This paper critically evaluates the changes introduced to the UK corporate constitution by the Companies Act 2006, with particular reference to the balance between shareholder and creditor protection. It examines the Act's corporate social responsibility provisions, the statutory protection of shareholders under section 994 against unfair prejudice, and the objective tests courts apply to determine whether conduct is unfairly prejudicial. The paper also considers changes affecting creditor protection, including amendments relating to capital reduction and the repeal of the financial assistance prohibition for private companies. The analysis draws on key legislative provisions and academic commentary to assess how the Act has shaped UK corporate governance.
The Companies Act 2006 is an Act of Parliament in the UK that forms the primary basis of UK corporate law. Since its enactment, it has been recognised as an evolution of previous legislation, simplifying the running of private companies and enhancing the level of shareholder engagement (Birds, 2007). The Act has the distinction of being the longest in the British Parliamentary system, comprising 1,300 sections covering close to seven hundred pages and containing a total of sixteen schedules.
The Companies Act 2006 was implemented in stages, with the final provisions coming into force on 1 October 2009. It effectively replaced the Companies Act 1985. The Act provides a comprehensive code of conduct for the UK corporate sector and introduced several significant changes to the corporate law governing UK companies. The key provisions include: the codification of certain elements of common law principles — such as those relating to the duties of directors; the implementation of the European Union's Takeover and Transparency Obligations Directives; the introduction of new provisions for both public and private companies; and the application of a single company law framework across the UK, replacing the two separate systems that previously existed for Great Britain and Northern Ireland.
The Companies Act 2006 contains several provisions relating to corporate social responsibility (CSR). CSR is important for the peaceful coexistence of a company with its employees, authorities, shareholders, stakeholders, and the general community (Carroll, 1991; Aguilera & Jackson, 2003; Berle, 1932). For an organisation to prosper, stakeholders need to be involved in almost every aspect of its governance (Freeman, Wicks and Parmar, 2004). In regard to corporate social responsibility, the Companies Act 2006 makes the following provisions:
Section 171 directs directors to act within their powers. Section 172 urges directors to promote the firm's success. Section 173 urges directors to exercise independent judgment. Section 174 urges directors to exercise a reasonable level of care, diligence, and skill. Section 175 urges directors to avoid situations that lead to conflicts of interest. Section 176 urges directors to avoid accepting any form of benefit from third parties, while section 177 urges directors to declare their interest in any transactions carried out within the company.
The relevance of legislation for corporate governance has long been a subject of debate in the literature (Pistor, Reiser and Gelfer, 2000, p. 325). Legal scholars have suggested that, when compared with competitive capital, managerial labour markets, and product markets, the role of law in corporate governance is at best of secondary importance (Easterbrook and Fischel, 1991). In countries with strong shareholder protection laws, the rights of shareholders are clearly specified in the legal system (Hart and Moore, 1990). The role of legislation in protecting shareholder and creditor rights is therefore apparent (Jensen and Meckling, 1976) and is clearly outlined in the Companies Act 2006.
Shareholders are protected from various corporate wrongs by the Companies Act 2006. The most common protection afforded to shareholders under the Act is protection from unfair prejudice (Marsden, 2011). Some protection is provided to shareholders under statute, and the particular provision that protects shareholders is section 994 of the Companies Act 2006 — a change that replaced the previous section 459 of the Companies Act 1985 (Ashfords, 2010).
According to section 994 of the Companies Act 2006, a member of a company may apply to the courts by petition for an order on the specific grounds that:
(a) The affairs of the company are being conducted, or have been conducted, in a manner which is unfairly prejudicial to the interests of the members generally or to some members, including at least the petitioner; or
(b) That an actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial.
There are two main elements that must both be present for a claim of unfair prejudice to succeed. These are:
First, the reported or observed conduct must be prejudicial in the sense that it causes harm or prejudice to an interest that is relevant to a given member or to some shareholders. Second, the conduct must also be deemed to be unfair.
The test for determining whether a particular action amounts to unfair prejudice is, as noted by Ashfords (2010), purely objective. This means it is not necessary for the petitioning shareholders to prove that anyone acted in bad faith or with the intention of causing prejudice. The courts will regard a case as involving unfair prejudice if a hypothetical, reasonable bystander would consider it to be unfair. Fairness is judged in the context of the commercial relationship — in terms of the contractual terms set out in the Articles of Association and any existing shareholders' agreements.
The inquiry should therefore begin by asking whether the conduct identified in the shareholder's complaint is in accordance with the powers of the board as recognised in the relevant Articles. Minority Shareholder Solutions (2012) indicated that the best protection for shareholders is the inclusion of appropriate protections in the relevant Articles themselves. This means that if conduct is deemed to be in accordance with the Articles to which the shareholders have agreed, it will be extremely difficult for a shareholder to succeed with an unfair prejudice petition. It is worth noting that even if conduct is not in accordance with the relevant Articles, this does not automatically render it unfair. Technical or trivial infringements of the Articles may not give rise to a remedy under section 994.
According to the Companies Act 2006, conduct must be regarded as unfairly prejudicial to the interests of the petitioners in their capacity as members of the company — in other words, they must be shareholders. The courts, however, adopt a broader perspective of what may be treated as a member's interest. The use of the word "unfairly" enables the court to consider wider equitable considerations and to recognise that members of a company may have rights and legitimate expectations that are not necessarily set out in the Articles of Association.
The concept of unfair prejudice is noted by Birds et al. (2010) to be a flexible one, with no exhaustive definition. There are, however, certain categories of conduct that may be deemed to amount to unfairly prejudicial conduct, and these categories remain open-ended (Birds et al., 2010, p. 1155). Common examples of acts that may constitute unfairly prejudicial conduct include: the exclusion of a shareholder from management in circumstances where there is a legitimate expectation of their participation; the diversion of the core business of a company in which the majority shareholder has a vested interest; the awarding of excessive benefits to a majority shareholder; and the abuse of power.
In regard to the remedies available for unfair prejudice, section 996(2) of the Companies Act 2006 provides various types of court orders that may be employed. It is therefore evident that the Companies Act 2006 introduced several changes relevant to the protection of shareholders, the most significant being the provisions contained in sections 994 and 996.
"Capital reduction rules and financial assistance repeal"
The UK's Department of Business, Innovation and Skills (2007) indicated that the UK government, via BERR, had amended the Companies Act 1985 and the Companies Act 2006 in order to reflect the creditor protection elements of the new Directive. The particular focus was on shifting the burden of proof from companies to creditors when objecting to a case of capital reduction.
A further change introduced by the Companies Act 2006 in relation to creditor protection was the repeal of the financial assistance prohibition for private companies (Moorcrofts, 2012). Prior to this change, it was illegal for any company to provide "financial assistance" to aid anyone in acquiring a stake in the same company. This rule had operated as a creditor protection mechanism, since a creditor who was aware of the risk of exposure in the event of the firm's collapse would find themselves placed behind a secured bank in the usual order of priority.
This review has indicated that the Companies Act 2006 introduced several changes affecting both shareholder and creditor protection. It is therefore important for amendments to be made to various clauses and sections in order to reflect the dynamic nature of the corporate governance landscape.
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