Shirlaw v Southern Foundries (1926) Ltd 17 Mar 1939 [1939] 2 KB 206, CA

A company appointed a managing director for a ten-year term. After a takeover, the company's articles were changed, enabling his removal. The court held this was a wrongful dismissal, implying a term that the company would not prevent his service.

Facts

In December 1933, the plaintiff, Mr Arthur Shirlaw, was appointed as the managing director of Southern Foundries (1926) Ltd (‘Southern’) for a fixed term of ten years. The appointment was made under an agreement. In April 1936, another company, Federated Foundries Ltd (‘Federated’), acquired the shares of Southern. Federated then altered Southern’s articles of association, adopting a new set of articles. Article 8 of the new articles gave Federated the power to remove any director of Southern. In April 1937, exercising this power, Federated delivered a document to Southern removing Mr Shirlaw from his directorship. As the 1933 agreement stipulated that Mr Shirlaw must be a director to hold the office of managing director, his removal from the board effectively terminated his position as managing director. Mr Shirlaw sued for damages for wrongful dismissal.

Issues

The central legal issue was whether Southern was liable for damages for breach of the 1933 employment agreement. This required the court to determine:

1. Whether a term should be implied into the contract that the company would not remove Mr Shirlaw from his directorship during the ten-year period, and would not alter its articles to create such a power of removal.
2. If such a term was implied, whether the company’s action in adopting the new articles and the subsequent removal of Mr Shirlaw constituted a breach of that contract.

Judgment

The Court of Appeal, by a majority, dismissed the appeal from the High Court, affirming the decision in favour of Mr Shirlaw. It was held that there was a breach of contract.

Implied Term

The court found that there was an implied term in the 1933 agreement that Southern would not remove Mr Shirlaw from his directorship for the duration of the ten-year term. MacKinnon L.J., in his concurring judgment, set out the now-famous ‘officious bystander’ test for implying a term into a contract:

Prima facie that which in any contract is left to be implied and need not be expressed is something so obvious that it goes without saying; so that, if, while the parties were making their bargain, an officious bystander were to suggest some express provision for it in their agreement, they would testily suppress him with a common “Oh, of course!”

Applying this test, he concluded it was obvious that the company was agreeing not to exercise its power of removal in a way that would nullify the ten-year appointment.

Breach of Contract

The court reasoned that by adopting the new articles which gave a third party (Federated) the power to remove directors, and then acting on that removal, Southern had breached the implied term. Sir Wilfrid Greene M.R. held that a company cannot rely on an alteration to its articles as a justification for breaching a contract. He stated:

The company cannot, in my opinion, be heard to say that it is a right and proper thing for it to do what it has empowered itself to do, although the result may be to destroy the tenure of office which, by a contract binding upon it, it had agreed to confer.

The act of removing Mr Shirlaw as a director was a wrongful repudiation of the employment agreement, as it made it impossible for the company to continue employing him as managing director.

Implications

The case is a leading authority in English contract law, primarily for MacKinnon L.J.’s articulation of the ‘officious bystander’ test, which remains a key tool for determining whether a term should be implied in fact into a contract. The decision also has significant implications for company and employment law. It establishes that while a company has a statutory power to alter its articles of association, this power does not permit the company to breach its contractual obligations. A service contract is separate from the articles, and a company cannot unilaterally change its articles to escape liability under such a contract.

Verdict: The appeal was dismissed. The court affirmed the judgment for the plaintiff, Mr Shirlaw, who was entitled to damages for wrongful dismissal.

Source: Shirlaw v Southern Foundries (1926) Ltd 17 Mar 1939 [1939] 2 KB 206, CA