You’re a trustee shareholder in an active trading company – you can sit back and be passive in your approach to company management right? Wrong.
Trustee shareholders should be active in ensuring protection of trust assets. The following article highlights issues to consider in remaining prudent and avoiding exposure to risk.
The responsibility for general company management and decision making is ordinarily shared between the board of directors and the shareholders.
Company management falls into three main categories including enterprise, capital and constitutional decisions. A decision made by the appropriate body is ultimately a decision of the company. This allocation of management power brings with it power to control the company.
The division of power between the directors and shareholders is defined by the company’s constitution, shareholders agreement and general principles of company law. Directors are given powers to manage the business of the company, with shareholders entitled to vote on matters reserved for them. Therefore, each organ of a company holds decision-making power, neither has to follow the instructions of the other and neither can usurp the decision-making power of the other.
In New Zealand the default position allows control power to reside with the board. If the company does not have a constitution, the power is provided under s 128 of the Companies Act 1993 (“Act”). The default rules give directors very broad powers of management. Therefore, the directors hold majority of power in regard to capital and enterprise decisions, and in their position as directors they must ensure all decisions meet the solvency test under section 4 of the Act. In order for a company to satisfy the solvency test the company must meet the following criteria:
- the company must be able to pay its debts as they become due in the normal course of business; and
- the value of the company’s assets must be greater than the value of its liabilities.
The division of management powers within a company are governed firstly by the Act and further by the individual company’s internal governance rules. The extent to which directors and shareholders can exercise their decision-making power will depend on the internal governance rules. Such rules may include either one or both of the following documents:
- a constitution
- a shareholders’ agreement
These documents must remain in compliance with the general principles of company law set out under the Act, and in the absence of such agreements the principles of the Act will apply.
Shareholders in active trading companies:
It is common for professional trustees to hold assets that include shares in active trading companies. This structure creates a mechanism for pooling assets. However, this role can cause uncertainty and risk for trustees.
The “prudent man of business rule” set out in Bartleet v Barclays Bank Trust Co. Ltd imposes obligations on trustees who hold a controlling shareholding. They are obliged to monitor the conduct of directors and intervene where appropriate to prevent any involvement of the company in ventures with intolerable levels of risk. These obligations provide a challenge as trustees may not be suited for the interventionist role required. They will not always have the skills, business acumen or appetite for risk correlated with success in a business enterprise. Therefore, neither the settlor (the creator of the trust) nor the trustee may want the trustee to become involved in the management of the company.
The Bartlett decision concerned how a prudent trustee should safeguard investment in a controlling block of shares. The company board decided to take on development activities which it had not previously done. Planning consent was never obtained for the development; however the company continued to acquire properties on the site. The beneficiaries claimed that the trustee was liable for the loss caused by permitting the company to engage in the property development.
It was held that where the trustees own a significant shareholding, it is crucial to ensure they have an adequate flow of information. This will ensure they are regularly informed about the intentions and activities of the directors and will place them in a better position to protect trust assets. The court stated that a reasonably prudent trustee would safeguard the trust’s investment in two ways. First, if facts come to his knowledge which put him on inquiry, he will take appropriate action. This may involve inquiry of and consultation with the directors or as a last resort their removal. In addition, a prudent trustee would also ensure he has sufficient information to determine whether matters should proceed as they are, or whether he should intervene. In Bartlett, information was only ever provided to the trustee in the annual accounts, the chairman’s report and just before the AGM. This was held to be insufficient.
The court found that the bank, as trustee, had failed in its duty to meet either the higher threshold of a specialist trustee or the lower threshold of the prudent man of business. Even without the regular flow of information the trustees should have taken action. The court rejected the trustee’s defence that it honestly and reasonably believed the board of directors to be competent and capable of running the business.
There may be a clause in the trust deed which confers a power on a trustee shareholder in a company to leave the management of the affairs of the company to its directors. This may lead shareholders to believe the management burden has completely passed to the directors, and that they can be passive in monitoring the affairs of the company. However, shareholders should be cautious in making any assumptions, as an analysis of whether or not the management structure is actually in the best interest of the beneficiaries will depend on the particular facts.
An example of steps that might be taken to safeguard the trustee’s position may involve obtaining the receipt of copies of the agenda and minutes of board meetings, or the receipt of monthly management reports or quarterly reports. The purpose is not to monitor every move of the directors but to have enough information to be able to safeguard the trust asset, being the shareholding.
The Bartlett decision can be contrasted with Hogg v Public Trust where the company board decided to undertake a kiwifruit venture. When the venture failed, the trustee was not liable for the loss. It was held that the trustee had sufficiently discussed the venture, and produced several reports on the need to diversify and on the kiwifruit business. It was recognised that there were not many other investment options.
The case is a reminder that trustees must be able to rely on the directors to a certain extent. They will not be liable for every loss which in hindsight was a bad investment decision. However, they must be diligent and follow a proper and reasonable process in looking after their investment, as this was not seen in Bartlett. In Bartlett there should have been more effort to seek further information. Whereas in Hogg there was a better flow of information and, in the circumstances, the decision of the trustee was not inappropriate.
If you would like further information on any issue raised in this update please contact:
Natasha Sutcliffe, Solicitor
DDI: 09 965 2663
Further advice should be taken before relying on the contents of this summary. Clendons North Shore accepts no responsibility for loss occasioned to any person acting or refraining from acting as a result of material in this summary.
 Farrar, John Company and Securities Law in New Zealand 2008, Chapter 11, Allocation of Power within a Company at 217.
 Johnson, Lucy Managed Approach, STEP, 2010.
 Bartleet v Barclays Bank Trust Co. Ltd (No. 2)  1 Ch 515.
 Heather, L Trustees as Shareholders Part One.
 Frater, E Tara Trustees as Shareholders Part Two.
 Frater, E Tara Trustees as Shareholders Part Two.
 Hogg v Public Trust (2008) 26 FRNZ 1043.
 Moses, Juliet and Ormsby, Jared Trusts for Company and Commercial Lawyers 2015.