Corporate Focus - November 2009

Unfair prejudice under the Companies Act 2006

The need for protection for minority shareholders has long been recognised. Section 459 of the Companies Act 1985 previously set out the basis upon which a minority shareholder could complain that their interests had been prejudiced. This has now been replaced by section 994 of the Companies Act 2006 and recently fell for consideration in Hequet v McCarthy [2008] EWHC 2279 (Ch) (“McCarthy”).

Background

Section 994 Companies Act 2006 deals with unfair prejudice claims brought by members of a company.  This section states that:

“A member of a company may apply to the Court by petition for an order… on the ground -

(a) that the Company’s affairs are being or have been conducted in a manner that is unfairly prejudicial to the interests of members generally or of some part of its members (including at least himself), or

(b) that an actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial.” 

As will be appreciated from the above there are two key elements which the member must prove to evidence a claim of unfair prejudice. Put simply, these are:

1.      That the conduct concerned causes prejudice or harm to the interest of the members of the company; and

2.      That the conduct concerned is unfair.

Unfairness/prejudice

The test of unfairness in relation to an unfair prejudice action is an objective one and as such the prejudice will be regarded as unfair if the hypothetical bystander would believe it to be unfair. 

Unfairness is measured by reference to the contract between the company and the shareholder, the terms of which are set out in the Articles of Association or any shareholder’s agreement that may be present.  As such, the first step is to consider whether the conduct of which the shareholder complains is in accordance with the articles and/or the shareholder’s agreement and if not whether it amounts to unfair conduct. 

Once the conduct has been demonstrated to be unfair the petitioner must then show that the conduct complained of has resulted in their interests being prejudiced. The most common examples of prejudice are the failure of the company to make payment of a dividend, diversion of business to another company and exclusion from management decisions.  

Remedies

Section 996 of the Companies Act sets out the remedies available to a petitioner.   The specific powers listed in Section 996(2) are as follows:

1.      Regulate the conduct of the company’s affairs in the future;

2.      Require the company to refrain from doing or continuing an act complained of, or to do an act which the petitioner has complained that it has omitted to do;

3.      Authorise civil proceedings to be brought in the name and on behalf of the company by such persons and on such terms as the Court may direct;

4.      Require the company not to make any, or any specified, alterations in its articles without the leave of the Court; and

5.      Provide for the purchase of the shares of any members of the company by other members or by the company itself and, in the case of the purchase by the company itself, the reduction of the company’s capital accordingly. 

In practice, the most common remedy awarded to a successful petitioner is an order that their shares be purchased. 

McCarthy

In McCarthy a petition for unfair prejudice was launched by a minority shareholder on the basis that the company had been run in a manner that was unfairly prejudicial to their interests.  The petition was heard by Michael Furness Q.C. and considerable evidence was presented about the basis of the allegations. In essence, the allegations made can be summarised as follows:

1.                  The entering into of “bonus agreements” between the directors and the company whereby the whole of the net profits from a lucrative contract were divided amongst the directors to the exclusion of the shareholders;

2.                  Property owned by the directors and leased to the company in return for rent was not a reasonable expense to incur;

3.                  A licence agreement entered into with a company owned by 1 of the directors which saw substantial payments made for use of software was not entered into for the benefit of the company;

4.                  Consultancy services provided by a further company linked with 1 of the directors were not for the benefit of the company; and

5.                  The failure to make payment of a dividend since 1996 and in particular the failure by the directors to give proper consideration to making a dividend payment.

The Judge found that the making of the bonus agreement constituted unfair prejudice as it was a device deliberately designed to ensure that none of the profits of a major and potentially lucrative contract would be available to the shareholders.   In this respect it was found that the directors had acted in breach of their fiduciary duties in exercising their powers for an improper purpose.  

It was further found that there was a complete failure on the part of the Board to consider whether or not to declare dividends which constituted a breach of duty and the Judge overall considered that there was a failure on the part of the directors to consider several contracts which the company entered into with an independent mind.  

In the circumstances, having regard to the extent of the prejudice that the petitioner had suffered and would continue to suffer, the Judge considered that the appropriate order was that the petitioner should be bought out at a valuation. 

As can be seen from the McCarthy case the Courts will not allow a company to be used as an open cheque book for directors to award themselves substantial benefits and to direct business towards other interests that they may have. Those controlling the company must be able to demonstrate that all decisions have been made in the best interests of the company whether in respect of dividend payments, awarding of business to companies in which they have an interest or otherwise. Where a member can demonstrate that this has not been the case and their interests have been unfairly prejudiced as a result they will be entitled to one of the remedies set out under Section 996 of the Companies Act 2006 which will clearly come at a cost to the company.  

Please contact Sarah Conroy in our Commercial Dispute Resolution department on 0151 242 6818 for further assistance or information on unfair prejudice claims under the Companies Act 2006.