When a shareholder’s rights have not been observed by a company and/or its directors, it is possible for them to ask the court to impose a fair remedy. There are three bases on which an application can be made to the court for shareholder remedies by a shareholder who seeks justice, namely an unfair prejudice petition, a derivative claim and a petition for winding-up on just and equitable grounds.
Lincoln & Rowe can help you understand shareholder remedies and what individuals and businesses can do to settle a shareholder dispute.
Unfair prejudice petition
If a shareholder believes that a company is operating in a way that is unfairly prejudicial to them, they can submit a petition to the court under s. 994 of the Companies Act 2006.
Unfair prejudice petitions are straightforward shareholder remedies if they can prove that:
- the potentially unfair conduct was proposed or carried out by the company;
- the conduct prejudiced the petitioner’s interests as a shareholder; and
- the conduct is unfairly prejudicial to the interests of some or all of the company members.
This means that a petition can be made before any prejudicial action has been taken, at the time that it is proposed. Even if it was proposed and the action not taken, a petition can still be submitted.
The question of what constitutes unfair prejudice will be decided by the court who will look for an action relating to the way in which the company is run which unfairly disadvantages people by treating them with a lack of justice or equality.
If a shareholder’s power was reduced, for example, by the creation of more shares in the company, thereby diluting voting power, this could be considered unfair. If the claimant has been unfairly excluded from decision-making that they had a right to be involved with, they may be entitled to make a claim. If agreements are not adhered to or the company’s articles of association are not observed, this could also constitute unfair prejudice. Similarly, misappropriation of funds or other company assets would allow a shareholder to make a claim.
Articles of association form a company document that specifies the regulations in regard to operations and company purpose. The document lays out how tasks are to be undertaken including the process for appointing directors, director duties and the handling of financial records.
Unfair prejudice often results in minority shareholders ending their relationship with the company by securing a sale of their shares. This could be as a result of an offer made by a majority shareholder, usually the defendant, or by an order of the court. Company directors will usually be the defendants in this type of claim and, if ordered to buy shares, will need to fund this personally and not from company funds.
Remedies for unfair prejudice
Under section 996 of the Companies Act, if the court finds there has been unfair prejudice, it has the discretion to make ‘such order as it thinks fit’. Options commonly used are:
- Instructing the company to implement a new practice
- Requiring the company to change its procedures
- Ordering that the company cease doing something
- Order the sale of shares at a fair value to a specific person or group
- Order the sale of the company
The most common result of an unfair prejudice claim is that a majority shareholder purchases the shares of a minority shareholder at a fair value, meaning that accurate share valuation becomes an important issue.
It is open to the court to set a price for the share sale that compensates for any wrongdoing on the part of the majority shareholder that may have adversely affected the share price. The court will aim to value the shares at the price they were prior to the wrongdoing.
Shares held by a minority shareholder may be discounted to take into account the lack of control they have in the company and the fact that while the majority shareholder may be key to the business’s success, the minority shareholder is not.
If the allegations of unfair prejudice are on the basis of failing to allow the minority shareholder to participate in management decisions, then the defendant is generally advised to make an out of court offer to buy the shares once they become aware of the claim. This type of offer is known as an O’Neill v Phillips offer, after the case which established the principles to be followed.
In giving the judgment, Lord Hoffman provided guidance on the sort of offer that could be made. If refused, then the defendant could ask the court to strike out the application. The aim is to encourage a case of unfair prejudice based on exclusion from management to be settled promptly out of court, while giving the same result as court proceedings might offer.
An O’Neill v Phillips offer should:
- Be an offer to buy the shares for a fair value, generally without a discount for the fact that they are minority shares.
- If the proposed valuation is not accepted, an expert should provide a valuation. The expert should be chosen and agreed upon by both parties and should only value the shareholding and not provide his reasons for the valuation, ie. he should not act as an arbitrator.
If the identity of the expert cannot be agreed upon, then the President of the Institute of Chartered Accountants can nominate an individual to carry out the valuation. The expert’s costs will normally be shared, but the expert will have the power to decide if another option is more appropriate.
- Both sides should be provided with the same company information that has been made available to the valuer and which is relevant to the share valuation process. They should also both have the option of putting forward their submissions to the expert. The expert can decide whether to take these in writing or orally.
- The defendant does not automatically have to offer to pay the claimant’s costs of the case. The defendant should be allowed time to consider the action and to prepare an offer to settle.
If the unfair prejudice is based on other factors than simply excluding the claimant from management, for example, if there have been breaches of fiduciary duty, then this type of offer may not be appropriate and the court can be asked to determine the share price.
If a director is negligent, in breach of trust, fails in their duties or defaults on their duties, then shareholders can bring what is known as derivative action against the director under s. 260 of the Companies Act 2006. This extends to former directors of a company and also allows a shareholder to continue a derivative claim commenced by the company against one of its directors. This type of claim must be in the best interests of the company and the court is stringent in testing this.
When an application is received by the court, it will firstly consider whether the case qualifies to be taken forward. It will examine whether two pre-conditions have been met, as well as looking at whether any other remedies are available, what the views of other shareholders are, why the company has not brought the case itself and whether the application has been made in good faith.
The first pre-condition requires that the claim cannot be based on the fact that a director has not fulfilled their duty to promote company success.
The second pre-condition is that the act complained of in the claim cannot have been approved or authorised by the company in the time since it took place. The court may also give a company time to formally approve the act complained of, provided that it is a legal act and the company would be acting within its powers to approve it.
The court will also consider whether it is in the best interests of the company for the case to go ahead. To establish this, they will ask whether the shareholder is pursuing the claim for their own advantage and whether a director acting in good faith on behalf of the company would pursue such a claim.
Once the pre-conditions have been shown to be fulfilled, the court can grant permission for the case to proceed to a court hearing, although this permission may be limited or conditional.
Seeking shareholder remedies can be a complex business and it is usually recommended that independent legal advice is sought. In some circumstances, an action may be both unfairly prejudicial and a negligent or breach of trust act on behalf of a director. An experienced company lawyer will be able to advise how best to proceed and how to ensure each stage of any claim is proved.
The court may order an injunction to stop a breach of duty from continuing, award damages or return of company property or rescind a contract, for example, where a director held an undisclosed interest. The claim is run by shareholders on behalf of the company, so anything recovered in the action goes to the company initially. It is then a matter for the board as to whether to pass the benefit on to shareholders.
Winding-up petition on just and equitable grounds
The most extreme application in shareholder remedies is for the company to be wound up, meaning it would be placed into liquidation by the court and its business would be at an end. The application is made under s. 122(1)(g) of the Insolvency Act 1986. As well as shareholders, directors and creditors may also request a winding-up petition.
Because of the severity of the remedy, the court requires strict proof of one of a number of facts.
Occurrences which have been classed as just and equitable grounds for a company to be wound up include:
- Mismanagement of the company;
- Where the person making the application has been excluded from management decisions that they should have been involved in;
- Where there is a deadlock within the company as to how to proceed;
- There has been a material failure to adhere to the articles of association or to the shareholders’ agreement and this failure equates to unfair treatment of the minority by the majority shareholders
- Where it is no longer possible for the company to carry on the business for which it was established.
Examples of occurrences that could justify a winding up petition include:
- Ignoring pre-emptive rights when transferring shares so that minority shareholders are unfairly prejudiced
- Incompetence on the part of directors
- A breakdown in trust and confidence that was not caused by the claimant
- A deadlock in voting
- Directors have breached their duties in a way that unfairly prejudices the minority shareholders
- Minority shareholders were excluded from decision making that they were entitled to be a part of
- A failure in honesty when carrying out the company’s affairs
- Not permitting minority shareholders the role they reasonably expected in the company
The shareholder must have held shares for at least six months out of the 18 months before the date of the petition.
It is sometimes the case that an action for winding-up could be brought at the same time as a claim of unfair prejudice.
To be eligible to seek a winding-up petition, the shareholder must have tangible interest remaining in the company once it has been liquidated. This means that there must be a value to what remains of the business after it has been ended. Because of the severity of winding up a business, the court will also consider whether there is a different and preferable remedy that could be considered, particularly if the company is profitable and solvent.
It is vital for businesses to act as soon as notice of a winding-up petition is received if attempts are to be made to save the business. If you’ve received a winding-up petition, here’s 9 things you need to consider.
Before starting legal action, it is always advisable to work with an expert corporate solicitor to explore whether there are ways of resolving matters out of court. This is likely to be less damaging to a business and is often a more flexible option, as you are free to find a solution that might not be available to the court.
We can advise you of suitable methods of alternative dispute resolution for your case and represent you in starting the process and negotiating an acceptable outcome.
- Early neutral evaluation
These are generally quicker and more cost-effective than litigation. They also have the advantage of being private, while court action will expose the company to public scrutiny.
Mediation involves meetings with a neutral mediator who will work with all parties to help them consider the way forward. The mediator will not make decisions but can suggest ways in which a compromise could be reached.
If you and the other parties reach a solution, this will be one that you all agree on. The mediator will not impose a decision on you, so you can be sure that you will not end up with an unwanted outcome.
Arbitration can be thought of as private court proceedings. An independent arbitrator will hear the evidence and make a binding decision. It is faster than court and appointments can be arranged at a time to suit you, meaning it is a more flexible option.
Early neutral evaluation
Early neutral evaluation is sometimes referred to as a sense-check. It is an assessment of the facts early on in the process, with the aim of avoiding protracted litigation.
An independent expert will give the parties their opinion on the strengths and weaknesses of their case, which can help facilitate an agreement before the situation and the costs escalate.
For more information, see Minority shareholder disputes: What are your rights?
Bringing a claim as a shareholder can be complicated and confusing. If an action fails, there will usually be a liability for costs, both the shareholder’s own and that of the company. For this reason, it is important that anyone dealing with a shareholder action understands the law and the court’s requirements.
For tips on avoiding disputes, see Strategies for preventing shareholder disputes.
At Lincoln & Rowe we understand the importance of helping our clients keep their businesses running smoothly. As well as in-depth commercial expertise we provide an excellent service to our clients and practical advice and guidance.
We have wide-ranging experience in litigation and corporate law, and were named as winner of the Global 100 for Best Firm for Commercial Disputes of the Year 2024 and Gamechangers Global Awards for Boutique Litigation Law Firm of the Year 2023.
If you would like to talk to one of our expert legal team about any queries you may have, contact the author, Dipesh Dosani, or call the team today on 020 3968 6030 and we’ll be happy to help.
The above information is for general guidance on your rights and responsibilities and is not legal advice. If you need more details on your rights or legal advice about what action to take, please contact a legal advisor.