Unfair Prejudice and Minority Shareholders' Rights in Company Law, Exams of Remedies

Download Unfair Prejudice and Minority Shareholders' Rights in Company Law and more Exams Remedies in PDF only on Docsity! -1- MINORITY SHAREHOLDERS & UNFAIR PREJUDICE BY DOV OHRENSTEIN OF RADCLIFFE CHAMBERS INTRODUCTION 1. Parties may have expectations and common understandings as to how a business will be run. When those expectations are not met or there is a departure from the common understanding, there may be a conflict between the rights of the majority shareholders under the articles to control the company and the expectations of the minority. Such conflicts regularly come before the courts. LEGISLATIVE HISTORY 2. It has always been the case that if a majority shareholder acts oppressively towards the minority that the latter may petition the court to wind up the company on the ground that it is just and equitable to do so. (see now s.122(1)(g) of the Insolvency Act 1986). However, it is often not in the interests of the minority shareholder for the company to be wound up as: - this drastic remedy would result in the sale of company assets at break up value without regard to good will; - long term company debts may become due immediately; - the process of winding up the company is slow; - the liquidator’s expenses may be high. 3. Accordingly, legislation (s.210 of Companies Act 1948) introduced an alternative remedy. This was based on the concept of “oppression”. However, the courts were restrictive in their application of this remedy and it was often more difficult to obtain than a just and equitable winding up. 4. The Companies Act 1980 (s.75) attempted to overcome the limitations of s.210 by introducing the concept of unfair prejudice in place of oppression. This concept was then carried through into s.459 of the Companies Act 1985. Part 30 (ss 994-999) of the Companies Act 2006 replicates the unfair prejudice provisions of the 1985 Act. 5. The old case law on what amounts to oppression is still of relevance because oppressive conduct would inevitably amount to unfair prejudice although not all conduct which is unfairly prejudicial would have met the oppression test. 1 Re Quickdrome Ltd [1988] BCLC 370 2 CA 2006 s.112 3 Re Brightview Ltd [2004] BCC 542 4 Re McArthy Surfacing [2006] EWHC 832 (Ch) 5 Re a Company No 00330 of 1991 [1991] BCLC 597 -2- SECTION 994 OF COMPANIES ACT 2006 6. Section 994 of the 2006 Act (like s.459 of the 1985 Act) provides that a member of a company may petition the court on the grounds that - the company’s affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of members generally or of some part of its members (including at least himself ) - an actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial. WHO MAY PETITION? 7. By s.994 any member may petition. This has an extended meaning and includes: - Someone to whom shares have been transferred This requires that an instrument of transfer has been executed even if not registered.1 - Someone to whom shares have been transmitted by operation of the law i.e. personal representatives, trustees in bankruptcy, etc.2 8. A person who is a mere nominee shareholder is a member and may petition because his interests include the economic interests of the beneficial owners.3 9. A person who is a mere beneficial owner of shares may not petition.4 10. A former member has no standing to petition.5 However, other members may be injuncted to prevent the compulsory acquisition of a petitioner’s shares. 11. Although the petitioner must be a member of the company when the petition is presented, he may rely in support of the petition on events which occurred before he became a 15 Re Bovey Hotel Ventures Ltd unreported but quoted and followed in RA Noble & Sons Clothing Ltd [1983] BCLC 273 at 290 16 Jesner v Jarrod Properties [1992] BCC 807 17 Rock Nominees Ltd v RCO (Holdings) Ltd [2004] 1 BCLC 439 CA 18 Re Metropolis Motorcycles Ltd [2005] 1 BCLC 520 19 Re Baumler (UK) Ltd [2005] 1 BCLC 92 -5- a reasonable bystander observing the consequences of their conduct, would regard it as having unfairly prejudiced the petitioner’s interests.”15 The Distinct Requirements 21. Prejudice and unfairness are distinct requirements: - The mere fact that respondents have caused prejudice to the petitioner does not always mean that there has been unfairness. So where two companies were always run as a single unit in disregard of the constitutional formalities of both of them but with the acquiescence and knowledge of the petitioners there was prejudice but no unfairness.16 - Conversely, reprehensible conduct by those in control of a company may be unfair and reprehensible but not prejudicial. So where directors entered into transactions pursuant to which (despite obvious conflicts of interest) they purchased company assets, this was unfair but no s.994 remedy was granted as the price paid by the directors was not less than the company would have obtained from an arm’s length purchaser.17 The need for substantial prejudice 22. Prejudice must be substantial relative to the remedy sought by the petitioner. - In particular, a respondent will not be required to buy out the petitioner’s shares at a fair price if the prejudice is relatively trivial and the petitioner has already accepted the role of a passive investor.18 - It has been held that in a quasi partnership company a justifiable loss of confidence by the petitioner in the other quasi partner which leads to a breakdown in the relationship may amount to sufficient prejudice even if there is nothing more tangible by way of prejudice19, but a mere breakdown of trust in confidence among quasi partners will not be a basis for a successful petition- the breakdown must relate to conduct which is unfair 20 Re Jayflex Construction Ltd [2004] 2 BCLC 145 21 Re RA Noble & Sons (Clothing) Ltd [1993] BCLC 273 22 Re a Company [1986] BCLC 376, per Hoffman J. 23 Re Posgate and Denby (Agencies) Ltd [1987] BCLC 8 at 14 24 Re a Company (2015 of 1996) [1997] 2 BCLC 1 -6- and prejudicial.20 23. Prejudice is harm in a commercial and not merely emotional sense yet while it is helpful to a petitioner’s case to show that the conduct complained of has caused a loss in the value of the petitioner’s shares, this is neither a necessary or sufficient basis for a petition. - It is not sufficient because conduct by the majority which is not unfair (eg commercial misjudgment) might cause a fall in the value of the shares. - It is not necessary because there may be unfairness and prejudice from an exclusion from the management of a company.21 Unfairness & Legitimate Expectations 24. The Courts have used the concept of legitimate expectations to describe the types of interests that may be protected by a s.994 petition.22 Members have a legitimate expectation that a company will be managed lawfully, ie in accordance with its articles and the duties of directors but where there is no illegality the task of identifying legitimate expectations is harder. 25. It has been held that “Section [994] enables the court to give full effect to the terms and understandings on which the members of the company become associated but not to re- write them”23 26. The existence of formal agreements does not necessarily prevent the existence of unwritten understandings giving rise to legitimate expectations but it does reduce their likelihood.24 27. In larger companies a legitimate expectation based upon informal arrangements supplementing the company articles will be difficult to establish and, even if established, unlikely to be given effect to by the courts. For example, in a case where a company was quoted on the Unlisted Securities Market it was said: 25 Re Blue Arrow [1987] BCLC 585 at 590 26 [1999] 1 WLR 1092 27 Re Guidezone Ltd [2000] BCLC 321 at 356 28 ibid -7- “Outside investors were entitled to assume that the whole of the constitution was contained in the articles, read, of course, together with the Companies Acts. There is in these circumstances no room for any legitimate expectation founded on some agreement or arrangement made between the directors and kept up their sleeves and not disclosed to those placing the shares with the public through the Unlisted Securities Market.” 25 Equitable considerations 28. Lord Hoffman in the leading case of O’Neill v Phillips26 commented on his earlier use of the phrase “legitimate expectations” and said it was “probably a mistake” and that the phrase “should not be allowed to lead a life of its own”. His concern was to make clear that s.994 petitions did not give the courts a general power to assess the fairness of the conduct of company controllers. He said that he preferred to use the phrase “equitable considerations” to describe the circumstances when the courts should grant relief to petitioners. While this is a shift in language it is not a change of approach which is still almost contractual when the complaint concerns legitimate expectations. 29. Cases often use the language of equity and fairness. For example: -Unfairness is to be judged “by testing whether, applying established equitable principles, the majority has acted, or is proposing to act, in a manner which equity would regard as contrary to good faith”. 27 30. However, when assessing what is equitable a petitioner will normally need to prove the existence of agreements, promises, or understandings, reached among the shareholders at the time the company was established or subsequently and reliance on any such informal understandings.28 Reliance at the time a company is established is likely to be easily established by the fact that someone chooses to invest money/ effort in the creation of a new business. Subsequent reliance may be harder to prove. EXAMPLES OF UNFAIRLY PREJUDICIAL CONDUCT Majority taking financial benefits from minority 37 Re a Company (No 8699 of 1985) [1986] BCLC 382 38 Bermuda Cablevision Ltd v Colica Trust Co Ltd [1998] AC 198 39 CA 2006 section 994(1A) -10- Prevention of sale of shares at higher value 39. A minority shareholder can be unfairly prejudiced by being prevented from selling his shares to the highest bidder.37 Criminal Conduct 40. The conduct of a company’s affairs by the majority in a criminal way can amount to unfair prejudice.38 Removal of an auditor 41. Removal of a company auditor for an improper reason may amount to unfairly prejudicial conduct.39 REMEDIES 42. Section 996 of the Companies Act 2006 provides that. the court may make “such order as [the Court] thinks fit for giving relief in respect of the matters complained of” 43. The 2006 Act expressly sets out potential remedies such as: - Regulating the affairs of the company by either altering its constitution or forbidding the alteration of its constitution - Requiring the company to do or to refrain from doing an act such as the disposal of an asset. - Authorising the bringing of proceedings in the name of or on behalf of the company (i.e. a derivative claim) - Ordering the purchase of some of all of the shares in the company. 44. Key points to note are that: - The courts have a wide discretion as to remedies. 40 Re Bird Precision Bellows Ltd [1986] Ch 658 at 669 41 Grace v Biagioli [2006] BCC 85 42 Irvine v Irvine (No 2) [2007] 1 BCLC 445 43 eg Shah v Shah [2011] EWHC 1902 (Ch) -11- - The Court has to look at all the relevant circumstances when deciding what type of order to make. - It has been said that the appropriate remedy is one which would”put right and cure for the future the unfair prejudice which the petitioner has suffered at the hands of the other shareholders of the company”. 40 - The Court is not limited to reversing or putting right the immediate conduct which justified the making of the order. 41 - The prospective nature of the jurisdiction is reflected in the fact that the court must assess the appropriateness of the remedy as at the date of the hearing and not as at the date of the presentation of the petition and may even take into account conduct which has occurred between those two dates. The Court is entitled to look at the reality and practicalities of the overall situation, past, present and future. Orders for the purchase of shares 45. Where a court orders the purchase of shares this usually involves the purchase of the petitioner’s shares by the other shareholders. Valuation questions are often the focus of much of the litigation: - Minority shareholders can often expect their shares to be valued at a discount to reflect the lack of a controlling interest but this should not apply to quasi partnership companies. 42 - It is sometimes but not necessarily the case that a break up valuation rather than a going concern valuation is appropriate. 43 - Where unfairly prejudicial conduct has damaged the value of a petitioner’s shares then a buy out can be ordered based on historical valuations or on the hypothetical basis that such conduct has not occurred. Relationship with Derivative Claims 44 Bhullar v Bhullar [2004] 2 BCLC 241 45 Cooke v Cooke [1997] 2 BCLC 28 46 Re Guidezone [2001] BCC 692 47 Bamber v Eaton [2007 BCC 272 -12- 46. So long as the petitioner seeks only personal relief (eg to be bought out) , the use of s.994 where the majority shareholder has acted in breach of duty to the company is not problematic. However, even if the petitioner also seeks corporate relief (eg it wants a derivative claim to be brought) this can be achieved by s.994.44 47. Many petitions are founded on conduct which consists of wrongs done to the Company where the petitioner is unable because of the rule in Foss v Harbottle and the prohibition on the recovery of shareholder’s reflective losses to bring a claim. In such circumstances a 994 Petition can be a useful alternative way to bring a derivative claim. While proceeding by s.994 may avoid the formalities of a statutory derivative action a petitioner should not expect the court to take a less vigorous approach to the question of whether a derivative claim is appropriate. 48. In a case where a derivative action had been brought, a shareholder was given leave to join an unfair prejudice petition to the derivative action but the derivative action was then stayed in favour of the petition since this enabled all the proceedings between the parties to be decided at a single trial.45 Such an approach is convenient where the petition is based in part on allegations of breach of duty on the part of the majority and in part on allegations of mere unfairness. Relationship with Just and Equitable Winding Up 49. Section 122(1)(g) of the Insolvency Act 1986 provides the drastic remedy of winding up a company on just and equitable grounds. A winding up petition should not be issued in conjunction with a 994 petition unless the petitioner has a genuine intention to seek the winding up of the company. If unfair prejudice under s.994 cannot be established then just and equitable winding up will not be available either.46 Note that a just and equitable winding up petition engages s.127 of the Insolvency Act 1986 (restriction on post petition dispositions by the company). PRACTICE AND PROCEDURE 50. Relief under s.994 requires a petition otherwise it will be struck out. Failure to proceed by petition is not a defect in procedure that can be remedied under the CPR.47