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Shareholder Rights: Unfair Prejudice

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Shareholder Rights

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

An Example

You own a 5% stake in a trading company. There are 2 director shareholders each holding 40% of the issued share capital. There are 3 further shareholders each holding 5%. The company is generally profitable and you receive a sizable dividend from your small shareholding. The director shareholders then decide to increase the company’s share capital and issue non voting preference shares to raise finance for a scheme which you believe will be unsuccessful and will result in the company’s reputation and profitability being damaged.

Provided that the scheme is not unlawful and that there is no shareholders agreement to the contrary, the directors are within their powers to carry out the above scheme. Although increasing the issued share capital of the company and issuing shares of a different class would require a resolution of the shareholders, the directors have a sufficient shareholding to enable them to force the resolution through. As a minority shareholder you have no powers to prevent the scheme proceeding unless you go to court or negotiate an acceptable outcome with the directors.

Applying To Court

You can make a petition to the court under section 459 of the Companies Act 1985. The criteria for making the petition are:

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

The court has very wide powers to deal with a section 459 petition. Section 461 provides that the Court may make such order as it thinks fit and then goes on to list a few examples. The most common remedy claimed under section 459 is for the shares of the petitioning shareholder to be bought at a fair value to be determined by the court if not agreed.

The Likely Outcome

In the absence of any definitive evidence that the scheme would not be in the best interests of the company, the court would be most likely to order the director/shareholders of the company to purchase your shares. If it appeared that the scheme was not in the best interests of the company, the court could prevent the directors from proceeding and may order that the constitution of the company not be changed. The court would be more likely to intervene in the affairs of a company to this extent if one or more of the following could be shown:

• Creditors of the company would be prejudiced by the scheme
• The other minority shareholders shared your opinion
• The directors were acting in breach of their fiduciary duties and not in the best interests of the company
• The scheme was unlawful or had an unlawful purpose.

Generally when considering petitions the courts will take a very pragmatic approach. Chances are that the relationships within the company have broken down due to the dispute. This is particularly likely to be the case in disputes involving companies which are quasi-partnerships – 50/50 split shareholder director companies. The court will take this into consideration and is more likely to order a buyout of one party’s shares.

The Mechanism of a Buyout

If the parties agree on a mechanism for valuing shares, the court will usually uphold this. Otherwise the court will usually order that an expert is to determine the value of the shares. The court can specify what the expert should and should not take into consideration. In a recent court decision the court ordered that the valuation of the shares be backdated and include assets which had since been stripped out of the company. Ordering such measures will usually only be considered where there is a suggestion of bad faith on the part of one or more of the parties.

Generally the threat of section 459 petitions can be a very useful tool in relation to shareholder disputes. They should only really be considered as a last resort though as it is likely that relationships within the company will be soured through the process of litigation.
 

Posted December 4, 2006