Managed approach

Friday, 01 January 2010
Considering the best ways for trustees to work with family trading companies.

Some intractable problems arise when family trading companies are held within trust structures, including issues of confidentiality, payment of dividends and the tensions between the trustees’ duties and the board’s duties. This article will consider some of these issues.

Should the trustees seek appointment as directors?

The trustees should consider this on their appointment, or at a later stage if they become concerned at the actions of the Board.

The trustees need to bear in mind their duty of care, and will be subject to a higher standard if they are professional (Bartlett v Barclays Bank [1980] Ch. 515). In Bartlett it was held that information provided to a standard shareholder will be insufficient where the trustees own a significant majority shareholding. It will be insufficient in such a case for the trustee to merely attend annual meetings and it is also crucial to ensure an adequate flow of information to the trustees. In Bartlett the trustees relied on a professional board (including two surveyors) and did not know of the investment undertaken by the Board, which proved disastrous.

Do anti-Bartlett clauses provide significant protection? A common form of such a clause will be: ‘the trustees are not bound to interfere in the conduct of the business provided the trustees have no notice of acts of dishonesty or misappropriation and the trustees are at liberty to leave the conduct of company to the directors.’ This does not, however, exclude the duty of care, and the trustees must still take precautions to ascertain whether the company is managed properly.

The trustees should consider appropriate standards of corporate governance. The Higgs Code applies only to listed companies, but if an unlisted company is substantial in value or complexity, trustees would be well advised to take the view that the governance principles in the Code should be adhered to. Under the Code, an independent non-executive director should be appointed to ‘constructively challenge and help develop proposals on strategy… scrutinise the performance of management… and monitor the reporting of performance. They should satisfy themselves on the integrity of financial information and that financial controls and systems of risk management are robust.’

If an experienced non-executive director, able to take an independent view from the family, is on the Board, the trustees may be more willing to consider that they do not need to appoint themselves as director/s. The non-executive could act as the trustees’ representative to provide information to the trustees.

Alternatively, the trustees could appoint an observer. This may be more acceptable to family directors, who may resent the assumption of authority by trustees from outside, The observer would have all powers of a director, except for a vote on the Board. The observer may also have the power to attend and speak at meetings and have access to all information that would be provided to directors.

However, there is much to be said for having at least one trustee on the Board as a director. The trustee can then discuss and influence matters at Board level; and this may also help to avoid arguments from the Board as to the proper extent of shareholder involvement in company affairs. Without a representative on the Board, it can be difficult for trustees to achieve change without threats of sacking the Board.

Trustees need to consider whether they need also to be on boards of subsidiaries. Structures with layers of holding companies between the trust and operating companies may appear to strengthen an argument that the trustees are not liable should problems arise. But if the trust owns 100 per cent of intermediate companies, which hold 100 per cent of the operating companies, such intermediate layers may not provide much actual protection, if trustees knew, or should have known of, actions of companies further down the line.

The disadvantages of a trustee being appointed as a director include conflict issues. Companies Act 2006 s.175 provides that potential conflicts of interest must be reported. The conflict can be authorised by resolution of other directors on the Board, but this could be made subject to conditions. In addition, the older provisions, as to reporting and abstaining where a conflict arises in respect of a specific transaction, still apply. The trustee director would commit an offence were he to fail to disclose his interest in a transaction proposed by the company.

A trustee acting as a director may face a real conflict between his duty as director and his duty as trustee. As a director, it may be appropriate to concentrate the company’s investment in one geographical area or market sector; but as trustee he must consider diversification of trust assets overall, and may therefore need to consider investment in other asset types.

A practical way to mitigate tension between trustees and directors is to have an agreement between them, to define the areas where the trustees must be consulted, and where they will not be involved, for example by providing a definition of strategic, as opposed to non-strategic, issues.

Issues for trustees as shareholder

Additionally, there are concerns for trustees in their capacity as the controlling shareholder of a trading company.

Minorities

Trustees who hold the majority of the shares need to take into account the minority’s rights to take action to redress prejudice, such as non-payment of a dividend without commercial justification. The invariable result of a successful, or frequently settled, unfair prejudice claim is the buying out of the aggrieved shareholders. Is this what the trustees wish to achieve?

Conflicts

The trustees may not always be able to vote all the shares together to obtain a majority, if the shares are held through different trusts and the interests of the beneficiaries of those trusts conflict. In such cases the trustees will need to record separate decisions carefully in relation to separate trusts.

Conflicts within trusts may also arise. Whether or not there are beneficiaries entitled to income, the trustees need to give consideration to whether the company’s policy on dividends or investment favours some beneficiaries over others, for example if there is a lack of income, or of capital growth.

Information

Problems arise where information is received by a trustee in different capacities, either as a trustee/director subject to the duty of confidentiality to the company, or as a trustee/shareholder who has a duty to her beneficiaries. The problems are acute where one beneficiary is on the company board and has full access to information, but another beneficiary is outside the board and has access to information only via the trustees.

The trustees cannot provide more information to one beneficiary than to another if they have similar interests. They will need to consider what information a beneficiary needs to be satisfied that the trustees have acted properly in exercise of their functions. The trustees should start from the premise that they should be open with beneficiaries, but withhold commercially sensitive information.

As a shareholder, the trustees have no duty of confidentiality to the company, but their duty to protect the interests of the trust as a whole would prevent them from revealing information that could damage the company’s interests. On that basis, the directors could properly pass information to trustee shareholders.

If trustee shareholders have agreed to receive information on a confidential basis, they cannot pass it on to beneficiaries without the agreement of the Board. The beneficiaries may nonetheless seek information under the principles outlined in Butt v Kelson [1952] Ch. 197, CA: they must request specific information (management accounts etc.), which should be provided if there are no valid objections.

The directors, on the other hand, owe their duty to the company, not to shareholders, and will want to keep information confidential if there is any commercial sensitivity. Prima facie information relating to the management of the company is confidential and directors are liable if they breach confidentiality.

The principles in Butt v Kelson may therefore conflict with the directors’ duty of confidentiality: a director may be in breach of that duty if he complies with requests for information without the agreement of all shareholders, or a court order.

One approach is that trustees (at the outset) might accept information from the Board on a confidential basis, as the information is received to enable them to exercise their discretions properly, and like all such information, that would be confidential to the trustees. The beneficiaries are only entitled to know that the trustees have had access to sufficient information to enable them to reach a proper decision. This approach would cease to be sufficient if beneficiaries seek further information in order to satisfy themselves that the trustees have, in fact, exercised their discretions properly.

Dividends

The directors usually have the power to declare dividends. The shareholders have no direct power, generally, to force them to do so.

There is no obligation on directors to declare a dividend, but in Re A Company (1988) WLR 1068 the Court granted a petition by the shareholder to have the company wound up due to the company’s failure to pay adequate dividends, despite significant distributable reserves. The judgment suggested that the members may have a legitimate expectation of receiving a dividend.

Where beneficiaries have a life interest, they will be in a stronger position than if they are only a discretionary beneficiary, to argue that a dividend should be paid, since they can be said to have a legitimate expectation of receiving some income benefit from the trust, provided there is no strong reason not to pay a dividend in line with other comparable companies.

The trustees’ position in seeking a dividend at a certain level will be difficult to attack if appropriate advice is taken analysing the approach of similar companies, using a reasonable sample, showing that the dividend the trustees seek is compatible with them, and other relevant factors have been considered, including interests of different beneficiaries, the company’s own reserves and the company’s need for capital in the short term.

Jones v Firkin Flood (2008) EWHC 2417, considered in the STEP Journal October 2009, was a good example of the pitfalls. The trustees failed to secure a dividend from the company over a period of seven years, although beneficiaries of the shareholder trust had rights to income. This was one of the factors which led the Court to conclude that the trustees had not acted impartially, had failed to fulfil their duties and should be removed.

Conclusion

The economic climate provides a testing environment for trustees who are majority holders of shares in trading companies. It will be essential for trustees to be fully informed about the company’s financial position, and to be in a position to make their views known, and acted upon, speedily. In most cases at present it seems probable that the risks to trustees from taking too active a role in such companies are likely to be outweighed by the risks in not exercising sufficient vigilance in safeguarding the trust’s major assets.

This article is based on a talk given at STEP Central Branch on 1 October 2009.

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Lucy Johnson

Lucy Johnson TEP is a Solicitor at Withers LLP.

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