CONCEPTUAL CONFUSION

• Published date: 01 December 2011
• Author: Susan WATSON LLB (Hons) (University of Auckland), MJur (University of Auckland); Deputy Director of the New Zealand Corporate Governance Centre; Professor, University of Auckland.
• Date: 01 December 2011

Organs, Agents and Identity in the English Courts

This article aims to address some of the more conceptual questions about companies sitting behind two recent cases. Lord Scott in the House of Lords described Stone & Rolls Ltd v Moore StephensELR[2009] 1 AC 1391 as difficult but the facts in Stone & Rolls and the subsequent Court of Appeal case Safeway Stores Ltd v Twigger[2010] EWCA Civ 1472 could hardly be simpler. It is argued that the apparent complexities (and the occasional counter-intuitive outcomes) expose a fundamental misconception about the structure of companies brought about by the unwillingness in UK company law to acknowledge the place of the board in the company. The application of Meridian Global Funds Management Asia Ltd v Securities CommissionELR[1995] 2 AC 500 is also discussed.

I. Introduction

1 Stone & Rolls Ltd v Moore Stephens1 (“Stone & Rolls”) involved a claim by a fraudulent one-man company against its auditors for negligence for failing to detect its fraud. In one of the shorter judgments of the eight from the Court of Appeal and House of Lords, Mummery LJ asked:

Does common sense matter? Yes. It is contrary to all common sense to uphold a claim that would confer direct or indirect benefits on the corporate vehicle, which was used to commit the fraud and was not the victim of it, and the fraudulent driver of the fraudulent vehicle.[2]

Mummery LJ described the claim as “astounding”.3

2 Common sense and the law are sometimes uneasy bedfellows. Indeed, the use of the phrase “common sense” in a judgment brings to mind one of the many memorable “old darlings” created by John Mortimer in his Rumpole stories, Mr Justice “Ollie” Oliphant, the practical red judge from the North who equated common sense with his view on the correct outcome in a case and whose “affectations of Northern bluntness and ‘common sense’ drove Rumpole to distraction”.4

3 Lord Phillips was mindful of criticism of the use of the phrase common sense, beginning his speech in the House of Lords by saying that “[m]y initial reaction to S & R's claim was that, as a matter of common sense it could not succeed”,5 setting out reasons why common sense led him in that direction before continuing:6

In a lecture to the Chancery Bar Association entitled ‘Common Sense and causing Loss’ given on 15 June 1999 Lord Hoffmann commented adversely on the practice of those judges who justify their decisions by reference to ‘common sense’. He suggested that this was far too often an unsatisfactory alternative to the identification of the relevant principles. The differences of opinion between the members of the Committee underline the need to identify the relevant principles that apply in this case.

4 In fact Lord Hoffmann's criticism of the resort to common sense by judges to justify their decisions was more trenchant than that. In the speech referred to by Lord Phillips he said: “This phrase is often used challengingly, even rather aggressively, implying an accusation of lack of practicality, unworldliness, fussiness and pedantry against anyone who asks for further explanation.”7 This use of the phrase common sense was, the South African-born Lord Hoffmann commented, “in the best tradition of British anti-intellectualism”.8

5 The judges in the House of Lords clearly took Lord Hoffmann's criticism to heart, identifying, in five opinions and almost 100 pages of speeches, the relevant principles. Common sense dictates that the claim would in fact be struck out and that is what happened (but only by a bare majority.) In this article, it is argued that the principles set out and used to reach that finding were misguided and those principles laid the

ground work for the outcome of Safeway Stores Ltd v Twigger9 (“Safeway”) in the English Court of Appeal. In Safeway, a company was convicted of competition law breaches due to the actions of some of its employees and directors. The company was unsuccessful in an action against those directors and employees on the basis that the wrongdoing employees and directors were identified as the mind of the company and therefore exempt from liability. It is an outcome that some might say is lacking in common sense.

6 This article does not provide a detailed analysis of Stone & Rolls and Safeway but rather aims to address some of the more conceptual questions about companies sitting behind the two cases. Lord Scott in the House of Lords described Stone & Rolls as difficult.10 The facts in Stone & Rolls and Safeway could hardly be simpler. Why do the UK courts struggle with these cases? It may be that the apparent complexities expose a fundamental misconception about the structure of companies. In this article, it is argued that in both cases the rules of attribution as set down by Lord Hoffmann in Meridian Global Funds Management Asia Ltd v Securities CommissionELR11 (“Meridian”) were misunderstood and misapplied.

7 The first misapplication was brought about by the unwillingness in UK company law to acknowledge the place of the board in the company.12 The rules of attribution as applied necessarily mean that the board collectively and the shareholders collectively sit at the core of the company. When directors are acting collectively as part of the board, they are not the agents of the company. Their knowledge as part of the board is attributed to the company by the primary rules of attribution. Absent statutory provisions that override company law principles, or

breach of duty, the board of directors collectively should therefore be immune from liability when they act in that role. But when accepting that the members of a board that acts collectively are, as a general principle, immune from liability, it is crucial to accept also that individuals who are directors are likely to have many different legal relationships with a company that in a temporal sense occur concurrently or sequentially. An example is Standard Chartered Bank v Pakistan National Shipping Corp (No 2),13 where a director of a one-man company incurred liability for deceit when the House of Lords determined that when he committed the wrong he acted as an agent of the company. It was a reversal of the Court of Appeal where, counter intuitively, it was decided that the deceitful director was identified as the mind of the company and could not therefore be made personally liable.14 There are some similarities to the outcome in Safeway in the Court of Appeal.

8 The second misapplication was of the special rules of attribution. For the purposes of a rule, usually statutory, the special rules of attribution can override the principles of company law, meaning that the company can be primarily liable for the knowledge and actions of a corporate agent. Crucially though, and unlike, the doctrine of identification, the primary liability brought about by the special rules of attribution is only for the purposes of that statutory rule; it does not change the underlying structure of the company.

9 Cases with facts such as those outlined above reach the highest level of courts in the UK but do not seem to trouble the US courts to the same extent. The first section of this article explores the differences between UK and US corporate law that might explain why the US enjoys this absence of concern. The second section briefly outlines the development of modern UK company law. The next section looks at examples of the way in which the courts in the past have viewed the structure of companies and the legal relationship of directors to companies. The following section sets out the place of Meridian and the final section contains a brief discussion of Stone & Rolls and Safeway in light of the preceding discussion.

II. North American law

10 The interesting and multi-faceted story of the origins of the modern UK company is briefly outlined in the next section. The history of the US corporation is, by contrast, much more straight-forward. The modern US corporation is a direct descendant of the corporations –

governmental and municipal, rather than business – that American colonists brought with them to America in the 17th and 18th centuries.15 As the Supreme Court in Bank of the United States v Deveaux16 put it: “As our ideas of a corporation, its privileges and its disabilities, are derived entirely from the English books, we resort to them for aid in ascertaining its character.” Companies are acknowledged in North America to be direct descendants of the chartered corporation, a legal form that was widely adopted by the colonists17 and a form where the powers of the board were allocated to the board by the charter with the sanction of the Crown or the State. The central role of the board was always characteristic of corporations' law. As pointed out by Professor Bainbridge:18

[I]t is instructive to note the corporation, unlike partnerships, for example, did not evolve from enterprises in which the owners of the residual claim managed the business. Instead, as a legal construct, the modern corporation evolved out of such antecedent forms as municipal and ecclesiastical corporations. The board of directors as an institution thus predates the rise of shareholder capitalism. When the earliest industrial corporations began, moreover, they typically were large enterprises requiring centralized management.

11 Boards or their equivalent, such as town councils in municipal corporations, were one of the key components of all early corporations. A requirement for an elected board was in the first US incorporation statutes.19 The idea of a shareholder democracy with an elected governing body was strong in US corporate law from the beginning but has been eroded in more recent years by the agency theory. The standard clause in almost all US corporation statutes requires that a corporation be managed by or under the direction of its board of directors.20

12 The standard clause, until 1974, just stated that the company shall be managed by the...