Case Study: Minority Shareholder's Right to appoint Director. The Court of Appeal Makes a Ruling
Introduction
In a recent case, the Singapore Court of Appeal commented on a Minority Shareholder's right to appoint a director.
The Court of Appeal pointed out that
it is common for shareholders' agreements (and joint venture agreements) to say
a shareholder is entitled to nominate (or appoint) a director to the company's board of directors.
However, just as often,
the company's constitution (memorandum and articles of association) says that
the company's board of directors have the power to appoint directors.
(paragraph 1)
Questions
Thus, various questions arose in that case:
The minority shareholder claims it has a right to appoint any person
unless such appointment would be injurious to the company, and
that its nomination of that person, ipso facto (that is, that is, by virtue of the nomination itself on its own, without more),
makes its nominee a director with immediate effect.
But is this correct?
The majority shareholders claim
the minority shareholder has a mere right to nominate a person for directorship, and
the board of directors retains the discretion not to appoint that person
if it would not be in the company’s interests to do so.
Which position is correct?
Is the company obliged to accept the shareholder’s nominee/appointee without question?
If not, what principles (if any) constrain its discretion to reject the nominee/appointee?
How does this interact with the company’s constitution which vests the power of appointment in the board of directors?
(paragraph 2)
Shareholders' Agreement
In that case, several parties entered into a Shareholders' Agreement which said:
5. Board of Directors (of TWG)
5.1 Number: The Board shall comprise three Directors.
5.2 Composition: The Board shall comprise:
5.2.1 two persons appointed by [Paris] and [Wellness]; and
5.2.2 one person appointed by OSIM, for so long as OSIM’s Shareholding Percentage is not less than 25 per cent. That person shall be Mr Ron Sim.
(paragraph 4)
So, here, the company was
TWG whereas
the shareholders were
Wellness (54.7% of the shares)
Paris (10.3%) and
OSIM (35%).
(paragraph 5)
Counterintuitive Situation
Over time, the shareholding changed to as follows:
Wellness (30.1% of the shares)
Paris (11.3%) and
OSIM (58.6%).
The situation was counterintuitive because
OSIM (which had more than 50%) was entitled to appoint one director whereas
Wellness & Paris (which, together, had 41.4%) were entitled to appoint two directors.
(paragraph 6)
Lower Court's finding of Implied Term
In the lower court (the High Court), the learned Judge found that
a term should be implied into the Shareholders’ Agreement because
it “omitted to address the situation where [Wellness], whether by itself or with Paris, ceased to be the majority shareholder/s in [TWG]”.
The parties had not contemplated this lacuna (gap, hole), and
it was necessary in the commercial sense to imply a term in order to give the contract efficacy because otherwise
Wellness and Paris would continue to control the TWG Board regardless of how small their combined shareholding came to be and
the parties could not have intended such a result.
The Judge said that the specific term to be implied was that
“the majority shareholder(s) (whoever they may be) would be entitled to appoint two directors, and the minority shareholder(s) would be entitled to appoint one director so long as they hold at least 25% of the shares in [TWG]”
Thus, Wellness, being the minority shareholder, was entitled to appoint one director pursuant to the Implied Term.
(paragraph 7)
Wellness' Failed Attempts to Appoint Director
Wellness tried to appoint Mr Murjani to the Board of TWG.
Mr Murjani had previously sat on TWG’s Board before resigning, and
Wellness had not appointed another director in his place since then.
However, TWG, OSIM and Paris refused to appoint Mr Murjani on the basis that
his appointment would not be in TWG’s best interests
Instead, they invited Wellness to appoint either
Ms Kanchan Murjani, who is Mr Murjani’s wife, or
Mr Finian Tan, both of whom were also directors of Wellness.
To resolve this impasse, Wellness wrote to TWG
proposing that Associate Professor Mak be appointed to the Board of TWG instead of Mr Murjani.
Wellness also requested
(a) that the Board authorise Prof Mak to disclose to Wellness information in relation to TWG which he would have access to in his capacity as director, in accordance with s 158 of the Companies Act; and
(b) that TWG arrange for Prof Mak to be covered by director and officer insurance to the same extent as TWG’s other directors; and if no such insurance had been purchased for the directors, that it be purchased.
These two matters were referred to as “the Ancillary Matters”.
TWG did not reply.
Wellness wrote to TWG to “request” that
it “immediately take all necessary steps to formalise the appointment of Professor Mak, including the [A]ncillary [M]atters”.
TWG did not reply.
Wellness wrote again to
“demand” the formalisation of Prof Mak’s appointment,
without mentioning the Ancillary Matters.
TWG replied to say that
it would not appoint Prof Mak because
the board of directors was “unable to accede” to the Ancillary Matters, which were in any event not in TWG’s interests.
(paragraphs 8 to 11)
Wellness Sues
Wellness filed a case in court and applied for:
(a) a declaration that it was entitled to appoint one director to TWG’s board as long as it held at least 25% of the shares in TWG;
(b) an order that Prof Mak be appointed as a director of TWG; and
(c) an order that the three defendants (being Paris, OSIM, and TWG) execute the necessary documents to give effect to Prof Mak’s appointment.
(paragraph 12)
Situation in TWG's Board of Directors
The board of directors of TWG comprised of
Mr Taha Bouqdib (“Mr Bouqdib”) (appointed by OSIM) and
Mr Ron Sim Chye Hock (appointed by Paris).
Wellness had not been represented on the board of directors for some time already.
(paragraph 13)
Issues (Key Questions) before the Court of Appeal
The first issue pertains to the nature of Wellness’ contractual right under the Implied Term.
In particular, does the Implied Term entitle Wellness to appoint a director to the Board of TWG, or
merely to nominate a director whose appointment can only be effected by the Board?
If Wellness has only a right of nomination,
must TWG accept Wellness’ nominee without question; and if not,
what principles (if any) constrain its discretion to reject the nominee?
The second issue is whether the Implied Term has been breached.
This requires the court to determine:
whether the Ancillary Matters were mere requests or conditions attached to Prof Mak’s appointment, and
whether the respondents’ refusal to appoint Prof Mak in those circumstances constituted a breach of the Implied Term.
The third issue is, if there has indeed been a breach of the Implied Term, what relief ought to be ordered?
Wellness wants
(a) a declaration that it is entitled to appoint one director to TWG’s Board;
(b) an order that Prof Mak be appointed as a director of TWG; and
(c) an order that the respondents execute, or procure the execution of, the necessary documents to give effect to Prof Mak’s appointment.
The respondents say that
specific performance is unavailable for various reasons,
including that such relief will not be ordered in respect of a contract for services, and
that Wellness did not come to the court with clean hands and therefore is not entitled to the relief.
(paragraphs 20 to 22)
The Court of Appeal's Decision
The Implied Term gives Wellness a right to nominate one person to be a director of TWG, with a corresponding obligation on the part of the Board of TWG to appoint that nominee as a director, subject to two important caveats.
First Caveat: the nomination of a person who is statutorily disqualified under the Companies Act from assuming directorship, or who does not consent to act as a director, would be defective in and of itself. There would clearly be no obligation to appoint such a person.
Second Caveat: even if the nomination is not defective, the Board of TWG would not be obliged to appoint the nominee if it is able to establish that the nominee would be obviously unfit for office or that his appointment would be obviously injurious to the company. The burden is not on Wellness to positively establish the suitability of its nominee, but upon the Board to prove his unsuitability. In this regard, it will not suffice for the Board to simply assert that the nominee lacks relevant experience or skills. The fact that he might disagree with the other directors on matters pertaining to the management of the company is also not in itself a basis to refuse appointment. Rather, the Board must adduce clear evidence to show the shortcomings of the nomination, such as if the nominee would be placed in a position of a conflict of interest or a breach of fiduciary duty. This might be the case if, as a more specific example, the nominee operates a business in competition with the company to which he is nominated as director.
(paragraph 33)
The Court of Appeal's Comments
The purpose of cl 5 of the Shareholders’ Agreement, as well as the Implied Term, is to ensure that the minority shareholder is represented on the Board of TWG and is not totally excluded from decision-making by the majority. Such provisions entitling a shareholder to appoint a director to the board are an important and common feature of joint ventures and serve to guarantee a minimum degree of protection of the shareholder’s interests. The Implied Term would be ineffective if the majority could obstruct or indefinitely delay the appointment of Wellness’ nominee by requiring Wellness to prove the suitability of its nominee to the majority’s subjective satisfaction.
(paragraph 35)
There is the principle that a power to appoint the directors, “even if conferred on a named shareholder, is not constrained by any fiduciary or similar obligation and may be exercised in the shareholder’s own interests”.
(paragraph 36)
The fact that Wellness’ right was provided for by contract, rather than in TWG’s Constitution, does not suggest that the parties intended it to have lesser force or effect. There are multiple advantages to creating such a right by contract, rather than by way of constitutional amendment. Unlike a contract binding the shareholders, the articles are vulnerable to amendment by special resolution and cannot be enforced by a person who is not a member of the company. Indeed, a shareholders’ agreement to which all the shareholders are parties can be “fully effective as a constitutional document”. Clause 12 of the Shareholders’ Agreement shows irrefutably that the shareholders intended the Shareholders’ Agreement to take precedence even over TWG's constitution.
(paragraph 39)
Clause 12 of the Shareholders’ Agreement states:
12. Prevalence of Agreement
In the event of any inconsistency or conflict between the provisions of this Agreement and the provisions of the Articles, the provisions of this Agreement shall as between the Shareholders prevail (subject to applicable law) and the Shareholders shall, so far as they are able, cause such necessary alterations to be made to the Articles as are required to remove such conflict.
It unequivocally expresses the shareholders’ unanimous intention that the terms of that agreement should prevail in the event of conflict with the Constitution.
All the shareholders of TWG are parties to the Shareholders’ Agreement. There is thus no question of the shareholders accomplishing through the Shareholders’ Agreement what they would be unable to achieve at a general meeting for want of unanimity.
Paragraph (c) of the preamble to the Shareholders’ Agreement shows that the shareholders fully intended it to govern the operation of TWG:
It is the common intention of the Parties hereto to operate the Company as a joint venture company for the purpose of carrying on the Business and to this end, the Parties have agreed to regulate the affairs of the Company and the respective rights and obligations of the Parties as shareholders of the Company on and after the Effective Date, on the terms and subject to the conditions of this Agreement.
(paragraph 70)
The respondents must accept that the Implied Term curtails the operation of Art 91, since they acknowledge that the board of directors cannot simply appoint whoever it pleases without reference and deference to the choice of the shareholders.
Moreover, it has been held that a shareholders’ agreement to exercise their votes in a particular way is valid and enforceable by the courts.
If there was any inconsistency between Art 91 and the Implied Term, the shareholders would have been legally obliged to amend the Constitution, and would not be able to take advantage of their breach of cl 12 to avoid their contractual obligation under the Implied Term to appoint Prof Mak.
(paragraph 71)
On the other hand, the Implied Term does not give Wellness the power to constitute a person a director of the company simply by selecting or nominating its candidate.
(paragraph 41)
The right that Wellness acquires under the Implied Term therefore lies somewhere between these two poles (a mere right to nominate on one hand, and an unqualified right of appointment on the other).
(paragraph 45)
The Court of Appeal's Conclusions
Art 91 of the Constitution, states, “The Board of Directors may, at any time, and from time to time, appoint any person to be a Director, either to fill a casual vacancy, or by way of addition to their number.”
(paragraph 63)
The Implied Term does not give the shareholders the power to appoint directors per se, but rather to determine who they shall be. The power of appointing the directors remains with the Board pursuant to Art 91 of the Constitution, although it must now be exercised in accordance with the shareholders’ wishes pursuant to the Implied Term.
(paragraph 64)
The Ancillary Matters were never attached as conditions to Prof Mak’s appointment. The breach of duty which Wellness alleges on the part of TWG, both in the OS and on appeal, consists simply in the Board’s refusal to appoint Prof Mak without good reason.
(paragraphs 81 and 82)
The Court of Appeal ordered that Prof Mak be appointed a director of TWG and that the respondents, their directors and/or their officers execute or procure the execution of the documents necessary to give effect to his appointment.
(paragraph 92)
Action
The above is not legal advice and should not be considered legal advice.
If you have any questions about shareholders' agreements or minority shareholders' right to appoint a director or other issues, please feel free to call Lam & Co. at 6535 1800.
