Video Transcript of Shareholder protection from unfair prejudice – Part (3) The elements of unfairness and prejudice.

Transcript of seminars delivered by Andrew Marsden on Shareholder protection

Note: It is recommended that you watch the videos of the 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/

Part (3) The elements of “unfairness” and “prejudice”

Good afternoon to you all.

Welcome to the second in this series of short seminars by me, Andrew Marsden, on the subject of the protection of shareholders from unfair prejudice.

I have once again muted the sound for all of the participants and turned everyone’s cameras off in order that the bandwidth can be preserved and the best experience had by all.

Before I start, can I just say a word or two about a couple of kind comments that were made following the last of these seminars? Presenting the seminars doesn’t come easily to me, and your comments were very well received, so thank you very much for that.

Again, I have prepared some slides to go with these seminars and I’m going to be using the screen share function with you. I shall turn that on now and you should have in front of you now the title slide to the seminars.

I hope you’ve all had a chance to download my case and statute citator. If you haven’t, it’s available at the Commercial Chamber’s website and forms the notes to accompany these seminars.

As I said previously, I’m very happy to answer any questions you may have but I don’t intend to do so during the course of these seminars. I’ll attempt to do so at the end of the final seminar. So, if you could let me have those questions by email, that would be terrific.

Last week I introduced you to the jurisdiction and we examined some of the practice and procedure in this area. This week, I intend to take a closer look at the nature of unfairly prejudicial conduct itself.

First, I want to begin by reminding you of the words of the section itself. section 994 provides “a member of a company may apply to the court by petition for an order under this part 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 or that an actual proposed act or omission of the company is or would be so prejudicial”.

As I said last week, it’s clear from the terms of section 994 itself that unfairly prejudicial conduct can take the form either of an act or of an omission. So, for example, section 994 applies equally both to a positive act in the form, let’s say, of a misappropriation of assets or business opportunities from the company, and also to an omission in the form of, let’s say, again, a failure to exploit a business opportunity that might otherwise have been available to the company and for the benefit of the company.

It is also clear, again, from the terms of section 994 itself that the act or omission that is complained of can be one of an historic or a current or a threatened nature.

Concentrating first on the question of past conduct. Theoretically, at least, the unfairly prejudicial conduct may include conduct that took place even prior to the petitioner acquiring his shares in the company. In such a case, however, it is often difficult to demonstrate that a shareholder has suffered unfair prejudice, and that is particularly so if the effects of the conduct complained of had already been experienced at the time that the petitioner acquired his shares or if the conduct complained of was acquiesced in or consented to by the then existing shareholders in the company.

Historic conduct aside, as I’ve already said, quite clearly current unfairly prejudicial conduct is captured by the jurisdiction as is future unfairly prejudicial conduct or threatened unfairly prejudicial conduct.

It’s also quite clearly the case that the conduct complained of can take the form either of an isolated incident or instance of unfairly prejudicial conduct or it can take the form of a course of conduct extending over a period of time. So, for example, conduct might involve, or rather unfairly prejudicial conduct might involve, say, the isolated incident of a dismissal of a petitioner from his position as a director of the company or it might involve conduct over a sustained period in the form of his exclusion from meetings of directors or his failure to be invited to meetings of directors.

Likewise, the unfairly prejudicial conduct can take the form of a single misappropriation of funds, such as a selective dividend payment, for example, or it can take the form of a series of misappropriations, such as a series of excessive salary payments over a considerable period of time.

The conduct complained of must clearly be conduct of the affairs of the company. Conduct of matters external to the company will not engage the jurisdiction. Therefore, conduct of matters unrelated to the company, however unfair or prejudicial, will not permit the exercise of the judicial discretion to grant relief under section 994 of the Companies Act. In this connection I ask you to contrast, if you will, a demand for rent by a landlord who happens to be a shareholder, which, even if it may be said to be excessive and therefore unfair, is conduct external to the company from conduct that might take the form of a director making arrangements for the actual payments to himself of excessive rent by the company of which he holds a directorship. That latter conduct would clearly involve conduct of the company’s affairs and so would fall within examination under the jurisdiction provided for by section 994 of the Companies Act. Similarly, a failure to transfer shares in the company in accordance with an agreement reached between a shareholder and a third party, would be unlikely to be treated as the conduct of the company’s affairs, whereas a wrongful issue of shares, for example, would be considered as the conduct of the company is affairs and so, again, could form the subject of unfairly prejudicial conduct the subject of review under section 994.

It has clearly been established that the affairs of a company are to include the affairs of its subsidiaries; whether those be wholly owned or partially owned subsidiaries. So, for example, where the petitioner holds shares in a holding company which has an operating subsidiary. The conduct of the affairs of the operating subsidiary might involve unfairly prejudicial conduct of the affairs of the holding company, thereby entitling the shareholder in that holding company to relief under the section and possibly, in an appropriate case justifying, say, an order for purchase of the petitioner’s shares in the holding company.

Usually, the conduct complained of is that of the controllers of the company. It’s often the majority shareholder whose actions are complained of. Very often that person also controls the board of directors. But under section 994, there is no requirement that the respondent to an application for relief should hold majority control, whether at a board or shareholder level. In practice, often the conduct complained of is not necessarily of one person who holds an outright majority interest, but often the conduct complained of is on the part of a number of respondents who together control the board or the shareholding voting power in the company.

But the point to note here is that the section actually includes no requirement that the respondents should have board or shareholder control. They don’t need to hold a majority interest. The jurisdiction is actually one that extends against all persons who involve themselves in the conduct of a company’s affairs.

In fact, it’s not even necessary for the proposed respondent to hold any shares at all in the company. Proceedings can be brought under section 994 or against a person who engages in the conduct of a business’s affair or a company’s affairs, even where that person doesn’t hold a shareholding at all. So, for example, a shareholder may complain of unfairly prejudicial conduct of the affairs of a company by a non-shareholding chief executive officer.

Indeed, the application and ambit of the section is so broad that there’s not even a requirement that the respondent should actually be a director of the company. All that is required is that the person should be involved in the conduct of the affairs of the company. So the section is capable of capturing conduct by senior employees who have sufficient conduct of the affairs of the company. They too will find themselves subject to review of their actions in accordance with section 994.

In order for the jurisdiction to be invoked, however, there are two requirements that do need to be satisfied. The petitioner must demonstrate that the conduct complained of is both “unfair” and that it has caused him or shareholders generally “prejudice”.

They are two separate requirements, both of which require to be demonstrated. In this jurisdiction the courts have repeatedly emphasised that section 994 does not comprise a medium through which no fault divorce of the interests of participants in a company can be achieved. That was perhaps most clearly stated by Lord Hoffman in the leading authority in this area of O’Neill and Phillips. It’s true that in other jurisdictions, and a notable one is in fact the Singaporean jurisdiction, there has been a move to permit the courts to resolve deadlock in the affairs of private companies in circumstances where there is no element of unfairly prejudicial conduct but simply the existence of deadlock. That is not the case in this jurisdiction. In this jurisdiction mere deadlock does not bring the matter within the ambit of relief under section 994. There needs to be unfair prejudice before the jurisdiction is engaged.

So let’s turn to the first of those requirements; that of “unfairness”. It’s fair to say, I think, that the concept of “unfairness” in this context has proved seemingly difficult to define with any precision. It certainly appears to be something of a flexible concept within the section 994 jurisdiction. That being said, some general observations can certainly be made and conclusions drawn from the authorities (and there are numerous ones within this area of jurisprudence). Some general observations can certainly be drawn.

The first is that the concept of “unfairness” is one that is to be judged objectively. The subjective views of the participants are entirely irrelevant. Consequently, whether a particular participant within a company believes that he has acted fairly or unfairly is not relevant. It is for objective determination by the court as to whether the conduct constitutes unfair conduct in any given circumstance.

The second point I think worth emphasising is that there doesn’t need to be any element of discrimination against the petitioner. I mean that in the in the sense that there doesn’t need to be discrimination of the petitioner as compared to other shareholders. Rather, it’s perfectly sufficient for there to be unfairness being shown to all shareholders in a company in order that the jurisdiction should be engaged. So, for example, a wrongful failure to convene a meeting of shareholders to pass a resolution when such a meeting and resolution would be required for some particular corporate step would not be discriminatory as far as the particular shareholder is concerned but would be wrong for as far as all shareholders were concerned. That lack of discrimination does not oust the jurisdiction. It can be unfair to all shareholders.

It’s, I think, fair to say that where the conduct complained of is both unlawful and causes prejudice to the petitioner that the jurisdiction is generally invoked. Unlawful behaviour seems to certainly comprise unfair behaviour within this context, but I think the important point to note is that the conduct of the petitioner does not have to involve an infringement of a legal right held by the petitioner or the infringement of a duty owed to the petitioner.

Generally, unfairness involves a failure to keep to promises or to honour agreements. Those agreements or promises are often found in the formal, written constitutional documents of a company and those regulating its affairs, for example, in articles of association or in formal shareholders agreements. But agreements between or promises made between the participants of a company may also be found in much less formal contexts. So, for example, oral agreements between the participants or even implicit agreements between the participants are honoured or respected by this jurisdiction. A breach of such informal agreements may well be seen to involve unfairness, entitling the court to exercise its discretion to grant relief under section 994.

And when I say agreements, whether I’m talking about express or implicit agreements, I’m not necessarily restricting that observation to a legally enforceable agreement. I should make it plain that unfairness can be found where there is a breach of an agreement which might not in itself have the standing of a legally enforceable agreement or understanding.

Looking at implicit agreements for one second, generally, the courts have recognised that it is implicit in the participation within a company that the shareholders each recognise to one another that they will act in accordance with the Companies Act and the duties imposed by the Companies Act. In particular, the courts have recognised an implicit agreement or understanding that the affairs of the company will be conducted by the directors of that company in accordance with the duties that they have under sections 171 to 177 of the Companies Act. So, and it’s important in practice, section 172, as you will know, imposes on directors a duty to promote the success of their company. If a director conducts himself in breach of that duty, in other words, fails to promote the success of the company of which he is a director, that behaviour is likely to comprise unfair conduct of the company’s affairs and likely to entitle a shareholder to relief under section 994.

If the conduct is not contrary to an express or an implied agreement, whether formal or informal, as I’ve described it, the participators will, generally, it seems to me, only be considered to have acted unfairly if the circumstances of the case are such that the Court concludes that there exists in the particular circumstances of that case, rights in equity as between the participants. Such equitable rights, expectations and obligations exist and supplement the expectations that are inherent within the promises or agreements, however formal or informal, that are made between the participants and those equitable expectations or obligations are generally determined as existing in a situation where the company can be said to comprise a “quasi partnership”.

It is, I think fair to say that it’s been notoriously difficult to define and identify the characteristics of a “quasi partnership” in this context. It clearly involves a personal relationship between the participants. It clearly involves more than a mere commercial relationship. A “quasi partnership” is often said to be reliant on a relationship of trust and confidence that exists between the participants. I think it’s important to note that a relationship of “quasi partnership” is really the exception rather than the rule. It’s not the norm in practice. In other words, the normal relationship between the participants in a company is a straightforward relationship of a commercial nature. In that more common guise of a straightforward commercial relationship, these equitable obligations, expectations or rights do not supplement the rights defined by the agreements, however formal or informal, that form the basis upon which people participated within the corporate enterprise. But when the matter does involve a company of a “quasi partnership” nature then these equitable rights, expectations and obligations may also be found to exist and a breach of them may also be found to involve unfairly prejudicial conduct of the affairs of the company.

Perhaps the classic situation in which a finding of quasi partnership is likely to be made is where the business of a conventional partnership goes through a process of incorporation and the practice of the participants in that form of partnership and now in relation to the company are barely different in practice. In other words, matters continue, rather as they had before incorporation in relation to the old partnership as they do after incorporation in relation to the new company.

Another classic case in which a finding of the existence of “quasi partnership” often arises is the situation that surrounds a small, family owned company. I don’t mean small in the sense that the enterprise may be small, it may be of considerable value, but often its ownership may be restricted to a small number of family members. It may have passed down through generations and in that sort of context quite regularly are many findings of the company possessing this “quasi partnership” nature.

But again, let me just emphasise it again, a finding of “quasi partnership” is and should be seen as an exceptional case and not the norm where the relationship is governed by, or is a straight commercial one and should be governed by, the nature of agreements between the participants whether express implied or implied agreements.

It’s also worth noting, I think, in the context of “quasi partnerships”, that the relationship between participants in a company can change over time, so that what might at one point have been regarded as a “quasi partnership” may cease to be a “quasi partnership” and vice versa. What may start off as a simple commercial relationship between the participants may then evolve into one of “quasi partnership” in due course.

As I say, if a “quasi partnership” is found on any given facts to exist, then the affairs of the company will be expected to be conducted in accordance with certain equitable rights, expectations and obligations that the courts deems the parties to owe to each other in that context. Those rights are often held to include rights to continued participation in the direction and management of the affairs of the company. They’re often found to extend to rights of provision of information; additional rights to provision of information over and above those that might be found in favour of shareholders in an ordinary commercial context. So, for example, the removal of a participant in a “quasi partnership” company from involvement in the direction or management of the business concerned or to deprive of him from sufficient information may be regarded as involving unfair prejudice to that participant.

Likewise, in addition to the rights of participation and information, it is often determined by the courts that in the case of a “quasi partnership” company, there is also an overarching, equitable duty of good faith between the participants, so that if one side acts contrary to good faith, motivated by objectionable motives is a fairly frequent example, that may also lead to a finding of unfair conduct of that corporate enterprise founding relief or founding the entitlement to relief under section 994.

I think before moving on from the concept of unfairness, I want to give you a couple of quotes which I find helpful in practice in determining whether or not any particular factual situation involves an element of unfairness of which complaint may be made under section 994.

The first is a quote from the Jenkins report, which I think itself was quoting a judge in a Scottish case. In that report or in that case, it was said that unfairness involves “a visible departure from the standards of fair dealing and a violent violation of the conditions of fair play on which every shareholder who entrusts his money to a company is entitled to rely”. I find that a helpful summary of the notion of unfairness.

Perhaps the most – certainly the most often cited guidance in this area comes from the leading judgment of Lord Hoffman in the O’Neill and Phillips case, where he concludes after a close analysis of the jurisdiction in this regard with a view that unfairness consists in “a breach of the rules or in using the rules in a manner in which equity would regard as contrary to good faith”. I think in that quote, Lord Hoffman uses the reference to the rules as a reference to the agreements, both formal and informal, between the participants (and including an agreement that the business and affairs of the company concerned will be conducted in accordance with the law generally, including in compliance with directors duties) and you can quite clearly see Lord Hoffman’s reference to the requirements of compliance with the equitable principles that I have referred to previously as well.

The leading textbook in this area is that of Robin Hollington C, a textbook that deals with shareholders rights generally, but concentrates on this jurisdiction. I find his summary of the approach of the courts to be a useful one in practice as well. He says the court’s approach is one of “respect for contract in a wide sense, in the non-technical sense” that I’ve described it “tempered by equity”. And again, I think that sums up the court’s approach to unfairness in this context.

A few concluding observations in relation to unfairness.

Firstly, it’s quite clear that the conduct need not justify winding up on the just and equitable basis. In other words, unfairness in this context is not to be equated with the sort of conduct that might justify the court exercising its jurisdiction to wind a company up.

Secondly, it’s quite clear that the jurisdiction does not extend to provide a mechanism through which review can be had of commercial decisions. In other words, this jurisdiction is not one that’s invoked simply by reason of allegations of poor commercial management or bad business decisions. Those are not unfair and are not subject for review by the courts. That is an incidence of involving oneself in business in a commercial way with other people. That is to be expected. You enjoy the benefits of good decisions and you suffer the consequences of bad decisions. This is not a jurisdiction under which hindsight can be used to criticise or evade the consequences of such bad business decisions.

It is also clear that the conduct of the petitioner himself may be relevant in determining whether or not conduct has been unfair. So, for example, you will understand this quite clearly of course, if a petitioner is found to have proverbially had his hand in the till, then, his dismissal from a position of a director of that company is highly unlikely to be considered unfair to him in those circumstances. So whilst his removal from a position of directorship might generally be considered to be unfair to his interests as a shareholder and the company, if it is in circumstances where his conduct justifies that removal, then it’s highly unlikely to be considered unfair.

In a similar vein, if it’s conduct that the petitioner has acquiesced in, whether acquiesced or participated in, then it’s highly unlikely that that conduct is going to be considered unfair and such as to entitle him to relief under Section 994.

Finally, in this context, I just want to mention delay again. It may be that there is no positive acquiescence or participation or consent to a course of conduct. But if the petitioner fails to raise unfairly prejudicial conduct for a considerable period of time, the delay in his making complaints over that conduct may actually prejudice his ability to demonstrate the unfairness of that conduct.

So though there is no limitation period applicable to claims under section 994, delay may very much come to the fore and be relevant in a consideration of whether the alleged conduct is unfair to the petitioner in circumstances where the petitioner substantially delays in coming forward to complain of that conduct and to seek relief from it.

Turning to the other element that needs to be satisfied in order to engage the jurisdiction; the requirement that there should have been “prejudice” suffered by the petitioner. This is generally not too difficult an aspect of this jurisdiction for the petitioner to establish.

It’s quite clear that the concept of “prejudice” doesn’t require a narrow or technical construction.

It’s equally clear that the prejudice suffered must be substantial. Mere trivial prejudice will not be considered sufficient to engage the jurisdiction.

Often the prejudice suffered by the petitioner takes the form of a financial disadvantage that he suffers. So, for example, if a respondent director misappropriates assets of a company that will generally result in losses in the value of the petitioners shareholding and that comprises his prejudice. Similarly, it may take the form not of a loss reflected necessarily in his shareholding, though it might be, but it may take the form of a loss of his salary entitlement following an unjustified dismissal from him of his participation in the company as a director.

It’s worth pointing out that in circumstances where there is a disposal of the assets of the company, even if that disposal is wrongful in that it’s not authorized, if there is a disposal at the full market value of those assets, it may be difficult to establish that any prejudice has actually been suffered by the petitioner in circumstances where full value has been obtained in respect of that disposal.

I’ve concentrated up till now on financial disadvantages comprising the potential “prejudice” that grounds this application. It’s quite clear that prejudice in the form of a financial loss is not a prerequisite. “Prejudice” can involve a simple denial of the petitioner’s rights as a shareholder. So for example, the denial of his rights to a vote or the denial of his rights to the provision of information can comprise sufficient prejudice in this context, just as much as financial prejudice comprises sufficient prejudice to the jurisdiction.

Lastly, I think I just want to emphasise the point, which I think I made to you last week, that there are numerous dicta in the cases to the effect that the prejudice that has to be suffered in order to bring an application for relief under section 994 has to be prejudice to the petitioner’s interests as a shareholder rather than his interests in some other capacity. That is a true reflection of the observations made in many cases in this area but I think, as I’ve already indicated, there is quite a lot of jurisprudence that suggests that the petitioner’s interests as a shareholder may be considered to be a relatively wide concept within this jurisdiction. So, for example, it may well include prejudice to a petitioner’s interests as a lender at the time that he made his investment in the company, both in the form of lending, as well as taking a subscription for shares. So prejudice to his ability to enforce the loan made at that stage may well involve sufficient prejudice to his interest as a shareholder, even though strictly it is in relation to his lending that the enforcement suffers.

I think that’s probably covered enough for this session. There’s quite a lot in what I discussed there. I think there is a convenient place to break. I thank you all for joining me again. I hope you found this talk interesting and I look forward to speaking with you all next week when I’ll be considering specific examples of unfairly prejudicial conduct in practice and looking at examples that you come across pretty regularly.

In the meantime, if you do have any questions, please let me have them by email and, as I say, I’ll address them at the end of the final seminar.

Otherwise, until next week, I hope you will all keep well and I wish you all well for the forthcoming week. Bye bye. Thank you very much for joining me.