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Chapter 11: Minority ProtectionIntroduction It is clear from the rule in Foss v Harbottle (1843)that the majority member(s) holds the balance of power in a company. ◦This puts the interest of the minority member(s) in the company at risk. ◦In order balance majority rights with minority interest, the...

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Company Law Lecture

Chapter 11: Minority Protection Introduction • It is clear from the rule in Foss v Harbottle (1843) that the majority member(s) holds the balance of power in a company. ◦ This puts the interest of the minority member(s) in the company at risk. ◦ In order balance majority rights with minority interest, the law has introduced two remedies for an individual member to employ for their protection. ◦ The two remedies are (1) winding up order on ‘just and equitable’ ground under s.122(1)(g) of the Insolvency Act (IA) 1986, and (2) unfair prejudice petition under ss.994 and 996 of the Companies Act (CA) 2006. • Before going into the two remedies, it must be observed that the two remedies are not the only remedies available for a minority member to protect him/herself. ◦ As discussed in Chapter 8: Dealing with Insiders, if the rights of a member under the AA are infringed, a personal action defending the rights is possible (provided that the hurdles in the enforcement of AA are cleared); ◦ Also, if the interest of a minority member is threatened in the context of alteration of the AA, the range of options discussed in Chapter 8 and Chapter 9: Class Rights could also come to aid the minority member. ◦ Lastly, if what has been wronged is not the interest of a minority member, but of the company, then a derivative claim could be brought when the procedural requirements are satisfied. Winding up order on ‘just and equitable’ ground • s.122 of the IA 1986 provided a range of grounds upon which the court could wind up a company and only the last ground (s.122(1)(g)) is relevant to minority protection. ◦ In s.122(1)(g), the court could wind up the company if it is ‘of the opinion that it is just and equitable that the company should be wound up.’ ◦ The obvious question is therefore what is the meaning of ‘just and equitable’? • The case laws tell us of five situations in which the court would consider it ‘just and equitable’ to wind up a company. They are (1) substratum has failed, (2) fraud, (3) deadlock, (4) justifiable loss of confidence in the company’s management, and (5) exclusion from participation. ◦ Substratum has failed ▪ This is a situation where the commercial object (in the object clause1) of a company has failed or has been fulfilled (Re German Date Coffee Co. (1882)). 1

Note that companies formed under the CA 2006 are not required to have a commercial object, although they could have one if they choose to (s.31(1)).

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Company Law Lecture

◦ Fraud ▪ Fraud in the context occurs when a company has been formed by the promoters as a fraud engine against the shareholders (Re Thomas Edward Brinsmead & Sons [1897]). ◦ Deadlock ▪ Deadlock referred to here refers to a breakdown of the relationship of the parties (usually member/director) that disables the proper function of the company, and there is no hope of reconciliation (Re Yenidje Tobacco Co. Ltd [1916]). ▪ Such situation will usually happens only in a quasi-partnership. ◦ Justifiable loss of confidence in the company’s management ▪ This is a scenario where the members have lost confidence in the competence/probity of the management, provided that the company is a quasi-partnership. ▪ As it is really quite subjective as to what incompetence or a lack of probity means in this context, you should study the facts of Loch v John Blackwood Ltd [1924] to know extent required to justify winding-up. ◦ Exclusion from participation ▪ The picture here is where a quasi-partnership reflects an understanding that the members will participate in management, there is a restriction on the transfer of the members’ interest, and a member has been excluded from participation in the company’s management. ▪ Ebrahimi v Westbourne Galleries Ltd [1973] is not only the case illustrating this ground, but also a key case on the meaning of ‘quasi-partnership’ as well as the idea of ‘equitable restraints’. → This case also greatly influence the development of the case laws under the s.994 remedy. • Quasi-partnership? ◦ Three of the grounds mentioned above concern quasi-partnership, but there is no fixed legal meaning on what a quasi-partnership is. ◦ Quasi-partnership can be said to be a small and private company that functions much like a partnership, with personal relationships between the members (who are usually the directors as well) being the foundation of the company. ◦ Such personal relationships often reflect understanding or informal agreements as to the functioning of the company, and such understanding or agreements are often not reflected in the AA of the company. • Besides the grounds for bringing the petition, you also need to know who has the right to bring such petition. ◦ s.124 IA 1986 states that, inter alia, the company, its director(s), its creditor(s), contributory(ies) to the company, and a liquidator all have a right to bring a petition for winding-up. 2

© 2019 Chang Wei Sheng

Company Law Lecture

▪ A contributory is a person who is liable to contribute to the assets of the company in the event of a winding-up according to s.79 IA 1986, and s.74 IA 1986 provides that every member past and present is a ‘contributory’. ▪ Thus, a member has the right to bring a petition for winding-up. ◦ A related issue to a member bringing the petition is the petitioner’s conduct. ▪ Under the s.994 remedy (to be discussed below), if the petitioner bears (or at least shares) the blame for the breakdown of the relationship, remedy would be refused. ▪ However, this is not so for the winding-up remedy; in Re RA Noble & Sons (Clothing) Ltd [1983], a winding-up order was granted even though the petitioner was substantially at fault for the breakdown of the relationship. • Finally, you should note that a winding-up order has very harsh effects and is considered as a remedy of the last resort. ◦ It breaks up the company and distribute the remaining assets to the members, which is harsh because not every member wishes for a breakup even though the petitioner wishes for one. ◦ Besides, once the petition is brought, the company cannot function as usual. ▪ s.127 IA 1986 provides that any disposition of the company’s property, and any transfer of shares etc made after the petition is void. ▪ This means that those transactions are liable to be set aside. ▪ Banks will also freeze the company’s accounts once notified of the petition (Re XYZ Ltd [1987]). Unfair prejudice petition • At a time before the unfair prejudice petition, a 1945 Cohen Committee report found that the minority in a company had faced difficulty in challenging the conduct of the majority. ◦ The only real means was the winding-up order, which is not beneficial as the breakup value is small; the Committee thus recommended that the court should be given discretion to impose remedy that is ‘just and equitable’. • The oppression remedy introduced under s.210 CA 1948 was the answer. ◦ Under this provision, the minority could challenge the majority if there is ‘oppression’ on the part of the majority. ◦ However, the remedy was found largely unsuccessful because: ▪ Oppression meant burdensome, harsh, and wrongful (SCWS Ltd v Meyer [1959]) and it was difficult to establish that; ▪ Oppression will only be proven if the oppressive conduct was continuous (Re HR Harmer Ltd [1959]); and

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Company Law Lecture

▪ Remedy will only be granted if the oppression affected the rights (as opposed to the interests) of the members. • After another report in 1962, this time by the Jenkins Committee, which reviewed the oppression remedy and recommended a new remedy that would ‘extend to cases in which the acts complained of fall short of actual illegality’, the unfair prejudice petition was introduced. ◦ The remedy was first introduced in s.459 CA 1985, and is today reproduced in s.994 CA 2006. • Read s.994(1) CA 2006. ◦ s.994(1) CA 2006 provides that a member2 of a company may bring a petition, and followed by the ground in s.994(1)(a) and (b). ◦ For the purpose of convenient study, the ground can be broken down into three elements: the conduct of company’s affairs, members’ interests, and unfair prejudice. You should, however, note that in cases the judges do not see the three elements as distinct, because the elements are inter-related components of a single ground. ◦ The conduct of company’s affairs ▪ The unfair prejudice complained of occur in the conduct of the company’s affairs, as opposed to the personal dealings between the members. → In Re Legal Costs Negotiators Ltd [1999], the refusal to sell shares as a member was held not related to company’s affairs. → In Re Coroin Ltd [2012], it was held that personal disputes between members do not relate to company’s affairs. ▪ However, if the personal dealings/disputes have bearings (even indirect ones) on the management/functioning of the company, it will be considered as part of company’s affairs. → In Re Home & Office Fire Extinguishers Ltd [2012], it was held that if the personal dispute made it impossible for the members to work together, it relates to company’s affairs. → In Graham v Every [2014], a non-observance of a pre-emption clause was held to relate to company’s affairs because it has indirect bearings on the directors’ remuneration - which is a matter considered to be company’s affairs. → In Oak Investment Partners XII, Limited Partnership v Boughtwood [2009], the court held that company’s affairs concern substance rather than form, and the court is to take account of all the myriad different ways in which the affairs of a company might be carried on.

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The definition of a ‘member’ usually does not prove controversial in exams. However, Lowry & Dignam discusses it. Read the part on locus standi under unfairly prejudicial conduct for more.

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Company Law Lecture

• In other words, personal dealings or not (the form), as long as it relates to company’s affairs (the substance), the first element will be established. ▪ See Nicolas v Soundcraft Electronics Ltd [1993] and Re City Branch Group Ltd, Gross v Rackind [2005], for when the conduct of the company’s affairs of a parent may be deemed as the company’s affairs of the subsidiary and vice versa. ▪ One final note of company’s affairs is that a member can complain of unfair prejudice in a company’s affair that occurred before he/she became a member (Lloyd v Casey [2001]). ◦ Members’ interests ▪ The unfair prejudice complained of must affect the ‘interests of members generally, or of some part of its members’ (s.994(1)(a)). ▪ The first question to be asked here is what are interests? → In Re Sam Weller & Sons Ltd [1990], Peter Gibson J held that ‘interests’ is term that is wider than ‘rights’. • Rights of members can only stem from either the statute or the company’s constitution. • This means that interests are not confined within the boundaries of the statutes or the company’s constitution (Re a Company (No. 0047 of 1986) [1986]). → Although interests are a concept that is wider than rights, the interests affected must be, after all, the interests of members in the capacity of members (Re a Company (No. 0047 of 1986) [1986]). ▪ The next question to be asked in the elucidation of the concept of ‘interests’ is how then, are we supposed to determine the interests of the members in a company? → Prior to the landmark case of O’Neill v Phillips [1999], the approach was to determine if the member complaining unfair prejudice had any legitimate expectation for the offending party to act otherwise. • E.g. if the member can prove he has a legitimate expectation to participate in the management of the company as a director, then his removal as a director could be said to affect his interest. → Legitimate expectation here can arise either from the company’s constitution, or the informal agreement/understanding between the members (Re Fildes Bros Ltd [1970]). • However, in finding the legitimate expectation of members, the court will start with the company’s constitution, and will not look beyond it unless there is ‘something more’ on the facts (Re Saul D Harrison & Sons plc [1995]). 5

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Company Law Lecture

• What then is this ‘something more’? In the cases where the court found legitimate expectation outside of the company’s constitution, ◦ the companies were usually quasi-partnership that reflect an understanding (and thus give rise to a legitimate expectation) that a constitutional power (e.g. the power to remove a director) will not be exercised; or ◦ a power in the company’s constitution was exercised for an improper purpose. • Moreover, in a public limited company that will never be considered as a quasi-partnership3 the court will not look beyond the company’s constitution to find legitimate expectation (Re Blue Arrow plc [1987]). → Post O’Neill v Phillips [1999], the approach remains the same so far as the ‘not looking beyond company’s constitution without something more’ is concerned, but the court chose replaced the concept of ‘legitimate expectation’ with ‘equitable restraints’. • The court now chooses to see the informal understanding in a quasi-partnership as giving rise not to a legitimate expectation that a certain constitutional power will not be exercised, but that the understanding gives rise to an equitable restraint that restrain the exercise of the constitutional power. • While the practical effect will be the same, theoretically there is quite a radical difference. ◦ Under the concept of ‘legitimate expectation’, the court started with the member and say that the minority could expect the majority not to use a constitutional power. ◦ Under the concept of ‘equitable restraints’ however, the court starts with the majority by saying that legally they have a right to exercise their power, but equity steps in to constrain that exercise because of the informal understanding they have reached with the minority. ◦ Unfair prejudice ▪ Unfair prejudice is at the centre of this petition; there must be unfair prejudice in the conduct of the company’s affairs that affects the interest of members. But what is unfair prejudice? ▪ Although unfairness and prejudice mean different things4, the two are usually considered together. → Again, prior to O’Neill v Phillips [1999], the approach was an objective one - whether a reasonable bystander observing the 3

Can you think why a public limited company will never be a quasi-partnership?

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Unfairness means ‘A visible departure from the standards of fair dealing and a violation of the conditions of fair play on which every shareholder who entrusts his money to a company is entitled to rely’ (Jenkins Committee), and prejudice means a damage to member’s interest – whether financial or not (Re Coroin Ltd [2012]).

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Company Law Lecture

consequences of the majority’s conduct, would regard it as having unfairly prejudiced the petitioner’s interests (Re Bovey Hotel Ventures Ltd [1981]). → The House of Lords in O’Neill v Phillips [1999] introduced an open-textured approach in assessing unfair prejudice. In other words, overall conclusion must be formed by assessing and interpreting all relevant circumstances, especially the informal understanding of the parties. • The facts of O’Neill v Phillips [1999] are important for you to understand this open-textured approach. ▪ The case laws recognised instances where there has been unfair prejudice and these cases could also be a guide. The instances are: → When there is exclusion from management • Only when there is a quasi-partnership and the understanding reflects that the petitioner should participate in management. • There will be no unfair prejudice if it is a public limited company (Re Tottenham Hotspur plc [1994]), or where the petitioner is to be blamed for the exclusion (Re RA Noble & Sons (Clothing) Ltd [1983]). → When there is mismanagement • The general rule is that mismanagement will not be unfairly prejudicial to members’ interest if it is a matter of poor management (Re Elgindata Ltd [1991]; Oak Investment Partners XII, Limited Partnership v Boughtwood [2009]). • However, if it is proven that the directors had abused their powers or exercised them for some ulterior purpose so as to step outside the bargain between the shareholders and the company, then unfair prejudice will be established (Re Saul D Harrison [1995]). → When there is a breach of directors’ fiduciary duties • Re London School of Electronics Ltd [1986], Re Little Olympian Each-Ways Ltd (No 3) [1994], Re Baumler (UK) Ltd [2005] all provide good examples. → When there are excessive remuneration and the failure to pay dividends • The general attitude of the court is disinclination to interfere with the business judgement of the board, and so provided it has honestly and genuinely determined the level of remuneration the court will not enquire whether the award was reasonable (Re Halt Garages (1964) Ltd [1982]). • However, if remuneration and dividend levels cannot be justified by ‘objective commercial criteria’, then unfair prejudice could be established (Re a Company (No 004415 of 1996) [1996]). 7

© 2019 Chang Wei Sheng

Company Law Lecture

• See also Re Cumana Ltd [1986], Re Saul D Harrison [1985] and Anderson v Hogg [2001]. • If the ground in s.994 is established, the court under s.996(1) CA 2006 ‘may make such order as it thinks fit for giving relief in respect of the matters complained of. ◦ Two points are to be observed from this power-conferring section: ▪ The court has wide discretion to give any order as it thinks fit. → The discretion is so wide that the court could even award damages for reflective loss under this remedy (Re Brightview Ltd [2004]). → Perhaps the only limitation is winding-up order. Given that winding-up order is still a remedy to be granted under s.122 IA 1986, the court has no discretion to grant it under s.9965. ▪ The objective of the remedy is to give relief, and not necessarily complete protection of the minority. → Indeed, the court will take into account all relevant circumstances such as the rights of the majority, the conduct of the minority etc in order to strike a balance and give the most appropriate remedy. → In Re a Company (No 00314 of 1989) [1989], Mummery J held that The 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.

• s.996(1) conferred the wide discretion to the court, s.996(2) listed down non-exhaustive options for the court to exercise when giving relief. Read s.996(2). ◦ In the case laws there is a presumption in favour of exercising the last option in s.996(2)(e) (Grace v Biagioli [2005]) ◦ Known as the ‘buy-out order’, the option in s.996(2)(e) is an order of the court for the shares of any members to be bought out by other members/the company. ▪ Given the usual scenarios involving s.994, i.e. minority complaining of the unfair prejudice in the conduct of the company’s affairs, the court usually order the shares of the minority to be bought out by the majority.

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Note Re Phoneer Ltd [2002].

© 2019 Chang Wei Sheng

Company Law Lecture

▪ This may not be the most desirable option for the minority6 but it would, most of the time, be the most appropriate remedy for the company.7 ▪ However, if the majority is found unfit to exercise control of the company, the court could order the majority’s shares to be bought out by the minority. (Re Nuneaton Borough Association Football Club Ltd [1989]). ◦ Given that in the usual scenario of the majority buying out the minority, the objective is to give the minority a fair exit, the crucial point would thus be the valuation of the shares in a buy-out order. ▪ In a public limited company, the share price is dependent on the market; in a private limited company, a valuatio...