Decision making in a company is subject to certain formal requirements both under the Companies Act 2006 and also under the company's own articles of association.
But for many companies, particularly small owner-managed businesses, decisions are taken with little reference to formalities and with a high degree of fluidity between decisions taken as shareholders and the executive acts of directors/managers. In those cases, the principle of unanimous shareholder consent may offer some protection against an allegation that the correct formalities have not been followed.
The Duomatic principle
The 'Duomatic principle' is the shorthand used by lawyers to refer to the common law principle of decision-making by shareholders by way of informal unanimous consent. The theory behind the principle is that where all the shareholders of a company agree on a matter, and none of them object to a procedural irregularity, it would serve no useful purpose to insist on adherence to formal procedures.
For the principle to apply the shareholders' consent must be both unanimous and informed.
However there are limits on the application of the Duomatic principle and it will not provide a cure for all situations in which the required formalities have not been followed.
In a recent case the High Court considered the application of the Duomatic principle when a director sought to rely on the principle as a defence to a claim for breach of duty.
The case involved a falling out between a former father- and son-in-law who had been in business together for some time through the Tonstate Group of companies. The father-in-law discovered that over a number of years the son-in-law had caused the group to make payments totalling c£13.5m to other companies owned or controlled by the son-in-law. The payments had been made without the father-in-law's knowledge and in breach of the son-in-law's duties to the Tonstate Group as a director. So the father-in-law brought a claim against his former son-in-law to recover the payments.
The son-in-law argued that, as part of the property development deals that the parties were involved in, he and his former father-in-law had adopted a practice of making payments to themselves. Although those payments were purportedly for the purposes of the relevant company involved in the property development, in reality they were made to benefit themselves at the expense of the companies. The son-in-law said the payments were used to disguise the profits made by the relevant Tonstate Group company with the purpose of defrauding the revenue.
The son-in-law accepted that the payments had no legitimate business purpose and would otherwise amount to a breach of duty. But his defence was that the payments had been made with the agreement of his former parents-in-law and so were made with the approval of all the shareholders of the relevant companies.
However, the judge confirmed that the Duomatic principle cannot apply to conduct which the company could not lawfully carry out itself. The son-in-law's conduct in procuring the payments was a breach of fiduciary duty, in particular because the payments were made for the unlawful purpose of defrauding the revenue. The Duomatic principle could not be used to cure that unlawful conduct.
The judge also confirmed that the Duomatic principle does not apply where the company is or is likely to become insolvent. This is because in those circumstances the directors' duty to act in the best interests of the shareholders changed to a duty to act in the interests of the company's creditors. The consent of the shareholders could not cure a breach of that duty to the creditors.
The case is a useful reminder that whilst the Duomatic principle can be a helpful tool when seeking to cure procedural irregularities in a company's management, there are limits to its application. The better course of action is to comply with all required formalities in the first place!