Impact of O’Neill v Phillips on Minority Shareholder Rights in Company Law, Study notes of Law

Download Impact of O’Neill v Phillips on Minority Shareholder Rights in Company Law and more Study notes Law in PDF only on Docsity! Page 1 On Divorce: The atomic bomb, the sell-out or the pre-nuptial agreement? ‘The speech of Lord Hoffmann in the case of O’Neill v Phillips [1999] 1 WLR 1092 says everything which needs to be said about section 459 of the Companies Act 1985 and (by implication) section 122 (1)(g) of the Insolvency Act 1986.’ Discuss that proposition. Robert Harker, Senior Honours Student Edinburgh University School of Law Introduction Formerly one of the most stagnant and moribund areas of company law, due in large part to the stringent requirements laid out in section 210 of the 1948 Act, has now, arguably, become one of the most active.1 The advent of s459 was seen as a golden new dawn for the rights of the minority shareholder against a background in which majority rule is regarded as fundamental.2 Given the recent Law Commission’s Report on Shareholder Remedies,3 which, inter alia, sought to improve the expediency and cost of s459 litigation through a more efficacious case management system, it seems rather appropriate that O’Neill v Phillips4, the first case in the House of Lords to undertake directly an examination of the minutiae of the section, will now have the opportunity to offer a definitive account of this area of law. It will be seen that O’Neill, where it might not say everything expressly, certainly by implication, or at least by omission, is so far the most conclusive case on the subject of a s459 petition, especially if it is read in light of Re Saul D Harrison & Sons Plc.5 It is difficult, even for a decision of the House of Lords, to offer a completely determinative account of the law, but if we are to interpret ‘everything’ as meaning anything that warrants either a clarification or a re-appraisal, then Lord Hoffmann’s attempt is a commendable one. His Lordship gave the leading judgment in the case, scrutinising four of the most important aspects of the remedy’s operation: • The concept of unfairness and equitable considerations in a s459 petition; • The nature of ‘legitimate expectations’ and the scope of its ambit; • The availability of a right to ‘exit at will’ and the concept of a ‘No-fault divorce’; and • The most important remedy under s461: an offer to buy the petitioner’s shares at a ‘fair’ value. 1 B Clark: Unfairly Prejudicial Conduct SLT 1999 Issue 38 2 See e.g. Prudential Assurance v Newman Industries [1982] Ch. 204, in which the Court of Appeal supported the rule in Foss v harbottle (1843) 2 Hare 461 3 Law Commission no 246 CM 3769, The Stationary Office, 1997 4 [1999] 2 BCLC 1 5 [1995] 1 BCLC 14 Page 2 In part 1 I will use these four heads as a guide to discuss the impact of the case on the compass and subsequent potency of a s459 remedy, and, in part 2, the position of a ‘just and equitable’ winding- up petition under s122(1)(g) will be examined in light of Lord Hoffmann’s learned judgment. PART 1 The concept of fairness The concept of ‘fairness’ is the overarching principle around which s459 operates. The notion of fairness must facilitate two roles which are in constant tension. Firstly, it must be active in encouraging the liberalisation and enhanced scope of minority shareholder protection. Its predecessor, s210 of the Companies Act 1948, which talked in terms of oppression6, was unduly restrictive and therefore redress could often only be had under the usually less than satisfactory remedy of what is now a s122(1)(g) winding-up. Secondly, as Lord Hoffmann mentioned in O’Neill7, the ambit of its application cannot be broadened too widely; minority protection must never be seen to be encroaching too substantially on majority rule. Indeed, ‘The concept of fairness must be applied judicially and the content which it is given by the courts must be based upon rational principles. As Warner J. memorably said in In re J. E. Cade & Son Ltd.8: “The court . . . has a very wide discretion, but it does not sit under a palm tree”.’9 Nevertheless, the courts, in something of a reversal from their previous non- interventionist position, with perhaps the teleological approach taken by the European Courts becoming increasingly more prevalent, still wield a considerable degree of discretion, and the wording and purposive interpretation of the section has conferred a wide power on the courts to do what appears ‘just and equitable’. The starting point for the notion of unfairness, and thus a s459 petition, must therefore always be the case of Ebrahimi v Westbourne Galleries.10 In re Saul D Harrison & Sons Plc.11, Lord Hoffmann agreed with the petitioner when he said the ‘only test for unfairness was whether a reasonable bystander would think that the conduct in question was unfair.’12 The court is therefore applying an objective standard of fairness, looking not at the nature of the unfairness, but the impact that that unfairness has had on the petitioner.13 In establishing 6 Viscount Simonds adopted the dictionary definition of the word i.e treatment which was ‘burdensome, harsh and wrong’: Scottish Co-operative Wholesale Society Ltd. v Meyer [1959] AC 324 7 O’Neill v Phillips [1999] 2 BCLC 1 at p.8g 8 [1992] B.C.L.C. 213, at 227 9 [1999] 2 BCLC 1 at p.7e 10 [1973] AC 360 11 [1995] 1 BCLC 14 12 Ibid. at p.17f 13 As was stated by Nourse J in Re RA Noble & Sons (Clothing) Ltd. [1983] BCLC 273, 290-291 when quoting the dictum of Slade J in Re Bovey Hotel ventures Ltd. (Unreported, 31 July 1981): ‘The test of unfairness must, I think, be an objective, not a subjective, one. In other words it is not necessary for the petitioner to show that the persons who have had de facto control of the company have acted as they did in the conscious knowledge that this was unfair to the petitioner or that they were acting in bad faith; the test, I think, is whether a reasonable bystander observing the consequences of their conduct, would regard it as having unfairly prejudiced the petitioner’s interests’. Page 5 (iv) Lord Hoffmann adverted to this specifically in his judgment: unfairness may be present when the majority maintains the parties’ association in circumstances where the minority ‘can reasonably say it did not agree to27’: non haec in foedera veni.28 Companies which reflect these features are often referred to as ‘quasi-partnerships’. This term, however, although now firmly subsumed into judicial parlance, must always be used with caution29. Nevertheless, it remains a useful gauge to differentiate between companies where equitable considerations arise and those where they do not have to be drawn, both in cases where winding up on the just and equitable ground is claimed, and where relief from unfairly prejudicial conduct is sought. This liberal, more expansive approach, having regard to equitable considerations over and above strict legal rights is testament to the fact that a 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.’30 This appraisal of the law has been giving statutory force in s459 when it is the ‘interests of its members’, and not just their legal rights, that may found a petition for unfair prejudice and thus embrace the ‘equitable considerations’ espoused by Lord Wilberforce above. It has been noted that to give a more precise definition of s459 may be unwise: ‘Illustrations may be used, but general words should remain general and not be reduced to the sum of particular instances'.31 Lord Hoffmann accepted this, stating that it is both impossible and undesirable to define exhaustively the circumstances in which equitable principles would preclude the exercise of legal rights; it was however the case that the manner in which ‘equitable principles operate is tolerably well settled and … it would be wrong to abandon them in favour of some wholly indefinite notion of fairness’.32 Indeed, because s459 petitions are often like a divorce, with lengthy and expensive litigation made even more exorbitant by spurious allegations and mudslinging hyperbole, the factors first espoused by Lord Wilberforce in Ebrahimi are essential because they will indicate when a petition is likely to succeed or not, and will therefore drive down the number of undeserving claims. Despite the Law Commission’s concerns about adopting such an approach, it will be necessary for ‘…a balance … to be struck between the breadth of the discretion given to the court and the principle of legal certainty.’33 Lord Hoffmann favoured this more restrictive approach, because in an area such as this, legal certainty is undoubtedly more desirous than ambiguous flexibility; parties must know of their relative success before embarking on such a lengthy and expensive journey. His Lordship was concerned too that the needle had perhaps shifted too far in favour of minority shareholders themselves, particularly in light of the Court of Appeal’s judgment in O’Neill34, where they held that 27 Virdi v Abbey Leisure Ltd. [1990] BCLC 342 28 [1999] 2 BCLC 1 at p.11d 29 In re Westbourne Galleries Ltd. [1973] AC 360 at p.380: ‘A company, however small, however domestic, is a company not a partnership or even a quasi-partnership …’ 30 Ebrahimi v Westbourne Galleries Ltd. [1972] 2 All ER 492 at 500 31 Supra. At p.496 32 [1999] 2 BCLC 1 at p.8h 33 Supra 34 Re a Company [1997] 2 BCLC 739 Page 6 Mr. O’Neill had been constructively ‘driven out’ of P Ltd. on facts that would not have rendered it unfair for Mr. Phillips to withdraw from the negotiations. Lord Hoffmann used O’Neill to establish the more restrictive approach to the principle of fairness, and, more pertinently, in light of the Court of Appeal’s reasoning in the case, to re-examine the notion of ‘legitimate expectation’, which he held to be parasitic in nature and not capable of an independent or wholly separate existence, and thus needed to be tightened up and redefined more systemically, after his Lordship felt that his judgment in Re Saul D Harrison35 was misapplied rather too frequently in subsequent cases. Legitimate Expectation The Court of Appeal in O’Neill, relying unduly heavily on Lord Hoffmann’s ‘legitimate expectation’ yardstick first adumbrated in Re a company36, found for Mr O’Neill, equating legitimate expectation as a precursor to unfairness, stating that if a legitimate expectation had been lost, then it invariably followed that it would be unfairly prejudicial to deny these expectations, and so a remedy under s461 should be given. In the present case, Mr. Phillips should offer to buy Mr. O’Neill’s shares at a fair value.37 Lord Hoffmann, presiding in the House of Lords, disagreed with the Court of Appeal, particularly their excessive reliance on ‘legitimate expectation’, which he said in his own judgment was perhaps ‘a mistake’ that he used this term.38 He said that it should only exist as a corollary to the equitable principles discussed below, and ‘should not be allowed to lead a life of its own’. It is implicit in his judgment that Hoffmann realised that his term had unduly broadened the ambit of successful redress under a s459 petition, and that the Court of Appeal ‘may have been misled by the expression’39 because they thought it was a cause, rather than a consequence, of the equitable restraint.40 A ‘legitimate expectation’ properly so called in the Hoffmann sense, could never be stretched to the facts of O’Neill, when what was in dispute was not even an unconditional promise, but a conditional agreement that would only be made concrete if O’Neill had indeed reached the goals set for him. ‘The real question is whether in fairness or equity Mr. O’Neill had a right to the shares. On this point, one runs up against what seems to me the insuperable obstacle of the judge’s finding that Mr. Phillips never agreed to give them’.41 No-Fault Divorce 35 [1995] 1 BCLC 14 36 [1986] BCLC 376 at 379. Hoffmann J., as his Lordship was then, imported the concept of legitimate expectation from administrative law. See Re Postgate and Denby(Agencies) Ltd. [1987] BCLC 8 at p.14 for a definitive account of the concept. 37 For what is a ‘fair value’ see later 38 [1999] 2 BCLC 1 at p.11h 39 [1999] 2 BCLC 1 at p.12h 40 See Co. Lawyer Vol.20 no.7 p.221 Page 7 Mr. O’Neill’s counsel, Mr. Hollington, raised the interesting notion of a no-fault separation, especially in relation to a quasi-partnership; in other words, it did not matter whether Mr. Phillips had done anything unfair, the fact of the case was that the mutual confidence and trust between the parties had irretrievably broken down and therefore there ought to be a ‘parting of the ways’, and the unfairness lay in Mr. Phillips, who was not prepared to settle it in this amicable way. In essence, Mr. O’Neill should be allowed to recover his stake in the company automatically. It must be noted at this juncture that Lord Hoffmann, when speaking of a ‘no-fault’ divorce, meant it in the specific sense that a member or members (usually the minority) of the company, in the absence of any impropriety by the majority, will still be able to sell his shares in the company, and did not mean it in the more general sense of a winding-up. A s122(1)(g) petition may be granted in a no-fault scenario (provided fault in this sense connotes a degree of unfairness or culpa) if the mutual trust and confidence of the parties have broken down to such a degree that it would be 'just and equitable’ to wind up the company. It would appear that Mr. Hollington was trying to merge together both s459 and s122(1)(g) by saying that it did not matter if Mr. Phillips had done anything unfair because the unfairness lay in not allowing Mr. O’Neill to recover his stake in the company. Surely this is just allowing s459 in by the back door by circumventing the crucial requirement of establishing unfairness before Mr. Phillips wished to be bought out? In this case, a s122(1)(g) petition would have been the more applicable action, when all that has transpired is the fact that the trust and confidence between the parties has broken down. Lord Hoffmann was highly dismissive of such a ‘stark right of unilateral withdrawal’42, and agreed with the Law Commission in that allowing recourse to such a notion would ‘fundamentally contravene the sanctity of the contract binding the members and the company’.43 By implication, therefore, Lord Hoffmann preserves the status of s122(1)(g), and despite Gower and other commentators’ contentions, the winding-up petition will remain an important remedy when all that can be established is that the mutual confidence between the parties has broken down to such an extent that it would be ‘just and equitable’ to wind up the company. However, its scope will be limited and only be adverted to as a ‘remedy of last resort’.44 Share valuation machinery and the ‘reasonable offer’ Where a petitioner is successful in showing that he has been treated in an unfairly prejudicial manner, the remedies available to the court are extensive.45 The most important and widely used order under s461 is undoubtedly the ability of the courts to make the respondent purchase the shares of the 41 [1999] 2 BCLC 1 at p.12h 42 [1999] 2 BCLC 1 at p.14f 43 Report No.246 (Law Society, 1997) at para. 3.66 44 Re A Company [1997] 1 BCLC 479 at p.487 45 Section 461 provides the court with an unlimited discretion in the granting of remedies for the relief of unfairly prejudicial conduct. Subsection 461(2) lists four (merely illustrative) orders. An order under s461(2)(d) providing for the purchase of the petitioner’s shares by other members of the company or the company itself is by far the most common. Page 10 be qualified by the case of North Holdings63, where resort to the court to value the shares at a ‘reasonable and proper’64 price was held to be needed, for it was thought that an accountant would not be competent to determine a fair price in light of the case’s complicated issue of mixed fact and law.65 Whether this approach taken by the Court of Appeal will be restricted to its particular facts, and only be used when an accountant could not possibly be asked to assess the valuation of a minority shareholding because of its complexity, or whether it will be applied more generally, is not known at present. In any event, it does seem to curtail the use of ‘the fair offer’, supported both by Lord Hoffmann and by the Law Commission66, to alleviate any question of unfairness, and might once again signal a return to superfluous litigation when recourse to an accountant would be the more practical solution in all but the most unique of cases. Despite Aldous LJ’s reasoning, in light of the facts of North Holdings itself, it would appear that an accountant would have been competent to evaluate a ‘fair offer’ since the profit made by Kasmare Ltd. From the use of Southern Tropics Ltd.’s assets would presumably have been only its saving of the additional costs of obtaining other funds or premises. O’Neill will thus have to be read with this qualification, however important it will prove to be in the future.67 What was not addressed in Hoffmann’s analysis was the time at which the shares should be valued. Should it, for example, be at the date the unfairly prejudicial conduct occurs, the date of the petition, the date of the judgment, or at some other date? Again, the courts have to always consider the overarching principle of fairness, and so any general rule is eschewed in favour of the courts doing what they think is fair in light of the circumstances of each case. Lord Hoffmann, since he had already given his interpretation of fairness, perhaps thought it was therefore unnecessary to opine on such matters, although more than tacit recognition of this area would have provided much needed clarification to a rather labile area of law. To highlight the inconsistency of the cases, in Re London School of Electronics Ltd.68, it was the ‘date of the order or the actual valuation [that] would be more appropriate than the date of the presentation of the petition or the unfair prejudice’; in Re Cumana Ltd.69 Vinelott J ordered shares to be valued as of the date of the petition as this was the ‘date on which the petitioner elects to treat the unfair conduct of the majority as in effect destroying the basis on which he agreed to continue to be a shareholder’. However, it would appear that the overriding principle of fairness ‘would by exceptions reduce it to no rule at all’.70 63 North Holdings Ltd. V Southern Tropics Ltd. [1999] 2 BCLC 625 64 Supra at p.668 65 Supra at p.635B. The facts of the case where that Mr. and Mrs Clarke had allegedly misused the assets of North Holdings to set up another company, Kasmare, which had made substantial profits, and this had unfairly prejudiced the other shareholder of North Holdings, who now demanded that, when they bought his shares, the value of them would reflect this. He felt that an accountant was unable to do this, and so resort to the law was the only practical consequence. 66 See above 67 See D Sellar Paper on Company Law 2000 at p.9 68 [1985] 3 WLR 474 at 484B 69 [1986] BCLC 430 70 Re London School of Electronics Ltd. [1986] Ch 211 at p.224 Page 11 The Court of Appeal in O’Neill also expressed considerable doubt71 about the availability of ‘expectation’ damages’ being paid as part of the fair value for the shares. Lord Hoffmann’s reasoning could be seen to implicitly concur on this point, and it seems unlikely in the future whether a fair valuation will include damages for a ‘loss of a chance’ of an entitlement to receive a certain sum of profits in the company. PART 2 The Interrelation between s459 and s122(1)(g) A s122(1)(g) petition, to wind up the company on just and equitable grounds is sometimes referred to as a ‘sledgehammer’ remedy; often the company that is to be wound up is still highly successful and prosperous, and the petition would be ‘tantamount to killing the goose that might lay the golden egg’.72 Indeed, it seems that the remedy has become increasingly dormant, and it would appear that Lord Hoffmann ascribes to it a very small area of effective operation, which might cast doubt on cases decided before O’Neill.73 One must now query exactly where the s122(1)(g) petition lies after the liberalisation of s210 into s459 of the companies Act 1985. Indeed, as a result of this, s125(2) of the Insolvency Act 1986 states that the court need not grant a winding-up order if it is of the opinion that some alternative remedy is available to the petitioners and that they have acted unreasonably in not pursuing it. This will help dissuade an aggrieved member from maliciously destroying the company when a less abrasive remedy would be more prudent; often the petitioner will use a s122(1)(g) petition purely for tactical considerations, even if it only results in pyrrhic victory. What the court has to evaluate is the reasonableness of the one petition over the other; unless the petitioner can show that it would be more reasonable for him to pray for an order under s122 rather than s459, then in the event that he cannot, it would seem, after the practice directive74, and s125(2), that the petitioner should be solely confined to the s461 remedies. It seems increasingly unlikely, in light of the statutory provisions and a growing body of case law which concludes that resort to s122(1)(g) should only be used when it is wholly impracticable to use any other remedy75, that a winding-up order on the ‘just and equitable’ 71 Re A Company [1997] 1 BCLC 479 at p.772 per Nourse J. 72 Gower’s principles of modern company law 6th Ed. P.750 73 See Re RA Noble & Sons (clothing) Ltd [1983] BCLC 273 and Jesner v Jarrad Properties Ltd. 1994 SLT 83 74 Chancery 1/90, [1990] 1 WLR 490 75 Re Full Cap International Trading Ltd. [1995] BCC 382 Page 12 ground will be granted. Does this mean, therefore, that the winding-up petition has ‘finally come of age?’76 The case law in this area is becoming increasingly difficult to reconcile without recourse to rather tenuous distinctions. To be sure, O’Neill places due regard on the fact that at all times it should be more difficult to obtain a winding-up than any other remedy under s461, and thus must be said to cast significant doubt on a number of important cases which seemed to suggest the converse of that proposition.77 Pre-O’Neill, it could be said that the case law conclusively proved that there was indeed a fundamental difference between the two remedies, although the relationship still remained somewhat problematic and the cases themselves often imprecise about their exact connection. What is clear, however, at least before O’Neill, is that the facts which go to the heart of the conduct of the parties might satisfy the test under section 122(1)(g) may not necessarily satisfy the test under section 459. In Re RA Noble & Sons (clothing) Ltd.78 the claimant failed to satisfy the requirements of a s459 petition. This was because, inter alia, while the treatment of the petitioner was undoubtedly prejudicial, it was not unfair; unfairness must always connote a degree of culpa in the actings of the defendant party, and, in the above case, the petitioner’s exclusion from participation in the company’s affairs was to a large extent due to his own apathy and 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 therefore the Ebrahimi test was satisfied. The confusion in some of the cases stems from the fact that although the very foundation of a successful s459 petition is constructed from the same building blocks that can found a winding-up order, because each use Ebrahimi as their starting point, and embrace the same equitable constraints therein, the identical nature of the remedies ceases completely at this stage. After that, s459, solely in the conduct that is required for a successful petition under it, is ‘completely different’79 from s122(1)(g). On this interpretation, the opinion of Lord Morison in Jesner is therefore correct on this point, and the decision will continue to have an important role to play in delimiting between the two remedies. However, it would appear from their judgments that both Lord Morision and Lord Justice Clerk Ross think that it would be easier to achieve redress under s122 than s459. In light of O’Neill, this must be open to considerable doubt. The case of Jesner seems to operate on similar lines to RA Noble and Sons, whereby all that is needed under s122(1)(g) is that it would be ‘just and equitable’ to wind up the company, and while, coupled with the criteria needed to fulfil a quasi-partnership, unfair prejudice would be a most potent example of this, no allegation of unfairness whatsoever may be made to bring a successful case under this head.80 Hoffmann himself said, ‘the parallel [between s122(1)(g) and s459] is not in the conduct 76 Gower’s principles of modern company law 6th Ed. P.750 77 In particular Jesner v Jarrad Properties Ltd. 1994 SLT 83 which is of binding precedent in the Scottish courts. 78 [1983] BCLC 273 79 Jesner v Jarrad Properties Ltd.1994 SLT 83 per Lord Morison at p.92I 80 Re RA Noble & Sons (clothing) Ltd. supra Page 15 was given in later cases, particularly regarding the term ‘legitimate expectation’.93 I think that Lord Hoffmann was desirous to once again lay down his formulation, pointing out the exact ambit and scope of each criterion, and applying the breaks to certain areas that, after his reasoning in Saul D94, became too enlarged. In the House of Lords he had the chance to set his judgment in stone. Does it, by implication, say all that needs to be said about s122(1)(g)? If we accept that Lord Hoffmann’s analysis of a no-fault divorce was constrained only to the facts of a buy-out, and not to a ‘parting of the ways’ in the sense of a winding-up, then it would seem that a s122 petition will still have an important role to fill, although it will be rather more limited in its practical application than first envisaged. If his concern, however, were centred on the latter, more general exposition, then it would appear that a s122 petition has been curtailed to the point of redundancy. Bibliography Textbooks Gower’s principles of modern company law (6th Ed.) Charlesworth & Morse Company Law (15th Ed.) Farrar Company Law (4th Ed.) Ferran Company Law and Corporate Finance (1st Ed.) Pennington’s Company Law (7th Ed.) Sealy’s Cases and Materials on Company Law (6th Ed. 1996) Andrew Hicks & SH Goo Cases and Materials on Company Law (3rd Ed. 1999) Articles DD Prentice The Theory of the Firm: Minority Shareholder Oppression: Sections 459-461 OJLS 1988 vol. 8 No.1 B Clark Unfairly Prejudicial Conduct SLT 1999 Issue 38 Robert Goddard An Oppressed Majority? Co. Lawyer Vol.20 no.7 p.241 Robert Goddard Closing the categories of unfair prejudice? Co. Lawyer Vol.20 no.10 p.333 View Jenny Payne and DD Prentice Section 459 of the Companies Act 1985 - The House of Lords’ (1999) 115 LQR 587 93 See the Court of Appeal decision of O’Neill: Re a Company [1997] 2 BCLC 739 94 [1995] 1 BCLC 14 Page 16 DD Prentice Minority Shareholder Oppression: Valuation of Shares (1986) 102 LQR 179 Comment Practical Solutions for unhappy shareholders Co. Lawyer Vol.20 no.7 p.221 Alistair Clark Unfair prejudice and the corporate quasi-partnership Co. Lawyer Vol.10 no.7 p.153 Stephen Griffin Defining the scope of a membership interest Co. Lawyer vol.14 no.3 p.64 Say Hak Goo The Companies Act 1985, s 459 and the Insolvency Act 1986, s 122(1)(g) Co. Lawyer vo.15 no.6 p.184 Riley (1992) 55 MLR 782 Lowry [1996] 17 Co Law 67 Sugarman Reconceptualising Company Law: reflections on the Law Commission’s Consultation paper on shareholder remedies: Part1 [1997] 18 Co Law 226 Roberts and Poole [1999] JBL 38 D Sellar Company Law 2000 Andrew Hicks Valuation of shares: a legal and accounting conundrum [1995] JBL 56 Commission Reports The Law Commission Shareholder Remedies (Law Com.No.246)