Company - week 6 notes PDF

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Company – week 6Managing companies: minority shareholder remediesCovering: Unfair prejudice  Just and equitable winding up  Derivative claims  Personal claims and specific statutory rightsMinority shareholders and the ‘majority rule’ principle: As you know, the directors are responsible for the...

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Company – week 6 Managing companies: minority shareholder remedies

Covering:    

Unfair prejudice Just and equitable winding up Derivative claims Personal claims and specific statutory rights

Minority shareholders and the ‘majority rule’ principle: 

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As you know, the directors are responsible for the day-to-day running of the company and have the authority necessary to act on the company's behalf in this regard (MA 3). Certain key decisions require shareholder approval eg amending the company's articles (s 21). However, all of these decisions require either an ordinary resolution (over 50% vote in favour) or a special resolution (75% or more). Both the directors and shareholders act by majority and the principle of "majority rule" pervades company law. A minority shareholder often has little impact on shareholder voting and therefore little input into the way in which the company is managed. There therefore needs to be a remedy in appropriate circumstances for minority shareholders, where the majority abuse their position, mismanage the company, or act unfairly. However, the law needs to be carefully balanced, since otherwise a litigious or vexatious shareholder could obstruct the company's legitimate business.

Unfair prejudice – s 994 – 996: 

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Historically, minority shareholders had little recourse when seeking to challenge the conduct of the majority, with the only remedy being to petition the court for the company to be wound up on the grounds that it was just and equitable to do so. However, generally, the winding up of the company did not benefit the minority shareholders as the break-up value of the assets of the company may be low, or the only available purchaser may be the majority shareholder whose oppression had caused the minority shareholder to seek a remedy in the first place. The introduction of the action for unfair prejudice sought to provide minority shareholders with a better remedy.

Section 994(1) provides that: 

"A member of a company may apply to the court by petition for an order … on the ground:

(a) that the company’s affairs are being or have been 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), or (b) that any actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial." 

We will look at the case law in order to understand what types of conduct will be found to constitute unfair prejudice. The key case is that of O'Neill v Phillips.

Following this case, in order to establish unfair prejudice, a petitioner must prove: Breach of contract (the articles or a shareholders' agreement), or Breach of some fundamental understanding. 

A claim for unfair prejudice can be brought by any shareholder. The most common remedy the court will grant is an order for the purchase of the petitioner’s shares.

Just & equitable winding up 

This was historically the only remedy available to an aggrieved minority shareholder, before the introduction of claims for unfair prejudice. Petitions for just and equitable winding up are now relatively rare.

This remedy is set out in s 122(1)(g) Insolvency Act 1986 (IA 1986), which states:   

"A company may be wound up by the court if the court is of the opinion that it is just and equitable that the company should be wound up." Any member may petition the court for the company to be wound up on the grounds that it is just and equitable to do so under s 122(1)(g) IA 1986. This is an equitable remedy, and the court has a wide discretion as to whether to make the order. However, it is a draconian remedy, resulting in the end of the life of the company, and therefore will not be ordered where another remedy is available. Often, the shareholder may have grounds for a claim for unfair prejudice, and if this is the case then the court would not allow the winding up of the company.

Typical grounds on which companies have been wound up include:  

Company's substratum has failed (rare now considering s 31(1) CA 2006) Fraud

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Deadlock Justifiable loss of confidence in the company's management Exclusion from participation in a small private company where there was a relationship based on mutual confidence.

Derivative claims 

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A "derivative claim" is a claim brought by a member in respect of a cause of action vested in the company, seeking relief on behalf of the company. As you know, the doctrine of separate legal personality (Salomon) means that the company can sue and be sued in its own name. Where the company has suffered loss, it is therefore the company that is the proper claimant. However, companies are inanimate and therefore can only act through their directors, or in certain circumstances, through the members by majority vote in general meeting. Where the loss has been caused by the action of an internal stakeholder, for example one or more directors, or the majority of the members, clearly vested interests may prevent the company from bringing an action. The law therefore allows members to bring a claim on the company’s behalf in certain circumstances. The disadvantage of derivative claims is that the relief gained is only awarded to the company, not the individual member bringing proceedings. The advantage of derivative claims are that they allow individual members to "right a wrong" on behalf of the company in circumstances where the company itself does not bring a claim.

Under the statutory procedure: 1. A claim may be brought by any member - s260(1). 2. A claim may be brought against any director and/or another person, including former directors - s260(3)/(5) 3. The grounds for bringing a claim: any act or omission, actual or proposed, involving negligence, default, breach of duty or breach of trust by a director - s260(3). Note that it is immaterial whether the cause of action arose before or after the claimant became a shareholder – s260(4) 

There is a two-stage permission process for a derivative claim to be brought, which enables the court to quickly dismiss vexatious or groundless cases. Derivative claims are very rare in practice.

Personal claims and specific statutory minority rights

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In addition to the claims for unfair prejudice or just and equitable winding up that we have already considered, where a personal right of a shareholder has been infringed by the majority, the board or an outsider, the individual shareholder may be able to bring a claim to recover loss suffered under the general principles of contract or tort law. These claims often arise from breaches of the company's constitution (the articles) or a shareholders' agreement. The key issue is to look at the loss suffered and whether it is “reflective loss” or whether the shareholder has suffered loss to them personally in addition to the loss suffered by the company. Where the alleged wrong results in a loss to the company as well as the shareholder and the ONLY loss alleged to have been suffered by the shareholder is in fact a reflection of the loss sustained by the company (eg the shareholder's shares have decreased in value due to the wrong suffered by the company), the courts will not allow the shareholder to bring a personal claim. However, where the shareholder can establish that the defendant's conduct constituted a breach of a legal duty owed to them personally (eg in contract or tort) and that the breach of duty caused them personal loss, separate and distinct from the loss caused to the company, they will be permitted to bring a personal action.

Minority shareholders have a number of specific statutory protections, in addition to the statutory remedies of unfair prejudice and just and equitable winding up considered earlier in this topic. These specific statutory protections include:   

Protection against alteration to the company's constitution (s 21); The right to requisition a general meeting (s 303 – 305); The right to demand a poll vote (s 321).

1. Unfair prejudice

Minority shareholders  

Both the directors and shareholders act by majority and the principle of ‘majority rule’ pervades company law. Therefore, a minority shareholder often has little impact – there needs to be a remedy in appropriate circumstances for minority shareholders.

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This is needed in instances when the majority abuse their position, mismanage the company, or act unfairly.

Rights of minority shareholders     

Unfair prejudice Just and equitable winding up Derivative claims Personal claims Costly and uncertain: shareholders instead advised to enter into shareholder agreements

Development of the law relating to unfair prejudice   

Firstly, only just and equitable winding up Winding up didn’t benefit them – break-up value of the assets were too low, or the only available purchaser was the majority shareholder who caused the oppression in the first place. Introduction of unfair prejudice, not set out in s 994 CA 2006

Unfair prejudice – s 994 – 996 CA 2006 Section 994(1) provides that: "A member of a company may apply to the court by petition for an order … on the ground: (a) that the company’s affairs are being or have been 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), or (b) that any actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial."

(1) Conduct of the company's affairs 

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In order to succeed with a petition under s 994(1), a petitioner must establish unfairly prejudicial conduct arising from an act or omission of the company, or made on the company's behalf. The conduct complained of must be an act or acts done by the company (eg by the directors), not the conduct of an individual shareholder acting in their private capacity. The complaint must relate to how the affairs of the company have been managed personal disputes between shareholders fall outside the scope of s 994.

Re Legal Costs Negotiators Ltd [1999] 2 BCLC 171 CA:  

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This company was incorporated by four individuals who were equal shareholders, directors and employees. Unfortunately, relations broke down and the fourth individual was dismissed as an employee and resigned as a director just before he was to be removed. He remained as a shareholder and refused to sell his shares to the other three, who petitioned under s 459 seeking an order that he transfer his shares to them. The Court of Appeal rejected this petition on the basis that the other three shareholders, being the majority, could prevent any prejudice from this shareholder. It was held that simply remaining as a shareholder was not conduct relating to the company's affairs.

Re Home & Office Fire Extinguishers Ltd [2012] All ER D 31: 

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This case illustrates that there may be an overlap between the requirement that the conduct relates to the company's affairs and personal disputes where such disputes make it impossible for the parties to continue working together as directors/shareholders. In this case two brothers, S and G, were directors and equal shareholders in the company. S attacked G with a hammer at the company's premises following G's refusal to make a salary advance. S was charged with grievous bodily harm but acquitted. The court ordered S to sell his shares to G, holding that S's conduct related to the affairs of the company because it was a breach of the implied understanding that S and G would act properly and in good faith towards each other.

Re City Branch Group Ltd, Gross v Rackind [2005] BCC 11: 

The court in this case held that the conduct of a subsidiary could be regarded as falling within the affairs of a holding company, especially in the situation in this case where the directors of the holding company and subsidiary are the same or substantially the same.

(2) Interests of the members   

The petitioner must also prove that their interests in their capacity as a member have been unfairly prejudiced as a result of conduct on the part of the company. This requirement is construed widely. For example, members have an interest in the value of their shares and will therefore be able to bring a claim if they can show that "the value of their shareholding has been

seriously jeopardized by reason of a course of conduct on the part of those persons who have had de facto control of the company, which has been unfair to the member concerned" Re Bovey Hotel Ventures Ltd (1981).

Gamlestaden Fastigheter AB v Baltic Partner Ltd [2007] UKPC 26: 

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In this case a member had provided a loan to the company and the issue was whether the member's petition should be struck out in circumstances where the company was insolvent and the relief sought (payment of compensation by the directors to the company) would confer no financial benefit on this member in his capacity as a member. The Privy Council held that "interests" may extend to cover those of a member who is a creditor as in this case where, in the circumstances, the distinction becomes artificial.

(3) Unfair prejudice 

The leading authority in the interpretation of "unfair prejudice" is the House of Lords case of O'Neill v Phillips.

O'Neill v Phillips [1999] 1 WLR 1092 HL:     

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The petitioner, O, was employed by the company, whose sole director and shareholder was originally P. P was impressed with O's work and in 1985 O was awarded 25% of the company's shares and made a director. P told O that he would eventually take over the business and would then receive 50% of the profits. In December 1985 P retired from the board and O became the sole director. The business initially did well but then began to decline and in August 1991 P used his majority voting rights to appoint himself managing director and took over management of the business, telling O that he would no longer receive 50% of the profits, or receive certain share incentives. O issued a petition for unfair prejudice based on a legitimate expectation of receiving 50% of the voting shares. The House of Lords held that there was no unfair prejudice here as the entitlement to 50% of the profits was never formalized and was conditional on O running the business, which he was no longer doing.

Hoffmann LJ in O'Neill v Phillips stated that fairness for the purposes of s 994 must be viewed in the context of a commercial relationship and that the relationship between the shareholders and the company is set out in the articles, which must be the starting point when determining whether conduct was unfair.

In Re Tobian Properties Ltd [2012] EWCA Civ 998 Arden LJ stated: "The key phrase in section 994(1), ‘unfairly prejudicial’, comprises two elements, unfairness and prejudice but both of these must be understood in the context of company law. The concept of fairness inherent in this phrase is flexible and open-textured but it is not unbounded. The courts must act on a principled basis even though the concept is to be approached flexibly. They cannot decide whether to grant or refuse relief from unfair prejudice on the basis of palm-tree justice."

Unfair prejudice – summary Following O'Neill v Phillips, in order to establish unfair prejudice, a petitioner must prove: • Breach of contract (the articles or a shareholders' agreement), or • Breach of some fundamental understanding. The court will begin by looking at whether the conduct complained about is in accordance with the articles. The court will next consider the scope of any fundamental understandings between the parties. Unfairness must be tested by looking at whether the majority had acted or was proposing to act in a manner which equity would regard as contrary to good faith. Unlawful conduct will not necessarily be unfairly prejudicial, and trivial or technical infringements of the articles may not give grounds for a s 994 petition.

Examples of unfairly prejudicial conduct 1. Exclusion from management This is the most common ground for unfair prejudice petitions. 

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In a small quasi-partnership private company, a member may expect to continue to participate in the management of the company on the basis of a fundamental understanding between the parties, despite the fact that any director may be validly removed from office by an ordinary resolution of the members under s 168 CA 2006. However, this will not be the case in larger companies with outside investors. It is also not the case that in every small quasi-partnership company, the removal from office of a director will automatically give rise to an unfair prejudice claim – there needs to be some conduct which is "unfairly prejudicial" regarding the removal.

Re Tottenham Hotspur plc **[1994] 1 BCLC 655:**

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Terry Venables, chief executive of Tottenham Hotspur football club, brought a petition claiming unfair prejudice after he was dismissed from office. It was held that he had no legitimate expectation of remaining in control of the company, so the action failed.

2. Mismanagement 

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In general, poor management of a company will not give rise to a claim for unfair prejudice, since the courts are very reluctant to find that management decisions amount to unfair conduct. It has been held that the risk of poor management is inherent in share ownership and the courts will not interfere with a bona fide business decision made by a company’s board or its majority shareholders except where there is a clear conflict of interests (Re Elgindata Ltd [1991] BCLC 959). However, where the directors have abused their powers or exercised them for some ulterior purpose, an allegation of mismanagement may amount to unfair prejudice.

Re Macro (Ipswich) Ltd **[1994] 2 BCLC 354:**   

In this case an allegation of mismanagement over 40 years resulting in economic loss to the company was found to amount to unfairly prejudicial conduct. Here the sole director of the two associated companies neglected his management responsibilities allowing dishonest employees to steal from the company. The petitioners successfully argued that substantial financial losses were suffered by the companies as a result, which caused unfair prejudice to them.

3. Breach of directors' fiduciary duties This is a common ground for petitions for unfair prejudice and there have been a number of successful petitions brought on this ground. Examples are set out below. **Re London School of Electronics****[1986] Ch 211:** 

In this case the petition for unfair prejudice succeeded where those in control of the company had misappropriated its assets by diverting them to another business owned by them.

Re Little Olympian Each-Ways Ltd (No 3) **[1995] 2 BCLC 420, ChD:** 

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The directors sold the company's business at a substantial undervalue to another company as part of a wider transaction in which the directors received significant personal benefit. This was held to be unfairly prejudicial conduct.

Re A Company (No 005287 of 1985) [1986] BCLC 68:

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In this case the petition for unfair prejudice succeeded on the grounds that the directors had made secret profits.

4. Excessive remuneration and refusal to pay dividends 

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Althou...