Guide to Unfair Prejudice Against Shareholders Monday, 7th...

Guide to Unfair Prejudice Against Shareholders

Monday, 7th October 2013

This Guide explains Unfair Prejudice and Shareholder Disputes under English Law in general terms. The intention of the Guide is not, however, to advise you on whether or not to petition for unfair prejudice (which will depend on the facts of your case). The subject of unfair prejudice is a complex area and no guide can ever set out all the factors relating to a particular case. This Guide is not therefore a substitute for detailed advice on your case. If you would like further explanation of any points in this guide, please contact us.

Shareholder Protection

Some protection is given to shareholders under statute, and in particular section 994 of the Companies Act 2006 (which has replaced 459 of the Companies Act 1985).

What is Unfair Prejudice?

Section 994 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 that is unfairly prejudicial to the interests of members generally or of some part of its members (including at least himself), or (b) that an actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial."

There are two elements to the requirement of unfair prejudice, and both must be present to succeed in a claim:

• the conduct must be prejudicial in the sense of causing prejudice or harm to the relevant interest of the members or some part of the members of the company (i.e. shareholders), and
• it must be unfair.

Test of Unfairness

The test as to what amounts to unfair prejudice is objective. It is not necessary for the petitioning shareholder to show that anybody acted in bad faith or with the intention of causing prejudice. The courts will regard the prejudice as unfair if a hypothetical reasonable bystander would believe it to be unfair.

Fairness is judged in the context of a commercial relationship, the contractual terms of which are, in the main, set out in the Articles of Association of the company and in any shareholders agreement. The starting point is therefore to ask whether the conduct of which the shareholder complains is in accordance with the Articles and the powers which the shareholders have entrusted to the board. In a Law Commission report it was said that "The best protection for a shareholder is appropriate protection in the articles themselves". Therefore, if the conduct is in accordance with the Articles, to which the shareholder has agreed, it will be more difficult to succeed with an unfair prejudice petition.

Even if the conduct is not in accordance with the Articles, it does not necessarily render the conduct unfair, as trivial or technical infringements of the Articles may not give rise to a remedy under s.994.

The Rights/Interests of the Shareholder must have been Prejudiced

The conduct must be unfairly prejudicial to the Petitioner's interests in his capacity as a member of the Company (i.e. as a shareholder), but the Court takes a broad view of what might be regarded as his interests as a member of the Company.

The word "unfairly" enables the Court to consider wider equitable considerations and recognises that the members have rights and expectations which are not necessarily included in the Articles of Association. For example, a member's interest may arise out of an agreement that some or all members should participate in the management of the Company. A member's interest is not, therefore, limited to his strict legal rights, but can extend to legitimate expectations arising from the nature of the Company and agreements and understandings between the parties. A common example of this is the corporate "quasi-partnership", in which members may have expectations of participating in the management and profits of the Company, which arise from the understandings on which the Company was formed and which may be unfair for other members to ignore.

Apart from in the case of "quasi-partnerships", it is more difficult to establish legitimate expectations beyond the member's strict legal rights. If such expectations exist, a Petitioner must in general show some abuse by the directors of their powers, or an infringement of the member's strict legal rights under the Company's constitution or the Company's legislation.

Types of unfairly Prejudicial Conduct

Unfair prejudice is a flexible concept, and incapable of exhaustive definition. The categories of conduct which may amount to unfairly prejudicial conduct are not closed. However, common examples of what may constitute unfairly prejudicial conduct are:

• exclusion from management in circumstances where there is a (legitimate) expectation of participation;
• the diversion of business to another company in which the majority shareholder holds an interest;
• the awarding by the majority shareholder to himself of excessive financial benefits; and
• abuses of power and breaches of the Articles of Association. For example, the passing of a special resolution to alter the Company's Articles may be unfairly prejudicial conduct if such alterations would affect the Petitioner's legitimate expectation that he would participate in the management of the Company. Also, repeated failures to hold AGMs; delaying accounts, and depriving the members of their right to know the state of the Company's affairs may all be unfairly prejudicial to a member's interests.The conduct of the Petitioner is relevant, as the conduct complained of may be found to be prejudicial but not "unfair". The Petitioner's conduct may also affect the relief granted by the Court.

Chances of Success

In general terms, the Courts have, over recent years, restricted the extent to which relief is given for unfair prejudice. The Petitioner must therefore normally prove an actual breach of terms that have been agreed as to how the Company will be run, or show that such terms were being used in a way which offends equitable considerations.

Remedies Available

Section 996 of the Companies Act 2006(2) lists particular types of orders which may be made by the Court if it decides that there has been unfair prejudice, although the Court retains a general discretion under Section 996(1) to make any order it thinks fit. The powers listed in 996(2) provide that the Court can:

• regulate the conduct of the Company's affairs in the future;
• require the Company to refrain from doing or continuing an act complained of, or to do an act which the Petitioner has complained that it has omitted to do;
• authorise civil proceedings to be brought in the name and on behalf of the Company by such person/s and on such terms as the Court may direct;
• require the Company not to make any, or any specified, alterations in its articles without the leave of the court; and
• 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 the purchase by the Company itself, the reduction of the Company's capital accordingly.

The power to authorise civil proceedings subject to terms directed by the Court can be a particularly useful remedy, as it enables an action to be pursued by the Company, meaning that the majority of the costs of that action would then be borne by the Company rather than by the Petitioner.

However, in practice, the most common remedy awarded to a successful Petitioner is to order that their shares be purchased by those who caused the unfair prejudice.

The valuation of shares can however cause considerable problems, as there are many conflicting methods of valuation. The Courts have in general held that the shares should be valued at such date as is fair to the Petitioner, which is usually the date when the prejudice to the Petitioner began. The Court can also order that the valuation should be on the basis that the unfairly prejudicial conduct (which may have devalued the Company's shares) had not taken place.

In some circumstances it may be appropriate for the Court to order that the majority shareholder sells his shares to the Petitioner, although this is considerably less common.

Procedure on Petition

Court proceedings for Unfair Prejudice are begun by way of a petition. The petition must specify the grounds on which it is presented and the nature of the relief which is sought by the Petitioner (i.e. the Shareholder who is bringing the claim). The Court will fix a hearing date on which the Petitioner and any respondent must attend at Court or directions to be given as to the procedure in respect of the petition.

Interlocutory relief may be available to protect the Company's and the Petitioner's position pending the hearing of the petition.

Respondants to the Petition

The shareholders or directors who it is alleged have been guilty of unfair conduct should be named as respondents to the petition, together with all members of the Company whose interests have been affected by the alleged misconduct or who would be affected by a Court order. A third party who is not a member of the Company should also be joined if it might be affected by the remedy sought, or was directly involved in the allegedly unfairly prejudicial conduct. Finally, the Company itself is normally named as a respondent, although it is to some extent a nominal respondent.

Legal Professional Privelege

In general, in Court proceedings, communications between a Client and their lawyers with a view to receiving and giving legal advice are privileged from production, and therefore do not need to be shown to the other side in the court proceedings. However, there is an important exception to this rule in the case of Unfair Prejudice proceedings in that, as a nominal party, communications between the Company and its lawyers may not be privileged from production in s.994 proceedings.

Therefore, care needs to be taken by a Company, in taking legal advice on a matter that may conceivably result in a s.994 petition, in that anything that is said to or by the Company's lawyers may need to be revealed to the disgruntled shareholder in the subsequent s.994 proceedings.

Costs

Although it is not possible in this guide to estimate the level of costs incurred in s.994 proceedings, they are, by their nature, expensive and time consuming.

Alternative Remedies

There are additional shareholder remedies that should also be considered and may, depending on the circumstances, either be more suited to a shareholder's circumstances than an unfair prejudice petition, or may put forward as additional arguments or claims together with a s.994 Petition. Other remedies to consider include petitioning for "just and equitable winding-up" under s.122(1)(g) of the insolvency act 1986 and a derivative action under sections 260-264 of Companies Act 2006.

For further information on shareholder disputes and unfair prejudice claims please contact Antony Lee.

Ashfords LLP is regulated by the Solicitors Regulation Authority. The information in this note is intended to be general information about English law only and not comprehensive. It is not to be relied on as legal advice nor as an alternative to taking professional advice relating to specific circumstances.