1While shareholder value is treasured and retained, an expanded notion of stakeholder value is given prominence and wide publicity as well. Companies owe a duty not only to shareholders but also to its employees, consumers, suppliers, society and the State. This is because of the fact that all these stake holders are directly or indirectly connected with the companies’ affairs. It may be argued that if these stakeholders enjoy the fruits of earnings, or in other words get benefit out of companies’ profits, why shouldn't they be part of losses also…. The good governance of a company would mean and include safeguard of stakeholders and they should be protected. This is applicable to every stakeholder1. In the light of the above statement it is evident that present corporate regime craft new legal mechanism to protect the interest of shareholder and creditors. The author of the paper examines orthodox corporate principles and its effective protections as to the interest of the stakeholders. The basic concept of Limited Liability, in which the legal protection available to the shareholder of company under which liability of each shareholder for the company’s debt is limited to the amount agree to pay. Limited liability is often criticized for which shifts the risk of business loss away from shareholder to creditors2. In other words, when a company fails, the creditors swallow the failure or the loss instead of shifting it to members. There may well be good reasons for this shift. The rights of the creditors against the company are essentially a matter of contract between the company and the creditors. Creditors are in the better position to bargain and to decide terms of the contract3. Courts protect the creditors, in some situations, through piercing the corporate veil. Corporate statute maintains the concept of Limited Liability in ambiguous and concrete sense4. In order to maintain the balance benefits of limited liability against its costs, courts are more likely to allow creditors to claim the assets of shareholders. 1 Shanthi Segarajasingham, STAKEHOLDER SAFEGUARD AGAINST UNFIT DIRECTORS: A WAY FORWARD FOR GOOD GOVERNANCE UNDER THE COMPANY LAW OF SRI LANKA, International Journal of Business, Economics and Law, Vol. 6, Issue 4 (Apr.) ISSN 2289-1552, 2015 http://ijbel.com/wpcontent/uploads/2015/05/Law47_PAID_IJBEL_KLIBEL6_Law__47_O19Od6RJB8_D47.pdf 2 B.Cheffins, Company Law, 1997, citing R.A. Posner, Economic Analysis of Law (4th edition, Little Brown,1992) 3 Levy vs. Abercorries State and Slap Co (1887) 37 CH.D. 260; if a creditor invests by way of debenture, where he knows its status whether it was secured or unsecured. The right of the debenture-holder is found in the debenture which confers contractual rights independent of the company’s article . 4 DEL.CODE ANN tit.8 section 152 (1983) and Model Business Corporation Act section6.22 (1984) provides “a stockholder is not liable to the corporation or its creditors with respect to the shares” Present Companies Act introduces a fundamental change of “self-help model” by granting creditors the right to enforce the provision of the Companies Act through the private prosecution. The Doctrine of Ultra Vires. the doctrine of ultra vires has lost its application explicit in terms of sections 13 and 17(2) of the Companies Act. The Doctrine of Ultra Vires was realized as it helps to protect the investors and creditors of the Company. by examining the objects clause. at page 74 . 5 Charlesworth & Cain. 12th edition. This twofold coverage of law paved a way to achieve the goals which a company intends in its incorporation and benefits to improve the national economic. This is the welcomed change of the law as on the one hand it enhances the ability of the company to develop the business and on the other hand law is safeguarding the stakeholders from wrongful activities of the directors. 12th edition. Creditors would be protected because in entering onto a credit agreement with a company they can discover the purpose of the business for which the credit facilities were to be employed. thus. The doctrine prevents the wrongful application of the company’s assets likely to result in the insolvency and thereby protects creditors. The present Companies Act done away with the requirement of Memorandum of Association. It can be defined as any excessive use of corporate power that has been granted to a company by its Constitution. Any act of the company must not be beyond the object clause. 2 In Sri Lanka previous Companies Act limits the creditors’ rights were based on “contract” and the company’s articles of association. Company Law. However some fundamental aspects of the doctrine still retained to some extent as visible under section 16. The aim of the Doctrine of Ultra Vires mainly to protect the investors and creditors however it is now effecting by various provisions as mentioned above therefore it can be said that safeguards equivalent to ultra vires guaranteed under Companies Act. Company Law. otherwise it will be ultra vires. at page 73 6 Charlesworth & Cain. 17(1) of the Act.5 The object clause of the (under the previous Companies Act) memorandum of the Company contained the object for which the company was formed. which was conceived as an important principle of stakeholder protection. Therefore such act is void and cannot be ratified even if all members consent to ratify it6. therefore. Further the directors are required to act in the interest of the company. and second. in “the Judicial extension of 8 As per the dictum of Standard chartered Bank Ltd vs. ‘Company Directors (1959) 33 Australian Law Journal 156. The ambit of these powers was however subjected to the obligations imposed by equity. And Sir Douglas Menzies. Lecturer.R. if a company is 7 Ross Grantham. These duties required the board of directors to exercise due care and skills in the management of the company’s affairs8 and an application of the trustee’s duty of diligence9. The directors become accountable principally to the creditors. 10 Walker vs. Powers and Duties and Responsibilities (1967) 2 University of Tasmania Law Review 361 . Mason J. Directors are indirectly owed to creditors too. Public investment in Golden Key amounting to nearly 300 million Sri Lanka rupees was at stake and cases were filed by depositors in every court in Sri Lanka using different laws and grounds… One of the grounds that the Directors of these two entities and the Chairman failed to exercise due diligence and care towards the creditors or depositors of the company. Wimborne (1980) 5 ACLR 546 11 Mills vs Mills. Golden Key Credit Card Company Ltd. The traditional view of the company saw the board of directors vested with wide power to conduct the company’s business. Seylan Bank is a member of Ceylinco Group that faced crisis in 2009 due to the sudden collapses of one of the sister companies. in Walker vs.L. Walker 1992 W. that directors owe a duty to act ‘in the best interests of the company’. it should be noted from the Golden Key Credit Card issues that the Directors owe a duty to their company to take into account the interest of creditors. Wimborne10 The directors of a company in discharging their duty to the company must take account of the interest of its shareholders and its creditors. first the interest of the company includes the interests of the creditors11. skill and diligence. The creditors. Author of this paper examines following arguments. 3 Judicial extension of creditors’ protection One of the interesting developments in the field of company law has been the extension of the board of director’s fiduciary duties to provide protection for companies’ creditors7. entitled to some form of fiduciary protection. University of Auckland New Zealand. without the interference of shareholders. As per Dixon J. Zelman Cowen ‘Company Directors. described that duty of a director in terms of honesty. held that “the Directors of the Company are fiduciary agents. 561 9 In Re City Equitable fire Insurance Co Ltd (City Equitable case) Romer J. In this regard. (d)the impact of the company's operations on the community and the environment. customers and others. and in doing so have regard (amongst other matters) to— (a)the likely consequences of any decision in the long term. second which impose potential personal liability so that they do not take actions which may well affect creditors’ rights. (2)Where or to the extent that the purposes of the company consist of or include purposes other than the benefit of its members. Thus 12 Section 172 of the Companies Act of United Kingdom -2006 (1) A director of a company must act in the way he considers. Thus. the duty to take account of creditors’ interests seeks to mitigate the shift. In United Kingdom earlier creditors’ protections were recognized under section 214 of the Insolvency Act of 1986 later incorporated with Companies Act of UK in section 172 12. in situation of insolvency. Further the duty to take into account creditors’ interest is twofold protection. (c)the need to foster the company's business relationships with suppliers. Statutory protection The insolvency legislation developed the doctrine against the wrongful trading. once there is no reasonable steps prospect of the company avoiding insolvent liquidation. which in effect creates a duty of care owed by the directors towards the creditors to take reasonable steps to minimize further loss to the creditors. subsection (1) has effect as if the reference to promoting the success of the company for the benefit of its members were to achieving those purposes. in good faith. and (f) the need to act fairly as between members of the company. whilst the doctrine of limited liability shifts the risk of failure from the shareholders to the creditors. 4 insolvent or if they employ funds that are payable to creditors in order to continue the business of the company. would be most likely to promote the success of the company for the benefit of its members as a whole. The board of directors must take into account creditors’ interest when insolvency exists but there is significant authority to suggest that this same duty is required when a company’s solvency is doubtful or even a company is suffering financial instability. (e) the desirability of the company maintaining a reputation for high standards of business conduct. . (b)the interests of the company's employees. It seems that deciding whether the duty to protect creditors’ interests had arisen will depend on the fact of each particular case. first shareholders are unable to ratify directors transaction when it was a breach of that duty. In such situation creditors rights could be affected as they invest on such activity. diligence. when exercising powers or performing duties as a director. Shareholders are entitled to make an application to court when the company’s affairs are being conducted in a manner oppressive to any shareholder. As per section 17(3) shareholder is entitled to prevent the company from dealing with other kind of business of the company by making an application to the court for restraining order under section 233. to consider or act in the interests of creditors of the company. . must exercise the care. 13 Section 137 of New Zealand Companies Act A director of a company.— (a) the nature of the company. (3)The duty imposed by this section has effect subject to any enactment or rule of law requiring directors. In such situation company cannot treat shareholder’s rights and creditors’ rights on the same footing. Further under section 234 shareholders are entitled to bring derivative action when company’s interest affected under section 224. and skill that a reasonable director would exercise in the same circumstances taking into account. Under the Sri Lankan Companies Act considers the shareholders’ rights as paramount than creditors of the company. 5 the duty imposed by section 172(1) on directors to promote the success of the company for the benefit of its members will severely qualified by the duty of care towards creditors contained in section 214 of Insolvency Act. and (c) the position of the director and the nature of the responsibilities undertaken by him or her. Under section 189 of the Companies Act of Sri Lanka imposes duties upon the directors as the author mentioned above statutory protection not expressly provides the creditors’ protection but only court interpret the provisions and safeguards the creditors during the life time of the company. in certain circumstances. In New Zealand earlier creditors’ protection was recognized under section 135 of the Insolvency 1967 but later section 13713 reflected in the statutory statement of director’s duties under Companies Act of New Zealand in 1993. Therefore present Companies Act of Sri Lanka should be reformed by introducing provisions relation to the creditors’ right to sue against the oppressive management of the company while maintaining integrity of a company. but without limitation. and (b) the nature of the decision. “It is inconsistence with the essential nature of a company that it should become a member of itself. A company may by special resolution reduce its stated capital16 to an amount it thinks appropriate. The prohibition on a company accruing its own shares17 and giving finance assistance18 in connection with the purchase of its own shares has been removed and a company may now carry out both of these. Company may by special resolution reduce its stated capital to such amount as it thinks appropriate20 and the public notice of a proposed reduction of a company’s stated capital shall be given not less than sixty days before the resolution to reduce stated capital is passed. Whitwoth (1882) 12 App. The rule was established in the case of Trevor vs. The reasoning was that the capital of a company could be discovered by adding up the amount paid for the shares it had issued. Whitwoth14. in that case Lord Watson ruled that. a creditor would be relying on illusory prosperity if he relied on the value of shares issued when giving credit to the company.21 When we compare with the previous Companies Act of Sri Lanka it requires sanction of the court to 14 Trevor vs. Stated capital15 is defined in the Act to mean the total of all amounts received by the company or due and payable to the company in respect of the issues of shares and in respect of the issues of shares and in respect of calls on shares. Thus. 6 Capital maintenance rules The basic common law rule was that it was illegal for a company to acquire its own shares. Case at page 409 15 Section 58 of the Companies Act 2007 16 Section 59 of the Companies Act 2007 17 Section 64 of the Companies Act 2007 18 Section 70 of the Companies Act 2007 19 Section 57 of the Companies Act 2007 20 Section 59 (1) of the Companies Act 2007 21 Section 59 (2) of the Companies Act 2007 . It cannot be registered as a shareholder to the effect of becoming a debtor to itself for calls…” This rule ensures that the directors applied the equity capital of the company properly. provided the solvency test19 is satisfied. we can find almost similar arrangement as in Sri Lankan Act.17 of 1982 of Sri Lanka 23 Section 59 (4) of the Companies Act 2007 24 Section 59 (3) of the Companies Act 2007 25 Section 57 of New Zealand Act. 7 reduce the authorized capital in addition to the special resolution. it requires the company must satisfy the solvency test. that it will not reduce its stated capital below a specified amount without the prior consent of the creditor or unless specified conditions are satisfied at the time of the reduction.23 However present Act some extent considers the creditors’ protection impliedly though. before they discharge their duties. When we compare with Section 57 of the New Zealand’s Act 25. however Section 645 of the U. A resolution to reduce sated capital passed in breach of any such agreement. creditors are entitled to enforce their right as without creditors consent in writing company cannot reduce its capital. These procedures restrict the company’s arbitrary actions and ensure the rights of the creditors are protected.22 Even though the new Companies Act of Sri Lanka eliminates the requirement to get courts permission to reduce the capital. shall be invalid and of no effect24. . Its play a vital role in protecting the creditors’ right during the life time of the company because it requires the director to take this into consideration in various activities if the company.K’s Companies Act requires court sanction still for the reduction of sated capital. requires courts sanction to reduce the sated capital however private companies can reduce the stated capital without the sanctions of the courts.26 Solvency Test The solvency test plays an important role in the management of companies and presents challenges to the board of directors of a company as to how a company enhances its solvency position. which also requires no court sanction to reduce the stated capital 26 Section 645 of UK Act 2006. 68 of the previous Companies Act No. “A company may agree in writing with a creditor of the company. 22 Section 67.” As per the section 59(3) of the Act. cmb.lk/wp-content/uploads/THE-SOLVENCY-REGIME. the company could recover the distribution from the shareholders. (1)A solvency statement is a statement that each of the directors— (a)has formed the opinion.K28.e. merely requires that companies should be able to pay their debts as they become due in the normal course of business (i. The need to ensure that the company has sufficient financial resources at all times. and (b) the value of the company’s assets is greater than the value of its liabilities. addition to the single phrase to section results in the capital maintenance rule being embedded in the definition of the solvency test. In the event of distribution having being made without the solvency test being satisfied.. Although the wording of Sri Lankan Companies Act is almost identical to the wordings in the New Zealand Act of 1993. including contingent liabilities.ac. (1)For the purposes of this Act. equity test or liquidity test) ensures that company’s assets are greater than their liabilities. THE SOLVENCY REGIME – A CRITICAL EVALUATION OF THE LEGAL FRAMEWORK IN SRI LANKA.pdf . INDIRA NANAYAKKARA. The recent plight of the Golden Key Credit Card Company and the major corporate scandals such as Sakvithi created a severe umbrage amongst the investors in Sri Lanka. 28 U. 27 Section 4 of the New Zealand Act of 1993 . as regards the company's situation at the date of the statement. 8 New Zealand27 and U. W. http://www. Companies Act section 643. so that there is no significant risk that the company cannot meet its obligation when they fall due. which could otherwise stultify the stability of the company.K. Solvency regime is a major step in ensuring the integrity of the corporate sector and it provides a better protection to the creditors of a company as opposed to the protection afforded by capital maintenance rules. a company satisfies the solvency test if— (a) the company is able to pay its debts as they become due in the normal course of business. The Law makes the directors vigilant in exercising their powers and discretion. failing which every director who authorizes the distribution could be personally liable for such distribution. that there is no ground on which the company could then be found to be unable to pay (or otherwise discharge) its debts 29 MS. The mismanagement of the corporate sector and the lack of a proper legal regime to monitor the internal management of the company as to the solvency led the creditors into unpleasure end29.