Managing companies: Minority shareholder remedies

Question 1

Could minority shareholders always bring claims?

Answer 1

Historically courts reluctant - CA 2006 does now certain limited remedies.

Question 2

What are the equitable remedies?

Answer 2

1. Unfair prejufice
2. Just and equitable winding up
3. Derivative claims (on behalf of company)
4. Personal claims

(note there’s also the remedies of voting powers - see table)

Question 3

Is it advisable for clients to bring claims under minority shareholder remedies?

Answer 3

Not always - claims are costly to bring and uncertain in outcome, as the court has a wide discretion as to remedies. Advised instead to enter into Shareholders’ Agreements

Question 4

Why was the action for UNFAIR PREJUDICE introduced and where is it set out?

Answer 4

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.

Section 994 CA 2006 is substantially the same as s 459 CA 1985, so the old case law remains relevant.

Question 5

Elements of unfair prejudice under s994(1)?

Answer 5

(a) that the COMPANIES 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)

Question 6

In order to succeed with a petition under s 994(1) what must a petitioner establish re. company’s conduct?

Answer 6

unfairly prejudicial conduct arising from an act or omission of the company, or made on the company’s behalf. - must relate to affairs of company NOT personal
Re Legal Costs Negotiators Ltd
Re Home & Office Fire Extinguishers Ltd
Re City Branch Group Ltd, Gross v Rackind

Question 7

In order to succeed with a petition under s 994(1) unfair prejudice what must a petitioner establish re. interests of the members?

Answer 7

his interests in his capacity as a member have been unfairly prejudiced as a result of conduct on the part of the company. Construed WIDELY. Re Bovey Hotel Ventures Ltd
Gamlestaden Fastigheter AB v Baltic Partner Ltd

Question 8

In order to succeed with a petition under s 994(1) what must a petitioner establish re. ‘unfair prejudice’?

Answer 8

O’Neill v Phillips: Leading authority in the interpretation of “unfair prejudice”.
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.

See also Re Tobian Properties Ltd: Arden LJ
‘unfairly prejudice’ comprises two elements: unfairness and prejudice but both of these must be understood in the context of company law.

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.

Question 9

4 examples of unfairly prejudicial conduct?

Answer 9

1. Exclusion from management: most common
   Re Tottenham Hotspur plc
2. Mismanagement: In general, poor management of a company will not give rise to a claim for unfair prejudice - courts reluctant. 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
3. Breach of directors’ fiduciary duties
   Common ground & several successful petitions
   Re London School of Electronics
   Re Little Olympian Each-Ways Ltd
   Re A Company (No 005287 of 1985)
4. Excessive remuneration and refusal to pay dividends
   Court will tend not to interfere but clear there is ample scope for abuse
   Re a Company (No. 004415 of 1996)

Question 10

Who can bring a claim for unfair prejudice?

Answer 10

s 994(1) - a ‘member’
s 112 defines ‘member’ as subscriber to memorandum and registered - but courts have been broad here.
Harris v Jones
Blunt v Jackson

Question 11

Remedies for unfair prejudice?

Answer 11

s 996:
Court may “make such order as it thinks fit for giving relief in respect of the matters complained of”.

s996(2): possible orders court may make:

(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 as the court may direct;
(d) require the company not to make any, or specified, alterations in its articles without the leave of the 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…

presumption that 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 [2005]. Most common remedy and usually sought in small private companies (as they cannot offer shares to the public s 755).

Question 12

Issues in valuing the shares under courts ordering purchase for petitioner’s shares?

Answer 12

Price that is fair: Re Bird Precision Bellows Ltd
Date they should be valued: Abbington Hotel Ltd: starting point for the date of valuation of shares for a buy-out order under s 996 is the date of judgment, but the court is free to choose a date that is most appropriate

Question 13

Unfair prejudice versus just and equitable winding up?

Answer 13

Claims for just and equitable winding up under s 122(1)(g) Insolvency Act 1986: were often brought in alternative together with unfair claims under s 994 - however courts opposed to this.

Civil Procedure Rules (CPR) Practice Direction 49B (the rules for civil courts) states that winding-up orders should not be sought unless that is the preferred relief or it is thought that it is the only available relief.
Fulham Football Club (1987) Ltd v Richards

Further examples:
McCallum-Toppin
Re Sprintroom

Question 14

Reform of the law relating to unfair prejudice?

Answer 14

In 1996 the Law Commission proposed to reform statutory shareholder remedies, particularly unfair prejudice, as well as derivative actions (which we consider in the next element).

The Law Commissions’s Consultation Paper No 142 (1996) noted a concern relating to the length and cost of unfair prejudice proceedings and the destructive effect of these actions on small private companies.

For example, in Re Elgindata Ltd [1991] BCLC 959, the trial lasted 43 days and cost around £320,000. The shares in the company fell in value from £40,000 to £24,000. The Commission therefore recommended that the courts should actively case manage these types of cases, considering trialling preliminary issues, or having the power to dismiss a claim or part of a claim considered to have no realistic prospect of success.

set out three proposals:

1. There should be rebuttable presumptions of unfair prejudice in small private companies where the petitioner has been excluded from management.
2. Winding up should be added to the potential remedies under s 996.
3. The Model Articles should be amended to include an exit provision setting out what will happen in the event of a shareholder dispute. This provision would allow the shareholder to leave the company without necessarily having to bring proceedings for unfair prejudice. Alternatively, shareholder agreements should be adopted to deal with this issue.

Question 15

Why was the action for JUST AND EQUITABLE WINDING UP introduced and where is it set out?

Answer 15

Historically, this was the only remedy available to an aggrieved minority shareholder. This remedy is set out in s 122(1)(g) Insolvency Act 1986 (IA 1986).
Minority shareholder may apply to the court (“petition”) under s 122(1)(g) IA 1986 for the company to be wound up and the assets distributed amongst the shareholders.
Draconian remedy of last resort - since s994 unfair prejudice this is more common

Question 16

Consequences of a just and equitable winding up petition?

Answer 16

Can have dire consequences for a prosperous company
Section 127 IA1986
Banks will freeze 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 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.

Question 17

Grounds for petition for just & equitable winding up?

Answer 17

Key case: Ebrahimi v Westbourne Galleries Ltd
Court has wide discretionary jurisdiction.
Usually succeed when shareholder/director relationship has broken down: final three grounds include:

1. Deadlock: rare for total deadlock, but where there is; can be ordered to wind up - Re Yenidje Tobacco Ltd
2. Justifiable loss of confidence in the company’s management: overlaps with deadlock needs to be lack of probity in way company is being run by the majority: Loch v John Blackwood Ltd
3. Exclusion from participation in a small private company where there was a relationship based on mutual confidence: situation in Ebrahimi; Lord Wilberforce listed typical elements as:

(i) the basis of the business association was a personal relationship and mutual confidence (often where a pre-existing partnership converts into a limited company);
(ii) an understanding that all shareholders will participate in management;
(iii) a restriction on the transfer of members’ interests preventing the petitioner leaving.

Substratum has failed: commercial object for which the company was formed has failed or been fulfilled, this will be a ground for just and equitable winding up: much less important now s31(1) provides unrestricted objects.
Re German Date Coffee Co

Fraud: Re Thomas Edward Brinsmead & Sons

Question 18

Who can bring a petition for just and equitable winding up?

Answer 18

Section 124(1) IA 1986: a “contributory”.
– means any person liable to contribute to the assets of a company in the event of it being wound up, which includes every past and present member.
Must have “tangible interest in the company”
– has been held to mean that the shareholder must prove (on the balance of probabilities) that there will be a surplus among the shareholders after payment of the company’s debts, liabilities and the expenses of the liquidation (Re Rica Gold Washing Co).
Petitioner’s own conduct is relevant - if court finds their conduct is the result for the breakdown, this will be relevant.

Question 19

Just and equitable winding up relationship with other remedies?

Answer 19

s125(2) IA 1986: court will not grant if other remedy available.
Usually viewed as last resort.

Question 20

Why was the action for DERIVATIVE CLAIMS introduced and where is it set out?

Answer 20

Think of doctrine of separate legal personality - where loss for company has been caused by action of internal stakeholder, it's so that individual minority shareholder can bring a claim where the board refuses. 
Courts have been reluctant, but...
- Foss v Harbottle rule
- Then s 260-263 statutory authority 
So common law AND statute.

Question 21

Key case for derivative claims?

Answer 21

Foss v Harbottle - 1843 - common law basis

Question 22

Why both Foss v Harbottle rule and CA 2006 basis?

Answer 22

Common law essential for personal claims.

Statutory basis - only affect claims for wrongs done to the company, and claims for wrongs done by directors.

Question 23

Rule in Foss v Harbottle? (2)

Answer 23

(i) PROPER CLAIMANT PRINCIPLE: The proper claimant in an action in respect of a wrong done to a company is prima facie the company itself.
Burland v Earle.

(ii) INTERNAL MANAGEMENT PRINCIPLE: Where the alleged wrong is a transaction which might be made binding on the company and all its members by a simple majority of the members, no individual member of the company is allowed to maintain an action in respect of that matter “for the simple reason that, if a mere majority of the members of the company … is in favour of what has been done, then cadit quaestio” (in other words, the majority rule).
MacDougall v Gardiner.

Also; (iii); IRREGULARITY PRINCIPLE: if the matter relates to an irregularity that the company is able to ratify or condone by its own internal procedure then no individual member may bring an action.

Question 24

Exceptions to the rule in Foss v Harbottle?

Answer 24

1. Where the act complained of is ultra vires or illegal;
2. Where the matter is one which could validly be done or sanctioned only by some special majority of members, or there has been non-compliance with a special procedure;
3. Where the personal and individual rights of the member have been infringed; or
4. Where what has been done amounts to a “fraud on the minority” and the wrongdoers are themselves in control of the company.

—> some academic debate as to whether these are true exceptions or separate rights of action. The generally accepted view is that only the fourth exception set out above is a true exception to the rule in Foss v Harbottle, since the other exceptions can be explained on the basis of the member being allowed to sue for breach of their personal rights.

Question 25

Further info on 1. Where the act complained of is ultra vires or illegal?

Answer 25

Prudential Assurance Co Ltd v Newman Industries Ltd: CoA explained: in this situation, Foss v Harbottle does not operate because majority of members cannot ratify. Questionable - whether true exception, or whether example of personal claim - Smith v Croft.

Question 26

Further info on 2. Where the matter is one which could validly be done or sanctioned only by some special majority of members, or there has been non-compliance with a special procedure?

Answer 26

Again - company which has done something wrong, rather than being the victim of a wrong, so this does not seem to be a true exception to the rule in Foss v Harbottle.

Edwards v Halliwell
Quin & Axtens Ltd v Salmon

Question 27

Further info on 3. Where the personal and individual rights of the member have been infringed?

Answer 27

Depends whether breach is ‘internal irregularity’ re. procedure, or constitutional infringement.

If internal, no claim.

If constitutional infringement, falls under exception - but again seems to be using personal rights to sue rather than true exception to rule in Foss v Harbottle.

Pender v Lushington.

Question 28

Further info on 4. Where what has been done amounts to a “fraud on the minority” and the wrongdoers are themselves in control of the company?

Answer 28

ONE TRUE EXCEPTION:

Burland v Earle:
No precise def of fraud: wider than meaning at common law. Includes abuse/misuse of power.
i.e. where majority are “endeavouring directly or indirectly to appropriate to themselves money, property or advantages which belong to the company or in which the other shareholders are entitled to participate.”

For minority shareholder to bring action under this exception: must be established that the wrongdoers had control over the company and were able to prevent proceedings being brought in the name of the company, either through their shareholding or influence (Prudential Assurance Co Ltd v Newman Industries Co Ltd (No 2) (1982).

However, if the “innocent majority” oppose the proceedings, the claim cannot proceed (Smith v Croft (No 2)).

Question 29

Derivative actions under CA Part 11?

Answer 29

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 or another person eg auditors (or both) - s260(3). Note that it is immaterial whether the cause of action arose before or after the claimant became a shareholder – s260(4)

Question 30

What’s the relief from derivative claims under statute? Is it personal?

Answer 30

No - relief gained is only awarded to the company, not the individual member bringing proceedings.

Question 31

What’s the two stage process for an application for permission to continue derivative claim?

Answer 31

s 261- 263: apply for permission. Involves 2 hearings.

1. The court will consider whether the applicant has a prima facie case for permission to continue the derivative claim. If the application is not dismissed at this first stage (because the applicant provides evidence of a good cause of action) then it moves to the second stage.
   - purpose of first stage is to quickly dismiss those with little chance of success - some parties may bypass this Franbar Holdings Ltd v Patel. Has been criticised. Re Severn Holdings
2. If the application shows a prima facie case for permission under stage 1, it then proceeds to the second stage under s 263, which is the full permission hearing. The court may order the company, as well as the applicant, to provide evidence at this stage.

Question 32

Bars to a derivative claim?

Answer 32

s 263 sets out absolute and discretionary bars to granting permission to a member to continue a derivative claim.

Absolute bars: Section 263(2)
“(a) that a person acting in accordance with section 172 (duty to promote the success of
the company) would not seek to continue the claim, or
(b) where the cause of action arises from an act or omission that is yet to occur, that the act or omission has been authorised by the company, or
(c) where the cause of action arises from an act or omission that has already occurred, that the act or omission—
(i) was authorised by the company before it occurred, or (ii) has been ratified by the company since it occurred.”

Discretionary bars: s 263(3)
“(a) whether the member is acting in good faith in seeking to continue the claim;
(b) the importance that a person acting in accordance with section 172 (duty to promote the success of the company) would attach to continuing it;
(c) where the cause of action results from an act or omission that is yet to occur, whether the act or omission could be, and in the circumstances would be likely to be—
(i) authorised by the company before it occurs, or
(ii) ratified by the company after it occurs;
(d) where the cause of action arises from an act or omission that has already occurred, whether the act or omission could be, and in the circumstances would be likely to be, ratified by the company;
(e) whether the company has decided not to pursue the claim;
(f) whether the act or omission in respect of which the claim is brought gives rise to a cause of action that the member could pursue in his own right rather than on behalf of the company.”

Question 33

Other considerations court takes into account for derivative claims, and approach of the court?

Answer 33

Section 263(4): court must have particular regard to any evidence before it as to the views of members of the company who have no personal interest: Smith v Croft (No 2)

Approach: statutory procedure similar to Foss v Harbottle; court will presume to dismiss derivative claim unless an exception applies.
- Was concern of floodgates, however not happened - disincentives to bringing claim, members do not recover damages themselves.

Question 34

Case law under CA 2006 s 260, derivative claims?

Answer 34

Mission Capital v Sinclair
Franbar Holdings v Patel
Iesini v Westrip Holdings Ltd
Stainer v Lee
Cullen Investments Ltd v Brown
Bridge v Daley

Question 35

Is there a problem with derivate claims re. the cost?

Answer 35

YEs - members have to pay; company will benefit.

Rule 19.9E of The Civil Procedure Rules allows the court to order the company to indemnify the claimant against any liability in respect of costs incurred in the claim or the permission application, or both. This is called a pre-emptive costs order, first awarded in Wallersteiner v Moir (No 2) - known as ‘Wallersteiner orders’

Question 36

Derivative claims – overlap with s 994?

Answer 36

It is clear from the case law that if the facts giving rise to a derivative action under s 260 also give rise to a claim for unfair prejudice under s 994, the court will be reluctant to grant permission to continue the derivative claim.

However; not an absolute bar. In appropriate circumstances the discretion may be exercised the other way, and the court may hear the proceedings under s 994 and s 260 together, as was the case in Phillips v Fryer.

Question 37

Derivative claims vs s 994 - advantages and disadvantages?

Answer 37

Advantages: unfair prejudice easier to proceed (as there is no permission requirement) and also that the remedy obtained is for the member, not the company.

However; derivative action may be preferable to a claim for unfair prejudice where the aim of the claimant is not to be bought out (which is the most common remedy in unfair prejudice claims), but for the company to benefit Clark v Cutland.

Question 38

What case illustrates that claims may often be brought on more than one ground?

Answer 38

Paramount Powders (Badyal v Badyal):

• Unfair prejudice - s 994
• Just and equitable winding up - s 112
• Derivative claim - s260

Question 39

When a shareholder has suffered PERSONAL loss as a result of the majority, does the Foss v Harbottle rule apply?

Answer 39

No - they can claim under contract or tort law. Possibly unfair prejudice also.
Lee v Sheard - dividend declared but not paid.

Question 40

What’s a ‘reflective loss’ personal claim?

Answer 40

Where the only loss alleged to have been suffered by the shareholder is in fact a reflection of the loss sustained by the company - courts will NOT allow shareholder to bring personal claim.
Prudential Assurance Co Ltd v Newman Industries Ltd (No 2)

Question 41

When CAN shareholders bring a personal claim in situations of ‘reflective loss’?

Answer 41

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.
Johnson v Gore Wood - could not show.
Giles v Rhind - could show.

Question 42

What’s a representative action?

Answer 42

Action brought by one claimant on behalf of a group of claimants - loss also suffered by other members.

Governed by: Civil Procedure Rule 19.6(1).
which avoids multiplicity of claims by providing that where more than one person has the same interest in a claim:
(a) the claim may be begun; or
(b) the court may order that the claim be continued,
by or against one or more of the persons who have the same interest as representatives of any other persons who have that interest.

Question 43

Other shareholder minority rights under CA 2006 which give rights to minority shareholders in respect of particular decisions taken by the company? (4)

Answer 43

1. Protection against alteration to the company’s constitution (s 21)
   - at least 75%
   - Court will look at ‘good faith’ in altering articles - not to undermine substantive rights of minority shareholders
   - possible to ‘entrench’ provisions by providing higher majority required
   - possible for shareholders in shareholders’ agreement to agree how will exercise voting rights
2. The right to requisition a general meeting (s 303 – 305)
   - can be brought by not less than 5% of voting paid-up capital of the company - refer to previous notes.
3. The right to demand a poll vote (s 321)
   may be demanded by:
   • Not less than 5 members having a right to vote at the meeting;
   • Members holding not less than 10% of all voting rights that could be cast at the meeting;
   • Members holding shares conferring a right to vote at the meeting on which the aggregate paid up sum equals not less than 10% of the total sum paid up on such shares.
4. The right to enforce the articles (s 33)