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Reining in the Enthusiastic Director
By Christopher J Sherliker

By their very nature, many company directors have an entrepreneurial spirit which, at times, encourages them to come up with schemes to leverage or utilise company assets to create value for themselves that might not benefit the shareholders in the same way. This can lead to problems if not properly thought through before implementation, and great care needs to be exercised.

In the Ryman case referred to above, the activities of a number of the directors had been challenged by a minority shareholder who endeavoured to bring a derivative action to try to secure some of the profits made by Mr Paphitis when the company he bought was later sold on at an appreciable uplift.

The company he had acquired operated in an allied field to one of the Ryman subsidiaries; he and others acquired the competitive business using funding provided by the Ryman Group, indicating that the reason Rymans was not the buyer was because of risks which could have jeopardised the Ryman share price. Yet it transpired to be a canny buy when it was later sold for £100 million, so it was not surprising that a minority shareholder whose company’s assets were levered was so aggrieved.

The disgruntled minority shareholder probably still can’t understand why he was refused leave to proceed with his action – which highlights the difficulties in challenging the well-advised director.

Whenever the interests of shareholders and directors are not entirely identical, a situation can quickly arise when one or more members of the board comes up with a proposition involving a commercial opportunity, whether or not in the same field of activity as the company, which they decide to pursue independently. This is especially likely in the present economic climate, where it may be far easier to use the company's existing funds than to seek bank financing for a new project.

As for the lawyers involved in these situations, the challenges can be significant and a clear understanding of what is proposed is essential before one can possibly offer advice. The first aspect to identify is whether the prospective acquisition is going to be made by the company itself or by some other entity, and to establish the relationship between the parties.

If it is the former then, in all probability, it will be a straightforward transaction. However, in the latter case, advisers need to exercise real care as the matter moves forward, especially if there is a change in plan or structure in any way. Regularly revisiting any possible conflict of interest will be a prudent step to take.

As the first point of reference, look at the individual directors’ service agreements to establish whether or not they contain provisions prohibiting the directors from operating outside the company, whether by having investments or by accepting directorships. If there are, dispensation will be essential to protect them from future challenges and those board meetings need to be fully and thoroughly minuted, with full disclosure having been made by all concerned.

Similarly, any shareholders’ agreements must be reviewed, since they may well contain restrictions against engaging in activities outside of the company.

The general premise that the shareholders need not be consulted may have to be reviewed if the intention is to allow the directors to capitalise, either directly or indirectly, from a business venture which has been initially brought to the company where the purchase is going to be financed directly or indirectly using the company's assets.

The Ryman's case is a good example of how funds were effectively utilised and leveraged for the benefit of the third-party acquisition, and how a reasoned argument permitting this has prevailed.

Similarly, one must look at any restrictions within the company's articles or in any shareholders agreements prohibiting the use of company assets for purposes other than the mainstream activities of the business.

Whilst in the Ryman case there was no suggestion that it was in any way improper for the company to give guarantees or to lend money to a non-group company, this could be a cause of some difficulty in other circumstances if the facts were different from the present case under consideration.

A company’s banking arrangements must also be checked to ensure that the proposition is not going to lead to a breach of any banking covenant.

As will be apparent from the above, there is much to consider as the series of transactions progresses; not least of which is to ensure that separate advice is obtained if any potential conflict of interest arises.

As to considering what other alternatives are available to a minority shareholder who feels he is rightly aggrieved, other than trying to pursue a derivative action, that must wait for another day.

Added: 29th November 2011

Christopher J Sherliker is a partner for Silverman Sherliker LLP who provide legal solutions across a spectrum of requirements.  Find out more about Silverman Sherliker LLP.

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