` Shareholder Rights: Unfair Prejudice

Shareholder Rights: Unfair Prejudice

Alan Massenhove, a member of Sykes Anderson LLP discusses the rights of shareholders and the operation of section 994 Companies Act 2006 and some related matters.

Shareholder Rights

As a general rule, the larger a company is, the less say its shareholders have in its activities. Although shareholder consent is expressly required for a number of specific transactions or types of transaction, the day to day control of the company is in the hands of its directors. So, if the directors are exercising their lawful powers to control the company in a way which prejudices you as the shareholder, what can you do about it?

An example

You own a 5% stake in a trading company. There are 2 director shareholders each holding 40% of the issued share capital. There are 3 further shareholders each holding 5%. The company is generally profitable and you receive a sizable dividend from your small shareholding. The director shareholders then decide to increase the company’s share capital and issue non-voting preference shares to raise finance for a scheme which you believe will be unsuccessful and will result in the company’s reputation and profitability being damaged. Provided that the scheme is not unlawful and that there is no shareholders’ agreement to the contrary, the directors are within their powers to carry out the scheme. Although increasing the issued share capital of the company and issuing shares of a different class would require a resolution of the shareholders, the directors have a sufficient shareholding to enable them to force the resolution through. As a minority shareholder you have no powers to prevent the scheme proceeding unless you go to court or negotiate an acceptable outcome with the directors.

Applying to court

You can make a petition to the court under section 994 of the Companies Act 2006. The criteria for making the petition are:

  • You are either a registered shareholder or a person who is entitled to shares as a result of transfer or transmission by operation of law (e.g. a personal representative of a shareholder);
  • The company’s affairs have been or are being run in a way which is unfairly prejudicial to the interests of its shareholders generally or some of its shareholders;

The court has very wide powers when dealing with a section 994 petition. Section 996 provides that the court may make such order as it thinks fit to give relief in respect of the matters complained and lists examples, which are that the court’s order may:

  1. regulate the conduct of the company’s affairs in the future;
  2. require the company –
    1. to refrain from doing or continuing an act complained of, or
    2. to do an act that the petitioner has complained it has omitted to do;
  3. authorise civil proceedings to be brought in the name and on behalf of the company by such person or persons and on such terms as the court may direct;
  4. require the company not to make any, or any specified, alterations in its articles without the permission of the court;
  5. provide for the purchase of the shares of any members of the company by other members or by the company itself and, in the case of a purchase by the company itself, the reduction of the company’s capital accordingly.

A remedy commonly sought and ordered is the one under section 996(e) for the shares of the petitioning shareholder to be bought by another shareholder (or by the company) at a fair value; with the amount to be determined by the court if not agreed. Such an order, once put into effect, gives what is referred to as a “clean break”. When parties have fallen out, for whatever reason, this is often the best resolution which can be achieved (though arguably it is not ideal).

The likely outcome

The outcome in any particular case will depend on its own facts. In our example in the absence of any cogent evidence that the scheme would not be in the best interests of the company, the court would be most likely to order the two major shareholders of the company to purchase your shares. If it appeared that the scheme was not in the best interests of the company, the court could prevent the directors from proceeding and may order that the constitution of the company (its articles) must not be changed. The court would be more likely to intervene in the affairs of a company to this extent if for example one or more of the following could be shown:

  • Creditors of the company would be prejudiced by the scheme.
  • The other minority shareholders support your opposition to the scheme.
  • The directors were acting in breach of their fiduciary duties and not in the best interests of the company.

Generally when considering what order to make the court can be expected to take a pragmatic approach. If a dispute reaches the stage of a petition being issued this will be a reflection of the fact that relationships within the company have broken down. This is particularly likely to be the case in disputes involving companies which are quasi-partnerships. The court will take this into consideration and this is why a buy out of the shares of one party is often ordered.

The mechanism of a buy out

If the parties agree on a mechanism for valuing shares the court will usually uphold this. Otherwise the court will usually order that an expert is to determine the value of the shares. The court can specify what the expert should and should not take into consideration. For example the court may order that the valuation of the shares be backdated to include assets stripped out of the company.

The threat of a section 994 petition can be a useful tool in relation to shareholder disputes and may lead to an amicable resolution without the need for proceedings. Such a claim should not be intimated unless there are good grounds for doing so and the aggrieved party is willing, if need be, to issue a petition and carry it through to its conclusion. Issuing a petition is what may be referred to as a last resort and almost inevitably will further sour already damaged relationships. However, on occasions a minority member who has not been fairly treated and who wishes to resolve the problem may have little alternative. The service of a petition might encourage further thoughts about settlement and could lead to a resolution.

Another possibility

Under section 122(1)(g) Insolvency Act 1986 the court has power to order the winding up of a company if it is of the opinion that it is just and equitable to do so. A request for such an order could be sought as an alternative to a buy out at a fair price under section 996(e) Companies Act 1996. To obtain an order for a just and equitable winding up the claimant must amongst other things produce evidence to satisfy the court that he is not at fault in respect of any of the matters complained of and that on a winding up being concluded there would, after paying off all liabilities of the company, be a surplus available for distribution to the members (shareholders).

A further alternative; a derivative claim

A minority shareholder may be aggrieved by something which has caused loss to the company, for example a sale of property by the directors at less than the market value to someone connected with the directors. In such a situation the court may allow the shareholder to bring a claim in the company’s name. The power for a derivative claim under section 260 Companies Act 2006 exists in respect of an action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company. If such a claim is successfully pursued and damages are recovered the money goes into the company, not to the shareholder who has sued in the company’s name.

Costs

If there is a petition or other proceedings each party will have made an arrangement with their solicitor in relation to costs. The court has a discretion in relation to ordering one party to pay the costs of another, the exercise of which may be affected by settlement offers made, the way in which a claim has been conducted and whether some but not all issues alleged have been proved. If at the end of a trial the judge finds in favour of one party in respect of all matters which he has pursued to the hearing it can be expected that the loser will be ordered to pay the winner’s costs, in an amount which will be assessed by the court if not agreed. If a party has put forward four grounds of “unfair prejudice” and pursues them all and proves two at trial and obtains an order requiring the defendant to buy him out at a fair price he may not be awarded the costs associated with the two grounds he did not prove. As with all litigation it is important to think about funding and potential costs consequences before embarking on the issue of a petition.

In certain cases it may be possible to obtain an order to prevent the company’s money being used to fund an action. For example if a minority shareholder sues the holders of the majority they may be prevented from using the company’s money to fund their defence. A minority shareholder who issues a derivative claim which the court permits him to continue may obtain an order allowing the company’s money to be used to fund the action as it goes forward against the director who is being sued.

Please note that this area of the law is a complex subject and you should not take or refrain from taking any step without full legal advice on your particular circumstances. The content of this article is of a general nature and no liability is accepted in connection with it or if any reliance is placed on it.