Company Law Assessment

1 Company Law Assessment Question B From the facts of the case, it is clear that the members of the company are both directors and shareholders. In this case, however, David and Olga are no longer company directors because they were stripped of their directorship as a result of the resolution passed

by Jason, Mariam, and John. Thus, in asking to be allowed to sell their shares, David and Olga were not acting as directors but shareholders. In this respect, any remedy that they seek will be as shareholders. The following sections will therefore explore the notion of unfair prejudice as the most reasonable method through which they can seek a remedy.

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2 Unfair Prejudice Under UK Company law,1 the concept of unfair prejudice seeks to protect the rights of shareholders. In the typical case, unfair prejudice occurs where the affairs of a particular company are conducted in a manner that is likely to unfairly prejudice all the members of a company or some members of the company. In order for one to institute a cause of action alleging unfair prejudice, the petitioner has to demonstrate that they are among the company members who would suffer prejudice from the conduct in question.2 Section 994 of the Companies Act contains provisions regarding unfair prejudice. It provides that a member of a company may petition the Court for an order on two main grounds. The first is that the company’s affairs have either been conducted in the past or continue to be conducted in a manner that is unfairly prejudicial to the interests of the members. The second ground is that an act that has already been carried out or a proposed course of action – or an omission – would be prejudicial to the interests of the members of the company.3 From section 994 of the Act, therefore, it could be said that there are two elements of unfair prejudice.4 Both of these have to be present in order for shareholders like David and Olga to be able to obtain their remedies. First, they must demonstrate that the conduct that they are alleging to be prejudicial must have been of the kind to cause not just prejudice, but also harm to the members of the company. Secondly, the aggrieved parties will have to demonstrate that the conduct was indeed unfair.

It is worth noting that the unfair prejudice is not exhaustible. Thus, every set of facts has to be considered with respect to the circumstances. Even so, there are some common

Companies Act, 2006 Stephen Griffin, “The significance of determining the nature of a company in the context of an unfairly prejudicial conduct petition” [2013] Company Law Newsletter 1 1

2

3 4

Companies Act 2006 Ibid.

3 examples that have previously been seen to constitute prejudicial conduct. The first of these is exclusion from management in circumstances where there is a legitimate expectation of participation. In such a case, the petitioner will have to demonstrate that they had been operating in the expectation that they would be able to participate in the company’s operations. As Bryan Clark5 notes, unlike the common law remedy, the statutory provision on what constitutes unfairly prejudicial conduct has been interpreted to encompass “not only acts which are contrary to the company’s constitution and the general law bit also those which are contrary to the company’s constitution and the general law but those which are contrary to legitimate expectations which a disaffected member holds.”

The second common example is where there is evidence that there has been the diversion of business to another company where the majority shareholders hold some kind of interest. The other common example is where the petitioner is able to demonstrate that the majority shareholder has facilitated the transfer of financial benefits to themselves. Finally, another common example typically involves gross abuses of power that are contrary to the provisions in the Articles of Association. The failure to hold the required meetings, to keep the necessary books of accounts, and other faults may also be said to be prejudicial to the interests of certain company members. Even so, it will be necessary to demonstrate that there is a difference between conduct that is prejudicial and one that is ultimately unfair. For a petitioner to obtain remedies, they have to demonstrate unfair prejudice. As was seen in the case of Re Elgindata,6 serious lapses in standards of management could give rise to conduct that is determined to be unfairly prejudicial. Such conduct includes the failure to consult directors or substantial minority shareholders over policy decisions. This failure may also include the misuse of company assets by a director for their own personal use.

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Bryan Clark, “Unfairly prejudicial conduct: a pathway through the maze.” [2001] Company Law Newsletter 1

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[1991] BCLC 959

4 It is worth noting that the law on the parameters of prejudicial conduct has been relatively unclear. However, the law was clarified in the case of O’Neill v Phillips,7 which involved an element of prejudicial conduct. In this case, the petitioner (O’Neill) had 25% of the shares of the company in which he was also an employee. As an employee of the company, his aim was eventually to have the responsibility of running the company and receiving 50% of the profits. O’Neill subsequently took over the running of the company and duly received his 5% share of the profits. Thereafter, O’Neill and the respondent (Phillips) entered into negotiations to increase O’Neill’s shareholding from 25% to 50%. Even so, after he raised concerns over the manner in which O’Neill had been running the company, the respondent resumed personal control of the company and informed O’Neill that he would only receive the remaining portion of his salary and dividends based on the 25% shareholding that he had.

In the court of first instance, the judge held that there had been no legitimate expectation on the part of O’Neill as there had been no unconditional agreement that O’Neill was supposed to receive 50% of the shares. In addition to this, the judge held that the facts of the case had not revealed any prejudice to O’Neill’s interests resulting from the reduction of the profit share. Perhaps more significantly, the judge noted that the O’Neill had not suffered any prejudice in his capacity as a shareholder. Instead, he was alleging unfair prejudice in his capacity as a managing director.8 In the Court of Appeal, however, the court took a different approach. In allowing the appeal, the court noted that the absence of a conclusive agreement to increase O’Neill’s shareholding did not mean that there had been no legitimate expectation to receive the shares when the company’s targets had been reached. More importantly, the Court held that the expulsion of O’Neill from the company’s management effectively meant that his rights as a 7 8

[1999] UKHL 24 Ibid.

5 shareholder would be affected. Even so, when the court was brought before the House of Lords, the decision in the Court of Appeal was reversed. According to Lord Hoffman, the critical question in that case was whether it could be said that O’Neill had a right to the shares. As a rationale for allowing the appeal, he noted as follows: The real question is whether in fairness or equity Mr O'Neill has a right to the shares.

On this point, one runs into the insuperable obstacle of the ... findings [of the judge at first instance] that Mr Phillips never agreed to give them ... From which it seems to me to follow that there is no basis, consistent with established principles of equity for a court to hold that Mr Phillips was behaving unfairly in withdrawing from the negotiation.

The facts in the O’Neill case are essential in determining whether David and Olga had a legitimate expectation that they could transfer their shares if and when they wanted. As per this case, it would seem that legitimate expectation can only be said to exist if it was clearly spelt out. However, one could also argue that the transfer of shares is one of the legitimate expectations of any shareholder and, as such, it should be possible for them to exercise this right. This fact notwithstanding, it is also possible to note that the complaint that David and Olga have with respect to the unfair refusal to carry out a transfer may not be necessarily construed as a limitation of their legitimate expectation. As Bryan Clark suggests, it is possible that a court of law – bound by the precedent in the O’Neill case, may find it difficult to have the refusal fall under the ambit of the remedy.9 It is necessary to note, nevertheless, that the manner in which a court decides the matter in the case of David and Olga will be dependent on the circumstances of the case.

Indeed, as was seen in Simply Alarming Security Ltd,10 the Court refused to order that the respondent had to purchase the shares offered by the petitioner who had alleged that she had been the subject of unfair conduct from the respondent. If a petitioner is able to prove their case, then they will be able to benefit from a number of remedies. Even though a court does 9

Bryan Clark, “Unfairly prejudicial conduct: a pathway through the maze.” [2001] Company Law Newsletter 1 [2020] 7 WLUK 330

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6 not face restrictions as to the kind of order that it can make to remedy unfair prejudice, the most common remedy when it comes to the question of a refusal to transfer shares is to require the stake of the shareholder to be bought out at a fair price. Therefore, in the present case, the remedy that would ameliorate the situation of both David and Olga would be to require that the other directors buy their shares.

Finally, it is worth noting that, in exercising its discretion in offering remedies to David and Olga, the court does not have to be limited to ordering that there be a transfer of shares. Under section 996(1) of the Companies Act,11 the court is given the discretion to make any order it thinks fit. Section 996(2) provides the additional orders that a court may make.

First, a court may order for the regulation of the conduct of the company’s affairs in future.

Secondly, the court may require the company to refrain either from committing or from continuing an act that one has complained of. It may also compel the company to refrain from carrying out a certain act. The court may authorise civil proceedings to be brought in the name and on behalf of the company. Finally – and perhaps more crucially for the facts of this case – the court may order the purchase of shares of any members of the company by any other members of the company or, in some cases, by the company itself. To benefit from any or all of these remedies, David and Olga – as the petitioners – will have to specify the relief that they are seeking.

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2006

7 Question C Section 172 and 174 of the Companies Act12 sets out the duties that the directors of a company owe not just the company, but also the shareholders. In other words, this legislative provision imposes a duty on directors to promote the success of the company. Section 172(1) of the Act provides that directors of companies are under an obligation to act in the way that they consider, in good faith, to be most likely to promote the success of the company for the benefit of its members as a whole. In doing so, some of the matters to which they should have regard include having in mind the likely consequences of decisions in the long-term; keeping in mind the interests of the company’s employees; taking note of the need to foster the company’s business relationships with suppliers, customers and others; taking note of the impact that a company’s operations have not just on the community, but also on the environment; the desirability of the company in maintaining a high reputation for high standards of business conduct; and the need to act fairly as between members of a company.

The duty that section 172(3) imposes also means that directors have the responsibility always to consider or act in the interests of the company’s creditors. Section 174 of the Companies Act also provides that directors have a duty to exercise reasonable care, skill, and diligence when exercising their duties. Under this section, the standard that is required is that of a person who has the general knowledge, skill, and experience that would be reasonably expected of a person who carries out the functions typically carried out by the director in relation to the company and by a person who has the general knowledge, skill, and experience that a director generally has.13 The two provisions detailed above will be essential in examining the extent to which the Builders’ directors could be said to have been in breach of their directors’ duties.

2006 Andrew Keay, “Office-holders and the duty of directors to promote the success of the company.” [2010] Insolvency International 129 12

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8 Furthermore, the sections will allow for an interrogation of the possible consequences of breaching the said duties. From the facts of the case, it is clear that the directors knew that they had a duty to maintain proper accounts. Therefore, it is not a matter of contention that, in waiving the liability of their subsidiary company, then they were effectively acting contrary to their responsibilities with respect to the necessary record-keeping. In order to examine the extent of their breach of duties, it may be worthwhile to juxtapose the provisions of Section 172 and 174 with their actions.

First, all the directors were aware that Joiners, as their subsidiary, was facing some financial trouble. The proper thing for them to do at that point was to record the extent of that liability in the company’s books. In knowingly failing to make this record, the directors breached 172(1) of the Companies Act.14 This section makes it clear that the directors have to consider the company’s long-term interests when making decisions. In this case, the directors were aware that Builders was already facing financial difficulties. Therefore, it is possible for one to argue that they did not take the interests of the company into consideration and, in this regard, were in breach of their duties.

Waiving the claim against Joiners also placed the directors of Builders in breach of the duty to act fairly as between the members of the company. It is notable that when the motion to waive the claim against Joiners was raised, the only director who opposed it was John. In his view, the company was already facing numerous financial difficulties. Therefore, in waiving the claim against Joiners, it would effectively be acting in a way that jeopardizes the company’s future. The action of the other two directors not to take John’s opposition in mind demonstrates that there was a failure to act fairly as between the members of the company.

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2006

9 The actions of the directors could also be said to be in breach of section 174 of the Companies Act15. As outlined above, this section provides that directors have a duty to exercise reasonable care, skill, and diligence when exercising their duties. Furthermore, the standard required in the exercise of their duties is objective. It is that of the person who has the general knowledge, skill, and experience reasonably expected of the directors. In this case, the expertise of the directors shows that they had the required knowledge and experience to make the correct decision. The two directors who were in support of waiving the claims against Joiners did so in spite of the fact that they had sufficient experience to show them that taking that decision would go against the interests of the company. Jason has substantive experience in running various companies. On the other hand, Mariam is a finance director who is also a qualified accountant. Their combined experience therefore shows that they were in breach of their duties as directors.

In Regentcrest Plc (In Liquidation) v Cohen,16 the court held that when dealing with duty to act in the bona fide interests of the company, the directors will have to provide evidence that shows that they were acting in a manner that they believed to be in the best interests of the company. In this case, therefore, the directors of Builders will have to demonstrate that, in waiving the claim against Joiners and failing to keep proper accounts, they were acting in a manner that they truly believed to be in the best interests of the company.

In his article, Andrew Keay17 argues that the requirement for directors to promote the success of a company cannot be stated in conclusive terms. However, in general, it typically means that it achieves the business objectives that the company lays down for itself. These objectives could be either financial or strategic. The specific parameters of success can only 2006 [2001] 2 BCLC 80 17 Andrew Keay, “Office-holders and the duty of directors to promote the success of the company.” [2010] Insolvency International 129 15 16

10 be determined on a case-to-case basis. Furthermore, what constitutes success is usually on the good faith judgement of the director in question. Ultimately, therefore, in the facts of the case, the essential thing for the directors to do in order to avoid liability is for them to establish that they had belief in the fact that their actions would promote the company’s success.

The consequences for directors who breach the duties provided by Section 172 and 174 of the Companies Act are provided under section 178. This section provides that when a breach occurs, then the consequences will apply as if the corresponding common law or equitable principle applied. The consequences for the breaches include the imposition or compensation in the case that a company has suffered a loss; the restoration of the property of the company; rendering an account of the profits made by the director; the rescission of a contract where the director failed to disclose a particular interest. With respect to the specific facts of the case, two issues are worth noting. The first issue is that the court can only provide the damages that are requested. In this case, the dissenting director (John) could bring a suit against the rest of the directors. The second issue is that, due to the fact that the breach of the duty to exercise reasonable care, skill, and diligence is not fiduciary, then the remedy can only be damages.

11 Bibliography Primary Sources Case Law Re Elgindata [1991] BCLC 959 Regentcrest Plc (In Liquidation) v Cohen [2001] 2 BCLC 80 Simply Alarming Security Limited [2020] 7 WLUK 330 O’Neill v Phillips [1999] UKHL 24 Legislation Companies Act 2006 Secondary Sources Andrew Keay, “Office-holders and the duty of directors to promote the success of the company.” [2010] Insolvency International 129 Bryan Clark, “Unfairly prejudicial conduct: a pathway through the maze.” [2001] Company Law Newsletter 1 Stephen Griffin, “The significance of determining the nature of a company in the context of an unfairly prejudicial conduct petition.” [2013] Company Law Newsletter 1