The death of informal unanimous shareholder assent?

The recent Supreme Court decision in Ririnui has triggered some debate about the efficacy of the earlier principle that the informal unanimous assent of shareholders binds the company.

There are a number of difficulties with citing the decision as authority on the matters that lie at the heart of this article – because the broad thread of the decision hinges on administrative law issues on which the Supreme Court, by a majority, allowed an appeal in part only. And, of the majority, only O’Regan J. addressed the company law issue in any detail. Nonetheless, at least one commentator has suggested that the comments by O’Regan J. provide a useful steer on an important (but controversial) company law issue.

Briefly, the principle of informal unanimous assent (the Duomatic principle) after a 1969 English decision was that where shareholders who have a right to vote at a general meeting of the company assent to a matter which a general meeting of the company could carry into effect, that assent is as binding as a formal resolution.

In Ririnui the applicant sought the judicial review to overturn a decision by Landcorp to sell one of its farms. One of threads of argument pursued by the applicant was that Landcorp’s shareholding Ministers could (relying on the Duomatic principle) have intervened in the sale process and, in effect, instructed the directors not to proceed with the sale. This is a sort of reverse application – because the Duomatic principle is usually seen as allowing informal (shareholder) ratification where the correct formalities have not been observed. Often the effect of that ratification is to excuse directors from breaches of duty.

Application of the principle in New Zealand

In a New Zealand context, Duomatic was extended by the 1994 Court of Appeal in Kensington and has been thought as being summarised by the comments of Lord Hoffman, in the 1995 Privy Council decision of Meridian Global Funds Management that:

“…the unanimous decision of all shareholders in a solvent company about anything which the company under its memorandum of association has power to do shall be the decision of the company.”

This extension is not without its difficulties, particularly since the Companies Act 1993 came into force. In particularly, section 128 of the 1993 Act delegates the management of the company to the board. As a result, when shareholders do not agree with management of the company’s business, it is generally thought that their remedy is to remove the board.

Ririnui

In the High Court, Williams J relied on Duomatic as authority to support his finding that the shareholding Ministers of Landcorp could have stepped in to stop the sale of a farm which was potentially subject to a Treaty claim. By contrast, the Court of Appeal held that Duomatic is not authority for the proposition that a company’s shareholders have the power to make management or operational decisions normally reserved to shareholders. Instead, the Court of Appeal accepted that the purpose of the Duomatic principle was to permit corrections of technical non-compliance.
In the Supreme Court, the only judge to address Duomatic was O’Regan J. And, besides indicating that he did not believe that the Duomatic principle did not apply to SOEs (because he considered that any resolution to amend the constitution to reallocate a management power from the board to the shareholding Ministers would not be consistent with the SOE Act, which legislatively allocates powers between the board and shareholders in a carefully calibrated way), he noted his doubts that Duomatic had survived the passing of the Companies Act 1993.

This is a matter that is currently the subject of some debate in academic circles – with Professor Peter Watts suggesting that Duomatic does survive (and that it would be highly inconvenient if it did not). By contrast, Professor Susan Watson and, in a very recent article, Auckland barrister John Land cast serious doubt on its survival.

While O’Regan did not reach a final landing on the issue, his judgment points to three reasons why the enactment of the 1993 Act brought about the demise of Duomatic:

• Law Commission: The Law Commission reports that led to the enactment of the 1993 Act can be taken as indicating a rejection of the Duomatic principle. Report No. 9 discusses whether to include a provision allowing shareholders acting by unanimous resolution to exercise powers of the company and decided against it. Instead it proposed the allocation of powers reflected in what is now section 128 of the 1993 Act (see below) and that, subject to the constitution would not leave shareholders with a residual power to decide on management matters – which were the domain of directors.

Interestingly, the Law Commission also proposed that unanimous shareholder approval to ratify a breach of directors’ duties not be allowed – but the section 177(4) of the 1993 Act preserved the existing law – allowing the ratification or approval by the shareholders or any other person of any act or omission of a director or the board.

• Section 107: Section 107 of the 1993 Act expressly provides for the unanimous assent of shareholders to certain specified actions, which can be taken as an indication of a legislative intent that the Duomatic principle is now limited to those specified actions – subject to certain conditions being met (including that the assent be in writing and (in all but two cases) the solvency test met). Therefore, it would be quite odd to provide a finite list of matters that can be achieved by means of a section 107 entitled persons’ assent – and at the same time keep alive a much wider (and more informal) power for shareholders to undertake certain management functions.

• Section 128: The allocation of management powers to the Board under section 128 of the 1993 Act also suggests that, in the absence of a reallocation of such powers to shareholders by the constitution, shareholder approval of such actions would be ineffective.

The commentary by Professors Watts and Watson, respectively, pre-dated the Supreme Court decision in Ririnui. The John Land article concludes that O’Regan J.’s comments, whilst not an essential part of the Supreme Court decision (in which the majority allowed Landcorp’s appeal, in part, on other grounds), should be followed and that the earlier decision in Kensington, which predated the 1993 Act, and contemplated some sort of default setting that shareholder resolutions on management issues was no longer relevant.

Takeaways

The primary takeaways from the Supreme Court decision in Ririnui and recent commentary appear to be that:

• Unless the constitution specifically allows – shareholders cannot exercise management decisions. (Note also that section 109(3) of the 1993 Act does provide scope for the constitution to expressly permit shareholders to pass binding resolutions on management issues. I have yet to encounter a constitution which does so).

• Otherwise, the scope for shareholders to deal with management matters is specifically limited to:

o the matters covered by the unanimous asset procedure under section 107; and
o the power to ratify the acts or omissions of directors or the board that is preserved by section 177(3).

Failing that, the remedy of shareholders who disagree with management decisions taken by the board is to remove the directors.

Shareholders’ Agreements

One permutation on these issues which does not appear to have (yet) come before the Courts is the interaction between the constitution and a Shareholders’ Agreement (if there is one in place).

In my experience, it is an increasingly common drafting practice (where there is a Shareholders’ Agreement in place) to state, in the constitution, that the directors’ powers of management are subject to the restrictions contained in the Shareholders’ Agreement.

Most Shareholders’ Agreements will contain negative assurance or veto powers – stating that certain types of decisions (many of which affect matters that might otherwise be regarded as management decisions) may not be made without certain thresholds being met in the form of shareholder approvals.

Increasingly, those provisions in the Shareholders’ Agreement are also being reflected by constitutional provisions which address:

• The nature of the Shareholders’ Agreement: Noting that there is, in addition to the constitution, a Shareholders’ Agreement in place which is binding as between each shareholder in accordance with its terms.

• Primacy: By providing that the constitution shall be applied having regard to the terms of the Shareholders’ Agreement – and to the extent of any inconsistency between the terms of the constitution and the Shareholders’ Agreement, the provisions of the Shareholders’ Agreement shall prevail.

• Limits on the Board’s management powers: Some constitutions now go so far as to provide that the Board’s powers of management (being those delegated to the Board under section 128 of the 1993 Act) are limited by any specific provisions in the constitution or the Shareholders’ Agreement.

Ultimately, the question of the relationship between the constitution and the 1993 Act and Shareholders’ Agreements must come before the Courts. Whether the constitutional provisions referred to above can be said to incorporate key elements of the Shareholders Agreement into the constitution (and thereby limit directors’ management powers by reference) by reference and thereby effectively rely on the limitation contemplated by section 128 is an interesting question. Possibly, the issue is more problematic where a subset of the shareholders (say – only the majority shareholders) is a party to the Shareholders’ Agreement.

Finally, in the context of what has in some quarters become the new weapon of choice as a vehicle for commercial transactions, namely the limited partnership – there is scope for further permutations. Amongst the practices that have developed are different structures in which the limited partners do or don’t also hold shares in the general partner. In some cases, there is appearing Shareholders’ Agreements (sometimes labelled ‘General Partner Agreements’) governing the actions of the general partner. Just what a Court would make of such an agreement – where it purported to give the shareholders of the general partner (who may or may not be different to the limited partners) veto rights or something stronger affecting management decisions by the general partner is a topic for another day.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.