UK: England and Wales: unfair prejudice and directors' fiduciary duties

Interim post: Allegations concerning breaches of directors' fiduciary duties are often considered in the context of the unfair prejudice remedy (Section 994 of the Companies Act (2006), formerly Section 459 of the Companies Act (1985)). The recent High Court decision O'Donnell v Shanahan [2008] EWHC 1973 (Ch) provides a good example but the case is of particular interest because of the discussion of fiduciary duties. For example, the trial judge observes (at para. [212]):

Whilst the authorities make clear that, if a breach of the no conflict rule (and also the no-profit rule) is made out, it does not matter if the company (or trust or partnership) could not of itself have proceeded with the transaction, it does appear to me permissible to take into account when determining the scope of the directors' duties and in deciding whether 'there is a real sensible possibility of conflict' the inherent likelihood in fact of the company extending its existing scope of business into areas of business which might give rise to a conflict".

Notes:

[1] The judgment is not yet available on BAILII although it is available on Lawtel (for subscribers). The trial judge relied heavily upon the first instance decision Wilkinson v West Cost Capital & Ors [2005] EWHC 3009 (Ch). Update (28 August 2008): the decision is now available on BAILII - click here.

[2] The Companies Act (2006) has codified directors' fiduciary duties: see Part 10, Chapter 2 (and remember that the provisions within this Part have different implementation dates).  The O'Donnell case was concerned with the common law duties on which these codified duties are based. 

UK: Scotland: unfair prejudice, implied terms and the affairs of the company

An interesting judgment was handed down yesterday by Lord Glennie in Scotland's Court of Session (Outer House). The case - Gowanbrae Properties Ltd., a petition of [2008] CSOH 106 - concerned a petition presented under Section 994 of the Companies Act (2006) (the unfair prejudice remedy, formerly Section 459 of the Companies Act (1985)). The case deserves attention because of Lord Glennie's comments on the width of the remedy and also because it provides a good illustration of the difficulties associated with determining whether prejudice has been suffered by a shareholder qua shareholder.

The petitioner held redeemable preference shares in the company. At the time that the preference shares were created, the company's articles were amended to provide for the redemption of the preference shares on a specified date: the day on which a certificate of practical completion was issued in respect of the development of a property owned by the company. The company's board decided not to proceed with the development of the property. The petitioner claimed that this prevented the redeeming of its shares and that this amounted to the conduct of the company's affairs in a manner unfairly prejudicial to its interests.

In order to bring their claim within Section 994, the petitioner argued that the directors' decision ended the basis on which the parties had entered into association; it was thus unfair, the petitioner argued, for it to be bound to continue as a shareholder in the company. Lord Glennie rejected this argument and the argument that a term should be implied requiring the company to achieve practical completion. His Lordship dismissed the petition and in the course of his judgment observed (at para. [20]):

If there is no obligation on the Company in terms of the implied term contended for by the petitioner, it must follow that the Company is free to make commercial decisions in its own interests. The directors owe a fiduciary duty to the Company and complaints can be made against them if, in breach of that duty, they have regard to extraneous matters, such as a desire to benefit some other company. The court will not lightly infer from surrounding circumstances the existence of an understanding to which the Company should be held in equity and which would prevent it from making decisions in its best interests..."

Lord Glennie also made the following interesting observations with regard to the petitioner's claim and the court's jurisdiction under Section 994 (at para. [22]):

The essence of that jurisdiction [Section 994] is that the affairs of the company have been conducted in a manner which is unfairly prejudicial to the interests of the petitioner as a member of the company. The petitioner's claim, as was stressed repeatedly in argument, is based on the fact that it had an accrued right to payment ... It seems to me to be arguable that the prejudice which the petitioner has suffered, if it be prejudice, is as a seller of shares rather than as a member of the company. In response to this argument, I was referred on behalf of the petitioner to the case of Gamlestaden Fastigheter AB v Baltic Partners Limited [2007] 4 All ER 164. In that case a shareholder claimed under the Jersey equivalent of section 459 on the basis that he was a creditor, and would not have advanced sums to the company but for having been a shareholder. This, it was argued, illustrated the width of the jurisdiction. Those facts are, of course, the reverse of the present circumstances ..."

Note: For an earlier decision of Lord Glennie considering Section 994, see: West Coast Capital (Lios) Ltd. [2008] CSOH 72.

UK: England and Wales: the Companies Act (2006): the statutory derivative action

In Franbar Holdings Ltd v Patel and others [2008] EWHC 1534 (Ch), the High Court considered the operation of the statutory derivative action introduced by Part 11 of the Companies Act (2006). This is one of the first reported cases concerning the operation of the statutory derivative action. Although not a full trial of the various claims, Franbar is nevertheless important because it provides (a) clarification regarding ratification and (b) insights concerning the relationship between the new statutory derivative action and the unfair prejudice remedy in Section 994.

In Franbar the trial judge (Mr William Trower QC, sitting as a Deputy Judge of the High Court) had before him several applications including a petition under Section 994 of the Companies Act (2006) and an application to continue a derivative action.  Section 261(1) of the 2006 Act requires a member bringing a derivative action to seek the court's permission to continue the action. Section 263 sets out the circumstances in which permission should be given and, in subsection 2, provides that permission must be refused if the court is satisfied:

(a) that a person acting in accordance with section 172 (duty to promote the success of the company) would not seek to continue the claim, or
(b) where the cause of action arises from an act or omission that is yet to occur, that the act or omission has been authorised by the company, or
(c) where the cause of action arises from an act or omission that has already occurred, that the act or omission— (i) was authorised by the company before it occurred, or (ii) has been ratified by the company since it occurred.

The judge did not consider head (b) because the allegations concerned past conduct.  With regard to head (a) - referring to the duty imposed on company directors - the trial judge identified several factors  which the hypothetical director would take into account including:

• The prospects of success
  
• The disruption which would result if the proceedings continued
  
• The cost of the proceedings
  
• Any damage to the company's reputation and business if the action failed

With regard to head (c) - authorisation or ratification - the trial judge considered Section 239 which governs ratification by the shareholders of a director's acts. Section 239 provides that a resolution proposed at a meeting will only be passed if the necessary majority is obtained excluding the votes of the director (if a shareholder) and any shareholder connected with him (on the latter, see Section 252). It was argued that Section 239 had replaced the principle that directors' acts cannot be ratified where they constitute a fraud on the minority and the wrongdoers are in control of the company. 

The trial judge rejected this argument, relying upon Section 239(7) which provides that the framework for ratification in Section 239 "does not affect any other enactment or rule of law imposing additional requirements for valid ratification or any rule of law as to acts that are incapable of being ratified by the company". In the judge's opinion (at para. [45]):

...the [following] words of Sir Richard Baggalay ... in North-West Transportation v Beatty (1887) 12 App Cas 589, 594, describing the circumstances in which a company cannot ratify breaches of duty by its directors, remain good law:

"... provided such affirmance or adoption is not brought about by unfair or improper means, and is not illegal or fraudulent or oppressive towards those shareholders who oppose it"

It follows that, where the question of ratification arises in the context of an application to continue a derivative claim, the question which the court must still ask itself is whether the ratification has the effect that the claimant is being improperly prevented from bringing the claim on behalf of the company ... That may still be the case where the new connected person provisions are not satisfied, but there is still actual wrongdoer control pursuant to which there has been a diversion of assets to persons associated with the wrongdoer, albeit not connected in the sense for which provision is made by section 239(4)". 

The judge also considered Section 263(3), which specifies several factors to be considered when determining whether permission should be given, including factor (f): "whether the act or omission in respect of which the claim is brought gives rise to a cause of action that the member could pursue in his own right rather than on behalf of the company". The trial judge observed that where an act or omission gives rise to a claim for unfair prejudice (under Section 994) against a member and a claim for breach of duty against a director, Section 263(3)(f) is engaged. He also held that the adequacy of the remedy in (f) was a relevant consideration.  

The trial judge's decision was that permission should not be given for the derivative action to proceed. Although he found that there was substance in some of the complaints made, further work was needed to establish a clear claim of breach of duty.  For this reason it was open to a hypothetical director to decline to proceed with the derivative action. The judge also attached significant weight to the fact that the shareholder bringing the derivative action would be able to gain what it wanted through its separate Section 994 petition and shareholder action. 

Notes:

[a] The Franbar judgment has not yet appeared on BAILII although it is available on Lawtel (for subscribers only). A summary has, however, been provided here by the ICLR as part of its free WLR(D) service. This summary - which focuses on the issues surrounding ratification - will be removed if, as is likely, Franbar is reported in one of the ICLR series of law reports. Update (22 September 2008): the judgment is now available on BAILII - click here.

[b] Separate sections of the 2006 Act deal with derivative proceedings in Scotland: see Part 11, Chapter 2.

UK: England and Wales: unfair prejudice and just and equitable winding-up

Earlier this year, in Hawkes v Cuddy [2009] EWCA Civ 261, the Court of Appeal declined to follow the position, adopted in Re Guidezone [2000] 2 BCLC 321 by Jonathan Parker J., that conduct which is not sufficient to found an unfair prejudice petition is necessarily insufficient to found a winding-up petition based on the "just and equitable" ground (see, in particular, para. [107]). 

Last Friday judgment was given in Amin v Amin [2009] EWHC 3356 (Ch), in which the trial judge, Warren J., considered the Court of Appeal's decision and the relationship between the unfair prejudice remedy (Section 994 of the Companies Act (2006)) and just and equitable winding-up (Section 122(1)(g) of the Insolvency Act (1986)). 

Warren J. found the petitioners' allegations of unfair prejudice unfounded but nevertheless recognised that the circumstances may well have founded a successful petition for just and equitable winding-up, although the petitioners had not sought this (see para. [613]). Interestingly, Warren J. also observed, obiter, at para. [584]:

"If the facts are such that a winding up petition on the "just and equitable" ground would succeed but the majority refuse to agree to a winding-up out of court, that conduct might amount to unfair prejudice, the unfairness being to compel the minority to continue to participate in the company when the court would, on this hypothesis, wind it up".

Scotland: Directors' duties and unfair prejudice

The Court of Session has, today, declined to grant West Coast Capital (WCC) an interim interdict (injunction) which would have prevented Dobbies plc from proceeding with a rights issue.  WCC, a minority shareholder in Dobbies, presented a petition under Section 994 of the Companies Act (2006), alleging that the Dobbies directors (several of whom were officers or directors of Tesco plc and had been appointed last year when Tesco became a majority shareholder) had exercised their powers in Tesco's interests to the prejudice of the other shareholders and had failed to act fairly between Tesco and the other shareholders.  

Lord Glennie was not satisified that WCC had an arguable case.  His opinion is available here and it is important for several reasons:

[1] There is discussion of Section 171 and Section 172 of the Companies Act (2006).  Section 172 imposes a duty on company directors to promote the success of the company for the benefit of the shareholders as a whole.  In doing so, directors are required to have regard to various factors, including the impact of the company's operations on the community and the environment and the need to act fairly as between members of the company.  In Lord Glennie's view, Section 172 does "little more than set out the pre-existing law on the subject" (para. [21]).  Some may question that interpretation because Section 172 sets out, for the first time in companies legislation, certain factors that directors are required to consider. 

[2] There is the clear recognition that breaches of directors' duties can be unfairly prejudicial.  This point remains controversial.  Lord Glennie nevertheless observes: "... it is important to have in mind that fairness and unfairness (in the context of assessing whether conduct is "unfairly prejudicial") are not abstract concepts. They are used in the context of a commercial relationship, where the parties' rights and expectations are governed by contract, namely the articles of association, and, possibly, by other agreements or understandings, as well as by the fiduciary duties which directors owe to the company" (para. [19]).

The case has attracted widespread attention in the media because of the parties involved. See, e.g., The Scotsman, The Guardian and The Times.

Postscript (21 May 2008): The Guardian has reported that West Coast Capital has agreed to accept an offer from Tesco of £12 per share.

UK: NAPF: Company articles and arbitration clauses

The UK's National Association of Pension Funds (NAPF) has updated Section D of its Corporate Governance Policy and Voting Guidelines 2007. Section D now includes a new section - D.1.6 - dealing with arbitration clauses and which reads as follows:
----------
D.1.6: Dispute Resolution
The introduction or maintenance of a provision in the Company's Articles of Association which prescribes arbitration as the sole mode for settlement of all or a significant class of disputes between shareholders (whether acting in their own right or in the name of the Company, as applicable) and any one or more of the Company, its directors, executive management, or its professional advisors, should be viewed in the first instance as a material reduction in shareholder rights.
Voting
Investors will normally wish to oppose any such provision in the absence of a clear demonstration by the Board that the inherent detriment of a reduction in shareholders rights represented by such provision is outweighed by the benefit the provision brings in the light of specific and extenuating circumstances to which the Company is subject.
----------

It is worth pointing out that even where such clauses are present in a company's articles of association, the right to petition under Section 994 of the Companies Act (2006) cannot be removed through contract. This point was made in Exeter City AFC Ltd v Football Conference Ltd [2004] EWHC 831 (Ch), [2004] 1 W.L.R. 2910, with regard to Section 459 of the Companies Act (1985) (the predecessor of Section 994). Such petitions are, however, unusual in public companies.

UK: Scotland: remedies for unfairly prejudicial conduct and the powers of the court

The Court of Session (Inner House) has today given its opinion in Li v Holouis Ltd [2009] CSIH 87. The principal issue before the court concerned the remedies available to the Sheriff court when granting relief for unfairly prejudicial conduct under Section 996 of the Companies Act (2006). Lord Carloway delivered the opinion of the court and, at paras. [14] and [15], stated:

Section 994 of the Companies Act 2006 provides, inter alia, that a shareholder can apply to the Court for relief in a situation where a company's affairs are being, or have been, conducted in a manner unfairly prejudicial to him. Section 996 allows the Court to "make such order as it thinks fit". It is recognised that this gives a court the "widest possible discretion" in the selecting the remedy (Wilson v Jaymarke Estates Ltd 2006 SCLR 510, Lord President (Cullen) at para [12]). However, this does not mean that the court can create new remedies, of a type which it otherwise has no power to grant. Thus, it can select from its armoury of competent remedies the one which it thinks appropriate to a given situation. Obvious examples will be orders for payment, ad factum praestandum and interdict. But, in the absence of an express statutory provision, a court cannot grant a remedy which it has no general power to grant.

The Sheriff Court has no jurisdiction to grant the remedy of reduction of documents (Dobie: Sheriff Court Practice, p 22, under reference to Donald v Donald 1913 SC 274). As distinct from the situation where a statute permits the Sheriff Court to "set aside" a decision or other matter as between the parties to a cause or where reduction ope exceptionis constitutes a defence, reduction of deeds can have a much wider effect. It can affect third parties, over which the Sheriff Court may have no general jurisdiction. In the case of heritable rights, any potential Sheriff Court jurisdiction may rest exclusively in another Sheriffdom. Hence, reduction has tended to be restricted to the Court of Session. It may be that this will change in the future (Report of the Scottish Civil Courts Review chapter 4, para 141, recommendation 29) but that is the law at present. The Sheriff's objections to it, however well reasoned in practical terms, cannot change that. In short, the Sheriff Court has no power to grant reduction in a petition under section 994".

Note: a glossary of Scottish legal terms is available here. 

UK: England and Wales: unfair prejudice - improper accounting and removal of an auditor

Judgment was given today in Kohli v Lit & Ors [2009] EWHC 2893 (Ch), a case in which a shareholder successfully sought relief for unfairly prejudicial conduct under sections 994 to 996 of the Companies Act (2006). The allegations were wide-ranging but of particular interest are those concerning the preparation of accounts and the non-disclosure of directors' remuneration, which the trial judge (HHJ Purle QC, sitting as a High Court judge) held established unfair prejudice. The trial judge also discussed Section 994(1A) and this would appear to be the first time that this new provision has been judicially considered. 

In the case, the remuneration of the highest paid director was not, as required, disclosed and had been included in an amount for "administrative expenses".  It was argued that this did not matter because a shareholder could have asked a question at an annual general meeting in order to elicit further information. The trial judge rejected this position, observing that (para. [218]): 

Transparency demands that the unvarnished truth should be revealed by the accounts, not hidden, and not left to the shareholder to ask questions at a shareholders' meeting".

Although the trial judge found that there was no deliberate plan to conceal the truth from the petitioning shareholder, it was, he observed (para. [224]):

... readily understandable that the improper accounting should cause her to lose all confidence in the competence and integrity of the board, or (which is probably a more realistic appraisal of the situation) that such possibility that there ever was that she should regain trust and confidence in the board has been destroyed".

It would appear that this finding was an important factor in the trial judge's finding of unfair prejudice.  In reaching this decision, HHJ Purle QC briefly considered the knowledge of accounting to be expected of individual directors (para. [220]):

It would be wrong to expect individual directors to be on top of the detail of the accounting requirements of successive Companies Acts and allied regulations. It is their duty, however, to read the accounts carefully before their approval and query anything that strikes them as odd, or questionable".

Elsewhere in his judgment, when exploring the extent to which breaches of companies legislation should be unfairly prejudicial, he referred to Section 994(1A) - inserted by Regulation 42 of the Statutory Auditors and Third Country Auditors Regulations 2007 - and which provides that "a removal of a company's auditor from office - (a) on grounds of divergence of opinions on accounting treatments or audit procedures, or (b) on any other improper grounds - shall be treated as being unfairly prejudicial to the interests of some part of the company's members". HHJ Purle QC observed that the effect of Section 994(1A) was that (para. [20]): 

[there must] be a finding of unfair prejudice even though the effect of the conduct complained of has no necessary impact on the value of the complaining shareholders' investment. Moreover, a board acting in good faith may genuinely, and correctly, disagree with (say) the accounting treatments, but removal of the auditor on those grounds will be unfairly prejudicial, reflecting the importance the law attaches to absolute standards of behaviour in the accounting process. Whilst this particular provision is new, I regard it as declaratory (except as to its mandatory application) of the kind of conduct that can amount to unfair prejudice, both today, and in a case concerning events before 2008, as this case does. Having said that, it does not follow, even where unfair prejudice is established, that the Court will necessarily grant relief. There will be cases where the Court concludes that the unfair prejudice is not sufficiently serious to justify its intervention, or its intervention may be limited".

UK: England and Wales: a couple of section 994 cases

A couple of High Court decisions concerning petitions under Section 994 of the Companies Act (2006) - the unfair prejudice remedy - were handed down yesterday: Shah v Shah [2010] EWHC 313 (Ch) and Sharafi v Woven Rugs Ltd [2010] EWHC 230 (Ch).

Whilst not adding anything important to our understanding of Section 994, the decisions provide good examples of conduct that will be regarded as unfairly prejudicial. This said, in Shah an interesting argument was made by the petitioning minority shareholder: that the appointment by a majority shareholder of a director who was not independent of the majority shareholder was unfairly prejudicial under Section 994. The trial judge rejected this argument, observing that the appointment per se of such a director would not be unfairly prejudicial.

England and Wales: Unfair prejudice: deadlock and the company's affairs

S. 994 of the Companies Act (2006) – formerly S. 459 of the 1985 Act – has been considered in Hawkes v Cuddy [2007] EWHC 2999 (Ch). The trial judge held that there was no absolute rule that the affairs of one company could not constitute the affairs of another for the purposes of S. 994. His Lordship also accepted that relief could be granted under S. 994 where there is a breakdown in trust and confidence coupled with deadlock, the result of which is that the company cannot be run as initially contemplated.

UK: England and Wales: the statutory derivative action - Franbar judgment available on BAILII

BAILII now contains a copy of the judgment Franbar Holdings Ltd v Patel and others [2008] EWHC 1534 (Ch), in which the High Court considered the operation of the statutory derivative action introduced by Part 11 of the Companies Act (2006). This is one of the first reported cases concerning the operation of the statutory derivative action. Although not a full trial of the various claims, Franbar is nevertheless important because it provides (a) clarification regarding ratification and (b) insights concerning the relationship between the new statutory derivative action and the unfair prejudice remedy in Section 994. Further information is available in this earlier post.

UK: the Companies (Unfair Prejudice Applications) Proceedings Rules 2009

The Companies (Unfair Prejudice Applications) Proceedings Rules 2009 were laid before Parliament last week and come into force on 1 October. A copy of the Rules has been published on OPSI: see here (html) and here (pdf). The purpose of the Rules is explained in the accompanying explanatory memorandum as follows:

The Companies Acts provide that a member of a company can petition the court on the grounds that the company is being run in a way that is unfairly prejudicial to the members as a whole or some part of them. And they apply rule-making powers in the Insolvency Act 1986 to enable rules to be made supplementing the Civil Procedure Rules for unfair prejudice petitions. This was in Part XVII of the Companies Act 1985, which has been replaced – without significant change – by Part 30 of the Companies Act 2006. The new Rules will bring the references into line with the Companies Act 2006, including removing the requirement for the petitioner to state the objects of the company. They also take account of changes in the Civil Procedure Rules since 1986".