Minority Shareholder Remedies - Revision PDF

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Co law 6: Minority Shareholderremedies - RevisionI. Unfair PrejudiceMinority shareholders  RECAP: Directors responsible for day-to-day running, though certain decisions require shareholders approval, e. amending the company’s articles (s 21), granting a director a long-term service contract (s 188)...

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Co law 6: Minority Shareholder remedies - Revision I. Unfair Prejudice Minority shareholders  RECAP: Directors responsible for day-to-day running, though certain decisions require shareholders approval, e.g. amending the company’s articles (s 21), granting a director a long-term service contract (s 188), making loan to a director (s 197), removing a director from office (s 168). However, all of these decisions require either an ordinary or special resolution.  THUS, 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 needs to be a remedy in appropriate circumstances for minority shareholders, where the majority abuse their position, mismanage the company, or act unfairly; however, law needs to be carefully balanced since otherwise a litigious or vexatious shareholder could obstruct the company’s legitimate business. Rights of minority shareholders  CA 2006 does allow minority shareholders certain limited remedies where the management of the company causes them prejudice or loss – however, these claims are costly to bring and uncertain in outcome, as the court has a wide discretion as to remedies. In order to protect their position, shareholders are instead advised to enter into Shareholders’ Agreements.  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 grounds it was just and equitable to do so. **The introduction of the action of UNFAIR PREJUDICE sought to provide minority shareholders with a better remedy. This remedy was initially set out in s 459 CA 1985, now s 994 CA 2006.  So, unfair prejudice is a statutory remedy for members in relation to wrongs done to them personally (not in relation to wrongs don to the company) 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. Analysis (i) Conduct of the company’s affairs  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 done by the company not the conduct of an individual shareholder acting in his 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.  Legal Costs Negotiators Ltd: four individuals all equal shareholders, directors and employees. One dismissed as employee and refuses to sell shares to the other three – who petition under s 994 CA 85 for order he transfer shares to them. COA rejected petition on basis that other three shareholders, being majority, could prevent any prejudice from this shareholder. Was held that simply remaining as a shareholder was not conduct relating to the company’s affairs.  Re Home & Office Fire extinguishers: Illustrates there may be an overlap between the requirement that 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. Two brothers, directors and equal shareholders, S attacked G, court orders S to sell his shares to G holding that S’s conduct related to affairs of the company because was a breach of the implied understanding that S & G would act properly & in good faith towards each other.  Re City Branch Group Ltd, Gross v Racking: Court held that conduct of a subsidiary could be regarded as falling within affairs of a holding company, especially when directors the same. (ii) Interests of the members  The petitioner must also prove that his interests in his 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 jeopardised 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).

 Gamblestaden Fastigher AB v Baltic Partner Ltd: member was a creditor and issue was whether member’s petition should be struck out in circumstances where the company was insolvent and the relief sought (payment of compensation by the directors of the company) would confer no financial benefit on this member in his capacity as a member. 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. (iii) Unfair Prejudice  Leading authority in the interpretation of ‘’unfair prejudice’’ is the HoL case of:  O’Neill v Phillips: Petitioner, O, employed by company, whose sole director and shareholder was originally P. P impressed with O awards him 25% shares and makes him director, also tells him 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 sole director – declines and in August 1991 P used his majority voting right 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 petition for unfair prejudice based on a legitimate expectation of receiving 50% of voting shares. HoL held there was no unfair prejudice as entitlement to 50% of profits was never formalised and was conditional on O running the business, which he was no longer doing.  ^Hoffman in O’Neill stated that fairness for the purposes of s 994 must be viewed in the context of commercial relationship and that the relationship between the shareholders and is set out in the articles, which must be the starting point when determining whether conduct was unfair. ***Following O’Neill v Phillips, in order to establish unfair prejudice, a petitioner must prove: a) Breach of contract (the articles or a shareholder’s agreement), or b) Breach of some fundamental understanding  SO, the courts will begin by looking at whether the conduct complained about is in accordance with the articles.  Then 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 s994 petition. Examples of unfairly prejudicial conduct 1. Exclusion from management  Most common ground for unfair prejudice petitions

 In a small quasi-partnership 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 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 Hotspure plc – chief executive claimed unfair prejudice after he was dismissed from office. Held he had no legitimate expectation of remaining in control of the company, so action failed. 2. Mismanagement  In general, poor management of a company will not give rise to a claim for unfair prejudice, since courts reluctant to find management decisions amount to unfair conduct. It has been held that the risk of poor is inherent in share ownership and 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) 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 – allegation of mismanagement over 40 years resulting in economic loss to the company was found to amount to unfairly prejudicial conduct. 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 on this ground.  Re London School of Electronics: 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: Directors sold the company’s business for a substantial undervalue to another company as part of a wide transaction in which the directors received significant personal benefit. This was held to be unfairly prejudicial conduct. 4. Excessive remuneration and refusal to pay dividends  In practise the power to determine directors’ remuneration is delegated to the board. It is clear that there is ample scope here for abuse of power, and in these cases the court will be prepared to hold that failure to pay dividends and/or directors’ awarding themselves excessive remuneration will be unfairly prejudicial conduct. Re a Company: Courts held that if remuneration and dividends level cannot be justified by ‘’objective commercial criteria’’ then it would follow that the affairs of the company have been managed in a way which is unfairly prejudicial to the interests of shareholders who are not directors.

Who may bring a claim for unfair prejudice?  Under s 994(1) the petition for unfair prejudice may be brought by a ‘’member’’ of the company. S 112 defines a ‘’member’’ as a subscriber to the company’s memorandum and ‘’every other person who agrees to become a member of the company and whose name is entered into the register of members.’’ However, case law indicates courts will be prepared to interpret this broadly in appropriate circumstances, Harris v Jones Courts held that a person to who shares had been transferred but had not been registered as a member had the right to bring a s 994 petition. Remedies – s 996  Court has a wide discretion in determining the appropriate remedy. S 996 (1) states that a court may ‘’make such an order as it thinks fit for giving relief in respect of the matters complained of.’’  S 996(2) then lists possible orders court might make, although this list is not determinative: (a) regulate the conduct of the company’s affairs in the future; (b) require the company (i) to refrain from doing or continuing an act complained of, or (ii) to do an act which the petitioner has complained it has omitted to do (c) authorise civil proceedings to be brought in the name and on behalf of the company by such person or persons and on such terms the court might direct; (d) require the company not to make any, or specified, alterations in its articles without the leave of court (e) provide for the purchase of the shares by any members of the company by other members of the company or by the company itself. Remedies - Share purchase order  So, there is ^ a presumption ^ that the court will grant an order for the purchase of the petitioner’s shares by the company or another shareholder under s 996(2)(e) (Grace v Bigioli).  *This is the most common remedy and is usually sought by shareholders in small private companies who have limited options to sell their shares (remember that private companies are prohibited from offering shares to the public under s 755 CA 2006).  Re Bird Precision Bellows Ltd – Nourse J, determined that for quasipartnership companies, at least, it would normally be unfair to impose a discount on the shares to represent the limited voting power and control of a minority shareholder, since for these companies generally the minority shareholder is being forced to sell their shares as a result of the unfairly prejudicial conduct. Valuation of the Shares  One critical issue is the date on which the shares should be valued since the value of the shares may have changed

considerably between the date on which the petition to court was made and the date of judgement.  Abingdon Hotel Ltd: The starting point for the date of valuation of the shares for a buy-out under s 966 is the date of judgement, but the court is free to choose a date that is most appropriate in the circumstances of the case. The date should be ‘’that which best remedies the unfair prejudice held to be established.’’ Note that in O’Neill v Phillips, Hoffman LJ noted that if the respondent (company or majority shareholder) had made a reasonable offer to buy out the petitioner, based on an expert variation, then the respondent may be entitled to have the petition for unfair prejudice struct out. Unfair prejudice v just and equitable winding up  Fulham Football Club v Richards: Courts held that s 994 will usually provide a satisfactory remedy in cases of shareholder disputes, and that winding up under s 122(1)(g) is therefore a last resort and an exceptional remedy.  McCallum-Toppin: The estate of a deceased director in a successful closely held family company succeeded with a claim under s 994 CA 2006 that the affairs of the company had been carried out in an unfairly prejudicial manner. The majority: Deprived the minority of dividends where there would have been sufficient reserves to pay them, but for the majority paying themselves salaries which were largely unjustified. Had been using the company as a personal piggy bank, borrowing in excess of £1 million from the company for personal expenses. Remedy? Under s 996 CA, the majority were ordered to buy the minority’s shares at a ‘’fair value’’ at an undiscounted valuation.  Sprintroom: As director, although the minority had breached s 172 and 175 CA 2006, this was not sufficient to justify his exclusion as the dispute to IP rights was conducted openly; whereas a more egregious breach in bad faith. SUMMARY o Any member may apply to the court for relief under s 994 on the grounds of unfair prejudice. o The test is set out in s 994(1). The petitioner must show that the company’s affairs were 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). o The unfair prejudice must result from the actions of the company and not shareholders personally. o In order to establish unfair prejudice, the petitioner needs to establish a breach of the articles or shareholder’s agreement or breach of an understanding. o Common examples of unfair prejudice include exclusion from management in a quasi-partnership small private limited

company, breach of directors’ fiduciary duties or excessive remuneration and/or refusal to pay dividends.

Minority Shareholder remedies II: Just & Equitable Winding up Background & Act  Historically, only remedy available to aggrieved minority shareholder.  Remedy set out in s 122 (1)(g) Insolvency Act 1986 (IA 1986): ‘’A company may be wound up if the court is of the opinion that it is just and equitable that the company should be wound up.’’  SO, minority shareholder may apply to the court (petition) under s 122(1) (g) for the company to be wound up and the assets distributed among the shareholders.  Just and equitable winding up is a draconian remedy of last resort resulting in the end of the life of the company. The courts will therefore attempt to find alternative remedies where possible (Unfair Prejudice used far more commonly).  Section 125(2) IA 1986 provides that the court will not grant a winding up order if another remedy is available and the court is of the opinion that the petitioners are ‘’acting unreasonably in seeking to have the company wound up instead of pursuing the other remedy.’’ Thus, if any alternative remedy is available, the winding-up petition will usually be struck out. E.g. where the articles of association provide a procedure for a shareholder to sell their shares at a fair price, and without discount, any petition for winding-up is likely to be struck out on the basis that the petitioner is acting unreasonably in seeking a winding-up order. (Re a Company) Consequences  Petition under s 122(1)(g) has dire consequences for a prosperous company.  Banks will freeze the company bank accounts as soon as they receive notice of such a petition, since any payments made out of the company’s bank account after the presentation of the petition can be set aside by the liquidator when the company has been wound up. This means that the company is in effect paralysed pending the outcome of the petition.  Section 127 IA 1986: ‘’any disposition of the company’s property, and any transfer of shares, or alteration in the status of the company’s members, made after the commencement of the winding up is, unless the court otherwise orders, void.’’ Grounds for petition

 Ebrahimi v Westbourne Galleries Ltd. Lord Wilberforce – remedy gave courts a wide discretionary jurisdiction and cases should be considered individually. Generally speaking, successful petitions usually result when the relationship between directors and/or shareholders has broken down to the extent that it is not possible for the company to be run effectively: Examples of this include deadlock, justifiable loss of confidence in the company’s management and exclusion from management. Eastbourne (longstanding partners fall out and result is one, E is voted off the board. HoL concluded that although E has been validly removed as a director, as the company had been formed on the understanding that E would remain in management, his exclusion was in breach of that understanding and therefore it was just and equitable to wind up the company. Company was held to be a quasi-partnership. Exclusion.  This is a draconian remedy and will only be ordered compelling grounds. Number of cases which illustrate the circumstances in which this remedy may be appropriate.  ***Here a company will be seen as a quasi-partnership where the directors and shareholders are the same individuals and the company was formed with an expectation that all shareholders would continue to participate in management.  1. Substratum failed, German Date Coffee  2. Fraud: Where a company has been formed to perpetrate a fraud and winding up represents the best way for its shareholders to recover the money they invested, court may grant a winding up order. Re Thomas Edward Brinsmead & Sons.  3. Deadlock: Total deadlock in the management of the company rare since the chairman generally has a casting vote at board meetings. However, where deadlock does occur, the court may order the company to be wound up. Re Yenidje Tobacco Ltd.  4. Justifiable loss of confidence in the company’s management: Where a company is in effect a quasipartnership, the court may order it to be wound up where there is a lack of confidence in the management. For this ground to apply there needs to be a lack of probity in the way the company is being run by the majority, effectively driving the minority out, so that it is just and inequitable to require the minority to remain shareholders (Loch v John Blackwood – majority shareholder in the company dominated board of directors, refused to declare dividends, call general meetings or publish accounts – Privy Council ordered the company to be wound up).  5. Exclusion from participation in a small pri...