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A Re-Examination of Ratification

Published online by Cambridge University Press:  01 November 1999

Jennifer Payne
Jennifer Payne*
Affiliation:
Fellow of Merton College, Oxford
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Extract

The issue of ratification is one whose “tentacles creep into every part of company law”. When a wrong has been done to the company, it is the mechanism which determines whether that wrong can be put right, and, if it can be, whether it will be; whether the wrongdoers ought to be released from their liability, and, ultimately, whether litigation can and will be commenced. That is a lot to ask of a single doctrine, and it is not, therefore, surprising to find that this topic has been described as being “singularly muddled”. The confusion has not been helped by the fact that the courts have often avoided tackling this difficult area head on, one judge going as far as to say “I do not think that it is necessary, nor do I feel competent to disentangle the many threads of principle in this tangled skein”. The Law Commission has also said that the “law on ratification is by no means clear” but has failed to tackle the complexities of the issue, stating that “[a]lthough there may be a need for modernising and simplifying the law of ratification, we are of the firm view that any changes need to be considered in the context of a comprehensive review of directors’ duties.” However, when recently given such an opportunity the Law Commission did not consider any changes to the law regarding ratification.

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Articles
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The Cambridge Law Journal , Volume 58 , Issue 3 , November 1999 , pp. 604 - 626
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Copyright © The Cambridge Law Journal and Contributors, 1999

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Footnotes

I would like to thank Richard Nolan and Professor Len Sealy for their comments on an earlier draft of this article. Any errors remain entirely my own.

References

1 K. W. Wedderburn “Derivative actions and Foss v. Harbottle” (1981) 44 M.L.R. 202, 212.

2 R. Cranston, “Limiting Directors’ Liability: Ratification, Exemption and Indemnification” [1992] J.B.L. 197, 199.

3 Winthrop Investments Ltd. v. Winns Ltd. [1975] 2 N.S.W.L.R. 666, 671 per Glass J.A.; and K. Yeung, “Disentangling the Tangled Skein: The Ratification of Directors’ Actions” (1992) 66 A.L.J. 343.

4 Law Commission Report No. 246, Shareholder Remedies, para 6.81.

5 Ibid., at para. 6.85. The Law Commission rather blandly recommended that, in relation to its new derivative action ratification should continue to be effective in the cases where it is currently effective, to bar an action by a minority shareholder, but will otherwise be only a factor to which the court has regard (para. 6.84).

6 In its Consultation Paper “Company Directors: Regulating Conflicts of Interest and formulating a Statment of Duties” (No. 153).

7 It contented itself with a restatement of some of the principles regarding ratification: paras. 11.30–11.38. However, it should be said that the Law Commission's terms of reference were rather limited in this Consultation Paper: paras. 1.2–1.4.

8 See R. J. C. Partridge, “Ratification and the release of directors from personal liability” [1987] C.L.J. 122; Yeung, at note 3 above; Cranston, at note 2 above.

9 Section 35 Companies Act 1985 (as amended) requires a special resolution by the shareholders in order to allow a company to rely on an ultra vires act against a third party and a separate special resolution to release the directors from their breach of duty in allowing the company to act in an ultra vires manner.

10 See Yeung, at note 3 above.

11 After all, where “the company is defrauded by outsiders … or by insiders of a minor kind” (Wallersteiner v. Moir (No. 2) [1975] 1 All E.R. 849, 857 per Lord Denning M.R) the principle of ratification works reasonably well, because there is then no reason to doubt that those acting on the company's behalf in resolving to ratify are, in fact, acting in the company's interests (whether that is in fact the case or not) and therefore no reason for the courts to interfere with the concept of majority control.

12 Technically, a prospective release is not a “ratification”, but rather a conferring of future powers. There may be some practical points of difference, for example more detailed disclosure may be required for a retrospective release rather than a prospective one, but the distinction is not an important one for the purposes of this article, and therefore the term “ratification” will be used to apply to both.

13 Gower, Principles of Modern Company Law, 6th ed., by Paul Davies (London 1997) (hereafter “Gower”), p.644.

14 See e.g. Gower, p.598 and Ch.s 2 & 3; L. S. Sealy, “The Director as Trustee” [1967] C.L.J. 83.

15 Brice v. Stokes (1805) 11 Ves. 319: Nail v. Punter (1832) 5 Sim. 555 and see Spellson v. George (1992) 26 N.S.W.L.R. 666.

16 Farrant v. Blanchford (1863) 1 De G.J. & Sm. 107.

17 Farrant v. Blanchford (1863) 1 De G.J. & Sm. 107, although difficult issues arise as to what the knowledge must relate to: what the beneficiary is doing or what the legal effect of his actions are. Perhaps the best view is simply that “the court has to consider all the circumstances in which the concurrence of the cestui que trust was given with a view to seeing whether it is fair and equitable that, having given his concurrence, he should afterwards turn around and sue the trustees: that, subject to this, it is not necessary that he should know what he is concurring in is a breach of trust, provided that he fully understands what he is concurring in, and that it is not necessary that he should himself have directly benefited from the breach of trust”: Re Pauling's Settlement [1961] 3 All E.R. 713, 730 per Wilberforce J.

18 Overton v. Bannister (1844) 3 Hare 503.

19 Farrant v. Blanchford (1863) 1 De G.J. & Sm. 107; Lloyd v. Attwood (1859) 3 De G. & J. 614.

20 Brice v. Stokes (1805) 11 Ves. 319; Ghost v. Waller (1846) 9 Beav. 497.

21 In fact it will be necessary for all those who can benefit under a trust, not just those in existence, to completely release the trustees in this way, under the principle in Saunders v. Vautier (1841) Cr. & Ph. 240, see, for example, Haynes v. Haynes (1866) 35 L.J. Ch. 303.

22 Section 30(2) Trustee Act 1925 allows trustees to reimburse themselves out of the trust for all expenses incurred by the trustees in the “due performance of theur duties and due exercise of their powers”: Carver v. Duncan [1985] S.T.C. 356, 363 per Lord Templeman.

23 No right of indemnity can, of course, arise in respect of expenses improperly incurred through unreasonable conduct on the part of the trustee: Re Chapman [1895] L.T. 66.

24 This may, of course, be contrasted with a company in which the directors, acting as agents for the company, do have the power to bind the company, depending upon the terms of their agency, and upon the concept of ratification. Thus outsiders in a company context, unlike the third parties to a trust, certainly will need to be interested in the extent of a director's powers. Accordingly the two issues of release and validation are relevant in a company context, though, as stated above, these two concepts tend to be combined within the single word “ratification”.

25 See Gower, Chapters 2 & 3.

26 Those acting for the members had two distinct functions: holding the property as trustees and contracting for the company as agents. These two functions could be caried out by two distinct groups: Sealy, op. cit., p. 84.

27 Whilst it was possible for directors to fulfil both the role of trustee and agent, it was actually relatively uncommon for this to occur.

28 Sealy, op. cit., at p. 89.

29 Or more if the interests of creditors, employees and others, discussed below at notes 39-41, are taken into account.

30 Salomon v. Salomon & Co. Ltd. [1897] A.C. 22.

31 In addition, of course, a director of a modern company cannot to be regarded as in any way an owner of property belonging to his principal.

32 Percival v. Wright [1902] 2 Ch. 421.

33 Breiss v. Woolley [1954] A.C. 333; Allen v. Hyatt (1914) 30 T.L.R. 444; Coleman v. Myers [1977] 2 N.Z.L.R. 225 where Woodhouse J. said it would depend “upon all the surrounding circumstances and the nature of the responsibility which in a real and practical sense the director has assumed towards the shareholder” (p. 324), a view adopted by Browne-Wilkinson V.-C. in Re Chez Nico (Restaurants) Ltd. [1991] B.C.C. 736, 750.

34 Regal (Hastings) Ltd v. Gulliver [1967] 2 A.C. 134n, 150 per Lord Russell. cf., where the company is insolvent or on the verge of insolvency, in which case it has been suggested that the interests of the creditors will intervene and the shareholders are not then the correct medium of ratification.

35 E.g. L. S. Sealy, “The Director as Trustee” [1967] C.L.J. 83, 102, although Professor Sealy discounts ultra vires acts from his analysis, believing that these can be ratified by shareholders without offending the managerial principle.

36 E.g. Breckland Group Holding Ltd. v. London and Southwark Properties Ltd. [1989] B.C.L.C. 100 per Harman J.; Queensland Mines Ltd. v. Hudson (1978) 52 A.L.J.R. 399 (P.C.), although in Queensland, since the only two shareholders of the company were themselves companies in which the two directors played leading parts, the Privy Council may have treated the approval of the board as equivalent to that of the shareholders’ nominees.

37 See, e.g., Table A Companies Act 1985, A. 70.

38 This is obviously subject to the ability of the shareholders to insert a provision into the articles of the company which authorises the directors to ratify in such circumstances.

39 The interests of creditors in the well being of the company, at least as regards a company which is insolvent or is nearing in solvency, have been recognised by the courts (Winkworth v. Baron Developments [1986] 1 W.L.R. 1512 and see D. Prentice, “Creditors’ Interests and Directors’ Duties” 10 O.J.L.S. 265) to the extent that doubt has been cast on the ability of shareholders to continue to ratify directors’ wrongdoing in such circumstances.

40 Companies Act 1985, s. 309 states that directors are to have regard to the “interests of the company's employees in general, as well as the interests of its members” though this duty remains enforceable only by the shareholders and is merely permissive in nature: Re Welfab Engineers Ltd. [1990] B.C.L.C. 833. It may be noted that, in comparison to the position of creditors, at least at the time of insolvency, that it “seems to be assumed that the statutory recognition of the employed has not affected the power of the shareholders to ratify breaches of duty, though it is not clear why this should be the case where the breach consists of a failure to consider the interests of the employees”: Gower, p. 645 fn. 71.

41 “Modern Company Law for a Competitive Economy” (DTI, London, February 1999) discusses whether directors should take account of other interests, including those of employees, creditors, customers, the environment, and the wider community :chapter 5.1.

42 North-West Transportation Co. Ltd v. Beatty (1887) 12 App. Cas. 589.

43 This principle has been recognised for over 250 years: R v. Varlo (1775) 1 Cowp. 248; Att. -Gen. v. Davy (1741) 2 Atk. 212.

44 North-West Transportation Co. Ltd v. Beatty (1887) 12 App. Cas. 589, 593 per Sir Richard Baggallay.

45 E.g., Companies Act 1985, s.9 which requires a special resolution for the alteration of a company's articles.

46 For example, by a provision in the company's articles, or by way of a shareholders’ agreement.

47 Re Duomatic [1969] 2 Ch. 365; Cane v. Jones [1980] 1 W.L.R. 1451.

48 K. Wedderburn, “Shareholders’ Rights and the rule in Foss v. Harbottle” [1957] C.L.J. 194, 197 et seq.

49 MacDougall v. Gardiner (No. 2) (1875) 1 Ch. D. 13, 25 per Mellish L.J.

50 See note 20 above.

51 (1887) 12 App. Cas. 589.

52 Ibid., at p. 593 per Sir Richard Baggallay.

53 The most obvious exception is, of course, in regard to the alteration of a company's articles, where some constraints are imposed upon the voting of the shareholders.

54 [1980] 2 All E.R. 841. This case did, of course, go to the Court of Appeal where Vinelott J's decision was affirmed only in part: [1982] Ch. 204. Vinelott J. drew a distinction between the transaction (wrong done to the company) and the exercise of the shareholders’ votes to ratify that wrong (wrong done to the other shareholders). To the extent that the shareholders are representing the company, and therefore the wrong done to them is in fact a wrong done to the company, this is an acceptable distinction to draw, even if Vinelott J. was wrong to believe that this did represent the position of the law at the time. Both of the constraints which will be discussed here refer to the relationship between the company and the shareholders: either the transaction puts the company at risk from the shareholders and constraints should be imposed (transaction-based constraints) or the manner of the voting demonstrates this risk and constraints should be imposed (voting-based constraints). In either case the constraints are being imposed to protect the company, represented ultimately by the minority shareholders, not to protect the shareholders per se.

55 Ibid., at p. 862.

56 This obviously conflicts with earlier caselaw on this point, e.g. Mason v. Harris (1879) 11 Ch. 97, 109 per James L.J.

57 See, for example, K. Wedderburn, “Derivative Actions and Foss v. Harbottle” (1981) 44 M.L.R. 202; L. S. Sealy, “Foss v. Harbottle—AMarathon where Nobody wins” [1981] C.L.J. 29, 32. For approval of this principle see, for example, S.M. Beck, “The Saga of Peso Silver Mines: Corporate Opportunities Reconsidered” (1971) 49 Can B. Rev. 80; R. Baxt, “Judges in their own cause: The Ratification of Directors’ breaches of duty” (1978) 5 Monash U.L. Rev. 16, 49; G.R. Sullivan, “Restating the Scope of the Derivative Action” [1985] C.L.J. 236, 245.

58 [1982] Ch. 204.

59 Beyond saying (at pp. 221–222) firstly that there was no exception to Foss v. Harbottle simply where justice requires it, as suggested by Vinelott J., and, secondly, that Vinelott J. should have decided whether the plaintiffs were entitled to sue on behalf of Newman as a preliminary issue.

60 This is the case where the wrong is done to the shareholders of the company in their personal capacity, for example a breach of the section 14 contract: Hickman v. Kent or Romney Sheep Breeders’ Association [1915] 1 Ch. 881; K. Wedderburn, “Shareholders’ rights and the Rule in Foss v. Harbottle” [1957] C.L.J. 194 and [1958] C.L.J. 93.

61 North-West Transportation Co. Ltd v. Beatty (1887) 12 App. Cas. 589, 593 per Sir Richard Baggallay.

62 The obvious examples of this are illegality, e.g. the provision of financial assistance by the company in contravention of Companies Act 1985, ss. 151–155, and, prior to the Companies Act 1989, ultra vires. See K. Wedderburn, “Shareholders’ rights and the Rule in Foss v. Harbottle” [1957] C.L.J. 194 and [1958] C.L.J. 93.

63 Gower goes as far as to say that “it is impossible to reconcile all the decided cases with any simple set of propositions”: Gower, p. 670.

64 Foss v. Harbottle. (1843) 2 Hare 461.

65 Other than by following the analysis laid down by Vinelott J. in Prudential Assurance Co. Ltd. v. Newman Industries (No. 2) [1980] 2 All E.R. 841.

66 K. Wedderburn, “Shareholders’ rights and the Rule in Foss v. Harbottle” [1957] C.L.J. 194 and [1958] C.L.J. 93; B. Rider, “Amiable Lunatics and the Rule in Foss v. Harbottle” [1978] C.L.J. 270; S. Beck, “The Shareholders Derivative Action” (1974) 52 Can. B.Rev. 159; S. Beck, “The Quickening of the Fiduciary Obligation” (1975) 53 Can. B.R. 771; B.H. McPherson, “Duties of Directors and the powers of shareholders” (1977) 51 Aust. L.J. 460; S. Beck, “The Saga of Peso Silver Mines: Corporate Opportunities Reconsidered” (1971) 49 Can. B. Rev. 80.

67 [1916] 1 A. C. 554.

68 [1967] 2 A. C. 134n.

69 The lack of clarity surrounding the concept of “company property”, for instance, seems to spring from the judgment of Lord Davey in Burland v. Earle [1902] A. C. 83, 93, in which he stated that company property included “money, property or advantages which belong to the company or in which the other shareholders are entitled to participate” (emphasis added), leading to the arguments regarding the misappropriation of corporate opportunities.

70 K. Wedderburn, “Shareholders’ rights and the Rule in Foss v. Harbottle” [1958] C.L.J. 93, 105.

71 Ibid., at p. 95.

72 Ferguson v. Wilson (1866) 2 Ch. App. 77, 90 per Cairns L.J.

73 In this situation the courts are of the view that it is ratifiability rather than ratification per se. which is relevant: Hogg v. Cramphorn Ltd. [1967] Ch. 254, cf. Vinelott J. in Prudential Assurance Co. Ltd. v. Newman Industries (No. 2) [1980] 2 All E.R. 841. In view of these cases the term “ratification” in this section should therefore be interpreted as including a situation in which ratification is possible but has not actually occurred.

74 Edwards v. Halliwell [1950] 2 All E.R. 1064, 1066 per Jenkins L.J.

75 [1982] 1 W.L.R. 2, 11.

76 (1843) 2 Hare 461.

77 Law Commission report. This is because only in the “fraud on the minority” exception can a wrong be identified in relation to which the individual may sue derivatively even though the shareholders could ratify.

78 [1988] Ch. 114.

79 Then Companies Act 1981, s. 42, now Companies Act 1985, ss. 151–152.

80 See, now, Companies Act 1985, s. 35 (as amended) which provides that a third party who is not an insider (see section 322A) can rely on an ultra vires act as against the company whether or not it has been ratified, and that the company can enforce against the third party provided the action has been ratified by a special majority.

81 [1988] Ch. 114, 189.

82 Knox J.'s judgment goes further and leaves open the possibility that the “independent organ” of the company “will vary according to the constitution of the company concerned and the identity of the defendants” (pp. 159–160) i.e. it leaves open the possibility that this independent organ could be all, or part of, the board of directors.

83 [1988] Ch. 114, 189

84 Gower, p. 675.

85 E.g., Salomon v. A. Salomon & Co. Ltd. [1897] A.C. 22, 57 per Lord Davey; In re Horsey & Weight Ltd [1982] Ch. 442, 454 per Buckley L.J.; Rolled Steel Ltd v. British Steel Corporation [1986] Ch. 246, 296 per Slade L.J.; Aveling Barford Ltd. v. Perion Ltd. [1989] B.C.L.C. 626, 630–631 per Hoffmann J; Multinational Gas and Petrochemical Co. v. Multinational Gas and Petrochemical Services Ltd. [1983] Ch. 258, 280 per May L.J.; Meridian Global Funds Management Asia Ltd. v. The Securities Commission [1995] 3 All E.R. 918, 923 per Lord Hoffmann.

86 E.g., Menier v. Hoopers Telegraph (1874) L.R. 4 Ch.App. 376; Cook v. Deeks [1916] 1 A.C. 554.

87 Re Duomatic [1969] 2 Ch. 365; Cane v. Jones [1980] 1 W.L.R. 1451. For a full discussion of the principle of unanimous informal consent see R. Grantham, “The unanimous consent rule in company law” [1993] C.L.J. 245.

88 Salomon v. A. Salomon & Co. Ltd. [1897] A.C. 22, 57 per Lord Davey; In re Horsey & Weight Ltd [1982] Ch. 442, 454 per Buckley L.J.; Rolled Steel Ltd v. British Steel Corporation [1986] Ch. 246, 296 per Slade L.J.; Aveling Barford Ltd. v. Perion Ltd. [1989] B.C.L.C. 626, 630–631 per Hoffmann J.

89 At this point, of course, the interests of the creditors will intervene: Winkworth v. Edward Baron Development Co. Ltd. [1987] B.C.L.C. 193.

90 [1983] Ch. 258, 280.

91 [1995] 3 All E.R. 918, 923.

92 R. Grantham, “The unanimous consent rule in company law” [1993] C.L.J. 245.

93 The cases in which shareholders appear to be able to take valid decisions concerning matters which are properly within the directors’ sphere of competence, e.g. Re Fletcher Hunt (Bristol) Ltd. [1989] B.C.L.C. 108, merely by acting unanimously do not sit well with cases such as Automatic Self- Cleansing Filter Syndicate Co. Ltd. v. Cunninghame [1906] 2 Ch. 42 which regard the spheres of authority of the directors and the shareholders as being quite separate and should be regarded with caution: R. Grantham “The unanimous consent rule in company law” [1993] C.L.J. 245.

94 Whilst it is hoped that shareholders who are not wrongdoers would vote in the company's best interests, this cannot be guaranteed: North-West Transportation v. Beatty (1887) 12 App. Cas. 589.

95 See note 85 above, and associated text.

96 If a valid ratification is extinctive of the shareholders’ right to sue in the future, see note 85 above and associated text.

97 Mason v. Harris (1879) 11 Ch. D. 97, 109 per James L.J.

98 [1980] 2 All E.R. 841, 862.

99 Ibid., at p. 874 (emphasis added).

100 See, e.g., K. Wedderburn, “Derivative actions and Foss v. Harbottle” (1981) 44 44 M.L.R. 202, 208; L. S. Sealy, “Foss v. Harbottle—AMarathon where Nobody wins” [1981] C.L.J. 29, 32. For approval of this principle see, for example, S.M. Beck, “The Saga of Peso Silver Mines: Corporate Opportunities Reconsidered” (1971) 49 Can B. Rev. 80; R. Baxt, “Judges in their own cause: The Ratification of Directors’ breaches of duty” (1978) 5 Monash U.L. Rev. 16, 49; G.R. Sullivan, “Restating the Scope of the Derivative Action” [1985] C.L.J. 236, 245.

101 [1988] Ch. 114 and see D. Prentice, “Shareholder action: the rule in Foss v. Harbottle” (1988) 104 L.Q.R. 341.

102 [1980] 2 All E.R. 841, 874 per Vinelott J.

103 However, in one Australian case, Biala Property Ltd. v. Mallina Holdings Ltd. (No. 2) (1993) 11 A.C.S.R. 785, the court was prepared to undertake a detailed examination of how major shareholders acquired their shares, and to find that a number of apparently independent shareholders were not, in fact, as disinterested as they appeared. In Australia the Companies and Securities Law Review Committee has recommended that interested directors, their associates and relatives, should not be able to vote on a decision to relieve that director from liability for wrongdoing: Company Directors and Officers: Indemnification, Relief and Insurance, Report No. 10, May 1990, para. 60.

104 In particular, the share register in England does not reflect the beneficial interests which exist in shares. Company law has generally allowed that beneficial holder to remain well hidden, so that, for example, there is no duty on a company to take account of such interests, even if they are known to the company: Re Perkins, ex p. Mexican State Barbara Mining Co. (1890) 24 Q.B.D. 613 as codified in s. 360 Companies Act 1985.

105 As the Australian courts found in the Biala case; see note 103, above.

106 Smith v. Croft (No. 2) [1988] Ch. 114, 189 per Knox J.

107 [1967] 2 A.C. 134n, 150.

108 [1980] 2 All E.R. 841, 862.

109 (1887) 12 App. Cas. 589.

110 This is akin to the approach taken by Dixon J. in Peters’ American Delicacy Co. Ltd. v. Heath (1939) 61 C.L.R. 457 in which he held that where an alternation of articles of a company has taken place and there is a conflict between the majority and the minority interests, the will of the majority should prevail except where no reasonable person could regard the alteration as a fair one to be made.

111 Companies Act 1985 s. 9.

112 Allen v. Gold Reefs of West Africa Ltd. [1900] 1 Ch. 656, 671 per Lindley M.R.

113 Greenhalgh v. Arderne Cinemas Ltd. [1951] Ch. 286, 291 per Evershed M.R.; Peters’ American Delicacy Co. Ltd. v. Heath (1939) 61 C.L.R. 457 per Dixon J.; Gambotto v. W.C.P. Ltd (1995) 16 A.C.S.R. 1; F.G. Rixon, “Competing Interests and Conflicting Principles: An Examination of the power of alteration of articles of association” (1986) 49 M.L.R. 446.

114 Nguli v. McCann (1953) 90 C.L.R. 425; Winthrop Investments Ltd. v. Winns (1975) 2 N.S.W.L.R. 666; Residues Treatment and Trading Co. Ltd. v. Southern Resources Ltd. (No. 4) (1988) 51 S.A.S.R. 196 and see E. Boros, Minority Shareholders’ Remedies (Oxford 1995) p. 200 et seq.

115 North-West Transportation Co. Ltd v. Beatty (1887) 12 App. Cas. 589, 594 per Sir Richard Baggallay.

116 E.g., Greenhalgh v. Arderne Cinemas Ltd. [1951] Ch. 286.

117 [1916] 1 A.C. 554.