Court corrects blunder made by well-meaning company directors

The High Court has overturned a major mistake made by directors that would have had serious consequences for their company and its shareholders.

The problem arose because one of the directors had terminal cancer. The company was indebted to him for £600,000 and it was believed that upon his death, that amount would become immediately repayable, causing considerable difficulty for the business.

The other directors quickly passed resolutions that had the effect of the company issuing 490,000 B shares with a nominal value of £1 each and allotting them to their sick colleague to reduce the liability for his loan account. This amounted to a substantial over-valuation of the company and a dilution of the value of existing shares.

Following the death of the director, his family and the other shareholders became aware that issuing the shares had created a potential for tax charges on his estate and had fundamentally altered the balance of interests in the company between the shareholders.

The company asked the court to rectify the problem, arguing that the decision about the share issue was voidable and should be set aside.

The judge said it was plain that the directors did not understand the effect of the transaction they approved by passing the resolution and, had they understood it, they would not have passed it. Where things went wrong was their decision to issue shares with a nominal value of £490,000 where the existing share capital had a nominal value of only £10,000.

The directors did not fulfil their fiduciary duties because, principally, they failed to take into account relevant considerations such as the massive dilution of the value of the ordinary shares and the potentially very serious tax consequences for the shareholders that would flow from the transaction.

Those were matters within their remit and they could reasonably have been expected to have spotted the obvious mismatch between the value of the existing share capital and the new shares.

The decision over the share issue was set aside.

Please contact Sarah Liddiard if you would like more information about the issues raised in this article or any aspect of company law.