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Removal of Directors: Mechanisms and Implications

Removal of Directors: Mechanisms and Implications

A company may, for a variety of reasons, choose to remove a director from office. In this respect, due consideration should be given to what statutory or constitutional devices are available for the purposes of taking such a radical step, and what the resultant implications might be for all those who are implicated or are key players in this process.

Affording shareholders the power of removing directors is, in effect, a means by which the former may exercise a degree of influence over the latter, in terms of putting members of the board “on notice”, that their directorial positions are by no means sacrosanct, and ought not be taken for granted. In a nutshell, and as aptly pointed out by John E Moye in “The Law of Business Organisations” (2004) 166, the fact remains that “directors serve at the pleasure of the shareholders”. In essence, this serves to counter-balance and compensate for the fact that those who have been designated as directors of the company, cannot ordinarily be subject to the control of the shareholders as regards the day-to-day management of the business, neither can their decisions be overruled by members who may be disenchanted with a particular course of action that may have been taken by them.

The members’ power to remove directors may be conferred in a number of ways, one of which derives statutorily from the provisions of S178 (1) of the Cyprus Companies Law CAP 113 (“CAP113”) whereby a company is duly empowered to do so, by ordinary resolution, prior to the expiration of a director’s term of office, irrespective of anything to the contrary that might have previously been expressly agreed between the director and the company (accordingly, S178 will, for example, effectively override any stipulation in a director’s contract of service, shareholders ’agreement or articles of association which might seek to remove the corporate entity’s well-entrenched statutory entitlement to remove a director). An analysis and commentary on the application of this section will follow in the ensuing text of this article.

It is perhaps pertinent to draw attention to the fact that this far-reaching statutory power is readily available as a supplementary means by which a director may be removed from office. That this is so, is borne out by S178 (6) CAP113 which, inter alia, states that “Nothing in this section shall be taken as ... derogating from any power to remove a director which may exist apart from this section,”. Accordingly, the company would, for example, not be precluded from incorporating an alternative, more expeditious process in the articles, provided that no attempt is made to dislodge the company’s inalienable right of removal conferred by S178 CAP113. This is clearly reflected by the provisions of subsection (1), which may be seen to immortalise the applicability of the company’s mandate to rid itself of a director under this ‘rigid’ statutory mechanism, “notwithstanding anything in its articles or in any agreement between it and him”. Thus, an express stipulation in the articles that certain directors had the “power to terminate forthwith the directorship ... by notice in writing”, was held to have been valid, notwithstanding the fact that England’s Companies Act 1948 contained an identical removal provision corresponding to that of S178 CAP113 (Bersel Manufacturing Co Ltd v Berry [1968] 2 All ER 55). Conversely, should the company’s articles provide for a decision to remove which would be more difficult to attain (as with a 75% majority for a special resolution), there is nothing to prevent the shareholders in general meeting from resorting to the power conferred on them by S178 (1) CAP 113, which allows for a lower voting threshold.

Whilst implementation of S178 (1) CAP 113 would, on the face of it, appear to be a relatively straightforward exercise, the reality is that the applicable special procedural elements for giving effect to its provisions, are such that the affected director is, in essence, afforded certain safeguards which might well curtail the otherwise unimpeded execution of the proposed removal process. In circumstances where an ordinary resolution is to be pursued under S178 (1) CAP 113, it is essential that a special 28- day prior notification of the proposal be given to the company by the shareholder who has initiated matters in this regard (S178 (2) CAP113). In effect, any meeting convened by the shareholders prior to the expiration of this statutory period, will therefore effectively preclude the tabling of any motion for the director’s removal at that particular meeting. The procedure calls for a copy of the relevant notice to be made available to the director who, irrespective of whether he is also a member, should in turn be afforded the right to attend the meeting in question and (should he choose to do so), to make such representations as he considers appropriate in respect of his impending removal from office. (In this regard, an interesting point, but one that is no doubt open to argument, is that referred to by Paul L Davies and Sarah Worthington, Gower, Principles of Modern Company Law, 10th edition, at p381, which suggests that “apparently the director can be deprived of this protection if the articles contain an express power to remove a director by ordinary resolution and the company acts under that power”. According to the authors, this viewpoint would appear to be based on the wording of the S178(2) CAP 113 English law equivalent provision, which, in essence, applies only to the removal of a director “under this section”, and the stipulation in S178(6) CAP 113 which, as previously mentioned in this text, states that “Nothing in this section shall be taken ... as derogating from any power to remove a director which may exist apart from this section”. Furthermore, should he consider it useful or prudent to do so, the director concerned may, under S178 (3) CAP 113, and prior to the meeting being held, choose to make written representations “not exceeding reasonable length”, accompanied by a request to the company that his submissions are duly circulated and brought to the attention of the members along with the notice of the scheduled meeting.

S178 (3) CAP113 further provides that in circumstances where the company receives such representations belatedly, the director in question is at liberty to insist that these submissions are read out at the meeting (needless to say, by virtue of a director’s entitlement to put his case forward in person, the ordinarily permissible written resolution procedure would necessarily be inapplicable in such circumstances). Such rights on the part of the director are however qualified, to the extent that, under a proviso to S178 (3) CAP113, a court may deny him the benefit of stating his case in this manner (along with burdening him with an order for costs should it consider it appropriate to do so), in the event that it is satisfied that these “rights are being abused” by him so as “to secure publicity for defamatory matter”.

Although S178 CAP113, unequivocally precludes the circumvention of the inalienable right of members to remove a director by passing an ordinary resolution, the decision in Bushell v Faith [1970] AC 1099, is worthy of mention in that a director was able to by-pass the impact of the section by virtue of what the court considered to be a perfectly valid and permissible weighted voting stipulation in the articles. In effect, this enabled the shareholder/director in question (with an initial one vote per share), to block his impending removal by relying upon, and exercising a right conferred on him by the articles, to triple his voting power, on any attempt by the company to pass a resolution, and thereby remove him from office. The House of Lords adopted the view that the English law equivalent of S178 CAP 113 was not inconsistent with a company’s right to attach a special voting capability to selected shares, even when this prevented the applicability of the statutory right of removal.

In the Bushell case, the court sought to further justify its decision by referring to what under English law was the equivalent of article 2 per the TABLE A model articles of association, CAP 113, the wording of which would appear to expressly recognise the right to embrace weighted voting mechanisms by virtue of the stipulation to the effect that “any share in the company may be issued with such preferred ... special rights ... in regard to voting ... as the company may from time to time by ordinary resolution determine”.

The above decision has not gone without criticism. Indeed, in the case itself, Lord Morris, remarked in a dissenting judgment that the weighted voting article essentially constituted a “mockery of the law”, only to be contradicted by Lord Upjohn who, as one of the majority, broadly pointed out that to deny weighted voting would be tantamount to suggesting that Parliament had legislated that all shares should each be restricted to carrying one vote – something which was clearly not the case. In the final analysis, the consensus of opinion is that a weighted voting article would seemingly have justifiable utility value in a private company which is historically perceived as being akin to a so-called quasi or incorporated partnership, the members of which ordinarily actively participate in management, with the reasonable expectation that they may shield themselves against removal (Gower, Principles of Modern Company Law: Paul L Davies and Sarah Worthington). The upshot of this position is that it would conceivably be more difficult to justify the notion of weighted voting in the context of larger corporate entities where, needless to say, there are likely to be relatively frequent changes amongst shareholders which would, in practical terms, hardly be conducive to the adoption and implementation of a device which alters voting strength in this manner.

It is possible for the removal of a director from office to be be achieved by effecting alteration of the articles pursuant to section S12 CAP113. Should such a step be anticipated in time by the director concerned, it may be open to him to seek an injunction with a view to preventing the company from implementing his contemplated removal from office. However, if the company proceeds unimpeded and goes through with the proposed amendment of the operative article, compensation may thereby be sought, as was indeed the case in Southern Foundries (1926) Ltd v Shirlaw [1940] AC 701, where damages for breach of contract were nevertheless forthcoming, despite the fact that the company had properly exercised its statutory power to alter the relevant provision of the articles (so as to confer the right on a parent company to remove the managing director of a subsidiary entity).

What might conceivably be regarded as a possible negative repercussion following the removal of a director, is that any initiative taken by members under S178 CAP113, might constitute a consequential breach of an operative service agreement, a prospect which could generate adverse cost implications for the company. In this regard, it is pertinent to first draw attention to S178 (6) CAP113 which, inter alia, expressly provides that “nothing in this section shall be taken as depriving a person ... of compensation or damages payable to him in respect of the termination of his appointment as director...”. In essence, this would mean that, even In circumstances where a director were to have a fixed term contract of employment, the continuing validity of which hinges on his retaining his holding the office of director, any removal effected pursuant to this section would nevertheless permit him to institute proceedings for the unwarranted termination of his contract of service, be this on the basis of contractual principles for wrongful dismissal, or in conformity with his statutory rights under the Termination of Employment Law 24/1967 (as amended), for unfair dismissal (Southern Foundries (1926) Ltd v Shirlaw [1940] AC 701).
In the context of matters referred to in the preceding paragraph, it is of course conceivable for the agreed terms of an executive director’s terms of employment to expressly provide that , in the event of a cessation of his directorship, his operative contract of service would, ipso facto, terminate accordingly. Any breach thereof could thereby trigger payment of damages in conformity with an express term which might call for a pre-determined level of compensation – suffice it to say that if the affected director had a hand in ensuring that this would entail a substantial payment by the company, it might well turn out to be prohibitive enough to deter the company from taking action, thereby effectively entrenching the director’s position in the face of any attempt to remove him from office.

Whilst S178 CAP 113 makes it abundantly clear that the company is at liberty to remove a director “notwithstanding anything in its articles or in any agreement between it and him”, it would appear to be settled that whilst the corporate entity itself is precluded, under this provision, from validly contracting to refrain from removing a director (as with an article which in effect fetters its statutory power to do so), the members themselves can, as between themselves, nevertheless agree to do this, by incorporating an appropriate contractual term in a shareholders’ agreement. Authority for this proposition, under English law, derives from the decision Russell v Northern Bank Development Corporation Ltd [1992] 1 WLR 588, a case which will no doubt have a significant persuasive effect on how the matter might conceivably be approached by the courts in Cyprus. Whilst the facts did not relate to a director’s removal, but dealt with the company’s inalienable statutory power to alter the articles by special resolution, the principle enunciated by the House of Lords in Russell, effectively affirmed that an agreement outside the ambit of the articles and entered into between the members (as to the manner in which they would utilise their voting power), could arguably be applied to effectively fetter a company’s S178 CAP 113 statutory power of removal and thereby entrench the director’s position on the board.

Another factor which might well pose an obstacle to the removal of a director is the prospect that he himself might bring forth a claim against the company, on the basis of what he considers to be unjustified or inappropriate corporate conduct on its part. In this context, it stands to reason that in smaller corporate entities, there is, needless to say, a greater likelihood that the removal of a director would accelerate the prospect of an accentuated adverse impact on operational and managerial effectiveness, due to the seemingly closer/overlapping roles of shareholders and directors which typify so-called quasi-partnerships. The upshot of this is that any director faced with the prospect of removal, might conceivably contemplate a claim under S211 CAP 113, with a view to seeking an order for the compulsory winding-up of the company, on the ground that it is “just and equitable” to do so (Ebrahimi v Westbourne Galleries Ltd [1973] AC 360). Alternatively, circumstances may be such that the aggrieved director may seek to prevent his removal by resorting to another remedy, in the form of petitioning for relief pursuant to S202 CAP 113, on the basis that the affairs of the company were being conducted in an oppressive manner (Re Bird Precision Bellows Ltd [1984] Ch 419).

A key question which emerged as a direct consequence of the removal of a director, is what impact this is likely to have on his shareholding in the event that he is not only an officer (or indeed an employee as well, if he is an executive director) but also a member of the corporate entity. In such circumstances, it stands to reason that in the absence of any prescribed mechanism to this effect, no pressure may be brought to bear on the affected director to shed his shares by way of a sale to the company’s shareholders. Indeed, any attempt to achieve this by way of a purported alteration of the articles of association under S12 CAP113, might also conceivably unleash a claim (per S202 CAP113), from the director, in his capacity as member, to the effect that the affairs of the company are being conducted in an oppressive manner (vis-a-vis the minority shareholders). This remedy would only be available in circumstances where the court would ordinarily be justified in making a winding-up order but nevertheless considers it would be unfairly prejudicial to the minority to liquidate the company under the circumstances (Iordanou & Co v Confirmex (Ioannou Bros) Ltd and Others: District Court Judgment No. 10304/97 and Re Pelmako Development Ltd: Civil Appeal No.8966, 10/9/1999).

In light of the foregoing, the issue of how to deal with a director’s shares on his impending departure from office, should, in the absence of any stipulated resolution process, best be dealt with and resolved by a company initiative to offer to buy the shares in question, through an appropriate process of negotiation. A more effective approach to such important matters, is to ensure the inclusion of a so-called “bad leaver” or “good leaver” clause, as the case may be, (otherwise referred to as a “buy-back” clause), which would necessarily avoid subsequent rash or ad-hoc decisions that may not necessarily bring forth the desired result. In this context, one might, for example, be considered a “bad leaver” if he were to be regarded by the company as being in breach of an operative contract of service. Conversely, a director/shareholder would, for instance, be perceived as being a “good leaver” if his removal from office would be tantamount to wrongful or unfair dismissal. In the latter case, the departing officer might well be given the option to sell his shares to the company rather than being obliged to do so. Should he elect to dispose of his shares, the purchase price would in all likelihood reflect a fair market value to be determined by the board of directors or, alternatively, by an impartial external expert.

Whilst the requirements and process for the removal of a company director might at first sight appear to be a relatively straightforward corporate exercise, in essence, and in light of the issues highlighted in this article, one may conceivably encounter a plethora of procedural, constitutional, legislative, contractual and other legal hurdles, culminating in significant and often costly consequential implications which would need to be carefully considered and diligently addressed. Accordingly, in order to alleviate any complications which may emerge to the detriment of corporate stability, it is imperative that “preventative” expert advice or “remedial” professional guidance is sought, with a view to pre-empting or resolving (as the case may be), complex problematic issues and possible adverse repercussions which are often associated with initiatives to remove a director from office.

 

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