However, disputes between shareholders are not uncommon in companies of all sizes. Relationships can turn sour where one or both parties consider that their expectations are not being met. Where this happens minority shareholders can often feel aggrieved at the way in which the company’s majority shareholders can conduct the company’s affairs to suit themselves.

In this article, Gosschalks’ Head of Company, Nigel Beckwith , and Litigation Partner, Phil Osborne , discuss the ability for minority shareholders to petition the court to seek relief from unfairly prejudicial conduct under section 994 of the Companies Act 2006 (‘the Act’). It is important for all shareholders to understand these rights so that they can utilise them should the need arise, or guard against actions which might form the basis of an unfair prejudice action.

Unfair prejudice petition

Under section 994 of the Act, shareholders can petition the court: -

1. That the company’s affairs are being, or have been, conducted in a manner that is unfairly prejudicial to the interests of shareholders generally, or part of the shareholders (including at least the petitioner himself or herself); or

2. That an actual or proposed act or omission of the company (which includes an act or omission on the company’s behalf) is or would be prejudicial.

   The respondents to an unfair prejudice petition may be the majority shareholders, the company and or any third-party wrongdoers.

The test for unfair prejudice

In order to bring a successful unfair prejudice action, three requirements must be satisfied:

1. The conduct complained about must be conduct of the company’s affairs

Conduct of the company’s affairs will include all matters decided by the board of directors. However, conduct complained of that only concerns the activities of shareholders in their personal capacity and between themselves, not corporate conduct, will not be sufficient.

2. The conduct must prejudice the petitioner’s interest as a shareholder

The inclusion of the words “including at least himself or herself” means that a member cannot petition unless his or her interests have been adversely affected by the unfairly prejudicial conduct.

The most obvious example of prejudice suffered by a petitioner is damage to the value of the petitioner’s shareholding. Even if the shares have no value a petitioner can still suffer prejudice because prejudice is not limited to financial loss. For example, a petitioner may be prejudiced by being excluded from his or her right to participate in the management of the business.

However, the prejudice needs to be substantial relative to the remedy claimed. Where the prejudice is trivial and the petitioner had accepted the role of passive investor, the petition is likely to fail.

3. The conduct complained of must be unfair

Unfairness must be judged in context in the which it is applied. In O’Neill v Phillips ([1999] 1 WLR 1092) the House of Lords stated that conduct which might be fair between competing businessmen might not be fair between family members.

Unfair prejudice requires the conduct complained of to be both prejudicial and unfair. Conduct that prejudices the petitioner may not necessarily be unfair. Similarly, conduct may be unfair but not prejudicial.

The test for unfair prejudice is an objective test not a subjective one. It is not necessary to show that the majority acted in the knowledge that the conduct complained of would prejudice the petitioner. Instead, the question is whether a reasonable man would regard the conduct as having unfairly prejudiced the minority’s interests.

The essence of an unfair prejudice petition is some breach of an agreement, promise or understanding between the shareholders as to how the affairs of the company are to be conducts. The primary source of such agreement or understanding will be the company’s articles of association and any shareholders agreement. Therefore, the starting point is to ask whether the conduct complained of by the petition in in accordance with those agreements. An unfair prejudice petition is likely to fail if there has been no breach of the terms on which the petitioner has agreed that the affairs of the company will be conducted either in the articles of association or any shareholders agreement.

However, the court will also look, beyond these formal agreements, to any wider equitable considerations and recognise that shareholders have “legitimate expectations” that the company will be managed lawfully; this means in accordance with the articles of association and the directors’ duties.

In doing so the court will consider how relations between the petitioner and the respondents have evolved to establish whether understandings have developed on which legitimate expectations or equitable considerations can be based that the court should protect. For example, where the petitioner’s interest arises out of an agreement that he or she should participate in the management of the company, which is often argued in cases involving “quasi-partnerships”.

Quasi-partnerships

In Re: Westbourne Galleries ([1973] A.C. 360), a quasi-partnership was held to be a company that possesses all of the characteristics of a partnership and includes one or more of the following:

1. a relationship of mutual trust and confidence between the participants;

2. an understanding that some or all of the shareholders will participate in the conduct of the business of the company; and

3. restrictions on the ability to transfer shareholdings.

   The relevance of a company being found to be a quasi-partnership is that the shareholders hold reciprocal duties of good faith towards one another and the relationship and common understandings between them can displace the formal written agreements that govern the company’s affairs to the extent a breakdown in the relationship between them can be sufficient to found a winding up petition based on equitable considerations. There is also a presumption that the exclusion from management of a minority shareholder will constitute unfair prejudice unless it is accompanied by an offer to buy the minority’s shares at a fair value

Examples of unfair prejudice

Whether the majority have engaged in unfairly prejudicial conduct is fact specific, however examples of unfairly prejudicial conduct may include:

• Minority shareholders being excluded from the management of the company in breach of the terms of an agreement or understanding between the shareholders. However, it is not unconscionable to exclude the petitioner from the management if there has been a breakdown of trust between the parties and the majority have offered to buy out the petitioner at a fair price or if the petitioner has been guilty of gross misconduct.

• New shares being allotted in bad faith or without complying with the rights of pre-emption, which may benefit the minority shareholders. This could be the case even if the rights issue was open to all shareholders, but the majority knew that the petitioner could not afford to take up the offer and this was the reason for making it.

• Where the company amends the company’s articles of association and such amendments have a prejudicial effect on the minority shareholders.

• The directors grant themselves excessive remuneration while refusing to consider paying dividends. However in this instance the prejudice must be suffered by the minority, not to the majority, of the company, so it must be that the minority are not provided with declared dividends.

• Directors improperly remove the company auditor.

• Mismanagement of the company’s business by the board is not usually sufficient to found an unfair prejudice petition unless that mismanagement involves a breach of the directors’ duties under sections 171 to 177 of the Act.

Remedies

The court has a very wide discretion as to the relief it may order under section 996 of the Act. That discretion includes considering the petitioner’s own conduct when deciding whether and what relief to grant.

The most frequently sought relief is an order that the majority buy the petitioner’s shares.

However, the court can make a range of other orders including:

1. An order regulating how the company’s affairs may be conducted in future;

2. An order requiring the majority to refrain from, or to do, a particular act;

3. An order requiring the company not to make any or any specified alterations to its articles of association without the leave of the court;

4. An order authorising the petitioner to bring civil proceedings in the name of the company (known as a derivative action); An order that the company distribute its assets to the shareholders; or

5. An order the minority to purchase the majority’s shares (although this is rare).

Valuation Principles

Where the petitioner is seeking an order that the majority buy his or her shares, it is necessary for the parties to obtain expert evidence on the valuation of the minority’s shareholding.

The court’s aim is to obtain a fair valuation of the shareholding on the specific facts of the case. Therefore, the court will give directions to the experts as to what they are valuing, the date at which the shareholding should be valued and any special considerations that should be applied to the valuation (for example, to take account of the conduct of one or both of the parties or any sums wrongfully taken from the company).

A few issues arise from the valuation exercise, which include:

1. The valuation date: The starting point is that the valuation date is the date when the shares are going to be purchased, not the date of the petition. However, the court has a discretion to order a different valuation date to be used, for example, the date of the minority’s exclusion from the management.

2. The valuation basis: There are three potential bases for the valuation, which in descending order are:

   • As a rateable proportion of the total value of the company as a going concern without any discount for the fact that the holding in question is a minority holding;

   • As above but with such a discount; and

   • As a rateable proportion of the net assets of the company at their break up or liquidation value (although it is difficult to see any justification for this basis where the purchaser intends to continue to carry on the business of the company as a going concern because this would give the purchaser a windfall at the expense of the seller).

3. The valuation standard: There is a difference between the open market value of the company to a third-party arms’ length purchaser, and a fair value to a known purchaser (e.g. the majority shareholder). Consideration needs to be given to this issue both when determining the valuation standard and when considering the issue of discount or premium to ensure that they are neither neglected nor double counted.

4. Discount: Generally, the shares of a minority shareholder will be valued at a discount to reflect the lack of control. There is no rule about what that discount should be, and the level of the discount is something a valuer will opine on; however, the underlying principle is fairness. Where a quasi-partnership exists, the shares are valued on a non-discounted basis.

5. Adjustments: If the conduct of the majority or the minority has adversely affected the value of the company, the court may order that the shares of the minority are bought at a valuation that reflects the valuation of the company prior to that conduct or on an assumption that the conduct did not occur.

There is no limitation period applicable to unfair prejudice petitions, but in keeping with the ‘equitable’ approach of the court, where there has been excessive delay the courts are less likely to grant relief.

Tips for avoiding or reducing the risk of an unfair prejudice petition

1. Documentation: Thought needs to be given at the outset of the relationship between you and your fellow shareholders to decide what relationship you wish to have and to avoid the potential for creating a quasi-partnership. These decisions regarding the management of the company should then be documented carefully in company’s articles of association and / or as appropriate in any shareholders’ agreement.

   Although a shareholders’ agreement does not preclude the court finding the company is a quasi-partnership, they should contain clauses expressly excluding the relationship of trust and confidence which reduce the risk of a finding of a quasi-partnership relationship. Any subsequent variations to, or new understanding reached between, the shareholders should be reflected in updated documentation.

2. Record Keeping: Where the minority shareholders are likely to be adversely impacted by a decision, make sure the company properly documents in its board minutes why that decision is in the best interests of the company (as opposed to in the best interests of some of the shareholders).

3. Valuation: The petitioner’s primary aim is most often an order that their shares in the company are bought out (although the court retains a wide discretion as to what order to make). Therefore, if faced with a petition, it is prudent to obtain expert advice from an accountant on the valuation of the petitioner’s shares and to make an early offer to buy the petitioner’s shares.

   The basis of any offer will depend on whether the company is a quasi-partnership and what adjustments, if any, need to be made to the valuation to reflect the impact of any breaches of duty effected by the majority.

   An unreasonable refusal to accept a reasonable offer can provide grounds to strike out the petition. However, even if it does not, it can provide the majority with strong protection when the court is considering the costs of the proceedings, which can be significant.

4. Audit Request: If a minority shareholder (or group of minority shareholders) holding not less than 10% of the company’s issued share capital suspect that the company’s affairs are being conducted by the majority in a way that is prejudicial to them, they can exercise their right under section 476 of the Act to request that the company’s accounts are audited. The request must be made in writing to the company’s registered office and must be made at least one month before the end of the financial year to which the audit request relates. A new request must be made for each successive financial year.

5. Use of company money: The majority must use their own personal funds, rather than company money, to pay their legal expenses in connection with any claim for unfair prejudice by the minority. Otherwise, this would be prima facie evidence of unfairly prejudicial conduct by the majority.

Need advice? Get in touch today...

If you are a minority shareholder who believes that they have suffered unfairly prejudicial conduct at the hands of the majority, or if you are a majority shareholder being threatened with an unfair prejudice petition, you should contact Nigel Beckwith or Phil Osborne today to review your options:

Nigel Beckwith | Tel: 01482 590272 | Email: njb@gosschalks.co.uk
Phil Osborne | Tel: 01482 590256 | Email: pjo@gosschalks.co.uk