Small companies are often described as ‘quasi-partnerships’. That is because the owners are the day-to-day operators and know what is going on. When it is operating well, it is great. But sometimes minority shareholders can feel disadvantaged. They can suffer an ‘unfair prejudice’ which, if enough to satisfy the requirements of section 994 of the Companies Act 2006, may allow them to successfully present a court petition to challenge the direction of travel of the controlling directors/shareholders.

 

 

This may occur not just in quasi-partnerships but larger companies as well, and the key to understanding unfair prejudice petitions relies on two core elements;

• What has been done or is being threatened which is prejudicing a shareholder?
• Is it unfair?

It is important to appreciate both of these elements. Any court petition has to address the way the company’s affairs are being conducted. This should be clear and straightforward for most people to understand as ‘the company’s affairs’ is a very broad definition. It can cover all matters decided by the company’s board of directors.  

What is ‘prejudice’?

Prejudice is another very broad term which can be an advantage or disadvantage depending on whether you are looking to bring or defend a petition for unfair prejudice. Prejudice is not limited to financial loss; however, loss in the value of the member’s shares is the most common reason a petition is pursued.  

Prejudice can include breaching a member’s right to be involved in the management of the company and the decisions it is taking including its strategic direction. Again, the breadth of “prejudice” allows a creative lawyer the opportunity to show harm and damage in different ways.  If there is a genuine dispute and a legitimate interest of a shareholder that needs to be protected, this requirement is therefore usually straightforward to meet.

Unfairness

The more subtle question is whether the conduct, even if it is potentially prejudicing the interest of a shareholder, is unfair. What is fair can only be decided on, based on the underlying facts and dynamics in the company.

I have described the process as being like a corporate divorce. The appeal courtshave observed in leading cases that what is fair between competing business people may not be fair between members of a family, for example.  Therefore, it is important to understand in precise detail the history of the company and the nature of the shareholders in dispute; their background, expectations and a range of other details.

However, although fairness is something that can only be considered in each individual situation, this is an area that has seen a considerable amount of litigation over the years and particular examples of what has been recognised to be unfair include:

1. Failing to allow a member to be involved in the management of a company or to be properly consulted about decisions being made will amount to unfair prejudice; if there is a quasi- partnership; or there is a particular shareholders agreement that is being breached. Alternatively, if a party has been guilty of some form of gross misconduct, excluding them would not be unfair.

 

2. Paying moderately excessive remuneration or bonuses to directors is not normally unfair prejudice unless it breaches either the terms of the articles of association or an agreement between the shareholders. If however, the payments are so high that they are unreasonable, that could amount to unfair prejudice. This is because the company should properly distribute profits via dividend or try to direct an unfair share of profits or resources by way of director remuneration.

 

3. Failure to pay dividends can be a base of unfair prejudice if there is no good reason for it, and it is continued over a sufficient length of time to amount to some form of unfair prejudice.

 

4. Mismanagement of the company by the board of directors is not commonly unfair prejudice unless there is some deliberate flouting of the director’s duties. If that breach is sufficiently severe, it could form the basis of unfair prejudice. Still, mismanagement to be an effective form of unfair prejudice is usually part of a broader narrative.

 

5. Exclusion from management, breaches of articles of association or a shareholders agreement, or breaches of ‘fiduciary duties’ are possible grounds.

It is important to note that while any one instance as above might not be unfair when all conduct is taken together, it can become unfair.

It is therefore critical when considering unfair prejudice to understand the full history of the parties; the range of dynamics at play and their various effects to know whether a shareholder is suffering from something this can be a remedy for; as well as considering whether a court can order what a shareholder wants.

Who can bring a claim for unfair prejudice?

Only a shareholder, or someone to whom shares should be legitimately transferred.

Remedies from the court

Possible remedies include an order to regulate the future conduct of the company, to require the company to perform a particular act, or prevent an act, or require a purchase of shares at a fair valuation. 

Prevention is always better than cure: My advice is to have a shareholders agreement drawn up by a competent lawyer at the outset. That will avoid the sort of issues which could cost a five-figure sum or more in costs though litigation if a dispute arises.

At the time of writing this article, I am dealing with a potential unfair petition claim on which I may have avoided litigation by negotiating a settlement whereby my client, the shareholder, will receive a agreed settlement. But if that deal falls apart, we will not hesitate to issue an unfair prejudice petition under section 994.

 

Kuldeep S. Clair, Consultant Solicitor

Solicitor of the Senior Courts of England and Wales

07484 614090  kuldeep@ksclegal.co.uk    

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