The Judicial Committee of the Privy Council (JCPC) has considered the validity of a shareholder resolution amending a company's articles to introduce a share redemption mechanism aimed at forcing out a minority shareholder.

Facts

Two parties (Mr Chen and Mr Cha) set up Staray Capital Limited (Staray), a BVI company, to undertake a new mining venture. Both were shareholders (80 per cent for Mr Chen and 20 per cent for Mr Cha) and directors. Later their relationship broke down and Mr Chen claimed that Mr Cha had misled him with various representations before they had set up the venture.

Mr Chen sought to remove Mr Cha from Staray by passing a shareholder resolution to amend the company's articles of association. The amendment would enable the company to redeem a shareholder's shares where that shareholder had made false and material representations in the course of acquiring those shares. Mr Chen then served a redemption notice to make use of the new mechanism and redeem Mr Cha's shares. He also acknowledged that the resolution was directed at removing Mr Cha from Staray. Mr Cha challenged the shareholder resolution to amend the articles. He argued that it was invalid as it had been directed solely at him and not passed in good faith in the interests of Staray. He also challenged the redemption notice.

Held

The JCPC found the amendment to the articles was valid. It cited certain principles of law established from previous authorities. In particular:

  • An exercise of the power to amend articles will be valid if done in good faith in the interests of the company.
  • It is for the shareholders, and not the court, to say whether an amendment to the articles is for the benefit of the company. However, it will not be for the benefit of the company if no reasonable person would consider it to be for the benefit of the company.
  • The fact that an amendment adversely affects (and is intended to adversely affect) one or more minority shareholders and benefits others does not, of itself, invalidate the amendment, provided the amendment is made in good faith in the interests of the company.
  • The burden is on the person challenging the validity of the amendment to the articles to satisfy the court that there are grounds for doing so.

Here, it was Mr Chen's view of the company's benefit (as that of majority shareholder) which was determinative, unless it was a view which no reasonable person could have held. In the JCPC's view, the lower courts had considered these tests and rightly upheld the validity of the amendment.

However, the JCPC held that Mr Chen's case failed in relation to the redemption notice. The JCPC agreed with the trial judge's assessment that none of the alleged misrepresentations was material. On that basis the redemption notice was invalid and Mr Chen could not, therefore, use the new mechanism to redeem Mr Cha's shares. The compulsory redemption mechanism (and requirement for the misrepresentations to be material) had to be considered from the perspective of the company, rather than the individual shareholders.

The decision serves as a useful reminder that, where a commercial relationship has broken down, it may be possible for shareholders to amend a company's existing articles to introduce compulsory redemption, acquisition or transfer mechanisms. However, they must be acting in good faith and believe it would be for the benefit of the company, which it cannot be if no reasonable person would consider it so. It may be easier to establish "good faith" if the mechanism is deemed to be fair – in this case, the price payable was to be fair market value.

For minority shareholders faced with this type of scenario, it is worth considering the validity of both the purported constitutional amendments themselves (by reference to the established legal tests) and any subsequent attempt to trigger the new provisions.