This might seem like a simple question, but it’s not.
Although as a shareholder you may own a chunk of the company, it is the directors who get to make all of the important day-to-day decisions. So getting a seat at the table is all important.
The basic rule is that ‘the shareholders’ of your company get to appoint the directors. But this rule is subject to a lot of variations and exceptions. In order to understand your right to board representation, you need to look in the company’s constitution, as well as the Corporations Act. You may be surprised what you find (or don’t find).
When we say generally the ‘shareholders’ have the power to appoint directors, we usually mean a simple majority of the shareholders have this power, i.e. more than 50%. This means that if you hold more than 50% of the voting shares, you have the power to appoint all the directors, and to sack all of the directors.
Under this standard scenario, if you hold say 30% or 40%, you technically have no right to representation on the board. That is, unless the majority shareholders specially agree otherwise.
This simple fact can catch people out. Let’s say you leave the shares in your company to your three children. Two of those children could gang-up on the third, and exclude them from any involvement at board level. If your company acts as the trustee of a discretionary trust, then the two children could control the trust exclusively for their own benefit, leaving the third child with nothing.
If you hold a significant stake in a large, widely held company, then you may be able to lobby for a directorship with something less than 50%, say 10-20%, but this is not guaranteed, as Solomon Lew found out in his bid for a board seat on Coles Myer.
But your company’s constitution may provide other methods for appointing directors.
Although the power to appoint directors is generally vested in the shareholders, your company’s constitution can provide the existing directors with the ability to appoint one or more other directors. Such a person is called a ‘board appointed director’. This may be to fill a ‘casual vacancy’, i.e. if a director suddenly resigns or dies, or it may be a simple ongoing authority. Sometimes the existing board can only appoint an ‘independent director’, who often also serves as the chairperson. This can be a good idea when the board is otherwise stacked with related parties.
A particular shareholder, or class of shareholders, may be given the authority to appoint (and then remove) a director to the board by simply giving written notice to the company. No shareholder vote is required in this case, just a simple notice. A private equity investor will usually seek this right before taking up a minority shareholding in your company.
Another method is what is called ‘proportionate appointments’. Under this method the constitution provides that a shareholder (or a group of shareholders) who hold a certain percentage of the shares in the company can appoint a director. This provides minority shareholders (or a group of them acting together) with the right to appoint a director to the board with something less than 50%.
For example, your constitution may provide that a 20% shareholding entitles the holder to appoint one director. Therefore technically up to 5 directors can be appointed. A shareholder holding say 45% would be entitled to appoint 2 directors, (i.e. two lots of 20% entitles the appointment of 2 directors).
Your constitution can also provide for directors to be appointed by someone, (or a group), who is not a shareholder. For example, it may give the members of a holding company, the employees, or a significant debt provider, the right to appoint a director.
Your constitution will set the qualifications required before someone can act as a director. It is common to not require a director to hold any shares in the company, but this may not be the case in an older constitution. Other qualifications can be set out in the constitution, for example, being a member of a certain family, or having a particular qualification or licence. The Corporations Act requires a director to be at least 18, and to not be an un-discharged bankrupt.
You may ask, who cares about representation on the board?
Well if you are going make a significant investment in a company, then some representation on the board is a very smart idea. Otherwise your ability to influence the direction of your investment will be very limited.
Most decisions of a board are made by a simple majority vote, so the people with the power to appoint a majority of directors can therefore control the day-to-day activities of the company. However, this does not mean that a minority director has no authority or relevance. On the other hand, it is also not the case that a person appointing a majority of directors can do what they want with the company.
This is because a director has duties to perform that are independent of who has appointed them, and in fact may require them to act contrary to the interests of their appointor.
A director owes their primary duties to the company, and a director must act in the best interests of the shareholders as a whole. Your constitution can vary these duties to a limited degree, but anyone who takes on the role of director needs to have the courage to act independently.
Even if you are not able to change the outcome of a board vote, being present at the board table gives you the ability to influence debate. It also gives you access to information that is not otherwise available to shareholders – although once again, you must only use this information in the best interests of the company, (and not your own personal interests or those of your appointor).
So in short, if you already hold shares in a company, or if you are considering investing in one, then you need to understand how directors are appointed. Otherwise you may be wasting your money, or setting yourself or your family up for a nasty control fight down the track.
To better understand your rights as a shareholder or director, or to put in place a comprehensive control structure for your investments, please contact us on 1300 654 590.
While you are here, check out these other articles on shareholder agreements, constitutions and managing your company:
Most Shareholder Agreements, Constitutions and Partnership Agreements provide 'pre-emption' rights. These are rights that require someone wanting to sell an interest in the enterprise, to first offer the interest to the other equity holders. But they do not necessarily require the majority to buy.
When you first read these clauses it isn’t always clear what they are trying to achieve, and why you would include them in your Shareholders Agreement (or Constitution).