One of the likely consequences of an economic slowdown is an increase in the number of boardroom and shareholder disputes. Ninety per cent of UK private companies have fewer than five shareholders and in most of those companies the shareholders will participate in the management and operation of the company. Very few companies, however, give minority shareholders any contractual protection in the company’s memorandum or articles of association or in the form of a shareholders’ agreement. When disagreement occurs, therefore, the minority shareholder may have to fall back on the statutory remedy previously known as a “section 459 petition” but now set out in section 994 of the Companies Act 2006.
Section 994 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 some part of its members (including at least himself); or
(b) that an actual or proposed act or omission of the company … is or would be so prejudicial.
So, what is unfairly prejudicial conduct? Generally, conduct that is unfair but not prejudicial to the petitioner’s interests as a shareholder, or prejudice to the petitioner that is caused by conduct that is not unfair, will not be actionable. Hence, a majority shareholder forcing through commercial decisions against the minority shareholder’s wishes is unlikely to be guilty of unfair prejudice.
Aggrieved shareholders cannot invoke section 994 solely on the basis that trust and confidence between the shareholders has collapsed – more is needed. This will typically be the exclusion of one shareholder from management participation where there was a legitimate expectation that this would continue, failing to pay proper dividends, diverting business away from the company, allotting shares in breach of preemption rights or the controlling shareholder paying himself an excessive salary or using the company’s assets for his/her own benefit. Many small companies are regarded as “quasi-partnerships” – in other words, they are owned and managed by a small number of individuals who, in practical terms, run the business as if it were a partnership. The legitimate expectations of a director/ shareholder working in a quasi-partnership may well be not only to obtain a dividend or an increase in share value, but also to be employed by that company and to receive a salary. If that individual is forcibly removed as a director and excluded from the management of the company (without good reason) the court is likely to view this as a breach of the terms on which that individual joined the company and to offer redress.
If unfair prejudice is established, the court can make any order it likes to regulate the company’s affairs. It can order the company to do or not to do something, it can authorise proceedings to be brought in the name of the company, it can require the majority shareholders to sell their shares to the aggrieved minority shareholder or it can require that the aggrieved shareholder’s shares be purchased by the other shareholders or by the company itself. The last of these is the most commonly sought remedy and is particularly popular with minority shareholders in quasi-partnerships who have been removed from office and who would otherwise, due to the restrictions on share transfer in the articles, remain locked into a company over which they have no continuing control.
Minority shareholder actions consume time and money and are a major distraction from the day-to-day running of the business. Furthermore, the majority shareholders are unlikely to be able to use the company’s money to discharge their legal costs of defending an unfair prejudice petition. If they do, this is likely to be cited as a further act of unfair prejudice.
Majority shareholders who are on the receiving end of a section 994 petition should therefore think long and hard about whether they wish to defend it. If it is likely that unfair prejudice will be made out, then they should give serious consideration to making a formal offer to purchase the petitioner’s shares. Providing the offer complies with certain requirements, the respondent may well be able to get the petition struck out if the offer is refused. The requirements are that:
- the offer is to buy the shares at fair value, which generally means a pro-rata, undiscounted value;
- the value is to be determined by an independent valuer acting as expert, not arbitrator;
- the offer provides for equal rights of access to relevant information and gives both sides the right to make representations to the expert; and
- the offer addresses the issue of legal costs.
Of course, well-drafted articles of association or a shareholders’ agreement prepared at the outset of the business relationship – providing for a clearly defined exit route in the event of disagreement – will significantly reduce the chances of proceedings being issued in the first place.