Director duties in family-held quasi-partnerships – Saad Qureshi

“Director duties in family-held quasi-partnerships”

Those who have studied company law should be familiar with a key authority that is Salomon v Salomon decided in 1897.  Mr. Salomon was considered a very successful and reputable business man in Whitechapel, London, as a boot manufacturer with large warehouses. For thirty years Mr. Salomon had been trading and his four children also assisted him but were not partners in the business. After some time, Mr. Salomon’s children began requesting their father to give them an official capacity in the business. He eventually did so by setting up a private limited company called A Salomon & Co Ltd, and made all of his family members shareholders of the company. Through a general meeting, Mr. Salomon and his two elder sons were appointed as directors. The limited company took over Mr. Salomon’s business of manufacturing boots for a price over £39,000, which was paid to Mr. Salomon. One of the company’s creditors, and the courts, later said that this was a seemingly generous offer.

Unfortunately, after some time the business failed, and Mr. Salomon, or to be more precise, the company, could not pay its creditors. A claim brought in the courts against the company, which included that Mr. Salomon did not run the business properly and that the creditors should be paid. When the company went into liquidation it paid a substantial chunk of the debt owed to a secured creditor, however, there was apparently still £7,773 which was owed to the company’s unsecured creditors. Mr. Salomon also invested in the business in the form of debentures and so had already paid himself as a return on his debentures, which meant he was unable to pay the aforementioned unsecure creditors. The liquidators said that Mr. Salomon was in breach of his fiduciary duties.

Indeed in the original decision by Vaughn Williams J it was held that the A Salomon & Co Ltd was Mr. Salomon’s business and no one else’s as the remaining members (his family) were merely dummies.  However Lindley LJ in overturning the decision of Vaughn Williams J stated that there was nothing in the Companies Act 1862 which stated that a shareholder must be an independent and beneficially interested person.

There was clearly a question of whether the ‘closely-held’ nature of the company A Salomon & Co Ltd (i.e. that the shareholders and directors were family members) contributed to the issues in the company and its inability to pay its creditors. Quasi-partnerships may pose challenges because of the inherent way in which they are structured and operate.

Under common law today, such a close-held company, subject to meeting further strict criteria, is increasingly being called a ‘quasi-partnership’ as defined in the case Ebrahimi v Westbourne Galleries Ltd. In this case, Lord Wilberforce presiding defined the criteria to be met if a standard limited liability were to qualify as a quasi-partnership. These criteria include: 1) An association formed or continued on the basis of a personal relationship involving mutual confidence – which can be shown if the company has taken over a former partnership business; 2) An agreement that all or some (there may be sleeping members) of the shareholders will be involved in the conduct of the business; 3) Restrictions on the transfer of a member’s interest (i.e. on disposal of shares).

Based on the above criteria it can be seen how the company, A Salomon & Co Ltd, could be considered a quasi-partnership. Firstly, the association was formed on the basis a personal relationship involving mutual confidence between Mr. Salomon and the other shareholders and directors of the company, as they were his family members, and the company also took over the pre-existing business of Mr. Salomon in which four of his sons were already assisting him. Secondly, as per the second criterion, five members of his family including his wife were shareholders, and at least two of these shareholders (his two eldest sons) were appointed as directors and were involved in the running of the business. Thirdly, there was a restriction on shares, with Mr. Salomon and his family owning all the 40,000 shares of the company with no outside member, and more particularly, where Mr. Salomon owned majority of the shares at 33,000, and thus, was majority owner at approximately 82%.

Numerous case law have similar characteristics, and this article will analyse the criteria set in common law to define a quasi-partnership. Quasi-partnerships are further peculiar because they are not defined in the Companies Act 2006 in the forms of companies that can be registered and established under it in sections 3-6 of the Act. In addition, the criteria used to define them such as the existence of a ‘personal relationship’ and ‘mutual confidence’ between members, is problematic, and such relationships are often not defined within the articles of association of the companies hence the need for the courts to decide whether a company is a quasi-partnership or not.

Apart from the above issue of the unique characteristics of a closely-held company identified above in the Salomon case and whether this contributed to the issues of the company, another underlying issue which this article seeks to raise, is that of a duty of directors of a company. Directors’ duties were not defined in the Companies Act 1862 at the time of the Salomon case, and were only codified in the Companies Act 2006. Under today’s legislation and common law, Mr. Salomon and indeed its fellow directors may have been in breach of a director duty related specifically to the company’s suppliers/creditors which is described in section 172 of the Companies Act 2006. These two underlying issues discussed above require further examination.

With the above background scene, the type of quasi-partnership chosen for this article is one which is run by a majority members of a family, given this was the position in the Salomon case. This is known in the field of family enterprise as a ‘family firm’, the characteristics of which shall also be compared to the criteria of a quasi-partnership.

In order to appreciate the scope of directors’ duties in quasi-partnerships, first and foremost an analysis of the concept of quasi-partnerships will be provided. The article will then turn to defining the fiduciary and statutory duties of directors in private limited liability companies. For the purposes of this article the directors duties that will be explored in detail are those found under  section 172, with emphasis on two subsections in particular: (1)(c) which relates to duties of directors owed to suppliers, customers, and other stakeholders; and (1)(f) which is the duty of directors to act fairly between members of the company. The article will conclude with a summary of the key findings from the literature review and where possible make some recommendations based on the findings.

This article is doctrinal involving analysis and interpretation of case law. It also incorporates literature from the field of family enterprise and management studies, as the type of quasi-partnership chosen is a company run by majority members of a family. A ‘family firm’ is a concept more thoroughly researched in these disciplines.

The first case in the UK to define ‘quasi-partnerships’, Ebrahimi v Westbourne Galleries, was decided in 1973 which demonstrates that this is still a new area. The case law and academic texts and research accept that there is a difference in practice between quasi-partnerships and limited liability companies, however, neither the case law nor the legal research considers whether, by quasi-partnerships being different, this could lead the company’s directors being in breach of section 172 of the Companies Act 2006.

The debate around quasi-partnerships exists because the above criteria are not covered in the companies act in any shape or form, and are not used in the memorandum of association or articles of association of the company, yet the model articles of association, which is a template developed to assist small companies in preparing their articles or are the default articles if one is not registered by the company itself, do not cover the above criteria in quasi-partnerships. The articles are a company’s constitution. This leaves the circumstances very vague should a problem occur, and some have called for separate shareholder agreements to be used by members of a quasi-partnership.

Therefore, it is left to the courts, should a case be entered, to decide whether a company is indeed a quasi-partnership. The Companies Act 2006 could be considered so out of touch with quasi-partnerships that judges in various case law to do with quasi-partnerships have relied on principles from partnerships and the partnership act, such as the concept of ‘deadlock’, where relations have broken down between members or where the purpose for which the association was formed has been achieved or is no longer viable.

There is a particular issue that, where there is no need to, the Judges do not categorise the firms as quasi-partnerships and are happy to treat them within the ‘confines’ as such of a limited liability company. This article relies on case law where the companies involved have been specifically defined as quasi-partnerships in order for the Judge to make a decision in the case, and in other circumstances, case law will be referred to where it appears it was not necessary for the company to be defined as a quasi-partnership, yet a closer examination of the company structure reveals it fits well into the criteria of a quasi-partnership.

As stated a quasi-partnership was defined in the case law adjudicated by Lord Wilberforce in Ebrahimi v Westbourne Galleries Ltd. The case highlighted features which determine if a limited liability company is a quasi-partnership. These include: 1) An association formed or continued on the basis of a personal relationship involving mutual confidence; 2) An agreement that all or some (there may be sleeping members) of the shareholders will be involved in the conduct of the business; 3) Restrictions on the transfer of a member’s interest (i.e. on disposal of shares – so that if confidence is lost, or if one member is removed from management, he cannot take out his stake and go elsewhere). Subsequent case law has recognised the above criteria of a quasi-partnership. The same criteria above has been adopted in other common law jurisdictions such as in Ireland (Murph’s Restaurant Ltd., Re [1979] IEHC 1) Malta (Suzanne Busuttil and others v Francis Busuttil & Sons Ltd and others [2014] C.A Malta) and Singapore (Eng Gee Seng v Quek Choon Teck and Others [2009] SGHC 205).

There is a growing body of management and enterprise research which examines the nature, issues and challenges of these family firms. Research from these fields is useful to further understand how quasi-partnerships are structured and operate to provide useful insights.

Whilst quasi-partnerships may encompass family-held companies, there is a separate definition of ‘family firms’ which appears more in management literature. A firm is deemed to be a family business if it meets the following criteria:

• The majority of votes are held by the person who established or acquired the firm, or their spouse, parents, child or child’s direct heirs, and
• At least one representative of the family is involved in the management or administration of the firm.
• In the case of a listed company, the person who established or acquired the firm, or their family, possesses 25% of the right to vote through their share capital, and that there is at least one family member on the board of the company.

The first criterion of a personal relationship in quasi-partnerships is inherent in family firms where the members belong to a family, but can also be gleaned from point one above in the definition of family firms where majority of votes are held by the person who established or acquired the firm, or their spouse, parents, child or child’s direct heirs. A family business is one in which the family bonds are crucial in the succession process and where the strategic positions of the company. This is why mutual confidence is (expected to be) higher.

The second criterion of a quasi-partnership is that the some of the members have to be involved in the management of the company. Compared to the above criteria of family firms, this relates well as in a family firms at least one representative of the family is involved in the management or administration of the firm. Research from Gallo and Sveen also shows that members have to take part in the management as well as having an important role as decision makers. Although it may appear that a ‘family business’ are small firms, family businesses are of varying sizes, the extent of family involvement and age.

Looking at family firms is also useful because whilst there are no statistics on the number of quasi-partnerships per se, there are on family firms, where in 2011 there were 3 million family businesses in the UK, or two in three of all private sector firms, and they were made up predominantly of Small and Medium-sized Enterprises (SME) according to the Institute for Family Business (2011) so the figure is reliable as the companies are not large international businesses. Looking at the case law referred earlier, majority are small and medium sized enterprises. This therefore demonstrates the size of family firms and therefore quasi-partnerships and indicates the importance for an understanding on whether the directors of such companies are meeting their duties under section 172 of the Companies Act 2006.

With regards to an understanding of how quasi-partnerships are different to limited liability companies, there is good recognition from the Ebrahimi case and other sources such as Derek Dunne, that quasi-partnerships are indeed different, and only use limited liability companies as a means to benefit from the protection of ‘limited’ liability. In the case Yenidje Tobacco Co Ltd Lord Cozens-Hardy MR said “but ought not precisely the same principles to apply to a case like this where in substance it is a partnership in the form or the guise of a private company?”

In order to further highlight the distinction between a standard limited liability company and a quasi-partnership, it is necessary to address each of the individual criteria of quasi-partnerships with reference to the Ebrahimi case and other case law. This leaves room for further research to be conducted in this area.

In the leading authority, the Ebrahimi case, a personal relationship existed between two friends, Mr. Ebrahimi and Mr. Nazar. They were both directors in Westbourne Galleries Ltd, and were also equal shareholders meaning that there was a mutual confidence that they would each be involved in the business. Later Mr. Nazar’s son joined as a director and shareholder thus effectively making Mr. Ebrahimi a minority shareholder. Lord Wilberforce stated in this case that one way a ‘personal relationship’ can exist in a limited company is if the persons were previously involved in business together before establishing a private limited company. Therefore, in the Ebrahimi case, Mr Ebrahimi and Mr Nazar were previously partners for around 10 years before they decided to incorporate as a business in 1958 due the success they were enjoying in the purchase and sale of expensive rugs.

Similarly, in the case of Bhullar v Bhullar from around the 1950s, Mohan Singh Bhullar and Sohan Singh Bhullar, who were brothers, ran a grocery store in Huddersfield, and were equal partners. Taking the view of Lord Wilberforce in the Ebrahimi case, a personal relationship and mutual confidence existed in the Bhullar case as a company called Bhullar Bros Ltd was incorporated in 1964 by Mohan and Sohan to take over their former grocery business. The company grew and eventually involved around a total of 8 family members of the Bhullar family, consisting of the two brothers Mohan and Sohan, their children, and their spouses.

Equally, in the Murph case in Ireland there were three shareholders, Brian Suiter, Kevin O’Driscoll and G. Murph O’Driscoll, who were closely associated. Two of them, Brian and Kevin, were good friends and worked in the same company IBM Ltd, and Murph the third shareholder/director was the brother of Kevin. Together, all three successfully ran a restaurant business that was incorporated in 1972. Though the company that was incorporated was not formed to continue an existing business, which is one of the signs of a personal relationship and mutual confidence, it was still held to be a quasi-partnership because of the association and the company was formed on the basis of the close relations between the members.

Symington v Symington is also a case from Scotland involving three brothers, and was one of the first cases that were relied upon by Lord Wilberforce in the Ebrahimi case. Two brothers ran a partnership business, and the business was later transferred to a private limited company, hence, it meets criterion one of a quasi-partnership. Further, each brother held half the shares, a third brother held a small number of shares to assist in the balance of voting, and there were other members with nominal interests. Through a general meeting, one brother along with other members holding only nominal interests in the company, voted and passed a resolution to make himself the sole director. The other two brothers filed a petition to wind up the company.

Taking another case, Cuthbert Cooper & Sons Ltd[1] the company was certainly a family-held quasi-partnership, where the father and his two elder sons were shareholders. This is further denoted by the use of ‘sons’ in the company name although clearly many quasi-partnerships that are family run do not use this reference in their company name.

In the Ebrahimi case, the share capital issued was 1,000 at £1 per share, and 500 were issued to Mr. Ebrahimi and Mr. Nazar.  Later when Mr. Nazar’s son joined the shares were devided as 30% each to Mr. Nazar and his son, and 40% to Mr. Ebrahimi. All three directors and shareholders were actively involved in the management of the business of purchasing and selling rugs and had a share of the profits. It is not easy to deduce the actual involvement of Mr. Nazar’s son in the business, as soon after his son’s appointment as shareholder and director relations between Mr. Nazar and Mr. Ebrahimi broke down. However it clear frm criterion two that not all members have to be involved in the business.

In the Bhullar case, there were five directors of the family company Bhullar Bros Ltd; Sohan, Mohan, two of Sohan’s sons and one of Mohan’s sons. Hence Sohan’s family had at all times had a majority of 3:2 on the board of Bhullar Bros Ltd. It was not clear to deduce the exact role of some of the family members but it is clear that this involved sourcing and purchasing properties, which was the business stated in the company’s memorandum and articles.

In the Murph case, two of the three shareholders, Kevin and Murph, were actively involved in the conduct of the business and running branches of the restaurant. Brian the third shareholder held a full time post in another company as an employee but eventually joined Kevin and Murph to run a new branch in Cork which became profitable in one year. Here it was clear that Kevin actually was appointed as a shareholder

Clearly a member will have to be a director in order to be involved in the affairs of the business. Therefore, it is pertinent to understand that there are different types of directors. In Hydrodan Ltd[2] the judge defined three types of directors. These include those known as de jure, who have been  officially  appointed at Companies House. There are de facto directors, that  is, those  who  act  as  directors even though they have not  been officially appointed as such, and  shadow directors  who  have been defined in section 251 of the Companies Act 2006, as a person in accordance with whose directions or instructions the directors of the company are accustomed to act.

In addition to common law, section 250 of the Companies Act 2006 also seems to suggest that the above is achievable as the definition of a director is given as ‘any person occupying the position of director, by whatever name called’.

The de-facto director notion came about due to some directors continuing to act in a similar capacity after they had left the company, or those acting as directors even though there appointment was defective for one reason or another.  The involvement of de-facto directors in a company’s management is so significant that they should be considered de facto directors. [3] Here their involvement would be equivalent or mostly equal to those that are formally appointed ‘de-jure’ as directors and thus they are equally liable as de jure directors.[4] The test would be whether they were part of the governance structure and decision making and took on the responsibilities similar to that of a director.

The concept of de facto directors is important as the criteria of quasi-partnerships state that not all the members of the company shall be involved in the business. This is highlighted in the case Mumtaz  Properties Ltd[5], which was family-held quasi-partnership involving of the Ahmed family.  The company went into liquidation and the liquidator sought to take action for misfeasance against a person who wasn’t formally appointed as a director of the company. The liquidator had to demonstrate that the person was therefore a de facto director. The court found that the person was part of the corporate governance structure and indeed was ‘one of the nerve centres from which the activities of the company radiated’.

The restriction on shares in quasi-partnerships can be due to a number of factors. Firstly as discussed quasi-partnerships are private limited liability companies, and there is a restriction in shares in private companies where shares cannot be sold easily and to the public as they can be done in a listed company. Secondly, there is a restriction on members interest because of criteria one and two of quasi-partnerships, where the company is formed on the basis of personal relationships and mutual confidence, and that the members expect to be involved in the running of the business. Disposal of shares would jeopardise this harmony and threaten the very existence of the quasi-partnership.

One obvious way to identify a restriction on shares is examine the company’s Articles of Association to see if they preclude a member from transferring shares. However, it is not that easy to view the articles of such companies unless they have been referred to within the case law. Another way to illuminate this criterion is by examining the case law is to see if they involved the sale of shares of any of the members. The additional guidance by Lord Wilberforce for this criterion stated the restriction of shares is there so that if confidence is lost, or if one member is removed from management, he cannot take out his stake and go elsewhere. This implies that where relations are good, and if, for example, the members agree and consent to sell part of the company’s shares, then this would be acceptable. There is only a restriction on the sale of shares where this is not agreed between the parties and is done without consent, or in the case where mutual confidence has in any case eroded.

Interestingly, in the case of Ebrahimi, under the articles shares could be transferred without the directors’ consent. Thus in this sense there were no restrictions. However, as previously stated, Mr. Nazar and Mr. Ebrahimi were initially equal shareholders and directors. When a new director and shareholder was appointed this was agreed mutually between Mr. Ebrahimi and Mr. Nazar. The new director and shareholder was the son of Mr. Nazar, who was given an equal shareholding, where between them they held 60% and Mr. Ebrahimi held 40%. It is highly unlikely that Mr. Ebrahimi, and indeed Mr. Nazar for that matter, would have agreed to give away part of their shares to a complete stranger.

Similarly, in the Bhullar case, the shares were restricted to 8 family members and no outsider. Mohan, Sohan, and their respective families held 50% of the shares of the company. The case itself did not involve the sale of shares by one of the members, and was related to conflict of interest. Lord Wilberforce stated in the Ebrahimi case that there is not limit on the number of members of managers in order for the company to qualify as a quasi-partnership.

In the Murph case it was clear that shares were restricted to only the three shareholders[6] as they each held equal shares in the business. Equally although in this case neither member contemplated selling their shares to an ‘outsider’ who was unknown to them, Brian who was the petitioner, presented his shares to the other two shareholders Kevin and Murph to buy, the two offered to purchase them, but as stated by Brian, they offered to do so at a gross undervaluation of the fair price for the shares.

As can be seen from the analysis of the three criteria for quasi-partnerships most of these cases show familial associations within the companies and thus that many quasi-partnerships are indeed ‘family held’, which makes sense since the personal relationship and mutual confidence would be expected to exist in families.

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Saad Qureshi’s expertise is in education, business, law, and human rights. He is currently employed at King’s College London as an Education Manager/Head of Teaching Office responsible for a budget of circa £6m, is a Fellow of Association of University Administrators (AUA) and a Member of Association for Learning Technology (ALT). He has written a number of articles including on Director Duties in the Companies, the effectiveness of the UN Guiding Principles of Human Rights in Business, and various other topical issues. He supervises Masters research students. At present he is pursuing his PhD with the Department of Management at King’s College London on family business. He holds an LLM International Commercial Law from Bucks New University and a BSc (Hons) with First Class from Queen Mary University. He was bestowed the Lambeth Civic Award in 2008 for his services to the community. He has also been an Assessor for the Santander Bank’s Small Responsible Business Award as well as a mentor for Mosaic, a Prince of Wales charity.