Shareholders’ Agreement to Appoint a Director: Not an Absolute Right

Shareholders’ agreements and joint venture agreements usually contain provisions that allow for a shareholder to appoint a certain number of directors to the Board of the company. This allows for the balancing of the rights and commercial interests of the shareholders. For example, a minority shareholder may want to ensure that there is a guaranteed minimum Board representation that the minority shareholder can have.

The question is whether this contractual right to appoint a director is an absolute right and what is the legal nature of this power to appoint a director. Could there be situations where the board of directors will refuse to recognise the appointment of a director under a shareholders’ agreement? How is this interpreted in Malaysia under the Companies Act 2016?

Part A. Singapore Court of Appeal Decision: Not Absolute Right of Appointment. Board Has Limited Discretion to Refuse Appointment of Shareholder-Nominated Director

The Singapore Court of Appeal in The Wellness Group Pte Ltd v Paris Investment Pte Ltd and others [2018] SGCA 47, in its grounds of judgment dated 29 August 2018, has  interpreted the legal nature of the shareholder’s contractual right to nominate or appoint directors to the Board of the company.

The Supreme Court of Singapore website has a helpful case summary. I want to examine the legal issues before the Singapore Court of Appeal. The key point was that the minority shareholder in this case had a right under the shareholders’ agreement to appoint one director. The Singapore Court of Appeal had to determine the legal nature of this right of appointment. Where there was a refusal to appoint, could the Court order specific performance and order the necessary steps to be taken to effect the appointment of the director?

(i) Legal Nature: Contractual right to nominate one person to be a director of the company, a corresponding obligation on the part of the Board to appoint the nominee

There were competing arguments raised on the legal nature of this right of appointment under the shareholders’ agreement.

Counsel for the minority shareholder argued that this right is an unfettered and unqualified right to appoint the candidate of his choice as director. This nomination was effective immediately and the candidate would be a de facto director immediately.

Counsel for the opposing parties maintained that the power to appoint directors is vested solely in the Board by virtue of the Article 91 of the company’s constitution. This Article 91 is similar to Regulation 68 of the Table A Articles of Association in Malaysia’s Companies Act 1965. It essentially states that the directors shall have power at any time, and from time to time, to appoint any person to be a director, either to fill a casual vacancy or as an addition to the existing directors. Therefore, this argument was that the shareholder only had a contractual right to nominate and not to appoint the candidate.

The Singapore Court of Appeal held that the arguments were too broad and too narrow respectively.  Instead, the correct interpretation was that the shareholder had a contractual right to nominate one person to be a director of the company, and with a corresponding obligation on the part of the Board to appoint the nominee. This was subject to two important caveats.

First, the nomination of a person who is statutorily disqualified under the Companies Act, or who does not consent to act as a director, would be defective in and of itself. So there would be no obligation for the Board to appoint this person.

Second, the Board is not obliged to appoint the nominee if it is able to establish that the nominee would be obviously unfit for office or that his appointment would be obviously injurious to the company. The burden is not on the appointing shareholder to positively establish the suitability of its nominee. Instead, the burden is on the Board to prove his unsuitability. The Board must adduce clear evidence to show the shortcomings of the nomination, such as if the nominee would be placed in a position of a conflict of interest or a breach of fiduciary duty. For example, such a case may arise where the nominee operates a business in competition with the company to which he is nominated as director.

In the end, it was held that the power of appointing directors remained with the Board pursuant to the company’s constitution. However, that power would have to be exercised in accordance with the shareholders’ wishes pursuant to the term in the shareholders’ agreement. The Board’s limited discretion not to appoint a nominee if he was obviously unfit for office or injurious to the company struck a balance between the shareholders’ liberty to appoint persons as directors, and the Board’s interest in appointing suitably qualified persons to manage and supervise the company.

(ii) Specific Performance to Require the Appointment of the Director

The opposing parties also argued that the court could not order specific performance of an obligation to appoint a director on the basis that it is a contract for services. The Singapore Court of Appeal went through the authorities cited and distinguished them.

Hence, the Court ordered that the minority shareholder nominated director be appointed and that the other shareholders, their directors and/or their officers execute or procure the execution of the documents necessary to give effect to this appointment.

Part B. Application in Malaysia and the Companies Act 2016

The above legal issues may be interpreted slightly differently in Malaysia due to the Companies Act 2016 regime. The section references below are all to the Companies Act 2016

I believe that, regardless of the provisions of a shareholders’ agreement, the Companies Act 2016 will always maintain the right of shareholders to appoint directors by way of ordinary resolution. This is seen in section 202(2) where “[a]ll subsequent directors of a company may be appointed by ordinary resolution.” This raises a few issues.

First, drawing from the above principles, would this statutory right of appointment by ordinary resolution merely mean the shareholders nominate a director and it is still up to the Board to confirm the appointment? Would the Board retain limited discretion to reject the appointment of the director if that candidate was obviously unfit for office or injurious to the company? Arguably, with the clear wording of section 202(2), there should be a direct appointment of the director by ordinary resolution and with no further discretion on the part of the Board.

Second, I don’t think section 202(2) would prohibit typical clause in a shareholders’ agreement granting certain shareholders the right to appoint and remove directors. Such a clause can still be effective. However, I think section 202(2) would continue to exist in parallel with any provision in the shareholders’ agreement. This is due to the reading of section 31(2) (for a company with a constitution) and section 31(3) (for a company without a constitution). Essentially, the company, each director and each member shall have the rights, powers, duties and obligations set out in the Act, unless permitted to be modified in accordance with the Act and so modified by the constitution. Section 202(2) is not made subject to the constitution and therefore, the shareholders shall have this right.

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