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Deadlock In Management

Nathalie Ker discusses a recent case on the scope of shareholders' reserve powers

In Company Law, there is usually a clear division of power between the board of directors and the shareholders of a company. Subject to the articles of association, the business and affairs of a company are managed by the board of directors. However, where there is deadlock in the board of directors, shareholders may be vested with reserve powers of management under the common law in order to break such deadlock.

 

When do shareholders have such reserve powers? How is the scope of such powers determined? These were the underlying questions behind the legal issues that were before the Singapore High Court in the recent case of TYC Investment Pte Ltd and others v Tay Yun Chwan Henry and another [2014] SGHC 192.

BACKGROUND OF THE COMPANY

The case concerns TYC Investment Pte Ltd ("TYC"), a family holding company for the well-known Singaporean luxury watch retailer, The Hour Glass Limited ("THG"), and other family assets. The dispute arose out of the 2010 divorce proceedings between Dr Henry Tay Yun Chwan ("Tay") and Ms Jannie Chan Siew Lee ("Chan"), the founders of THG. Tay and Chan were also the founders and the only directors of TYC, each holding a founder share in TYC which gave them 46% and 44% of the voting rights respectively. The other shareholders were their three children.

Article 8 of the Articles of Association of TYC provided that Tay and Chan were to be the permanent 'Governing Directors' of TYC until they resigned from office, and all other directors would be under their control and would have to conform to their discretion regarding TYC's business. Article 8, with its restrictions on any other directors of the Company, was central to the dispute at hand.

THE DIVORCE SETTLEMENT AND PAYMENT CLAUSE

As part of the settlement of the divorce proceedings, three agreements were entered into by Tay and Chan ("Settlement Agreements"). One of these agreements contained a payment clause (amended by a subsequent agreement) ("Payment Clause") which required payments by TYC to be approved by both Tay and Chan, and neither could sign a cheque on TYC's bank accounts unless the other had signed a voucher approving the payments.

TYC was bound by the Payment Clause by a deed entered into among Tay, Chan and TYC. Article 16 of the Articles of Association of TYC further prohibited TYC from amending, varying or waiving its rights and obligations under the aforesaid deed without the unanimous consent of the shareholders of TYC.

What neither Tay nor Chan foresaw in the drafting of the Payment Clause was that either of them could unilaterally cause TYC to withhold payments of apparently legitimate expenses by simply refusing to sign a corresponding voucher.

EVENTS LEADING TO THE DISPUTE

The events leading up to the suit revolved around the refusal of Chan to approve various payments by TYC. As most of the disputes over the payments were settled by the time the suit was heard by the Court, the only payments in issue were payments of fees to KPMG in connection with its engagement to advise on accounting and tax issues arising from the Settlement Agreements, and fees due to solicitors, TSMP Law Corporation ("TSMP"), in connection with the commencement of the suit.

As a result of Chan's refusal to approve payments, Tay convened an Extraordinary General Meeting ("EGM") of TYC on 4 September 2013 to pass resolutions to appoint TSMP to commence an action against Chan and to authorise Tay to unilaterally sign cheques and vouchers to effect certain payments. The EGM was attended by Tay and one of the three children. As they collectively held 51% of the voting rights in TYC, the resolutions were passed.

Chan opposed the appointment of TSMP, arguing that the appointment by way of the resolutions on 4 September 2013 was improper as the management and administrative powers of TYC vest with its board of directors.

The Court had to decide whether the shareholders of a company in general meeting could pass a resolution to approve the appointment of solicitors and to commence proceedings against a director where such a director was able to veto any proposed board resolution to commence such proceedings.

THE DECISION OF THE COURT

Lee Kim Shin JC began his legal analysis by considering the issue of the division of powers between the board of directors and the shareholders of a company and an examination of the seminal common law authorities. Section 157A of the Singapore Companies' Act, which states that "the business of a company shall be managed by or under the direction of the directors" and that "[t]he directors may exercise all the powers of a company except any power that this Act or the memorandum and articles of the company require the company to exercise in general meeting", was also brought into the equation.

It was concluded that section 157A settled the position that where powers of management are vested in the board of directors, then ordinarily, the board alone could exercise those powers. This position was reflected in Article 73 of the Articles of Association of TYC.

The Court then went on to consider whether there was an exception to the general position where shareholders had 'reserve powers' of management when the board of directors was in deadlock. After reviewing various English authorities and an Australian authority, the Court concluded as follows:

  1. Reserve powers are a matter of implication under a company's constitution on the basis of necessity or business efficacy, and the scope of such powers is narrow, with the express terms of the contract between the shareholders and the directors (i.e. the articles of association) to be respected as far as possible;
  2. Reserve powers do not devolve to the shareholders unless the board is unable or unwilling to act. The fact that shareholders disagree with a bona fide board decision will not in itself be sufficient. However, if the directors who are preventing the company from suing are the wrongdoers themselves, this requirement is more often than not satisfied;
  3. If the deadlock in management may be broken in some other way under the company's constitution, the Court should refuse to recognise any such reserve powers of management. Thus, mere convenience will not justify the exercise of management powers by shareholders;
  4. The scope of the reserve powers which the shareholders may exercise would depend on the facts of each case - a useful yardstick being "what is reasonably necessary in the circumstances to break the deadlock?"; and
  5. The resolution to commence proceedings must be validly passed in accordance with the company's constitution, depending on whether a super-majority decision is needed or merely an ordinary resolution will suffice.

APPLICATION TO THE FACTS

Did the shareholders by way of the EGM have the power to appoint TSMP and commence legal proceedings in the name of TYC?

The learned judge then applied the principles set out above to the TYC suit. It was not disputed that there was a deadlock in management, the source of the deadlock being two-fold: first, the requirement that both Tay and Chan approve payments according to the Payment Clause; and second, the fact that they were the only two directors of TYC and had to agree on management decisions.

It was decided that TYC did not have a contractual remedy under its articles to break the deadlock in relation to the resolutions raised at the EGM as payments had to be approved by both Tay and Chan. Thus any appointment of additional directors would not break this deadlock. Further, any additional directors appointed would still have to submit to the discretion of Tay and Chan in respect of the management of TYC including the commencement of any legal action.

Having decided that it was necessary for the shareholders to have reserve powers in this case, the next issue was the scope of these reserve powers. On the facts, it was held that it was reasonably necessary for the shareholders in the EGM to have the limited power to appoint solicitors to commence proceedings to determine the rights and obligations of the relevant parties under the Settlement Agreements, in order to break the deadlock in management.

Could the shareholders in the EGM authorise the unilateral approval of payments by Tay or compel Chan to sign the relevant cheques or payment vouchers?

Having decided that the appointment of TSMP at the EGM of 4 September 2013 was valid, the Court nevertheless went on to hold that the reserve powers of the shareholders did not extend to authorising the unilateral approval of payments by Tay as this was inconsistent with the Payment Clause, and it would not be reasonable to imply a reserve power which would allow the EGM to determine payment matters for itself, as opposed to allowing the commencement of legal proceedings in order to enable the Court to determine the rights and obligations of the parties under the Settlement Agreements or at general law.

It was also decided that there was no breach of fiduciary duty by Chan in her refusal to approve the payments to KPMG as she had a bona fide belief that KPMG had not discharged fully or properly its obligations under the terms of the engagement. Thus, she could not be compelled to approve such payments.

Further, the Court did not make any order to compel Chan to approve payments to TSMP as the Court held that it was not in a position to determine whether the fees due to TSMP were reasonable and ought to be paid by TYC; this was a matter for TYC and its directors to decide.

COMMENTS

The decision in TYC Investment reinforces the general position that management powers, including the power to commence litigation, are the domain of the board of directors. Reserve powers of management are to be given to the shareholders only in exceptional circumstances: where it is necessary in order to overcome a deadlock in the board and where there is no contractual remedy available under the articles of association.

The scope of such reserve powers is narrow and fact-sensitive, and is to be determined by what is reasonably necessary to break the deadlock. It is also clear from the decision that the articles of association of a company are paramount, and reserve powers to shareholders cannot empower the shareholders in general meeting to rewrite their obligations in relation to the directors and the company under the articles of association.

The position regarding such devolution of powers to the shareholders in general meeting has yet to be fully canvassed in the Malaysian Courts. As the division of powers between the board of directors and shareholders in general meeting under Malaysian law is substantially similar to that under Singapore law, the principles enunciated in TYC Investment will provide a useful guide for the Malaysian Courts in this area.

Writer's e-mail: This e-mail address is being protected from spambots. You need JavaScript enabled to view it

WRITER'S NAME : NATHALIE KER SI MIN

WRITER'S PROFILE:

Nathalie is an Associate in the Dispute Resolution Division of SKRINE. She graduated from University of Leeds in 2012.

SUBJECT : CASE COMMENTARY

 
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