Shareholder decisions and the Duomatic principle

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The frequently informal nature of small private limited companies often means that major decisions are agreed about the company’s business or its constitution without being recorded in minutes or writing.

This, in turn, can lead to validity issues when decisions are challenged by disgruntled shareholders on the basis that they do not comply with the formal requirements of the Companies Act.  The Courts have adopted a pragmatic approach in such situations, applying the ‘Duomatic principle’. In this instance, the law treats shareholder decisions made unanimously in full knowledge of relevant facts as having the same effect as those passed by formal resolution at a general meeting.

However, principle has its limits and cannot be relied on where the Companies Act 2006 specifically requires a decision to be taken by formal resolution or to authorise an act beyond the company’s jurisdiction.  Additionally, the principle cannot be used to ratify a decision taken in bad faith or a fraudulent transaction.

A recent Court of Appeal ruling clarified the scope of the Duomatic principle. In this case, the validity of decision to appoint an administrator was challenged by creditors on the basis that the meeting appointing the administrator was not quorate. 

One shareholders held 75% of the shares on bare trust for his father, who was disqualified from acting as a director. The remaining 25% of the shares where held by an Isle of Man investment company, which had been dissolved in 1996. The Court found it likely that the father held all the shares in the investment company.

The Company’s constitution required two directors to be present for board meetings and two shareholders to be present for shareholders meetings. The decision to appoint the administrators was taken at meeting at which only the son was present although the decision to put the Company into administration was taken at an informal meeting between father and son. 

In the High Court, the administrators successfully defended the creditors claim to have their appointment declared invalid, as the judge agreed that the Duomatic principle applied because the father had allowed his son to act as a sole director, thereby informally amending the Company’s constitution to that effect.

Moreover, the High Court took the view that, as the investment company was dissolved, there was only one shareholder and, therefore, only his consent was required.

The Court of Appeal overturned the High Court’s decision. Despite being dissolved, the investment company was still listed in the Company’s register of members. The fact that it had been dissolved was irrelevant as its right to vote had passed to the Crown on its dissolution. The Duomatic principle could not apply as it requires the consent of all registered members and investment company was listed as a member but incapable of voting. 

What does this decision mean in practice for shareholders and directors of private companies?

Directors and shareholders of private companies are often too busy or feel they lack the necessary skills to consider minuting decisions or resolutions. All major decisions should be minuted and there should be written evidence of the consent of all registered shareholders. Equally, the Company’s register of members should be kept up to date, accurately reflecting the existing membership. Failure to do so exposes directors and shareholders to risk especially when shareholders disputes arise or the prospect of insolvency looms.

If you are concerned that you may be exposed in relation to how major decisions of your company have been recorded, or because your company books are not up to date, please contact us for advice on what action you need to take to protect your position.