SHAREHOLDERS AND DIRECTORS- DISTINGUISHED

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In the course of my interactions with clients I very often find that some clients do not understand the difference between being a shareholder and a director. They believe that being a shareholder is the same thing as being a director.

This misconception may be as a result of what is usually obtainable in small private limited liability companies where the promoters of the company are usually both shareholders and directors at the same time. Although there is nothing wrong with this type of arrangement under the law (especially given that it is very convenient for small private limited liability companies) there is a huge difference between shareholders and directors and a shareholder must not necessarily be a director and vice versa. Basically shareholders own the company while directors manage the company.

Another question that naturally follows after the clarification is made usually goes like this: “If we make a person who is not a shareholder a director in our company (merely because we need his skills and expertise in running the company) how does that impact on the powers of the shareholders?”  In essence the question is will the shareholders be able to control such a director? Between the directors and the shareholders who possesses the ultimate powers?

In this post we will attempt to clarify the issue regarding the status of shareholders and directors. We will also provide an insight as to the respective powers of the shareholders and directors in a company and the extent of such powers.

The Company

In this post, the word “company” simply refers to a limited liability company. It is instructive to note that a company is a legal entity that is distinct from its members (i.e. shareholders). Under the law, a company is an artificial person and for the purpose of carrying on its authorized business is deemed to have all the powers of a natural person (like you and I). The legal implication of this is that a company can, in its own name, buy properties, borrow money, sue and be sued etc.

However, being an artificial person, a company can only act through natural persons as its agents. To this end, a company acts through its members in general meetings or its board of directors or through officers or agents appointed by or under authority derived from the members in general meeting or the board of directors. This simply means that a company operates and acts through two principal organs i.e. (1) the shareholders in general meeting; and (2) the board of directors.

The relationship between the company, the shareholders and the directors is regulated by the constitution of the company which is the Memorandum and Articles of Association of the company. The Memorandum and Articles of Association has the effect of a contract under seal between the company, the shareholders and the directors and between the shareholders and the directors and as such all the relevant parties are bound to perform and observe the provisions of the Memorandum and Articles of Association as amended from time to time.

Who is a shareholder?

A shareholder of a company is any person that holds part of the shares constituting the authorized share capital of the company. Under the law a person must hold at least one share to qualify as a shareholder and is also regarded as a member of the company. The shareholders exercise their powers and make decisions in general meetings (i.e. either Annual General Meetings or Extra Ordinary General Meetings)

Who is a director?

A director is a person duly appointed by the company to direct and manage the business of the company. The responsibility of managing the day to day business of the company is vested in the board of directors unless the Articles of Association (the Articles) of the company states otherwise. Directors exercise their powers and make decisions in board meetings.

The powers of the shareholders Vs the powers of the directors:

Subject to the express provisions of the law, the powers of the shareholders in a general meeting and that of the board of directors are determined by the Articles. The shareholders can, through the Articles, delegate some powers to the directors like the power to allot shares, or to borrow money for the purpose of running the company’s business etc. The shareholders can also through the Articles restrict the powers of the directors by exclusively reserving some matters for the sole decision of the shareholders.

Notwithstanding the power of the shareholders to regulate the powers of the directors through the provisions of the Articles, there are certain powers attached to the board of directors by law which cannot be interfered with by the shareholders. For instance the shareholders can only declare dividends on the recommendation of the board of directors. Also in declaring the dividend, the shareholders have the power to only reduce the amount recommended by the directors for dividends; they cannot increase the amount recommended by the directors.

Furthermore, once the actions of the directors are in accordance with the law and the Articles, the shareholders cannot interfere with or reverse such actions. The board of directors, while acting within the powers conferred on it by the law or the Articles, is not bound to follow the instructions of the shareholders given in a general meeting in so far as the directors are acting in good faith and with due diligence.

What then happens if the shareholders are not happy with the way the directors are exercising their powers? The shareholders, in such a situation, will either wait for an opportunity to remove the director(s) whose behavior and actions are unsatisfactory or alternatively the shareholders can amend the Articles to remove such powers from the board of directors and reserve same for the shareholders.

Finally it can be argued that the shareholders have the ultimate powers basically because they have the power to appoint and remove directors from office, to regulate the powers of the directors through the Articles and to act in place of the directors where the directors neglect or are unable or unwilling to act. However, it is important to note that notwithstanding this “ultimate powers” of the shareholders, what determines at every given point in time the powers of the directors and the shareholders and the validity of their respective actions is the Articles and the law. Every power validly exercised under the Articles or the law either by the shareholders or the directors remains valid even when the Articles is later amended to provide otherwise.

7th May, 2014