Shareholder Remedies | Law Commission, Slides of Remedies

Download Shareholder Remedies | Law Commission and more Slides Remedies in PDF only on Docsity! iii 226-425-21 THE LAW COMMISSION SHAREHOLDER REMEDIES CONTENTS Paragraph Page PART 1: OVERVIEW 1 Terms of reference 1.2 1 Scope of the project 1.4 1 Structure of the paper 1.15 6 Scottish Law Commission 1.19 6 Acknowledgments 1.20 7 SECTION A: THE PERSONAL ACTION PART 2: A SHAREHOLDER’S PERSONAL RIGHTS ARISING FROM THE COMPANY’S CONSTITUTION 8 Introduction 2.1 8 The company constitution 2.2 8 The section 14 contract and how it differs from other contracts 2.6 9 Membership rights 2.15 12 Internal irregularities 2.21 14 Transactions outside the company’s powers 2.29 17 Restraining future transactions 2.29 17 Past transactions 2.30 17 Challenging resolutions to amend the articles of association 2.31 17 Identifying enforceable personal rights in the articles 2.39 20 PART 3: OTHER CIRCUMSTANCES IN WHICH A SHAREHOLDER CAN BRING A PERSONAL ACTION 22 Introduction 3.1 22 Statutory rights 3.2 22 Shareholder agreements 3.3 22 Introduction 3.3 22 Advantages 3.4 23 Contents 3.6 23 Disclosure of agreements 3.8 24 Enforceability 3.9 24 Conclusion 3.17 26 SECTION B: THE DERIVATIVE ACTION PART 4: A SHAREHOLDER’S RIGHT TO BRING AN ACTION ON BEHALF OF THE COMPANY 27 Introduction 4.1 27 The majority rule and proper plaintiff principles 4.2 27 Fraud on the minority 4.7 29 Fraud 4.9 30 Wrongdoer control 4.12 31 iv Paragraph Page When fraud and control must be shown 4.17 33 “Independent organ” does not wish the action to proceed 4.18 34 Ultra vires transactions 4.19 35 Is the transaction ultra vires? 4.21 35 No need to show fraud on the minority 4.25 36 “Independent organ” does not wish the action to proceed 4.27 37 Breaches of special resolution procedures 4.30 38 Conclusion 4.35 40 PART 5: RESTRICTIONS ON MEMBERS’ ABILITY TO BRING ACTIONS ON BEHALF OF THE COMPANY 41 Introduction 5.1 41 Ratification 5.2 41 Ultra vires acts 5.3 42 Acts outside the powers of the board 5.4 42 Acts in breach of fiduciary duty 5.6 42 Inequitable conduct of the minority shareholder 5.18 46 Availability of other adequate remedies 5.19 47 Companies in liquidation 5.20 47 PART 6: PROCEDURE AND COSTS IN RESPECT OF ACTIONS ON BEHALF OF THE COMPANY 48 Introduction 6.1 48 Types of action 6.2 48 Determining standing as a preliminary issue 6.6 49 RSC, O 15, r 12A 6.7 50 Costs orders 6.10 51 General principles 6.10 51 Costs in derivative actions 6.11 52 Conditional fees 6.15 53 SECTION C: UNFAIR PREJUDICE REMEDY PART 7: INTRODUCTION AND HISTORY OF SECTIONS 459-461 OF THE COMPANIES ACT 1985 55 Introduction 7.1 55 History of sections 459-461 7.5 56 PART 8: RELATIONSHIP WITH JUST AND EQUITABLE WINDING UP 62 Background 8.1 62 Who may petition 8.3 62 Grounds for a petition 8.5 63 Relief under section 122(1)(g) where an alternative remedy is available 8.13 66 Pleading section 122(1)(g) and section 459 in the alternative 8.18 69 Reasons for pleading in the alternative 8.18 69 Effect of pleading winding up in the alternative — section 127 of the Insolvency Act 1986 8.19 70 1990 practice direction 8.22 71 vii Paragraph Page Type of duty 16.9 153 Should the new procedure be available for breaches of duty by others apart from directors? 16.10 154 Partial abrogation of the rule in Foss v Harbottle 16.12 155 Notice to the company 16.15 156 Consideration by the court 16.18 158 Issues relevant to the grant of leave 16.20 159 Threshold test on the merits 16.21 159 Summary of approach to derivative actions in foreign jurisdictions 16.23 161 Applicant’s good faith 16.27 162 Interests of the company 16.32 164 That the wrong has been, or may be, approved by the company in general meeting 16.35 165 The views of an independent organ 16.38 166 The availability of alternative remedies 16.39 167 Advantages and disadvantages of express list of criteria 16.42 167 Additional qualifying requirement 16.45 168 Court’s power to appoint an independent expert 16.46 169 Remedy 16.48 169 Multiple derivative actions 16.51 171 PART 17: CASE MANAGEMENT BY THE COURTS OF SHAREHOLDER PROCEEDINGS 172 Introduction 17.1 172 Proposals in the Woolf Report 17.3 172 Introduction to our provisional recommendations for case management 17.5 173 Case management of derivative actions 17.6 174 Stage at which discretion to grant leave to continue a derivative action will be exercised 17.6 174 Power to direct the company to convene a meeting of the shareholders 17.7 174 Costs indemnity orders 17.8 174 Addition or substitution of applicant 17.9 175 Leave of the court for compromise or abandonment of derivative actions 17.10 175 Case management of all shareholder proceedings 17.11 176 Preliminary issues 17.11 176 Security for costs 17.13 176 Power to dismiss claim or part of claim or defence which has no realistic prospect of success 17.16 177 Adjournment to facilitate alternative disposal arrangements 17.17 178 Determination of how facts are to be proved 17.18 178 Exclusion of issues from determination 17.19 178 PART 18: A NEW ADDITIONAL UNFAIR PREJUDICE REMEDY FOR SMALLER COMPANIES 180 Introduction 18.1 180 Suggested scheme for new remedy for smaller companies 18.4 180 PART 19: ARTICLES OF ASSOCIATION 185 Introduction 19.1 185 Shareholder exit article for smaller private companies — draft regulation 19.3 186 Companies to which this regulation would apply 19.3 186 Circumstances that give rise to the exit rights 19.4 186 Exit provisions 19.7 187 viii Paragraph Page Arbitration — draft regulation 120 19.12 189 Valuation procedure — draft regulation 121 19.16 190 General 19.18 191 PART 20: OTHER REFORMS 192 Introduction 20.1 192 Reform to section 14 by clarification of the types of situations that may fall within the section 20.2 193 Other reforms relating to proceedings under sections 459-461 20.5 193 Clarification of section 459 by authoritative guidance 20.5 193 Amendment of section 459 to impose a limitation period on claims under the section 20.9 195 Amendment of section 459 to make it clear that it is specific conduct, rather than the affairs of the company overall, that has to be shown to be unfairly prejudicial 20.15 198 Amendment of section 459 to ensure that “unfair prejudice” is construed as broadly as appears to have been intended by the Jenkins Committee 20.17 199 Amendment to add winding up to the remedies available under section 46120.24 201 Extension of the power to determine relief as between respondents to a section 459 petition 20.29 204 Provision in the 1986 Rules to state that there should be no advertisement until the court so orders 20.31 204 Permitting former members to bring proceedings 20.32 204 Pre-action discovery 20.39 206 PART 21: SUMMARY OF PROVISIONAL RECOMMENDATIONS AND CONSULTATION ISSUES 209 APPENDIX A: RELEVANT EXTRACTS FROM THE COMPANIES ACT 1985 224 Section 14 224 Section 35 224 Section 35A 224 Section 459 225 Section 460 226 Section 461 226 Section 726 227 APPENDIX B: RELEVANT EXTRACTS FROM THE INSOLVENCY ACT 1986 228 Section 122 228 Section 125 228 Section 127 229 APPENDIX C: RELEVANT EXTRACTS FROM THE RULES OF THE SUPREME COURT 230 Order 15, rule 12A 230 Order 23, rule 1 232 ix Page APPENDIX D: PREDECESSORS TO THE CURRENT SECTION 459 OF THE COMPANIES ACT 1985 233 Section 210 of the Companies Act 1948 233 Section 75 of the Companies Act 1980 233 Section 459 of the Companies Act 1985 (pre amendment by the Companies Act 1989) 234 APPENDIX E: STATISTICS 235 Statistics relating to the filing of section 459 petitions 235 Statistics relating to the size of companies 239 APPENDIX F: SUMMARY OF “OPPRESSION” OR “UNFAIR PREJUDICE” REMEDIES AND DERIVATIVE ACTIONS IN OTHER JURISDICTIONS 241 Australia 241 Canada 246 Ghana 249 New Zealand 252 Republic of South Africa 255 United States of America 259 APPENDIX G: RELEVANT EXTRACTS FROM FOREIGN LEGISLATION DEALING WITH STATUTORY RIGHTS TO BRING ACTIONS ON BEHALF OF A COMPANY 261 Australia 261 Canada 266 Ghana 268 New Zealand 272 Republic of South Africa 275 United States of America 276 APPENDIX H: PROPOSED NEW REGULATIONS TO BE INSERTED IN TABLE A 277 Shareholders’ exit article for smaller private companies — draft regulation 119 277 Arbitration article — draft regulation 120 279 Valuation article — draft regulation 121 279 APPENDIX I: SUGGESTED WORDING FOR NEW REMEDY FOR SMALLER COMPANIES 281 APPENDIX J: LIST OF INDIVIDUALS AND ORGANISATIONS WHO HAVE ASSISTED WITH THE PROJECT 282 By Companies Act 1985, s 461(2)(c) (first enacted in Companies Act 1980, s 75(4)(c)); see10 generally paras 7.11 and 10.8-10.9 below and Appendix D. See Appendix F.11 Arts 452-454 of the Companies (Northern Ireland) Order 1986 (SI 1986 No 1032).12 Of 156 s 459 petitions issued in 1994-1995, 84.6% related to companies in which there were13 5 or fewer shareholders. 96.2% of all petitions concerned private companies. Just under 79% of the petitions concerned companies in which all or most of the shareholders were concerned in management. See further, Appendix E, Table 1. Of 156 petitions brought under s 459 in 1994-1995, 67.3% included an allegation of14 exclusion from management. See Appendix E, Table 1. Just under 70% of the petitions sought the purchase of the petitioners’ shares. See Appendix15 E, Table 1. In Re Elgindata Ltd [1991] BCLC 959 the hearing lasted 43 days, costs totalled £320,00016 and the shares, originally purchased for £40,000, were finally valued at only £24,600. In Re Macro (Ipswich) Ltd [1994] 2 BCLC 354 the hearing of s 459 proceedings and a related action lasted 27 days at first instance alone. The parties subsequently claimed that they were entitled to recover total costs of £725,000 under orders of the court; see Re Macro (Ipswich) Ltd [1996] 1 WLR 145, 148. This did not include the costs of the subsequent appeal hearing: Re Macro (Ipswich) Ltd 22 May 1996 (unreported, CA). 3 in Foss v Harbottle. The exceptions are rigid. The law in this field is complex and obscure, and this may well deter minority shareholders from bringing such proceedings. The attempt to provide an alternative procedure for minority shareholders’ actions by statute has not been successful. Other common law10 jurisdictions have recently introduced or considered the introduction of a statutory derivative action. Accordingly, the first problem on which this paper concentrates is11 the law relating to actions by minority shareholders on behalf of their company. 1.7 The second main problem on which we focus in this paper is the efficiency of the remedy which is most widely used by minority shareholders to obtain some personal remedy in the event of breaches of directors’ duties, or of other unsatisfactory conduct of company business. This is the remedy for unfairly prejudicial conduct, to be found in sections 459-461 of the Companies Act 1985. These sections provide remedies for12 types of conduct which sometimes cannot be remedied in any other way. Such conduct occurs most frequently in smaller companies in which most of the members are involved in management. An example of such conduct is the exclusion from13 management of one of the owner-managers by the others. These sections provide14 personal remedies, such as an order that a party’s shares should be bought by other shareholders or by the company. This remedy is particularly needed by shareholders in companies in which there is no market for the shares. However, proceedings for15 relief from unfair prejudice often entail complex factual investigation and result in costly and cumbersome litigation, which is particularly detrimental to smaller companies, in which most of the members are involved in management. In a small16 company the management time used in litigation rather than running the business is more likely to damage the business than in larger companies. In this connection, see generally ProShare, Code for Nominee Operators of Listed Companies17 (1995). CREST is the electronic share settlement system, under which transfers on the share register18 may be effected electronically. It became operational on 15 July 1996. Trading electronically through CREST requires membership of the system. Private investors now have a choice of three ways of holding shares: in certificated form, in a nominee company, or, a new option, as a sponsored member in CREST. A sponsored member is the direct legal owner of the shares, but the shares are held in electronic form and transactions are carried out through CREST by the sponsor, usually a bank or stockbroker. According to a survey conducted by the Office for National Statistics (formerly the Central19 Statistical Office), Share Ownership: A Report on the Ownership of Shares at 31st of December 1994 (1995), pension funds and insurance companies owned approximately 49.7% of the equity of listed companies as at 31 December 1994. See, for example, The Responsibilities of Institutional Shareholders in the UK (December 1991)20 published by the Institutional Shareholders’ Committee. 4 1.8 A third problem which this paper examines is the enforcement of shareholders’ contractual rights under the articles of association. This includes the question of the extent to which a member can insist upon the affairs of the company being conducted in accordance with the articles of association. 1.9 In examining the rights of members under the articles of association, we have not examined rights which they may have in some other capacity, such as directors, employees or creditors. Examination of these “outsider” rights is beyond the scope of this project. Likewise, we have not considered whether the division of power between members on the one hand and directors on the other hand should be changed. This again would be outside the scope of our project as it would involve consideration of the content of shareholders’ rights rather than the means by which they may be enforced. 1.10 Likewise we have not addressed the problems which arise through shares being held by nominees. This is becoming increasingly common in public companies, because17 of the ability to deal with shares more easily if they are in the name of a nominee of the shareholder’s financial adviser, and because of the introduction of CREST. The use18 of nominees also occurs in private companies, as, for example, where a husband becomes a director but places the shares in the names of his wife and children as nominees for him. 1.11 There is a wide variety of different shareholder profiles. In the smaller companies there may be only a handful of shareholders who, but for the desire to have limited liability, may well have combined together in partnership. At the other end of the scale there are very large public listed companies. Many of their shareholders these days will be institutional shareholders who can exercise influence on the company because of their19 financial muscle, without exercising any legal remedy. Moreover, some institutional20 shareholders only manage the funds of others and therefore are not provided by their clients with funds for litigation purposes. See Appendix E, Tables 2-4.21 See Gore-Browne on Companies (44th ed 1986) para 1.4 and S Turley, “The Impact of the22 Seventh EEC Directive on UK Group Accounts” (1986) 7 Co Law 10. In Scottish law, the paucity of case law in this area means that whilst the substantive law is23 the same as that in English law, however, no special procedural rules have developed; see para 6.5, n 8 below. A personal action may be brought by a shareholder in a representative capacity if there are24 numerous persons who have the same interest in the proceedings: Rules of the Supreme Court (“RSC”), O 15, r 12. When considering more generally the remedies available to shareholders, and setting out our25 provisional proposals for reform, we have used the term “applicant” to denote the person who is seeking to pursue the remedy. Access to Justice, Final Report to the Lord Chancellor on the Civil Justice System in England and26 Wales (July 1996) (“the Woolf Report”). Ibid, Recommendation 114.27 However, trade unions are not included. Trade unions are not in general treated as bodies28 corporate; see Trade Union and Labour Relations Act 1992, s 10(2). 5 1.12 Companies come in all sorts of shapes and sizes. A provision which is appropriate for21 certain companies may be inappropriate for others operating in a different environment. Furthermore, it is very common these days for companies to organise in groups or to carry on business through associated and related companies.22 1.13 In reviewing the law of shareholder remedies, there are competing goals. On the one hand, a benefit of improving shareholder remedies would be to enhance shareholder confidence. It would also highlight private enforcement of shareholder rights and reduce reliance upon criminal sanctions, which are in any event inadequate to deal with many of the problems that arise within companies. At the same time it is as important not to impose significant new burdens on management. A proper balance must be struck between these competing goals. 1.14 We have used the term “derivative action” to denote proceedings which a shareholder brings to enforce a cause of action vested in the company. We have used the term23 “personal action” to denote an action which a shareholder may bring in his own right, for example because he has a statutory right to do so or because he has some contractual right under the articles of association or under a shareholder agreement.24 We have used the term “petitioner” to describe an applicant under section 459 of the Companies Act 1985 and/or section 122(1)(g) of the Insolvency Act 1986, although25 if the recommendations made by Lord Woolf in his report are implemented, petitions26 may no longer be used. We have used the words “member” and “shareholder”27 interchangeably, though in most situations it is not necessary that the member holds shares, so that members of companies limited by guarantee which do not have a share capital are included. We have used the expression “minority shareholder” for28 Article 25 of the Companies (Northern Ireland) Order 1986.1 See paras 2.6-2.14 below.2 See paras 2.15-2.20 below.3 See paras 2.21-2.28 below.4 See paras 2.29-2.30 below.5 See paras 2.31-2.38 below.6 See para 2.39 below.7 Agreements between members and matters agreed by resolution may also be seen as part of8 the company’s constitution. See Companies Act 1985, s 35A(3). 8 SECTION A THE PERSONAL ACTION PART 2 A SHAREHOLDER’S PERSONAL RIGHTS ARISING FROM THE COMPANY’S CONSTITUTION Introduction 2.1 In this part of the consultation paper we look at shareholders’ remedies arising from the constitution of the company. We consider the contractual nature of such rights under section 14 of the Companies Act 1985 and consider how they differ from1 common law contractual rights. We consider the nature of membership rights and2 3 restrictions on the enforcement of such rights where breaches are held to be merely internal irregularities, in respect of which the shareholder cannot bring a personal action. We next consider whether, and in what circumstances, a shareholder can bring4 a personal action in respect of transactions outside a company’s powers, and the basis5 on which resolutions altering the articles can be challenged. Finally, we consider if it6 is possible to identify personal rights in the articles which will be enforceable by a member bringing a personal action.7 The company constitution 2.2 The constitutions of companies registered under the Companies Acts comprise two separate documents — the memorandum of association and the articles of association.8 In broad terms, the memorandum governs the relationship between the company and the outside world, whereas the articles represent the domestic regulations of the company and govern its internal administration. 2.3 The Companies Act 1985 provides that a company’s memorandum and articles shall be in the form specified in regulations made by the Secretary of State “... or as near to Section 3(1) of the Companies Act 1985.9 The Companies (Tables A to F) Regulations 1985 (SI 1985 No 805). Section 8A of the10 Companies Act 1985 empowers the Secretary of State to prescribe a new Table G which would be a model set of articles of association for a “partnership company”. The DTI published a Consultative Document on Table G in March 1995 (URN 95/609). Section 7 and Sched A. Neither the 1844 Act, nor the subsequent Limited Liability Act 185511 applied to Scotland. The Joint Stock Companies Act 1856 and later legislation applied equally to Scotland. Ibid, s 7.12 9 that form as circumstances admit”. The current regulations contain six tables, one9 10 of which is Table A. 2.4 Table A prescribes model articles which will bind public or private companies limited by shares which do not register articles and which will apply insofar as registered articles do not exclude or modify them. A company may adopt articles by reference to Table A. Many companies specifically exclude Table A, however, adopting regulations tailored to their own needs, or adopt only those parts of Table A which suit them. 2.5 Many companies will, for example, need to modify the provisions of Table A relating to the transfer of shares, and attach voting and other special rights to classes of shares. Various model forms of articles suitable for different types of company are available commercially. The section 14 contract and how it differs from other contracts 2.6 Section 14(1) of the Companies Act 1985 prescribes the legal effect of the memorandum and articles of association. It provides that: Subject to the provisions of this Act, the memorandum and articles, when registered, bind the company and its members to the same extent as if they respectively had been signed and sealed by each member and contained covenants on the part of each member to observe all the provisions of the memorandum and of the articles. 2.7 The source of the present wording of the section is the Joint Stock Companies Act 1844 which continued to rely on the “deed of settlement”, the then existing common11 law method of forming companies. Subscribers agreed in the deed to be associated in an enterprise with a prescribed joint stock divided into a specified number of shares. Under the 1844 Act, the deed was to be registered and was to contain “... a Covenant on the Part of every Shareholder, with a Trustee on the Part of the Company to pay up the Amount of the Instalments on the share taken by such Shareholder and to perform the several Engagements in the Deed contained on the Part of the Shareholders”.12 See, for example, Companies Act 1948, s 20(1).13 See Re Compania de Electricidad de la Provincia de Buenos Aires Ltd [1980] Ch 146, 187, per14 Slade J. The company has long been assumed, however, to be a party to the statutory contract. See Hickman v Kent or Romney Marsh Sheep Breeders’ Association [1915] 1 Ch 881 (“Hickman’s case”). Over the years, many academics have attempted to resolve the debate as to the precise nature15 of this statutory contract, but without any real consensus emerging. See, for example: K W Wedderburn, “Shareholders’ Rights and the Rule in Foss v Harbottle” [1957] CLJ 194; G D Goldberg, “The Enforcement of Outsider Rights under Section 20 of the Companies Act 1948” (1972) 35 MLR 362; G N Prentice, “The Enforcement of ‘Outsider’ Rights” (1980) 1 Co Law 179; R Gregory, “The Section 20 Contract” (1981) 44 MLR 526; G D Goldberg, “The Controversy on the Section 20 Contract Revisited” (1985) 48 MLR 158; R R Drury, “The Relative Nature of a Shareholder’s Right to Enforce the Company Contract” [1986] CLJ 219. See also n 16 below. See C Shepherd, “Distinctive Features of the Section 14 Contract” (1993) 27 Law Teach 80;16 S Griffin, “The Limited Contractual Nature of Section 14 of the Companies Act 1985” (1993) 14 Co Law 217; T E Crowther, “The Nature of the Contract in Section 14(1) of the Companies Act 1985” (1992) 24 Bracton LJ 81. One example of the differences between such contracts is illustrated by Sched 1 of the Unfair17 Contract Terms Act 1977 which provides that: “Sections 2 to 4 of this Act do not extend to — ... (d) any contract so far as it relates — (i) to the formation or dissolution of a company ..., or (ii) to its constitution or the rights or obligations of its corporators or members.” See, for example, Companies Act 1985, s 303 which provides that, subject to certain18 conditions, a director can be removed by ordinary resolution notwithstanding anything in the articles or in any agreement between the company and the director. Bratton Seymour Service Co Ltd v Oxborough [1992] BCLC 693, 696, per Dillon LJ.19 10 2.8 The Joint Stock Companies Act 1856 subsequently substituted the modern form constitution — the memorandum and articles of association — for the deed of settlement and adopted wording similar to that now in force. It did not take fully into account, however, the new development of the incorporated company as a separate legal entity; the memorandum and articles were to bind “... as if ... signed and sealed by each member ...”, there being no reference to the company also being deemed to have signed and sealed. This omission survived subsequent Acts and is maintained13 in the Companies Act 1985 where, again, no provision is made for any deemed sealing on the part of the company.14 2.9 Section 14 creates a contract which forms the basis of legal relations between the company and its members and between the members inter se. It is well recognised,15 16 however, that this so called “statutory contract” differs in a number of significant respects from a standard contract.17 2.10 Section 14 is deemed to be “... subject to the provisions of the Act”. The18 memorandum and articles are the statutory documents of the company and, as such, are also governed by the statute which controls them. Statutory provisions to which19 the contract is subject include provisions authorising alteration of the memorandum See Pulbrook v Richmond Consolidated Mining Co (1878) 9 Ch D 610 (right to take part in35 management); Imperial Hydropathic Hotel Co, Blackpool v Hampson (1882) 23 Ch D 1 (right to hold office). See also Quin & Axtens Ltd v Salmon [1909] AC 442 (right to veto certain board resolutions). Eley v Positive Government Security Life Assurance Co Ltd (1876) 1 Ex D 88; the Court of36 Appeal holding that the plaintiff was unable to rely on this provision as he was not a party to the articles. It appears that the plaintiff was not a member of the company when the articles were adopted but had become one several months after its incorporation. It is not clear whether this was seen as significant by the court. See also dicta in Cumbrian Newspapers Group Ltd v Cumberland & Westmorland Herald Newspaper & Printing Co Ltd [1987] Ch 1 (a case involving class rights) where, at p 16, Scott J referred to Eley and held that, although the timing of the plaintiff’s membership may have been relevant, in such a case, “... if, in all the circumstances, the right conclusion was still that the rights or benefits conferred by the article were not conferred on the beneficiary in the capacity of member or shareholder of the company, then the rights could not, in my view, be regarded as class rights”. Melhado v Porto Alegre, New Hamburgh, and Brazilian Railway Co (1874) LR 9 CP 503.37 Again, it is unclear whether the plaintiff was also a shareholder and whether this factor was relevant in the court’s decision. On this point see n 39 and n 40 below. Pritchard’s case (1873) 8 Ch App 956. The articles provided that, on incorporation, the38 company should enter into an agreement with the vendor of the mine, under which the purchase of the mine from him would be funded partly in cash and partly in fully paid shares. The articles were signed by the vendor who received the stated number of shares. When the company went into liquidation, the vendor brought an action on the question of whether the articles constituted a contract in writing with him so that the shares could be considered as fully paid. Mellish LJ held that the articles could not be considered as a contract between the company and the vendor as, “... in themselves the articles of association are simply a contract as between the shareholders inter se in respect of their rights as shareholders”. Ibid, at p 960. See L S Sealy, Cases and Materials in Company Law (5th ed 1992) pp 95-97; R Gregory,39 “The Section 20 Contract” (1981) 44 MLR 526; G D Goldberg, “The Controversy on the Section 20 Contract Revisited” (1985) 48 MLR 158. See also K W Wedderburn, “Shareholder Rights and the Rule in Foss v Harbottle” [1957] CLJ 194, 213 whose view is that a member can enforce outsider rights “... so long as he sues qua member and not qua outsider ...” (emphasis added). See Gower’s Principles of Modern Company Law (5th ed 1992) pp 284 and 646. Other40 commentators have accepted that outsider rights are not usually enforceable but have suggested situations in which they should be so. The view is expressed by K W Wedderburn, “Shareholders’ Rights and the Rule in Foss v Harbottle” [1957] CLJ 194, 212 that it may be possible for a member in that capacity to enforce a right given to him in some other capacity 13 remuneration. In other cases, directors have been able to rely on such provisions and so to enforce their rights under them.35 2.19 The court has refused, however, to allow a plaintiff to rely on a provision in the articles that he should be the company’s solicitor. It has also been held that a company36 promoter could not rely on provisions in the articles providing for his costs and that37 the vendor of property to a company could not rely on articles which provided for the payment of consideration for that property.38 2.20 The court’s application of the “outsider rights” restriction suggested by Astbury J in Hickman’s case has been inconsistent. It is difficult to reconcile Hickman’s case with39 some of the earlier cases. However, the general view continues to be that “... the section confers contractual effect on a provision in the memorandum and articles only in so far as it affords rights or imposes obligations on a member qua member”.40 by the articles. This view is based on Quin & Axtens Ltd v Salmon [1909] 1 Ch 311, affirmed [1909] AC 442, but it would not appear to be consistent with the approach adopted in other cases such as Beattie v E & F Beattie Ltd [1938] Ch 708. Compare also Cumbrian Newspapers Group Ltd v Cumberland & Westmorland Herald Newspaper & Printing Co Ltd [1987] Ch 1. See also G D Goldberg, “The Enforcement of Outsider Rights under Section 20(1) of the Companies Act 1948” (1972) 35 MLR 362, 363, who suggests that a member has “... a contractual right to have any of the affairs of the company conducted by the particular organ of the company specified in the Act or the company’s memorandum or articles ...” and that “outsider rights” should only be enforced if they are “incidental to this right”. G N Prentice, “The Enforcement of ‘Outsider Rights’” (1980) 1 Co Law 179 suggests that a member only has rights under the articles insofar as they relate to the company’s power to function (in which case outsider rights would be enforceable). For other comment on the scope of outsider rights see R R Drury, “The Relative Nature of a Shareholder’s Right to Enforce the Company Contract” [1988] CLJ 219; N A Bastin, “The Enforcement of a Member’s Rights” [1977] JBL 17; R J Smith, “Minority Shareholders and Corporate Irregularities” (1978) 41 MLR 147; R Gregory, “The Section 14 Contract” (1981) 44 MLR 526 and M Blackman, “Members’ Rights Against the Company and Matters of Internal Management” (1993) 110 SALJ 473. The practical effect of the rule that the statutory contract does not create outsider rights is41 that rights given by the company to directors, solicitors and others should be contained in separate agreements. Directors should (and usually do) have service contracts. Promoters may need first to enter into a contract with the company’s proposed members or directors and then into a post-incorporation contract with the company. See Kelner v Baxter (1866) LR 2 CP 174 and s 36C of the Companies Act 1985. The courts have been prepared, however, in certain cases, to infer an extrinsic contract from provisions in the articles. See Swabey v Port Darwin Gold Mining Co (1889) 1 Meg 385. Internal irregularities might arise from a breach of the company’s articles, or from provisions42 of the Companies Act 1985 (see, for example, breaches of notice provisions discussed at paras 2.25-2.27 below). (1843) 2 Hare 461; 67 ER 189. This case involved an action by two shareholders against five43 directors (three of whom had become bankrupt) and others claiming, among other things, that there had ceased to be a sufficient number of qualified directors to constitute a board and that a receiver should be appointed over the company’s assets. Wigram V-C held that any injury was to the company which was, therefore, the proper plaintiff. (1847) 1 Ph 790; 41 ER 833. Two shareholders sought to restrain four directors of the44 company from acting as directors when they should have retired in rotation under the articles. Cottenham LC refused to permit the shareholders to bring their action; he relied on the decision in Foss v Harbottle and held that the company was the proper plaintiff. In the words of Gower (Gower’s Principles of Modern Company Law (5th ed 1992) p 644), Mozley v Alston extended the rule in Foss v Harbottle to “... cases where there has been an irregularity in the operation of the company”. Gower adds that “... the test of whether the irregularity was such that a member could bring an action in respect of it was said to be whether the irregularity 14 Clearly, this restriction may have practical implications for those seeking to rely on certain provisions in the articles.41 Internal irregularities42 2.21 Even if the articles which have been breached create insider rather than outsider rights, members may not be able to bring personal actions in respect of those breaches. This is because of the court’s classification of breaches of certain constitutional provisions as “internal irregularities” for which no personal action will lie. 2.22 The internal irregularities restriction stems from the majority rule and proper plaintiff principles explained in Part 1 above and forming part of the so-called rule in Foss v Harbottle. These principles were said by the court in Mozley v Alston to apply to43 44 was one that could not be rectified by an ordinary resolution”. [1950] 2 All ER 1064, 1066-1069.45 [1982] Ch 204.46 Ibid, at pp 210-211.47 (1875) 1 Ch D 13.48 (1843) 2 Hare 461; 67 ER 189.49 (1847) 1 Ph 790; 41 ER 833.50 MacDougall v Gardiner (1875) 1 Ch D 13, 23. For discussion of this decision see N A Bastin,51 “The Enforcement of a Member’s Rights” [1977] JBL 17 and R J Smith, “Minority Shareholders and Corporate Irregularities” (1978) 41 MLR 147. (1875) 1 Ch D 13, 25.52 15 cases involving internal irregularities and are used as justification for the court’s refusal to uphold personal actions by shareholders. The statement of the rule in Foss v Harbottle in the case of Edwards v Halliwell as restated in Prudential Assurance Co Ltd45 v Newman Industries Ltd (No 2) is set out here for ease of reference:46 (1) The proper plaintiff in an action in respect of a wrong alleged to be done to a corporation is prima facie the corporation. (2) Where the alleged wrong is a transaction which might be made binding on the corporation and on all its members by a simple majority of the members, no individual member of the corporation is allowed to maintain an action in respect of that matter because, if the majority confirms the transaction, cadit quaestio [the question is at an end]; or, if the majority challenges the transaction, there is no valid reason why the company should not sue. (3) There is no room for the operation of the rule if the alleged wrong is ultra vires the corporation, because the majority of members cannot confirm the transaction. (4) There is also no room for the operation of the rule if the transaction complained of could be validly done or sanctioned only by a special resolution or the like, because a simple majority cannot confirm a transaction which requires the concurrence of a greater majority. (5) There is an exception to the rule where what has been done amounts to fraud and the wrongdoers are themselves in control of the company.47 2.23 MacDougall v Gardiner was one of the earliest cases in which these principles were48 applied. Mellish LJ referred to Foss v Harbottle and Mozley v Alston and rejected the49 50 plaintiff’s application to set aside a resolution for an adjournment passed on a show of hands when his right to call for a poll had been refused by the chairman. He held that, if the internal affairs of the company were not being properly managed, “... the company are the proper persons to complain”. There was no use in having litigation51 “... the ultimate end of which is only that a meeting has to be called and then ultimately the majority gets its wishes”.52 Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656, 671, per Lindley MR.67 [1951] Ch 286.68 See also Lord Wilberforce in Howard Smith v Ampol Petroleum Ltd [1974] AC 821 (PC), at p69 835 where he said of the phrases “bona fide in the interest of the company as a whole” and “for some corporate purpose”, “[s]uch phrases if they do anything more than restate the general principle applicable to fiduciary powers, at best serve, negatively, to exclude from the area of validity cases where the directors are acting sectionally, or partially: ie improperly favouring one section of the shareholders against another”. [1951] Ch 286, 291 (footnote added).70 18 2.32 The power of the company to alter its articles under the section is subject to the provisions of the Companies Acts and to the memorandum of association. However, ... it must, like all other powers, be exercised subject to those general principles of law and equity which are applicable to all powers conferred on majorities and enabling them to bind minorities. It must be exercised, not only in the manner required by law, but also bona fide for the benefit of the company as a whole, and it must not be exceeded.67 2.33 In the later case of Greenhalgh v Arderne Cinemas Ltd, Evershed MR said:68 Certain principles, I think, can be safely stated as emerging from [the] authorities. In the first place, I think it is now plain that “bona fide for the benefit of the company as a whole” means not two things but one thing. It means that the shareholder must proceed upon what, in his honest opinion, is for the benefit of the company as a whole. The second thing is that the phrase “the company as a whole” does not ... mean the company as a commercial entity, distinct from the corporators: it means the corporators as a general body. That is to say, the case may be taken of an individual hypothetical member and it may be asked whether what is proposed is, in the honest opinion of those who voted in its favour, for that person’s benefit. I think that the matter can, in practice, be more accurately and precisely stated by looking at the converse and by saying that a special resolution of this kind would be liable to be impeached if the effect of it were to discriminate between the majority69 shareholders and the minority shareholders, so as to give to the former an advantage of which the latter were deprived. When the cases are examined in which the resolution has been successfully attacked, it is on that ground. It is therefore not necessary to require that persons voting for a special resolution should ... dissociate themselves altogether from their own prospects and consider whether what is thought to be for the benefit of the company as a going concern.70 See Gower’s Principles of Modern Company Law (5th ed 1992) pp 599-604. See also the71 decision of the High Court of Australia in Gambotto v WCP Ltd [1994] 16 ACSR 1, where the court departed from the Allen test on the particular facts of the case. See further D D Prentice, “Alteration of Articles of Association — Expropriation of Shares” (1996) 112 LQR 194. [1900] 1 Ch 656.72 [1920] 1 Ch 154.73 Lord Sterndale MR stressed in this case, that this question was “... a point which ought to be74 decided by the voices of the business men who understand the business and understand the nature of competition, and whether such a position is or is not for the benefit of the company”. Ibid, at pp 165-166. See also the comments of Atkin LJ in the Court of Appeal in Shuttleworth v Cox Bros & Co (Maidenhead) Ltd [1927] 2 KB 9, 20. [1920] 1 Ch 154, 166-167, per Lord Sterndale MR, 171-172, per Warrington LJ, 173-174,75 per Eve J. [1920] 2 Ch 124.76 19 2.34 These tests are not always easy to apply and have been criticised, but it is outside the71 scope of this project on remedies to consider whether some other test should be substituted as a matter of substantive law. However, examples can be given of alterations to the articles which have been set aside or upheld to illustrate how the principles operate. 2.35 In Allen v Gold Reefs of West Africa Ltd, the Court of Appeal held that the company72 could validly amend its articles so as to give itself a lien over fully-paid shares for other debts of the holder. This was so even though in practice this only adversely affected the position of those who sought to challenge the alteration, who were the executors of an insolvent member. This member had, at the date of his death (and before the alteration), become liable to the company in respect of calls on other partly-paid shares. However, the altered article was capable of applying to all fully-paid shares and was fair in principle, and the Court of Appeal (by a majority) therefore held that the alteration could not be said to have been passed in bad faith or other than for the benefit of the company as a whole. 2.36 In Sidebottom v Kershaw Leese & Co Ltd, the Court of Appeal upheld an alteration of73 the articles of the company which enabled the directors to require the transfer at full value of the shares of a shareholder competing with the company’s business. Lord Sterndale MR held that it was for the benefit of the company that it should not be obliged to have members who were competing with it in business, and who might be able to get knowledge from their membership which would enable them to compete better. The alteration would have been valid even if it was aimed at a particular74 shareholder.75 2.37 Sidebottom v Kershaw Leese & Co Ltd may be compared with the subsequent case of Dafen Tinplate Co Ltd v Llanelly Steel Co (1907) Ltd, in which an amendment to the76 articles to enable the majority shareholders to require any member (other than a named Ibid, at p 142. Moreover, the exclusion of the named shareholder was not shown to be for the77 benefit of the company as a whole. See also Brown v British Abrasive Wheel Co [1919] 1 Ch 290, which was explained in the case of Sidebottom v Kershaw Leese & Co Ltd. See North-West Transportation Co Ltd v Beatty (1887) 12 App Cas 589 (PC), at p 593.78 See generally Buckley on the Companies Acts (14th ed 1981) Vol 1 p 971.79 See the comments of Knox J in Smith v Croft (No 2) [1988] Ch 114, 186, discussed at para80 4.28 below and of Lord Greene MR in Greenhalgh v Arderne Cinemas [1946] 1 All ER 512, 513 discussed at paras 20.20-20.21 below. See also the comments of Lord Wilberforce and Lord Cross in Ebrahimi [1973] AC 360 at pp 381 and 386 on the applicability of this test to proceedings under s 122(1)(g) of the Insolvency Act 1986. [1976] 2 All ER 268. Foster J said at p 281 that the question was did the majority81 shareholder “... when voting for the resolutions, honestly believe that those resolutions, when passed would be for the benefit of the plaintiff.” Note the criticism of this approach in Gower’s Principles of Modern Company Law (5th ed 1992) p 603, which calls the decision “rather startling”. See also V Joffe, “Majority Rule Undermined?” (1977) 40 MLR 71. See, for example, N A Bastin, “The Enforcement of a Member’s Rights” [1977] JBL 17, 21-82 22, who suggests that a property right will be “... connected to the value and marketability of a share ...” or could be “... any right conferred by the articles which can be exercised and enjoyed by a shareholder without the concurrence of others”. He suggests that MacDougall v Gardiner can be explained in this way, as the right to demand a poll in that case “... was not a personal right or a right of property because the articles of the company provided for the taking of a poll only if demanded by five members”. He suggests that “... if the articles had provided for the taking of a poll if demanded by one member then the decision would have been different as the right would have become a right of property and therefore personal”. See also R R Drury, “The Relative Nature of a Shareholder’s Right to Enforce the Company Contract” [1986] CLJ 219, 238, who suggests that “... the existence of some proprietary interest weighed heavily with Jessel MR in Pender v Lushington”. 20 member) to transfer his shares was held to be invalid. This article would have applied whether or not the member was acting to the detriment of the company. Peterson J held that “... the power of compulsory acquisition by the majority of shares which the owner does not desire to sell is not lightly to be assumed whenever it pleases the majority to do so”.77 2.38 In general, the right of a shareholder to vote is regarded as a right of property which he is entitled to cast in his own interests. He is not bound to cast his vote in the78 company’s interests. However, the court will intervene if, for instance, the resolution deprives the minority shareholders of their share of the company’s assets. It is not79 clear whether the courts will apply the test used to assess the validity of resolutions amending the company’s articles to other types of resolution. In Clemens v Clemens80 Bros, however, Foster J assumed that the test could be applied to an ordinary81 resolution authorising the issue of shares. Identifying enforceable personal rights in the articles 2.39 It is clear that a member does not have a personal right to enforce all the provisions of the articles; where there are breaches of the articles which are ratifiable, he has no such right. Several writers have suggested criteria to identify such rights. It has been suggested, for example, that a member should be able to enforce rights of a proprietary nature. Ultimately, what constitutes a personal right must depend upon the terms of82 Note, however, that it is also possible to make rights given by the articles less vulnerable to6 alteration by creating a separate class of shares and attaching the rights to those. Such “class rights” may only be altered by three-quarters of the members of the class (s 125 of the Companies Act 1985) and there is provision for members to object (s 127). See paras 12.16- 12.17 below. Sections 4 and 9 of the Companies Act 1985.7 See paras 1.9 and 2.15 above.8 See para 2.9 above. Such a shareholder agreement might provide: “Each of the parties hereto9 ... undertakes with each of the others fully and promptly to observe and comply with the provisions of the Articles to the intent and effect that each and every provision thereof shall be enforceable by the parties hereto inter se and in whatever capacity” (emphasis added). See G Stedman & J Jones, Shareholders’ Agreements (2nd ed 1990) p 6. Note, however, the effect of Russell v Northern Bank Development Corpn Ltd [1992] 1 WLR 588, (on appeal to the House of Lords from the Court of Appeal in Northern Ireland) on parties to shareholder agreements. See paras 3.11-3.16 below. Re New British Iron Co, ex parte Beckwith [1898] 1 Ch 324, and see Bailey v Medical Defence10 Union (1995) 18 ACSR 521, which concerned the right of a member of a mutual insurance company to an indemnity on the terms contained in the company’s articles. 23 Advantages 3.4 A member can be given protection by a shareholder agreement in addition to that provided by the articles. For example, he may be given the right to require other members to acquire his shares in certain events. Unlike the statutory contract they are6 not subject to unilateral alteration by special resolution. The terms of such agreements7 can only be altered with the consent of all the parties thereto. Moreover, the ordinary remedies for breach of contract will be available for breach of a shareholder agreement. 3.5 If a shareholder agreement incorporates the provisions of an article, a member will be entitled to enforce that right in contract even though the article confers “outsider rights” which he could not enforce under the statutory contract created by section 148 of the Companies Act 1985. For example, a right of a director to receive remuneration9 on the basis set out in the articles will be enforceable in accordance with ordinary contract principles as a term of the contract for his appointment.10 Contents 3.6 A shareholder agreement may require shareholders to consult together before certain decisions are taken or to vote on resolutions of the company in general meeting in a particular way. If the company is a party it may agree to take or not to take certain action, or to consult the parties to the agreement before entering into certain transactions, for example, a secured loan or a contract for the sale of its business. A shareholder agreement may also give a member a right to receive certain information from the company. 3.7 A shareholder agreement may provide for arbitration and it may regulate events during the pre-incorporation period, whereas the company’s constitution only has contractual effect on incorporation. See G Stedman & J Jones, Shareholders’ Agreements (2nd ed 1990) p 54. See also A Marsden,11 “Does a Shareholders’ Agreement Require Filing with the Registrar of Companies?” (1994) 15 Co Law 19. This is the result of a pre-consolidation amendment recommended by the Law Commissions:12 see Amendment of the Companies Acts 1948-1983 (1983) Law Com No 126; Scot Law Com No 83; Cmnd 9114. See also the comments of Michael Wheeler QC (sitting as a Deputy Judge of the High Court) in Cane v Jones [1980] 1 WLR 1451, 1460. See, for example, Russell v Northern Bank Development Corpn Ltd [1992] 1 WLR 588, at paras13 3.11-3.16 below. [1994] 1 WLR 893.14 Ibid, at p 898. It is interesting to contrast this case with that of Re British Union for the15 Abolition of Vivisection [1995] 2 BCLC 1, where Rimer J, in the special circumstances of that case, held that directions could be given for a postal ballot on an application for an order to hold a meeting (under s 371 of the Companies Act 1985), even though, under the company’s articles, members had to vote in person. [1994] 1 WLR 893, 898.16 24 Disclosure of agreements 3.8 One of the recognised advantages of shareholder agreements is that, unlike the memorandum and articles, they are generally not open for public inspection. They are, therefore, useful tools where confidentiality is desired. However, such agreements11 need to be filed with the Registrar of Companies, pursuant to section 380(4)(c) of the Companies Act 1985, if they amount to an informal agreement between all the members to amend the articles.12 Enforceability 3.9 Shareholder agreements are commonly concluded between all the members inter se or between some of the members only. It is well established that agreements concluded between shareholders without the company as a party are valid and enforceable.13 3.10 A shareholder agreement may be enforced by injunction in the same way as any other contract. Moreover, the court will not exercise its power under section 371 of the Companies Act 1985 to give directions for a meeting of the company if those directions would conflict with an agreement entered into by all the members. Thus, in Harman v BML Group Ltd, where a shareholder agreement required the presence of a minority14 shareholder for meetings to be quorate, the Court of Appeal held that a direction could not be given for a meeting to be held with some other quorum requirement. Dillon LJ said: ... it is not right, in my view, to invoke section 371 to override class rights attached to a class of shares which have been deliberately — in this case by the shareholders’ agreement — imposed for the protection of the holders of those shares ... .15 He also observed that it was not for the court “... to make a new shareholders’ agreement between the parties and impose it on them”.16 [1992] 1 WLR 588.17 Section 121 of the Companies Act 1985.18 In so doing the House of Lords held that the agreement between the company and the19 shareholders which was void as being contrary to statute could be severed from the agreement between the shareholders inter se which was valid and enforceable. [1992] 1 WLR 588, 593.20 [1970] AC 1099. Their Lordships recognised that the clause was “... obviously designed to21 evade section 184(1) of the Companies Act 1948 ...” (now s 303 of the Companies Act 1985), which provided that a director is to be removable by an ordinary resolution notwithstanding anything to the contrary in the company’s articles. Ibid, at p 1105. E Ferran, “The Decision of the House of Lords in Russell v Northern Bank Development22 Corporation Ltd” [1994] CLJ 343, 345. 25 3.11 Prior to Russell v Northern Bank Development Corpn Ltd, the company was also17 frequently joined as a party. In this case, the shareholder agreement, to which the company was a party, purported to restrict the company’s statutory power to increase its share capital by ordinary resolution. Unanimous consent of the parties was18 required. The company gave notice of an extraordinary general meeting (“EGM”) to consider an ordinary resolution to increase its capital. A party to the shareholder agreement, who did not consent to this increase, sought an injunction restraining the other parties to the agreement from voting on the resolution. 3.12 The defendants argued that the agreement was void in its entirety, both as regards the company and as between the shareholders inter se, because it amounted to an unlawful and invalid fetter on the company’s statutory powers. Lord Jauncey (with whom the rest of the House of Lords agreed), held that the undertaking between the shareholders was enforceable insofar as it amounted merely to a private agreement as to the exercise by the shareholders of their respective voting rights. In so doing he found that “...19 shareholders may lawfully agree inter se to exercise their voting rights in a manner which, if it were dictated by the articles, and were thereby binding on the company would be unlawful”.20 3.13 This approach is consistent with Bushell v Faith, in which the House of Lords held21 that an article which gave a director weighted voting rights on any resolution to remove him was valid. 3.14 The significance of Russell v Northern Bank Development Corpn Ltd is that “... it puts beyond question that the shareholder’s freedom to contract in respect of voting rights is not constrained even in circumstances where the effect of a contract may be to prevent or fetter the exercise of a statutory power”.22 3.15 However, the undertaking by the company in a formal agreement, independent of its articles, not to exercise its statutory powers to alter its memorandum was “... as See Gray v Lewis (1873) 8 Ch App 1035, 1051, per Sir W M James LJ on the risk of multiple10 actions. See also Spokes v Grosvenor and West End Railway Terminus Hotel Co Ltd [1897] 2 QB 124, 126, per AL Smith LJ and at p 128, per Chitty LJ. Different procedures have been developed for personal actions by shareholders and for derivative actions to avoid this problem. See RSC, O 15, r 12A and paras 6.7-6.9 below. See n 8 above.11 See the court’s rationale for the fraud on the minority exception restated in Prudential12 Assurance Co Ltd v Newman Industries Ltd (No 2) at para 4.7 below. [1950] 2 All ER 1064, 1066-1069, per Jenkins LJ. Cases in which the rule in Foss v Harbottle13 would not apply had traditionally been divided into the following four categories, and often called “exceptions” to the rule: (i) Personal actions. (ii) Actions relating to ultra vires/illegal transactions. (iii) Actions relating to transactions which require a special majority. (iv) Actions relating to transactions which constitute a “fraud on the minority”. As is clear from Edwards v Halliwell, the only true exception to the rule is the fourth category. [1982] Ch 204.14 28 in relation to wrongs done to another could lead to multiple actions being brought against a single defendant in relation to a single wrong. As the company is, in law, a separate legal entity, it is the proper plaintiff where it has suffered injury, otherwise a defendant could face as many actions as there are shareholders.10 4.4 As mentioned above, the restrictions arising from these principles are referred to as11 the rule in Foss v Harbottle. Were such restrictions to amount to an absolute prohibition on derivative actions, they would allow the majority to prevent an action to remedy a wrong done to the company by or with their support. Hence the need to identify12 those cases where the rule will not apply. 4.5 We set out the statement by the Court of Appeal in Edwards v Halliwell as restated13 in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) of the rule in Foss v14 Harbottle: (1) The proper plaintiff in an action in respect of a wrong alleged to be done to a corporation is, prima facie, the corporation. (2) Where the alleged wrong is a transaction which might be made binding on the corporation and on all its members by a simple majority of the members, no individual member of the corporation is allowed to maintain an action in respect of that matter because, if the majority confirms the transaction, cadit quaestio [the question is at an end]; or, if the majority challenges the transaction, there is no valid reason why the company should not sue. (3) There is no room for the operation of the rule if the alleged wrong is ultra vires the corporation, because the majority of members cannot confirm the transaction. (4) There is also no room for the operation of the rule if the transaction complained of could be validly done or sanctioned only by a special resolution or the like, Ibid, at pp 210-211.15 [1982] Ch 204.16 29 because a simple majority cannot confirm a transaction which requires the concurrence of a greater majority. (5) There is an exception to the rule where what has been done amounts to fraud and the wrongdoers are themselves in control of the company.15 4.6 The basic approach of the rule in Foss v Harbottle is a sound one. An individual shareholder should only be able to bring a derivative action in an exceptional situation. He should not be allowed for instance to bring an action to complain about a procedural irregularity which is of no consequence, for example where the company issues notice of a general meeting without the authority of a duly constituted board meeting. If the company passes the resolution, the lack of authority is cured. If the resolution fails, that is the end of the matter in any event. However, there can be no justification for a company acting ultra vires once the matter has been drawn to its attention and accordingly in that situation an individual shareholder should have the right to bring a derivative action to prevent his investment and that of other shareholders being misapplied in this way. Similarly, there can be no doubt that a company should observe a requirement to proceed by a special resolution though no doubt again if the requirement was alterable and the company made it clear that it would first propose the appropriate resolutions to remove the requirement, the court would stay the action to see whether the change was made. Suppose, however, that the shareholder wishes to obtain recompense for the company’s benefit for a breach of duty by the directors. He can only enforce the company’s claim if the breach of duty was a “fraud” and the wrongdoers were “in control”. It is to that exception, commonly called “fraud on the minority”, that we now turn. In the remainder of this part we deal with the other branches of the rule. Fraud on the minority 4.7 After setting out the fraud on the minority exception to the rule in Foss v Harbottle, the Court of Appeal in Edwards v Halliwell explained why the exception is necessary. This explanation was set out as follows in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2):16 (5) There is an exception to the rule where what has been done amounts to fraud and the wrongdoers are themselves in control of the company. In this case the rule is relaxed in favour of the aggrieved minority, who are allowed to bring a minority shareholders’ action on behalf of themselves and all others. The reason for this is that, if they were denied that right, their grievance could never reach the court Ibid, at p 211. The suggestion in Edwards v Halliwell [1950] 2 All ER 1064, 1067 that the17 rule in Foss v Harbottle should be relaxed “where necessary in the interests of justice” was considered but rejected in Estmanco (Kilner House) Ltd v Greater London Council [1982] 1 WLR 2 and by the Court of Appeal (Vinelott J, [1981] Ch 257, had accepted this further exception at first instance) in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204 (although in this latter case the Court of Appeal did not hear full argument on this point). See paras 4.9-4.17 below.18 See Smith v Croft (No 2) [1988] Ch 114, and the discussion at para 4.18 below.19 Estmanco (Kilner House) Ltd v Greater London Council [1982] 1 WLR 2, 12, per Sir Robert20 Megarry V-C, discussing the judgment of Templeman J in Daniels v Daniels [1978] Ch 406. See n 26 and n 27 below. See Burland v Earle [1902] AC 83 (PC), at p 93, per Lord Davey.21 See Atwool v Merryweather (1867) LR 5 Eq 464n where the plaintiff claimed rescission of a22 contract entered into by directors and the return of money and shares paid to them in consideration for the sale, claiming that they had made a concealed profit. The court held that the directors had acted fraudulently and upheld the plaintiff’s claim. See, for example, Cook v Deeks [1916] 1 AC 554 (PC). This question is discussed further at23 paras 5.6-5.16 below. See Menier v Hooper’s Telegraph Works (1874) 9 Ch App 350 where the plaintiff minority24 shareholder in E Ltd claimed that the defendant company, the majority shareholder in E Ltd, had used its votes to procure the diversion of E Ltd’s business to a third company. James LJ referred to Atwool v Merryweather (1867) LR 5 Eq 464n, and upheld the plaintiff’s claim. See also Estmanco (Kilner House) Ltd v Greater London Council [1982] 1 WLR 2. A purported ratification of wrongful acts might itself, in some circumstances, constitute a25 fraud on the minority. See para 5.7 below. 30 because the wrongdoers themselves, being in control, would not allow the company to sue.17 4.8 We will now consider what constitutes “fraud” and “control”. We will then examine18 the circumstances in which the courts have held that if an “independent organ” of the company does not wish the action to proceed, an individual shareholder may be prevented from pursuing his action even though it is within the exception.19 Fraud 4.9 “Fraud” in this context means “... fraud in the wider equitable sense of that term”.20 Essentially, the term encompasses situations such as “... where the majority are endeavouring directly or indirectly to appropriate to themselves money, property or advantages which belong to the company or in which other shareholders are entitled to participate ...”. Therefore, attempts by the majority to sell worthless assets to the21 company, to divert business from the company to themselves in breach of fiduciary22 duty, or to compromise litigation against bodies in which the majority are interested23 on terms prejudicial to the company have all been held to amount to “fraud” in this24 context, entitling minority shareholders to bring derivative actions.25 indirectly exercise a decisive influence over the result”. (1875) LR 20 Eq 474.38 Ibid, at p 482. Ratification as a possible manifestation of wrongdoer control and the effect of39 ratification on derivative actions is discussed at paras 5.2-5.17 below. [1982] Ch 204.40 Ibid, at p 219 (emphasis added). It is far from clear what degree of “influence” the wrongdoer41 must have over a particular shareholder for the shareholder’s votes to be under the wrongdoer’s control. Similarly there is little guidance as to what conduct by a shareholder would be sufficient to establish “apathy” in this context. See also the first instance decision of Vinelott J, [1981] Ch 257, which provides a useful discussion of these issues. [1982] Ch 204.42 Ibid, at pp 221-222.43 33 4.15 In Russell v Wakefield Waterworks Co, Jessel MR stated:38 It is not necessary that the corporation should absolutely refuse by vote at the general meeting, if it can be shewn either that the wrong-doer had command of the majority of the votes, so that it would be absurd to call the meeting; or if it can be shewn that there has been a general meeting substantially approving of what has been done; or if it can be shewn from the acts of the corporation as a corporation, distinguished from the mere acts of the directors of it, that they have approved of what has been done, and have allowed a long time to elapse without interfering, so that they do not intend and are not willing to sue. In all those cases the same doctrine applies, and the individual corporator may maintain the suit.39 4.16 In Prudential Assurance Co Ltd v Newman Industries Ltd (No 2), the Court of Appeal40 recognised that the term “control” “... embraces a broad spectrum extending from an overall absolute majority of votes at one end, to a majority of votes at the other end made up of those likely to be cast by the delinquent himself plus those voting with him as a result of influence or apathy”. However, this still means that control of over 50 per cent of the41 votes must be shown. When fraud and control must be shown 4.17 In Prudential Assurance Co Ltd v Newman Industries Ltd (No 2), the Court of Appeal42 held: We do not think it right that the right to bring a derivative action should be decided as a preliminary issue upon the hypothesis that all the allegations in the statement of claim of “fraud” and “control” are facts, as they would be on the trial of a preliminary point of law. In our view, whatever may be the properly defined boundaries of the exception to the rule, the plaintiff ought at least to be required before proceeding with his action to establish a prima facie case (i) that the company is entitled to the relief claimed, and (ii) that the action falls within the proper boundaries to the rule in Foss v Harbottle.43 See paras 6.7-6.9 below and see Appendix C.44 See paras 4.9-4.16 above.45 See generally, paras 6.6-6.9 below.46 [1988] Ch 114. 47 Ibid, at p 185.48 See paras 4.28-4.29 below.49 See also the first instance decision in Prudential Assurance Co Ltd v Newman Industries Ltd (No50 2) [1981] Ch 257 and Taylor v National Union of Mineworkers (Derbyshire Area) [1985] BCLC 237. 34 This led in due course to the introduction of RSC, O 15, r 12A, which now requires44 a preliminary application in all derivative actions. However, it will be appreciated from the explanation of the law given above, that the factual difficulty of proving fraud and45 control will often make the preliminary application extremely complicated and lengthy. Moreover, if, as is almost inevitable, the application is opposed the defendants are likely to introduce a number of other issues said to be relevant to the question whether the derivative action should proceed. We return to these points below.46 “Independent organ” does not wish the action to proceed 4.18 In Smith v Croft (No 2), Knox J said “[u]ltimately the question which has to be47 answered in order to determine whether the rule in Foss v Harbottle applies to prevent a minority shareholder seeking relief as plaintiff for the benefit of the company is ‘Is the plaintiff being improperly prevented from bringing these proceedings on behalf of the company?’” He held that, if an “independent organ” of the company considered that48 such an action would not be in the interests of the company, the action was properly prevented. What constitutes an independent organ is discussed later. In many cases,49 there may not, as a matter of fact, be such an organ capable of making this decision.50 [1982] Ch 204.51 Ibid, at p 210.52 Ashbury Railway Carriage and Iron Co Ltd v Riche (1875) LR 7 HL 653. Acts which are ultra53 vires the company should be distinguished from acts which are outside the powers of the directors (see paras 5.4-5.5 below and see the dicta of Slade and Browne-Wilkinson LJJ in Rolled Steel Products (Holdings) Ltd v British Steel Corpn [1986] Ch 246 at pp 297 and 302- 304 respectively. Note also the discussion on challenging resolutions at paras 4.30-4.34 below). The standard practice is to include a long list of objects and powers in the memorandum54 covering every conceivable business activity. Under Companies Act 1985, s 3A, it is now possible for the memorandum to state that the object of the company is to carry on business as a general commercial company. This is then defined as meaning that the object of the company is to carry on any trade or business whatsoever, and the company has power to do all such things as are incidental or conducive to the carrying on of any trade or business by it. Because of doubts as to the precise effect of this provision, it does not appear to be being used as frequently as originally envisaged; see NJM Grier, “The Companies Act 1989 — a Curate’s Egg?” (1995) 16 Co Law 3, 5. [1988] Ch 114.55 35 Ultra vires transactions 4.19 The third part of the Edwards v Halliwell statement of the rule in Foss v Harbottle, was restated in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) as follows:51 (3) There is no room for the operation of the rule if the alleged wrong is ultra vires the corporation, because the majority of members cannot confirm the transaction.52 4.20 We next briefly examine the meaning of the term ultra vires and whether ultra vires acts can be ratified. Is the transaction ultra vires? 4.21 Ultra vires acts include acts which are beyond the capacity of the company as prescribed by its memorandum. The possibility of a transaction being ultra vires is53 greatly reduced now because of modern drafting techniques. Ultra vires acts also54 include acts which are beyond the powers given to the company by the Companies Acts, as where a company repays its capital in a manner not authorised by the Companies Acts. Such a repayment would be an unlawful reduction of capital and ultra vires. However, where an act which a company commits is illegal it is not also ultra vires unless it is also beyond the capacity it is given by the Companies Acts. In Smith v Croft (No 2), the illegal act was conceded to be ultra vires because it involved55 the giving of financial assistance for the purpose of acquiring shares in the company in a manner which the Companies Act 1981 did not allow. The description of the rule in Foss v Harbottle that is given above applies to illegal acts which are ultra vires in this sense. Where the company proposes to do some other illegal act, a member may bring proceedings to restrain the company from so acting, but it is doubtful whether he can bring proceedings to recover damages for any loss which the company may suffer as a result without showing a fraud on the minority. the right of the minority to sue under that exception should be taken away from them merely because the majority of the company reasonably believe it to be in the best interests of the company that this should be done. This is particularly so if the exception from the rule falls under the rubric of ‘fraud on a minority’”. Ibid, at p 12. [1988] Ch 114, 186.69 Ibid, at p 186.70 Ibid, at p 186.71 See D D Prentice, “Shareholder Actions: the Rule in Foss v Harbottle” (1988) 104 LQR 341,72 345-6. [1988] Ch 114, 185.73 For further consideration of how the views of an independent organ should affect a74 shareholder’s ability to bring a derivative action, see paras 16.35-16.37 below. As restated in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204,75 210. 38 on the facts before him, he thought that it was possible to give a more specific test and held that “... votes should be disregarded if, but only if, the court is satisfied either that the vote or its equivalent is actually cast with a view to supporting the defendants rather than securing benefit to the company, or that the situation of the person whose vote is considered is such that there is a substantial risk of that happening”. He70 continued, “[t]he court should not substitute its own opinion but can, and in my view should, assess whether the decision making process is vitiated by being or being likely to be directed to an improper purpose”.71 4.29 It appears that the appropriate independent organ need not be a group of shareholders and may even be the directors or a committee of the directors. Knox J suggested that72 “[t]he appropriate independent organ will vary according to the constitution of the company concerned and the identity of the defendants who will in most cases be disqualified from participating by voting in expressing the corporate will”. If the73 independent organ is a group of shareholders, they are not required to hold any particular percentage of shares, and so the percentage may be a small one.74 Breaches of special resolution procedures 4.30 We turn now to the fourth part of the Edwards v Halliwell definition of the rule in Foss v Harbottle: (4) There is also no room for the operation of the rule if the transaction complained of could be validly done or sanctioned only by a special resolution or the like, because a simple majority cannot confirm a transaction which requires the concurrence of a greater majority.75 4.31 Shareholders are generally able to pursue derivative actions where a special majority procedure has not been followed as the majority rule principle cannot apply; otherwise the majority would have the power “... to do de facto by ordinary resolution that which Edwards v Halliwell [1950] 2 All ER 1064, 1067, per Jenkins LJ. The members of a trade76 union had obtained a declaration that a union decision increasing union dues was invalid as the requirement that a two thirds majority of members should agree had not been observed. See also Cotter v National Union of Seamen [1929] 2 Ch 58, 69-70, per Romer J, and Baillie v Oriental Telephone and Electric Co Ltd [1915] 1 Ch 503, where Lord Cozens-Hardy MR was “not prepared for one moment” to assent to the proposition “... that the company by an ordinary resolution can indirectly do that which ... can only be done by a special resolution”. Ibid, at p 515. It is generally assumed that a member can sue where there has been a breach of a special77 resolution, notwithstanding proof that those who oppose him are sufficiently numerous to pass the special resolution which is needed. See R J Smith, “Minority Shareholders and Corporate Irregularities” (1978) 41 MLR 147, who suggests, however, that “... an irregularity in a special resolution should be regarded as being ratifiable by a three-quarters majority ...” and that the concept “... that the irregularity must be ratifiable by straight majority seems linked to the use of the corporate name in litigation by the majority and the need to avoid a straight majority doing what a special majority is required for”. Ibid, at p 160. This point may be arguable in principle but it has not been applied by the courts. See Edwards v Halliwell [1950] 2 All ER 1064. See also provisions in the Companies Act78 1985 which specify special resolution procedures; eg s 5 (amendments to the company’s memorandum; see para 12.11 below) and s 157 (financial assistance for the purchase of the company’s shares). Special resolutions amending the company’s articles which are not passed bona fide for the benefit of the company as a whole may themselves be challenged by members bringing personal actions. See paras 2.31-2.38 above. Eg Normandy v Ind, Coope & Co Ltd [1908] 1 Ch 84.79 See paras 2.23-2.27 above.80 [1982] Ch 204.81 [1988] Ch 114.82 39 according to its own regulations could only be done by special resolution”. To this76 extent, the fourth limb of the rule is the natural corollary to the second.77 4.32 Members can, therefore, bring derivative actions to restrain breaches of special majority procedures and to prevent the company from acting on resolutions passed as a result of such breaches. They can also apply to the court to restrain the company from acting on an ordinary resolution if it should have been passed as a special or an extraordinary resolution.78 4.33 As we have seen, however, in some cases, the courts have held that acts done in79 breach of the articles can be ratified by ordinary resolution, but, in other cases, a breach of the articles may involve a breach of a shareholder’s personal rights and found a personal action.80 4.34 In Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) the court held that81 shareholders would not be permitted to bring personal actions for damages for loss in the value of their shares to avoid the restrictions of the rule in Foss v Harbottle. In Smith v Croft (No 2), the court held that an action to recover damages for an ultra vires act82 was a derivative action. Accordingly, recent cases have had the effect of reducing the possibility of using the personal action as a means of avoiding the restrictions of a derivative action. (1843) 2 Hare 461; 67 ER 189.83 [1950] 2 All ER 1064, 1066-1067. These exceptions were restated with approval by the84 Court of Appeal in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204, 210-211. Smith v Croft (No 2) [1988] Ch 114, 185.85 Note Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204, in which a86 threshold test of whenever the justice of the case required was rejected by the Court of Appeal as impractical. See also n 17 above. A claim for negligence is an example of this restriction. See para 4.11 above.87 40 Conclusion 4.35 The legal rules that determine whether or not a member of a company may bring an action on its behalf (a derivative action) are known as the rule in Foss v Harbottle.83 This rule has been in a continuous state of development since the nineteenth century. It was authoritatively stated by Jenkins LJ in Edwards v Halliwell. Like many rules84 developed by the courts, the rules have some capacity to continue to develop. Were the courts to restate the rule in Foss v Harbottle today there would, in addition to the five principles identified by Jenkins LJ, have to be further rules stating that an action by a minority shareholder to recover damages for an ultra vires act was within the rule (notwithstanding that an action by a minority shareholder to restrain an ultra vires act was a personal action). It would also have to be stated that if an independent organ of the company decided that the action should not proceed, the minority shareholder would be unable to maintain the action. The rule in Foss v Harbottle represents the courts’ view that as a matter of policy the circumstances in which a shareholder can bring an action to enforce a cause of action vested in the company should be strictly limited; in the words of Knox J, the question is ultimately whether the plaintiff is being improperly prevented from bringing the action. If the answer to that question is yes,85 he is permitted to bring a derivative action. However, the rule in Foss v Harbottle is not stated in terms of this underlying principle; rather, because the rule has been formulated as one which permits the derivative action only in set circumstances, and86 this formulation has been approved by the Court of Appeal, the possibility that the rule could develop in a principled way to cover new situations is restricted. Moreover, to87 obtain a proper understanding of the rule, one needs to examine numerous reported cases decided over a period of 150 years, thus the law in this respect is virtually inaccessible, save to lawyers specialising in the field. We have not considered the situation where the effect of the director’s action is a fraud on14 creditors or makes the company less than fully solvent (cf Rolled Steel Products (Holdings) Ltd v British Steel Corpn [1986] Ch 246, 296, per Slade LJ). We have assumed here that the director’s action was intra vires. See para 4.6 above. The reason why shareholders are allowed to bring an action in such15 circumstances was set out in the fifth limb of the Edwards v Halliwell statement of the rule in Foss v Harbottle: “The reason for this is that, if they were denied that right, their grievance could never reach the court because the wrongdoers themselves, being in control, would not allow the company to sue”. [1950] 2 All ER 1064, 1067, per Jenkins LJ. See, for example, Cook v Deeks [1916] 1 AC 554 (PC), at para 5.8 below.16 In some circumstances, the ratifying resolution might itself constitute a fraud on the minority.17 [1916] 1 AC 554 (PC).18 Including Menier v Hooper’s Telegraph Works (1874) 9 Ch App 350; see para 4.9, n 24 above.19 Cook v Deeks [1916] 1 AC 554 (PC), at p 564.20 (1887) 12 App Cas 589 (PC).21 43 purpose, have been ratified. We consider the effect of ratification on a derivative action.14 5.7 As we have already discussed, shareholders wishing to bring a derivative action under this head must be able to show both fraud and wrongdoer control. Where they can15 do so, purported ratification of the acts in question will be a manifestation of wrongdoer control and will not prevent a minority shareholder from bringing a16 derivative action.17 5.8 A classic example of fraud on the minority was Cook v Deeks. The directors had18 breached their fiduciary duties by diverting business which belonged to the company for their own benefit. The Privy Council held that such a transaction could not be ratified by a resolution which was carried because the wrongdoing directors held the majority of the votes. Lord Buckmaster referred to earlier authorities on fraud on the minority and commented, “... even supposing it be not ultra vires of a company to19 make a present to its directors, it appears quite certain that directors holding a majority of votes would not be permitted to make a present to themselves. This would be to allow a majority to oppress the minority”.20 5.9 In North-West Transportation Co Ltd v Beatty, one of the directors was interested in a21 contract with the company for the sale to it of a ship. The sale was at a proper price and the company required the ship for the purposes of its business. The transaction was approved by the shareholders, but the directors held a majority of the votes. The Privy Council held that any shareholder could vote at a general meeting as he thought fit. Ratification rendered the transaction binding on the company. The question of fraud on the minority did not arise and the minority shareholder’s action to set the sale aside failed. Ibid, at p 593. However, such acts could be ratified, “... provided such affirmance or adoption22 is not brought about by unfair or improper means, and is not illegal or fraudulent or oppressive towards those shareholders who oppose it”. Ibid, at p 594. [1967] 2 AC 134n.23 Ibid, at p 150. See also n 26 below.24 [1967] 2 AC 134n.25 [1916] 1 AC 554 (PC). Cook v Deeks was not referred to in the judgments in Regal (Hastings)26 Ltd v Gulliver. Gower’s Principles of Modern Company Law (5th ed 1992) at p 595 concludes that “[a] satisfactory answer, consistent with common sense and with the decided cases is difficult (and perhaps impossible) to provide”. See also L S Sealy, “The Director as Trustee” [1967] CLJ 83, 102 and also L S Sealy, Cases and Materials in Company Law (5th ed 1992) p 269. 44 5.10 The Privy Council held that the director whose interests were at stake was entitled to vote on the ratifying resolution because with regard to “... any question with which the company is legally competent to deal ... every shareholder has a perfect right to vote upon any such question, although he may have a personal interest in the subject matter opposed to, or different from, the general or particular interest of the company”.22 5.11 In Regal (Hastings) Ltd v Gulliver, the directors took shares in a subsidiary company23 when the plaintiff holding company could not afford to take them up. The directors made a profit when both the holding company and the subsidiary were sold to a third party purchaser and they were held liable to account to the plaintiff holding company for that profit on the ground that they were in a fiduciary relationship with the company and had made the profit solely because of their position as its directors and in the course of carrying out their duties as such. Lord Russell suggested, however, that they could have protected themselves “... by a resolution (either antecedent or subsequent) of the Regal shareholders in general meeting”.24 5.12 Academic writers have questioned why ratification should have been considered effective in Regal (Hastings) Ltd v Gulliver but not in Cooks v Deeks. However, there25 26 are many points of distinction between the two cases, which may explain Lord Russell’s statement. Regal (Hastings) Ltd v Gulliver was not, like Cook v Deeks, a minority shareholder’s action. It was not a case of fraud; the directors in the Regal case had acted in good faith intending to benefit the company. There is no suggestion that they controlled a majority of the votes in general meeting. They were held liable because of the strict rule of substantive law that makes a fiduciary liable to account for a secret profit that he receives by reason of his fiduciary relationship. Regal (Hastings) Ltd v Gulliver was thus not a case where a minority shareholder could have brought an action on behalf of his company under the rule in Foss v Harbottle. But it follows from that case that, had he been able to do so, the action could not have been maintained if the company had in general meeting then passed a resolution ratifying the breach of fiduciary duty. There is nothing surprising in this result since it would be consistent with majority rule. (1978) 52 ALJR 399 (PC).27 See Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134n.28 See also dicta in Bamford v Bamford [1970] Ch 212.29 The Privy Council in Cook v Deeks distinguished North-West Transportation Co Ltd v Beatty on30 the grounds that the asset in that case on which the director had made a profit was his own rather than the company’s (see [1916] 1 AC 554 (PC), 563-564). However, it is doubtful whether this point is enough in itself to make the transaction ratifiable. [1967] Ch 254.31 [1970] Ch 212.32 See Re Sherbourne Park Residents Co Ltd [1987] BCLC 82, where Hoffmann J appeared to33 suggest that only a personal action could lie in such situations. He held that “[a]lthough the alleged breach of fiduciary duty by the board is in theory a breach of its duty to the company, the wrong to the company is not the substance of the complaint. The company is not particularly concerned with who its shareholders are. The true basis of the action is an alleged infringement of the petitioner’s individual rights as a shareholder ... An abuse of these powers 45 5.13 In Queensland Mines v Hudson, the Privy Council considered the case of a managing27 director who, by reason of his position as such, was able to secure and exploit for himself a mining exploration licence. The company itself was not in a position to do this and its board, on which representatives of its two shareholders sat, had, following28 full disclosure of the nature of the transaction, approved the defendant’s actions. The29 Privy Council held that the director was not liable to account for such benefits to the plaintiff company. 5.14 North-West Transportation Ltd v Beatty, Regal (Hastings) Ltd v Gulliver and Queensland Mines v Hudson are distinguishable from Cook v Deeks. In the first three cases, a reasonable shareholder could consider that the terms were beneficial to the company. In Cook v Deeks, however, the ratification procured by the directors involved a gift by the company to the directors. In Regal (Hastings) Ltd v Gulliver and Queensland Mines30 v Hudson, the company could not itself benefit from the transaction. In Queensland Mines v Hudson, the director made full disclosure of the nature of the transaction and obtained approval from the company. 5.15 In Hogg v Cramphorn, the directors had used their powers to issue shares for the31 purpose of forestalling a takeover bid. A minority shareholder brought a derivative action to have the issue set aside. The exercise of power for this purpose is a breach of fiduciary duty, even if the directors believe it to be in the interests of the company. In Bamford v Bamford, there was an agreed point of law as to whether ratification in32 similar circumstances would be effective. In both cases the court held that the allotment could be cured by ratification. In both Hogg v Cramphorn and Bamford v Bamford, ratification defeated the actions, but the votes attached to the “tainted” shares were not exercised. 5.16 In Hogg v Cramphorn, the court also held that a minority shareholder could bring a derivative action. (On the facts of that case the share issue was part of a scheme33 See paras 6.2-6.5 below.1 See para 6.6 below.2 See paras 6.7-6.9 below.3 See paras 6.10-6.15 below.4 In Spokes v Grosvenor and West End Railway Terminus Hotel Co Ltd [1897] 2 QB 124, 128, the5 court stressed that, in the case of derivative actions, “... what is recovered cannot be paid to the plaintiff representing the minority, but must go into the coffers of the company”. In Scottish procedure there has never been this distinction between “personal actions” and6 “representative actions”. Virtually all actions have been raised by the individual shareholder without reference to others with the same rights. See A Paterson, “The Aggrieved Minority and Scottish Law” (1981) 2 Co Law 155 for all reported Scottish cases; the exceptional case, in which the shareholder raised the action “... on behalf of himself and all others (sic) shareholders ...” is Lee v Crawford (1890) 17 R 1094. A judgment in an action by one shareholder would, however, be binding in practice in relation to others with the same rights. We understand that the Scottish procedure has caused no practical difficulties. See RSC, O 15, r 12. See paras 6.7-6.9 below and Appendix C for the specific procedural7 rules introduced for derivative actions. 48 PART 6 PROCEDURE AND COSTS IN RESPECT OF ACTIONS ON BEHALF OF THE COMPANY Introduction 6.1 In this part we look at a number of procedural and costs considerations in respect of actions on behalf of the company. First, we compare derivative actions with a number of other types of action which a shareholder may bring; next, we consider the1 requirement that a member’s standing to bring a derivative action must be determined as a preliminary issue; we then examine recent amendments to the procedure relating2 to derivative actions introduced by RSC, O 15, r 12A; finally we consider the position3 on costs.4 Types of action 6.2 There are three types of action that shareholders may bring: personal actions, representative actions and derivative actions. 6.3 Personal actions are actions by individuals seeking to enforce their personal rights. Plaintiffs in such actions seeking damages will, if they are successful, receive individual benefit from the action. In derivative actions it is the company itself which receives the benefit.5 6.4 Representative actions are proceedings in which a plaintiff is permitted to bring a personal claim on behalf of himself and other persons with the same interest. Specific6 procedural rules have evolved to deal with such actions.7 A relatively new term for what was traditionally called a “minority shareholder’s action”; see8 Jaybird Group Ltd v Greenwood [1986] BCLC 319, 320, per Michael Wheeler QC (sitting as a Deputy Judge of the High Court). The procedure set out in paras 6.5-6.9 below does not apply to an action before the Scottish courts. No special procedural rules apply, and the right of an individual shareholder to bring an action before the Scottish courts may be decided as a preliminary issue (see Orr v Glasgow etc Railway Co (1860) 3 Macq 799; Lee v Crawford (1890) 17 R 1094) or at the trial of the action (see Brown v Stewart (1898) 1 F 316; Hannay v Muir (1899) 1 F 306). See Re Sherbourne Park Residents Co Ltd [1987] BCLC 82. Also see Estmanco (Kilner House)9 Ltd v Greater London Council [1982] 1 WLR 2, 10, per Megarry V-C: “‘Derivative action’, I may say, is the convenient name to apply to an action by a member of a company who sues on behalf of the company to enforce rights derived from that company”. According to Lord Denning MR, derivative actions were first accepted by the courts as a method of avoiding the circuitous procedure involved in requiring minority shareholders to obtain leave to start a corporate action in the name of the company where the people who committed the wrong against the company were its directors. See Wallersteiner v Moir (No 2) [1975] QB 373, 390. See paras 6.7-6.9 below.10 In Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204, the plaintiff11 brought both personal and derivative claims in the same proceedings. This problem would be made worse were the view expressed by Lord Denning MR (that derivative actions need not be brought in “representative” form; see Wallersteiner v Moir (No 2) [1975] QB 373, 391) to be correct. For further criticism of the procedural aspects of the rule in Foss v Harbottle, see L S Sealy, “Problems of Standing, Pleading and Proof in Corporate Litigation” in Company Law in Change, Current Legal Problems (1987) p 1. [1982] Ch 204.12 Ibid, at p 222; ie unlike strike out applications and trials on a preliminary point of law, the13 court will not decide this issue “... upon the hypothesis that all the allegations in the statement of claim of ‘fraud’ and ‘control’ are facts”. Ibid, at p 221. Ibid, at pp 221-222. It would appear that usually such a hearing will not be by way of oral14 evidence. 49 6.5 Derivative actions are actions brought by an individual shareholder which seek redress8 for a wrong done to the company. The title to the proceedings will state that the9 plaintiff sues on behalf of himself and all other shareholders in the company, other than the defendants. Because the plaintiff in a derivative action will be suing in respect of a wrong done to the company, the company must also be named as a defendant to the action. Until recently, there were no specific procedural rules governing derivative actions and new procedural rules have not changed the basic form of such10 proceedings. It is not always clear simply from the title to the proceedings whether the shareholder is bringing a derivative action or is seeking to enforce personal rights common to himself and a group of other shareholders.11 Determining standing as a preliminary issue 6.6 It has been clear since the Court of Appeal’s ruling in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2), that minority shareholders must “... establish a prima12 facie case (i) that the company is entitled to the relief claimed, and (ii) that the action falls within the proper boundaries of the exception to the rule in Foss v Harbottle”.13 The Court of Appeal no doubt envisaged that the determination of this preliminary issue should involve a relatively short hearing. However, the hearing of Smith v Croft14 [1988] Ch 114.15 In 1981, Trusthouse Forte plc (“THF”) made an unsuccessful bid to acquire control of the16 Savoy Hotel plc (“Savoy”). Savoy’s share capital consisted of “A” shares and “B” shares. These shares carried the same rights except with respect to voting. On a poll the “B” shares were entitled to 48.55% of the votes even though they represented only 2.3% of the equity. (See Re Savoy Hotel Ltd [1981] Ch 351). Following THF’s bid, THF held 69% of the “A” shares but only 42% of the votes. “B” shares conferring some 5.77% of the votes capable of being cast on a poll were held by a Swiss foundation. In 1987, THF began a derivative action alleging that the then directors acted in breach of duty in allotting and issuing the shares registered in the name of the foundation. The circumstances in which the shares had been issued were complex and arose out of a transaction in 1970. Savoy applied to the court on a preliminary issue to determine whether or not THF could bring the action under the rule in Foss v Harbottle. Savoy contended that the action should be stayed on the grounds that THF was not entitled to bring the action on behalf of other shareholders. Lengthy affidavits were filed on both sides. At a late stage, pleadings were ordered. The preliminary stages of the application for a stay were heard by a Master in Chambers, as is usual in Chancery actions. In May 1988, Savoy convened a meeting of its shareholders to ratify the shareholding of the17 Swiss foundation and to authorise the discontinuance of the action. Savoy, acting by a litigation committee of the board of directors, issued a circular in which it was stated that if THF succeeded in the action it could, by purchases in the market, (and within the limits permitted by the Takeover Code), increase its percentage of the votes to 49% in little over a year, and that this would be likely to give THF effective control without having to make an offer for the remaining shares. The financial benefits to Savoy of cancelling the foundation shares were small, and the costs of defending the action were considerable. The circular further stated that THF’s predominant purpose in bringing the action was to enhance its ability to gain control of Savoy more cheaply than would otherwise be possible. This resolution was passed. THF continued to contend that it was entitled to bring its action. Savoy’s application had not yet been heard by the court when in November 1989, Savoy and THF came to an arrangement to end the litigation on terms that THF should not acquire any further shares in Savoy for five years, Savoy should not issue any further shares without the approval of THF for the same period and that THF should have two representatives on the board of Savoy. This arrangement was conditional on approval by the Savoy shareholders. This approval was given and the litigation was then brought to an end. See Appendix C.18 There is no equivalent provision in the RSC in Northern Ireland.19 See SI 1994 No 1975. Before it was introduced, there was doubt as to the correct procedure20 for establishing whether the action fell within the exceptions to the rule in Foss v Harbottle; see Smith v Croft [1988] Ch 114, 190, per Knox J. Within 21 days of service of the statement of claim or, if later, of service of the first notice of21 intention to defend (see RSC, O 15, r 12A(4) & (5)). See RSC, O 15, r 12A(2).22 50 (No 2), lasted 18 days. In that case complicated questions of law arose. Difficult15 questions of fact can also arise at this stage as the case of Trusthouse Forte plc v The Savoy Hotel plc illustrates. This case did not in the end come to trial, and the events16 which led to the termination of the litigation are of interest.17 RSC, O 15, r 12A18 6.7 A new procedural rule (RSC, O 15, r 12A) has now been introduced which19 specifically deals with derivative actions. This rule came into force on 1 September 1994 and requires the plaintiff minority shareholder to apply for leave to continue20 21 with his derivative action if the defendant has given notice of intention to defend.22 Failure to make such an application entitles the defendant to apply for the action to be [1975] QB 373.38 Which came into force on 1 September 1994.39 [1986] 1 WLR 580.40 Ibid, at pp 597-598, per Walton J. Cf Jaybird Group Ltd v Greenwood [1986] BCLC 319, 327-41 8, per Michael Wheeler QC (sitting as a Deputy Judge of the High Court). Even if an indemnity is given, the order will normally be limited to the costs of taking specific steps in the conduct of proceedings and will not extend to all the steps up to and including trial: McDonald v Horn [1995] 1 All ER 961, 975, per Hoffmann LJ. [1975] QB 373.42 Provided the agreement had received “... the permission, first of the Council of the Law43 Society and next of the courts”. Ibid, at p 396. Ibid, at p 403, per Buckley LJ, and at pp 408-409, per Scarman LJ.44 Contingency fees are also prohibited under Scots law. The Courts and Legal Services Act45 1990 does not apply to Scotland. The broad equivalent is s 61A(3) of the Solicitors (Scotland) Act 1980 (added in 1990) and r 42.17 of the Court of Session Rules 1994. The 53 the court came to deal with costs at the end of the trial, he would be treated as between himself and the company as having acted reasonably. The court would thus be likely to order the company to reimburse him for the costs he had incurred and to indemnify him against costs which he was ordered to pay any other party. The court may also at an earlier stage make an order in respect of costs to be incurred after the date of the order and such an order was made in Wallersteiner v Moir (No 2).38 6.13 RSC, O 15, r 12A(13) now provides that:39 The plaintiff may include in an application under paragraph (2) an application for an indemnity out of the assets of the company in respect of costs incurred or to be incurred in the action and the Court may grant such indemnity upon such terms as may in the circumstances be appropriate. 6.14 In Smith v Croft, Walton J held that a shareholder’s ability to finance the action40 himself will be relevant to the question of whether the court will make such a costs order. Walton J also said that, if an order was made, a percentage of the costs should still be paid by the shareholder, even if he was impecunious; this requirement would be a financial spur to ensure that the plaintiff proceeded diligently with the action.41 Conditional fees 6.15 In Wallersteiner v Moir (No 2), Lord Denning MR was prepared to agree, in principle,42 that contingency fees could be used as a mechanism to fund derivative actions. The43 majority of the Court of Appeal disagreed with this view, however. Buckley and Scarman LJJ took the view that the court had neither the power nor good reason (given the jurisdiction to make indemnity orders) to sanction a contingency fee agreement.44 Section 58 of the Courts and Legal Services Act 1990 provides for the introduction, in limited circumstances, of “conditional fee agreements” but the orders made so far by the Lord Chancellor under section 58 do not cover derivative actions.45 Court and Legal Services Act 1990 also does not apply in Northern Ireland. 54 Sections 459-461 and their statutory predecessors apply equally to companies registered in1 Scotland. The substantive law, but not the procedural details, are therefore the same as shown in the English cases. The only case under s 210 of the Companies Act 1948 to go to the House of Lords, Scottish Co-operative Wholesale Society Ltd v Meyer [1959] AC 324 (“SCWS v Meyer”) was, in fact, a Scottish case; the Scottish citation is Meyer v Scottish Co- operative Wholesale Society 1958 SC(HL) 40. The equivalent Northern Ireland provisions are contained in arts 452-454 of the Companies (Northern Ireland) Order 1986. See further at para 9.34 below. 2 See further at para 9.40 below. 3 See further at para 9.35 below. 4 See further at paras 9.36-9.38 below.5 See further at paras 9.41-9.43 below.6 Eg misappropriation of corporate assets. See also the recent decision in Lowe v Fahey [1996]7 1 BCLC 262. Eg non payment of a declared dividend.8 See further below in Part 10 for discussion as to the range of remedies available.9 Section 461(1).10 55 SECTION C UNFAIR PREJUDICE REMEDY PART 7 INTRODUCTION AND HISTORY OF SECTIONS 459-461 OF THE COMPANIES ACT 1985 Introduction1 7.1 Sections 459-461 of the Companies Act 1985 provide a remedy for a shareholder where a company’s affairs are being conducted in a manner which is unfairly prejudicial to the interests of its members generally or of some part of its members (including at least himself). 7.2 Common allegations made in petitions under section 459 include exclusion of a minority shareholder from management, or a misappropriation or diversion of2 corporate assets. Other typical allegations include failure to provide information,3 4 improper increases in share capital, excessive remuneration and non payment or5 payment of inadequate dividends. A number of allegations concern conduct which,6 prior to the introduction of the oppression remedy, might have been the subject of a derivative action or a personal action under section 14 of the Companies Act 1985.7 8 7.3 Once unfairly prejudicial conduct has been established, the court has a very wide range of powers under section 461. The section provides that the court may make such9 order as it thinks fit for giving relief in respect of the matters of which the petitioner complains. However, the order most frequently sought (and granted) is that the10 Report of the Company Law Committee (1962) Cmnd 1749, para 201.29 Ibid, at para 201.30 Ibid, at para 201.31 Ibid, at para 212.32 Re Jermyn Street Turkish Baths Ltd [1971] 1 WLR 1042.33 Report of the Company Law Committee (1962) Cmnd 1749, para 202.34 Ibid, at para 212.35 SCWS v Meyer [1959] AC 324, 342, per Viscount Simonds LC.36 Report of the Company Law Committee (1962) Cmnd 1749, para 203.37 Ibid, at paras 204 and 212.38 58 (i) The manner in which the section was linked with the winding up jurisdiction: “The effect of this is that the applicant in order to succeed must show not only that the company’s affairs are being conducted in a manner oppressive to some part of the members ..., but also ... ‘that to wind up the company would unfairly prejudice that part of the members, but otherwise the facts would justify the making of a winding up order on the ground that it was just and equitable that the company should be wound up’”. Evidence was given to the Jenkins Committee that “... a case for29 winding up under the just and equitable rule at the instance of a contributory is difficult to establish ...” and “... that there is no sufficient reason for making the30 establishment of such a case an essential condition of intervention by the Court”.31 The Jenkins Committee accepted these criticisms and recommended the repeal of the sub-section which linked the remedy with the winding up jurisdiction.32 (ii) The fact that a single act could not constitute “oppression”; rather, conduct33 had to be of a continuing nature. The section indicated “... a course of conduct as distinct from an isolated act”. The Jenkins Committee recommended that34 the section be amended to make it clear that it also covered isolated acts.35 (iii) The courts construed “oppression” as meaning “burdensome, harsh and wrongful” and not simply unfair. The Jenkins Committee were of the view that,36 if the section was to afford effective protection, “... it must extend to cases in which the acts complained of fall short of actual illegality”. They considered37 that the section should “... cover complaints not only to the effect that the affairs of the company were being conducted in a manner oppressive ... to the members concerned but also to the effect that those affairs were being conducted in a manner unfairly prejudicial to the interests of those members”.38 (iv) Omissions and future conduct did not come within the section. The Jenkins Committee agreed that the section should allow the court to restrain the Ibid, at para 208.39 Ibid, at para 209.40 See Re Five Minute Car Wash Service Ltd [1966] 1 WLR 745. In this case, Buckley J, in41 dismissing the petition, concluded that the allegations suggested that the chairman/managing director was “... unwise, inefficient and careless in the performance of his duties as managing director and chairman of the board of the company”. However, he could find in them “... no suggestion that he has acted unscrupulously, unfairly, or with any lack of probity towards the petitioner ..., or that he has overborne or disregarded the wishes of the board of directors, or that his conduct could be characterised as harsh or burdensome or wrongful towards any member of the company”. Ibid, at p 752. The only reference to such cases appears in the Jenkins Committee’s consideration of the rule42 in Foss v Harbottle at para 207 of the report, where they considered the risks in introducing the remedy that now appears in s 461(2)(c). See further para 7.11 below. However, the question whether the court should authorise proceedings against a director for breach of his duty of care is a separate question, since the issue in such a case under the statutory remedy is whether the company’s failure to bring such proceedings, not the subject matter of such proceedings, is within the section. On the question of whether mismanagement is now covered under s 459 see paras 9.44-9.48 below. Which had previously been held by the courts not to constitute oppression; see Re Jermyn43 Street Turkish Baths Ltd [1971] 1 WLR 1042. 59 commission or continuance of any act which would suffice to support a petition under the section.39 (v) The section did not cover personal representatives. The Jenkins Committee recommended express provision within the section entitling personal representatives to present a petition under the section.40 7.9 One additional point is that the courts excluded negligence and mismanagement from the types of conduct falling within the term “oppression”. However, it is not clear41 whether the Jenkins Committee intended the remedy to be available in cases of mismanagement.42 7.10 The Jenkins Committee recognised, as had the Cohen Committee, that it was impossible to frame a recommendation to cover every case. However, illustrations were given of the types of situations in which action under section 210 might be appropriate, such as the excessive remuneration of directors, which might lead to non payment or43 payment of inadequate dividends to members; the issue of shares to directors and others on advantageous terms; directors, with power under the articles to refuse to register personal representatives, forcing personal representatives to sell their shares to This is a dividend payable only out of the profits of each year, determined to be distributed in44 priority to the subordinate class of shares. If such profits are insufficient, the deficiency is extinguished instead of being carried forward as against subsequent profits, as would be the case with a cumulative preferential dividend. The difference means that for the latter, if the dividend for any year is passed, there is still the certainty that it will have to be paid before the subordinate shares get any dividend in the future. With a non cumulative dividend, if any year is passed, the preferential dividend may be entirely lost, as each year is treated as a separate venture. See generally Palmer’s Company Law (25th ed 1992) para 6.102. Report of the Company Law Committee (1962) Cmnd 1749, para 205.45 See further paras 4.7-4.18 above.46 Report of the Company Law Committee (1962) Cmnd 1749, para 206. 47 Ibid, at para 207.48 In the report of Standing Committee A, Mr Reginald Eyre, the Under Secretary of State for49 Trade, confirmed that the clause was based on the recommendations of the Jenkins Committee and implemented the main recommendations made in their report; see Report of Standing Committee A on the Companies Bill [Lords] (1979-80) HC 326, 22 November 1979, col 302. For the full text of s 75 see Appendix D. Section 75 came into force on 22 December 1980 and ss 459-461 on 1 July 1985. 50 A distinction between s 459 and s 210, as one writer has pointed out (G Stapledon,51 “Mismanagement and the Unfair Prejudice Provision” (1993) 14 Co Law 94), is the different focus of the two sections. With the old s 210, the focus was on the motive of the alleged oppressors and the nature of the conduct. Under the new section the test is generally regarded as being concerned with the impact of the conduct upon the petitioner. See Re Bovey Hotel 60 the directors at an inadequate price; and the passing of non-cumulative preference dividends on shares held by the minority.44 45 7.11 The Jenkins Committee also highlighted indirect wrongs to minority shareholders, where a wrong was done to the company and the control vested in the majority was wrongfully used to prevent action being taken against the wrongdoer. They accepted the force of the criticism that the fraud on the minority exception to the rule in Foss v Harbottle was too restrictive, and recommended an extension to section 210 to allow46 the court, upon hearing a petition under the section, to authorise proceedings to be brought against a third party in the name of the company. The Jenkins Committee47 referred to evidence that the derivative action had been abused in the United States of America, but said: It is not our intention to encourage litigation in cases in which, for instance, an independent majority has reached a bona fide decision to the effect that in the interests of the company as a whole no action should be taken. But we think that the discretion we propose should be given to the Court in such cases and the probable liability for costs of an unsuccessful litigant will be sufficient safeguards against abuse.48 7.12 The Jenkins Committee’s recommendations formed the basis of what was eventually enacted as section 75 of the Companies Act 1980, which subsequently became49 sections 459-461 of the Companies Act 1985. A further amendment was made by50 51 foreign jurisdictions. Although in Re Anglesea Colliery Co (1866) 1 Ch App 555, the court held that a holder of12 fully paid shares was a contributory. Re Rica Gold Washing Co (1879) 11 Ch D 36 approved in Re Chesterfield Catering Co Ltd13 [1977] Ch 373. However, note the following exception to this rule (although this only applies to prevent the petition from being struck out at an interlocutory stage: Re Commercial and Industrial Insulations Ltd [1986] BCLC 191). In Re Newman and Howard Ltd [1962] Ch 257, Pennycuick J held that the need to show a tangible interest was qualified when information which would allow the petitioner to determine whether he had such an interest was withheld. See also Re a Company (No 007936 of 1994) [1995] BCC 705. Although note Oliver J’s comments in Re Chesterfield Catering Co Ltd [1977] Ch 373 that the14 tangible interest of a fully paid up shareholder need not necessarily relate to the existence of a surplus, it may be a liability. See Farrar’s Company Law (3rd ed 1991) p 455. See also L S Sealy, “No Relief for the15 Minority Shareholder” (1995) 16 Co Law 178, 179, where he observes that this rule could leave a petitioner, in some situations, with no remedy to pursue. See the comments of Lord Oliver in Vujnovich v Vujnovich [1990] BCLC 227 (PC), at pp16 231-232, citing Lord Cross in Ebrahimi [1973] AC 360. Cf Plowman J in Re Lundie Bros Ltd [1965] 1 WLR 1051, 1056, where he said that a person could still obtain a winding up order where the breakdown “... has not been caused exclusively by the person seeking to take advantage of it”. [1990] BCLC 227 (PC), at p 232, per Lord Oliver.17 Whilst under s 124(1) of the Insolvency Act 1986 such petitions can also be brought by the18 company, the directors, or creditors, this paper will, in accordance with the terms of reference, only consider petitions brought by a contributory or contributories. See, for example, Buckley on the Companies Acts (14th ed 1981) Vol 1 pp 527-532, and the19 criticism of s 210(2)(b) made to the Jenkins Committee; see para 7.8(i) above. 63 encompasses shareholders who hold partly paid up shares, fully paid up shareholders are not always able to bring winding up proceedings. The courts have held that a fully12 paid up member who is not liable to contribute has to show that he has a tangible interest in the winding up. Thus there must be a likelihood of surplus assets13 14 remaining after the creditors have been paid for distribution amongst the shareholders.15 8.4 In addition to the above conditions, where misconduct by the petitioner is “causative” of the breakdown in confidence/relations between parties upon which the petition is based the court will not make an order under section 122(1)(g). However, conduct16 by the petitioner which occurs after relations between the parties have irretrievably broken down would not be a bar to the making of a winding up order on just and equitable grounds.17 Grounds for a petition 8.5 The court may make an order to wind up a company under section 122(1)(g) of the Insolvency Act 1986 if it “... is of the opinion that it is just and equitable that the company should be wound up”. Strong grounds need to be shown before the court18 will make a winding up order at the instance of a minority shareholder. In what is19 [1973] AC 360.20 [1970] 1 WLR 1378.21 He dismissed the petition under s 210 as not proved and no appeal was made with respect to22 this finding. [1971] Ch 799.23 The court rejected previous attempts to restrict its operation by reading it ejusdem generis24 with the preceding paragraphs of the section. See Re Agriculturist Cattle Insurance Co, ex parte Spackman (1849) 1 Mac & G 170, 174; 41 ER 1228, 1230 and Re Anglo-Greek Steam Co (1866) LR 2 Eq 1. [1973] AC 360, 374-375, per Lord Wilberforce. 25 Ibid, at p 375.26 64 now the leading case of Ebrahimi, however, the House of Lords considered some of20 the circumstances in which a winding up order could be so made. 8.6 In that case the petitioner and the second respondent (“Nazar”), having been in partnership for a number of years, decided to incorporate. The petitioner and Nazar became directors of the company and soon afterwards Nazar’s son (the third respondent) also became both a director and shareholder. Nazar and his son held the majority of shares. No dividends were paid, and all profits were distributed as directors’ remuneration. There was a breakdown in the relationship between the parties and Nazar and his son, in accordance with the articles, removed the petitioner as director. The petitioner commenced proceedings under both the old section 210 oppression remedy and section 222(f) of the Companies Act 1948 (now section 122(1)(g) of the Insolvency Act 1986) for winding up on just and equitable grounds. 8.7 At first instance, Plowman J ordered the company to be wound up. This order was21 22 reversed by the Court of Appeal but reinstated by the House of Lords. The decision23 of the House of Lords is important for two reasons. First, it stresses the wide discretionary jurisdiction which the provision confers on the court. The House of24 Lords held that the “... tendency to create categories or headings under which cases must be brought if the clause is to apply ...” was “wrong”. “Illustrations may be used, but general words should remain general and not be reduced to the sum of particular instances”. The House of Lords also held that, provided the petitioner was qualified25 to petition as a shareholder, he was not prevented “... from relying on any circumstances of justice or equity which affect him in his relations with the company, or ..., with the other shareholders”.26 8.8 Secondly, the House of Lords considered whether the power to order a company to be wound up on the grounds that it was “just and equitable” could be exercised where the members of the company were in substance partners and the court would (if there had been a partnership) have ordered that the partnership be dissolved on the grounds that dissolution of the partnership was just and equitable. Lord Wilberforce said: Ibid, at p 379.27 See Megarry J in Re Fildes Bros Ltd [1970] 1 WLR 592, 596. 28 [1973] AC 360, 379 (footnote added). Lord Wilberforce stressed that the fact that a29 company was small or private was not enough, as many of these types of companies were based on an association which was purely commercial and the basis of the association would be adequately and exhaustively laid down in the articles. To superimpose such equitable considerations required “something more”. Ibid, at p 379. “[T]he expressions may be confusing if they obscure, or deny, the fact that the parties ... are30 now co-members in a company, who have accepted, in law, new obligations”. Ibid, at p 380, per Lord Wilberforce. 65 The words [“just and equitable”] are a recognition of the fact that a limited company is more than a mere legal entity, with a personality in law of its own: that there is room in company law for recognition of the fact that behind it, or amongst it, there are individuals, with rights, expectations and obligations inter se which are not necessarily submerged in the company structure ... The “just and equitable” provision does not ... entitle one party to disregard the obligations he assumes by entering a company, nor the court to dispense him from it. It does, as equity always does, enable the court to subject the exercise of legal rights to equitable considerations; considerations, that is, of a personal character arising between one individual and another, which may make it unjust, or inequitable, to insist on legal rights, or to exercise them in a particular way.27 8.9 Whilst acknowledging that it was both impossible and undesirable to give an exhaustive definition of the circumstances in which such considerations might arise, the House of Lords indicated that they might include one or more of the following elements: (i) an association formed or continued on the basis of a personal relationship, involving mutual confidence — this element will often be found where a pre- existing partnership has been converted into a limited company; (ii) an agreement, or understanding, that all, or some (for there may be “sleeping” members ), of the shareholders shall participate in the conduct of28 the business; (iii) restriction upon the transfer of the members’ interest in the company — so that if confidence is lost, or one member is removed from management, he cannot take out his stake and go elsewhere.29 8.10 The House of Lords noted that the phrase “quasi-partnership” had often been used to describe companies in which one or more of these elements had been found to exist. It indicated that, although convenient, this expression may be confusing. Subsequent30 [1983] 1 WLR 927.44 This approach was subsequently followed in Re a Company (No 003843 of 1986) [1987]45 BCLC 562 and Re a Company (No 003096 of 1987) (1988) 4 BCC 80. Note, however, that a petitioner’s desire to continue participating in the company’s business may make it reasonable to pursue a winding up petition, even when a remedy under s 459 is sought or a fair offer made. See Re a Company (No 001354 of 1991) 20 August 1992 (unreported, CA). (1988) 4 BCC 80.46 Another was an application by the respondents to strike out the petition.47 The court relied on various factors: there were no allegations of impropriety in the running of48 the company and the petitioners had from time to time been prepared to contemplate the purchase of their shares, whereas this had never been the case with respect to the respondents. See also Re a Company (No 003843 of 1986) [1987] BCLC 562. 68 8.15 The court will not only consider whether the petitioner is behaving unreasonably in failing to pursue a remedy under section 459, but also the availability of other non statutory remedies. It has been held that such a remedy can include the rejection by a petitioner of a fair offer made to purchase his shares. In Re a Company (No 002567 of 1982), the petitioner was willing to sell his shares to the respondents if a fair price44 could be agreed, taking into account compensation for loss of office and loss of employment. The parties could not agree a price and the petitioner presented a petition to wind up the company on the just and equitable ground. The respondents subsequently offered to buy the shares at a fair market value fixed by an independent expert and not discounted to reflect a minority holding. The petitioner rejected the offer. On the facts it was held that the petitioner was acting unreasonably in refusing the respondents’ subsequent offer to purchase his shares at a value reached by machinery which met all his reasonable objections.45 8.16 A similar approach has been adopted in subsequent cases involving applications under section 459. In Re a Company (No 003096 of 1987) one of the petitioner’s applications46 before the court was for leave to amend the petition to include, as an alternative to winding up under section 122(1)(g), relief under section 459. The petitioners did not47 dispute that a fair offer had been made for their shares, but did dispute that they should leave the company. The court held that there had been an irretrievable breakdown in the relationship of the parties and that there had to be a parting of the ways. The main question was which party should leave and whether it was plain and obvious that it was the petitioners. On the evidence before the court it was plain and obvious and because a fair offer had been made for their shares which they had48 unreasonably refused, the petition was bound to fail and leave to amend was refused. 8.17 The conclusion which seems to be drawn from the above cases is that, if a fair offer is made that meets all of the petitioner’s reasonable objections, then it is possible, Matters that appear to be relevant are whether it is obvious that the petitioner should be the49 one to go and whether there are any allegations of impropriety on the part of the respondents. See also Re a Company (No 001354 of 1991) 20 August 1992 (unreported, CA), where an allegation that assets had been misappropriated was a factor taken into account by the court in refusing to strike out a petition under s 122(1)(g) where what was said to be a fair offer had been made. Cf the decision of Millett J in Re a Company (No 003843 of 1986) [1987] BCLC 562, 571, where he held that claims of impropriety by the directors could be taken into account by a valuer in valuing shares in the company. However, note the approach of the courts, discussed further at paras 9.49-9.52 below, where50 a provision exists in the company’s articles for valuation of a member’s shares. Initially, one of the reasons for pleading these remedies in the alternative was the difficulty of51 obtaining a remedy under s 210. The amendment to the section in 1980 removed this reason. Of 156 petitions under s 459 presented at the High Court during 1994 and 1995, just under 40% pleaded s 122(1)(g) in the alternative. See Appendix E, Table 1. Contrast the cases of Re RA Noble [1983] BCLC 273 and Re a Company (No 00314 of 1989),52 ex parte Estate Acquisition and Development Ltd [1991] BCLC 154. For the facts of Re RA Noble, see para 9.29, n 60 below. In this case, the petition failed to satisfy the s 459 test, inter alia, on the basis that the treatment of the petitioner whilst prejudicial, was not unfair. His exclusion from participation in the company’s affairs was to a large extent due to his own lack of interest. A winding up order was nevertheless made because the mutual confidence in the personal relationship between the parties had been destroyed and the Ebrahimi test was satisfied. In Re a Company (No 00314 of 1989), ex parte Estate Acquisition and Development Ltd, the petitioner became a director of a company, later acquiring a minority shareholding. She was subsequently made an offer for her shares by a co-director, who shortly afterwards suggested that she resign as a director. The petition complained of several attempts to alter the memorandum and articles, proposals to remove the petitioner as a director and appoint other directors, exclusion from management and failure to provide information. On a strike out application, Mummery J struck out those parts of the petition seeking a winding up order on the basis that the Ebrahimi test was not satisfied. The petition did not allege that the company had been formed out of any special relationship of mutual confidence, or that there was any special obligation entitling the petitioner to continue to participate in management. However, he held that the totality of the allegations relating to whether the petitioner’s complaint would satisfy the test under s 459 was not so clearly unarguable and that part of the claim was not struck out. (Note, however, that the s 459 petition failed at the full hearing before Ferris J: see Re a Company (No 00314 of 1989), ex parte Estate Acquisition and Development Ltd [1995] BCC 338.) See Re Full Cup International Trading Ltd [1995] BCC 682. For further consideration of this53 issue see paras 20.24-20.28 below. See paras 8.19-8.21 below.54 69 depending on the facts of the case, that he will not get relief either under section49 122(1)(g) or under sections 459-461.50 Pleading section 122(1)(g) and section 459 in the alternative Reasons for pleading in the alternative 8.18 Section 122(1)(g) is commonly pleaded in the alternative to section 459 for three main reasons. First, facts which satisfy the test under section 459, may not necessarily51 satisfy the test under section 122(1)(g) and vice versa. Secondly, winding up is not52 available as a remedy under sections 459-461. Pleading the two in the alternative53 therefore gives the court more flexibility to deal with the case. Thirdly, it may put pressure on the majority in the company.54 Effect of pleading winding up in the alternative — section 127 of the Insolvency Act 1986 Article 107 of the Insolvency (Northern Ireland) Order 1989.55 Section 129 of the Insolvency Act 1986.56 Re Gray’s Inn Construction Co Ltd [1980] 1 WLR 711.57 See the comments of Warner J in Re a Company (No 001363 of 1988), ex parte S-P [1989]58 BCLC 579, 586 and Hoffmann J in Re XYZ Ltd [1987] 1 WLR 102, 110. See also the recent case of Re Doreen Boards Ltd [1996] 1 BCLC 501. See the comments of Slade J in Re Burton & Deakin Ltd [1977] 1 WLR 390. The guidelines59 in this case were in relation to winding up petitions in solvent companies; ibid, at p 396. The case concerned a contributory’s petition and the reasoning behind the guidelines, together with the facts of the case, suggest that the test was only to be applied on validation orders relating to contributories’ petitions. In addition, see the comments of Warner J in Re a Company (No 001363 of 1988), ex parte S-P60 [1989] BCLC 579, 586 that such a hearing puts the directors to the cost and trouble of collecting and submitting evidence to demonstrate to the court that the company is solvent and able to pay its debts. See also Re Ringtower Holdings plc [1989] BCLC 427. There is also the possibility that contracts or leases taken out by the company may provide for61 that contract/lease to be determined where such proceedings had been commenced. Although we understand that this rarely occurs now in practice, practitioners inform us that such clauses in agreements are regarded as oppressive and unreasonable. 70 8.19 Seeking a winding up order in the alternative to relief under section 459 can have serious consequences for the company’s business. This is because of the effect of section 127 of the Insolvency Act 1986, which provides that any disposition of the55 company’s property made after the commencement of the winding up is void unless the court otherwise orders. The winding up is deemed to have commenced at the time of the presentation of the petition.56 8.20 The effect of section 127 is that any payments out of the company’s bank account after presentation of the petition can be set aside and reclaimed by the liquidator once the company has been wound up. In practice this means that as soon as a bank receives57 notice of a winding up petition it will freeze the company’s bank accounts. As a58 general rule, however, unless a contributory can adduce compelling evidence proving a disposition likely to injure the company, the court will validate a transaction which falls within the powers of the directors where there is evidence that it is necessary or expedient in the opinion of the directors in the interests of the company, and the reasons given for it are ones which an intelligent and honest man could reasonably hold. Furthermore, it is open to the company to apply to the court to validate59 payments in advance. 8.21 If the making of such an order is contested, this may involve the company in the expense both in time and money of a contested court hearing. Historically, the tactic60 of pleading a winding up petition as an alternative to section 459, even where this was not an appropriate remedy, allowed the petitioner to put the maximum pressure possible on the respondents to settle the case as soon as possible.61 See Harman J’s comments in Re a Company (No 001761 of 1986) [1987] BCLC 141, 143 that11 “[i]t is not going to be a defence to a s 459 petition to say that the conduct of which complaint is made has ceased six months before the petition was presented ...”. But note Peter Gibson J’s comments in Re DR Chemicals Ltd [1989] BCLC 383, 397-398 that laches may bar relief on a s 459 petition, although such a delay must have been inexcusable. See Re Kenyon Swansea Ltd [1987] BCLC 514 and Whyte, Petitioner 1984 SLT 330. Both12 cases concerned resolutions tabled at meetings to amend articles, which, if carried, would have had unfairly prejudicial consequences for the minority shareholders. In both cases the court granted an injunction to restrain the meeting. Re a Company (No 004475 of 1982) [1983] Ch 178. In this case, the majority in a private13 family company wanted to use the company’s assets to buy a wine bar, although no final decision had been made on this. The minority shareholders were executors holding shares on behalf of the testator’s two young children. They wished to sell the shares to put the children through school. They alleged, inter alia, that the suggested purchase was unfairly prejudicial as the company’s liquid resources might then be insufficient to buy out the shareholding. The court held that their petition, in so far as it related to this allegation, was premature as it had not yet been decided if the proposal was to be adopted. [1987] BCLC 141.14 Examples of other acts held to be personal rather than conduct of the company’s affairs, were15 rude and aggressive behaviour towards both customers and staff and asking the secretary to park the director’s car: Re a Company (No 001761 of 1986) [1987] BCLC 141, 145. See further Re Unisoft Group Ltd (No 3)[1994] 1 BCLC 609 at para 9.16 below. 73 Meaning of “affairs are being or have been conducted” 9.3 Section 459 allows a member to petition not only where the unfairly prejudicial conduct is continuing, but also where the conduct has finished by the time of the presentation of the petition.11 9.4 In addition, the section allows a member to petition in respect of threatened future conduct. It will generally be sufficient that the act has been proposed and, if carried out or completed, would be unfairly prejudicial. But the proposal must be at a sufficiently12 advanced stage, mere discussions which could result in a proposal being tabled at a future meeting are unlikely to provide sufficient grounds for a successful petition.13 What constitutes “the company’s affairs” 9.5 There is no definition within the Companies Act 1985 of what constitutes the “company’s affairs”, in the context of section 459. In Re a Company (No 001761 of 1986), Harman J made the distinction between conduct “in the company” and14 conduct “dehors” the company. In that case the main allegation was that the respondent shareholder had paid off the company’s bank loan and taken a transfer of the bank’s security. It was held that this was an act by the respondent in her personal capacity. It amounted merely to a change in the identity of the mortgagee and did not affect the mortgagor company’s position.15 9.6 Other examples can be given. The actions of a director who, like the petitioner, is a 50 per cent shareholder and who sets up a rival business and siphons work off to the new company has been found to be misconduct of the affairs of the company whose Re Stewarts (Brixton) Ltd [1985] BCLC 4.16 See the comments of Harman J in Re a Company (No 001761 of 1986) [1987] BCLC 141,17 148. North-West Transportation Co Ltd v Beatty (1887) 12 App Cas 589 (PC). This principle is18 subject to the qualifications described in para 2.38 above. Re Ringtower Holdings plc [1989] BCLC 427, 449, per Peter Gibson J and Re Unisoft Group Ltd19 (No 3) [1994] 1 BCLC 609, 611, per Harman J. Re Unisoft Group Ltd (No 3) [1994] 1 BCLC 609, 611, per Harman J. See also his later20 comments at pp 622-23 that a shareholder could act with malice when voting his shares against a resolution. Arguably, Harman J goes too far with this particular proposition. See D D Prentice, “Restraints on the Exercise of Majority Shareholder Power” (1976) 92 LQR 502. [1959] AC 324.21 74 interests are thus subordinated. But the actions of a director who steals from the16 company safe are not those of the company and in removing the money the director cannot be said to be conducting the company’s affairs. However, the position would be different if the board took no action as a result.17 9.7 So far as shareholders are concerned, a distinction is drawn between their votes as members, which are a private right and can be exercised as they choose, and the18 19 resolution itself, which is an act of the company and can, in certain circumstances, found the basis of a section 459 petition.20 9.8 Two particular types of situation have given rise to difficulty. The first concerns parent companies. The second relates to shareholder agreements. Parent companies 9.9 The issue here is whether conduct of the affairs of a parent company as majority shareholder in a subsidiary can be conduct in the affairs of the subsidiary. This appears to be of particular relevance where the subsidiary contains an independent minority of shareholders. It clearly has implications in certain limited circumstances for the freedom of the parent company to run its affairs. 9.10 In SCWS v Meyer the petitioners were minority shareholders and two of the five21 directors of a textile company (“the subsidiary”). The other three directors were nominees of the holding company and majority shareholder, the Scottish Co-operative Wholesale Society (“the parent company”). They were also directors of the parent company. When the parent company no longer needed the subsidiary for the purposes of its own business, it deliberately ran down the subsidiary’s business and started a similar business itself. It instructed its factory only to offer supplies to the subsidiary at excessive prices. Although the nominee directors knew of this policy, they did not pass the information on to the petitioners and did nothing to stop it. The shares in the subsidiary became worthless. Ibid, at p 367, per Lord Denning.22 Ibid, at p 367, per Lord Denning.23 [1993] BCLC 360.24 As Fox LJ said: “[the parent company] was, in effect, treating the financial affairs of the two25 companies as that of a single enterprise over which it had control”. Elements of control included key areas such as administration of export sales; personnel recruitment; supervision of the subsidiary by non executive directors appointed by the holding company; negotiating overdraft borrowing limits for the group; and supervision of finances by the holding company’s finance director. Ibid, at pp 363-364. However, such conduct was not unfairly prejudicial. It was in the interests of the parent26 company, which was in financial difficulty, to delay payment in order to keep the group afloat. Ibid, at p 366. Nicholas v Soundcraft Electronics Ltd [1993] BCLC 360, 368, per Ralph Gibson LJ and see also27 SCWS v Meyer [1959] AC 324, 343, per Viscount Simonds. For consideration of the issue of multiple derivative actions see para 16.51 below. 75 9.11 The House of Lords held that the parent company had acted towards the petitioners in an oppressive manner and that this conduct, through the nominee directors, amounted to conduct in the affairs of the subsidiary. “By subordinating the interests of the [subsidiary] to those of the [parent company], [the nominee directors] conducted the affairs of the [subsidiary] in a manner oppressive to the other shareholders”. The court considered the point that the directors had not actively done22 anything oppressive to the minority, but held that “... the affairs of the company can ... be conducted oppressively by the directors doing nothing to defend its interests when they ought to do something — just as they can conduct its affairs oppressively by doing something injurious to its interests when they ought not to do it”.23 9.12 The reasoning of the House of Lords in the above case was developed further in Nicholas v Soundcraft Electronics Ltd. This case involved a parent company’s failure to24 pay amounts to a subsidiary due in respect of sales of the subsidiary’s products effected by the parent company. Unlike in SCWS v Meyer, the two companies were not in the same line of business. However, the parent did exert a large degree of control over the subsidiary. The court was satisfied that on the facts the parent company’s control25 over the subsidiary was such that decisions made by the parent company amounted to conduct of the subsidiary’s affairs.26 9.13 The above cases illustrate that in section 459 proceedings the court has regard to “... the business realities of a situation”.27 Shareholder agreements 9.14 Shareholder agreements are likely to be relevant to proceedings under section 459. 9.15 When the court examines whether the conduct of which complaint is made is wrongful, the court has to consider the parties’ rights under the articles and other agreements Report of the Company Law Committee (1962) Cmnd 1749, para 203.40 [1995] 1 BCLC 14. The case involved a company incorporated in 1947 and run by four41 brothers. There was various restructuring of the shares over the years and at the time of the petition there were 3 main types of shares: A, B and C Ordinary shares, all of which were fully paid up, although only the A shares carried voting rights, with no right to a dividend or to company assets should the company be wound up. With respect to profits, these produced a percentage dividend to the B and C shares, which also had various rights should the company be wound up. The main allegation was that the directors and holders of the A shares were running the company solely for their own benefit and were ignoring the interests of, inter alia, the C shareholders, of which the petitioner was one. The A shareholders were being remunerated as directors, but, because of the poor performance of the company, no dividends were being paid to the B and C shareholders. Ibid, at p 17.42 Ibid, at p 18.43 Ibid, at p 18.44 Ibid, at p 18.45 78 acts complained of fall short of actual illegality“. In Saul D Harrison, the Court of40 41 Appeal laid down guidelines as to when conduct will be “unfairly prejudicial”. 9.22 In that case, Hoffmann LJ accepted that the test of unfairness was objective but he considered that rather than referring to a “reasonable bystander” it was more useful “... to examine the factors which the law actually takes into account in setting the standard”. In his judgment “... keeping promises and honouring agreements is42 probably the most important element of commercial fairness ...”, therefore, the43 starting point in any case under section 459 will be to ask whether or not the conduct is in accordance with the articles of association. He further held that: The answer to this question often turns on the fact that the powers which the shareholders have entrusted to the board are fiduciary powers, which must be exercised for the benefit of the company as a whole. If the board act for some ulterior purpose, they step outside the terms of the bargain between the shareholders and the company ... This seems to me in principle the correct point at which to start the inquiry into both whether the conduct in question could justify a just and equitable winding up and also whether it is unfair for the purposes of section 459.44 9.23 Hoffmann LJ also held that conduct could be unlawful but, nevertheless, might not be unfairly prejudicial, so it followed that “... trivial or technical infringements of the articles were not intended to give rise to petitions under section 459”.45 9.24 As for the circumstances in which lawful conduct which might form the basis of a successful petition, Hoffmann LJ held that this could be the case where the articles did not “ ... fully reflect the understandings upon which the shareholders [were] Ibid, at p 19.46 Ibid, at p 19.47 [1973] AC 360, 379 and see para 8.9 above.48 Hoffmann LJ accepted Lord Wilberforce’s comment in Ebrahimi that “[i]t would be49 impossible, and wholly undesirable, to define the circumstances in which these considerations may arise”. Ibid, at p 379. [1995] 1 BCLC 14, 30.50 Ibid, at pp 30-32. 51 He also emphasised the difference between the remedies available under s 122(1)(g) and s52 459. He cited with approval Mummery J in Re a Company (No 00314 of 1989), ex parte Estate Acquisition and Development Ltd [1991] BCLC 154, 161, who said: “Under ss 459 to 461 the court is not, therefore, faced with a death sentence decision dependent on establishing just and equitable grounds for such a decision. A court is more in the position of a medical practitioner presented with a patient who is alleged to be suffering from one or more ailments which can be treated by an appropriate remedy applied during the course of the continuing life of the company”. See also Peter Gibson J in Re Ringtower Holdings plc [1989] BCLC 427, 437.53 [1995] 1 BCLC 14, 31.54 79 associated”. He said that Lord Wilberforce “... drew attention to such cases ...” in46 47 Ebrahimi and that the same concept of unfairness applied in section 459 cases as48 formed the basis of a just and equitable winding up. In such cases shareholders could49 have what he referred to as a “legitimate expectation” that the board would not exercise the powers conferred on it in the articles. 9.25 Neill LJ thought that the protection offered by section 459 would have to be worked out on a “case by case basis”, but considered that some guidelines as to the correct50 approach to the concept of “unfairly prejudicial” had been developed. He set them out in ten paragraphs. Among his points were the following: the words “unfairly51 prejudicial” should be applied flexibly; that the width of the jurisdiction meant it52 should be carefully controlled or it could itself be a means of oppression; the conduct complained of must be both prejudicial and unfairly so; the petitioner’s legal rights53 were to be found in the memorandum and articles because they constituted the contract setting out his rights and liabilities as a shareholder; that the court should take account not only of his legal rights but also consider whether there were any equitable considerations “... such as the petitioner’s legitimate expectations ...” which could54 arise from agreements or understandings between members or between members and directors and that similar considerations to those explained by Lord Wilberforce in Ebrahimi are capable of being introduced into section 459 cases by the concept of fairness in the phrase “unfairly prejudicial”. Moreover, a managerial decision would be unlikely to amount to unfairly prejudicial conduct even if it damaged the petitioner’s interest, although it was open to the court to find unfair prejudice if serious mismanagement occurred. The third member of the court, Waite LJ, concurred with the judgments of Hoffmann and55 Neill LJJ. [1996] 1 BCLC 155. See also Arden J in Re Macro (Ipswich) Ltd [1994] 2 BCLC 354 and56 Vinelott J in Re a Company (No 002612 of 1984) [1986] 2 BCC 99,453, 99,461, on appeal sub nom Re Cumana Ltd, where both seem unwilling to limit the wide discretion that the words of the statute imply. They adopt a similar approach to that of the Jenkins Committee, looking instead for a visible departure from the standards of “fair dealing”. [1996] 1 BCLC 155, 243. See also her comments at p 237.57 For the relevance of a petitioner’s conduct to the issue of the court’s discretion to grant relief58 under s 461 and to the issue of valuation where a purchase order is sought, see paras 10.3 and 10.14, n 40 below. Re London School of Electronics Ltd [1986] Ch 211.59 Eg Re RA Noble [1983] BCLC 273. This case involved a company with two 50%60 shareholders, A and B. B was the financier of the company and held his shares through his company, Anafield. A ran the company but it was agreed he would consult B on important matters. The relationship between the two men broke down and, although A continued to run the business, contact between the two men became less and less frequent. Anafield commenced proceedings under s 75 (now s 459) and in the alternative under s 122(1)(g). The grounds of the petition were wide ranging, but broadly alleged that neither Anafield nor 80 9.26 The Court of Appeal unanimously upheld Vinelott J’s decision at first instance to strike out the petitioner’s claim. Although the company had traded unsatisfactorily, the55 directors had made some changes and considered that the business was viable and capable of expansion. The court was satisfied that there was no basis for alleging that the company had conducted its affairs in an unfairly prejudicial manner. 9.27 More recently, in Re BSB Holdings Ltd (No 2), Arden J, having reviewed the56 judgments in the above case, said: ... in my judgment, it is not the effect of Re Saul D Harrison & Sons plc that a remedy under section 459 can be given only if the directors have acted in breach of duty or if the company has breached the terms of its articles or some other relevant agreement. These matters constitute in most cases the basis for deciding what conduct is unfair. But the words of the section are wide and general and ... the categories of unfair prejudice are not closed. The standards of corporate behaviour recognised through section 459 may in an appropriate case thus not be limited to those imposed by enactment or existing case law.57 Conduct of petitioner58 9.28 Unlike the “just and equitable” winding up remedy, section 459 is not an equitable jurisdiction. There is, therefore, no requirement that the petitioner come to court with “clean hands”. However, the conduct of the petitioner will always be an important59 factor, because the court will examine all the facts of the case and weigh the conduct of the petitioner and that which is alleged to be unfairly prejudicial. 9.29 The consequence of this balancing act may be that if both parties have acted equally unreasonably the respondent’s conduct will not be found to be unfair. However, this60 Re a Company (No 007623 of 1984) [1986] BCLC 362 and Re XYZ Ltd [1987] 1 WLR 102. 75 See paras 12.24-12.39 below for further discussion of a shareholder’s rights of access to76 information. Such a failure may also be relevant in other cases, eg to provide information necessary to77 assess an offer to purchase shares: see Re a Company (No 00314 of 1989), ex parte Estate Acquisition and Development Ltd [1991] BCLC 154; and where a winding up petition has been presented and the petitioner is unable to state that the company is solvent because of the company’s failure to provide information: Re a Company (No 007936 of 1994) [1995] BCC 705. See further para 8.3, n 13 above. See Re RA Noble [1983] BCLC 273, 289, per Nourse J, although on the facts of the case the78 court was not prepared to make such a finding. Rudall v S & F (Quarries) Ltd 12 October 1994 (unreported, CA) at p 4, per Roch LJ79 commenting on the judgment of the court at first instance. See also Re Ringtower Holdings plc [1989] BCLC 427, 443, per Peter Gibson J, where he described an allegation that the directors had failed to file accounts as trivial. In this case the initial failure was admitted, but was rectified and the accounts were filed. Counsel had not alleged on the facts of the case that the petitioner was prejudiced by the failure. See, for example, Rudall v S & F (Quarries) Ltd 12 October 1994 (unreported, CA). In that80 case, the petitioner alleged, inter alia, that since his retirement as a director the other directors had failed to keep him informed of the company’s negotiations for a joint venture with another company to exploit a quarry, which was the company’s main asset. The court held that there was no legitimate expectation available to the petitioner that he would receive information on the details of the negotiations. See also Re Elgindata Ltd [1991] BCLC 959, where an allegation about failure to provide information concerning an approach that had been made to buy out the company was held not to be unfairly prejudicial conduct. 41.7% of 156 petitions filed in 1994-1995 contained an allegation relating to a failure to provide information. See Appendix E, Table 1. 10.3% of 156 petitions filed in 1994-1995 contained such an allegation. See Appendix E,81 Table 1. 83 see if it was justified and, more importantly, at the terms on which the exclusion was effected to see if they were fair.75 Failure to provide information76 9.35 An allegation commonly found in exclusion from management cases is that the majority shareholder(s) has failed to provide information about how the company is being run. Where the failure to provide information constitutes a deliberate policy not77 to consult the petitioner on major decisions on which he ought to be consulted, this could amount to unfairly prejudicial conduct. However, often the allegation would78 seem to be included simply to “... lend ballast to more serious allegations ...” or there79 is no legitimate expectation that the petitioner would receive the particular information.80 Increase of issued share capital 81 9.36 There are two different types of situation that are covered under this heading. The first situation involves an issue and allotment of shares, which is proposed or carried out in accordance with the provisions of the Companies Act 1985 but there has been a breach of duty by the directors of the company. The second type of situation is where an allotment is proposed or carried out in breach of statutory requirements. Which must be exercised for the benefit of the company as a whole.82 Saul D Harrison [1995] 1 BCLC 14, 18, per Hoffmann LJ.83 Re a Company (No 007623 of 1984) [1986] BCLC 362. In that case, the court found on the84 facts that the board genuinely believed that the company required additional capital and that it was reasonable for them to believe that this was the case. Re a Company (No 002612 of 1984) [1985] BCLC 80, where Harman J granted an injunction85 preventing the issue pending the full hearing of the case. See (1986) 2 BCC 99,453 for the full hearing on this case and [1986] BCLC 430 (sub nom Re Cumana Ltd) for the hearing on appeal. Re a Company (No 002612 of 1984) [1985] BCLC 80, 82, per Harman J. See also Re a86 Company (No 007623 of 1984) [1986] BCLC 362. Re DR Chemicals Ltd [1989] BCLC 383, 396, per Peter Gibson J.87 In Re DR Chemicals Ltd [1989] BCLC 383 the allotment of shares was carried out unilaterally88 by the majority shareholder without reference to the minority shareholder, resulting in a substantial dilution of the minority’s shareholding. This was in breach of s 17 of the Companies Act 1980, (now s 89 of the Companies Act 1985). The court held that there was a substantial contravention of s 17, which embodied “... ordinary and basic notions of fairness as between shareholders inter se and governing those with the power to allot shares”. Ibid, at p 396. In addition it held that the allotment was invalid in that it was made for an improper purpose, namely to change the balance of voting power inside the company. Accordingly the allotment was unfairly prejudicial to the interests of the petitioner. Note that to challenge an actual or proposed allotment a shareholder need not necessarily89 bring proceedings under s 459. Other statutory and common law remedies might be available. See paras 5.15-5.16 above and para 12.23 below. See also Howard Smith v Ampol Petroleum Ltd [1974] AC 821 (PC). In this case the shareholder brought a personal action challenging the issue and allotment of shares and the Privy Council upheld his challenge on the grounds that the issue of shares by directors with the main purpose of forestalling a takeover bid was an improper exercise of the directors’ power to issue shares. See also para 2.33, n 69 above. 84 9.37 In considering the first type of situation, a petitioner may succeed if he can prove that in carrying out the allotment the board have acted in breach of their fiduciary powers.82 If the board act “... for some ulterior purpose, they step outside the terms of the bargain between the shareholders and the company”. The court will examine the83 motives of the board in proposing it to see, for example, if the dominant purpose is84 to reduce the petitioner’s shareholding. The fact that the majority knows that the85 petitioner does not have the money to take up his rights may be an important consideration.86 9.38 So far as the second type of situation is concerned, an issue and allotment will generally not be held to be unfair where the breach of the legal requirements is merely technical. However, where there is a substantial breach of a statutory provision, the87 88 allotment is likely to be held to be unfairly prejudicial.89 Alteration of articles of association 9.39 A not uncommon allegation, which is related to an issue already touched upon earlier, concerns the situation where the majority attempt to alter a company’s articles of association by special resolution. We have already examined the circumstances in See paras 2.31-2.38 and 4.30-4.32 above.90 [1900] 1 Ch 656.91 [1951] Ch 286. Both cases concerned similar facts and were brought as derivative actions as92 an exception to the rule in Foss v Harbottle. Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286, 291, per Evershed MR.93 Re Ringtower Holdings plc [1989] BCLC 427, 450, per Peter Gibson J. In this case, resolutions94 were passed depriving the petitioners of pre-emption rights and seeking to re-register the company as a private company in order to facilitate a takeover by another company. The court found that the resolutions were passed bona fide and that there was no intention to discriminate because the purchasing company always intended to make its offer to buy the majority’s shareholding available to the minority shareholder as well. Although potentially prejudicial to the petitioners, the resolution could not be said to be unfair given the alterable nature of the articles and the offer by the purchasing company to them. Eg Re London School of Electronics Ltd [1986] Ch 211; Re Cumana Ltd [1986] BCLC 430 (at95 first instance sub nom Re a Company (No 002612 of 1984)); Re Stewarts (Brixton) Ltd [1985] BCLC 4. Eg Re Elgindata Ltd [1991] BCLC 959 and Re Little Olympian Each-Ways Ltd (No 3) [1995]96 1 BCLC 636, where in the latter case, the allegations related, inter alia, to a breach of trust by the sale of the company business to another company at an undervalue. 41% of 156 petitions filed in 1994-1995 involved such allegations. See Appendix E, Table 1.97 11.5% of 156 petitions filed in 1994-1995 involved such allegations. See Appendix E, Table98 1. 25% of 156 petitions filed in 1994-1995 involved such allegations. See Appendix E, Table 1.99 85 which a resolution altering the articles of association can be challenged at common law. The tests laid down in Allen v Gold Reefs of West Africa Ltd and Greenhalgh v90 91 Arderne Cinemas Ltd were that the resolution must be passed bona fide for the benefit92 of the company as a whole, and that the effect of the resolution must not be to discriminate between the majority and minority shareholders so as to give the former an advantage of which the latter is deprived. It has been said that a special resolution93 which is valid according to the test in Greenhalgh v Arderne Cinemas Ltd could nevertheless amount to unfair prejudice under section 459, but following Saul D94 Harrison, it is not clear whether (in the absence of some legitimate expectation) this is possible. Diversion of company business and misappropriation of assets 9.40 A number of successful cases have been brought under section 459 on the basis that there has been a deliberate diversion of a company’s business by those in control to another business owned by them, or that there has been misappropriation of company95 assets. These cases illustrate the fact that proceedings are brought under section 45996 to obtain a personal remedy for what are effectively breaches of fiduciary duty.97 Excessive remuneration and non payment of dividends98 99 [1991] BCLC 959, 994. See also Arden J in Re Macro (Ipswich) Ltd [1994] 2 BCLC 354,118 404-405. This approach has been regarded by some as unnecessarily restrictive. Whilst recognising the need to expect commercial risks to be taken, it is argued that there is a distinction between detriment to the company arising from the taking of reasonable commercial risks and negligence, gross inefficiency or carelessness: G Stapledon, “Mismanagement and the Unfair Prejudice Provision” (1993) 14 Co Law 94, 95. [1991] BCLC 959. The petition contained four broad allegations, one being that the119 respondent “... neglected and was incompetent in the management of the company’s business”. Ibid, at p 992. The others were (i) that the petitioner had been excluded from management decisions and his legitimate expectations frustrated; (ii) that there was late payment of a dividend; and (iii) that the respondent had used assets of the company for his personal benefit and the benefit of his family and friends. Although the court did hold that unfairly prejudicial conduct existed on other grounds.120 A further point also remains unresolved by the case law with respect to s 459. In Re Elgindata121 Ltd the court considered that one example of a case where there was no breach of the duty of care and skill, but where the court might nonetheless find that there was unfair prejudice to minority shareholders, would be where the majority shareholders, for reasons of their own, persisted in retaining in charge of the management of the company’s business a member of their family who was demonstrably incompetent. [1994] 2 BCLC 354. The conduct which it was held amounted to mismanagement of the122 property companies included: dishonest “pocketing” of commissions; failure to obtain competitive tenders for repairs; failure to conduct regular inspections of the properties so that defective work was not noticed and therefore builders were overpaid; failure to let the properties on the most advantageous terms; late registration of rent; and overpayment of management fees. Ibid, at p 406. However, see JP Lowry, “The Elasticity of Unfair Prejudice: Stretching the123 Ambit of the Companies Act 1985, Section 459” [1995] LMCLQ 337, 339. This article canvasses differing views as to directors’ duty of care and skill and comments on this decision. 88 care ... there is prima facie no unfairness to a shareholder in the quality of the management turning out to be poor”.118 9.48 In Re Elgindata Ltd, it was held that what the acts complained of were about was119 essentially a lack of purposefulness as opposed to a breach of duty of care and skill, and no remedy was available under section 459. However, it is clear that where the120 allegations concern serious acts of mismanagement a remedy will be available under section 459. In Re Macro (Ipswich) Ltd, the court gave some guidance as to what121 122 type of conduct might fall within this category. It was held that the allegations made in that case were not just of poor quality management, but specific acts of mismanagement which had been repeated over many years and which the respondent had failed to prevent or rectify. Those acts and failures were held to be serious enough to justify the court’s intervention.123 Effect of pre-emption articles on a petitioner’s ability to bring proceedings under section 459 9.49 It is common for private companies to have articles of association which contain pre- emption rights, giving the company or the remaining shareholders the right (or in some cases the obligation) to purchase the shares of a member who is leaving the company. Some provisions may oblige a member to sell his shares in certain circumstances (for Eg Re a Company (No 007623 of 1984) [1986] BCLC 362 and Re XYZ Ltd [1987] 1 WLR124 102. Eg Re Abbey Leisure Ltd [1989] BCLC 619 (Ch D), on appeal sub nom Virdi v Abbey Leisure125 Ltd [1990] BCLC 342 (CA). This is because a minority shareholding is usually regarded as being of a lower value per share126 than a majority shareholding. This stems from the fact that a minority may have limited voting power and therefore less control over management and day to day running of the company. See further para 10.14 below. Re a Company (No 007623 of 1984) [1986] BCLC 362 and Re XYZ Ltd [1987] 1 WLR 102.127 [1990] BCLC 342 (CA).128 Although the petition contained an application under s 459 in the alternative, the application129 for winding up was treated as the primary claim for relief and the Court of Appeal did not consider the applicability of their approach to petitions brought under s 459. The provision did not oblige the petitioner to sell, but did contain valuation machinery to130 determine the price of the shares of a member who chose to do so. It provided for an independent accountant to determine a fair value “... as between a willing seller and a willing buyer”; [1990] BCLC 342, 344. This should be contrasted with the pre-emption provision in Re a Company (No 00330 of 1991), ex parte Holden [1991] BCLC 597, which did in fact oblige the petitioner to sell; see n 138 below. Section 125(2) of the Insolvency Act 1986; see paras 8.13-8.17 above.131 89 example, on his ceasing to be a director or an employee), others may simply set out a procedure to follow should he choose to transfer his shares. There will generally be a mechanism for ascertaining the fair value of the shares in the event of disagreement. The articles may provide for this to be ascertained by the company’s auditors, or by124 an independent valuer. The fair value of a minority shareholding will frequently be125 on a discounted basis.126 9.50 Two early first instance decisions suggested that the failure of a dissatisfied shareholder to use provisions of this kind could constitute a bar to a remedy under section 459.127 However, this approach was rejected by the Court of Appeal in Virdi v Abbey Leisure Ltd in the context of an application for winding up under section 122(1)(g). The128 129 case concerned a quasi-partnership type company which (it was accepted for the purposes of the striking out application) had been formed on the understanding that it would undertake a single venture. The venture was completed but a new one was contemplated which the petitioner did not wish to pursue. The respondents made an open offer to buy the petitioner’s shares and to have them valued in accordance with a pre-emption provision in the articles of association but the petitioner refused to130 accept this offer and commenced proceedings under section 122(1)(g) and section 459. The issue was whether the petitioner was acting unreasonably in seeking to have the company wound up instead of pursuing another remedy.131 9.51 The Court of Appeal held that the petitioner’s failure to take advantage of the valuation procedure in the pre-emption provision was not unreasonable conduct. The company had been formed for a single venture which had come to an end and the assets of the company were almost entirely in cash. On a winding up this would have been Being a minority shareholding; see para 10.14 below.132 With whom Sir George Waller, the other member of the court agreed.133 [1990] BCLC 342, 349-350.134 Note the slightly different approach of the courts, at paras 8.15-8.17 above, where a fair offer135 has been made which meets all the petitioner’s reasonable objections. There are many possible distinguishing features between the factual situation in Re a Company (No 002567 of 1982) [1983] 1 WLR 927, discussed at para 8.15 above, and the factual situation faced by the Court of Appeal in Virdi v Abbey Leisure Ltd. In the first case the offer to purchase the shares was on a non discounted basis and the company was a going concern, (a fact which was emphasised by Balcombe LJ in his judgment; [1990] BCLC 342, 349). The petitioner was willing to sell his shares and the price was the best that he could reasonably expect to achieve. In Virdi, as Balcombe LJ remarked, the petitioner was not a willing seller who wished to transfer his shares pursuant to the relevant provision in the articles and there was a risk that his shares could be discounted as a minority shareholding. [1991] BCLC 597. The company’s articles had a mandatory share purchase provision, which136 provided that a member of the company who ceased to work for it was deemed to have served a transfer notice in respect of his shares. Such shares would then be valued by the company’s auditor or an independent valuer at a “fair” value. The case did not primarily relate to whether a petition under s 459 could be brought where pre-emption provisions existed, but rather whether such provisions could actively be used to undermine such a petition once started, by depriving the petitioner of his shareholding and therefore his locus standi to bring proceedings under s 459. However, the respondents also argued that there was no serious question to be tried under the petition, as the existence of the pre-emption provision meant that the petition would have failed, and this point was dealt with in the judgment. Ibid, at p 603. The court observed that, on the facts of the case, a valuation under the articles137 would be carried out by the valuer as an expert, who would give “... no explanation as to how he has come to his decision, leaving it unassailable even if apparently low or high”. Ibid, at p 603. The petitioner would have no right to make representations and there was no proper machinery to assist the expert in evaluating claims against the company, so that they might be inadequately taken into account. Furthermore, at the date of valuation dictated by the directors’ election to implement the pre-emption provisions, there were taxation considerations which meant the shares may have been worth less than they might have been after that accounting period. 90 distributed to the shareholders pro rata. On the other hand, had the mechanism in the articles been adopted, the petitioner was likely to receive a discounted valuation of his shares. Balcombe LJ, held that it was not unreasonable for the petitioner to refuse132 133 to run that risk. He referred to a line of authority in relation to valuation of shareholdings in quasi-partnership companies, in all of which the petitioner had been entitled to a pro rata rather than discounted valuation. He considered that on134 winding up there was machinery available for proper determination of the value of the shares and that it would be preferable to an accountant’s estimate and he was not convinced that it would be more expensive.135 9.52 The decision in Virdi v Abbey Leisure Ltd was followed in Re a Company (No 00330 of 1991), ex parte Holden. In this case the court considered that it “... was not136 unreasonable for the petitioner to refuse to accept a valuation under [a compulsory transfer procedure in] the articles”, invoked after the petitioner had been excluded137 from management, and held that the existence of a provision for valuation in the