Contracting Out of Company Law: Section 459 of the Companies Act 1985 and the Role of the Courts
| Published date | 01 November 1992 |
| Date | 01 November 1992 |
| Author | Christopher A. Riley |
| DOI | http://doi.org/10.1111/j.1468-2230.1992.tb00941.x |
Contracting Out
of
Company Law: Section
459
of
the
Companies Act
1985
and the Role
of
the Courts
Christopher
A.
Riley
*
Introduction
Since the late
1970s,
company law theory has been enriched by a vociferous debate
about the role of contract in explaining corporate personality.’ The advocates of
the contractual cause seek to challenge traditional legal theory by arguing that
companies represent a mere nexus of contracts between those various corporate actors
-
shareholders, directors, creditors, employees, etc
-
interested
in
the affairs of
the company.
This article seeks to join the debate and pursues two objectives. First, Section
I
describes and criticises the contractual approach. That approach purports to be
comprehensive in its application, in the sense of addressing
all
corporate relationships
and all classes of companies, yet the emphasis has usually been upon the larger,
public company and upon the shareholder-management relationship within such
companies. The focus for this article is the smaller, private company and the inter-
shareholder relationship therein. Moreover, as much as the contractarian position
seeks to offer a normative framework for all corporate contracting, it has proceeded
at a relatively abstract level, failing to address itself adequately to the detail of those
contracts it suggests constitute the company. This article sets out to examine the
actual process and form of inter-shareholder contracting. In
so
doing, it emphasises
the role of the judiciary in that process, and argues for the inevitability and legitimacy
of limited interference
in
private contracting.
Second,
it
is a theme of this article that the construction of the contract between
shareholders is driven by the particular remedy which is sought. To this end,
Section
I1
focuses upon the unfair prejudice provisions of sections
459-461
of the
Companies Act
1985.
This appears to be the regime resorted to with growing
frequency by minority shareholders, and its interpretation and application by the
courts should tell us much about the judiciary’s attitude towards the theoretical
position advanced
in
Section
I,
as well as offering the opportunity to look at
contractual construction
in
the context of specific remedies.
I
The Contractual Debate in Company Law
The Nexus
of
Contracts
Theory
The nexus of contracts theory challenges the hitherto dominant Managerialist schools
of thought in corporate law doctrine, which concentrated upon the problems posed
by the existence of hierarchies within corporate structures, and by imbalances of
*Lecturer in Law, University of Hull.
I
would like to thank Colin Baxter, Brenda Hannigan and the two anonymous readers for their helpful
comments and criticisms
of
earlier drafts
of
this article.
I,
of
course, remain responsible for all errors
and omissions.
A
useful
introduction
to
the contractual debate is provided by the collection
of
papers in 89
Colum
L Rev
7 (1989) and by Bratton, ‘The “Nexus
of
Contracts” Corporation: A Critical Appraisal’ (1989)
74
C~irnell
L Rev
407.
1
782
7he
Modern
hw Review
55:6 November 1992 0026-7961
November
19921
Contracting
Out
of
Company
Law
power in the operation of company affairs. The received model of the company
had become one in which ownership and control was divorced.Z Management held
the upper-hand and used its position of control to engage in self-dealing or to excuse
its own shirking. Shareholders suffered thereby, and needed protection. Likewise,
it became increasingly accepted that other corporate actors
-
employees, creditors,
consumers
-
also suffered. Again, protection was needed. The consequence was
a steady growth of mandatory regulatory provisions, designed to control the power
and actions of dominant actors, and to improve the lot of those needing protection.
The contractual conception of the company offered a quite different perspective
and had its origins in a renewed interest by economists in the internal workings
of the firm, and of corporations as a species of firm. Companies, long viewed as
vertical hierarchies of command and power, and as an alternative
to
contractual
exchanges amongst individuals in the market place, were reconceived by economists
as representing merely a different nexus of contracts amongst
individual^.^
These
individuals were the various corporate actors who contracted as self-interested profit-
maximisers. If hierarchies did exist,
it
was argued, they were only a product of
the web of agreements constituting the company.
At one level, this model simply purported to describe more accurately the
underlying nature
of
the corporation. But at the normative level,
it
has proved
amenable
to
those arguing against government interference in the private ordering
of
intra-corporate relationships.
Central to the contractarian~’~ normative argument is the voluntary nature of
corporate relationships. Those who join companies volunteer to do
so,
having
perceived the personal advantages in
so
doing. In the smaller company, the terms
of their entry may be actually bargained out by them. In the larger company, the
terms may be standard and non-negotiable. Either way, however, the decision to
accept membership on the available terms is a voluntary one. Ostensibly weak and
inadequately protected minority shareholders in a company, whose constitution offers
little protection against an overpowerful majority shareholder or a self-perpetuating
management, have chosen to become involved in such a company and have consented
to
the terms of their entry. Based on such assumptions, and applying a liberal theory
of contract, it follows that freely contracting parties should be bound by such
agreements as they choose to make. It ought not to be the role of some institution
-
whether the courts or the legislature
-
to relieve a contracting party from a bargain
which becomes a matter of regret.
2
3
See generally Berle and Means,
The Modern Corporation and Private Property
(revised ed,
1967).
Coase had suggested, as early as
1937,
that comparisons might be drawn between the internal
organisation
of
firms and market exchanges;
see
Coase, ‘The Nature of the Firm’
(1937) 4
Economica
386
(discussed by Prentice in ‘The Theory
of
the Firm: Minority Shareholder Oppression: Sections
459-461
of the Companies Act
1985’ (1988) 8
OJLS
55).
However, modern interest is usually seen
as beginning with Alchian and Demsetz, ‘Production, Information Costs and Economic Organisation’
(1972) 62
Am
Econ
Rev
777,
and Jensen and Meckling, ‘Theory of the Firm: Managerial Behavior.
Agency Costs and Ownership Structure’
(1976) 3
J
Fin
Econ
305.
For an early acknowledgement
of these ideas in legal literature, see Winter, ‘State Law, Shareholder Protection and the Theory
of
the Corporation’
(1977) 6
J
Legal Srud
25
I.
There is some difficulty in using such a term, which might suggest a homogenous body
of
views
where none exists. However, there seems sufficient consensus about the basic normative claim
of
freedom of contract
to
permit such a label
to
be used for convenience. The main arguments here are
drawn from Easterbrook and Fischel, ‘The Corporate Contract’
(1989) 89
Colum
L
Rev
1416.
For
a criticism
of
some of the analysis of Easterbrook and Fischel by fellow contractarians, see Butler
and Ribstein, ‘Opting Out of Fiduciary Duties: A Response
to
the Anti-Contractarians’
(1990)
65
Washington
L
Rev
I,
16.
4
783
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