Author: David Lee
The courts have long recognised that companies do not always follow all the procedures prescribed by company law and that, in certain circumstances, it would be unjust for the courts to punish a party just because of a failure to observe legal formalities.
One area is that of shareholder approval. With English companies varying in size and complexity from smaller, owner managed businesses to large trading companies or parent companies of multinational groups, the level of formality given to decisions varies, as does the degree to which these are formally recorded. With smaller companies and groups especially, the directors and the (major) shareholders can often be one and the same, and the reality is that decisions are taken on an ad hoc basis, as and when necessary, with less focus on legal formalities or documentation.
Ordinarily, to pass a shareholder resolution, a company can either hold a general meeting or circulate a written resolution requesting authorisation from the company’s members in writing. These processes, subject to certain statutory constraints, give flexibility to English companies to run their businesses in as efficient a manner as possible while protecting the interests of third parties such as shareholders and creditors.
But what if companies don’t follow these processes?
The case of Re Duomatic is one often cited example of this. In this case, the directors and (voting) shareholders were one and the same for a period of time. The remuneration of the directors required shareholder approval, but the directors (who were the shareholders) had failed to document that approval being given by them in their capacity as shareholders. The company was subsequently placed into voluntary liquidation and the appointed liquidators sought to recover the sums paid to the directors in breach of the requirement for formal shareholder approval.
For the period of time the directors and shareholders were one and the same, and despite a failure to properly document their decisions, the court found it fit to protect the directors from liability on the basis that they had not only the authority to make but also had unanimously made the necessary decisions.
The decision in this case gave rise to the eponymous ‘Duomatic Principle’. This principle provides that the agreement of the shareholders can be effective even if the necessary formalities are not met, as long as:
It perhaps goes without saying that if a party hopes to rely on the court’s discretion, it must meet the criteria laid down by the court. The recent case of Randhawa and another v Turpin and another reinforces that, for the Duomatic Principle to apply, the consent of the shareholders who are entitled to vote should be unanimous, and provides some guidance on who is considered to be such a shareholder for these purposes.
In this case, the company in question had two shareholders; one was the sole director (D), and the other a dissolved Isle of Man company (B). A previous judgment had found D was, in fact, holding his shares on trust for a third person, the father of D (R), who had been a director of the Company until his disqualification from acting as a director. It was also similarly likely that B was holding its shares on trust for R, though this point was never finally resolved.
The company was placed into administration, and Randhawas were creditors of the company. It should be noted that this case was part of a wider series of litigation between the parties. At this point, the company had emerged from administration and the Randhawas had acquired both the beneficial interest in 75% of the company’s voting shares and control of the board.
The Randhawas had previously sought to challenge the remuneration of the joint administrators, and in the present case sought to have the appointment of the joint administrators overturned on the basis that their appointment was invalid. This would invalidate their claim for fees against the company.
The company’s articles of association required two directors to form a quorum at a board meeting, and two shareholders to form a quorum at a shareholders meeting. The Randhawas maintained that as the company had one director and one shareholder (in existence), it was unable to hold a quorate board meeting or shareholder meeting and therefore that the joint administrators’ appointment had not been formally approved by the company.
The High Court originally found that the Duomatic Principle applied so as to save the appointment of the joint administrators as, among other things:
The High Court was satisfied that the Duomatic Principle applied and therefore the appointment of the joint administrators was valid, notwithstanding the procedural deficiencies. The Randhawas unsurprisingly disagreed and appealed to the Court of Appeal.
The Court of Appeal agreed with the Randhawas and disagreed with the High Court, finding that:
Therefore, in the words used by Sir Geoffrey Vos, Chancellor of the High Court, the resolution to appoint the joint administrators was ‘incurably invalid’, and ‘could not be rendered valid by the application of the Duomatic Principle’.
This case highlights a number of issues for internal company management and administration.
Firstly, the articles of the company in question were not observed. Where articles require a particular number of directors or shareholders to form a valid meeting, such requirements should be adhered to, or, if they include procedural matters which are no longer relevant or cannot be complied with, the articles amended. Had this been completed (which in the above case D as a 75% shareholder would have been, on the face of it, entitled to do), arguably the resulting chain of events could have been avoided.
Secondly, a dissolved (or deceased) shareholder can cause a company serious issues in the longer term. In the above case, B was dissolved in 1996 but it remained on the register of members and therefore had to be taken into account as a shareholder with an entitlement to vote. In the 20 plus years following its dissolution, it seems the company failed (whether intentionally or unintentionally) to take any action to resolve the matter.
While the Duomatic Principle is useful, and clearly has a continuing application, it should be regarded as a last chance saloon rather than a principle to be relied upon in the normal course of business. Due care and attention should be given to the internal management and record keeping of every company, regardless of size or complexity. Particular attention should be paid to statutory books and records (including the register of members) and to ensuring that they are kept up to date and reflect the true position. Where this ceases to be the case, advice should be taken to address any issues.
  EWCA Civ 1201
David Lee, Associate, Fladgate LLP (firstname.lastname@example.org)