Corporate rescue - raising new capital

How do you rescue a company in financial trouble?

One method is of course to raise new capital. This of course will not be easy. One change in the law that makes the process slightly easier is the removal of the concept of par value. Formerly, all shares had to have a par value which was the minimum price at which a company could issue its shares. In normal times, this was not too much of a restriction.

However, in bad times, it was unlikely that a new investor would be willing to pay par value for the shares. For example, if the existing shareholders paid $1 for each $1 share of the company's, with the company in desperate straits, a new investor would demand that new shares be issued to him at a much lower price, especially since it would not be clear how long the company would survive. The par value rules would prevent this new issue without court approval.

Now, without the rules relating to par value, companies will have more flexibility in raising capital.

section 216 - a trap for the unwary

Section 216 of the Companies Act is known as the oppression or unfair prejudice section.

Where someone has harmed the company but is in control of the company (for example, a director), the rule in Foss v Harbottle prevents shareholders starting a lawsuit against the wrongdoer.

However, section 216 allows the shareholder to apply to court and the court may allow an action (or lawsuit) to be started against the wrongdoer in the name of the company. However, this course of action is not recommended.

The foreign equivalents of this section have been described by judges as "a shambles" and "a legal minefield". These are warnings that even experienced lawyers may have a hard time navigating the complicated case law relating to this section. Perhaps using section 216A may be a better choice.

Directors duties, enforcement and s 216A

What happens when directors of the company who have breached their duties are also the ones in control of the company, e.g. through their majority shareholding?

Section 216A of the Companies Act provides a "simple" method to enforce the duties owed to the company. A minority shareholder of a private company can serve a 14 day notice on the board requiring them to take legal action in respect of a wrong done to the company. If the board fails to take the action, the shareholder can then apply to court for permission to start the lawsuit. The section requires the court to be very lenient in granting permission since the main requirement is that the lawsuit should prima facie (or at first sight) be in the interests of the company. The court should not examine the lawsuit in great detail to check whether it has a good chance of succeeding.

If the court grants permission, then the 2nd stage begins - the director(s) is sued for breaches of duty, which have to be proved on a balance of probabilities.

This second stage is called a statutory derivative action since the lawsuit is in the name of the company, and any damages awarded are derived from the harm to the company, and not harm to the shareholder.