The new model articles for private companies highlight a change in the law which needs to be carefully addressed by directors of private companies when considering share transfers.

The 1985 Table contained the following provision in article 24: “The directors may refuse to register the transfer of a share which is not fully paid to a person of whom they do not approve”. This was inappropriate for private companies for at least three reasons. First, private companies rarely had partly paid shares. Secondly, in so far as this article was relevant to a private company it was essentially a credit control measure. The directors might be happy that A should owe money to the company but considerably less than happy that B should owe money. Thus when A tried to transfer his partly paid shares to B, the company could refuse to register the transfer to B. Thirdly, most private companies would extend this article to cover fully paid shares so as to allow the board to exclude undesirables from membership generally. A typical special article might read: “The directors may, at their absolute discretion and without giving any reason therefor refuse to register the transfer of any share to a person of whom they do not approve”.

The reason why the words: “without giving any reason therefor” were typically included was because the right to refuse to register the transfer of a share is a fiduciary power exercisable by the directors. In Re Smith & Fawcett Ltd [1942] Ch 304,a case which required the Court of Appeal to consider a similarly worded special article,  Lord Greene MR expressed it thus: “In the present case the article is drafted in the widest possible terms, and I decline to write into that clear language any limitation other than a limitation, which is implicit by law, that a fiduciary power of this kind must be exercised bona fide in the interests of the company. Subject to that qualification, an article in this form appears to me to give the directors what it says, namely an absolute and uncontrolled discretion”. It was generally considered necessary in such an article to provide that the directors did not need to give a reason for their exercising their right to refuse to register the transfer. So long as the directors gave no reason for their refusal, their motives could not be called into question. If a rejected transferee wanted to show bad faith he had to put forward evidence of that bad faith. If no reasons had been given for the refusal, no evidence of bad faith could be evinced.

Three sets of model articles have now been produced for companies formed on or after 1^st October 2009. It was to be expected that the model articles for private companies would contain a restriction on the transferability of any share. It is to be found in article 26(5): “The directors may refuse to register the transfer of a share, and if they do so, the instrument of transfer must be returned to the transferee with the notice of refusal unless they suspect that the proposed transfer may be fraudulent”. Thus the right to refuse to register the transfer applies generally to companies having this article unless it is specifically excluded by a special article. The requirement that the instrument of transfer be returned to the transferee is new, as is the right of the directors to retain the documentation if they suspect that the proposed transfer may be fraudulent. But what is especially to be noted here is that the directors do not have a specific right to withhold the reason for refusal.

This is because of an innovatory provision in the Companies Act 2006. Section 771(1) provides that if the company refuses to register a transfer of shares or debentures, it must give the transferee its reasons for the refusal. Section 771(2) then states that the company must provide the transferee with such further information about the reasons for the refusal as the transferee may reasonably request. This does not extend to his being allowed to see the minutes of the board meeting at which the rejection occurred. Failure to comply with these provisions is a criminal offence committed by both the company and every officer who is in default.

The requirement to give reasons applies not only to companies formed on or after 1^st October 2009 but to all companies. Therefore the statutory requirement to give reasons might be said to trump any existing special article which provides that reasons need not be given. There is probably no justification for the articles of existing companies to be reviewed in the light of this change in the law, but care must be taken when refusing to register a transfer. The reason provided must be one which can be demonstrated to have been taken in good faith.

Guest author Mike Griffiths

Mike Griffiths is a contributor to Gore-Browne in Companies, Jordan’s Corporate administration and Governance and Charlesworth’s Business Law, and a co-editor of Loose on The Company Director, Charlesworth, Griffiths and Doyle on Company Voluntary Arrangements and Loose on liquidators and will join us to contribute technical articles on various subjects over the next few months.

mike@blossomfarm.co.uk

Why not follow @BroomfieldWales on Twitter to keep up with the latest information on business and financial topics, or simply register for our monthly newsletter.