Unfair prejudice – Shareholder protection

Shareholder protection from Unfair Prejudice (5) Remedies; and (6) Offers to purchase/striking out and examining ‘If the court is satisfied’

Note: It is recommended that you watch the videos of the shareholder protection from unfair prejudice seminars delivered by Andrew Marsden rather than relying on this transcript. The videos of this seminar series can be seen at: https://commercialchambers.org/videos/

Good afternoon everyone and welcome to the fourth and final in this series of seminars by me, Andrew Marsden, on the subject of the protection of shareholders from unfairly prejudicial conduct.

I have muted sound for all participants and I’ve turned everyone’s cameras off in order to preserve the bandwidth once again.

I have also prepared some slides to accompany this presentation and I shall attempt to share those with you now.

In the first of these seminars, I introduced you to the jurisdiction and we examined some of the points of practice and procedure relating to applications under section 994. In the second of these seminars, I looked at the elements that a petitioner needs to establish in order to invoke the jurisdiction and, in particular, the requirements of “unfairness” and “prejudice”. And then last week, I ran through some examples of the most common types of unfairly prejudicial conduct that one comes across in practice. This week I am going to examine the remedies for unfairly prejudicial conduct. If time permits, at the end of this examination of remedies, I’ll also say a few words about the discrete subjects of offers to purchase and applications to strike out petitions under section 994 and I’ll also have a few words to say about mediation in the context of these disputes.

So, beginning then with an examination of the remedies for unfairly prejudicial conduct of a company’s affairs. I need to take you back to section 996 (1) of the Companies Act 2006 which is entitled “Powers of the court under this Part’. It reads, as you can see, “if the court is satisfied that a petition is well founded, it may make such order as it thinks fit for giving relief in respect to the matters complained of”.

Let me first focus on the opening words there. “If the Court is satisfied that a petition is well founded”, those opening words mean that if the petitioner establishes that he has been the victim of unfairly prejudicial conduct, then the jurisdiction to grant relief is opened up. I’ve got to emphasise once again the importance of a careful and comprehensive drafting of the petition because it is only establishment of the matters complained of in the petition as involving unfairly prejudicial conduct that will give rise to the jurisdiction to grant relief. The petitioner will only be entitled to any relief at all if he can establish unfairly prejudicial conduct of one of the matters as it is pleaded within the petition. If he fails to establish any unfairly prejudicial conduct, then the simple fact of the matter is that the court has no jurisdiction to order any relief whatsoever.

If the jurisdiction is engaged through the petitioner’s demonstration of unfair prejudicial conduct, then the court has a very wide discretion indeed to make such order as it thinks fit.

On the face of it, subsection one affords the court perhaps not an entirely untrammelled discretion or unfettered discretion for on its face section 996 provides that the form of relief that the court is to order must give relief in respect of the matters complained of.

But in a leading case in this area, a case called Grace the Court of Appeal made it clear that the court has to look at all the relevant circumstances in deciding what kind of order it is fair to make, and that it’s not limited to making an order that just seeks to reverse or put right the immediate conduct complained of. For my part, I still think that it’s arguable on the face of the wording of subsection one itself that such a restriction does apply, namely that it is arguable that, in fact, the relief must be such as to give relief in respect of the matters referred to and established in the petition. Of course, given the standing of the Court of Appeals decision in the case, any court challenging that or any decision challenging it would have to be a decision of the Supreme Court, or at least another decision of the Court of Appeal.

Subsection two of section 996 then goes on, in its opening words to say without prejudice to the generality of subsection one; that is without prejudice to the general discretion to make such order as it thinks fit for giving relief in respect of the unfair prejudice, the Court’s order may and it then sets out a series of examples of the type of relief that the Court might consider appropriate in any particular case. Just running through those; the Court may consider it appropriate to make an order that regulates the conduct of the company’s affairs in the future. So, for example, it might require board or shareholder meetings to be called on a prescribed basis or with a prescribed regularity and it may regulate the participation in such meetings.

Secondly, the relief may take the form of an order by the court requiring the company to do or refrain from doing an act complained of. These are, of course, the prohibitive or mandatory injunctive reliefs. So, by way of an example, the court might think it appropriate in a given case to make an order preventing a rights issue in respect of shares in circumstances where the persons conducting the affairs of the company and proposing to exercise the power to make a rights issue were proposing to do so for an ulterior purpose such as for the consolidation of power in their hands or their associates hands rather than the raising of funds for the company itself.

The third listed example of the sorts of relief that the courts might may make as they’re referred to in subsection two, is a potential for the court to authorise proceedings to be brought in the name of and on behalf of the company. That is authorizing effectively derivative proceedings to be brought in the name of the company, say, against a director guilty of breaches of the duties owed to the company, such as, for example, a diversion of a business opportunity away from the company for his own benefit.

The fourth example is an example of a form of relief that might involve requiring the company not to make alterations in its articles. So the court may make an order prohibiting a change in articles, such as an order prohibiting the conferring of further powers on the majority directors and shareholders or removing or restricting a requirement for minority shareholder approval of some proposed action.

And then the final illustrative example given in subsection two and by far the most important in practice; certainly the most common form of relief that’s come across in practice, is the potential for the court to make an order providing for the purchase of the petitioner’s shares either by the members against whom unfairly prejudicial conduct is established or by the company itself. My experience in practice is that purchase orders, as contemplated by that part of subsection two, are very often made, even though the unfairly prejudicial conduct that is established might possibly have been remedied by a much less drastic form of relief than a purchase order, such as, for example, an order regulating the future conduct of the company in a manner that doesn’t involve unfairly prejudicial conduct. I’ll come back to explain why I think that is in practice in just on second.

In a minute, I’m going to concentrate on the aspects of the purchase order remedy. But, before I do so, I just want to make some general observations as regards the remedies and the principles governing the choice and form of remedy to be granted in any particular case. The first thing to emphasise again is that the remedies in subsection section 996 are merely illustrative and a non comprehensive list of the reliefs available. The courts can make any type of order that it considers appropriate. So, for example, the courts have made orders for damages in respect of financial losses suffered by the company or by the petitioner himself. And the courts have made orders for rectification of the company’s statutory books. So, for example, rectifying an unfairly prejudicial share transfer or issue of shares that has been recorded in the company’s register of members.

The courts will only make an order providing relief if they consider it appropriate to do so. There is no automatic entitlement to a form of relief once unfairly, prejudicial conduct has been established. If very little prejudice is suffered, the courts might be persuaded not to order any relief at all.

The courts will also try to grant relief in a form that it considers proportionate. It may not, for example, order a buyout if the unfairly prejudicial conduct is modest in nature. It’s also clear that the courts will seek to assess the appropriateness of a form of relief as at the date that the court makes its order. It will do so in light of the circumstances and practicalities of the situation as they then exist.

I said I’d come back to it and I think it’s this principle that underlines the approach that the court generally tends to favour the making of a purchase order in the face of a finding of unfair prejudice. The court recognises that if the case is continued all the way to a trial and it had to make a determination rather than the matter resolving itself by a settlement of some sort, then the relationship between the parties is likely to have broken down to such an extent that it’s no longer practicable to expect the participants to continue in business together. That realisation, in my view, generally leads to the making of a purchase order, even though the particular instance of unfairly prejudicial conduct might have been remedied by a less drastic remedy in any given case.

It may sound obvious, but it’s worth stating that the court will not grant relief if, were it to do so, would serve no useful purpose. So, the Court will not try to grant a relief in or will not accede to a grant of relief in a form that seeks to regulate, say, the conduct of future meetings if it’s clear that the participants, including the protagonists, shareholders and creditors, perhaps of the company, will not be able to work or deal with each other again in the future in any sort of practical sense.

Finally, as far as this slide is concerned, it’s worth emphasising that the courts will only grant a form of relief that it considers fair in all the circumstances; that is fair to all interested persons. And those interested persons include not just the protagonists. They may include other shareholders against whom unfairly prejudicial conduct is not alleged and they may include creditors of the company. And I can see no reason why it might not extend to other stakeholders in the company, such as employees in appropriate circumstances.

The court will do its best to grant relief in a form that avoids or seeks at least to avoid unjust enrichment to anyone. In particular, the court will be astute to avoid overvaluing the shares to be purchased resulting in an unjustified windfall to the petitioner.

When assessing the appropriateness of a form of relief, the conduct of the petitioner may again be relevant. It may be relevant, for example, in assessing what, if any, relief is fair and proportionate in any given case or the extent of any relief that should be granted.

The Court may quite clearly order a form of relief that is not the form of relief that is sought by the petitioner. So it is quite clearly the case that the court may be persuaded of the existence of unfairly prejudicial conduct by the petitioner but not be prepared to accede to an order sought by the petitioner for him to be entitled to purchase the respondent shareholding and order the respondents guilty of the unfairly prejudicial conduct to purchase his shares at their fair value.

The relief can quite clearly be against any and all respondents who are found guilty of unfairly prejudicial conduct of the affairs of the company but should not be ordered against innocent persons or persons not party to the proceedings.

The Court is not restricted to making orders against members of the company. As I’ve indicated previously, a director who is not a shareholder can be engaged in the unfairly prejudicial conduct of the affairs of the company and an order for relief can be made against that director or indeed senior manager of the company. For example, they could be required to purchase the petitioner’s shares in an appropriate case.

I think I’ve already mentioned as well the final point mentioned on this slide which is that relief can also be ordered against the company. Indeed, that’s one of the reasons, alongside requiring it to effect disclosure of relevant documents, that a company is joined and required to be joined into these proceedings.

By far, however, the most common form of relief is the purchase order, and I’ll now concentrate on that form of relief and certain observations in relation thereto.

Usually a purchase order requires the purchase of the petitioner’s minority shareholding by either the perpetrators of the unfairly prejudicial conduct of the company’s affairs or by the company itself. However, in appropriate cases, the court might be persuaded to order that the petitioner should be permitted to purchase the respondent’s shareholding.

An order may also permit a minority shareholder to purchase a majority interest. That, however, is a pretty rare phenomenon in this context.

Invariably the price ordered to be paid is the fair value of the petitioner’s shareholding. That fair value is often equated to the market value of the petitioner’s shareholding achievable on a hypothetical sale in the open marketplace but adjusted to take account of the unfairly prejudicial conduct that is proved or established.

In its judgment, the court will identify the assumptions to be made in arriving at that fair value. Those assumptions are generally designed to eliminate the effects of the unfairly prejudicial conduct. So as to render the price fair in all the circumstances.

The usual date for the valuation to take place is the date of the court’s judgment. But it’s important to emphasise that the court does have a discretion to select another date as the appropriate date for valuation of the interest that is to be brought if the circumstances of the case are such as to justify the choosing of an alternative date. For example, the court might consider it fair in all the circumstances to order an earlier date of valuation than its judgment date if, for example, the petitioner had been unfairly excluded from participation in the affairs of the company and its fortunes have dramatically declined following his exclusion.

Once the court has determined the date for the valuation then it is clear that all events prior to valuation or pertaining as at the date of valuation and all information that would have been available to a prospective purchaser as at that date will be taken into account in determining the fair value of the company as a whole and the petitioner’s shareholding in the company. That information may include, of course, forecasts as to future performance of the business. Those contained in a business plan, for example. But supervening events, those taking place after the date of the hypothetical purchase would not have been available. Information in relation to those events would not have been available to the hypothetical purchaser and so are consequently irrelevant for the purposes of valuing the fair value of the interest to be purchased. That point was neatly and poignantly demonstrated in a recent case. The court was asked to identify the appropriate value valuation date for the purposes of a purchase order, which it did, identifying that date as the date of its purchase order. That was the 25th of June 2019. That was a date prior to the outbreak of the coronavirus epidemic or certainly prior to the world’s knowledge of that outbreak. The respondents applied for a direction that the price that they were to be required to pay should reflect the disastrous effects that the coronavirus epidemic could have had on the value of the company. But the court straightforwardly rejected that contention, saying that the potential of that outbreak was or the effects of that outbreak were not known as at the date identified as the date for purchase. Consequently, the valuation was to be made without taking into account the effects of that coronavirus epidemic on the value of the company.

Let me turn to expert evidence in this context. It’s almost always required in order to assist the court in determining the value of the company and consequently the value of the petitioner’s interest and the price that should be paid under the terms of the purchase order.

Directions are often given for it in the form of a report from a single joint expert. But if the amount at stake or the issues involved in valuation are of such complexity as to justify it, permission may be given for each side to instruct their own expert.

Turning to methods of valuation. In the case of a trading company, the usual method of valuation is the application of a suitable multiple to the future maintainable profits together with the addition of the value of any surplus assets. That provides something which is often referred to as the “enterprise value” and identifies the fair value of the company against which the value of the petitioner’s interest can be assessed.

On the other hand, if the company is not a trading company, but an investment company or a property owning company, then it will usually be valued on the basis of its net assets. And in providing that asset based valuation, there’s often a need for revaluation, particularly in respect of property assets which are held at their costs or otherwise not recorded at their current values.

The current tendency, I think, is more and more for experts to give their evidence in a hot tub environment. That’s my impression. And indeed I have been pleasantly surprised by the effectiveness of hot tubbing experts as far as valuation evidence is concerned in these cases.

I’ll just emphasise again that the courts have made quite explicit statements about the desirability of obtaining expert evidence of value at an early stage in order to further the prospects of consensual resolution of these cases. And as I mentioned, I think last week or perhaps the week before, that tends to be the death knell to applications for the giving of directions for the determination of a preliminary issue as to an entitlement to a purchase order prior to obtaining expert evidence and the determination of the fair value to be paid for that petitioner’s shares.

Where the company comprises a “quasi partnership”, a subject which we discussed in the second of these seminars, that is where a company has a limited number of participants who are each involved in the management and control of the business and affairs of the company, then the Court can ordinarily be persuaded to order the price to be paid for the petitioner’s shares should be a proportionate part of the value of the whole company or undertaking. In other words, the Court can be persuaded that no discount should be applied to reflect the minority status of the petitioner’s shareholding. The rationale for that approach in the case of quasi partnerships seems to be the conduct complained of in the context of a quasi partnership generally is also likely to be sufficient to justify an order for the winding up of the company on the just and equitable basis. That, of course, would involve a sale of the assets and business of the company as a going concern and the distribution of the proceeds to the shareholders proportionate to their shareholdings. Having said that that’s the general rule in relation to quasi partnerships, I should just say that, in some circumstances, particularly where the petitioner’s shareholding may have been acquired by gift or at an undervalue, it may be possible still to persuade the court to apply a discount to reflect the minority status of the shareholding.

In contrast, in non quasi partnership situations, it was often the case that the court would apply a discount when identifying the fair price to be paid to the petitioner for his shares. That approach is now seemingly out of favour. The guiding principle, it seems, is that petitioner should be paid whatever is a fair value and even in the case of a company that’s not in the nature of a quasi partnership that value might not be reflected in a discounted price. For example, the petitioner may not have desired to sell his shares. He may not have been willing or prepared to sell his shares at a discounted price and requiring him to do so in the face of unfairly prejudicial conduct might in fact result in a windfall for the respondents. In other words, the respondent might be permitted to obtain, for example, a controlling interest in the company at a discounted price when, in truth, he might in fact have been prepared to pay a premium for those shares.

Before I leave the subject of purchase orders let me just touch on a couple of other issues that frequently arise in relation to them. First, as I’ve just indicated, where there is a potential marriage value between the shareholding to be purchased and that held by the respondents then that marriage value is likely to be taken into account; particularly if the marriage value is one that is recognised as a result of taking the relevant respondent over a critical threshold, say over 50% or 75% of the issued share capital or voting rights within the company. In those circumstances, then it may well be appropriate for a premium to be paid or recognised within the valuation of the subject shareholding.

Notional costs of sale are often taken into account when assessing the fair value. There will not be cost of sale but there would have been had there been a realisation is the theory. So often notional costs of sale may be deducted from the fair value payable to the petitioner.

Very often the respondents, particularly in circumstances where they don’t have available sufficient resources to enable them to pay immediately for the price determined by the court may be afforded time to pay that price. That may be considered fair in all circumstances. It may depend to some degree on the conduct of the respondents as to whether the court will be indulgent enough to afford them time.

If it does afford them time then generally interest will be payable on that part of the determined price that is left outstanding.

Whilst we’re on interest, I ought also probably to highlight the fact that often if a date for valuation is selected other than the date of the court’s order itself, say, at a prior point to when the petitioner had been excluded from participation in the company then often on top of the price as determined by the court by reference to the value as at that date the court may also order interest as being payable on that price as well.

I am now going to turn to briefly address another important aspect of the practice in relation to this area. I’m conscious that time is moving on, but I think I’ve got time to deal with this, albeit briefly, and that’s the other areas that were highlighted at the beginning of this seminar; the subject of agreements or offers to purchase and applications to strike out.

So, as I think I mentioned in the first of these seminars, this jurisdiction is subject to application under Part 24 of the Civil Procedure Rules for summary dismissal in the ordinary way if there is no real prospect of success for example.

But proceedings under section 994 may also be dismissed on the basis that either their issuance or their continuation represents an abuse of process. If either the articles or shareholders’ agreement contains a mechanism for the purchase of the alleged victim’s shareholding or provides that victim with an option to have his shareholding purchased at its fair value or if the alleged victim has been made an offer by the respondents to purchase his shares again for fair value. In other words, if he has been made an offer that can be said to represent all that the petitioner might reasonably expect to get from the issuance or continuation of proceedings then his issuance of those proceedings or continuation of those proceedings may be considered an abuse of the process of the court and subject to a striking act.

But to form the basis of a successful application to strike out a buyout mechanism, whether within the articles or a shareholders’ agreement or an offer to purchase, must effectively provide for payment of the fair value in all the circumstances as they are pleaded within the petition.

As far as offers to purchase are concerned, if they’re going to be considered to be fair, they need to be very carefully drafted indeed. In essence, any offer that is to form the basis of a successful application for strike out needs to be one that makes it clear and obvious that relief will not be granted to the petitioner beyond that contained within the offer itself. In particular, the offer itself must make it clear that the valuer to be appointed to value the shares is of an independent character. The offer must concede that adjustment should be made when identifying the fair value to reflect all of the alleged unfairly prejudicial conduct even though it’s not actually proven. The offer must concede that no discount should be applied to reflect the minority status, in other words, to take that issue out of debate. And finally, the offer must involve a fair procedure to both the petitioner and the purchasing respondents. It must, in other words, ensure an equality of access to the petitioner in respect of all records, documents and information relevant particularly to value in respect of the company. And similarly, in the context of ensuring fair procedure, it ought to also ensure that the valuation is made in the light of representations made by all concerned, particularly the petitioner, as to what a fair value is in any circumstance, any particular set of given circumstances.

I think it’s fair to say that offers to purchase and the obtaining of, in practice, a striking out in the face of an offer to purchase is never particularly straightforward. But it’s also, I think, realistic to suggest that a properly formulated offer of purchase for fair value can very often represent the quickest way to resolve what are widely recognised as notoriously expensive proceedings.

That brings us to the end of the slides. But before I go, I just want to highlight one other aspect of this jurisdiction, which I think is important for practitioners to bear in mind whenever they deal with a case of this nature. This form of litigation is one that is eminently suitable to both mediation and other forms of alternative dispute resolution procedures. The reason for that is, in my view, that this litigation is of a highly transactional nature. It’s not what I would describe as all or nothing litigation in the sense of a personal injury claim, for example. Resolution tends generally to involve one side getting a fair value for his shares whilst the other side gets the shares themselves. There is not an absolute winner and loser in this litigation and because of this transactional nature, disputes of this sort out are to my mind particularly suited to commercial settlement and often commercial settlement can be achieved through a sensible facilitation by the services of a suitable and experienced mediator.

Practitioners should, however, be cautious about the use of mediation in the context of these sorts of disputes. My experience is that ADR used properly, the form of mediation, can be very helpful in resolving these disputes. Increasingly, I think it’s common that mediation processes are being used in an abusive manner within this jurisdiction. Particularly, it seems to me misuse is being made of mediation in circumstances where there is no substantial intention to settle, but simply to obtain early disclosure of documentary evidence or evidence as to value or to obtain a better feeling as to the degree of confidence held by the other side in the dispute. Obtaining that sort of information, that sort of disclosure or that sort of feeling as to the confidence held by the other side can very often be of significant use in guiding the parties as to levels at which protective costs, protective settlement offers might be made; particularly protective settlement offers in terms of costs. So whilst I would encourage you certainly to explore mediation and other forms of alternative dispute resolution in the context of these disputes, and indeed the courts would echo that encouragement, I do so with that note of caution.

I think that is a convenient place to finish this series of introductory talks in relation to the protection of shareholders from unfairly prejudicial conduct.

A number of questions have been raised with me via email. I hope that during the course of these talks I have addressed all of those questions that have been raised. I’ve tried to do so as we’ve gone along, rather than just storing them up for the end of the seminars.

Certainly, if you’ve got any other questions, then please do email me or, better still, just give me a call. I’m always happy to discuss matters on a preliminary basis and without charge over the phone.

I hope you’ve all found these talks interesting. There are video recordings of the previous talks and there will, of course, be one in respect of this talk. Please encourage any colleagues who might find them useful to view those videos. They will be accessible from the Commercial Chamber’s website shortly.

Finally, can I encourage you all to download a copy of the Case and Statute Citator that I produce. As I’ve said, it forms the comprehensive notes to these seminars and should provide a clear source of reference to the authorities in this area.

I look forward to working with some of you in due course. Until then, I wish you all well and I’ll say goodbye and end the Zoom meeting. Many thanks for joining me. Bye bye.