510-lecture 10 Ownership

Law for New Zealand Business Week 10 Ownership, Financing and Distributions

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Objectives  To explain the differences between the position of shareholders (owners) and debenture holders (creditors)  To identify and explain the main rights enjoyed by shareholders

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Main forms of investment  Become a shareholder= own part of a company  Become a lender-= have a claim against the company

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A diversion:  How does a company obtain long-term finance?  Can invite the public to invest- in which case the Securities Act 1978 applies  This requires that a company (or other body) comply with disclosure requirements under the Act and regulations 1983 l4nzb11

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This regime covers:  Equity securities (shares)  Debt securities (debentures and bonds)  Participatory securities (syndicates, unit trusts etc)  Important- issues to members of the public

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And involves  The Securities Commission which supervises and enforces the regime 

Will take cases if necessary

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The differences between shareholders and debenture holders shareholders

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The differences between shareholders and debenture holders shareholders

Participate in Distribution -If declared

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The differences between shareholders and debenture holders shareholders

Participate in Distributions -If declared

Vote in General Meeting

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The differences between shareholders and debenture holders shareholders Participate in liquidation Participate in distributions -If declared

Vote in General Meeting

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The differences between shareholders and debenture holders debenture holders

shareholders Participate in liquidation Participate in distributions -If declared

Vote in General Meeting

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The differences between shareholders and debenture holders debenture holders

shareholders Participate in liquidation Participate in distributions -If declared

Vote in General Meeting

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Receive interest

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The differences between shareholders and debenture holders debenture holders

shareholders Participate in liquidation Participate in distributions -If declared

Vote in General Meeting

Receive interest Receive information

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The differences between shareholders and debenture holders debenture holders

shareholders Participate in liquidation Participate in distributions -If declared

Vote in General Meeting

Receive interest

Realise security

Receive information l4nzb11

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The main rights of shareholders  Shareholders are owners (equity)consequently they have powers in general meeting and as members of groups (shareholders with the same rights)

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These collective rights that are:  Exercised in General Meeting include:  

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Oversight of Directors Certain decisions are the prerogative of general meeting either by law or the constitution Appointment of auditors

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Oversight of Directors  Nb- separation of powers  But shareholders have the power to question Directors (s109) and vote them in and out

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Prerogatives under law or the constitution  The law specifies some decisions must be reserved to general meeting

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Prerogatives under law or the constitution  The law specifies some decisions must be reserved to general meeting

Ordinary resolution (s105)

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Prerogatives under law or the constitution  The law specifies some decisions must be reserved to general meeting

Ordinary resolution (s105)

Special resolution (s106)

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Prerogatives under law or the constitution  The law specifies some decisions must be reserved to general meeting

Ordinary resolution (s105)

Special resolution (s106)

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Unanimous Consent (s107)

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Why the differences?  Relate to: 

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The level of importance to the future of the company The impact on the rights of some or all shareholders The importance of informed choice Reduction in information otherwise provided

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Ordinary resolution  Applicable unless otherwise specified by the Act or the constitution  Includes:  

Appointment of auditor Appointment of Directors

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Special Resolution  Alteration of the constitution (s32)  Alteration of class rights (meeting of affected class) (s117)  Approving a major transaction (s129)  Approving an amalgamation (s221)  Putting the company into liquidation (s241 etc) l4nzb11

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Unanimous consent  Relates not so much to decisions but procedure 

If this does not comply with the Act Dividend  Discount scheme  Acquisition of shares  Redemption of shares  Financial assistance  Remuneration and other benefits for Directors 

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Nb: most likely to apply to small companies

 Appointment of auditor- decision not to appoint (at meeting)- s196(2)- does not apply to issuers l4nzb11

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Important right of shareholders  To receive a return on their investment

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Important in this context:  Old concept of capital maintenance  

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Companies had a registered share capital Dividends and other distributions could be paid out of revenue only The liability of members was the amount unpaid on shares- ie par value less what had been paid (excluding any share premium)

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Related to this:  The issue of a company buying its own shares or providing assistance to others to buy them  

Was a reflection of the capital maintenance rule However it caused problems and in some cases prevented management from taking steps that might benefit shareholders

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The issues relating to company capital  Were dealt with by the Law Commission

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The Report on Reform  “arbitrary and misleading concepts of nominal capital and par value should be abandoned and instead more direct safeguards be introduced for creditor and shareholder protection”  Hence its replacement with consideration of “solvency”  Also dealt with matters of share repurchase, assistance and distributions l4nzb11

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Therefore what we have now is:  The equity of a company is deemed to be the paidup capital.  This can be made up of various classes of share with different rights attached to them.  The need to identify those shares as “common” or “preference” has gone.  A company can issue similar shares but with different values at different times  When considering issues of repurchase, assistance and distribution, solvency is all important l4nzb11

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So what exactly is this “solvency”?  Before any distribution to shareholders can be made, the company must satisfy the “solvency test”  This means that once the distribution has been made, the company must remain solvent- able to meet its debts and obligations l4nzb11

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And this involves?  Balance-sheet solvency- assets exceed liabilities  Liquidity- a company can meet its debts as they fall due  Nb Applies to ALL distributions, not just dividend  Therefore includes: repurchase, assistance to purchase, reduction in liability of shareholders

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Why solvency rather than capital maintenance?  Because capital may not reflect the total indebtedness of the company  Because if a company distributes money while insolvent it is using the creditors’ money

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Summary  Shareholders (equity) are different to debenture holders (debt) in that their fortunes go with the company  Collectively they ARE the company in the sense they exercise their voting power in general meeting- different levels of majority approval are needed for different types of decision. l4nzb11

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The particular issue of shareholder remedies

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Reasons  Split of power between shareholders and directors  Directors have access to information and voting power  Potential for personalities to overwhelm business judgment  Power corrupts?? l4nzb11

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What can shareholders do to avoid problems?  The Act gives the shareholders certain rights. These are: Restrain buy-back (s61(8)) Information and Inspection (s178(3))

Restrain special redemption (s71(7)) Restrain special assistance (s178(6) & (7)) l4nzb11

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What if a member of the company believes something fishy is going on?

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What legal actions are available?

Derivative action (s165) nb tho, s177

Personal action (s169) Representative action (s173)

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Potential problem:  Negligent or dishonest act (normally by a director) affects the company  Therefore company should sue  Such action may be able to be ratified in general meeting  Directors often have majority voting power  Therefore can ratify 

Foss v Harbottle l4nzb11

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Question of ratification under s177 •Pavlides v Jensen (1956) cf •Daniels v Daniels (1978)- “to put up with foolish directors is one thing: to put up with directors who are so foolish that they make a profit of ₤115,000 odd at the expense of the company is entirely different” (Templeman J.) l4nzb11

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What if shareholders are prejudiced? S174

Unfairly discriminatory and unfairly prejudicial

Oppressive conduct

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What sort of situations are we talking about?- s175 Special offers (s61)

Preemptive rights (s45)

Stock exchange acquisitions (ss63 and 65)

Consideration (s47)

Financial assistance (ss76, 78 and 80)

Dividends (s53) Acquire own shares (s62) l4nzb11

Alteration of rights (s117) Major transactions (s129)

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Remedies available Liquidation Acquisition Compensation

rectification Alteration of constitution

Receiver

Regulation of future conduct

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Liquidation  Most significant- on “just and equitable grounds”  Most likely where the company is effectively a partnership- raises questions of mutual trust  

Vujnovich v Vujnovich (1988) Ebrahimi v Westbourne Galleries (1973)

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Note: buyout rights  When?

Major transaction

Changes to the constitution

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Buyout- Procedure Give written notice Board gives written notice of: Rescind

agreement Arrangement for purchase

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Apply to court

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What does such a shareholder get paid?  A fair and reasonable price- this might need to go to arbitration

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So that reflects the rights of shareholders  The principal intent is to ensure the majority do not use their power unfairly as against the minority or to adversely affect the company and its future viability

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The final aspect we need to look at is:  The responsibility of directors to account to shareholders (and other interested persons???!!)  And we will talk a little about liquidation and receivership  That is for next week- the last week for new material! l4nzb11

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Oh, and before you go  The format of the exam is the following:   

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Five questions each worth 20 marks. It will be an open book exam Question one is a general question allowing you to draw on the research and writing you did for your presentations The other four include two parts: Part 1- explain the meaning of specified terms- each is worth three marks (choice of three out of five)  Part 2- problem question asking you to apply the relevant law Each question will be headed up to demonstrate what general topic is being examined). This part of the question will be worth 11 marks. l4nzb11 52 