Southern Foundries Ltd v Shirlaw [1940]

Southern Foundries (1926) Ltd v Shirlaw [1940] AC 701 is notable in contract law case establishing the officious bystander test. The case is also noteworthy in company law as it establishes the principle that damages can be sought for breach of contract by a director, even when the contract appears to limit the company's power to terminate employment through its constitution.

Mr Shirlaw, the managing director of Southern Foundries Ltd, was removed from his position by the company after a change in its articles empowered certain individuals to do so. This change occurred after another company, Federated Foundries Ltd, took over Southern Foundries. Mr Shirlaw, whose contract stipulated a tenure of ten years, sued Southern Foundries for breach of contract.

The High Court awarded £12,000 in damages to Mr Shirlaw for the breach of contract. The Court of Appeal held that it was implied in the contract that the company would not remove Mr Shirlaw from his directorship during his tenure. They also concluded that altering the articles to enable removal was a breach of contract, affirming the damages awarded by the High Court. The Court of Appeal decision is famous for MacKinnon LJ's formulation of the officious bystander test. According to this test, a term should be implied in a contract if it is so obvious that both parties would have agreed to it if suggested by an officious bystander during the contract's formation.

The House of Lords upheld the Court of Appeal's decision, emphasising that the change in articles constituted a breach of contract. Lord Atkin, delivering the leading judgment, highlighted the contractual obligation for Southern Foundries to ensure Mr Shirlaw's continued directorship during the agreed ten-year term.

Lord Atkin's judgment clarified that the company's power to dismiss, as outlined in the articles, should be distinguished from the right to dismiss without just cause. The contract, in this case, effectively guaranteed Mr Shirlaw a ten-year tenure, subject to explicit exceptions. The House of Lords rejected the argument that a company could not guarantee a director's ten-year tenure, emphasising that the contractual agreement implied the company's commitment to maintaining Mr Shirlaw in his role.

The decision is significant for contract law, establishing the principle that the officious bystander test can be a useful tool in determining implied terms in contracts. Moreover, it reinforces the idea that companies can be held liable for damages if they breach contracts, even if such breaches involve changes to the company's constitution. The decision underscores the importance of upholding the terms of a contract and the implied duties that accompany it.
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