Stockholders Defined

By Sharon Arnolda | Published: 2:00 AM Sep 25 2021
Echo Stockholders Defined

By Sharon Arnolda

“Shareholder activism is not a privilege – it’s a right and a responsibility. When we invest in a company we are part of the company and we are partially responsible for that company progresses, if we feel that there is something going wrong with the company then we, as shareholders, must be active and vocal.” 

— Mark Mobius 

The eighth session of the SL Law Review web series hosted by American Chamber of Commerce in Sri Lanka (AMCHAM) was held recently, focusing on shareholders; their rights and obligations. The timely discussion was panelled by presidents Counsel Nihal Jayawardene who has been in the legal practise since 1983 also actively participated in the Company Law reforms process from May 1993 which resulted in the enactment of the Companies Act No. 7 of 2007; Senior Legal Counsel Hiran de Alwis practicing in Colombo over the last 25 years, specialising in Civil and Commercial Law, Financial and Securities Litigation and Commercial Arbitrations; Senior Attorney-at-Law Ayomi Aluwihare who is the Precedent Partner of the law firm F. J. & G. de Saram and is the Head of the Corporate Law/Commercial Division of the firm with over 20 years of experience; and was moderated by Attorney-at-Law Lalani Paranawithana who is attached to the AMCHAM and is the co-organiser of this series. 

Who exactly are shareholders and how did their role evolve into what it is today? 

In opening the discussion Jayawardene stated the following; To put it simply, shareholders are those that invest money in a company. The concept came into existence in the 19th century with the introduction of the concept of limited liability companies; which as a concept came into existence to divorce the entity that is a company from those who invest and manage it. 

He further stated that the concept evolved from the decision in ‘Borland’s Trustee v Steel Brothers & Co. Ltd. [1901] 1 Chapter 279’ in which it was elaborated that a ‘share’ measures a shareholders interest in the company measured monetarily based on the investment that was made for the purpose of ascertaining a shareholders liabilities and entitlements. In other words, a share is not a sum of money but an interest measured by it, he added. 

According to Section 49 of the Companies Act 0f 2007 (the Act) a share is defined as movable property which grants the holder rights in and against the company. In general, a share acquired will secure its holder a vote at a meeting or in passing a resolution, an equal share entitles its holder to equal distribution in the event of surplus following liquidation. He added that the rights, obligations, and interests of a shareholder are defined in the Act in addition to what is agreed in the shareholders agreement. 

Articles lay down all the governing laws for the company and usually are what you rely on, the shareholders agreement isn’t mandatory but is used to bring in additional clauses to protect investors. One example of where it is used is when a foreigner invests 100 per cent of the money but can only show 49 per cent ownership on the books. 

This would lay down the terms of repayment. The shareholders agreement can also lay down clauses that supersede the articles of association in terms of voting rights of shareholders but then, the shareholders agreement has to specify that in situations of ambiguity between the articles and the shareholders agreement that the shareholders agreement will supersede. 

The classification of shareholders 

Ordinary shareholders are those that make an investment in a company and therefore, are directly impacted by the profits and losses made by the company. In addition to this shareholders can be conferred rights and obligations based on what is agreed in the Agreement. Preference rights can be given to some shareholders in regard to payments of dividends or in the event of casting a vote. He further added that shareholding can be further classified into categories such as redeemable shares and nonredeemable shares. 

What are the fundamental rights and duties of a shareholder? 

A shareholder makes an initial investment in the capital and acquires rights and obligations based on the same; Prior to the existing Act a company could only perform according to the objectives laid out in the Memorandum of the Company, anything besides the defined actions would have been considered illegal. Which means that any party making an investment (a shareholder) was aware of the functioning of the company. 

However, under the new Act a company can carry out business activities besides what is laid out in the objectives in the Article of Association, provided that it is legal (subject to certain conditions). However, through section 16 of the Act a contract is created between the company and the shareholder and shareholder can sue the company for the breach and enforce conditions of the same. However such action needs to be taken in a court of law before the company starts carrying out the activity that is in contravention with the objectives. 

The act provides for Minority buy out rights; in which a minority shareholder can demand the company to buy them out in certain instances. In addition to the rights conferred through the Act, shareholders can agree on their rights and obligations towards a company based on the agreement between them. The Act gives further flexibility through Section 31 which states that the parties can even agree to terms that negatively affect the parties, and the parties can choose the application of the rights and obligations laid out in the Act. 

Shareholder rights are attached to groups. As a minority they can vote on aspects such as changing of directors and auditors. However, situations requiring the passing of special resolutions such as changing the articles of the company and amalgamations require a special majority vote (75 per cent of the shareholders present at the meeting), 10 per cent can call requisition a meeting. Further, if a shareholder acquires more than 90 per cent of the shareholding of a company such person has the right to ‘force out’ or ‘buy out’ the minority shareholders. In addition to which every shareholder has the right to request and receive details of the company such as annual reports and financial statements. 

Liabilities and powers of a shareholder 

Tackling the question Aluwihare stated that the fundamental understanding is that through the principle of the company being a ‘separate legal entity’, the liabilities imposed on a company does not directly affect the shareholders of the same. A shareholders liability is to contribute to the initial funding of the company after that there is no direct liability, she added. 

However, there are certain instances that the courts will look into the actions of the shareholders in the event of fraudulent activities such as tax evasion; where the court pierces/lifts the ‘corporate veil’ to look into the direct actions of the shareholders and find them directly liable. 

How is a shareholder protected? 

“The law provides a sword and a shield.” 

— Hiran de Alwis 

The primary right given to shareholders is the right to transfer their shareholding, in addition to which they are registered in the Company’s Register which gives them statutory, contractual, and equitable recognition. The existing sophisticated laws and the ability to alter their rights and obligations based on their agreement with the company gives shareholders the opportunity of protecting their rights and further expanding on them. 

There is a lack in the enforcement of these rights, de Alwis added. Prior to going to courts a shareholder is given the options of calling for a meeting or resolution, an audit or appealing for a seat on the Board in addition to the right of compensation in certain instances. The Act through section 224 onwards provides for the oppression and mismanagement of minority shareholders. 

Even though the Act provides for actions such as derivative actions the general understanding is that the Court does not tend to interfere in business policy. However, if there is mismanagement or a material change brought to its attention the court can in its discretion intertwine and make demands of the company. The main understanding between the company and its shareholders lies in the contract entered into by them through the articles of association. However, in the event of a material dispute or fraud the Act will generally take precedence over the agreement. 

De Alwis also went on to emphasise the importance of entering into a comprehensive agreement with the company and ensuring that such agreement is handled professionally. Subject to the terms of the agreement a shareholder can – based on such documents – sue the company for damages, demand for specific performance through the intervention of the court or turn to the court for injunctions and other remedies. 

Can a shareholder be a director? 

In answering Jayawardene stated that while in the initial stages a person had to be a shareholder to be a director such a requirement is not a necessity under the current regulations. In her closing remarks Aluwihare mentioned that the current Act which in addition to its English roots is also based on the Companies Act of New Zealand, which is based on the act of similar nature in North America. This has resulted in the current Companies Act providing for a lot of flexibility for companies to operate, especially from an investment point of view. 

By Sharon Arnolda | Published: 2:00 AM Sep 25 2021

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