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Law for Business

Knowhow - guidance - precedents

29 JUN 2015

Board decisions – a cautionary tale

Board decisions – a cautionary tale
Some cases are important because the court develops the law, whether by creating a new rule or by applying an existing rule in a new way. Other cases are important because, even if they do not take the law any further, they illustrate its practical impact.

The recent High Court decision in Re Melodious Corporation [2015] EWHC 621 (Ch) falls into the latter category, at least as far as its purely company law aspects are concerned. The fact that the judge in that case concluded that a board resolution which had been passed at an inquorate board meeting was invalid is hardly a surprise. However, the circumstances in which the resolution was passed, and the implications of its invalidity, should serve to remind directors, company secretaries and anyone else who is involved in companies’ affairs of the importance of ensuring that board decisions are taken in accordance with the procedure set out in the company’s articles of association.

Re Melodious Corporation (2015)

The facts of the case, so far as relevant for the purposes of this article, were as follows.

  • The case centred around a British Virgin Islands company, Melodious Corporation, which had two shareholders: a Miss Chan and a Mr Leung.
  • At the relevant time, the board of Melodious consisted of two directors, Miss Chan and her mother, Madam Ho.
  • The company’s articles stated that if the company had only two directors, the quorum for board meetings was two.
  • Following a consultation with a Mr Paterson, an insolvency practitioner who was a partner in a reputable firm of accountants, Miss Chan decided to put Melodious into administration.
  • Minutes of a board meeting in October 2007 stated that the board had decided to put the company into administration pursuant to paragraph 22(2) of Schedule B1 to the Insolvency Act 1986 (under which directors have the power to appoint an administrator) and to appoint Mr Paterson as its administrator.
  • Mr Paterson proceeded to act as the company’s administrator for approximately a year, and then took steps to convert the administration into a liquidation.
  • Some years later, in 2014, Miss Chan applied to the court for an order concerning the status of a sum of money derived from the company’s property investment activities. Whilst Mr Paterson contended that he had been appointed to be the company’s administrator and that the sum was an asset of the company, Miss Chan argued that the company had never been put into administration and that the sum should be paid into an account in the names of her solicitors and Mr Leung’s solicitors.
  • The basis of Miss Chan’s claim that the company had never entered administration was that Madam Ho had not attended the October 2007 board meeting, and that the meeting was therefore inquorate.
  • Although the minutes corroborated Miss Chan’s account, in that they stated that she was the only director in attendance, Mr Paterson argued that in fact Madam Ho was also present.
The case therefore turned on a very straightforward question of fact: was Madam Ho present at the board meeting? Having considered the evidence with some care, the judge concluded that she was not present, and accordingly held that the meeting was inquorate and that the decision to appoint an administrator was invalid. He reached this conclusion notwithstanding the fact that the intention had clearly been to appoint an administrator and notwithstanding also his finding that Madam Ho would have agreed to put the company into administration if she had been asked.

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In its efforts to balance the interests of shareholders, directors and creditors in order to ensure that the company remains an attractive business vehicle, the company law regime incorporates various features which are designed to reduce the burden of responsibility on one or other of those parties. A prime example of such a feature is the unanimous consent rule, under which a unanimous decision of a company’s shareholders will generally be valid even if it does not comply with the formal shareholder decision-making procedures in the Companies Act 2006. Oher examples include the rules governing the deemed re-appointment of the auditor of a private company (section 487) and those dealing with pre-incorporation contracts, which ensure that a third party who neglects to ascertain whether the company with which he believes he is dealing has actually been formed will generally be able to enforce the contract, albeit against the promoter rather than the company itself (section 51).

There are, however, limits to the lengths to which the regime is prepared to go in this regard. For example, a director who does not trouble to familiarise himself with the scope of his statutory duties is unlikely to receive much sympathy from the court in the event that a claim is brought against him for a breach of duty. In the course of upholding a judgment against a director for breach of duty, the Court of Appeal in Towers v Premier Waste Management Ltd [2011] EWCA Civ 923 noted that the judge at first instance “was not over impressed by Mr Towers [the director in question], finding that he down-played his role, regarded the whole matter as insignificant and did not seem to appreciate his position of trust as a director”. Indeed, the doctrine of limited liability – one of the foundations of English company law – assumes that creditors will take responsibility for their own protection by perusing a company’s public documents before deciding whether or not to do business with it. As Lord Watson put it in Salomon v A Salomon and Company, Ltd [1897] AC 22: “in my opinion, a creditor who will not take the trouble to use the means which the statute provides for enabling him to protect himself must bear the consequences of his own negligence”.

In Melodious, the judge declined to overlook the absence of a quorum, despite the fact that in his opinion the director whose presence would have rendered the meeting quorate would, if she had been asked, have voted in favour of the decision, and despite the fact that the effect of his conclusion was that a company which had apparently been placed in administration in 2007 was held, more than seven years later, not to have entered administration after all. In other words, this was an example of a situation in which those involved in a company’s affairs were expected to act with a degree of common sense and diligence.

There are some areas of the law in which it might be argued that the regime could do more to reduce the burden of responsibility on particular parties. The rule that an “outsider” cannot enforce the articles, for example, may be unduly harsh, given that many new directors have little experience of company law and may well assume that they can protect their position through appropriate wording in the articles. In other areas, however, it is difficult to argue that the regime should adopt a more lenient approach. In Melodious, the court had no qualms about imposing on Mr Paterson, the insolvency practitioner who subsequently acted as the company’s administrator, the burden of ensuring that the resolution was passed in accordance with the articles. Mr Paterson had prepared the minutes, and the judge noted that he had a copy of the company’s articles and had simply failed to check them. Here, the court’s strict approach was surely justified. (In fact, a stricter approach still would have been justified. Rather surprisingly, the judge appeared to take the view that Miss Chan, despite the fact that she was a director, did not bear any responsibility for the flawed decision.) One of the first lessons anyone associated with companies learns is that, in conducting a company’s affairs, regard must be had not only to the Companies Act 2006 and any other relevant legislation, but also to its articles. Directors or advisers who fail to follow this simple rule in relation to the taking of a board decision can have no grounds for complaint if the decision is later held to have been invalid, and if the events which flowed from it are thereby compromised.