbildern der business judgment rule aus dem angelsächsischen Rechtskreis ..." 81^ § 147a AktG (Klagezulassungsverfahren) that will be inserted by the UMAG. See the UMAG, Begründung. «16 §631(1) BGB. 817 §611(1) BGB. 818 See for example §§ 276(3) BGB and § 309 BGB. 819 § 93(1) A k t G as proposed to b e amended b y Artikel 1 o f the U M A G : " D i e Vorstandsmitglieder haben bei ihrer Geschäftsführung die Sorgfalt eines ordentlichen u n d gewissenhaften Geschäftsleiters anzuwenden. Eine Pflichtverletzung liegt nicht vor, w e n n d a s Vorstandsmitglied bei einer unternehmerischen Entscheidung ohne grobe
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The new mies will not limit the general liability for the breach of the provisions of the Aktiengesetz and articles of association, and there will be no "safe harbour" as regards the breach of duties like the duty of loyalty and the duty of disclosure. Liability relating to the German Corporate Governance Code. The Aktiengesetz sets out that the two statutory boards of a listed Company must annually make a Statement that the proposals of the German Corporate Governance Code have been, and will be, complied with or specify which of the proposals have not been, or will not be, complied with.^^o While members of the two statutory boards have a statutory duty to make this Statement, they do not have any corresponding statutory duty to comply with the Code as such.^^^ The German Corporate Governance Code is not regarded as a source of legally binding rules. For example, compliance with the Code does not exclude the existence of negligence and non-compliance does not amount to negligence under the Aktiengesetz. ^22 Management Duties of the Supervisory Board Similar principles govem the management duties of supervisory board members. Members of the supervisory board must apply the Standard of care of a prudent and diligent manager.^^^ They have a general duty to act in the interests of the Company (Untemehmensinteresse) and a duty to take into account a broad ränge of considerations.^^"* Members of the supervisory board have some management duties in the Company although the exact contents of these duties have not been set out in the Aktiengesetz. Supervision. The supervisory board has a general duty to supervise the management board.^^^ However, the Aktiengesetz does not lay down in detail how the supervisory board should take care of this function. While some of the modalities of supervision have been defined in the Aktiengesetz,^^^ other modalities have Fahrlässigkeit annehmen durfte, auf der Grundlage angemessener Information zum Wohle der Gesellschaft zu handeln ..." 820 § 161 AktG.
821 See Hommelhoff P, Schwab M, Regelungsquellen und Regelungsebenen der Corporate Govemance: Gesetz, Satzung, Codices, untemehmensinteme Grundsätze (2003) pp 5455. 822 See Hommelhoff P, Schwab M , ibid p p 5 6 - 5 7 : "Rechtsverbindliche Sollensätze enthalten die Empfehlungen u n d Anregungen des Deutschen Corporate G o v e m a n c e Codex nicht." Compare Ulmer P, D e r Deutsche Corporate G o v e m a n c e Kodex - ein neues Regulierungsinstrument fiir börsennotierte Aktiengesellschaften, Z H R 166 (2002) p p
166-167. 823 § 116 AktG. 824 See v o n Werder A in Ringleb H M , Kremer T, Lutter M , v o n Werder A , K o m m e n t a r
zum Deutschen Corporate Govemance Kodex (2003) 3.1 Rn 237-240 as well as Präambel Rn 87. 825 §111(1) AktG. 826 See for example §§ 111(2) and 111(4) AktG.
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been regulated indirectly by means of the general duty of care and the liability for breach of duty. Compliance with the German Corporate Governance Code. Like the management board, the supervisory board has no duty to comply with the German Corporate Governance Code as such. In any case, the German Corporate Governance Code contains few recommendations as regards the modalities of supervision. According to the Code, the supervisory board should cooperate closely with the management board and to the benefit of the enterprise.^^^ Major decisions. The Aktiengesetz nevertheless provides that some important business decisions require or can require the consent of the supervisory board.^^s According to the Code, the consent of the supervisory board should be necessary for transactions of fundamental importance, such as "measures which fundamentally change the asset, financial or eamings situations of the enterprise".^^^ Information. The supervisory board has a number of duties relating to information. Sometimes the supervisory board must disclose Information. The supervisory board also needs information in order to comply with its other duties. Normally, the provisions of the Aktiengesetz do not force the supervisory board to conduct inspections itself The supervisory board could conduct inspections in some cases,^^^ but this right is hardly ever used. Where reporting is found to be insufficient, the supervisory board tums to the management board.^^^ The management board must report to the supervisory board.^^^ The management board must report regularly,^^^ when necessary,^^'* or when asked to do so by the supervisory board. The supervisory board may request a report on any relevant matter.^^^ A member of the supervisory board may request a report to the whole board.^^^ The German Corporate Governance Code repeats the statutory duties: The management board should inform the supervisory board "regularly, without delay and comprehensively, of all issues important to the enterprise with regard to planning, business development, risk Situation and risk management", and the supervisory board should ensure that the management board coordinates the strategy of the firm with the supervisory board and discusses its implementation with the supervisory board regularly.^^"^
^^^ The German Corporate Governance Code, 3.1. ^28 See for example § 111(4) AktG. See also §§ 112 and 115 AktG (and item 3.9 of the Code) on loans to members of the two statutory boards. ^^^ The German Corporate Governance Code, 3.3. 830 §111(2) AktG. 83^ Semler J, The Practice of the German Aufsichtsrat. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit p 272. 832 § 9 0 AktG.
833 § 90(2) AktG. 834 §90(1)(4) AktG. 835 § 90(3) AktG. 836 § 90(3) AktG 83^ The German Corporate Governance Code, 3.2 and 3.4.
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The Code also provides that the supervisory board should obtain information in Order to carry out its duties: "Providing sufficient information to the Supervisory Board is the Joint responsibility of the Management Board and Supervisory Board.^^^ For example, the supervisory board should specify the management board's information and reporting duties in detail.^^^ The supervisory board of the parent is expected to monitor the entire group.^"*^ Normally, the reports of the management board cover the entire group.^"*^ Self-evaluation of board Performance, The Aktiengesetz does not require any self-evaluation of board Performance. Hovv^ever, the German Corporate Govemance Code provides that "the supervisory board shall examine the efficiency of its activities on a regulär basis".^'^^ This rule w^as inspired by the practice of board Performance evaluation in the USA.^"^^ The Code is silent on how the supervisory board should go about this task. Contracting out ofStatutory Board Members' Duties While shareholders have limited rights to sue or cause the Company to sue defaulting statutory board members, shareholders in general meeting may at least to some extent remove the liability of statutory board members. Main rule. To begin with, the duties set out in the Aktiengesetz are mandatory. It is prohibited to relieve, in advance, members of the two statutory boards from liability set out in the Aktiengesetz.^"^"^ This means that the statutory liability of board members may not be limited in articles of association or in a contract of employment. It is also prohibited to relieve a statutory board member from the Obligation to pay fines; to conclude such a contract vv^ould be regarded as the prevention of punishment (Strafvereitelung). ^"^^ On the other hand, it is sometimes possible relieve board members from liability under the general principles of the lav^ of obligations,^"*^ and a number of corporate acts that can in effect limit the statutory liability of board members or exclude it.
^^^ The German Corporate Govemance Code, 3.4. ^^^ The German Corporate Govemance Code, 3.4. 840 See for example § 90(1)(4) AktG. ^^^ See Semler J, The Practice of the German Aufsichtsrat. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit p 278. ^^'^ The German Corporate Govemance Code, 5.6. ^^^ See von Werder A in Ringleb HM, Kremer T, Lutter M, von Werder A, Kommentar zum Deutschen Corporate Govemance Kodex (2003) 5.6 Rn 816. ^^"^ See Habersack M, Die Freistellung des Organwalters von seiner Haftung gegenüber der Gesellschaft. In: Festschrift fiir Peter Ulmer (2003) p 156. See also § 120 AktG (Entlastung). ^^^ § 258 StGB. See Thümmel RC, Persönliche Haftung von Managem und Aufsichtsräten (2003) Rdnr 323. 846 § 257 BGB.
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Ratification ex ante. There is no cause of action where the general meeting has given its prior consent to the act complained of and the resolution is a valid one.^"^^ For example, the management board can have referred a normal management matter to the general meeting to be decided on by a simple majority of votes cast,^"^^ or the general meeting can have decided on a fundamental matter according to the Holzmüller principle. In the past, there has been no cause of action against persons who, by voting at a general meeting, have forced the statutory board members to act contrary to the interests of the Company or other shareholders.^"^^ A majority shareholder has not been liable for loss suffered by the Company where he has de facto forced the board to act in the way complained of The UMAG will abolish this rule.^^^ Ratification ex post. As minority shareholders can cause the Company to sue board members under some circumstances, shareholders have in effect discretion to waive the liability for loss sustained by the company.^^^ In addition, it is to some extent possible to relieve statutory board members from liability under the Aktiengesetz after the Company became entitled to the cause of action. No proceedings may be brought against members of the management board, where, after the expiry of three years, the shareholders approve the waiver or settlement at a general meeting with a simple majority of the votes, and the opposing shareholders either do not hold, in the aggregate, at least one-tenth (10%) of the share capital, or do not have their Opposition formally noted in the minutes maintained by a German notary.^^^ For example, in the Mannessmann case the trial judge mied that the bonuses awarded to members of the management board were illegal under Company law. She also said that the supervisory board members who had approved the bonuses had breached the Aktiengesetz because it had not been in the Company's interest to pay these bonuses. However, no proceedings were brought against the members of either board under the Aktiengesetz because the law requires any legal action to be brought by existing shareholders, and the existing majority shareholder, Vodafone, had approved the bonuses. Insurance. It is also possible for the Company to take out a D&O (directors and officers' liability insurance) policy for the management board and supervisory board and pay the premiums for maintaining the policy. The German Corporate Govemance Code recommends that if the Company takes out a D&O, "a suitable deductible" should be agreed.^^^ While shareholders in general meeting may de8^^ § 93(4) Akte. 848 §§119(2) and 133(1) Akte. 849§§ 117(1) and 117(7) Akte. 850 The U M A G will abolish existing § 117(7)(1) AktG: "[durch Ausübung] 1. des Stimmrechts in der Hauptversammlung ..."
851 See § 147 AktG. 852 § 93(4) AktG. 853 The German Corporate Govemance Code, 3.8. According to the UK Combined Code, the Company should arrange D&O cover for claims against its directors. See also Habersack M, Die Freistellung des Organwalters von seiner Haftung gegenüber der Gesellschaft. In: Festschrift ftir Peter Ulmer (2003) pp 151-152.
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cide on a D&O policy for the supervisory board,^^"^ the supervisory board may decide on a D&O policy for the management board. ^^^
5.6.6 The Liability and Management Duties of Sub-board Managers Both the Habihty and management duties of sub-board managers are different. While shareholders can sometimes sue statutory board members or cause the Company to sue them, shareholders do not have similar rights as regards sub-board managers. And while the main duties of statutory board members are determined by the provisions of the Aktiengesetz, the duties of sub-board managers are determined by employment contracts and labour laws. The Right of Shareholders to Sue Sub-board Managers As a rule, shareholders may neither sue sub-board managers for any loss they may have caused in the course of their management duties nor decide on the bringing of proceedings against them. The duties of sub-board managers are based on contract, and they are liable to the Company for loss caused by breach of contract through negligence.^^^ Therefore, only the Company may sue. Management Duties of Sub-board Managers Generally, the law does not give shareholders any power to regulate the management duties of sub-board managers or other employees. Neither the Aktiengesetz nor the articles of association are directly binding on sub-board managers and employees. Duties. The duties of a sub-board manager are based on his employment contract and labour laws. Sub-board managers are basically regarded as employees. The duties of senior officers and other employees are owed to the employer as party to the contract of employment. This is the case even in Company groups or when Services have been outsourced. An employee carrying out work for one Company on the basis of a contract of employment concluded with another Company owes his duties only to the latter.^^"^ Duty to comply with directions. All modalities of employees' duties cannot be regulated in advance. The contract of employment is therefore complemented by directions (Weisungen) given by the employer.^^^ Like any other employees, subboard managers must comply with directions given by the employer about the modahties of work.
854 § 113(1) AktG; Habersack M , ibid p 155.
855 §§111(1) and 112 Akte. 856 §§241(2) and 280 BGB. 857 See Zöllner W , Loritz K G , Arbeitsrecht (1998) § 12 II and § 2 7 III. 858 See for example H r o m a d k a W, M a s c h m a n n F, Arbeitsrecht (2002) p p 1 7 5 - 1 8 1 .
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The power to give directions to employees is vested in the employer (the Company), and exercised by the organ that represents the employer (the management board).^^^ Directions can also be given by the direct superior officer of the employee as an agent of the employer (Erfüllungsgehilfe).^^^ These directions must not conflict with the applicable statutory provisions, the terms of collective agreements, or any agreement between the employee and the employer. This means that there is only some room for directions.^^^ The use of directions is also constrained by the duty of the employer to discuss them with the Betriebsrat and, in some cases, the need to obtain the consent ofthat body.^^^ Generally, the employer has the discretion to give all directions that are reasonable, unless the employer and the employee have agreed otherwise.^^^ Sometimes the employee works for a third party on the basis of an agreement between his employer and the third party. In this case, the main rule is that the third party does not have the rights and obHgations of an employer. However, the third party may have a limited right to give directions.^^ Ancillary duties. Sub-board managers and other employees have important ancillary duties that complement the terms of the contract of employment. Some ancillary duties are based on the general provisions of the law of obHgations. For example, sub-board managers and other employees must employ customary Standard of care.^^^ An important source of ancillary duties is the general duty of loyalty (Treupflicht) between contract parties (§ 242 BGB).^^^ Many ancillary duties are based on labour laws. In principle, it is possible to agree on ancillary duties such as the duty not to compete. However, due to the mandatory and detailed nature of German labour law, there is not much room for contractual provisions.^^^ Contractual provisions that set out ancillary duties are therefore often based on model clauses. Management duties. The management duties of sub-board managers are determined on the basis of the express terms of the employment contract and the Position of the manager in question, that is, according to the same principles as the duties of employees in general.^^^ A sub-board manager is generally responsible for a narrower area than a board member and is not the sole person responsible for this area. A Prokurist has gener-
«59 See Zöllner W, Loritz KG, Arbeitsrecht (1998) § 4 V 2. ^^^ § 278 BGB. See also Kasseler Handbuch (1997)/Künzl 2.1. Rz 5. «61 See Zöllner W, Loritz KG, Arbeitsrecht (1998) § 5 III1 and § 12 III1. «62 § 87(1) BetrVG. See also Zöllner W, Loritz KG, Arbeitsrecht (1998) § 6 I 8. «63 § 315(1) BGB. See for example Hromadka W, Maschmann F, Arbeitsrecht (2002) pp 178-179. «64 See Hromadka W, Maschmann F, Arbeitsrecht (2002) p 175; Zöllner W, Loritz KG, Arbeitsrecht (1998) § 27III2. «65 § 276(2) BGB. «66 See Zöllner W, Loritz KG, Arbeitsrecht (1998) § 13 III. «67 See Zöllner W, Loritz KG, Arbeitsrecht (1998) § 13 V. «6« See also Thümmel RC, Persönliche Haftung von Managern und Aufsichtsräten (2003) p 45.
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ally wider duties than an ordinary manager. Also the exact modalities of the duties of loyalty, care and confidentiality depend on the level of hierarchy.^^^ LiabiUtyfor loss suffered by the Company. The HabiUty of sub-board managers for loss suffered by the Company is relatively limited. Sub-board managers are liable to the Company for loss caused by breach of contract through negligence. The liability of a sub-board manager is basically that of an employce.^"^^ The Aktiengesetz does not contain any special provisions on the liabihty of sub-board managers. The duties of a sub-board manager depend on the express terms of his employment contract and on his position in the Company. The degree of care required from a sub-board manager is objective and determined by what is generally expected ofa manager in the same position (verkehrsübliche Sorgfalt).^^^ On the other hand, the Federal Labour Court (Bundesarbeitsgericht, BAG) has limited the liability of employees for loss sustained by the Company. The BAG has held that an employee is liable for loss caused through wilful intent, and in most cases liable for loss caused through gross negligence. Where the employee has caused loss by mere negligence, the liability is divided between the Company and the employee and the employee is liable for part of the loss only. The employee is not liable for loss sustained by the Company where he has caused it through minor negligence.^^2 These principles do not apply to the liability of members of the two statutory boards under the Aktiengesetz. There are also other differences between the liability of members of the two statutory boards and that of sub-board managers. These differences relate to employer's directions (Weisungen), contributory negligence and bürden of proof. Sub-board managers have a duty to follow employer's directions (Weisungen). Where the Company has suffered loss by reason of sub-board managers following these directions through negligence, the liability of these sub-board managers may be reduced or excluded by the contributory negligence (Mitverschulden) of the Company. ^"^^ The contributory negligence of the Company can take even other forms. For example, the Company may be guilty of contributory negligence where the Company has failed to: give necessary directions to the manager; control the manager; organise the work of the manager; or notify the manager of the unusually high level ofriskinvolved.^"^"* The Company must prove the breach of contract, negligence, causation and loss according to the general principles of the law of obligations.^^^ 869 See Thümmel RC, ibid p 45. 8'70§§ 241(2) and 280 BGB. 8^1 § 276(2) BGB. 8"^^ See for example BAGE (der Gemeinsame Senat) 78, 56; Söllner A, Waltermann R, Grundriss des Arbeitsrechts (2003) Rn 811-818. 873 § 254(1) BGB. ^'^^ § 254(2) BGB. See also Thümmel RC, Persönliche Haftung von Managem und Aufsichtsräten (2003) pp 45-46. 875 Compare § 93(2) AktG.
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Liabilityfor loss suffered by thirdparties and shareholders. In principle, the liability of sub-board managers for loss suffered by third parties such as shareholders by sub-board managers' breach of duty is govemed by general tort law provisions (especially § 823(2) BGB) like the liability of statutory board members. In practice, however, sub-board managers are not liable for loss suffered by shareholders by reason of mismanagement.^"^^ Duties ofa Prokurist A Prokurist, who exceeds limitations on his power to represent the Company, breaches his duties under the contract of employment (but not any duty under the Aktiengesetz). The sanctions for this breach of duty include, for example, the termination of the employment relationship^'^'^ and liability for any loss sustained by the company^*^^ by reason of negligence (Fahrlässigkeit).^^^ The special position of a Prokurist in the management of the Company affects his duty of care. A Prokurist should thus be more diligent than normal employees.^^^ This special position can also be taken into account when applying the provisions of the Criminal Code (Strafgesetzbuch) on Untreue (see Chap. 5.6.4 below).88^ There are no special rules on the termination of the employment of a Prokurist. This matter is therefore govemed by the general rules applicable to employees or senior officers. For example, the provisions of the Unfair Dismissal Protection Act (Kündigungsschutzgesetz) that protect employees against the termination of employment Protect even Prokuristen.. ^^^ Groups A person can act as a member of one of the two statutory boards in one Company while under an employment contract with another Company. This is often the case in Company groups. Although members of the management board are not treated as employees and labour laws do not extend to members of the management board, a person can at the same time be a member of the management board of one Company and an employee of another. ^^^
^'^^ See Thümmel RC, Persönliche Haftung von Managern und Aufsichtsräten (2003) p 47. 877 §626(1) BGB. 878 §§823(1) and 823(2) BGB. 879 §276(1) BGB. 880 See Senne in Kasseler Handbuch (1997) 4.1.Rz 24.
881 § 266 StGB. 882 §§ 14(1) and 14(2) KSchG. See also §§ 3 and 9(1) KSchG; Kasseler Handbuch (1997) 4.1.Rz27. 883 See Kasseler Handbuch 4.1. Rz 5.
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5.6.7 The Liability and Duties of Statutory Auditors Shareholders in general meeting may elect the Company's statutory auditor or auditors,^^"^ but neither shareholders in general meeting nor individual shareholders may normally sue a statutory auditor for loss caused by breach of duty. Duties. The duties and liability of statutory auditors are based partly on the law of obligations and partly on the regulation of statutory audits.^^^ Some of the statutory provisions that set out sanctions for breach of duty are contained in the Act on the Profession of Auditors (Wirtschaftsprüferordnung). The inspections that auditors must carry out in the course of statutory audits have been listed in the Handelsgesetzbuch.^^^ The provisions of the Aktiengesetz influence the Performance of statutory auditors' duties because companies and their statutory board members must comply with them. For example, statutory auditors have a duty to inspect whether members of the management board have complied with the provisions of the Aktiengesetz on annual accounts^^"^ and Controlling Systems.^^^ The German Corporate Governance Code. There are different views on the duty of statutory auditors to inspect whether the Company in fact complies with the German Corporate Governance Code.^^^ The Government Commission did not propose any such duty.^^^ On the other hand, statutory auditors must inspect all Statements that must be made by the two statutory boards by law.^^^ Liability. Statutory auditors are liable for loss suffered by the Company by reason of breach of duty through wilful intent or negligence.^^^ They cannot contract out of this liability or limit it,^^^ but there is a statutory cap. The liability of negli884 §119(1)(4) Akte. 885 See § 323 HOB. 886 §§317 and 318 HOB. 887 § 317(1) HGB;§ 91(1) Akte. 888 § 317(4) HGB; § 91(2) AktO. 889 § 161 AktG. 890 B a u m s T (ed) Bericht der Regierungskommission Corporate Governance, U n t e m e h mensführung - Untemehmenskontrolle - Modernisierung des Aktienrechts (2001) Rdnr 12: "Dagegen braucht der Abschlußprüfer seine Prüfung bei Vorliegen der C o m p l i a n c e Erklärung nicht darauf auszurichten, o b tatsächlich abweichende Regelungen praktiziert werden. Dies würde d e m bei nicht a u f die Rechnungslegung bezogenen Gesetz- u n d Satzungsverstößen geltenden allgemeinen Prinzip widersprechen, d a ß der A b schlußprüfer insoweit keine aktive, erforschende Prüfung anzustellen, sondern n u r zu berichten hat, w e n n er gelegenthch der Prüfung solche Verstöße festgestellt hat (wobei es sich überdies u m schwerwiegende Verstöße handeln m u ß ; § 321 Abs. 1 S. 3 H G B a.E.)." 89^ §§ 316 and 317 H G B . See Ulmer P, Der Deutsche Corporate Governance Kodex - ein neues Regulierungsinstrument für börsennotierte Aktiengesellschaften, Z H R 166 (2002) p 177; Hommelhoff P, Schwab M , Regelungsquellen und Regelungsebenen der Corporate Governance: Gesetz, Satzung, Codices, u n t e m e h m e n s i n t e m e Grundsätze (2003) p p
55-56. 892 §323(1) HGB. 893 § 323(4) HGB.
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gent auditors is limited to € 1 million for each audit in an unlisted Company and to € 4 million for each audit in a listed Company.^^"^ These caps do not limit the liability of auditors for loss caused by breach of duty through wilflil intent. In addition, the statutory auditor can become liable in contract or tort for loss suffered by the Company. A statutory auditor may also become liable for loss suffered by an undertaking that belongs to the same group of companies as the audited Company.^^^ The Courts have held that a statutory auditor can be made liable to a third party for breach of an implied contract, an "information contract". A statutory auditor can also become liable for loss sustained by a third party by reason of breach of a statutory provision provided that the statutory provision also protects that third party (Schutzgesetz).^^^ Right to sue. However, the statutory auditor owes his duties under the Handelsgesetz to the audited Company. The main rule is therefore that only the Company (represented by its management board) may sue. Other parties may bring proceedings provided that they have a cause of action.
5.7 The Role of Individual Shareholders As discussed above, shareholders might try to act as a rule-maker in the Company by using their voting rights at a general meeting (Chap. 5.4.3) or by contracts (Chap. 5.5). Shareholders can also have rights to disclosure of information (Chap. 5.6.2), and some remedies are available to them (Chaps. 5.6.3 and 5.10.3). It should nevertheless be distinguished between the formal rights of individual shareholders and their de facto influence. Formal rights. As also discussed above, the formal rights of individual shareholders to influence management directly are effectively limited by the mandatory provisions of the Aktiengesetz setting out the distribution of powers in the company.^^^ The statutory model is that individual shareholders influence management by voting and making use of their other rights at the general meeting. One of the most fundamental powers of individual shareholders is the liberal power to put things on the agenda of a general meeting. However, apart from the powers of a parent Company by virtue of Konzemrecht, there are few statutory ways for an individual shareholder to influence management directly. Individual shareholders can monitor management ex post and thus influence management indirectly by virtue of the liberal right to contest resolutions passed at a general meeting. This remedy belongs to the most important formal powers of individual shareholders (see in particular Chap. 5.10.3 below). The threat of this remedy is a factor that increases compliance with the Aktiengesetz ex ante. 894 § 323(2) H G B .
895 HGB § 323(1). 896 § 823(2) B G B . 89'7 See for example Altmeppen H, Die Haftung des Managers im Konzern (1998) p 56.
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A shareholder has normally no direct recourse against members of the two statutory boards for alleged mismanagement. Apart from special circumstances, only the Company is entitled to damages from members of either board for breach of duty owed to the Company. Other formal powers vested in sharehlders can typically be used by shareholders holding a large majority of shares represented at the meeting or a shareholders holding a large block of shares. Defacto influence. However, major shareholders can sometimes enjoy a Position that gives them a de facto power to influence management regardless of their formal rights. Where the majority shareholder of the Company is a business undertaking, it can be assumed that the management board coordinates its actions with the majority shareholder regardless of the applicable mies. This is tolerated by the legislator, and the provisions of the Aktiengesetz on groups are based on this assumption.^^^
5.8 Shareholders and Dealings with Third Parties 5.8.1 Introduction In German law, it is necessary to distinguish between extemal power to bind the Company in its dealings with third parties (extemal relations, Aussenverhältnis) and intemal authority to represent the Company (internal relations, Innenverhältnis). As these two powers are seldom identical, a representative can make the Company bound by a contract although he should not do so: the Company is bound by acts done in its name by representatives within their extemal powers to bind the Company. ^^^ On the other hand, a representative who exceeds the (intemal) authority conferred on him by Company bodies can become liable to the Company for any loss suffered by the Company thereby. The main mle is that shareholders do not have any power to represent the Company in its dealings with third parties. On the other hand, shareholders do have some powers to influence the representation of the Company by its statutory board members. However, shareholders have few formal powers to punish board members (see Chap. 5.6.3 above), and they have normally no powers to invoke the breach of these restrictions vis-a-vis third parties. What all this means is that shareholders cannot do much about which acts should bind the Company and which not. Instead, this matter is determined by statutory provisions. While the most important mies on the representation of the Company by its shareholders or the members of its two statutory boards can be found in the Akti898 §§ 18(1), 17(2) and 16 AktG; see Altmeppen H, Die Haftung des Managers im Konzern (1998) p 56. 899 §164(1) BGB.
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engesetz, the most important mies on the representation of the Company by subboard managers are based on the Civil Code (Bürgerliches Gesetzbuch, BGB) and the Commercial Code (Handelsgesetzbuch, HGB).
5.8.2 Representation of the Company by its Shareholders There are hardly any exceptions to the rule that shareholders may not represent the Company in its dealings with Company insiders or third parties. Some exceptions relate to proceedings brought by shareholders in the name of the Company. Sometimes proceedings must be brought at the request of shareholders or shareholders may decide on the bringing of proceedings. In rare cases, a shareholder of a dependent Company may also bring proceedings on behalf of the Company against defaulting board members.^^^ The UMAG will make it possible for minority shareholders to bring proceedings in their own name on behalf of the Company against defaulting board members.
5.8.3 Representation of the Company by Other Representatives The main rule is that the management board has a general power to represent the Company extemally.^^^ The management board represents the Company both in its business dealings (in other than its legal affairs, außergerichtlich) and its legal affairs (gerichtlich). In practice, however, the Company can be represented by its management board in a relatively small number of transactions. In the vast majority of cases, the Company is represented by (other) agents. These agents include Prokuristen, who are holders of the general commercial power of attomey (Prokura), as well as persons held out by the Company in other ways as having authority to bind it. Representation ofthe Company by its supervisory board. The power of the supervisory board to bind the Company in its dealings with third parties is very limited, but the supervisory board has a power to represent the Company in two important cases. Firstly, the supervisory board represents the Company in its dealings with management board members.^^^ Secondly, the supervisory board represents the Company in its dealings with auditors.^^^ The default rule is that the supervisory board represents the Company as a collegiate organ. For practical reasons, the chairman often negotiates on the behalf of the supervisory board.^^"^ The supervisory board can also delegate the representation ofthe Company to a supervisory board committee.^^^
^^ §§ 309(4) and 310(4) AktG. See also §§ 317(4) and 318(4) AktG. 90^ § 78(1) AktG. 902 §112 AktG. 903 § 111(2) AktG. See also Hüffer U, Aktiengesetz (2002) § 142 R n 11. 904 See Hüffer U, Aktiengesetz (2002) § 111 R n 12a-12d.
905 §107(3) AktG.
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Representation of the Company by its management board. The management board is the organ that has the power to run the Company and to represent it in its business deahngs and legal affairs.^^^ The main rule is that acts done by the management board of an AG with regard to third parties are binding on the Company. The management board has a general power to represent the Company extemally. As a rule, this power is regarded as unlimited (unbeschränkt), and it may not be limited intemally (it is unbeschränkbar).907
The default rule is that the management board represents the Company as a collegiate organ. The articles of association can nevertheless provide that the Company can be represented by: a sole management board member; a management board member and a Prokurist together; or by two management board members together.^^^ The articles normally contain such a regulation. These rules are mandatory as regards acts the purpose of which is to change legal relations (these acts are called legally significant acts or Rechtsgeschäfte).^^^ They are not mandatory as regards the preparation of legally significant acts. The main rule that the powers of the management board cannot be delegated does not apply to all acts that fall within its powers (see Chap. 5.2.4 above). For example, a sole management board member is not prohibited from entering into negotiations with a third party in order to prepare a contract.^^^ The management board can also represent the Company by granting a power of attomey or holding a person out as having the power to represent the Company. Representation ofthe Company by a Prokurist. A Prokura empowers its holder (Prokurist) to represent the Company in the course of business (Handelsgewerbe).9i^ The scope of the power of a Prokurist to bind the Company is set out by statutory provisions. As a rule, all Prokuristen employed by German AGs can bind the Company in the same way in the course of business (Aussenverhältnis) when they act in this capacity, but the internal limitations on their authority to bind the Company are different depending on the Company (Innenverhältnis). All Prokuristen can thus bind the Company in the same way (Aussenverhältnis), but the Prokuristen of different companies should bind the Company in different ways (Innenverhältnis). The business of the Company (Handelsgewerbe) being a wide concept, the power of a Prokurist to bind the Company is quite wide. The concept of Handelsgewerbe does not cover only those acts that belong to the day-to-day business 906§76(l)and§78AktG 907 § 82(1) AktG. Deputy m e m b e r s have similar powers. See § 94 AktG. 908 § 78(3) AktG. ^o^Larenz K, Allgemeiner Teil des deutschen Bürgerlichen Rechts (1989) § 18 I: "Unter einem 'Rechtsgeschäft' versteht das B G B eine Handlung - oder eine eine Mehrzahl zusammenhängender Handlungen sei es einer, sei es mehrerer Personen - , deren Z w e c k es ist, eine privatrechtliche Rechtsfolge, also eine Änderung in den rechtlichen Beziehungen einzelner, herbeizuführen." 910 See § 164(1) B G B . See also Hüffer U, Aktiengesetz (2002) § 78 R n 9. 911 § 49(1) HGB.
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of the Company or the current business of the Company or the objects set out in the articles of association. For example, a Prokurist may represent the Company by employing workers or bringing court proceedings on behalf of the Company. On the other hand, this concept does not cover the sale of the business of the Company or corporate transactions such as the change of the Company's name or seat. The sale and purchase of real estate are not covered by the Prokura but it is possible to also grant the Prokurist a power of attomey for these transactions.^^^ The Prokura cannot be limited to some transactions or classes of transactions only as regards the company's relations with third parties (Aussenverhältnis).^'^ On the other hand, limitations on the internal authority of the Prokurist are possible (Innenverhältnis). There are sanctions for the breach of these internal limitations. The articles of association typically provide that the Company may be represented in transactions with third parties by two members of the management board acting jointly or by one member of the management board together with a Prokurist. It is possible to also limit the powers of a Prokurist in this way in the Prokura. A Prokurist can be given a power to bind the Company only jointly with another Prokurist or a statutory representative of the Company (Gesamtprokura). There are different types of Gesamtprokura.^^"^ Representation ofthe Company by other agents. The Company - represented by its management board or one of its Prokuristen - can also appoint other agents. The Company can have representatives with an express power of attomey or without any express power of attomey. The management board can grant an agent a general power of attomey to represent the Company provided that these powers do not exceed the powers of the management board to represent the Company and the power of attomey can be revoked at any time (Generalvollmacht).^^^ The management board can also appoint agents with a specific power of attomey to represent the Company in the ordinary course of business or in relation to a specific transaction (Handlungsbevollmächtigte).^^^ In many cases, the Company is bound by virtue of a real or fictive holding out of a person as its agent: the Company is bound by virtue of the powers of the person, who acts in its name, as they appear to others (Rechtsscheinsvollmacht).^^^ There are two important forms of holding out ofa person as a representative ofthe Company. The Company is bound by acts done by a person in the name of the Company where the Company: repeatedly allows that person to represent the com9^2 But See § 49(2) HOB. Compare § 54(2) HOB below. 913 § 50 HOB. 91"^ Allseitige Gesamtprokura, halbseitige Gesamtprokura, gemischte Gesamtprokura. 915 See Hüffer U , Aktiengesetz (2002) § 78 R n 10. 916 § 54 H G B . 91*^ B G H Z 86, 273: "Wie allgemein anerkannt ist, m u ß sich der Vertretene bei Vorliegen einer Vollmacht krafl Rechtsscheins so behandeln lassen, w i e w e n n er eine echte (Außen-) Vollmacht erteilt, b z w . ein vollmachtsloses Auftreten genehmigt hätte. Er haftet d e m Geschäftspartner daher nicht nur für den Vertrauensschaden, sondern wird durch das Vertretergeschäft gebunden ..."
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pany (Duldungsvollmacht); or appoints the person to a certain position and persons in that position normally have a certain scope of authority to bind the Company (Anscheins Vollmacht). ^^^ For example, a salesperson can seil things on sale in a shop provided that he does it in the normal way (Scheinvollmacht des Ladenangestellten).^^^
5.8.4 Shareholders as a Ruie-maker In some cases, shareholders have a power to influence the representation of the Company in its dealings with a third party by passing a resolution either on the substance of the matter or on the representation of the Company. It is again necessary to distinguish between the internal relations of the Company (Innenverhältnis) and the relationship between the Company and third parties (AussenVerhältnis). While shareholders have some influence as regards the liability of the representatives to the Company (Innenverhältnis), it is difficult for them to control which acts will bind the Company and which not (AussenVerhältnis). The objects clause of the articles of association. It would be unusual for the Company to be able to invoke against third parties (Aussenverhältnis) such regulations of the articles of association that restrict the kinds of transactions that may be carried out by Company representatives. Representatives who breach such restrictions may nevertheless become liable to the Company (Innenverhältnis). The most important restrictions in the articles of association relate to the Company's objects. The articles of association must lay down the objects of the Company. The objects clause sets out the business the Company is in.^^^ The objects clauses of German public limited-liability companies are normally much shorter and more generally formulated than those of UK public limited liability companies, and they do not contain any list of powers that the Company may exercise.^^* Where the Company is represented by its management board, breach of the objects clause cannot be invoked against third parties. This is because the power of the management board to represent the Company extemally (Aussenverhältnis) is unlimited (unbeschränkt)^^^ and cannot be limited by internal actions of the Company (it is unbeschränkbar),^^^ not even by limitations in the objects clause.^^"^ Members of the management board who breach the objects clause may neverthe-
9^8 §§ 170,171(2) and 172 BGB are examples of the principle. 919 § 56 H G B . 920 § 23(3)(2) AktG.
921 See for example § 2 of the articles of association of Siemens AG (available at 922 §78(1) AktG. 923 §82(1) AktG. 924 See Hüffer U, Aktiengesetz (2002) § 78 R n 5.
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less become liable to the Company (Innenverhältnis) for loss caused by negligent breachof duty.^25 Where the Company is represented by two members of the management board acting jointly or by one member of the management board together with a Prokurist by virtue of the articles of association, the breach of other regulations in the articles of association cannot be invoked against the third party. Like the powers of the management board, the power of these persons to bind the Company extemally (AussenVerhältnis) is regarded as unlimited (unbeschränkt).^^^ However, the breach can intemally lead to liability for loss sustained by the Company (Innenverhältnis). As regards the relations of the Company to third parties (Aussenverhältnis), the power of a Prokurist to bind the Company is unusually wide in these cases because he is not acting in the capacity of a Prokurist only.^^'^ Where the Company is represented by a Prokurist (acting in this capacity), the objects clause and other regulations in the articles of association do not limit his powers to bind the Company in its dealings with third parties (AussenVerhältnis). The power of a Prokurist to bind the Company extemally is determined by statutoiy provisions.^^^ Internal limitations cannot be invoked against third parties.^^^ The objects clause does not limit the power of other representatives to bind the Company either (Aussenverhältnis). And since the duties of sub-board managers representing the Company are not regulated in the Aktiengesetz in the first place, sub-board managers are not be liable to the Company under § 823(2) BGB for breach of objects. The power to represent the Company under the articles of association. The power to represent the Company can be regulated in the articles of association only to a limited extent. The articles of association can only provide that the Company can be represented by: a sole management board member; a management board member and a Prokurist together; or by two management board members together.^^^ The breach of either these regulations or the main rule that the Company is represented by its management board as a collegiate organ can be invoked by the Company against third parties (Aussenverhältnis). In these cases, acts allegedly done by the Company are not binding on the Company unless the Company ratifies them.931
^^^ § 93 AktG. Compare also §§ 82(1) and 82(2) AktG. The relationship between the Company and a third party is mentioned in § 82(1) but not in § 82(2) AktG. See also Hüffer U, Aktiengesetz (2002) § 83 Rn 14. 926 §§ 82(1) and 78(3) AktG; see Hüffer U, Aktiengesetz (2002) § 78 Rn 15. 927BGHZ13,61. 928 49 § H G B .
929 §§50(1) and 50(2) HGB. 930 § 78(3) AktG.
931 §177(1) BGB.
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5.8.5 Statutory Provisions on the Representation of the Company Shareholders thus do not have much influence on which acts should bind the Company. This matter is determined by statutory provisions. Different rules apply depending on the level of hierarchy. Management board. The main rule is that the management board can bind the Company in its deaUngs with third parties (Aussenverhältnis) without restrictions. This power is unUmited (unbeschränkt)^^^ ^nd cannot be limited by internal acts of the Company (it is unbeschränkbar).^^^ The effect of binding acts is govemed by the general provisions of the law of obligations (BOB).^^"^ However, there are some statutory restrictions on the extemal power of the management board to bind the Company; the acts of the management board are thus not always binding on the Company. The management board is generally bound by the provisions of the Aktiengesetz (Legalitätspflicht).^^^ The management board may not abuse its powers. The doctrine of abuse of agency (Mißbrauch der Vertretungsmacht) applies where the management board has abused its power to represent the Company in its dealings with a third party who is not regarded as worthy of protection.^^^ In particular, this doctrine, which can be based on either § 177 BGB (Vertragsschluß ohne Vertretungsmacht) or § 242 BGB (Treu und Glauben), applies where: (a) the representative of the Company has either knowingly or unknowingly exceeded his powers; (b) this was known to the third party in question; and (c) the actions of the third party can be regarded as particularly unjustifiable.^^^ The management board must not exceed its powers. The management board therefore must not represent the Company if this power is vested in the supervisory board. The supervisory board represents the Company in its dealings with members of the management board^^^ and where the management board has decided to sue the Company in order to contest a resolution of the general meeting (Anfechtungsklage,^^^ Nichtigkeitsklage^"^^).
932 § 78(1) Akte. 933 §§78(1) and 82(1) AktG. 934 See §164 BGB. 935 See Paefgen W G , Unternehmerische Entscheidungen und Rechtsbindung der Organe in
der Aktiengesellschaft (2002) pp 17-18 and 24-25. 936RGZ 134, 67, 71: "... wenn zuungunsten des Geschäftsgegners die Grundsätze vom Handeln wider Treu und Glauben Platz greifen und damit dem Vollmachtgeber die Einrede der ArgUst in die Hand gegeben wird ..." See for example Hüffer U, Aktiengesetz (2002) § 82 Rn 6; Lutter M, Europäisches Untemehmensrecht (1996) p 56. 937 See Wienand Meilicke, Selbstkontrahieren nach europäischem Gesellschaftsrecht, R I W ( 1 9 9 6 ) p 713. 938 § 112 AktG. See also §§ 84(1) and 84(3) AktG; Hüffer U, Aktiengesetz (2002) § 82 R n 4. 939 § 246(2) AktG. 940 § 249(1) AktG.
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It is again necessary to distinguish between the Company's relations with third parties and its relations with its representatives. There are many rules on the internal decision-making of the Company which do not affect the power of the management board to bind the Company in its dealings with third parties (Aussenverhältnis)^"^^ but the breach of which can make management board members liable for loss suffered by the Company (Innenverhältnis). Generally, the management board may not breach its duty to the Company to comply with the provisions of the Aktiengesetz, the regulations of the articles of association, the lawfül instructions of the supervisory board, the lawful resolutions of the general meeting, and the internal guidelines for its work (Innenverhältnis).^"^^ However, breach of these rules does not automatically make transactions carried out by the management board invalid in the Company's relations with third parties (AussenVerhältnis). There are some provisions on the internal decision-making of the Company the breach of which can be invoked against third parties.^"^^ In some cases, the act is not vahd without the consent of the general meeting.^"^"^ In other cases, the act is not valid without the consent of the supervisory board.^"*^ There does not seem to be any discussion on the compatability of these provisions with Article 9 of the First Company Law Directive that restricts the right of the Company to invoke breaches of rules on the internal decision-making of the Company against third parties. In any case, sometimes the management board concludes a contract without having the power to bind the Company. (a) A contract which exceeds the extemal powers of the management board to bind the Company (Aussenverhältnis) is not binding on the Company unless the Company ratifies it (§ 177 BGB). (b) A contract which the management board has concluded by breaching internal limitations on how it should exercise its powers to bind the Company (Innenverhältnis) is normally binding on the Company. It is not binding where the doctrine of abuse of agency applies (Mißbrauch der Vertretungsmacht, § 177 BGB and § 242 BGB). (c) The breach of internal or extemal limitations to bind the Company can amount to breach of duty of care under the Aktiengesetz and to a breach of the board member's Service contract with the Company. A representative who acted without power to bind the Company can also be liable for loss suffered by the
941 Compare the wordings of §§ 82(1) and 82(2) AktO. See Hüffer U, Aktiengesetz (2002) § 82 Rn 3, 4 and 14. 942 § 82(2) AktG.
943 See Hüffer U, Aktiengesetz (2002) § 82 Rn 4. 944 §§ 50, 52(1), 93(4), § 179a(l), 293 and 295 AktG; see Hüffer U, Aktiengesetz (2002) §
50 Rn 4, § 52 Rn 7-9, § 93 Rn 29 and § 179a Rn 13-14. 945 § 32(1) MitbestG; Hüffer U, Aktiengesetz (2002) § 7 8 R n 8a: "Regelung schränkt nicht nur Geschäftsführungsbefugnis des Vorstands ein ... sondern auch seine Vertre-
tungsmacht ..." See also §§ 89(5) AktG and § 114(2) AktG which lay down a duty to retum certain payments made by the Company.
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other party to the contract by reason of the contract not being valid^"^^ provided that the other party acted in good faith.^"^^ Supervisory board. The same principles apply in the rare case that the Company can be represented by the supervisory board in its relations with third parties. Prokurist. As explained above, the powers of a Prokurist to bind the Company are quite wide, and they are regulated by the provisions of the Handelsgesetzbuch. (a) Transactions carried out by a Prokurist are not binding on the Company where the Prokurist exceeds his extemal powers to bind the Company (Aussenverhältnis). (b) A Prokurist who breaches duties owed to the Company (Innenverhältnis) can be liable for loss suffered by the Company thereby, but the breach of these duties is normally not relevant as far as the relations of the Company with third parties are concemed (Aussenverhältnis). (c) The Company may nevertheless invoke the breach of these internal duties against third parties where the doctrine of abuse of agency (Missbrauch der Vertretungsmacht, §§ 177 or 242 BGB) can be apphed. Other agents. The principles that apply to Prokuristen also govem the representation of the Company by other agents. The powers of other agents to bind the Company are not as wide as those of a Prokurist,^"^^ but the same rules apply where an agent has exceeded his extemal powers to bind the Company (Aussenverhältnis)^"^^ or internal restrictions on how he should use his powers to bind the Company (Innenverhältnis).^^^
5.9 The Governance of Croups in Germany 5.9.1 Introduction What is characteristic of the regulation of the governance of Company groups in Germany is the existence of specific statutory provisions on groups of companies (Konzemrecht). It is sometimes argued that the institutions of the EU should adopt common rules modelled after the German rules. Perhaps a more important but in comparative studies often-neglected matter is the existence of GmbHs in German Company law. It is usual to combine a parent AG to raise capital from the public with domestic subsidiary GmbHs to organise the business activities of the group.^^^ For example, the following domestic subsidiaries belonged to the Transportation Systems division of Siemens AG in 2004: messMa GmbH; Transrapid International GmbH & Co. KG; Siemens Dispolok 946 § § 1 7 9 ( 1 ) and 179(2) B G B .
947 §179(3) BGB. 948 Compare § 4 9 H G B on one hand and § § 5 4 and 56 H G B on the other. 949 § 164(1) B G B . See also § 179 B G B . 950 § 611 B G B . See also §§ 177 and 242 B G B .
951 prigge S, A Survey of German Corporate Governance. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit pp 952-953.
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GmbH; Dienstleistungsgesellschaft für Kommunikation des Stadt- und Regionalverkehrs mbH; Technisches Gemeinschaftsbüro GmbH; Leipziger FahrzeugService Betriebe GmbH; and Leipziger Infrastruktur Betriebe GmbH. Some specific provisions have been found necessary because of the membership of employee representatives in the supervisory boards of companies to which the Co-determination Acts apply. The general rules on the internal decisionmaking of the Company have been modified in order to ensure that employees do not gain too much influence by participating in decision-making both in the parent Company and the subsidiary.
5.9.2 Fiduciary Duties of Group Members It is possible to distinguish between the fiduciary duties of the persons representing a group member and the fiduciary duties of the group member itself While the former are duties owed by persons who are responsible for the management or representation of a Company, the latter are owed not by these persons but by a Company either in its own capacity or in the capacity of shareholder in another Company. The duties of persons who are responsible for the management or representation of a Company are govemed by general Company law rules and owed to that Company. In a holding Company, the duty to act in the interests of the Company (Untemehmensinteresse) thus means a duty to act in the interests of the holding Company (das Untemehmensinteresse der Obergesellschaft); there is not yet any general duty to act in the interests of the group as a whole (Holdinginteresse).^^^ The fiduciary duties of group members are generally based on the duty of loyalty (Treuepflicht). The duty of loyalty belongs to the general principles of German Company law. This duty is based on the case law of the Federal Supreme Court (Bundesgerichtshof, BGH) and the principle of good faith in the law of obligations (Treu und Glauben, § 242 BGB).953 In Germany, a shareholder owes a duty of loyalty to the Company and other shareholders, and the Company owes a duty of loyalty to its shareholders. It is also clear that a Controlling undertaking owes a duty of loyalty to the companies that it Controls.^^"^ The duty of loyalty of the Controlling undertaking can cover even the subsidiaries of subsidiaries, which it controls indirectly. In the ITT case, the BGH held that
^^^ See Semler J, Die Rechte und Pflichten des Vorstands einer Holdinggesellschaft im Lichte der Corporate Govemance-Diskussion, ZGR 2004 p 644; Hüffer U, Aktiengesetz (2002) § 76 Rn 17a. ^^^ See for example BGHZ 65, 15 (ITT); see also Schneider UH, Burgard U, Treupflichten im mehrstufigen Unterordnungskonzera, Festschrift für Peter Ulmer (2003) pp 579, 582. 954 See BGHZ 103, 184 at p 194 (Linotype), BGHZ 129, 136 at p 142 (Girmes) and BGHZ 142, 167 (Hilgers). See also Hüffer U, Aktiengesetz (2002) § 53a Rn 2; Schneider UH, Burgard U,ibidp 581.
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the mere fact that the group of companies has been organised in a certain way could not affect the existence of this duty.^^^ The duty of loyalty includes in particular a duty to promote the purpose of the Company, a prohibition to cause the Company loss or damage, and a further duty to use shareholders' rights and powers in a responsible manner. 5.9.3 The GmbH While there are more than 15,000 AGs in Germany, the number of GmbHs exceeds 800,000. For many reasons, the GmbH is the preferred Company form for subsidiaries. Unlike the AG, the govemance of a GmbH is to a large extent based on flexible rules. Shareholders of a GmbH - in particular a parent Company which is the sole shareholder - have more say in the management of the Company and more discretion as far as the internal rule-making of the Company is concemed. The number of statutory rules is smaller and the statutory rules are less detailed. There are fewer mandatory rules.^^^ These rules relate in particular to the protection of creditors and minority shareholders,^^'' because the shareholders of a GmbH are presumed to take an active interest in the running of the Company. Compared to an AG, there are fewer formalities with the Operation of a GmbH. The management structure is simpler than for an AG, with one or more statutory managing directors (Geschäftsführer) acting in the place of the AG's management board. In addition, shareholders are entitled to waive formalities and decisionmaking may also take place by means of written resolutions.^^^ The powers of shareholders in general meeting to decide on management matters are to a large extent based on the Statutes of the Company (Gesellschaftsvertrag).^^^ The Statutes of a GmbH can be tailored to the requirements of the shareholders.960 Furthermore, shareholders in general meeting may give directions by a simple majority.^^^ The managing directors must comply with the resolutions of shareholders on Company policy or intemal guidelines, or Instructions on a specific transaction, unless the Statutes provide otherwise.^^^ ^^^BGHZ 65, 15 (ITT): "Die Treupflicht kann allein wegen der abweichenden organisatorischen Gestaltung und rechtlichen Einkleidung nicht anders zu beurteilen sein." See also BGHZ 89,162 (Heumann-Ogilvy); BGH ZIP 2001,1874 (Bremer Vulkan). 956 See for example § 45(2) GmbHG. 95'' See Hommelhoff P, Gestaltungsfreiheit im GmbH-Recht, ZGR-Sonderheft 13 (1998) pp 39-42. 958 §§ 48(1) and 48(2) G m b H G .
959 §45(1) GmbHG. 960 Hommelhoff P, Gestaltungsfreiheit i m GmbH-Recht, ZGR-Sonderheft 13 (1998) p p 4 5 -
46. 961 §§ 47(1) and 37(1) GmbHG. See also Lutter M, Hommelhoff P, GmbH-Gesetz (2000) § 37, 17. 962 § 37(1) G m b H G .
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The duty of managing directors to comply with directions given by resolutions of shareholders is characteristic of a GmbH.^^^ In practice, the position of managing directors can resemble that of employed executives who enforce the decisions of their superiors if this is what the shareholders want.^^"* A GmbH can have a supervisory board.^^^ A supervisory board is normally optional, but it is compulsory for companies with more than 500 employees because of co-determination.^^^ Some 300 GmbHs were subject to co-determination under the Co-determination Act of 1976 (MitbestG) in 2000, and some 7000 GmbHs were subject to co-determination under the Works Constitution Act of 1952 (BetrVG).967
5.9.4 Co-determination in Croups The System of co-determination has been modified in Company groups where: the parent Company must decide on the exercise of shareholders' rights in the subsidiary; both the parent and the subsidiary are subject to co-determination;^^^ and the parent owns at least 25% of the share capital of the subsidiary.^^^ When all these things apply, the Co-determination Act provides that the supervisory board of the parent must decide on some matters relating to the exercise of shareholders' rights in the subsidiary.^'^^ The supervisory board decides on: the appointment and removal of organ members of the subsidiary; waiver of liability of these organ members (Entlastung); enterprise contracts such as the Beherrschungsvertrag or the Gewinnabfährungsvertrag to be concluded with other undertakings (see below);^*^^ the extension of such contracts after their expiry; and the transfer of assets.^'^^ Only shareholder representatives participate in the decision-making in these cases. Employee representatives are not present at the meeting, and they do not vote.973 The decisions of shareholder representatives are binding on the management board of the parent like any other lawful decisions of the supervisory board.^^"*
963 See Lutter M, Hommelhoff P, GmbH-Gesetz (2000) § 37, 17. 964 Lutter M , Hommelhoff P, GmbH-Gesetz (2000) § 4 5 , 4, and § 37, 12. 965 § 52 G m b H G .
966§77BetrVG1952. 967 Lutter M , Hommelhoff P, GmbH-Gesetz (2000) Einleitung, 15.
968 §32(1) MitbestG. 969 § 32(2) MitbestG.
970 §32(1) MitbestG. 971 See §§291,292 AktG. 972 §32(1) MitbestG. 973 Majority view. See Hoffinann D , Preu P, Der Aufsichtsrat (2003) Rdn 347.
974 §32(1) MitbestG.
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5.9.5 Konzernrecht In Germany, the management of the subsidiary can be made to take into consideration the economic interests of the group as a whole even where this is not in the own particular interest of the subsidiary. For example, the management board of the subsidiary can be made to follow the instructions of the parent. The Aktiengesetz contains a large chapter on the govemance of groups ("Third Book"). These rules apply to "connected undertakings" (verbundene Untemehmen).^"^^ Connected undertakings include, for example, the parent and the subsidiary, two undertakings one of which controls the other, and companies that have concluded an "enterprise contract" (Unternehmensvertag). Unlike the Aktiengesetz, the GmbHG does not contain any similar Chapter on Company groups. But according to case law, similar rules can sometimes be applied to GmbHs and even to commercial partnerships. This is important in light of the fact that most subsidiaries are not AGs but GmbHs. In addition to the existence of GmbHs, a further factor that makes the provisions of the Aktiengesetz on contractual groups less important in practice is the fact that enterprise contracts between a German subsidiary and a foreign parent are problematic from a Company law perspective and not necessarily meaningful from a tax perspective.^^^ The govemance of a connected undertaking under an enterprise contract must be distinguished from the management of the Company's business by virtue of a management contract (Managementvertrag). An AG as the Controlled Company The provisions of the Aktiengesetz on Company groups apply where the controlled Company is an AG^^*^ (or a Kommanditgesellschaft auf Aktien, KGaA).^^^ The Controlling undertaking does not have to be an AG in order for the Konzemrecht to be applicable. In the Autokran case,^^^ the BGH held that even a natural person could be regarded as an undertaking for this purpose. The BGH focused on the potential conflict of interest between the Controlling person and the controlled Company instead of the legal nature of the Controlling person. Different types ofcontrol. The Konzemrecht distinguishes between three types of groups depending on the form ofcontrol. Companies can form a de facto group (faktischer Konzem),^^^ a contractual group (Vertragskonzem)^^^ or a group based ^^^ § 15 AktG: "Verbundene Unternehmen sind rechtlich selbständige Unternehmen, die im Verhältnis zueinander in Mehrheitsbesitz stehende Unternehmen und mit Mehrheit beteihgte Unternehmen (§ 16), abhängige und herrschende Unternehmen (§ 17), Konzernuntemehmen (§ 18), wechselseitig beteiligte Unternehmen (§ 19) oder Vertragsteile eines Untemehmensvertrags (§§291, 292) sind." ^^^ See Altmeppen H, Die Haftung des Managers im Konzern (1998) pp 52-54 and 3-4. 977 §291(1) AktG. 978 See also § 278 AktG. 979 B G H Z 95, 330. 980 §311(1) AktG.
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on the complete Subordination of one Company without this Company losing its legal Personality (Eingliederung).^^^ Contractual groups, The Aktiengesetz provides for two main types of enterprise contracts, contracts on the control of a Company (Beherrschungsvertrag) and contracts on the distribution of profits to another undertaking (Gewinnabführungsvertrag).^^^ There are also other types of enterprise contracts.^^"^ A Beherrschungsvertrag is mainly concluded for tax reasons and not in order to control a subsidiary. A Gewinnabfuhrungsvertrag normally complements the Beherrschungsvetrag.^^^ A Beherrschungsvertrag must be done in writing.^^^ The general meeting of the controlled Company decides on approval of the Beherrschungs vertrag by a majority of three-fourths (75%) of the share capital represented at the meeting.^^^ Where the controlled Company is an AG, the approval of the Beherrschungsvertrag requires the same majority.^^^ Some of the mandatory provisions that restrict payments to shareholders do not apply to payments by virtue of a Beherrschungsvertrag.^^^ In the controlled Company, shareholders other than the Controlling undertaking Company are entitled to periodic compensation payments from the Controlling undertaking (angemessener Ausgleich).^^^ They also have a right to seil their shares to the Controlling Company at a reasonable price as agreed in the Beherrschungs vertrag (Abfindung).^^^ The management board of the Company (or the boards of companies where both of them are AGs) prepare a report on the proposed contract and these two forms of compensation.^^^ According to a Beherrschungsvertrag, the Controlling Company may give binding directions to the Company controlled by it (Leitungsmacht).^^^ The Controlling Company is not empowered to give directions to other companies than its contract party, for example to the subsidiaries of the controlled Company.^^"^
981 § 291(1) AktG. 982 § 319(1) AktG.
983 § 291(1) AktG. 984 See § 292(1) Nr. 1 AktG (Gewinngemeinschaftsvertrag), § 292(1) Nr. 2 AktG (Teilgewinnabführungsvertrag), § 292(1) N r . 3 A k t G (Betriebspachtvertrag, Betriebsüberlassungsvertrag). There are also agreements on the Organisation of the Company (Organisationsverträge). 985 §§ 14, 17 o f the Körperschaftsteuergesetz (KStG). See Altmeppen H , Die Haftung des
Managers im Konzern (1998) pp 3-4. 986 § 293(3) AktG. 987 § 293(1) AktG. 988 § 293(2) AktG.
989 §291(3) AktG. 990 § 304(2) AktG.
991 § 305(1) AktG. 992 § 293a(l) AktG. 993 § 308(1) AktG. 994 See Altmeppen H, Die Haftung des Managers i m Konzern (1998) p 15.
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The directions can be given in many ways. There are no special provisions as to the form of directions.^^^ In principle, the right to give directions can be limited to some matters only (for example to purchases or marketing) or only to part of the business of the controUed Company, but this is rarely done.^^^ The directions are given by the organ that has power to represent the Controlling undertaking extemally. An AG is therefore represented by its management board.^^'^ This organ can also delegate the power to give directions. It is possible to delegate this power at least to a member of the controUing Company's management board^^^ or a senior manager such as a Prokurist or holder of a power of attomey (Handlungsbevollmächtigte) .^^^ The directions are given to the controUed Company, (a) The management board of the controUed Company has a duty to comply with these directions. ^^^^ This is an exception to the main rule that the management board is responsible for the management of the Company. ^^^^ (b) At the same time, the Controlling undertaking cannot give binding directions to individual members of the management board or sub-board managers of the controUed Company, (c) The latter rule is subject to exceptions. The management board of the controUed Company has a power to grant the Controlling undertaking a right to give directions to individual members of its management board or to its sub-board managers, although it does not have any Obligation to do so. In this case, the management board of the controUed Company should ensure that both the scope of the right to foUow these directions and the directions are well documented.^^^^ The directions do not have to be in the interests of the controUed Company, provided that they are in the interests of the Controlling Company or the group.^^^^ The management board of the controUed Company must execute these directions, unless it is obvious that the directions are not in the interests of the Controlling Company or the group.^^^"^ Some of the mandatory provisions restricting payments to shareholders do not apply to payments by virtue of a Beherrschungsvertrag.^^^^ The price of the power to control an AG is special protection of the shareholders and creditors of the controUed Company. Firstly, the representatives of the controUing undertaking have a duty of care (see below). They can become personally liable to the controUed Company. The Controlling undertaking can become Uable 995 996 997 998
See Hüffer U, Aktiengesetz (2002) § 308 R n 10. See Altmeppen H, Die Haftung des Managers im Konzern (1998) p 19. §§78(1) and 309(1) AktG. § 78(4) AktG; see Hüffer U, Aktiengesetz (2002) § 308 Rn 3; Altmeppen H, Die Haftung des Managers im Konzern (1998) p 12. 999 See Hüffer U, Aktiengesetz (2002) § 308 R n 5; Altmeppen H, ibid p 12. 1000 §308(2) AktG. 1001 §76(1) AktG. ^^^^ See Altmeppen H, Die Haftung des Managers im Konzern (1998) p 17; Götz J, Corporate Governance multinationaler Konzerne und deutsches Unternehmensrecht, ZGR 2003 pp 4 - 5 . 1003 §308(1) AktG. 1004 § 3Q8(2) AktG. 1005 §291(3) AktG.
5.9 The Govemance of Groups in Germany
369
as their employer and contract party.^^^^ Secondly, the Controlling undertaking must pay the controlled Company compensation for any losses incurred by the controlled Company (Verlustübemahme).^^^'^ Thirdly, the creditors of the controlled Company are protected by the Obligation of the Controlling undertaking to flimish a security at the expiry of the contract. ^^^^ De facto groups. Some statutory provisions govem even de facto groups. De facto groups are groups formed by two undertakings where one Company controls the other*^^^ without the parties having concluded a Beherrschungsvertrag. Majority ownership triggers the presumption that subsidiaries are dependent on their parent.ioio In de facto groups, the Controlling undertaking must not use its influence to cause the controlled AG to act according to the interests of the latter, unless the Controlling undertaking pays compensation (Nachteilsausgleich). ^^^^ There are also rules on reports by the management board of the controlled Company relating to dealings with the Controlling undertaking (Abhängigkeitsbericht),^^^^ and on the duties of auditors^^^^ and the supervisory board.^^^"^ These provisions are necessary in order to ensure that the Controlling undertaking pays compensation. ^^^^ The duty to publish a "dependency report" (Abhängigkeitsbericht) is the most important way to protect minority shareholders.^^^^ In this report, the management board of the controlled Company must disclose all transactions carried out with the Controlling undertaking and all transactions carried out in the interests of the Controlling undertaking.^^^"^ In addition, there are provisions on the duty of care in de facto groups. The Controlling undertaking, its legal representatives and members of the administrative Organs of the controlled AG may become liable to the controlled AG and its shareholders according to rules that resemble the provisions that apply to contractual groups.^^^^ One of the formal differences between contractual groups and de facto groups is that in the latter, it is slightly more difficult for the Controlling undertaking to give directions to individual managers of the controlled Company, because the management board of the controlled Company must be kept informed of the direc-
1006 1007 1008 1009 1010 1011 1012 1013 1014 1015
§278 BGB. § 302(1) AktG. §303 AktG. §17(1) AktG. §17(2) AktG. §311(1) AktG. §312 AktG. §313 AktG. §314 AktG. §312(3) AktG.
1016 See Altmeppen H, Die Haftung des Managers im Konzern (1998) p 60.
1017 §312(1) AktG. 1018 §§ 317 and 318 AktG, compare § 309 AktG.
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tions in order to know whether they are in the interests of the controlled Company. ioi9 Eingliederung. The Subordination of the Company (Eingliederung) has httle relevance in practice.^^^^ In the case of EingUederung, an AG becomes in effect a business division of its parent AG.^^^^ Both the controlled Company and the Controlling undertaking must be AGs and the Controlling AG must be the sole shareholder in the controlled AG. Contractual groups and de facto groups inpractice. For several reasons, many Controlling undertakings choose not to conclude a formal group contract with the controlled AG. This may be because of the burdens imposed on such groups, the reluctance of the courts to interfere in the Operation of de facto groups, and insuccifient incentives for the formalisation of the relationship.^^22 It is also clear that most subsidiaries are not AGs but GmbHs. The unsatisfactory reach of the Konzemrecht has led to the analogous application of the mies that govem contractual groups to de facto groups even when the controlled Company is a GmbH. A GmbH as the Controlled Company There are no statutory rules on controlled GmbHs as such^^^a although the GmbHG does contain some special provisions for groups^^^"^ and the Handelsgesetzbuch contains provisions on group accounts.^^^s j)^g ^Q ^j^g j^^k of specific provisions, the general rules protecting minority shareholders and creditors will apply. There are also rules on contractual groups and de facto groups. These rules are based on case law and the analogous apphcation of the provisions of the Aktiengesetz. General rules. The applicability of the general rules that protect minority shareholders means that a Controlling shareholder may not cause the controlled GmbH härm. There are no rules on "angemessener Ausgleich", "Verlustübernahme" and "Nachteilsausgleich" for controlled GmbHs, and actions that are not in the interests of the Company can lead to liability for breach of duty of care under the GmbHG and the liability of the Controlling undertaking under the German Civil Code (BGB) to pay compensation for loss suffered by the GmbH by reason of the Controlling undertaking's actions.^^^^ ^^^^ See Götz J, Corporate Govemance multinationaler Konzerne und deutsches Untemehmensrecht, ZGR 2003 p 6. Altmeppen H, Die Haftung des Managers im Konzern (1998) p 4. 1021 See Hüffer U, Aktiengesetz (2002) § 319 Rn 2. 1022 See Dine J, The Govemance of Corporate Groups (2000) p 58; Hofstetter K, Parent Responsibility for Subsidiary Corporations, ICLQ 39 (1990) p 582. ^023 See Lutter M, Hommelhoff P, GmbH-Gesetz (2000) Anhang §13,3. 1024 See Lutter M, Hommelhoff P, GmbH-Gesetz (2000) Anhang § 13, 5 (§§ 33, 47(4) and 51a/bGmbHG). 1025 §290HGB. 1026 § 43 GmbHG; § 249 BGB. See Lutter M, Hommelhoff P, GmbH-Gesetz (2000) Anhang §13, 13.
5.9 The Govemance of Croups in Germany
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For the same reason, the provisions of the GmbHG protecting creditors apply even where a GmbH is controlled by another undertaking. Unlike the Aktiengesetz, the GmbHG does not contain any rule that would limit the scope of provisions that Protect the share capital and restrict payments to shareholders.^^^"^ There are nevertheless rules on de facto groups and contractual groups also where the controlled Company is a GmbH. In German law, a distinction can be made between a qualified de facto group (der qualifiziert faktische Konzern) and a de facto group (der faktische Konzern). Contractual groups. Contractual groups with a GmbH as the controlled Company are govemed by rules developed by the BGH in the Supermarkt case, the Siemens case, and similar cases.^^^^ According to this case law, the provisions of the Aktiengesetz on contractual groups can be applied to GmbHs by analogy.^^29 Defacto groups. De facto groups with a GmbH as the controlled Company are defined in the same way as de facto groups with an AG in this position. There is in other words an undertaking that controls^^^^ the GmbH but no Beherrschungsvertrag between these two undertakings. In this case, the provisions of the Aktiengesetz cannot be applied directly.^^^^ In the absence of special provisions protecting the controlled GmbH, the general provisions of the GmbHG and the principles developed by the BGH will apply. According to the ITT case, the controlled GmbH and its minority shareholders and creditors will be protected by the Controlling shareholder's general duty of loyality.1032
It is possible for the Controlling undertaking to give directions to individual managing directors (Geschäftsführer) or sub-board managers of the GmbH provided that certain conditions are met. Even in this case, the directions should be documented so that the Geschäftsführer of the controlled GmbH can find out whether the directions are in the interests of the Company. ^^^^ Qualified de facto groups. Qualified de facto groups and the regulation of these groups have been defined by the BGH in the Video case and the TBB case.^^^"^ According to these principles, a qualified de facto group exists where: (a) a GmbH is a controlled Company in the sense of § 17 AktG; and (b) the Controlling shareholder abuses its position. In particular, the group exists where the Controlling shareholder causes the GmbH to act contrary to its own interests and the härm suffered by the GmbH cannot sufficiently be compensated for by individual acts
1^27 1028 1029 »030 '031 »032 »033
See §§30, 31 GmbHG. BGHZ 105, 324 (Supermarkt); BGH ZIP 1992, 395 (Siemens). See especially §§ 302, 303, 304 and 305 AktG. §17(1) AktG. See § 311 AktG and the foUowing provisions. BGHZ 65, 15 (ITT). Götz J, Corporate Govemance multinationaler Konzeme und deutsches Untemehmensrecht, ZGR 2003 p 7. »034 BGHZ 115, 187 (Video); BGHZ 122, 123 (TBB). For an English summary, see Wooldridge F, The Situation of Dependent GmbH in a De Facto Group in German Law, JBL 1996 pp 627-638.
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(such as payments). In light of the TBB case, the existence of abuse is based on an objective test.^^^^ In the Video case, the BGH held that a person is liable according to mies on qualified de facto groups where that person is both the sole owner of a GmbH (or a majority owner) and its sole managing director.^^^^ In the TBB case, the BGH clarified its earher position by saying that an undertaking that controls a GmbH is liable in accordance with §§302 and 303 AktG where it uses its power to control the group without properly taking the interests of the controlled GmbH into account and the härm suffered by the GmbH cannot be compensated for by individual acts.1037 Where the principles on qualified de facto groups apply, the Controlling undertaking will therefore become liable to pay compensation according to the principles of § 302 AktG.^^^^ Creditors may claim a security according to the principles of § 303 AktG. In addition, failure to flimish a security may give creditors a right to Claim compensation in the event that the controlled Company becomes insolvent.1039
Management Contracts A management contract (Managementvertrag) is a contract under which the contract party runs a part of the Company's business on behalf of the Company or in his own name. In Germany, there are no special statutory provisions on management contracts (Managementvertrag). There are different views on the permissibility of these contracts as far as AGs are concemed. According to most writers, management contracts are permitted under some circumstances,^^'*^ but there is so far no case law of the BGH interpreting the Aktiengesetz in this respect.
^035 BGHZ 122, 123 (TBB); compare the earlier tests in BGHZ 107, 7 (Tiefbau) and BGHZ 115,187 (Video). ^036 BGHZ 115, 187 (Video), 1. Leitsatz: "Der Allein- oder Mehrheitsgesellschafter einer GmbH, der gleichzeitig deren alleiniger Geschäftsführer ist und sich außerdem als Einzelkaufmann unternehmerisch betätigt, haftet grundsätzlich nach den Haflungsregeln im qualifiziert faktischen Konzern." ^^3"^ BGHZ 122, 123 (TBB), 1. Leitsatz: "Der eine GmbH beherrschende Untemehmensgesellschafter haftet entsprechend den §§ 302, 303 AktG, wenn er die Konzemleitungsmacht in einer Weise ausübt, die keine angemessene Rücksicht auf die eigenen Belange der abhängigen Gesellschaft nimmt, ohne daß sich der ihr insgesamt zugefugte Nachteil durch Einzelausgleichsmaßnahmen kompensieren ließe (Klarstellung zu BGHZ 115,187)." 1038 BGHZ 107, 7 (Tiefbau). 1039 BGHZ 95, 330 (Autokran); BGHZ 115, 187 (Video). ^040 Management contracts are arguably permitted in light of §§ 308(3) and 292(1) Nr. 3 AktG and the fact that they were permitted under the Aktiengesetz of 1937. This is so regardless of § 76(1) AktG. See Fleischer H, Zur Leitungsaufgabe des Vorstands im Aktienrecht, ZIP 2003 p 9.
5.9 The Govemance of Croups in Germany
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Management contracts could be permitted provided that the management board continues to manage the business at a higher level (Oberleitung).^^^^ This would require supervision by the management board not in name only, reports to the management board on an on-going basis, and the right of the Company to terminate the contract.^^'*^
5.9.6 Shareholders' Rights to Disciosure of Information in Company Croups In Germany, there are a number of special rules for Company groups dealing with the right of shareholders to disciosure of information, the remedies available to shareholders, and the duties of members of the management. It is possible to run a group of companies in the interests of the group as a whole. The rights of shareholders to disciosure of information are govemed by the provisions that govem the disciosure of information to shareholders in general. In addition, there are rules on group reporting as well as the rights of a Controlling Company or shareholders of a controlled Company to disciosure of information. Group reporting. The main provisions on the production and content of group financial Statements in a group are contained in the Handelsgesetzbuch. The management board of the parent is responsible for group reporting. ^^"^^ Disciosure of information to the Controlling Company. The controlled Company has a duty to disclose to the Controlling undertaking information necessary for the preparation of group accounts.^^"*"* In addition, the Controlling undertaking has a general right to request the disciosure of information. Where the controlled Company is an AG that has disclosed information to the undertaking that controls it, the AG has no automatic Obligation to disclose the same information also to its other shareholders. ^^"^^ Where the Controlling undertaking is an AG, the information is disclosed to its management board. The supervisory board of the parent Company has a duty to ^041 7he concept of Oberleitung or "management at a higher level" has been recognised in § 292(1) AktG: "Untemehmensverträge sind femer Verträge, durch die eine Aktiengesellschaft oder Kommanditgesellschaft auf Aktien ... 3. den Betrieb ihres Unternehmens einem anderen verpachtet oder sonst überläßt (Betriebspachtvertrag, Betriebsüberlassungsvertrag)." 1042 See Fleischer H , Zur Leitungsaufgabe des Vorstands i m Aktienrecht, ZIP 2003 p p 9 -
10. Fleischer also cites the Delaware case In re Bally's Grand Derivative Litigation, 23 Del J Corp L 677, 686 (Del. Ch. Oct. 9, 1997): "Where that ability is unfettered and the delegation may be terminated at will, a broader delegation of duties will be upheld, because at any point in the relationship the directors may resume their pre-delegation managerial role. On the other hand, the more restricted the directors' ability to terminate, the more narrow the delegation must be to sustain a finding that the board has not abdicated its directorial duties." 1043 § 290(1) HGB. 1044 §294(3) HGB. 1045 § 131(4) AktG.
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control the management of the whole group of companies, but the supervisory board does this by Controlling the management board of the parent Company. The supervisory board of the parent Company has no power to inspect the books of a subsidiary directly. ^^"^^ Information regarding corporate transactions. Many transactions that lead to group relationships require the consent of shareholders in general meeting. At or before the general meeting, the statutory boards of the Company have a duty of disclosure under the general provisions of the Aktiengesetz. For example, before the general meeting of the parent gives its consent to the conclusion of a Beherrschungsvertrag, the management board of that Company must teil about about the risks related to the Beherrschungsvertrag and the right to give directions to the controlled Company. ^^"^^ Failure to do so can lead to a liability for loss suffered by the Company by reason of negligent breach of duty of care.^^"*^ Information regarding dependency. In the absence of a formal statutory Beherrschungsvertrag, the management board of the controlled AG must prepare and publish a report on transactions carried out with the Controlling undertaking or its affiliates and on transactions carried out with third parties in the interests of these undertakings (Abhängigkeitsbericht). ^^"^^ This report is prepared according to the principles that govem periodical financial Statements.'^^^ It is therefore inspected by the Company's statutory auditors.^^^^ The supervisory board reviews both the dependency report and the report of the auditors^^^^ before submitting these documents to the general meeting of the controlled Company. ^^^^
5.9.7 Shareholder Remedies in Company Croups In a group of companies, the duties and liabihty of managers are govemed by the same rules that apply to a Single independent Company. But in addition to these rules, there are also special rules for groups. In a group, it is necessary to make several distinctions: managers are either managers of the Controlling undertaking or managers of the controlled Company; these managers can become liable either to the Controlling undertaking or the controlled Company; the group can be either a contractual group (Vertragskonzem) based on a formal agreement (Beherrschungsvertrag) or a de facto group (faktischer Konzern) not based on any such agreement; and the controlled Company can be either an AG (govemed by the specific provisions on groups set out in the Aktiengesetz) or a GmbH (not govemed by the Aktiengesetz).^^^"^ ^046 ^047 1048 1049 ^050 1051 1052 1053 1054
Compare§ lll(2)AktG. § 293 a Akte. § 93(2) AktG. See Altmeppen H, Die Haftung des Managers im Konzern (1998) p 8. §312 AktG. §312(2) AktG. §313 AktG. §314(1) AktG. §314(2) and (3) AktG. See Altmeppen H, Die Haftung des Managers im Konzern (1998) pp 3 and 73.
5.9 The Goveraance of Croups in Germany
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An AG as the Controlled Company In practice, an AG is more likely to be the parent that controls the group than a subsidiary controlled by another undertaking. It is nevertheless possible that an AG is controlled by a strong shareholder. The following rules apply where the AG is a Company controlled by another undertaking. Contractual groups, managers of the Controlling undertaking. Where the parties have concluded a formal control agreement, the managers of the Controlling undertaking can be liable to the controlled Company. In addition to the general principles that govem the duty of care, there are special rules on directions and the impact of the interests of the group as a whole. Members of the organ that represents the Controlling undertaking (the management board of an AG) have a limited statutory duty of care^^^^ (based on the principle negotiorum gestio) owed to the controlled company^^^^ and its creditors.^^^"^ Each shareholder of the controlled Company has standing to sue them for breach of this duty. On the other hand, a shareholder may claim compensation only to the Company and not to himself.^^^^ The derivative action set out in the Konzemrecht is an exception to the main rule that an individual shareholder may not sue on behalf of the Company. The same principles on the duty of care apply by analogy where the power to give directions has been delegated to a member of that organ (a member of the management board of an AG)^^^^ or to a senior manager such as a Prokurist or holder of a power of attomey (Handlungsbevollmächtigte).'^^^ These persons are thus personally liable to the controlled Company for breach of duty of care.'^^' Members of the organ that appointed these representatives may not breach their own duties and they can be liable to the controlled Company for example for the negligent choice of other representatives.'^^^ Where the Controlling undertaking is an AG, these principles do not apply to members of the supervisory board. As the supervisory board of the Controlling AG is not regarded as the organ that represents the Controlling undertaking, members of the supervisory board will not be liable to the controlled Company.'^^^ The statutory duty of care owed to the controlled Company applies only to directions actually given by the representatives of the Controlling undertaking. It does not cover failure to give directions. On the other hand, members of the management board of the Controlling AG owe a general duty of care to that Company »055 § 309(1) AktG. 1056 j 309(2) AktG. See also Altmeppen H, Die Haftung des Managers im Konzern (1998) p30. 1057 §309(4) AktG. »058 §309(4) AktG. 1059 §78(4) AktG. 1060 See Hüffer U, Aktiengesetz (2002) § 308 R n 5; Altmeppen H , Die Haftung des M a n agers im Konzern (1998) p 12.
1061 See Altmeppen H, Die Haftung des Managers im Konzern (1998) p 14. 1062 §309 AktG. 1063 See Hüffer U, Aktiengesetz (2002) § 309 Rn 4.
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and negligence in failing to give necessary directions can in some rare cases lead to liability for loss sustained by the Controlling Company,^^^"^ It is clear that the directions may not conflict with the provisions of any applicable Statutes or the regulations in the Beherrschungsvertrag.^^^^ On the other hand, the directions do not have to be in the interests of the controlled Company, provided that they are in the interests of the Controlling Company or the group.^^^^ Even an indirect benefit will suffice, but the directions should be in Proportion to the interests of the group ("nicht unverhältningsmäßig") and should not cause the controUed Company more disadvantage than is necessary.^^^"^ Directions that risk the existence of the controlled Company are not permitted.^^^^ In the case of a breach of this statutory duty of care, it can be difficult to determine whether the Company has suffered any loss and, if it has, to assess its amount.^^^^ Contractual groups, managers of the controlled Company. Where the parties have concluded a formal control agreement, the liabihty of the managers of the controlled Company remains basically unchanged.^^*^^ The most important change is that members of the two statutory boards of the controlled Company are not liable for loss sustained by the Company by reason of them following directions that they had a duty to follow.^^^^ Members of the management board of the controlled Company are therefore hardly ever liable where they have followed the directions of the Controlling undertaking.^^'^^ The management board of the controlled Company has a duty to execute lawful directions. ^^'^^ The management board of the controlled Company has virtually no power to refuse to execute directions that seem to be in the interests of the group. The management board of the controlled Company must execute these directions, unless it is obvious (clear to any expert at first sight) that the directions are not in the interests of the Controlling Company or the group.^^^"^
§ 93(2) AktG. See Altmeppen H, Die Haftung des Managers im Konzern (1998) pp 33 and 35-36. See Hüffer U, Aktiengesetz (2002) § 308 Rn 14 and 20; Altmeppen H, ibid pp 20 and 27. 1066 §308(1) AktG. 1067 See Hüffer U, Aktiengesetz (2002) § 308 Rn 17; Altmeppen H, Die Haftung des Managers im Konzern (1998) p 21. 1068 See Hüffer U, ibid § 308 Rn 19; Altmeppen H, ibid p 22. ^069 See Hüffer U, ibid § 309 Rn 17; Altmeppen H, ibid pp 41-42. ^070 §310(1) AktG. 1071 §310(3) AktG. 1072 See Altmeppen H, Die Haftung des Managers im Konzern (1998) pp 48-^9. ^^'^3 See Hüffer U, Aktiengesetz (2002) § 308 Rn 14 and 20; Altmeppen H, ibid pp 20 and 27. ^^'^4 § 308(2) AktG: "... [Der Vorstand] ist nicht berechtigt, die Befolgung einer Weisung zu verweigern, weil sie nach seiner Ansicht nicht den Belangen des herrschenden Unternehmens oder der mit ihm und der Gesellschaft konzemverbundenen Unternehmen dient, es sei denn, daß sie offensichtlich nicht diesen Belangen dient." "Offen-
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The Controlling undertaking may not sue repräsentatives of the controlled Company for failure to comply with its directions. The representatives of the controlled Company are not party to the Beherrschungsvertrag. The Controlling undertaking may sue only the controlled Company as its contract party.^^''^ Defacto groups. The main rule is that de facto groups are govemed by similar provisions to the extent that they protect the controlled Company. The provisions of the Aktiengesetz on the duties and liability of the Controlling undertaking are slightly stricter in de facto groups than in contractual groups. The Controlling undertaking and members of the organ that represents it have a statutory duty of care even in a de facto group, and they may become liable to the controlled AG and its shareholders according to rules that resemble the provisions that apply to contractual groups.^^^^ For example, the Controlling undertaking and its legal representatives may become liable for the failure to pay compensation (Nachteilsausgleich) to the controlled AG for any härm suffered by the controlled AG. Even in this case, a derivative action on behalf of the controlled Company is permitted as an exception to the main rule that individual shareholders may not sue on behalf of the Company. Other managers to whom the power to represent the Company has been delegated owe a similar duty of care by analogy. It is nevertheless unclear whether they are liable to the controlled AG for breach of this duty. The liability could again be based on analogy,^^^^ but the wording in the Aktiengesetz does not Support this conclusion.^^*^^ It would in any case be possible to apply the provisions on the abuse of influence.^^"^^ The members of the two statutory organs of the controlled AG can become liable for breach of duty according to the same rules that govem contractual groups.^^^^ There are some differences though. The main differences are the important role played by the dependency report (Abhängigkeitsbericht) and compensation (Nachteilsausgleich) in the de facto group, and the fact that directions do not limit the liability of the members of the management board of the controlled Company in the de facto group. (a) The dependency report must be prepared according to the same principles as periodical financial Statements, and failure to do so may lead not only to civil liability but also to penal sanctions.^^^^ (b) The management board of the controlled Company sichtlich" means in practice "für jeden Sachkenner ohne weitere Nachforschung erkennbar"; see Hüffer U, ibid § 308 Rn 22; Altmeppen H, ibid p 28. 1^75 See Altmeppen H, ibid p 29. 1076 § 317 AktG, compare § 309 AktG.
1077 § 317(3) AktG; see Altmeppen H, Die Haftung des Managers im Konzern (1998) p 64. 1078 See Hüffer U, Aktiengesetz (2002) § 317 Rn 13. 1079 § 117 AktG; see Hüffer U, ibid § 317 Rn 13; Altmeppen H, Die Haftung des Managers im Konzern (1998) p 64. 1080 §318 AktG. 1081 §§ 318^ 400(1) Nr. 1 (unrichtige Darstellung) and 403 AktG (Verietzung der Berichtspflicht) and § 323 HGB (Verantwortlichkeit des Abschlußprüfers). See Altmeppen H, Die Haftung des Managers im Konzern (1998) pp 60-61; Hüffer U, Aktiengesetz (2002) § 312 Rn 31-32.
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may not carry out acts that härm the Company regardless of the fact that they seem to be in the interests of the group as a whole, unless the Controlling undertaking has already agreed to pay compensation (Nachteilsausgleich).^^^^ (c) Without compensation, the management board of the controlled Company may not perform acts that cause the Company härm, (d) In a de facto group, the controlHng Company has no power to give binding directions, and if it does give directions, the management board of the controlled Company has no duty to follow them. Where the management board does follow directions, they do not relieve members of the management board from liability. In de facto groups, the provisions on Company groups do not limit the liability of members of the two statutory organs under the general provisions of the Aktiengesetz. ^^^^ From the perspective of the management board of the controlled Company, the provisions on de facto groups set out additional duties: the duty to prepare the dependency report (Abhängigkeitsbericht); the duty to see that the Controlling Company pays compensation (Nachteilsausgleich); and the duty to sue the Controlling Company in the event that it fails to pay enough compensation.^^^"^ A GmbH as the Controlled Company A domestic Company controlled by an AG is usually a GmbH. Like an AG, a GmbH can belong to different types of groups, in particular to contractual groups or de facto groups. Contractual groups, Where a GmbH is controlled by another undertaking in a contractual group, the provisions of the Aktiengesetz on contractual groups are applied by analogy to the duties and liability of managers.^^^^ The duty of care of managers under the GmbH-Gesetz^^^^ is then determined on the basis of the same principles as the duty of care under the Aktiengesetz.^^^"^ These rules have been discussed above. De facto groups. In a de facto group, the differences between controlled GmbHs and controlled AGs are clearer. While the managing directors (Geschäftsführer) of a GmbH have a general duty to follow the directions of shareholders,^^^^ members of the managing board of an AG do not have any duty to follow the directions of a Controlling undertaking in a de facto group. ^^^^ '082 '083 '084 '085
'086 '087 '088 '089
§ 311(1) Akte. See Altmeppen H, ibid p 69; Hüffer U, ibid § 312 Rn 31-32. §§ 93 and 116 AktO; see Hüffer U, ibid § 318 Rn 8; Altmeppen H, ibid p 68. See Altmeppen H, ibid p 70. See Altmeppen H, Die Haftung des Managers im Konzern (1998) p 73; Roth GR, Altmeppen H, Gesetz betreffend die Gesellschaften mit beschränkter Haftung (GmbHG) (1997) Anhang § 13 Rn 15; Lutter M, Hommerhoff P, GmbH-Gesetz (2000) Anhang § 13Rn48. §43(1) GmbHG. §93(l)AktG. See Lutter M, Hommelhoff P, GmbH-Gesetz (2000) § 37 Rn 1 and 17;. Roth GR, Altmeppen H, Gesetz betreffend die Gesellschaften mit beschränkter Haftung (GmbHG) (1997)§37Rn3. Compare § 308(2) AktG.
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5.10 Constraints on the Exercise of Shareholders' Powers 5.10.1 Introduction In Germany, the detailed and largely mandatory provisions of the Aktiengesetz lay down a large body of constraints on the exercise of shareholders' powers. At the same time, the rights of shareholders to contest resolutions for the breach of these constraints are the main formal way for minority shareholders to control management. General principles. In addition to express rules, the constraints can be based on the general principles of Company law. In particular, the Aktiengesetz provides for the equal treatment of shareholders,^^^^ and shareholders owe a duty of loyalty towards the Company and other shareholders (Treu und Glauben, § 242 BGB).^^^^ The duty of loyalty can also be combined with other statutory duties. For example, a shareholder who is regarded as a primary insider^^^^ may not take advantage of that information by acquiring or disposing of securities.^^^^ If he does so, he breaches not only insider rules by also his duty of loyalty. Powers of minority or individual shareholders. Some provisions of the Aktiengesetz act as constraints on the exercise of Controlling shareholders' powers by vesting powers in minority shareholders (see Chap. 5.4.1). For example, a general meeting must be called at the request of shareholders representing one-twentieth (5%) of the share capital.iö94 Some provisions of the Aktiengesetz create personal rights for shareholders. These rights include for example the right to bring proceedings against the Company in the event that a resolution passed at a general meeting is void or voidable.1095
Right to contest resolutions. In Germany, the main legal remedy available to individual shareholders is the right to contest resolutions of the general meeting. A shareholder may therefore not breach the articles of association or the provisions of the Aktiengesetz by using his voting rights. A resolution that does not comply with the provisions of the Aktiengesetz or the regulations of the articles of association is either void or voidable. The right to contest resolutions of the general meeting is also a means for individual or minority shareholders to indirectly control the two statutory organs. Resolutions passed at a general meeting are normally based on proposals submitted by the management board and the supervisory board.^^^^
1090 1091 1092 1093
§ 53a Akte. BGHZ65, 15(ITT). §13(l)(2)WpHG. §14(l)WpHG.
1094 ^ 122(1) and 122(3) AktG; see also § 121(2) AktG.
1095 §§ 241-257 AktG. 1096 See for example §§ 119(2) and 124(3) AktG.
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On the other hand, there is a risk that the right of individual shareholders to contest resolutions of the general meeting can sometimes tum into a means to block majority decisions or abuse shareholders' rights. Liability, Sometimes a shareholder may also become liable for loss suffered by the Company, other shareholders or third parties by reason of breach of duty by the shareholder.
5.10.2 Duty of Loyalty Shareholders owe a duty of loyalty (Treupflicht) to the Company and other shareholders. This duty is based on the case law of the BGH and the general good faith requirement in the law of obligations (Treu und Glauben, § 242 BGB).^^^'' The Contents of this duty have already been discussed above (Chap. 5.9.2). The duty of loyalty extends both to majority shareholders and to minority shareholders. For example, breach of duty of loyalty is one of the matters that can make a resolution void because minority shareholders may contest resolutions for a breach of this duty.^^^^ On the other hand, the duty of loyalty also prohibits the abuse by minority or individual shareholders of the right to contest resolutions of the general meeting. In the ITT case,^^^^ a minority shareholder of a GmbH could sue a majority shareholder for the breach of duty of loyalty owed to the Company. The BGH held that the majority shareholder had to compensate the Company for loss.^^^° 5.10.3 The Right to Contest Resolutions of the General Meeting In theory, the use of voting rights at a general meeting is generally constrained by the provisions of the Aktiengesetz and the articles of association. Resolutions of the general meeting must not violate the Aktiengesetz or the articles of association. 109^ See for example BGHZ 65, 15 (ITT); see also Schneider UH, Burgard U, Treupflichten im mehrstufigen Unterordnungskonzem, Festschrift für Peter Ulmer (2003) pp 579, 582. ^^^^ According to the principle codified in § 243(2) AktG. See for example BGH II ZR 212/99, judgment of 18 June 2001: "Insoweit sind die Aktionäre durch Rechte geschützt, die sich in § 117 Abs. 2, § 243 Abs. 2 AktG, der Treupflicht des Mehrheitsgegenüber den Minderheitsaktionären mit der bei ihrer Verletzung gegebenen Anfechtungsmöghchkeit nach § 243 Abs. 1 AktG sowie weiteren Schadensersatzansprüchen manifestieren." See also Hüffer U, Aktiengesetz (2002) § 243 Rn 24. 1099 BGHZ 65, 15 (ITT). ^^^ See also Bamert T, Die Gesellschafterklage im duahstischen System des Gesellschaftsrechts (2003) p 116: "Wird der ITT-Fall ... auf seinen GmbH-rechtlichen Kern reduziert, so ist Ausgangspunkt und Grundlage eines eigenen Ersatzanspruchs des Gesellschafters eine treuwidrige Schädigung der GmbH und die dadurch mittelbar verursachte Entwertung des Gesellschaftsanteils."
5.10 Constraints on the Exercise of Shareholders' Powers
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A shareholder may control the legality of resolutions. Defective resolutions can be either void (nichtig)^ ^^^ or voidable (anfechtbar). ^'^^ ^ court may declare an allegedly voidable or void resolution void at the request of a shareholder. Where the articles of association contain a regulation that is in conflict with the mandatory provisions of the Aktiengesetz, the regulation can be void or voidable. ^^^^ Voidable resolutions. The resolution is generally voidable (anfechtbar) where it violates the articles of association or the Aktiengesetz. ^^^"^ The same can be said of resolutions the purpose of which is to benefit one or more shareholders or a third party at the cost of the Company or other shareholders.^^^^ There are also special grounds such as: defective election of supervisory board members;^^^^ defective distribution of profits;^^^"^ and defective resolutions regarding the annual accounts.^^^^ These claims must be filed within one month from the passing of the defective resolution.^^^^ Void resolutions. The resolution is void (nichtig) in a number of situations listed in the Aktiengesetz.^^^^ For example, the resolution can be void because: it is not compatible with "the nature of the Company" (das Wesen der Aktiengesellschaft);^^^^ it violates provisions the main purpose of which is to protect the Company or the public interest; or it violates a mandatory rule that has been made necessary by EU Company Law Directives.^^^^ There are also special provisions on the defective election of supervisory board members,'^'^ defective distribution of profits,^^^"^ and defective resolutions on the annual accounts.^'*^ Right ofaction. Any shareholder may sue on these grounds.
^^01 § 241 AktG (Nichtigkeitsgründe). ^^02 § 243 AktG (Anfechtungsgründe). ^^^^ See Gessler E, Nichtigkeit von Hauptversammlungsbeschlüssen und Satzungsbestimmungen, ZGR 1980 p 444; Hüffer U, Aktiengesetz (2002) § 23 Rn 43. 1104 g 243(1) AktG: "Ein Beschluß der Hauptversammlung kann w e g e n Verletzung des
Gesetzes oder der Satzung durch Klage angefochten werden." 1105 j 243(2) AktG: "Die Anfechtung kann auch daraufgestützt werden, daß ein Aktionär mit der Ausübung des Stimmrechts für sich oder einen Dritten Sondervorteile zum Schaden der Gesellschaft oder der anderen Aktionäre zu erlangen suchte und der Beschluß geeignet ist, diesem Zweck zu dienen. Dies gilt nicht, wenn der Beschluß den anderen Aktionären einen angemessenen Ausgleich für ihren Schaden gewährt." 1106 § 251 AktG; see also § 250 AktG. 11Ö7 § 254 AktG; see also § 253 AktG. 1108 § 257 AktG; see also § 256 AktG. See nevertheless § 257(1) AktG. 1109 §246(1) AktG. 1110 § 241 AktG. See generally Gessler E, Nichtigkeit von Hauptversammlungsbeschlüssen und Satzungsbestimmungen, ZGR 1980 pp 427-454. 1111 See Gessler E,ibidpp 433-434. 111^ See for example Articles 15 and 29 of the Second Directive and § 241 AktG. 1113 §250 AktG. 1114 §253 AktG. 1115 §256 AktG.
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(a) A void resolution is void ipso iure without any court proceedings being necessary, but it is possible for a court to declare an allegedly void resolution void at the request of a shareholder (Nichtigkeitsklage). ^^^^ (b) A shareholder can also request a court to declare a voidable resolution void (Anfechtungsklage),^^^^ provided that the shareholder was present at the general meeting and voted against the resolution.^^^^ Any shareholder may sue where the resolution provides another shareholder improper benefits.^^^^ As these actions are basically available to any shareholder, a shareholder may sue regardless of whether his personal rights have been infringed or not. The proceedings are brought against the Company and not against other shareholders, the management board, the supervisory board, or the members of the two statutory boards.^^^^ If the plaintiff wins, the judgment of the court is binding on all shareholders and members of the two statutory boards.^^^^ A shareholder will therefore benefit from the judgment regardless of whether he has joined as a co-plaintiff or not. In addition to shareholders, the management board may sue. The management board may thus request a court to declare an allegedly void or voidable resolution void. Individual members of either the management board or supervisory board have a similar right where the enforcement of the resolution would make the member guilty of a criminal offence or liable for damages.^^^^ In theory, even other persons might be able to sue provided that they have a legitimate interest in the matter, but this would hardly ever be the case.^^^^ Number ofcases. In practice however, minor shareholders often do not sue because they find the legal costs too high. The number of court cases is still small although it has become less rare to contest resolutions in recent years. One of the most important grounds of action has been the breach of provisions on the disclosure of information to shareholders."^^^ Abuse. The right to contest resolutions of the general meeting can be a way for individual shareholders to block majority decisions. The use of this remedy is therefore subject to some restrictions.
^^16 ^117 "18 1119 1120 1121 1122
1123
§ 249(1) AktG. See also § 249(2) AktG. §245 AktG. § 245 Nr. 1 AktG. §§ 243(2) and § 245 Nr. 5 AktG. See also § 245 Nr. 2 AktG. §246(2) AktG. §248(1) AktG. § 245 AktG: "Zur Anfechtung ist befugt... 4. der Vorstand; 5. jedes Mitglied des Vorstands und des Aufsichtsrats, wenn durch die Ausführung des Beschlusses Mitglieder des Vorstands oder des Aufsichtsrats eine strafbare Handlung oder eine Ordnungswidrigkeit begehen oder wenn sie ersatzpflichtig werden würden." § 256 ZPO (Feststellungsklage). See Gessler E, Nichtigkeit von Hauptversammlungsbeschlüssen und Satzungsbestimmungen, ZGR 1980 p 454. See Baums T, Vogel HG, Tacheva M, Rechtstatsachen zur Beschlusskontrolle im Aktienrecht, Johann Wolfgang Goethe-Universität Frankfiirt am Main, Institut für Bankrecht, Arbeitspapier Nr. 86 (2000).
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Shareholders may not abuse their right to contest resolutions (§ 242 BGB). For example, a shareholder may not contest resolutions for the purpose of destroying the Company. ^^^^ A typical form of abuse is that an individual shareholder makes an offer not to sue if the Company or another shareholder pays him a sum of money.^^^^ Even other forms of blackmail are prohibited.^^^^ The possibility of abuse and the blocking of resolutions were some of the reasons why the Aktiengesetz now provides for a squeeze-out right. A majority shareholder holding at least 95% of the shares of an AG has a right to purchase the shares of the remaining shareholders for a reasonable cash compensation;^^^^ this requires the consent of the general meeting."^^ Minority shareholders have not had any corresponding general sell-out right in the past (the right to require the majority shareholder to buy their shares at a fair price), but the Takeover Directive (2004/25/EC) now requires a sell-out right (Article 16). Reform. The UM AG will change the right to contest resolutions. Instead of making it easier to contest resolutions of the general meeting, the UMAG is designed to: restrict the abuse of this right in some important situations; limit the right to contest resolutions on certain grounds; and limit the right of shareholders to ask questions at a general meeting. The UMAG will introduce a court procedure that will make important resolutions enforceable even after they have been contested (Freigabeverfahren).^^^^ However, the court will grant permission to file the resolution with the Trade Register (Handelsregister) and to enforce it under some circumstances only. This court procedure will cover only resolutions on matters relating to share capital (in particular resolutions on capital increases) and enterprise contracts (Untemehmensverträge).^^^^ Other resolutions will not benefit from this rule. Permission to file the resolution with the Trade Register can be granted not only where the court finds the claim clearly unfounded, but can also be granted where the court believes that the fast enforceability of the resolution outweighs, from the Company's and its shareholders' perspective, the material härm caused by the alleged breach. The new rules will leave the court plenty of discretion.^^^^ If 1125 BGHZ33,175. 1126 See Hüffer U, Aktiengesetz (2002) § 245 Rn 24.
1127 RGZ 146, 385. 1128 §327b(l)AktG. 1129 § 327a(l) Akte. See also § 35 WpÜG on mandatory bids. 1130 § 246a A k t G that will be inserted by the U M A G . See also § 16 U m w G .
1131 § 246a AktG (UMAG): "Wird gegen die Eintragung eines Hauptversammlungsbeschlusses über eine Maßnahme der Kapitalbeschaffung oder der Kapitalherabsetzung (§§ 182 bis 240) oder einen Untemehmensvertrag (§§ 291 bis 307) Klage erhoben..." 1132 § 246a AktG (UMAG): "... Ein Beschluss nach Satz 1 darf nur ergehen, wenn die Klage unzulässig oder offensichtlich unbegründet ist oder wenn das alsbaldige Wirksamwerden des Hauptversammlungsbeschlusses nach freier Überzeugung des Gerichts unter Berücksichtigung der Schwere der mit der Klage geltend gemachten Rechtsverletzungen zur Abwendung der vom Antragssteiler dargelegten wesentlichen Nachteile für die Gesellschaft und ihre Aktionäre vorrangig erscheint..."
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the party that contests the resolution wins the main proceedings, this party will be entitled to reimbursement by the Company for any loss caused by the entering of the resolution in the Trade Register. ^^^^ The UMAG will also restrict the right to contest resolutions of the general meeting on grounds relating to valuation if there is another statutory remedy (Spruchverfahren) for valuation matters.^^^"^ The new Special Award Proceedings Act (Spruchverfahrensgesetz) that introduced this remedy entered into force 1 September 2003. For example, the Spruchverfahren is available where minority shareholders have been squeezed out under the procedure set out in the Aktiengesetz and the parties cannot agree on the appropriate level of cash settlement. As the appropriate level of cash settlement is assessed by an expert auditor appointed by the court, the resolution on the squeezing out of minority shareholders cannot be contested on this ground. Furthermore, the UMAG will restrict the right to contest resolutions on grounds relating to disclosure of information."^^ In practice, the possibility to contest resolutions due to alleged breaches of disclosure rules have been the main way to abuse shareholders' rights."^^
5.10.4 Capped Voting, Restrictions on the Use of Proxy Votes Sometimes the use of votes attached to shares is specifically restricted by the provisions of statutory law or regulations in the articles of association. In Germany, the most important restrictions relate to the use of proxy votes by banks. Restrictions in the articles of association. In the past, the articles of association of a German public limited-liability Company could contain some special restrictions on the use of voting rights. The most common restriction was capped voting (Höchststimmrecht). In addition, the articles of association could provide for shares with multiple voting rights. The KonTraG abolished multiple votingrights^^^"^ and limited the use of capped voting. Capped voting is prohibited for listed AGs but permitted for unlisted AGs."38 Restrictions on the use of proxy votes by banks, One of the purposes of the KonTraG was to limit traditional bank influence over the proxy System of listed ^^33 § 246a AktG (UMAG): "... Erweist sich die Klage als begründet, so ist die Gesellschaft, die den beschluss erwirkt hat, verpflichtet, dem Antragsgegner den Schaden zu ersetzen, der ihm aus einer auf dem Beschluss beruhenden Eintragung des Hauptversammlungsbeschlusses entstanden ist. Als Ersatz des Schadens kann die Beseitigung der Wirkung der Eintragung nicht verlangt werden." 1134 § 243(4) AktG (UMAG). 1135 § 243(4) AktG (UMAG). 1136 See Paefgen WG, Unternehmerische Entscheidungen und Rechtsbindung der Organe in der Aktiengesellschaft (2002) p 2. 113"^ § 12(2) AktG. For transitional provisions see § 5 EGAktG (Einführungsgesetz zum Aktiengesetz, EGAktG). 1138 § 134(1) AktG. For transitional provisions see § 5(7) EGAktG.
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companies. The KonTraG therefore changed the rights of banks to use voting rights attached to shares deposited by their customers. A bank may not use voting rights attached to shares that it does not own unless it has been authorised to do so. At its own general meeting, the bank may not use such voting rights, unless the customer has given express directions on how to vote. The same rule applies to voting at the general meeting of another Company if the bank owns more than 5% of the share capital of the Company. ^^^^
5.10.5 Liability In Germany, a shareholder can in principle become liable for loss suffered by the Company, other shareholders or third parties. The liability of shareholders can be based on the express provisions of the Aktiengesetz, the general rules of the law of obhgations or, at least in theory, the doctrine of Durchgriff that resembles the UK doctrine of piercing the corporate veil. Aktiengesetz. The Aktiengesetz does not provide for the general liability of shareholders for loss suffered by the Company, other shareholders or third parties. A shareholder can nevertheless become liable under special circumstances. A shareholder must retum unlawful payments that he has received from the Company. ^^"^^ The Aktiengesetz also contains a provision preventing abuse by persons who use their influence on supervisory board members or management board members to make them act to the detriment of the Company or its shareholders.^^"^^ Even in this case, the Company is the right plaintiff where the loss is sustained by the Company, and shareholders have only a limited right to cause the Company to bring proceedings.^^"^^ An individual shareholder may nevertheless bring proceedings for personal loss which does not reflect the loss sustained by the Company. ^^"^^ A shareholder can also become liable in the capacity of statutory board mem]3gj.ii44 Qj.^ where a Company is dominated by another AG, in the capacity of management board member in the Controlling AG.^^"^^ The limited liabihty of shareholders^ ^"^^ does not exclude the liability of a Controlling undertaking for the debts of the controlled Company (faktischer Konzem).ii47 The law of obhgations. Under some circumstances, a shareholder can become liable under the general rules of the law of obhgations.
^^39 ^^"^^ '^41 ^^42 ^^43 1144 ^^^^ ^^46 ^147
§135(1) Akte. § 62(1) AktG; Article 16 of the Second Directive. § 117(1) AktG. § 147 AktG, see above. §117(1) AktG. §§93, 116 and 117 AktG. §309 AktG §1(1) AktG. §317 AktG.
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A shareholder can become liable where he can be assumed to owe contractual or quasi-contractual obligations towards another person.^^"^^ For example, such obHgations can be based on a comfort letter (Patronatserklärung). In Wibru Holding AGv Swissair Beteiligungen AG,^^"^^ it was held that a parent Company could be liable for the obligations of the subsidiary under a comfort letter only where the parent Company had expressly undertaken this liability. In Musikvertrieb AG v Motor-Columbus AG,^^^^ it was confirmed that a parent Company can become liable where: the parent Company makes specific Statements about its course of action as regards its subsidiary; the parent Company can be regarded to have a duty of care to a third party because of the Statements; the third party acts to his detriment in reliance on these Statements; and the parent Company is held to have breached the trust and confidence placed in it. It is nevertheless clear that the mere publication of a group relationship does not make the parent liable for the obligations of a subsidiary under German law.^^^^ A shareholder can also become liable under the general rules of tort law (§§ 823(2) and 826 BGB). For example, a shareholder can become Hable under § 823(2) BGB for loss suffered by other shareholders by reason of breach of duty of loyalty, and a shareholder can become liable for loss sustained by third parties by reason of breach of trust and confidence placed in him.^^^^ This applies also to parent companies. Durchgriff. In addition, the liability of the shareholder can be based on the doctrine of Durchgriff. According to this doctrine, the limited liability of shareholders will not apply in some cases. However, this doctrine is controversial. This doctrine is assumed to apply where the limited liability of shareholders is abused, but the detailed rules of the Aktiengesetz and related Statutes already cover most of such cases. Sometimes this doctrine is made unnecessary by the fact that the share-
1^^^ See for example BGB 120 II 331, a Swiss case cited in Hüffer U, Aktiengesetz (2002) § 1 Rn 22: "Eine Haftung der Muttergesellschaft für Verbindlichkeiten der Tochtergesellschaft ergibt sich, wenn sie sich gegenüber den Geschäftspartnern der Tochtergesellschaft vertragUch verpflichtet hat, beispielsweise eine Garantie im Sinne von Art. 111 OR übernommen hat. Ob das der Fall ist, entscheidet sich bei fehlendem tatsächlichem Konsens aufgrund einer Auslegung der Erklärungen der Muttergesellschaft nach dem Vertrauensgrundsatz. Eine vertragliche Bindung setzt voraus, dass die Empfänger aufgrund der Erklärungen nach Treu und Glauben von einem rechtsgeschäftlichen Bindungswillen der Muttergesellschaft ausgehen durften ... und dass sich die in Aussicht gestellte Garantie auf im voraus bestimmte oder zumindest bestimmbare VerbindUchkeiten der Tochtergesellschaft bezieht ... Die Übernahme einer Garantiehaftung darf somit nicht leichthin angenommen werden." 1^49 BGE 120 II 331, a Swiss case cited in Hüffer U, Aktiengesetz (2002) § 1 Rn 22 and Merkt H, Untemehmenspublizität (2001) pp 483-484. 1150 BGE 124III297, a Swiss case cited in Hüffer U, Aktiengesetz (2002) § 1 Rn 22. ^^^^ Merkt H, Untemehmenspublizität (2001) p 485: "So wenig, wie die Haftungsbeschränkung als solche Publizitätspflichten rechtfertigen kann, so wenig vermag die bloße Offenlegung einer Untemehmensverbindung eine Haftung zu legitimieren." "52 See BGE 120II 331.
5.10 Constraints on the Exercise of Shareholders' Powers
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holder is liable for his own obligations under the general rules of Company law, contract law, tort law, or criminal law.^^^^ Croups, GmbH-Gesetz. In any case, the BGH has developed special rules that provide for parent Company liability in highly integrated de facto groups.^^^"* Most domestic subsidiaries of large German companies being GmbHs, these rules can be found in GmbH law rather than AG law. The case law of the BGH in effect forces the parent to ensure that its subsidiary can fiilfil its obligations. The case law also makes it more difficult for the parent to use the assets of the subsidiary in Order to finance transactions within the group. In the Autokran case,^^^^ the BGH held that where a parent Company was "permanently and extensively" involved in the management of a subsequently bankrupt subsidiary, a rebuttable presumption exists that the parent did not show sufficient consideration for the subsidiary. Creditors of the subsidiary have then a direct claim against the parent, and the parent is liable for the obligations of the subsidiary unless it can defend the claim.'^^^ The BGH thus resorted to two legal techniques: the shifting of the bürden of proof to the parent Company, and the granting of a direct claim against the parent to subsidiary creditors. In the Video case,^^^*^ the BGH held that a sole shareholder is deemed to be "permanently and extensively" involved in the management of the Company. The extensive liability of the parent under the Autokran principles was mitigated by the BGH in subsequent decisions. The most important cases are the TBB case,^^^^ the Bremer Vulkan case^^^^ and the AT^Fcase. ^^^° In the TBB case, the BGH held that these principles can be applied provided that the Controlling shareholder has abused his position. According to the BGH, the fact that the Controlling shareholder does not show sufficient consideration for the Company amounts to abuse under some circumstances. Secondly, the bürden of proof was changed. The plaintiff must show not only why it should be assumed that the parent was "permanently and extensively" involved in the management of the subsidiary but also why it should be assumed that the parent did not show sufficient consideration for the subsidiary.^^^^ The Bremer Vulkan case was a major departure from the Autokran principles. In the Bremer Vulkan case, the BGH applied neither the statutory provisions on corporate liability within groups nor its previous case law although the facts of the case were that the subsidiary had incurred serious fmancial losses due to management decisions taken by its parent. Instead, the BGH said that the sole shareholder and its organs had: (a) a Company law duty to safeguard the financial interests of the subsidiary at least up to a certain point (the protection of the dependent com^^53 ^^^^ 1155 1156 1157 1158 1159
See Hüffer U, Aktiengesetz (2002) § 1 Rn 15-24. See Henze H, Konzemrecht (2001) pp 92-108. BGHZ 95, 330 ("Autokran"), confirmed in BGHZ 107, 7 ("Tiefbau"). See §93 Akte. BGHZ 115, 187 ("Video"). BGHZ 122,123 ("TBB"). BGHZ 149, 10 ("Bremer Vulkan").
1160 B G H Z 1 5 1 , 1 8 1 (Kindl Backwaren Vertriebs-GmbH, " K B V " ) .
1161 See Henze H, Aktienrecht. Höchstrichterliche Rechtsprechung (2000) p 101.
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pany against actions taken by its sole shareholder is limited to maintenance of its base capital and the safeguarding of its existence); and (b) a liability under provisions of tort law and criminal law where the subsidiary cannot flilfil its obligations because of breach of this duty ("Existenzvemichtung").^^^^ xhe BGH said that criminal penalties for Untreue^^^^ could in principle be applied where the sole shareholder breaches this duty.^^^"^ In the A^Fcase, the BGH confirmed the liability of a shareholder who abuses the Company form of GmbH by contributing to an act that undermines its very existence.^ ^^^
"^2 BGHZ 149, 10 ("Bremer Vulkan"): "Der Schutz einer abhängigen GmbH gegen Eingriffe ihres Alleingesellschafters folgt nicht dem Haftungssystem des Konzemrechts des Aktienrechts (§§ 291 ff, 311 ff. AktG), sondern ist auf die Erhaltung ihres Stammkapitals und die Gewährleistung ihres Bestandsschutzes beschränkt, der eine angemessene Rücksichtnahme auf die Eigenbelange der GmbH erfordert. An einer solchen Rücksichtnahme fehlt es, wenn die GmbH infolge der Eingriffe ihres Alleingesellschafters ihren Verbindlichkeiten nicht mehr nachkommen kann ..." ^^63 § 266(1) Strafgesetzbuch. 1164 BGHZ 149, 10 ("Bremer Vulkan"): "Veranlasst der Alleingesellschafter die von ihm abhängige GmbH, ihre liquiden Mittel in einen von ihm beherrschten konzemierten Liquiditätsverbund einzubringen, trifft ihn die Pflicht, bei Dispositionen über ihr Vermögen auf ihr Eigeninteresse an der Aufrechterhaltung ihrer Fähigkeit, ihren Verbindlichkeiten nachzukommen, angemessene Rücksicht zu nehmen und ihre Existenz nicht zu gefährden. Kommt er dieser Verpflichtung nicht nach, kann er sich eines Treubruchs i.S. des § 266 StGB schuldig machen." "65 See Schön W, Zur "Existenzvemichtung" der juristischen Person, ZHR 168 (2004) pp 272-274 and 282-284.
6 Comparison
6.1 General Remarks In a listed company with dispersed ownership, shareholders are not regarded as a suitable rule-maker after the company has been formed. This is hardly surprising.^ However, it can be surprising that German law seems to provide a better base for shareholder activism as far as listed companies with dispersed ownership are concerned. At the same time, it is less important for shareholders to be activists in a German company. This is made possible by the combination of a number of corporate governance tools: the use of a large body of statutory and mandatory rules, mixed monitoring, a statutory two-tier board with one board actually running the company and the other acting as a supervisory body, collegiate decision-making at board level, consensus-based decision-making, the liberal rights of shareholders to put things on the agenda of a general meeting, and the liberal rights of shareholders to contest resolutions of the general meeting. Although the regulation of corporate governance in the UK makes shareholder activism more important than in Germany, it also makes it more difficult for shareholders to be activists.^ In general, the legal principles that govern corporate governance in Germany look reasonably sound. For example, the supervisory board membership of at least some employee representatives seems to be a meaningful part of the German corporate governance model. Generally, the soundness of German corporate governance laws, the success of German firms, and the success of German economy as a whole are different things.^ Corporate governance laws only provide part of the legal fi-amework within which German firms operate, and the choices made by
For a summary of objections to letting shareholders set the rules, see Bebchuk LA, The Case for Increasing Shareholder Power, Harv L Rev 118 (2005) pp 875-890. See also Miles L, Proctor G, Unresponsive Shareholders in Public Companies: Dial "M" for Motivate, Comp Lawyer 21(5) (2000) p 144: "It is unfortunate that the U.K. corporate culture is such that shareholder participation in their companies is, in practice, very limited. Both statute and common law at present are not sympathetic to the ideas of an active, participative shareholder body." See for example The Economist 29 January 2005, Corporate governance in Germany. No time for consensus: "Germany's companies are falling behind their competitors, and they know it." Compare this with The Economist 19 February 2005, Germany's economy. A view from another planet: ''National stereotypes can become outdated ... German business is in ... great shape ..."
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German firms are influenced by cultural and economic factors in addition to legal factors. It is also worth noting that existing corporate governance laws do not explain differences in the levels of ownership concentration in these two countries. It is unlikely that a transition to an "Anglo-American capitalism" could be achieved in Germany simply by changing existing laws."^ Formal powers. In Germany and the UK, the most important formal powers of shareholders relate to share capital and structural change. Legal capital rules have largely been harmonised by several EU Directives, the purpose of which is to protect shareholders, minority shareholders and creditors. The Second Company Law Directive provides for the equal treatment of shareholders who are in the same position (Article 42). The Second Directive also provides that any increase in the subscribed capital must be decided upon by the general meeting (Article 25(1)) and that the pre-emption rights of existing shareholders may not be restricted or withdrawn without the consent of the general meeting (Article 29(4)). There are similar provisions on the reduction in subscribed capital. The Second Directive is complemented by the Third Directive, which provides that a merger requires the approval of the general meeting of each of the merging companies (Article 7), and the Sixth Directive, which contains a similar provision on the division of companies (Articles 5 and 6). The Takeover Directive (2004/25/EC) complements the Second Directive by providing for "squeeze-out" rights of the majority shareholder and "sell-out" rights of minority shareholders in the context of takeover bids. Apart from the formal powers relating to share capital and structural change, shareholders have limited powers to interfere with management. There is a duty to disclose information to shareholders. Shareholders can in theory oust the persons who monitor management. Sometimes their consent is required. Shareholders generally decide on the amendment of the company's constitution and, under the Takeover Directive, on some takeover defences (Article 9(2)).^ However, shareholders' formal rights can better be described as accountability or monitoring tools rather than rule-making tools.^ This is even more so because boards normally control general meetings in companies with dispersed ownership. De facto powers. As regards the general management of the company, the most important powers of shareholders are probably de facto powers that can be exercised by major shareholders. See also Cheffms BR, Law as Bedrock: The Foundations of an Economy Dominated by Widely Held Public Companies, OILS 23 (2003) pp 12-15 and 23. Member States shall bring into force the laws, regulations and administrative provisions necessary to comply with the Takeover Directive no later than 20 May 2006. See Bainbridge SM, Director Primacy in Corporate Takeovers: Preliminary Reflections, Stan L Rev 55 (2002) p 805: "Like many intracorporate contracts ... the shareholder wealth maximization norm does not lend itself to judicial enforcement except in especially provocative situations. Instead, it is enforced indirectly through a complex and varied set of extrajudicial accountabihty mechanisms. From this perspective, shareholder voting rights are not part of the firm's decisionmaking system, but simply one of many accountability tools."
6.1 General Remarks
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Position of shareholders. Without either controlling shareholders, who exercise their de facto powers, or a large body of mandatory rules, to rely on shareholders as a governance mechanism would be to allow managers "almost complete discretion subject to the unpredictable whims of the market for corporate control".'^ In Germany, the higher level of ownership concentration in listed companies gives shareholders larger de facto powers to influence management than the more dispersed ownership in the UK.^ The higher level of ownership concentration is complemented by the supervisory board membership of persons who represent the interests of large shareholders.^ In the UK, the legal powers of controlling shareholders seem to be stronger and the position of minority shareholders slightly weaker than in Germany. One could therefore argue that a controlling shareholder is likely to be able to run a UK listed company subject to less constraints than the controlling shareholder of a German listed company. On the other hand, minority shareholders enjoy slightly stronger rights in a German listed company. In Germany, the rights of shareholders are safeguarded by a large body of statutory rules that are mandatory as well as by the statutory two-tier board structure. Path dependency of corporate governance scholarship. The relatively strong position of minority shareholders in Germany is probably contrary to conventional wisdom in corporate governance scholarship,^^ but hardly surprising. The degree of protection afforded to shareholders was, in the words of Cheffins, a "striking feature of the legal milieu within which German companies operated" already at the turn of the 20* century.^^ Cheffins has also pointed out that "[rjeforms carried Compare Dine J, The Governance of Corporate Groups (2000) p 31. See also Bainbridge SM, Director Primacy in Corporate Takeovers: Preliminary Reflections, Stan L Rev 55 (2002) pp 804-805 on US law: "In sum, shareholders are almost wholly lacking in either direct or indirect mechanisms of control. Likewise, there is little evidence of effective shareholder demand for such control. Instead, both de facto and de jure control are vested in the board of directors." See for example Hopt KJ, The German Two-Tier Board: Experience, Theories, Reforms. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit pp 232-233 and 250; Davies PL, Struktur der Untemehmensflihrung in GroBbritannien und Deutschland: Konvergenz oder fortbestehende Divergenz? ZGR 2001 pp 290 and 293; Teichmann C, Corporate Governance in Europa, ZGR 2001 pp 652-653; Hansmann H, Kraakman R, The End of History for Corporate Law, Geo L J 89 (2001) p 468; Gorton G, Schmid FA, Universal Banking and the performance of German firms, J Finan Econ 58 (2000) pp 68-70. See Roth GH, Worle U, Die Unabhangigkeit des Aufsichtsrats - Recht und Wirklichkeit, ZGR 2004 pp 584-585, 594-595 and 599; Netzwettbewerb durch Regulierung, Vier-zehntes Hauptgutachten der Monopolkommission gemaB § 44 Abs. 1 Satz 1 GWB - 2000/2001 - Kurzfassung (2002) pp 21-22. Compare Coffee JC, The Future as History: The Prospects for Global Convergence in Corporate Governance and Its Implications, Nw U L Rev 93 (1999) p 681. Cheffins BR, Mergers and Corporate Ownership Structure: The United States and Germany at the Turn of the 20th Century, AJCL 51 (2003) p 499. The position of minority shareholders was probably not as strong in the USA. See Coffee JC, The Rise of Dis-
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out in the late nineteenth century meant that Gennany had legislation governing managerial misconduct and corporate disclosure that went further than anything in the UK and, presumably, the US''.^^ Previous comparisons of UK law and German law show that corporate governance scholarship is itself path dependent. The UK system of corporate governance is often regarded as one of the best. At the same time, the prevailing view probably is that the German model should not serve as a model for other countries in Europe. ^^ In reality, there is perhaps too much emphasis on the German system of codetermination, which is not popular outside Germany, and too little knowledge of the rest of German law. For example, it is sometimes thought that there is a "collision between the German version of capitalism and that of Anglo-Saxon countries" and that "Germans view a company's primary goal as not only maximizing shareholder value but also doing what's best for the business, workers, clients, shareholders, and even the country as a whole".^"^ Bizarrely, some journalists believe that Germans want to run their companies as "democracies".^^ However, apart from co-determination, German company and securities markets laws cannot generally be regarded as less shareholder-oriented than UK laws. This comparative study thus does not support the common assumption that UK laws would belong to the most shareholder-friendly and German laws to the least shareholder-friendly as far as rules on the governance of listed companies are concerned.^^ However, a distinction should be made between rules on governance and rules that act as constraints on governance (see Chap. 2.3.6 above). While it would be wrong to describe German rules on the governance of companies as labouroriented instead of shareholder-oriented,^'^ it would probably be right to say that the overregulation of labour by collective agreements and overregulation in German society in general act as constraints on the governance of companies. Many German firms have reacted by moving their factories to central and eastern Europe. ^^ persed Ownership: The Roles of Law and the State in the Separation of Ownership and Control, Yale L J 111 (2001) pp 27-30. Cheffins BR, Law as Bedrock: The Foundations of an Economy Dominated by Widely Held Public Companies, OILS 23 (2003) p 23. See for example Boot AWA, Macey JR, The Role of Objectivity, Proximity and Adaptability in Corporate Governance, Cornell L Rev 89 (2004) p 365. Business Week 25 October 2004, Gail Edmondson, Germany Inc.: Come Clean or Else. See for example The Economist 29 January 2005, Corporate governance in Germany. No time for consensus. Compare La Porta R, L6pez-de-Silanes F, Shleifer A, Vishny RW, Law and Finance, J Polit Economy 106 (1998) pp 1129, 1132 and 1139; Berkowitz D, Pistor K, Richard JF, The Transplant Effect, AJCL 51 (2003) p 166. See for example Hansmann H, Kraakman R, The End of History for Corporate Law, Geo L J 89 (2001) pp 444-446 where the German model is described as a labouroriented model. See The Economist 19 February 2005, Economics focus. The real picture.
6.2 Convergence
393
One of the factors that may distort the image of German law abroad is that German law is normally compared with US instead of UK law. The UK being a Member State of the EU, differences between German and UK law cannot be as big as differences between German and US law. For example, all Member States of the EU must comply with the same EU Directives on employee involvement in particular the European Works Councils Directive (94/45/EC), the information and consultation Directive (2002/14/EC) and the Directive on employee involvement linked to the European Company Statute (2001/86/EC).^^ Furthermore, the main principle of UK company and securities markets law is that of disclosure, and many disclosure rules have been harmonised in the EU. Interestingly, the argumentation style in US corporate law scholarship differs from that in Europe. While law and economics has had a major influence on corporate law scholarship in the USA, its influence has been relatively weak both in Germany and the UK so far.^^
6.2 Convergence There are signs of the convergence of both countries' legal model towards the other. It is possible to see signs of convergence towards the German model in the UK. The most important of them include the increased importance of external statutory rules that are mandatory (or de facto mandatory)^^ and the emergence of two-tier board structures. It is also worth noting that many legal rules apply not only to members of the board of directors (which has a largely supervisory role in real life) but also to sub-board managers (who manage the company's business). In addition, rules on measures relating to share capital are based on EU directives that are probably closer to traditional German law than UK law. The most important factor contributing to the convergence of the German model towards UK law is the approximation of laws in the EU. Some of the most important issues in this respect are related to disclosure and takeover bids. The use of UK disclosure rules as a model for German law and the convergence of German disclosure rules towards UK law started as early as in 1870.^^ Disclosure can also be expected to play a big role because of key company law judgments of the EC J in which the Court in effect held that a company's creditors are sufficiently proSee Lynch Fannon I, Working Within Two Kinds of Capitalism. Corporate Governance and Employee Stakeholding: US and EC Perspectives (2003) p 48: "For comparative purposes it is interesting that in the US, Germany is the European country which has been the sole focus of attention despite the fact that it is only one of a number of European countries with this sort of legislation." See Cheffms BR, The Trajectory of (Corporate Law) Scholarship, CLJ 63 (2004) p 503. See for example Sugarman D, Is Company Law Founded on Contract or Regulation? The Law Commission's Paper on Company Directors, Comp Lawyer 20(6) (1999) pp 181-183. See Merkt H, Untemehmenspublizitat (2001) p 128.
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tected by disclosure and EU company law.^^ The new EU regulatory regime contains a disclosure and transparency agenda. On the other hand, the way securities markets laws are being approximated contributes to convergence towards the German model. This does not mean the reception of German law.^"* But like the provisions of the German Aktiengesetz, these external rules are largely mandatory and favour two-tier board structures either inside a statutory one-tier board or otherwise. The Sarbanes-Oxley Act is one of the powerful forces that push European laws in this direction. The Sarbanes-Oxley Act reflects a potential shift in the philosophy underlying the US securities laws from disclosure to substantive regulation of corporate governance. Like the German legislator, US securities markets prefer a system setting out detailed requirements to be complied with by listed companies. US securities markets thus neither rely on voluntary disclosure nor adhere to the 'comply or explain' principle. One can cite professors Black, Cheffins and Klausner: "Outside directors of public companies face a daunting array of legal obligations. Under federal securities law, directors are potentially liable whenever a company makes misleading public statements. Under US corporate law, they can also be sued for a failure to oversee management adequately. Recent court decisions suggest that they can be liable under pension law as well if the company's retirement plan invests in the company's shares. To top matters off, procedural rules governing shareholder suits and the recovery of attorneys' fees make it easy for entrepreneurial lawyers to bring cases against directors."^^ It is also possible to fmd other forms of US law moving towards German law.^^
6.3 Fundamental differences Some fundamental differences nevertheless remain. Firstly, the underlying philosophies of how to address the matter of corporate governance by legal means are different. In Germany, corporate governance is perceived as something done by a group of people. At the same time, the legislator's focus is on organisational structures. In the UK, corporate governance is perceived as something done by individuals. Therefore, the focus is on the individuals who participate in the governance of companies. While the German legislator has regulated the management structure of companies, the UK way is to focus on the 23 C-212/97 Centros [1999] ECR 1-1459; C-208/00 Uberseering [2002] ECR 1-9919; C167/01 Inspire Art [2003] ECR 1-10155. See also Merkt H, Die Pluralisiemng des europaischen Gesellschaftsrechts, RIW 1/2004 p 6. 2"* See also Merkt H, Zum Verhaltnis von Kapitalmarktrecht und Gesellschaftsrecht in der Diskussion um die Corporate Governance, AG 2003 pp 130-131. 2^ Black BS, Cheffins BR, Klausner M, Outside directors and lawsuits: What are the real risks? McKinsey Quarterly (2004) Issue 4 pp 70-77. 2^ See Donald DC, The Nomination of Directors under U.S. and German Law, Institute for Law and Finance, Johann Wolfgang Goethe-Universitat Frankfurt, Working Paper Series No. 21 (2004) pp 4-7.
6.4 Conflicts between models
395
remuneration of individual directors, the independence of (at least some) individual directors and the protection of these directors against shareholders' claims. In addition, the UK legislator relies on the market. All this and more is done in the UK in order to overcome "agency problems" that exist in a "Berle-Means" corporation.^"^ Compensation is regarded as an effective way for achieving alignment of managers' and shareholders' interests in the UK. Secondly, there are differences as to where the legislator has assumed top management to be located. According to the German legislator, different company bodies should manage the company's business and supervise its management. The German legislator has regulated these two functions accordingly. On the other hand, the UK legislator has not said that a company should be managed by its board of directors. At the same time, the management of the company by its subboard executives has largely been left unregulated in this country. Thirdly, the general role of statutory and mandatory rules is different. Core company law matters are governed by statutory and mandatory rules in Germany rather than in the UK. There are more statutory rules in Germany. This reflects differences in the regulatory approach towards business. Fourthly, the interaction between rules is different. There are more statutory rules in Germany, and the legislator can ensure that there is a balance between different rules and a balance between different control mechanisms.^^ It would be more difficult to do so in the UK due to the importance of case law and industry self-regulation in this country. Courts have played a role in this. While equitable considerations are an important part of traditional UK company law and courts often try to avoid clear-cut rules, German courts have developed a thick web of detailed rules when interpreting statutory law. Fifthly, the culture of corporate decision-making is different. As a rule, consensus-based decision-making plays an important role in the governance of German listed companies. It can play an important role in the governance of some UK companies, but it does not always have to be so.
6.4 Conflicts between models These kinds of national differences have not sufficiently been taken into account in previous corporate governance scholarship. Corporate governance scholarship, which is to a large extent based on the existing US regulatory model, has not regarded statutory and mandatory rules, the organisational structure of the firm and consensus-based decision-making as impor-
^'^ See generally, Berle AA, Means GC, The Modem Corporation And Private Property (1932). ^^ See also Donald DC, The Nomination of Directors under U.S. and German Law, Institute for Law and Finance, Johann Wolfgang Goethe-Universitat Frankfurt, Working Paper Series No. 21 (2004) p 30.
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tant control mechanisms in the traditional area of company law.^^ US views have become even more influential in recent years at the same time as the SarbanesOxley provisions have been replicated in other countries. For these reasons, the previous lack of a German corporate governance code, the present lack of "independent" board members, and the participation of employee representatives in the governance of large companies have often been perceived as a w^eakness of the German legal model. However, it may be wrong to draw this conclusion, and the corporate governance rankings of Germany may have been too low or German corporate governance laws may have looked bad for wrong reasons. Corporate governance measures designed with the regulatory model of one country in mind do not necessarily have the intended effect if transplanted in the regulatory model of another country. The Sarbanes-Oxley Act is related to the US legal environment and can be seen as a reaction to mainly US financial reporting problems. Many of the Sarbanes-Oxley Act measures are unnecessary, disproportionate, or even impossible to apply for German companies. A cure to UK/US problems is not necessarily the proper cure to German problems if the problems are different, and the problems facing the regulator can be different due to fundamental differences relating to board structure, the philosophy of how to address the matter of corporate governance in the first place, the culture of corporate decision-making, the general role of statutory and mandatory rules, and the interaction between rules, among other things. Further differences are created by path dependency and the economic environment in general. It is nevertheless a popular belief that the cure to UK/US problems should be the model for the regulation of corporate governance in Europe. For example, the European Commission has adopted a Recommendation to reinforce the role of independent directors on listed companies' boards.^^ The Recommendation is based on UKAJS ideas and does not take into account that the independence of individual board members is less important in countries that have adopted the German Compare for example Lin L, The Effectiveness of Outside Directors as a Corporate Governance Mechanism: Theories and Evidence, Nw U L Rev 90 (1996) pp 957-958: "[T]he board of directors is only one of several corporate governance mechanisms, and if other mechanisms can serve as effective checks on managerial behaviors, there is less need for the board of directors to play this role. Besides the capital market, these other control mechanisms include the following: (1) the market for corporate control, (2) executive compensation programs with incentive systems such as stock options or adjustments in salary based on firm performance, (3) the product market, (4) the external managerial labor market, (5) competition among the firm's top managers, (6) monitoring by creditors, through covenants in loan agreements and their right to accelerate the maturity of their loan in the event of default, (7) monitoring by large blockholders unaffiliated with management, and (8) legal rights granted to shareholders, such as the right to bring actions against officers and directors for breach of duties of care and loyalty. To the extent that these control mechanisms are effective, it may be more difficult, or even impossible, for studies to detect the effects of outside directors on overall firm performance or specific corporate transactions." Commission Recommendation of 15 February 2005 on the role of non-executive or supervisory directors and on the committees of the (supervisory) board (2005/162/EC).
6.5 Basic Governance Structure
397
model. For example, German law tries to make the supervisory board independent as a whole and as a supervisory body. German law thus goes further than UK/US law and the Commission Recommendation in ensuring independent supervision. The fundamental differences between the German model and the UKAJS model can make it difficult to transplant UKAJS rules into German law. Legal transplants designed to cure UK/US problems can become "legal irritants" in German law.^^ A mismatch between the pre-existing model and transplanted law can make the rules that govern corporate governance less effective as a whole, unless large parts of German law are changed at the same time.^^ In order to avoid this transplant effect, there should be enough room for the Member States to develop their own corporate governance rules. Therefore, the lack of detailed harmonisation in the EU can be a good thing.
6.5 Basic Governance Structure The legal methods and tools utilised by these two countries tend to mirror the general regulatory approach towards business.^^ Generally, the rules governing the governance of German public limited-liability companies are more standardised and predictable than comparable rules in the UK. 6.5.1 Germany In Germany, the Aktiengesellschaft (AG) is a company form especially designed for public limited-liability companies. The structure and duties of top management of an AG have to a large extent been regulated by company law rules laid down by the Aktiengesetz. These rules can thus be found in the area of traditional company law. This can partly be explained by the fact that bank loans have traditionally been regarded as the default form of financing large companies. There is only a relatively small group of large,
See generally Teubner G, Legal Irritants: Good Faith in British Law or How Unifying Law Ends up in New Divergences, MLR 61 (1998) pp 11-32. Teubner defines a "legal irritant" as follows: "when a foreign rule is imposed on a domestic culture ... something else is happening. It is not transplanted into another organism, rather it works as a fundamental irritation which triggers a whole series of new and unexpected events ... it irritates law's 'binding arrangements'". See Habersack M, Der Aufsichtsrat im Vizier der Kommission, ZHR 168 (2004) p 381: [the Commission's consultation paper of 5 May 2004 on the role of independent directors] "konnte das Recht des Aufsichtsrats und mit ihm das geltende Konzemrecht in einer Art und Weise verandem, wie es selbst im Zeitalter gesellschafts- und kapitalmarktrechtlicher Jahresgesetze ohne Beispiel ist." Compare Ong DM, The Impact of Environmental Law on Corporate Governance, EJIL 12 (2001) p 725.
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publicly traded companies in Germany. The vast majority of corporate Germany has no public equity.^"^ The rules set out by the Aktiengesetz are quite detailed and largely mandatory in order to protect third parties and shareholders. Many provisions are necessary because of mandatory co-determination. Co-determination has made company law more complex. The AG has a statutory two-tier board structure. The mandatory provisions of statutory law govern the board structure, the distribution of powers between different organs, and the duties of both the supervisory organ (Aufsichtsrat), which monitors management and decides on some important matters, and the organ that takes care of the management of the company's business (Vorstand). The Aktiengesetz does not provide for a US-style CEO. Both of the two boards are by law collegiate organs. German company law is focused on the independence of the supervisory board, rather than the independence of individual supervisory board members. The independence of the supervisory board as a whole is safeguarded by structural measures, that is, by the mandatory and prescriptive statutory provisions of the Aktiengesetz and by the separation of management and supervision. Internal decision-making requires in effect broad consensus within each statutory organ, and decision-making in important matters typically requires consensus between different organs of the company. In addition, mandatory co-determination encourages consensus with the representatives of the workforce. In Germany, the large number of statutory provisions that are both mandatory and detailed leaves little room for corporate governance codes or other external rule-making. The German Corporate Governance Code can be regarded as a marketing tool for German securities rather than a valuable piece of external rulemaking, but it is in principle a flexible way for the federal government to complement the Aktiengesetz. For the same reason, the articles of association of German public limited-liability companies are relatively short.
6.5.2 The United Kingdom In the UK, companies formed under the Companies Act 1985 are companies that are formed either with or without limited liability, and companies that are either public companies (with public limited company as part of the company name) or private companies (with limited as part of the company name). The provisions of the Companies Act 1985 are not designed only for public limited-liability companies. The main corporate governance tools under UK company law are flexibility and disclosure. The Companies Act 1985 contains relatively few rules on the management of a public limited company. The most important rules governing management are the result of internal rule-making. Articles of association are the ^"^ Elsas R, Krahnen JP, Universal Banks and Relationships with Firms. In: Krahnen JP, Schmidt RH (eds) The German Financial System (2004) pp 197-198.
6.5 Basic Governance Structure
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most important source of rules as regards the distribution of powers between different company bodies. The articles of association of UK companies tend to be relatively long. Like US law, traditional UK company law is to a large extent a set of loosely defined guidelines made concrete by courts after the fact.^^ Listed companies must comply with the Listing Rules and other securities markets legislation. These rules are mandatory. For example, listed companies are required to disclose whether they comply with the Combined Code. A public limited company has a statutory one-tier board structure. The Companies Act 1985 with its few provisions on management does not prevent statutory boards with internal two-tier (or three-tier) structures or the delegation of management to largely unregulated executive bodies. It is usual to delegate management to sub-board executive bodies. It is normal for a public limited company to have a managing director who is a member of the board of directors and acts as a US-style CEO.
6.5.3 Two-tier Boards and Board Structures It is usually thought that one of the main differences between listed German companies and listed UK companies is that only the former have a two-tier board structure. One can cite Henry Hansmann and Reinier Kraakman who wrote in 2004: "With respect to board structure, convergence has been in the direction of a legal regime that strongly favors a single-tier board that is relatively small and has a substantial complement of outside directors, but contains insiders as well. Mandatory two-tier board structures seem a thing of the past; the weaker and less responsive boards that they promote are justified principally as a complement to worker codetermination, and this share - indeed, constitute one of - the weaknesses of the latter institution."^^ The study of UK and German law shows that convergence is not in the direction of one-tier boards.^^ It seems that convergence has been in the direction of a legal regime that strongly favours mandatory two-tier board structures. In Germany, this regime is already in place. In the UK, two-tier board structures can be found both inside the statutory (and nominally one-tier) board^^ and between the ^^ Compare Kamar E, Shareholder Litigation Under Indeterminate Corporate Law, U Chi L Rev 66 (1999) pp 891-892. ^^ Hansmann H, Kraakman R, The end of history for corporate law. In: Gordon JN, Roe MJ (eds) Convergence and Persistence in Corporate Governance (2004) p 52. ^^ See also Eisenberg MA, Corporate Law and Social Norms, Colum L Rev 99 (1999) pp 1278-1279: "The managerial model of the board has now been supplanted by a monitoring model. The monitoring model recognizes that in a publicly held corporation the management function is exercised by the senior executives ... Today, the monitoring model of the board has been almost universally accepted and adopted in large publicly held corporations." ^^ See Boot AWA, Macey JR, The Role of Objectivity, Proximity and Adaptability in Corporate Governance, Cornell L Rev 89 (2004) p 369 footnote 53: "This analysis assumes that the board monitors management. In a two-tier system (e.g., the Netherlands and
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statutory board and unregulated executive bodies.^^ In the UK, the use of two-tier board structures inside the statutory board is encouraged both by the Combined Code and the US Sarbanes-Oxley Act. The existence of two-tier board structures can be illustrated with board committees. (a) In the UK, board committees have an important supervisory function because of the lack of a statutory two-tier board. For example, the audit committee of a UK listed company consists of independent non-executive directors who monitor executive directors, (b) In contrast, in a German AG the purpose of supervisory board committees and management board committees is to make board work more effective. Because of the statutory two-tier board structure, a board committee does not monitor the work of the rest of the board and committee members do not have to be "independent"."*^ (c) While in a UK company the audit committee creates a two-tier board structure inside the statutory one-tier board, in a German company it does not do so. The "audit committee" (Priifungsausschuss) of a German listed company is therefore not directly comparable with the "audit committee" of a UK listed company."** It is worth noting that there is similar tension between German law and the audit committee provisions of the SarbanesOxley Act and rules issued by the SEC. While German law provides for a two-tier board, the Sarbanes-Oxley Act tries to create a two-tier board structure inside a one-tier board. For this and many other reasons, the audit committee of a German AG and an audit committee that complies with the Sarbanes-Oxley Act do not have identical powers."^^ Plenty of differences remain. Although a public limited-Hability company would have two-tier board structures in both of these two jurisdictions, the body that actually manages the company is necessarily a statutory organ under German law and thus regulated by statutory provisions in this country rather than in the UK."*^ This company body is by law a collegiate organ in Germany but not in the UK. Although the governance of public limited-liability companies is governed by Germany), this is clearly the supervisory board's task. Under a one-tier system (e.g., the United States and the United Kingdom), however, nonexecutive directors act as monitors." See also Zinser A, Spreng N, Der neue britische Corporate Governance Kodex: mit rechtsvergleichenden Betrachtungen zur deutschen Regelung, ZVglRWiss 103 (2004) pp 408 and 428-429. ^^ See Davies PL, Struktur der Untemehmensfuhrung in GroBbritannien und Deutschland: Konvergenz oder fortbestehende Divergenz? ZGR 2001 p 283. "^^ See also Donald DC, The Nomination of Directors under U.S. and German Law, Institute for Law and Finance, Johann Wolfgang Goethe-Universitat Frankfurt, Working Paper Series No. 21 (2004) pp 30-31. "^^ See Kremer T in Ringleb HM, Kremer T, Lutter M, von Werder A, Kommentar zum Deutschen Corporate Governance Kodex (2003) 5.3.2 Rn 691. ^'^ For the application of audit committee rules to foreign issuers see Securities and Exchange Commission, Standards Relating to Listed Company Audit Committees. See also Kersting C, Auswirkungen des Sarbanes-Oxley-Gesetzes in Deutschland: Konnen deutsche Untemehmen das Gesetz befolgen? ZIP 2003 p 239; Ribstein LE, International Implications of Sarbanes-Oxley: Raising the Rent on U.S. Law, JCLS 3 (2003) p 309. "^^ See Davies PL, Struktur der Untemehmensfuhrung in Grofibritannien und Deutschland: Konvergenz oder fortbestehende Divergenz? ZGR 2001 pp 283-284.
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a large number of statutory provisions that are mandatory, the board structure and the distribution of powers between different management bodies are regulated by such provisions in Germany rather than in the UK. In addition, there is mandatory co-determination in Germany only.
6.5.4 The Fundamental Problems of UK Company Law The recent reforms of UK company law can at least partly be explained by the need to cure certain fundamental defects of earlier law. In German law, these defects either do not exist at all or are less serious. It is nevertheless clear that German laws, like the laws of any country, always need some fine-tuning.'^'* In the UK, the statutory board of directors has relatively large powers under the articles of association. The board can micromanage the company and question the authority of the management. These powers are supplemented by relatively minor statutory constraints in the area of company law, because the main principle of UK company and securities markets laws is disclosure of information. The exact contents of these constraints are not always clear. The fact that traditional UK company law is to a large extent judge-made law - a set of loosely defined guidelines made concrete by courts after the fact - can undermine the efficiency of the law in directing managerial behavior."*^ It is accepted in the UK that the large powers of the board of directors need to be constrained and that mere disclosure is not enough. These constraints can be based partly on internal decision-making, partly on external rules. Internally, the management of a UK pic is increasingly being delegated to a sub-board executive body. This body has no statutory powers under the Companies Act 1985 or otherwise, apart from the powers delegated to it by the statutory board of directors. The acts of the body that actually runs the company are thus constrained relatively effectively. The company gets a two-tier board structure with the statutory board of directors as supervisory body and the internally regulated executive body as the body that actually runs the company. This nevertheless leaves the statutory board of directors with excess powers. Even after the delegation, the board of directors may exercise all management powers in the company under articles of association. Several external regulatory tools have been used in order to develop constraints on the exercise of these powers. Externally, the statutory boards of listed companies are increasingly being regulated by securities markets rules such as the Listing Rules and the FSMA 2000. These rules are mandatory. In addition to mandatory rules, the Combined Code contains recommendations supplemented by the mandatory duty to either comply with these recommendations or explain why the company does not do so. ^^ See also Lutter M, Vergleichende Corporate Governance - Die deutsche Sicht, ZGR 2001 pp 226-228. "^^ Compare Kamar E, Shareholder Litigation Under Indeterminate Corporate Law, U Chi L Rev 66 (1999) pp 891-892.
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One of the objects of these external rules is to regulate the structure of the board. Under these rules, the statutory board of a listed company consists of two blocks, independent non-executive directors and executive directors, which in effect monitor each other. The powers of the statutory board of directors are partly delegated to committees that supervise other board members. But regulating the structure of the statutory board of directors is not enough, because the Companies Act 1985 does not say how the powers of this board should be exercised. This makes it necessary to develop more external rules that govern the exercise of these powers. Like the rules on board structure, these rules can increasingly be found in securities markets legislation. In addition, a draft Companies Bill would codify some of directors' duties. A further matter that needs to be regulated is the management of the company by its sub-board executives. If the statutory board of directors does not really run the company, it is reasonable to regulate the acts of those who do. The regulatory technique used in the UK is to extend the scope of rules that apply to statutory board members to sub-board managers. This is done by applying mandatory provisions or penal sanctions under the Companies Act 1985 or FSMA 2000 to "officers" or "persons responsible", and by applying the common law fiduciary duties of directors to senior executives."^^ - Different rules penetrate the company hierarchy in different ways. For example, the Sarbanes-Oxley Act makes chief executive officers, chief financial officers and management directly responsible for accuracy and fairness of disclosure in the USA. In the EU, the Commission Recommendation on the remuneration of directors adopted by the Commission in October 2004"*"^ provides that a remuneration statement that focuses on the company's policy on directors' remuneration should be submitted to the annual general meeting of shareholders for a vote; in this Recommendation, "director" means "any member of the administrative, managerial and supervisory bodies of a listed
"^ This practice is not limited to the UK. See Hill J, Corporate Criminal Liability in Australia, JBL 2003 p 8: "There has been an increasing tendency in Austrahan statutes to impose individual liability on company directors and managers, on the premise that targeting such individuals for liability will promote greater monitoring by them." See also Ong DM, The Impact of Enviroimiental Law on Corporate Governance, EJIL 12 (2001) pp 702 and 717: "[There is] a general trend towards the imposition of strict, non-fault based, liability for corporate environmental damage ... Trends in corporate environmental liability and corporate environmental management systems have already made an impact on corporate governance: first, by the imposition of environmental liability directly upon company directors, senior management personnel, and even (corporate) shareholders; and, secondly, as part of proposed changes to corporate management structures designed to reflect environmental values, which necessarily encompass the imperative role of directors in setting an example for the rest of the company. It is significant, however, that the legal scope of directors' duties under domestic company laws has not been explicitly expanded to include established environmental concerns." "^^ Commission Recommendation on fostering an appropriate regime for the remuneration of directors of listed companies.
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company'V^ and the Recommendation applies even to the remuneration of "chief executive officers"."*^ In German law, these regulatory tools either have not been necessary or play a minor role. Top management cannot be delegated to a sub-board executive body because the statutory management board (Vorstand) actually runs the company and is not allowed to delegate its core powers. There is no need to delegate the actual running of the company to sub-board executive bodies in order to develop additional constraints on how the statutory board exercises its powers because plenty of constraints are already in place in the form of the supervisory board and the prescriptive and mandatory statutory provisions. On the other hand, the larger the company becomes, the fewer management matters can in practice be dealt with at this level. The scope of core issues of management has therefore been the subject of much analysis in Germany. Since top management functions cannot be delegated to sub-board executive bodies, the statutory management board does not have excess powers that would have to be constrained because of such delegation. The statutory powers of the statutory management board have already been constrained by the prescriptive and mandatory provisions of the Aktiengesetz. For the same reason, the rules that apply to statutory board members do not need to penetrate the company hierarchy. The main rule is that those rules on governance that apply to statutory board members are not applied to sub-board managers, although some securities markets rules, especially provisions adopted in the implementation of EU Directives, can apply even to other persons than statutory board members.^° The result is that the body that actually runs a German AG (its Vorstand) has far larger powers than the corresponding body of a UK public limited company (a sub-board executive body), and that the exercise of these powers is constrained relatively effectively by reasonably clear statutory provisions. One may ask whether UK company and securities markets laws have achieved with their new regulatory tools the benefits of German company law. The answer must be that they have not. As regards the regulation of the governance of modem listed companies, the fundamental problem of the Companies Act 1985 is that it is better suited for the governance of traditional small unlisted companies in which shareholders participate actively in management. There is no clear separation of supervision and management under the external rules that govern a UK public limited company; the separation of supervisory bodies and management bodies and the distribution of powers between these bodies is basically an internal matter. As the statutory gov"^^ Paragraph 2.1. "^^ Paragraph 1.3. ^^ For example, Article 14 of the Market Abuse Directive (2003/6/EC) provides that Member States shall ensure that appropriate administrative measures can be taken or administrative sanctions be imposed against the persons responsible where the provisions adopted in the implementation of the Directive have not been complied with.
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emance structure does not ensure that the bodies that supervise management are sufficiently independent of managers, the independence of at least some of the individual board members becomes important. Like in a small private company, a shareholder could become sure of this by becoming a board member himself or by participating in the management of the company through nominee directors, but for understandable reasons institutional investors are reluctant to do so.^^ A further problem is that since different companies can have very different management structures, investors should analyse the governance structure of each company separately. It is thus more difficult for them to compare investments in different companies. Only widespread reforms would cure these problems. This can be contrasted with the German Aktiengesellschaft, the company form specifically designed for large listed companies. In Germany, the interests of shareholders are safeguarded by a statutory governance structure and statutory constraints on the exercise of management powers. These safeguards make it less important for shareholders to participate in the management of the company or in the control of management. A further benefit of mandatory provisions is that the rules governing the governance and top management of German AGs are more standardised. This should make it easier for investors to compare investments in different AGs.^^ Within the limits of these mandatory provisions, the organisation of the management board can be flexible.
6.5.5 Commission Recommendation on the Role of Directors Both countries rely on several control mechanisms that complement each other. Disclosure and independent supervision are increasingly encouraged by mandatory and detailed statutory provisions and complemented by rules on board structure. Having a majority of independent directors on the board is not regarded as a sufficient instrument to make the board do what is right for shareholders.^^ In Germany, the independence of individual board members is not as essential as in the UK, because the statutory two-tier board system focuses on the independency of the supervisory board as a whole rather than on the independency of its individual members. And in the UK, the appointment of independent directors is combined with measures that create two-tier board structures inside the one-tier board.
See Davies PL, Struktur der Untemehmensfuhrung in GroBbritannien und Deutschland: Konvergenz oder fortbestehende Divergenz? ZGR 2001 pp 279-281. See also Coffee JC, The Future as History: The Prospects for Global Convergence in Corporate Governance and Its Implications, Nw U L Rev 93 (1999) p 694. See also Bebchuk LA, Coates JC, Subramanian G, The Powerful Antitakeover Force of Staggered Boards, Stan L Rev 55 (2002) pp 899-901 on US law: "... having a majority of independent directors on the board provides us with no confidence that the board will do what is right for shareholders ... To rely so heavily on outside directors, who in general cannot be expected to devote large amounts of time to their director tasks, and who are dependent on officers for information, seems fundamentally flawed."
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The Commission has so far expressed contradicting views about the roles of "independency", disclosure and mandatory rules. The non-binding Commission Recommendation on the role of directors adopted by the Commission in October 2004 concentrates on the role of independent representatives on the board and is thus based on the UK model: "The presence of independent representatives on the board, capable of challenging the decisions of management, is widely considered as a means of protecting the interests of shareholders and other stakeholders ... In order to ensure that the management function will be submitted to an effective and sufficiently independent oversight function, the (supervisory) board should comprise a sufficient number of committed non-executive or supervisory directors, who, in addition to not performing management duties in the company or its group, are independent, i.e. free from any material conflict of interest."^"* Furthermore, the Commission says that it is not in favour of detailed and binding rules: "In view of the complexity of many of the issues at stake, the adoption of detailed binding rules is not necessarily the most desirable and efficient way of achieving the objectives pursued. Many corporate governance codes adopted in Member States tend to rely on disclosure to encourage compliance, based on the 'comply or explain' approach: companies are invited to disclose whether they comply with the code and to explain any material departures from it. This approach enables companies to reflect sector- and enterprise-specific requirements, and the markets to assess the explanations and justifications provided."^^ However, "non-executive or supervisory directors" cannot play a meaningful role in overseeing management without the use of a two-tier board or a clear twotier board structure inside a one-tier board, and this cannot be achieved without detailed and binding rules. Furthermore, it would be easier for these directors to monitor compliance with clear rules rather than compliance with broad principles. Capital markets do not generally find the "comply or explain" principle and disclosure sufficient. On the contrary, both the Sarbanes-Oxley Act and EU capital market Directives contain mandatory and detailed disclosure rules and substantive rules. The same can be said of the regulation of listed companies in the UK and Germany. In Germany, mandatory and detailed statutory provisions leave little room for corporate governance codes. A large and growing body of mandatory and detailed rules is already in place in the USA and in the Member States of the EU. Such rules can also be found in EU securities markets law. Although the Commission Recommendation does not seem to acknowledge that mandatory and detailed rules are necessary, the Recommendation is intended to lead to new detailed rules and the approximation of previous rules. Member States are "invited" to apply the Recommendation, which requires in practice a set of detailed rules at national level. The Commission Recommendation does not go very as far as board structure is concerned. The default board is the one-tier board. 54 Recitals 8 and 9.
55 Recital 4.
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The Commission Recommendation on the role of directors encourages neither the use of two-tier boards nor the division of supervision and management by clear rules. Instead, the underlying philosophy of the Recommendation is to cure some of the problems of one-tier boards by inserting two-tier structures inside them.^^ For example, the Commission says: "The oversight role of non-executive or supervisory directors is commonly perceived as crucial in three areas, where the potential for conflict of interest of management is particularly high, especially when such matters are not a direct responsibility for shareholders: nomination of directors, remuneration of directors, and audit. It is therefore appropriate to foster the role of non-executive or supervisory directors in these areas and to encourage the creation within the (supervisory) board of nomination, remuneration and audit committees. "^"^ The Commission does not take into account the fact that large firms with a nominally one-tier board are increasingly being run by a sub-board executive body with the statutory board becoming a monitoring body.^^ For example, the Commission writes in the Recommendation on the remuneration of directors:^^ "The form, structure and level of directors' remuneration are a matter in competence of companies and their shareholders. This should enable recruitment and retaining of directors meeting the quality criteria required to run a company."^^
6.5.6 The SE Company The differences between UK law and German law will persist even in relation to SE companies. The SE Regulation contains only some provisions on the management of an SE company. While the Regulation sets out general principles on the management of an SE company, the modalities of management are governed by Member States' laws applicable to public limited-liability companies. For example, the SE Regulation provides that an SE company can choose between a statutory one-tier and a statutory two-tier board structure but does not say to what extent the administrative board or management board may, like in the UK, delegate its powers to a sub-board executive body. It is therefore open how a statutory onetier board can be combined with a non-statutory executive body. Furthermore, the SE Regulation does not contain many rules on how the management powers of the statutory organs should be exercised.
^^ See also Habersack M, Der Aufsichtsrat im Vizier der Kommission, ZHR 168 (2004) pp 375-378. ^'^ Recital 9. ^^ See also Eisenberg MA, Corporate Law and Social Norms, Colum L Rev 99 (1999) pp 1278-1279. ^^ Commission Recommendation of 14 December 2004 on fostering an appropriate regime for the remuneration of directors of listed companies (2004/913/EC). 60 Recital 2.
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6.6 Shareholders and Internal Management In both Germany and the UK, the main powers of shareholders to run a listed company are de facto powers of influential shareholders. Shareholders have few powers to influence management under the statutory provisions that govern the governance of public limited-liability companies. In Germany, the powers of shareholders are limited especially by the mandatory provisions of the Aktiengesetz that set out the distribution of powers between different company organs. These provisions are necessary partly because of co-determination and the mandatory supervisory board membership of employee representatives. In the UK, articles of association normally vest few management powers in shareholders. There are nevertheless some differences between German and UK law.
6.6.1 Articles of Association Articles of association play very different roles in Germany and the UK. While the memorandum and articles of association are the most important source of internal rules as regards the governance of a UK pic and the contents of articles are to a large extent at the company's discretion, the articles of a German AG may contain only those few regulations that have been expressly permitted by the Aktiengesetz (principle of Satzungsstrenge). The articles of a UK pic are therefore much longer and much more detailed than those of a German AG. For example, the articles of association of Vodafone Group pic, a large UK company, contain 70 pages and 170 detailed articles, but the articles of association of Siemens AG, a large German company, contain 13 pages and 25 short paragraphs. One could assume that the articles of a UK pic should be amended more often than the articles of a German AG and that the majority requirement could be different due to the lack of Satzungsstrenge in the UK. The differences are nevertheless marginal. In a German AG, the amendment of articles requires a majority of three-fourths (75%) of the registered capital of the company represented at the general meeting in addition to a majority of votes cast. In a UK pic, amendment of articles requires a majority of not less then three-fourths (75%) of such members as (being entitled to do so) vote. While shareholders of a German AG cannot derogate from the largely mandatory laws that govern the company (and exclude many regulations in the articles), it is not easy for shareholders of a UK pic to amend articles of association. On the other hand, while it is very difficult for shareholders of a UK pic to enforce articles of association, it easier for shareholders of a German AG to enforce statutory rules. The effect of articles of association and the way they can be amended is modified in takeover situations. The breakthrough rule contained in Article 11 of the Takeover Directive (2004/25/EC) makes many takeover defences less useful. The Directive provides that restrictions on the transfer of securities, restrictions on voting rights, extraordinary appointment rights and multiple voting rights must be removed or suspended: (a) during the time allowed for the acceptance of a bid;
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and (b) when shareholders in general meeting decide on defensive measures, on amendments to the articles of association or on the removal or appointment of board members at the first general meeting following closure of the bid.
6.6.2 Appointment of Managers As a rule, shareholders do not appoint the managers who actually run the company. In a German AG, shareholders can appoint shareholder representatives to the supervisory board (Aufsichtsrat). The Aufsichtsrat supervises management and appoints the members of the management board (Vorstand). Although the Aufsichtsrat has some management powers, it is basically a monitoring organ that cannot run the company. In a UK pic, members of the board of directors can be appointed either at a general meeting or by the board itself, depending on the articles of association. The Combined Code does not say by whom directors should be appointed. The directors can be executive directors, who run the company, or non-executive directors, who do not. In any case, shareholders in general meeting do not appoint sub-board executives to whom the running of the company is often delegated. Nomination of candidates to the board. There are differences regarding the right to nominate candidates to the (supervisory) board. In Germany, the general meeting appoints supervisory board members who represent shareholders. Although the supervisory board has a duty to nominate candidates to the supervisory board, it is easy for shareholders to put things on the agenda and any shareholder may nominate competing candidates. In the UK, board members are not necessarily appointed at a general meeting. The board can usually fill casual vacancies. The Combined Code recommends that "[a]ll directors should be subject to election by shareholders at the first annual general meeting after their appointment, and to re-election thereafter at intervals of no more than three years". The right of shareholders to nominate candidates to the board is usually subject to restrictions. It is interesting to note that the US Securities and Exchange Commission has proposed new rules that would require companies to include in their proxy materials security holder nominees for election as director.^^ These rather modest proposals have been criticised by the Business Roundtable. According to this lobbying group, such a change would substantially disrupt corporate affairs.^^ Critics of the proposed rules argue that shareholder access may lead to special interest directors, "balkanization of the board", and adversarial relationships within the board room. However, Germany has had a very liberal system of shareholder proposals and nominations without any major problems. Decisions on the appointment and remuneration of auditors. There are also differences as regards the appointment and remuneration of auditors. In a German AG, statutory auditors are elected by the general meeting, but the supervisory ^^ Proposed Rule: Security Holder Director Nominations, SEC Release No. 34-48626. ^^ Detailed Comments of Business Roundtable on The "Proposed Election Contest Rules' of the US Securities and Exchange Commission.
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board decides on their remuneration and other contract terms. In a UK pic, statutory auditors are normally appointed by shareholders in general meeting on the basis of a proposal submitted by the board of directors. The board's audit committee should make a recommendation to the board. The board of directors - the body whose activities the auditors are expected to monitor - normally decides on the remuneration of statutory auditors, but the remuneration should be approved by the audit committee. In the future, the Directive on statutory audit of annual accounts and consolidated accounts^^ will provide that statutory auditors shall be appointed at a general meeting (Article 35). Listed companies will have to have an audit committee, composed of "non-executive members of the administrative body" or "members of the supervisory body" with at least one "independent member with competence in accounting and/or auditing" (Article 39(1)). The proposal for the appointment of a statutory auditor or audit firm will have to be based on a selection made by the audit committee (Article 43).
6.6.3 Decisions on IVIanagement IVIatters in General Shareholders in general meeting are not empowered to decide on matters that belong to the general management of the company. However, there are important exceptions to this main rule. Firstly, some corporate transactions and matters related to share capital require the consent of shareholders in general meeting under EU company law. For example, their consent is required for formal mergers and divisions of companies. It is nevertheless interesting to note that although the Second Directive provides for the pre-emptive rights of shareholders, it is slightly easier to waive these rights in the UK.^"^ Generally, German capital maintenance rules and other rules relating to share capital are stricter than comparable rules in the UK.^^ Secondly, there is an exception relating to substantial transactions.^^ For example, the Holzmuller principle requires the management board of a German AG to obtain the prior consent of the general meeting for fundamental matters that severely affect the rights and interests of shareholders. The scope of this principle is ^^ Proposal for a Directive on statutory audit of annual accounts and consolidated accounts and amending Council Directives 78/660/EEC and 83/349/EEC. ^^ See Article 29(5) of the Second Directive (77/91/EEC) and section 95(1) of the Companies Act 1985. See also Enriques L, Schweigen ist Gold: Die Europaische Aktiengesellschaft als Katalysator fur regulative Arbitrage im Gesellschaftsrecht, ZGR 2004 pp 746747. ^^ See Micheler E, Glaubigerschutz im englischen Gesellschaftsrecht. Reformvorschlage mit Implikationen fur Europa, ZGR 2004 pp 325 and 329; Merkt H, Der Kapitalschutz in Europa - ein rocher de bronze? ZGR 2004 p 312. ^^ See also Rock EB, Kanda H, Kraakman R, Significant Corporate Actions. In: Kraakman R, Davies P, Hansmann H, Hertig G, Hopt KJ, Kanda H, Rock EB (eds) op cit p 153: "The most striking conclusion to emerge from our review of significant corporate decisions is how uniform major jurisdictions are ..."
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rather limited. In the UK, some substantial transactions require the consent of shareholders under the Listing Rules. This rule would be applied more often than the Holzmiiller principle. However, the supervisory board would decide on many substantial transactions under the Aktiengesetz. Thirdly, some takeover defences require the consent of shareholders in general meeting. In the UK, this requirement is normally based on the City Code on Takeovers and Mergers. The City Code has also influenced the EU Takeover Directive (2004/25/EC). In Germany, the Wertpapierubemahmegesetz vests similar powers in the supervisory board of the target company instead of the general meeting. The German Act has rejected the principles of "board neutrality" and "shareholder choice" partly due to the mandatory distribution of powers between different company organs under the Aktiengesetz. This will have to change when Germany brings into force the laws necessary to comply with the Takeover Directive.^^ In both countries, the success of takeover bids lies in the hands of shareholders. Shareholders "vote" by holding on to their shares or selling them to the bidder. Neither the general meeting nor company directors decide when, and at what price, a firm sells itself to a hostile bidder.
6.6.4 Shareholder Remedies According to conventional wisdom, the degree of shareholder protection in Germany is lower than in the UK.^^ However, shareholders of a German AG probably have slightly more efficient statutory remedies against breaches of law and articles of association.^^ In both countries, shareholders have hardly any formal powers to enforce remedies against defaulting managers, although influential shareholders do have de facto powers regardless of the legal rules. A majority - in Germany, a very large majority - can formally oust statutory board members, although this does not happen very often in practice. In the UK, shareholders in the general meeting can terminate board memberships. In both cases, the termination of statutory board memberships may turn out to be expensive because shareholders do not have any power to terminate board members' service contracts.
^'' Article 21 of the Takeover Directive provides that Member States shall bring into force the laws necessary to comply with the Directive no later than 20 May 2006. See also Articles 9(2) and 9(6) of the Takeover Directive. ^^ Theissen E, Organized Equity markets. In: Krahnen JP, Schmidt RH (eds) The German Financial System (2004) p 142; La Porta R, L6pez-de-Silanes F, Shleifer A, Vishny RW, Law and Finance, J Polit Economy 106 (1998) pp 1129, 1132 and 1139. See also van Aaken A, Shareholder Suits as a Technique of Internalization and Control of Management. A Functional and Comparative Analysis, RabelsZ 68 (2004) p 305. ^^ See also La Porta R, L6pez-de-Silanes F, Shleifer A, Vishny RW, Investor Protection and Corporate Governance, J Finan Econ 58 (2000) pp 3-27 on the importance of the enforcement of rights.
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Shareholders have nevertheless very limited formal powers to oust managers who actually run the company. In the UK, shareholders in the general meeting cannot terminate the service contracts of sub-board managers, and shareholders of a German AG cannot terminate the board membership of management board members. It is difficult for shareholders to bring proceedings against defaulting managers. In the UK, this is largely due to the doctrine that directors' duties are "owed" to the company and not to shareholders. The lack of duties "owed" to shareholders is coupled with the fact that many common law duties are indeterminate.^^ In Germany, the mainly statutory duties of board members are more determinate than in the UK. On the other hand, only very large shareholders could bring proceedings against statutory board members in the past. The UMAG will make it easier for minority shareholders of a German AG to sue. A court will filter the claims by authorising the proceedings (Klagezulassungsverfahren), and the company will normally bear the costs of the proceedings. In practice, managers and board members are hardly ever made personally liable for loss suffered by shareholders. This outcome is not limited to these two countries. For example. Black, Cheffins and Klausner have pointed out that "outside directors almost never end up paying money out of their own pockets." They could find only one case in the USA since 1968 in which that had happened, the famous Smith v Van Gorkom case. This lead to the following conclusion: "As long as outside directors of a public company refrain from enriching themselves at its expense, they face only a minute risk of having to pay damages or legal fees out of their own pockets - in the United States as well as in less lawsuit-happy countries."^^ The ex-directors of WorldCom and Enron have later agreed to pay out of their own pockets despite the fact that they did not enrich themselves at company expense.'^^ In the UK, one of these rare cases is expected to come to court in 2005 when nine former non-executive directors of Equitable Life are to be sued for their alleged role in bringing the insurer to the brink of collapse."^^ Despite similarities relating to existing rights of shareholders to bring proceedings against managers, there is a fundamental difference between these two jurisdictions. In Germany even individual shareholders have a right to contest resolu-
70
In the USA, indeterminate corporate law is coupled with better rights to sue. Compare Kamar E, Shareholder Litigation Under Indeterminate Corporate Law, U Chi L Rev 66 (1999)p 894. Black BS, Cheffins BR, Klausner M, Outside directors and lawsuits: What are the real risks? McKinsey Quarterly (2004) Issue 4 pp 70-77. The authors write: "Under securities law, more than 3,000 suits, many naming outside directors as defendants, have been filed in US federal courts since 1990. Only three cases have gone to trial, however. Only one involved outside directors as defendants: it was unsuccessful, and the directors were protected by both indemnification and D&O insurance." Black BS, Cheffins BR, Klausner M, Why directors' damages may harm investors, Financial Times, 20 January 2005. See The Economist 16 December 2004, Non-executive directors. A chink in the boardroom door.
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tions of the general meeting.'''* Since the resolutions are normally based on proposals submitted by one of the two statutory boards or both of them, a shareholder may at the same time indirectly contest acts done by the two statutory boards. The right to contest resolutions of the general meeting means that, compared with the rights of shareholders under UK law, shareholders of a German AG have wider powers to enforce the largely statutory rules that govern the management of the company.^^ There are fears of abuse, and one of the purposes of recent company law reforms in Germany is to limit the right to challenge resolutions.
6.6.5 Legal Costs At the moment, the loser pays principle combined with the usual lack of indemnification in respect of legal costs is likely to deter minor shareholders from pursuing these remedies in both jurisdictions.^^ The loser pays principle not only discourages speculative litigation. In Germany, the lack of indemnification by the company discourages shareholders from pursuing legitimate claims.'^'^ It is probably clear that provisional and protective measures are in practice not available against the company because a party who loses the case has a strict liability for damage caused to the company by such measures.'^^ In Germany, the UMAG is intended to help cure this problem in relation to gross breaches of duty by statutory board members. The UMAG will provide that the company will bear the costs of proceedings authorised by the court. On the other hand, the general rule (and the rule that was applied before the UMAG) is that legal costs are calculated on the basis of the value of the disputed case (Gegenstandswert).^^ This rule is likely to keep legal costs modest where the plaintiff is a minor shareholder who asks the court to confirm that a resolution is not valid.^^
74 See §§ 245 and 249 AktG. 7^ See also Ulmer P, Die Aktionarsklage als Instrument zur Kontrolle des Vorstands- und Aufsichtsratshandelns, ZHR 163 (1999) pp 323-326. ''^ Compare Ulmer P, ibid p 307 on US law. See also Easterbrook FH, Fischel DR, The Economic Structure of Corporate Law (1991) p 101: "... the method of compensating attorneys and assessing costs will have a large influence on the costs and benefits of derivative litigation." ^' ^' See Ulmer P, ibid pp 300-301; van Aaken A, Shareholder Suits as a Technique of Internalization and Control of Management. A Functional and Comparative Analysis, RabelsZ 68 (2004) p 322. '^ § 945 ZPO. See Cahn A, Anspriiche und Klagemoglichkeiten der Aktionare wegen Pflichtverletzungen der Verwaltung beim genehmigten Kapital, ZHR 164 (2000) p 118. 79 §2RVG. ^^ See Cahn A, Anspruche und Klagemoglichkeiten der Aktionare wegen Pflichtverletzungen der Verwaltung beim genehmigten Kapital, ZHR 164 (2000) pp 117-118.
6.6 Shareholders and Internal Management
413
Neither class actions nor contingency fees belong to the legal tradition in these two countries. 6.6.6 Management Duties In both jurisdictions, the general standard of managers' duties is defined by their duty of care. The duty of care may vary depending on whether the manager is a statutory board member or a sub-board executive. While sub-board managers are regarded as employees in both jurisdictions, in the UK their duty of care is at least partly determined by applying the rules applicable to statutory board members directly or by analogy. In Germany this would be the rare exception rather than the rule. In Germany, the duties of the body that runs the company (the management board) are governed by statutory provisions that are largely mandatory. Furthermore, shareholders of a German AG have larger powers to enforce remedies at this level of company hierarchy where these duties are breached. In Germany, traditional company law penetrates the company hierarchy better as far as the duties of the body that actually runs the company are concerned. Firstly, the management board will normally act in accordance with mandatory statutory provisions by virtue of their mere existence. Secondly, the Aktiengesetz provides for remedies against defaulting managers who breach their duties. It is true that the main rule in both jurisdictions is that shareholders cannot enforce any remedies against sub-board managers and that they cannot enforce remedies against statutory board members directly for the breach of a duty owed to the company. But in Germany, either one of the statutory boards can sue defaulting members of the other. In theory, it would thus be less important for shareholders to bring proceedings on behalf of the company. In practice, statutory boards hardly ever want to sue members of the other statutory board. For this reason, minority shareholders may under some circumstances decide on the bringing of proceedings and force one of the statutory boards to sue members of the other board. These remedies are normally not very effective, but in normal cases management board members try to act in accordance with statutory provisions and there is no reason to sue them. Thirdly, shareholders have wide rights to contest resolutions of the general meeting, and these resolutions are sometimes voidable (or void) because of statutory board members breaching their own duties. 6.6.7 Stakeholders' Interests There are hardly any differences as regards the duty to act in the interests of stakeholders. The few differences that exist are attributable to cultural reasons rather than regulation: German shareholders and managers have been brought up in a different tradition than their UK counterparts.
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6 Comparison
It is clear that neither German nor UK law prevents managers from taking into account interests that are important for the company, for example environmental considerations^^ and the interests of creditors.^^ In Germany, members of the two statutory boards have a duty to act in the interests of the company (Untemehmensinteresse). They do not act only for the benefit of shareholders. The duty to act in the interests of the company contains the general duty to act for the purpose of making a profit. At the same time, it is necessary for board members to take into account the interests of many stakeholders; they have a duty to do so, because anything else would be contrary to the long-term interests of the company. This duty is coupled with statutory constraints protecting shareholders. The most important constraints are based on a large body of mandatory provisions of company law and the two-tier board structure.^^ In the UK, statutory board members do not have any general statutory duty to act for the benefit of shareholders. The duties of directors are basically owed to "the company as a whole". But while directors may, like in Germany, take into account many different interests, the prevailing attitude towards employees in UK company law is that they are suppliers of a commodity. The duties of sub-board executives, who often run the company, are basically owed to the employer (that is, the company). At the same time, there are few mandatory rules telling them how to run the company. What is characteristic of UK company law is that there are fewer statutory constraints protecting shareholders than in Germany. In reality, it would be a challenge to find a recent annual report of any big international company that justifies the firm's existence merely in terms of profit, rather than "service to the community". Big firms generally want to show that they are good corporate citizens.^"^
6.6.8 Voting It is slightly easier for shareholders of a German AG to cause the management to call an extraordinary general meeting. Under UK law, the holders of one-tenth (10%) of the voting power at a general meeting may require the directors to convene the meeting. Under German law, one-twentieth (5%) of the share capital is sufficient. For example, two hedge funds with a combined holding of less than 8% ^^ See Ong DM, The Impact of Enviromnental Law on Corporate Governance, EJIL 12 (2001)p 718. ^^ See Keay A, The Duty of Directors to Take Account of Creditors' Interests: Has It Any Role to Play? JBL 2002 pp 380 and 385; Keay A, Directors Taking into Account Creditors' Interests, Comp Lawyer 24(10) (2003) pp 300-306; Micheler E, Glaubigerschutz im englischen Gesellschaftsrecht. Reformvorschlage mit Implikationen fur Europa, ZGR 2004p329. ^^ See also Hopt KJ, Ubemahmen, Geheimhaltung und Interessenkonflikte: Probleme fur Vorstande, Aufsichtsrate und Banken, ZGR 2002 p 360; Easterbrook FH, Fischel DR, The Economic Structure of Corporate Law (1991) p 38. ^^ The Economist 20 January 2005, A survey of corporate responsibility. The good company.
6.7 Proximity and Objectivity in Monitoring
415
of the shares in Deutsche Borse AG asked the management board of Deutsche Borse in January 2005 to call an extraordinary general meeting at which the shareholders would seek the removal of the supervisory board; these shareholders opposed Deutsche Borse's bid for the shares of London Stock Exchange. It is also slightly easier for shareholders of a German AG to put items on the agenda. In addition to the wider rights of minority shareholders to call an extraordinary meeting, any shareholder may submit a counter proposal (Gegenantrag). In both countries, shareholders can appoint proxies by electronic means. However, it is at the moment not possible for shareholders to vote by electronic means without being physically present at the general meeting or without being represented by a proxy. The Transparency Directive (2004/109/EC) enables listed companies to use electronic means to inform their shareholders. The Commission considers that there is a need for enhancing the exercise of the right to vote in absentia and to participate in general meetings via electronic means.
6.7 Proximity and Objectivity in iVionitoring Boot and Macey have distinguished between proximity and objectivity in monitoring: "Proximity exists when monitors maintain close contact with management and participate in important decisions on a real-time basis. Objectivity exists when monitors, such as hostile acquirers, analysts, credit rating agencies, accounting firms, and outside lenders, remain distant from management and evaluate management's performance without influence by management."^^ The authors assume that although a firm could have both proximate and objective monitors, most countries' corporate governance laws encourage only one monitoring function, thus rendering such mixed monitoring unlikely: "either proximity or objectivity will necessarily dominate throughout successful corporate governance systems".^^ Boot and Macey point out that proximity gives better access to information but inevitably results in the monitors becoming subject to capture by the firm they monitor. Capture means that the monitor adopts the perspective of the management team under supervision. There is therefore a trade-off between proximity and objectivity. The trade-off between proximity and objectivity has been regulated in very different ways in Germany and the UK.
Boot AWA, Macey JR, The Role of Objectivity, Proximity and Adaptability in Corporate Governance, Cornell L Rev 89 (2004) p 357. Boot AWA, Macey JR, ibid p 358. See also Macey JR, Efficient Capital Markets, Corporate Disclosure, and Enron, Cornell L Rev 89 (2004) pp 400-402.
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6 Comparison
6.7.1 Approximation of Laws To begin with, some minimum requirements are more or less similar due to the approximation of laws in the EU (see Chap. 3.2 above). For example, matters relating to share capital often require the consent of shareholders in general meeting under laws that implement EU Directives. EU Directives also cover auditing matters and the duty to disclose information to the public.^^ There will probably be closer approximation of laws in these areas in the future. New legislative projects include a proposal for a Directive to amend the Second Directive, a proposal for a new Directive on statutory audit, and Commission Recommendations on the role and remuneration of directors.
6.7.2 Germany What is characteristic of the German system is mixed monitoring,^^ the existence of many different types of internal and external monitors and the fact that decision-making often requires consensus between managers and the monitors of management. The most important part of monitoring occurs ex ante rather than ex post, but the deficits of this monitoring system are partly compensated by ex post monitoring by shareholders and others. In Germany, the rule is early correction of major management decisions by proximate monitors;^^ however, late intervention by objective monitors is also possible.^^ Mixed monitoring also makes it less important for individual shareholders to monitor management, and less important for individual supervisory board members to be "independent". In a German AG, proximate monitors include in particular the statutory supervisory board, members of the management board, large shareholders, banks, and representatives of the workforce, (a) The rights and duties of the statutory supervisory board have been set out in detail in the Aktiengesetz. (b) The same can be said of the management board, the statutory organ that runs the company. The two statutory boards being collegiate organs, each member of the management board ^^ See also La Porta R, L6pez-de-Silanes F, Shleifer A, Vishny RW, Law and Finance, J Polit Economy 106 (1998) pp 1140-1141. ^^ See also Eisenberg MA, Corporate Law and Social Norms, Colum L Rev 99 (1999) p 1279: "... because all systems to monitor the efficiency of the management of publicly held corporations are imperfect, it is important to construct a web of overlapping and even redundant monitoring systems." ^^ Compare Boot AWA, Macey JR, The Role of Objectivity, Proximity and Adaptability in Corporate Governance, Cornell L Rev 89 (2004) p 373: "From a firm valuemaximization viewpoint, early correction is preferable to late intervention." ^^ Compare Boot AWA, Macey JR, ibid pp 375-376: "... efficiency may improve if corporate governance systems increase the distance between the monitor and management in an effort to obtain greater monitor objectivity". See also Ulmer P, Die Aktionarsklage als Instrument zur KontroUe des Vorstands- und Aufsichtsratshandelns, ZHR 163 (1999) p321.
6.7 Proximity and Objectivity in Monitoring
417
has in effect a duty to monitor other management board members. Proximate monitoring by other management board members coupled with a large body of mandatory rules makes it easier for the supervisory body to monitor the management board, (c) Large shareholders enjoy some de facto powers regardless of the formal regulation of companies, and these de facto powers are particularly important in Germany where concentrated ownership prevails. In addition, several major decisions require the consent of the general meeting, (d) It is also normal for German companies to have a close relationship with a house bank. The rights of a house bank can be based on contract terms, but the role of a house bank is not based on contract, (e) Representatives of the workforce can monitor management not only under the statutory co-determination regime (Mitbestimmung), but also due to the right of many other statutory bodies to be informed or consulted. These bodies include in particular workers' councils (Betriebsrat) and the economic committee (WirtschaftsausschuB). The statutory governance system of a German AG is specifically designed for listed companies with dispersed ownership and is intended to protect shareholders without minority shareholders having to actively monitor management ex ante. But the close contacts between proximate monitors make some objective monitoring necessary ex post.^^ One of the interesting things about the German system is the scope of shareholders' control rights.^^ Individual and minority shareholders have been able to act as objective monitors due to the relatively wide scope of individual shareholders' rights to contest resolutions of the general meeting or sue the company for breach of the provisions of the Aktiengesetz. However, the rights of individual and minority shareholders will be limited by the UMAG in 2005 in order to prevent possible abuse. A German AG cannot freely choose between objective and proximate monitoring, because the basic governance system is determined by mandatory law. The most important things that the company can choose are probably whether to have a close relationship with a house bank or not and whether to become a listed company (with a changed ownership structure) or not. On the other hand, the company can influence the quality of proximate monitoring.^^ The relative lack of discretion in this respect has sometimes been misunderstood abroad.^"^ ^^ Boot AWA, Macey JR, ibid p 377: "This analysis highlights an additional flaw associated with monitoring by boards of directors who are closely involved in management's decisionmaking processes: the risk that monitors will fail to punish bad managers, even after managers' decisions are revealed as flawed, for fear that their own reputations will suffer." ^2 See Boot AWA, Macey JR, ibid p 362: "... shareholders are the prime candidates for increased control rights". ^^ Compare Boot AWA, Macey JR, ibid pp 376-377: "Simply put, when establishing systems and institutions for monitoring, firms must choose whether the monitor will be objective or proximate." ^"^ See for example The Economist 29 January 2005, Corporate Governance in Germany. No time for consensus: "Yet there are a few simple things that can be done by the companies themselves. They could slash the size of supervisory boards; hive their real deci-
418
6 Comparison
6.7.3 The United Kingdom In the UK, there is more reliance on directors monitoring their fellow directors. Under the Combined Code, independent non-executive directors are expected to monitor executive directors. The board as a whole is expected to monitor subboard executive bodies of which the executive directors are members. The close proximity of independent directors to executive directors is likely to make them adopt the perspective of the management. There are mixed views about the success of non-executive directors as monitors in the UK.^^ On the other hand, UK company law makes direct shareholder involvement very difficult, and direct shareholder involvement, if any, is most likely to be based on the de facto powers of influential shareholders such as large institutional investors.^^ In the UK, market forces and outside institutions must act as a substitute for direct shareholder involvement.^"^ One of the cornerstones of the regulation of corporate governance is therefore disclosure of information to the public. But the fact that public disclosure is nowadays largely governed by EU Directives makes UK disclosure rules look less unique than in the past. The relative lack of effective monitoring of top management by company insiders and the problems relating to monitoring by shareholders should give banks more reason to regulate the governance of companies in financial contracts.^^ The relatively small amount of statutory rules regulating the management of companies makes it legally possible to do so. For many reasons, financial contracts are relatively long and detailed in the UK, and debt covenants are more developed in the UK than in Germany.^9
sion-making into smaller committees; and upgrade the quality and broaden the selection of board members. Better still, they could switch to the Anglo-Saxon system of a single board in which independent non-executive directors spar with executives." Most of these things are not legally possible. 9^ See Davies PL, Struktur der Untemehmensfuhrung in GroBbritannien und Deutschland: Konvergenz oder fortbestehende Divergenz? ZGR 2001 pp 281-282; The Economist 18 March 2004, Non-executive directors. Where's all the fun gone? 9^ See for example The Economist 23 October 2003, Corporate governance. The shareholders' revolt. 9"^ Compare Boot AWA, Macey JR, The Role of Objectivity, Proximity and Adaptability in Corporate Governance, Cornell L Rev 89 (2004) p 359. 9^ Compare Easterbrook FH, Fischel DR, The Economic Structure of Corporate Law (1991) pp 45, 5 land 68. 99 See Merkt H, Der Kapitalschutz in Europa - ein rocher de bronze? ZGR 2004 pp 313314 and 318; Hopt KJ, Gesellschaftsrecht im Wandel. In: Festschrift flir Herbert Wiedemann (2002) pp 1018-1019. For the length of contracts in common law jurisdictions see Lundmark T, Common law-Vereinbarungen - Wortreiche Vertrage, RIW 2001 pp 187-191.
6.8 Consensus
419
6.7.4 Authorities as Objective IVIonitors What is common to both jurisdictions is that shareholders can hardly ever sue managers for loss suffered by the company, and other internal monitors will not sue. There is therefore room for other objective monitors such as the Financial Services Authority (FSA) and Bundesanstalt fur Finanzdienstleistungsaufsicht (BaFin). Supervisory authorities like the FSA and BaFin have been given increasing powers under EU capital markets laws. The new securities markets Directives not only lay down duties of market participants but also require Member States to ensure that they are coupled with effective sanctions. Not all of these powers have been harmonised. It would be unusual to find provisions on the investigative powers of national authorities and sanctions in securities markets Directives,^^^ although some investigative powers and sanctions have been set out in the Investment Services Directive (2004/39/EC).^^^ For example, Article 24(1) of the Transparency Directive (2004/109/EC) provides: "Without prejudice to the right of Member States to impose criminal sanctions. Member States shall ensure, in conformity with their national law, that the appropriate administrative measures can be taken or administrative sanctions be imposed against the persons responsible where the provisions adopted in the implementation of this Directive have not been complied with. Member States shall ensure that these measures are effective, proportionate and dissuasive."^^^ There are similar provisions in the Market Abuse Directive (2003/6/EC),^°^ the Prospectus Directive (2003/71/EC),io4 the Investment Services Directive (2004/39/EC)^o5 ^nd the proposed Directive on statutory audit of annual accounts and consolidated accounts and amending Council Directives 78/660/EEC and 83/349/EEC.'^6 In addition to supervisory authorities, prosecutors can be expected to play a bigger role as objective monitors. There is an increasing number of offences in company law and securities markets legislation. These offences are regarded as a good thing. For example, the judgment in the Mannesmann case has forced companies to rethink the remuneration of statutory board members and made supervisory board members more aware of their statutory duties.
6.8 Consensus The role of consensus is different in these two countries. Consensus-based decision-making is an important governance tool in Germany rather than in the UK. ^00 The Lamfalussy Report, pp 84 and 88. 10^ Articles 26, 50, 51, 57 and 59. ^^^ See also recital 27. 103 Article 14(1). See also recitals 38 and 39. 104 Article 25(1). See also recital 43. 105 Articles 10(6), 51 and 62. 106 Article 30. See also recitals 16 and 21.
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6 Comparison
In Germany, top management decisions are made by groups of people. The same can be said of monitoring. A German AG also relies on mixed monitoring by many different monitors. What keeps top managers and monitors glued together is that many decisions require a fair amount of consensus. Chairmen of the management board and board members need an ability to achieve change by persuasion. One of the benefits of consensus-based decision-making is that this way of proximate monitoring ex ante can help cure some of the problems related to the enforcement of rules ex post. Consensus-based decision-making could be expected to prevent abuse and enable early correction. Consensus-based decision-making can make individual monitors identify with management,^^"^ but it may make them more objective as a group.^^^ Participation in monitoring and proximity to management can make even employee representatives in supervisory boards and workers' councils (Betriebsrat) identify with management. As a rule, neither employee representatives in supervisory boards nor workers' councils are very confrontational.^^^ The most obvious drawback with consensus-based decision-making could be that it can sometimes make fast decision-making more difficult: it is generally more complicated to rely on collective intelligence than let "wise individuals" decide alone. However, evidence from Japanese firms with works councils in Europe does not show that the existence of works councils would have made decisionmaking slower. ^^^ In many German companies, this problem could also be cured by the de facto powers of controlling shareholders. This type of consensus-based decision-making does not change the fact that the residual power to act follows the residual claim to the firm's income. German codetermination thus does not mean that employee representatives, or any other stakeholders for that matter, would hold the same kinds of voting rights as shareholders."^
^^"^ See Boot AWA, Macey JR, The Role of Objectivity, Proximity and Adaptability in Corporate Governance, Cornell L Rev 89 (2004) pp 369 and 373. See also Hopt KJ, The German Two-Tier Board: Experience, Theories, Reforms. In: Hopt KJ, Kanda H, Roe MJ, Wymeersch E, Prigge S (eds) op cit pp 247-248 and 234-235; Davies PL, Struktur der Untemehmensfiihrung in GroBbritannien und Deutschland: Konvergenz oder fortbestehende Divergenz? ZGR 2001 pp 288-291. ^^^ Compare Elson CM, Enron and the necessity of the objective proximate monitor, Cornell L Rev 89 (2004) p 497: "I beUeve that while active, nonproximate monitors may be helpful, the real key to the prevention of Enron-type scandals centers on the proximate monitors ... The secret lies in making them more objective and engaged monitors." ^^^ See for example the interview of Mr. Klaus Franz, the chairman of the workers' council of Adam Opel AG, in Der Spiegel, Das wird eine harte Nuss 52/2004 pp 74-76. "^Nakano S, Management Views of European Works Councils: A Preliminary Survey of Japanese Multinationals, EJIR 5 (1999) p 324; cited in the Explanatory Memorandum for the UK Parliament on the European Public Limited-Liability Regulations 2004 (SI 2004/2326), paragraph 36. '^* Compare Easterbrook FH, Fischel DR, The Economic Structure of Corporate Law (1991)p 69.
6.9 Which Monitoring Model is Better?
421
The consensus requirement is caused by several legal reasons. It is partly caused by the division of powers between the two statutory boards inter se and between the boards and the general meeting. Furthermore, the boards are collegiate organs. Also the supervisory board membership of employee representatives has contributed to the spreading of the monitoring function. ^^^ In addition, consensus plays an important role in German business culture in general. There is interaction between societal and corporate cultures.^^^ The beliefs and attitudes that make up a culture filter into everything else: decisions on organisation, basic strategy, management style, and so forth. "Stakeholder value" thinking is deeply rooted in German society. For example, one of the central provisions of the German Civil Code (Biirgerliches Gesetzbuch) is § 242 BGB that lays down a general fiduciary duty for all contract parties ("Treu und Glauben"). This fiduciary duty is applied as a general principle in the law of obligations; it enables German courts to fill gaps in a contract on the basis of what they view as reasonable. Stakeholder value thinking is thus not limited to the interests of the workforce. In UK law, the rules of interpretation are far stricter.^^"^
6.9 Which Monitoring IVIodel is Better? It is not the purpose of this book to study which monitoring model is better. In order to answer this question, the objectives of monitoring would have to be determined first. In any case. Boot and Macey have argued that "four groups of measures, which are newly cited as important to improving corporate governance, can all be connected to the objectivity-proximity debate: (1) measures aimed at ensuring that nonexecutive directors are more independent and professional that will achieve greater objectivity; (2) measures increasing shareholders' rights that will tend towards more effective intervention by an objective, distant monitor; (3) measures improving disclosure and transparency requirements that will increase the efficacy of distant monitors; and (4) ownership structure issues, such as concentration of ^^^ See O'Connor MA, The Human Capital Era: Reconceptualizing Corporate Law to Facilitate Labor-Management Cooperation, Cornell Law Review 78 (1993) p 937: "By enhancing workers' ability to monitor the firms' performance, codetermination restraints opportunistic conduct by firms." Mark J. Roe, Political Preconditions to Separating Ownership from Corporate Control, Stan L Rev (2000) p 548: "the monitoring role of an active board is fulfilled apart from the supervisory board, whose meetings are stale, formal, and ineffective". ^'^ See O'Connor MA, ibid p 945 (the author cites Williamson OE, The Economic Institutions of Capitalism: Firms, Markets, Relational Contracting. The Free Press, New York 1985); Black BS, Kraakman R, A Self-enforcing Model of Corporate Law, Harv L Rev 109 (1996) p 1914. ^ ^"^ Compare this with the US view. Easterbrook FH, Fischel DR, The Economic Structure of Corporate Law (1991) p 90: "Fiduciary principles are uncommon in contractual relations. Parties dealing at arm's length may bargain hard and enforce their deals to the letter, no matter how severe the consequences for the other side."
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6 Comparison
shareholdings, which relate to the ability of shareholders to act as effective outside monitors". ^^^ German law seems to address these issues better. (1) German law focuses on the independence of the supervisory board from the management board. In a German AG, the independence of individual supervisory board members is less important than the independence of individual directors in a UK pic. It is reasonable to assume that the statutory two-tier board system makes supervisory board members feel more independent from the management than is the case with the "independent" non-executive members in a one-tier board system.^^^ (2) German law gives individual and minority shareholders wider rights to sue, because German shareholders have relatively liberal rights to contest void or voidable resolutions of the general meeting. Resolutions can be void or voidable because statutory board members or controlling shareholders have breached their obligations. These obligations have largely been regulated by the mandatory provisions of the Aktiengesetz and are thus clearer than similar obligations in the UK. This means that German law also addresses the problem of capture by giving individual and minority shareholders a chance to act as objective monitors and sue.^^^ (3) As regards the third group of measures mentioned by Boot and Macey, disclosure and transparency requirements are to a large extent governed by EU Directives. Listed companies comply with similar requirements in all Member States. (4) In addition, there is a higher level of ownership concentration in Germany. It is worth noting that mixed monitoring and consensus-based decision-making play important roles in the governance of a German AG. Mixed monitoring and consensus-based decision-making help to make the "independence" of individual persons who participate in monitoring less important. For example, it is normal to promote the former chairman of the management board to the post of chairman of the supervisory board. Although this practice has angered many corporate governance activists in the past, it has not been necessary to restrict these moves in the German Corporate Governance Code. Commission Recommendation. The non-binding Commission Recommendation on the role of directors^ ^^ relies heavily on the "independency" of individual nonexecutive directors or supervisory board members. It is thus based on the UK model rather than the German model.
*^^ Boot AWA, Macey JR, The Role of Objectivity, Proximity and Adaptability in Corporate Governance, Cornell L Rev 89 (2004) pp 377-378. ^^^ See also Boot AWA, Macey JR, ibid p 378. '^'^ Compare Boot AWA, Macey JR, ibid p 384; Macey JR, Efficient Capital Markets, Corporate Disclosure, and Enron, Cornell L Rev 89 (2004) p 402: "Direct shareholder involvement might solve the problem of corporate governance." ^^^ Commission Recommendation on the role of non-executive or supervisory directors and on the committees of the (supervisory) board.
6.11 Groups
423
6.10 Constraints on the Exercise of Shareholders' Powers Shleifer and Vishny have argued that the principal agency problem in large corporations around the world is that of restricting expropriation of minority shareholders by controlling shareholders, rather than that of restricting empire building by professional managers unaccountable to shareholders.^^^ This description fits Germany better than the UK due to the higher concentration of ownership in German listed companies. In Germany, the rules that restrict expropriation of minority shareholders by the controlling shareholders are also more advanced than in the UK. Again, minority shareholders of a German AG benefit from the large body of statutory and mandatory rules. They can also enforce these rules by contesting resolutions of the general meeting. In addition, shareholders are bound by a general duty of loyalty to each other and the company. This duty is necessary in order to prevent abuse of shareholders' rights. In the UK, the main legal constraints on the exercise of controlling shareholders' powers consist of the statutory provisions under section 459 of the Companies Act 1985 on unfairly prejudicial conduct and the obligation of controlling shareholders to act in the interests of the members of the company as a whole. The protections for minority shareholders have been described as "patchy" or as being "in a confused state", ^^^ Although minority shareholders do not owe any duty of loyalty to other shareholders or the company, the lack of this duty does not lead to widespread abuse of minority shareholders' rights because these rights are rather limited. On the other hand, this means that there are probably less effective constraints on a controlling shareholder that runs a UK pic than on a controlling shareholder that runs a German AG.
6.11 Groups Apart from group audits and the disclosure of group accounts,^^^ EU company law contains few special provisions on the governance of groups. The proposed draft Ninth Directive has been dropped. ^^^ On the other hand, the structure of groups is affected by EU merger control, which has been applied to concentrations for years, and will be affected by the new SE Regulation, the Directive on crossborder mergers as well as the possible approximation of tax laws in the future. ^^^ Shleifer A, Vishny RW, A survey of corporate governance, J Finance 52 (1997) pp 737783. ^^^ Davies PL, Gower and Davies' Principles of Modem Company Law (2003) pp 484, 510 and 483-486. 121 Seventh Company Law Directive (83/349/EEC). 122 See also the principles proposed by Forum Europeaeum Konzemrecht, Konzemrecht fiir Europa,ZGR 1998 p 672.
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6 Comparison
Germany has had a pioneering role in the area of corporate group law. However, the codified provisions of the Konzemrecht are less important than it would seem. What seems to be more important is that most subsidiaries are GmbHs. The GmbH is a company form that combines the limited liability of shareholders with some of the flexibility of partnerships. Some of the codified provisions of group law are applied to GmbHs by analogy. Group interests. The main rule is that each company belonging to the group is regarded as a single independent company. Unlike in France, the interests of the group do not prevail.^^^ In both countries, the duties of the parent's managers are owed to the parent, but the parent might owe some fiduciary duties to a subsidiary. In both countries, the duties of a subsidiary's managers are owed to the subsidiary. The interests of the subsidiary thus prevail at least formally over the interests of the group as a whole. According to German law, the interests of the controlling (parent) company may be taken into account by the organs of the subsidiary, provided that the subsidiary and its creditors are protected by the payment of compensation. Shareholders of the parent company. As regards the power of shareholders of a listed parent company to act as a rule-maker in matters relating to subsidiaries, there are no major differences between German law and UK law. The powers of shareholders to control management ex ante are limited, although shareholders can sometimes vote on major transactions proposed to be carried out by the parent. The powers of a parent company's shareholders do not normally cover transactions proposed to be carried out by its subsidiary. In this case, the rules that govern the governance of the parent company do not penetrate the structure of the group. Managers of the parent company. In a group of companies, the distribution of powers between managers of the parent company and its shareholders is governed by the same rules that apply to single companies, and the exercise of powers vested in the managers of the parent is constrained by the same rules. On the other hand, the same can be said of the distribution of powers between the parent and the subsidiary. In a subsidiary, managers of the parent represent a shareholder and exercise powers vested in that shareholder only. Their powers are thus diluted by the structure of the group. In the subsidiary, the exercise of the powers of the parent's managers is formally constrained by two things: rules on the distribution of powers in the subsidiary; and rules that set out how shareholders' powers can be exercised. There are nevertheless some special rules or instruments that modify the allocation of powers between the parent and its subsidiary or the constraints on the exercise by the parent company's managers of their powers in the subsidiary. Directions to the subsidiary. While the organisation of top management is largely standardised in a German listed company, the internal organisation of domestic groups of companies is relatively flexible both in Germany and the UK. In both countries, the parent company can give directions to the board of a wholly ^^^ See Forum Europeaeum Konzemrecht, Konzemrecht fur Europa, ZGR 1998 pp 710712.
6.11 Groups
425
owned subsidiary. In the UK, this power is based on a common law principle. In Germany, the general principles of GmbH law apply. Constraints. There are special constraints on the exercise of the parent's powers in the subsidiary. These constraints apply to a variety of situations ranging from the legitimate involvement of the parent company in the affairs of the subsidiary to abuse of the corporate form. Where the subsidiary is a listed company, share ownership by the parent can in effect be constrained by mandatory bid rules. A major shareholder must either keep his ownership below a certain threshold or make a bid to minority shareholders.^24
Some constraints are based on a duty of loyalty, fiduciary duties or similar duties. In Germany, shareholders of an AG or GmbH owe a duty of loyalty to other shareholders and the company. In the UK, the main rule is that shareholders do not owe fiduciary duties to other shareholders, but the acts of a majority shareholder are in practice constrained by similar duties. Some constraints apply typically to shareholders of close corporations in which there is no clear separation of ownership and control.^^^ The parent company can thus become liable for acts done within the sphere of its subsidiary in some cases. The liability of the parent can be based on contract or agency and the parent can become liable in tort for its own acts or omissions under the general principles of the law of obhgations.^2^ In both countries, there are special provisions or doctrines developed by the courts in order to address what is perceived as abuse of limited liability. In Germany, parent company liability can be based on specific statutory provisions or principles developed by the BGH. (a) There is a doctrine of piercing the corporate veil or "Durchgriff' in German company law. On the other hand, this doctrine is hardly ever necessary because the possible liability of shareholders is almost always governed by one or more specific statutory provisions on capital maintenance or insolvency.^^'^ (b) In the past, the parent could become liable under the Autokran doctrine developed by the BGH for the obligations of a bankrupt subsidiary in integrated de facto groups where the subsidiary was controlled by the parent. The recent case law of the BGH {Bremer Vulkan and KBV) makes shareholders liable where they have contributed to an act that undermines the very existence of the company. In the UK, the courts have developed the doctrine of "piercing the corporate veil". The metaphoric use of "piercing" the corporate veil may have prevented the courts from developing clear general concepts of parent responsibility. ^^^ It can '24 See Article 5(1) of the Takeover Directive (2004/25/EC). '25 See also Easterbrook FH, Fischel DR, The Economic Structure of Corporate Law (1991) pp 54-56. '26 See also Muchlinski P, Multinational Enterprises and the Law (2004) pp 323 and 330. '27 See Huffer U, Aktiengesetz (2002) § 1 Rn 18. '28 Hofstetter K, Parent ResponsibiHty for Subsidiary Corporations, ICLQ 39 (1990) p 577, citing Phillip Blumberg, The Law of Corporate Groups, Substantive Law (1987) p 136. See also Easterbrook FH, Fischel DR, The Economic Structure of Corporate Law (1991) p55.
426
6 Comparison
also be noted that UK company law contains provisions on de facto directors, but the liability of the parent is in practice not based on them. UK law thus differs from French law. French bankruptcy law provides for statutory consolidation in the bankruptcy of the subsidiary where the parent acts as a director, notwithstanding its formal position. ^^9
6.12 Government Policy on Enforcement Governments can choose from a number of enforcement policies regarding corporate governance. ^^^
6.12.1 Private Enforcement In theory, private enforcement of rules that belong to the core area of company law is possible in both countries. However, there is hardly any litigation against defaulting managers, and there are restrictions on the rights of shareholders to sue. In the UK, the doctrine that the duties of managers are owed to the company makes it difficult for shareholders to sue, and plaintiffs are discouraged by high legal costs. In Germany, the mandatory provisions on the distribution of powers within the company vest the power to bring proceedings against defaulting managers in one of the two statutory boards. In addition, legal rules typically protect only some interests, which limits the right of shareholders to sue. It is nevertheless relatively easy for shareholders of German AG to contest resolutions passed at a general meeting. Private enforcement of securities markets rules is either very difficult or not possible. For example, US-style class actions are rare. It is difficult to organise class actions in these two countries.
6.12.2 Self-enforcement Self-enforcement of external rules plays an important role in both countries. Selfenforcement works because external rules are complemented by cultural and market constraints. Although legal standards of conduct are characteristically accompanied by liability rules or other enforcement regimes, even a legal standard of
^^^ Hofstetter K, ibid p 584. The other side of the coin is the "Rozenblum" doctrine according to which the interests of the group as a whole prevail to a certain extent the interests of individual companies belonging to the group; see Forum Europaeum Konzemrecht, Konzemrecht fur Europa, ZGR 1998 pp 705-709. ^^^ Compare La Porta R, L6pez-de-Silanes F, Shleifer A, What Works in Securities Laws? NBER Working Paper 9882, July 2003.
6.12 Government Policy on Enforcement
427
conduct that is not accompanied by any such regime can be effective because of its impact on social norms.^^^ Compliance with external rules is relatively effective as a social norm in these two countries.^^2 Managers and large shareholders usually want to comply with these rules voluntarily. ^^^ In the UK, compliance is perhaps enhanced by the inquisitive British media or the general idea that fair play is a good thing. In Germany, mixed monitoring and consensus-based decision-making can serve the same purpose. In addition, managers and controlling shareholders normally know how to comply with external rules. One of the factors that contribute to compliance is the relatively high level of professionalism of managers, their advisors and market participants. In Germany, self-enforcement of traditional company law rules is made easier by several legislative instruments. Firstly, wider use is made of clear rules, rather than standards, to define proper and improper behavior. In Germany, statutory company law is more detailed and prescriptive than in the UK. Secondly, there is greater reliance on procedural protections due to the statutory two-tier board structure and the importance of consensus-based decision-making. ^^^^ What is said of external rules applies even to internal rules. Compliance with internal rules is relatively effective as a social norm for the same reasons as compliance with external rules.
6.12.3 Self-governance of the Business Organisation Both countries rely to a large extent on the self-governance of the business organisation that is distinct from the company's shareholders and non-executive moni^3^ Eisenberg MA, Corporate Law and Social Norms, Colum L Rev 99 (1999) p 1269. ^^^ For social norms see Eisenberg MA, ibid pp 1255-1258. Eisenberg writes at p 1262: "Most legal and economic accounts of social norms are directed toward the dynamics that govern the adoption of social norms, and focus on external reasons for adhering to social norms, rather than on intemal beliefs. Legal and economics scholars have done very little work on why particular social norms (other than rudimentary coordinating or cooperative norms, which are usually in the self-interest of actors) originate and why norms are often internalized." ^^^ Eisenberg MA, ibid p 1265: "The level of directorial care is largely driven by social norms, rather than by the threat of liability or the prospect of gain." ^^"^ Compare Black BS, Kraakman R, A Self-enforcing Model of Corporate Law, Harv L Rev 109 (1996) pp 1916-1918: "The central features of our 'self-enforcing' model of corporate law are: (i) Enforcement, as much as possible, through actions by direct participants in the corporate enterprise ... (ii) Greater protection of outside shareholders ... (iii) Reliance on procedural protections ... rather than on flat prohibitions of suspect categories of transactions ... (iv) Whenever possible, use of bright-line rules, rather than standards, to define proper and improper behavior ... (v) Strong legal remedies on paper, to compensate for the low probability that the sanctions will be applied in fact." See also Eisenberg MA, Corporate Law and Social Norms, Colum L Rev 99 (1999) p 1270: "Legal rules may also serve to clarify social norms by providing focal points for their meaning."
428
6 Comparison
tors; at the same time, the self-governance of the business organisation is subject to a large number of legal, procedural and market constraints. There are nevertheless some differences. In the UK, there is little room for shareholders to act as an important monitoring body in a listed company with dispersed ownership. The statutory board of directors is turning into a body with largely monitoring and supervisory functions, and its decision-making powers are being delegated to sub-board executives. The acts of sub-board executives are usually not governed by company law. Unlike in the UK, the top management of a German AG is govemed by the mandatory provisions of the Aktiengesetz. Company law thus penetrates the business organisation to this extent. Shareholders can to some extent monitor management ex post by virtue of their liberal rights to contest resolutions of the general meeting.
6.12.4 Public Enforcement Public enforcement is becoming increasingly important in areas where private enforcement, self-enforcement and self-governance are not regarded as sufficient. Public enforcement plays a growing role in new securities markets legislation. For example, the Market Abuse Directive (2003/6/EC), the Prospectus Directive (2003/71/EC) and the Transparency Directive (2004/109/EC) force Member States to designate central competent administrative authorities. The Directives also list the minimum powers necessary for the performance of these administrative authorities' functions. ^^^ There is a Commission Recommendation on quality assurance for the statutory audit in the European Union (2001/256/EC). According to this Recommendation, Member States should take measures to ensure that all persons carrying out statutory audits are subjected to a quality assurance system. The Commission is in favour of disciplinary sanctions and states that it is necessary to have a systematic link between negative outcomes of quality reviews and initiating sanctions under the disciplinary system. In October 2004, the Commission also published a draft Directive with a view to preparing a revision of the EU regime for the clarification of the responsibility of board members for financial statements and key non-financial information. The Commission believes that there is a need to clarify that all board members are collectively responsible for financial statements and key non-financial information and that all board members have to be held accountable for their actions. According to the draft Directive, the Member States should "lay down the rules on penalties applicable to infringements of the national provisions" adopted pursuant to the Fourth and Seventh Company Law Directives and should "take all measures necessary to ensure that they are implemented". In addition, the penalties and measures provided for should be "effective, proportionate and dissuasive".
^35 See for example Article 24(4) of the Transparency Directive (2004/198/EC).
6.12 Government Policy on Enforcement
429
In both Germany and the UK, independent bodies seek to ensure that the provision of financial information by listed companies complies w^ith relevant accounting requirements. In this respect, the US Securities and Exchange Commission has wider pov^ers than the Deutsche Prufstelle fur Rechnungslegung (DPR) and the BaFin; on the other hand, the DPR and the BaFin have wider powers than the Financial Reporting Review Panel (FRRP) in the UK.^^^ The role of public enforcement of rules that govern the management of companies is relatively modest in the traditional core area of company law. In Germany, there are nevertheless prominent cases where penal sanctions have been applied to breach of fiduciary duty (Untreue).
^^^ See Hennrichs J, Fehlerhafte Bilanzen, Enforcement und Aktienrecht, ZHR 168 (2004) pp 399-400.
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