Theresa May on Corporate Governance: A misguided approach?

When last I wrote, I rose some preliminary objections to the idea of employee representation on corporate boards in the UK. I am not against strengthening the position of employees because I do not believe the current 'normative consensus' espoused by Hansmann and Kraakman: that the best way to achieve aggregate social welfare is through running the company in the collective interests of shareholders.

However, I noted that giving employees a voice on the board would be nothing more than a palatable political response because of the legal structure in companies it probably would not change the way companies operate. An employee representative would be under the same duties as any other director and it may cause new conflicts of interest or raise questions as to their independent judgement.

Now, fortunately, her government appears to have rowed back from this position and it is being reported instead that the proposed reforms will include:

1. Introduce corporate governance codes to private companies
2. Require companies to publish pay ratio between CEO chief executive and average employee
3. Improve effectiveness of remuneration committees and the extent to which they should consult shareholders and the wider company
4. Introduce binding votes on executive pay packages

The reasons behind this reform are, supposedly, to 'increase public trust in business in the face of the rise in anti-globalisation and anti-business sentiment'.

In response to this, the common objection is dusted off that more controls on business and boards will lead to some sort of mass exodus of top management talent from the country, just as there was a mass exodus from Britain after Brexit and America after Trump... as if the only thing tying management to this country is whether or not shareholders have a binding say on their pay.

Yet, what I object to under these proposals is the government's inability to think outside the box. Everytime, there is a scandal we hear the same story: "More shareholder power", that is the answer, despite seemingly ignoring considerable evidence that shows increasing shareholder power does not improve business.

There is the work from Cheffins that shows increase in investor confidence often comes from essentially soft forms of control rather than granting shareholders more rights.

There is work from Armour, Siems et al that shows increasing shareholder power in some cases decreases prosperity as it significantly relates to reduced public listings.

We must also consider some of the seminal work on agency theory by the likes of Fama, who highlighted matters such as portfolio theory. Shareholders diversify their risk and have little incentive to monitor one company. There is also the problem of information asymmetries between company and shareholder, that even if they did have the incentive they may not be properly informed to make good or fully informed decisions.

There is also the fact the government point to other countries' practices, such as the US, France, and Australia, but ignore work by Tubner that highlights the impact of developing legal systems by analogy or legal transplant can result in legal irritants as laws operate out of context. Not to mention using Australia as an analogy for legal development of strengthening shareholder power ignores there own reforms of removing the 100-member rule that allows 100 shareholders to table resolutions at annual general meetings.

Then you have my own current work (forthcoming, so don't want to give too much away just yet) that shows even if shareholders tried to legally enforce anything against the company, the courts are parsimonious in allowing shareholders to enforce the company's rights due to restrictions on locus standi.

So, I am not sure the case is really made out, that the way to improve public confidence in business is to give shareholders more power. It is built on a faulty premise that: (1) we trust shareholders to make the right decision, or any decision at all; and (2) the faulty premise that the best way to achieve aggregate social welfare is to run companies for the shareholders' collective interest.

This begs the question, of course, what should we do? Now, I have many angles I could take on this, but I draw attention to Cheffins' work on whether law matters, and I also draw inspiration from Schynder's recent paper on why should law matter.

It would appear that the objective of reforming the law, i.e. why should law matter, is to improve public confidence. It does appear there are other objectives, such as deterrence, but confidence appears to be the main concern. The reasons for this are highlighted in the news article such as 'good governance helps companies take better decisions, for their own long-term benefit and the economy overall'; and 'businesses are a pillar of our society, creating employment opportunities and contributing significantly to funding our country's public services'. Seemingly if we are confident in what businesses are doing we can rely on them and we as the public and consumers become more confident in the market and continue to spend.

Cheffins points to the different ways investor confidence is improved, noting this is not achieved through increasing their rights. Factors such as financial intermediaries and the stock exchange are better at achieving this.  One must stress that this looked at increasing investor confidence, so one must be careful in drawing an analogy between investor and public confidence. But from this observation our working hypothesis could be increased shareholder rights will reduce public confidence in business.

It is taken from this that increasing shareholder rights we would observe a decrease in public confidence in business. While I said it was a danger to draw analogies with investor confidence as to whether increased rights would reduce public confidence, the hypothesis can be supported by the idea that shareholders, with their lack of incentives, will fail to monitor the company properly to increase confidence; those that do monitor the company will only do so to increase their own personal wealth; and when things do turn sour shareholders will lack the appropriate legal mechanisms to enforce the desired standards through the courts or company resolution.

If we want to increase public confidence we need more imaginative ways of doing that. Now, I am openly in favour of good regulation of business. I am not necessarily going to say what regulation that should be, as I do not think it is a matter for company law, nor is there the space or time to do so here. But, for example, employment law could be strengthened to support the statement above. That we rely on business for employment opportunities. We are not going to be confident in business if we feel they can remove us from our role in favour of short-sighted profit. So getting the balance of employment law right can help increase confidence. Yet, this Conservative government has gone about restricting employment rights.

This then boils down to what I said previously, these reforms are nothing more than palatable political responses.

Derivative Claims: Bridge v Daley [2015] EWHC 2121

Cases are slowly filtering through on the new derivative claim procedure as I work on my British Academy project on the subject. Bridge v Daley [2015] EWHC 2121. Bridge is the 18th derivative claim to be heard under the Companies Act 2006, part 11, and the 17th of note for my empirical study, since FanmailUK.com Ltd v Cooper [2008] EWHC 2198 was adjourned. (NB: table updated 11th Dec 2015 to incorporate 18th case Hook v Sumner [2015] Unreported)

The relevant factors from Bridge are detailed below, including practical circumstances and outcome. The particular points of note from this case relate to: 1) information asymmetries between weaker and stronger parties; 2) statutory procedure; 3) wrongdoer control; and 4) it involved a plc.

I will not say too much about these but briefly outline the points:

1) Information asymmetries
This was brought by a minority shareholder, Bridge, who owned 1.83% in an AIM company. He appeared as litigant in person but failed to substantiate any of his claims against the four directors since he had no proof of any of his claims nor could he direct any of his claims against any particular director. The judge (at [76]) was highly critical of this noting Bridge's submission that the directors were "all in it together" as insufficient for establishing a cause of action against all four. He also noted that Bridge was 'a highly opinionated individual who is incapable of any objective analysis of evidence placed before him' (at [85]).

Bridge surely should have taken legal advice but his lack of any evidence is a telling problem with derivative claims. His claims were severe, despite not substantiated, and the judge noted that he might have a remedy for unfair prejudice. He did also have the support of a further 4 minority shareholders as the claim progressed. Therefore, the information asymmetries that exist between shareholders and directors/controllers can be a difficult obstacle to seeking redress through the courts since it is difficult to turn suspicions in to substantive arguments.

2) Statutory Procedure
This links to a second point where one might be critical of the court for not following the statutory procedure. At [98] the judgment notes that Bridge should have seen his claim was "doomed" to failure. Why did it get this far then where time and expense of the company was taken up? The judge noted that it was unlikely that there was even a prima facie case but seemed very confused as to what was required for a prima facie case based on his citation of the incorrect statement from Stimpson on establishing one. In Stimpson v Southern Landlords Association [2009] EWHC 2072, as cited by Bridge, it was said by Judge Pelling that in considering whether there was a prima facie case that the court was bound to consider those factors in section 263(3) and (4) and all other relevant circumstances. This is wrong. A prima facie case is set out in s.261 that it must be: 1) a cause of action vested in the company; 2) in relation to a breach of duty, trust, negligence or default; and 3) brought by a shareholder. The discretion is for part two.

The judgment is littered with contradictions by the judge. Despite citing Stimpson he had earlier cited Iesini v Westrip Holdings Ltd [2009] EWHC 2526 (at [13]-[15]), which is the correct authority for the statutory procedure, where it was noted that at the second stage, something more is needed than a prima facie case to satisfy the court that permission should be given.

Therefore, in one part of the judgment the judge claims a prima facie case is about the whole circumstances of the case, whereas earlier he recognises that the procedure is two distinct parts.

This contradiction is followed by failing to hear the ex parte application separately, describing it as pragmatic to do so (at [9]). It is difficult to see how it is pragmatic to dispense with the need for establishing a prima facie case and involving the company when the judge later uses terminology such as the claim was 'doomed' and the claimant had failed to clearly demonstrate a prima facie case since Bridge could not direct his claims at any director in particular or submit them in the form of breaches covered by the Act.

By not hearing an ex parte application the company was involved unnecessarily, which is what is meant to be avoided by having an ex parte application. Both Stimpson and Bridge failed to hear a prima facie case but both were dismissed for mandatory bars. Both stated that not hearing the first stage was pragmatic but do not cite any authority for judges being permitted to avoid a statutory procedure on the basis of pragmatism.

3) Wrongdoer control
This case revisits the issue of wrongdoer control and confirms that wrongdoer control is not a bar to claim but can form part of the discretion when determining whether to grant permission. In this case, the judge found no reason why the company should not pursue this claim if it wished to do so, since independent shareholders did not support the claim nor did the company.

4) Plc
The final point is that this was a public limited company. It serves as some anecdotal evidence of attempts at frivolous litigation and the wider availability of the derivative claim itself. The fact the claim got as far as it did might cause some minor concern for companies.

Figures and tables updated 11th Dec 2015.

Therefore from the 18 cases the following stats on derivative claims are:
Prima Facie Case: 100% (18/18)
Mandatory Bars: 27.78%% (5/18)
Permission Refused Discretion: 38.46% (5/13)
Permission Allowed Discretion: 61.54% (8/13)
Permission Refused Overall: 55.56% (10/18)
Permission Granted Overall: 44.44% (8/18)

Case Name	Dismissed For/Allowed	Significant Circumstances Considered
Bamford	Dismissed at court’s discretion	Wrongdoer control
Bridge	Mandatory Bar	No reasonable director would pursue the claim; alternative remedy; company decision; independent views; wrongdoer control
Cinematic Finance	Dismissed at court’s discretion	Majority bringing derivative claim; wrongdoer control; side-stepping insolvency rules
Cullen Investments	Permission granted	Hypothetical director would question if full and frank disclosure was given for authorisation; and case was simple on this premise; significant sum could be recovered based on lack of evidence to contrary; no basis for lacking good faith; hypothetical director would attach considerable importance; claim being funded by C so no financial risk to company and possible benefit; claimant’s action may give rise to action in own right but this was not a decisive consideration since the defence necessitated it and as a precaution since the company was entitled to some or all of the relief
FanmailUK	Case adjourned	Case adjourned
Franbar	Dismissed at court’s discretion	Strength of legal claims; ratification; alternative remedy
Hook	Permission Granted	Good faith; strength of legal claims; ratification; Alternative remedy
Hughes	Permission granted	Strength of legal claims; ratification; alternative remedy
Iesini	Mandatory Bar	Weak legal claims
Kleanthous	Dismissed at court’s discretion	Independent review of whether litigation was beneficial; strength of legal claims; alternative remedy; and benefit would be small
Kiani	Permission granted	Failure of defendant to produce any evidence to the contrary; alternative remedy
McAskill	Permission granted	Good faith; Alternative remedy; director would attach weight to the claim under s.172
Mission Capital	Dismissed at court’s discretion	Alternative remedy; little weight to a claim for wrongful dismissal of a director
Parry	Permission granted	Strength of legal claims; ratification; good faith; alternative remedy
Phillips	Permission granted	Alternative remedy; matter of urgency case was brought to recover sums taken from the company without good reason
Seven Holdings	Mandatory Bar	Claims did not relate to a breach of duty, care, negligence or default
Singh	Mandatory Bar	No director would continue the claim if acting in accordance with s.172; fides of the claimant in question; s.994 more appropriate
Stainer	Permission granted	Strong grounds that there had been a breach of duty; strength of legal claims; disinterested shareholders deceived in to approving the loan
Stimpson	Mandatory Bar	The impact an action would have on the interests of the employees; claim of little value compared to cost of claim; legal claims were not realistically arguable

Case	Type of company	Costs indemnity sought	Financial State of the company	Shareholding % (respondent/claimant)	Amount Claimed for*	Concerned a conflict of interest?	Length of proceedings
Bamford	Ltd	Yes	Solvent	50/50	£3,500,000	No	1 day
Bridge	Plc	Yes	Solvent	Minority (1.83%)/Director	N/A	Yes	2 days
Cinematic Finance	Ltd	N/A	Doubtful solvency	0/100	N/A	Yes	N/A
Cullen Investments	N/A	No	N/A	N/A	“Scant evidence”	Yes	N/A
Fanmailuk	Ltd	N/A	Solvent	Majority/minority	£70,000,000	Yes	N/A
Franbar	Ltd	N/A	Solvent	75/25	N/A	Yes	2 days
Hook	Ltd	Yes	Solvent	Minority/Majority		Yes	2 days
Hughes	Ltd	Likely	To be dissolved	50/50	£100,000+	Yes	1 day
Iesini	Ltd	N/A	Doubtful solvency	Majority/minority	N/A	Yes	4 days
Kleanthous	Ltd	N/A	Solvent	84.5/15.5	£120,000,000	Yes	4 days
Kiani	Ltd	Yes	Solvent	50/50	£296,000	Yes	1 day
McAskill	Ltd	Yes	Solvent	50/50	£197,640	Yes	1 day
Mission Capital	Plc	N/A	Solvent	N/A	N/A	Yes	N/A
Parry	Ltd	N/A	No assets	50/50	£248,577.24	Yes	1 day
Phillips	Ltd	N/A	Solvent	50/50	N/A	Yes	2 days
Seven Holdings	Ltd	N/A	Effectively no assets	50/50	£1,693,212.32	No	1 day
Singh	Ltd	Yes	Solvent/not trading	50/50	£873,000	Yes	1 day
Stainer	Ltd	Yes	Solvent	87/0.08	£7,000,000	Yes	1 day
Stimpson	Ltd by guarantee	N/A	No assets	Majority/minority	£5,300,000	Yes	4 days