Chapter 6: Minority Shareholder Remedies

Question 1

1.1 Minority shareholders

Answer 1

Both the directors and shareholders act by majority and the principle of ‘majority rule’ pervades company law. A minority shareholder often has little impact on shareholder voting and therefore
little input into the way in which the company is managed.

There needs to be a remedy in appropriate circumstances for minority shareholders, where the
majority abuse their position, mismanage the company, or act unfairly. However, the law needs to be carefully balanced, since otherwise a litigious or vexatious shareholder could obstruct the
company’s legitimate business.

Question 2

1.2 Rights of minority shareholders

Answer 2

Historically, the courts were reluctant to allow minority shareholders to bring claims. The law has now developed, and CA 2006 does allow minority shareholders certain limited remedies where the management of the company causes them prejudice or loss.

Question 3

Equitable remedy of Unfair Prejudice

Answer 3

In this topic you will consider the equitable remedy of unfair prejudice and just and equitable winding up. Minority shareholders can also bring derivative claims against directors on behalf of the company, and you will consider the grounds and effect of these claims in detail. Finally, in certain circumstances shareholders may bring personal claims, where they are able to show that they have suffered loss personally, over and above any loss suffered by the company.

Question 4

Shareholders’ Agreements.

Answer 4

These claims are costly to bring and uncertain in outcome, as the court has a wide discretion as to remedies. In order to protect their position, shareholders are advised to instead enter into shareholders’ agreements

Question 5

1.4 Unfair prejudice – ss 994–996 CA 2006

Answer 5

Section 994(1) provides 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 which is unfairly prejudicial to the interests of its members generally or of some part of its members (including at least himself), or
(b) that any actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial. We will consider the constituent elements of s 994(1) and the relevant case law below.

Question 6

1.4.1 Conduct of the company’s affairs

Answer 6

In order to succeed with a petition under s 994(1), a petitioner must establish unfairly prejudicial conduct arising from an act or omission of the company, or made on the company’s behalf. The conduct complained of must be an act or acts done by the company (eg by the directors), not the conduct of an individual shareholder acting in their private capacity. The complaint must relate to how the affairs of the company have been managed - personal disputes between shareholders fall outside the scope of s 994.

Question 7

Key case: Re Legal Costs Negotiators Ltd [1999] 2 BCLC 171 CA

Answer 7

This company was incorporated by four individuals who were equal shareholders, directors and employees. Unfortunately, relations broke down and the fourth individual was dismissed an employee and resigned as a director just before he was to be removed. He remained as a
shareholder and refused to sell his shares to the other three, who petitioned under s 459 seeking an order that he transfer his shares to them.

The Court of Appeal rejected this petition on the basis that the other three shareholders, being the majority, could prevent any prejudice from this shareholder. It was held that simply remaining as a shareholder was not conduct relating to the company’s affairs.

Question 8

Key case: Re Home & Office Fire Extinguishers Ltd [2012] All ER D 31

Answer 8

This case illustrates that there may be an overlap between the requirement that the conduct relates to the company’s affairs and personal disputes where such disputes make it impossible for
the parties to continue working together as directors/shareholders. In this case two brothers, S and G, were directors and equal shareholders in the company.

S attacked G with a hammer at the company’s premises following G’s refusal to make a salary advance. S was charged with grievous bodily harm but acquitted. The court ordered S to sell his shares to G, holding that S’s conduct related to the affairs of the company because it was a breach of the implied understanding that S and G would act properly and in good faith towards each other

Question 9

Key case: Re City Branch Group Ltd, Gross v Rackind [2005] BCC 11

Answer 9

The court in this case held that the conduct of a subsidiary could be regarded as falling within the affairs of a holding company, especially in the situation in this case where the directors of the holding company and subsidiary are the same or substantially the same.

Question 10

1.4.2 Interests of the members

Answer 10

The petitioner must also prove that their interests in their capacity as a member have been unfairly prejudiced as a result of conduct on the part of the company. This requirement is construed widely. For example, members have an interest in the value of their shares and will therefore be able to bring a claim if they can show that “the value of their
shareholding has been seriously jeopardised by reason of a course of conduct on the part of those persons who have had de facto control of the company, which has been unfair to the
member concerned” Re Bovey Hotel Ventures Ltd (1981).

Question 11

Key case: Gamlestaden Fastigheter AB v Baltic Partner Ltd [2007] UKPC 26

Answer 11

In this case a member had provided a loan to the company and the issue was whether the member’s petition should be struck out in circumstances where the company was insolvent and
the relief sought (payment of compensation by the directors to the company) would confer no financial benefit on this member in his capacity as a member. The Privy Council held that ‘interests’ may extend to cover those of a member who is a creditor as in this case where, in the circumstances, the distinction becomes artificial.

Question 12

1.4.3 Unfair prejudice, Key case: O’Neill v Phillips [1999] 1 WLR 1092 HL

Answer 12

The petitioner, O, was employed by the company, whose sole director and shareholder was originally P. P was impressed with O’s work and in 1985 O was awarded 25% of the company’s shares and made a director. P told O that he would eventually take over the business and would then receive 50% of the profits. In December 1985 P retired from the board and O became the sole director. The business initially did well but then began to decline and in August 1991 P used his majority voting rights to appoint himself managing director and took over management of the
business, telling O that he would no longer receive 50% of the profits, or receive certain share incentives.

O issued a petition for unfair prejudice based on a legitimate expectation of receiving 50% of the voting shares. The House of Lords held that there was no unfair prejudice here as the entitlement to 50% of the profits was never formalised and was conditional on O running the business, which he was no longer doing

Question 13

In Re Tobian Properties Ltd [2012] EWCA Civ 998 Arden LJ stated:

Answer 13

The key phrase in section 994(1), ‘unfairly prejudicial’, comprises two elements, unfairness and prejudice but both of these must be understood in the context of company law. The concept of fairness inherent in this phrase is flexible and open-textured but it is not unbounded.

The courts must act on a principled basis even though the concept is to be approached flexibly. They cannot decide whether to grant or refuse relief from unfair prejudice on the basis of
palm-tree justice.

Question 14

O’Neill v Phillips, in order to establish unfair prejudice, a petitioner must prove:

Answer 14

• Breach of contract (the articles or a shareholders’ agreement); or
• Breach of some fundamental understanding.

The court will begin by looking at whether the conduct complained about is in accordance with the articles. The court will next consider the scope of any fundamental understandings between the parties.

Unfairness must be tested by looking at whether the majority had acted or was proposing to act in a manner which equity would regard as contrary to good faith. Unlawful conduct will not necessarily be unfairly prejudicial, and trivial or technical infringements
of the articles may not give grounds for a s 994 petition.

Question 15

1.5 Examples of unfairly prejudicial conduct

1.5.1 Exclusion from management

Answer 15

This is the most common ground for unfair prejudice petitions. In a small quasi-partnership private company, a member may expect to continue to participate in the management of the company on the basis of a fundamental understanding between the parties, despite the fact that any director may be validly removed from office by an ordinary resolution of the members under s 168 CA 2006.

Question 16

Key case: Re Tottenham Hotspur plc [1994] 1 BCLC 655

Answer 16

Terry Venables, chief executive of Tottenham Hotspur football club, brought a petition claiming
unfair prejudice after he was dismissed from office. It was held that he had no legitimate expectation of remaining in control of the company, so the action failed.

Question 17

Key case: Re Compound Photonics Group Ltd [2022] EWCA Civ 1371

Answer 17

In this case two minority shareholders petitioned for unfair prejudice following the termination of their roles as directors of the company by the majority shareholders. The basis of the petition was that their removal breached the Shareholders’ Agreement which provided that shareholders act in good faith and that the board, not the majority shareholders, would determine commercial strategy.

Question 18

Key case: Re Compound Photonics Group Ltd [2022] EWCA Civ 1371 Judgement

Answer 18

The Court of Appeal rejected the petition and held that the good faith clause in the Shareholders’
Agreement should not be interpreted so widely as to require the shareholders to retain the minority as directors.

Therefore, it did not preclude the majority from voting to remove the
minority as directors where there commercially justifiable reasons for doing so. It was held that there was no unfair prejudice as the absence of express provisions to entrench the directors evidenced a lack of intention to do so

Question 19

1.5.2 Mismanagement

Answer 19

In general, poor management of a company will not give rise to a claim for unfair prejudice, since the courts are very reluctant to find that management decisions amount to unfair conduct. It has been held that the risk of poor management is inherent in share ownership and the courts will not
interfere with a bona fide business decision made by a company’s board or its majority shareholders except where there is a clear conflict of interests (Re Elgindata Ltd [1991] BCLC 959). However, where the directors have abused their powers or exercised them for some ulterior
purpose, an allegation of mismanagement may amount to unfair prejudice.

Question 20

Key case: Re Macro (Ipswich) Ltd [1994] 2 BCLC 354

Answer 20

In this case an allegation of mismanagement over 40 years resulting in economic loss to the
company was found to amount to unfairly prejudicial conduct. Here the sole director of the two associated companies neglected his management responsibilities allowing dishonest employees to steal from the company. The petitioners successfully argued that substantial financial losses
were suffered by the companies as a result, which caused unfair prejudice to them.

Question 21

1.5.3 Breach of directors’ fiduciary duties

Answer 21

This is a common ground for petitions for unfair prejudice and there have been a number of successful petitions brought on this ground

Question 22

Key case: Re London School of Electronics [1986] Ch 211 (misappropriation of assets)

Answer 22

In this case the petition for unfair prejudice succeeded where those in control of the company had
misappropriated its assets by diverting them to another business owned by them.

Question 23

Key case: Re Little Olympian Each-Ways Ltd (No 3) [1995] 2 BCLC 420, ChD (substantial undervalue)

Answer 23

The directors sold the company’s business at a substantial undervalue to another company as part of a wider transaction in which the directors received significant personal benefit. This was held to be unfairly prejudicial conduct.

Question 24

Key case: Re A Company (No 005287 of 1985) [1986] BCLC 68 (secret profits)

Answer 24

In this case the petition for unfair prejudice succeeded on the grounds that the directors had
made secret profits

Question 25

1.5.4 Excessive remuneration and refusal to pay dividends

Answer 25

Although generally companies’ articles of association provide that directors’ remuneration should be determined by the general meeting, in practice the power to determine directors’ remuneration is delegated to the board, and the court will tend not to interfere with the business judgement of the board provided it has honestly determined the level of remuneration. However, it is clear that there is ample scope here for abuse of this power, and in these cases the court will be prepared to hold that failure to pay dividends and/or directors’ awarding themselves excessive remuneration will be unfairly prejudicial conduct.

Question 26

Key case: Re a Company (No. 004415 of 1996) [1997] 1 BCLC 479 (cannot be justified by objective commercial criteria)

Answer 26

Here the court held that if remuneration and dividend levels cannot be justified by ‘objective commercial criteria’ then it would follow that the affairs of the company have been managed in a way which is unfairly prejudicial to the interests of shareholders who are not directors.

Question 27

1.6 Who may bring a claim for unfair prejudice?

Answer 27

Under s 994(1) the petition for unfair prejudice may be brought by a ‘member’ of the company. Section 112 defines a ‘member’ as a subscriber to the company’s memorandum and ‘every other person who agrees to become a member of the company and whose name is entered into the register of members’. However, the case law indicates that the court will be prepared to interpret this broadly in appropriate circumstances.

Question 28

Key case: Harris v Jones [2011] EWHC 1518

Answer 28

The court held that a person to whom shares had been transferred but had not been registered as a member had the right to bring a s 994 petition.

Question 29

Key case: Blunt v Jackson [2013] EWHC 2090

Answer 29

The judge in this case noted that the court had the power to retrospectively amend the register of members, and so allowed a person who had agreed to become a 50% shareholder and had worked for the company on low wages in the belief that he was a shareholder, but was not registered as such, to succeed in a petition for unfair prejudice based on his exclusion from management.

Question 30

1.7 Remedies – s 996

Answer 30

The court has a wide discretion in determining the appropriate remedy. Section 996(1) states that the court may ‘make such order as it thinks fit for giving relief in respect of the matters complained of’. Section 996(2) then lists possible orders that the court may make, although this list is not determinative. Section 996(2) states that the court’s order may

Question 31

1.7 Remedies – s 996

Answer 31

(a) regulate the conduct of the company’s affairs in the future; (b) require the company (i) to refrain from doing or continuing an act complained of, or (ii) to do an act which the petitioner has complained it has omitted to do; (c) authorise civil proceedings to be brought in the name and on behalf of the company by such person or persons and on such terms as the court may direct; (d) require the company not to make any, or specified, alterations in its articles without the leave of the court; (e) provide for the purchase of the shares by any members of the company by other members of the company or by the company itself […].

Question 32

1.8 Remedies – Share purchase order

Answer 32

There is a presumption that the court will grant an order for the purchase of the petitioner’s shares by the company or another shareholder under s 996(2)(e) (Grace v Bigioli [2005] EWCA Civ 1222). This is the most common remedy and is usually sought by shareholders in small private companies who have limited options to sell their shares (remember that private companies are prohibited from offering shares to the public under s 755 CA 2006). The court must then determine the valuation of the petitioner’s shares. The key issue is for the court to determine a price that is fair in all the circumstances.

Question 33

Key case: Re Bird Precision Bellows Ltd (1984) [1986] Ch 658, CA

Answer 33

In this case Nourse J looked at the valuation process in detail, noting that for quasi-partnership companies at least, it would normally be unfair to impose a discount on the shares to represent the limited voting power and control of a minority shareholder, since for these companies generally the minority shareholder is being forced to sell their shares as a result of the unfairly prejudicial conduct.

Question 34

1.9 Valuation of the shares

Answer 34

One critical issue is the date on which the shares should be valued, since the value of the shares may have changed considerably between the date on which the petition to court was made and the date of judgment

Question 35

Key case: Abbington Hotel Ltd [2011] EWHC 635

Answer 35

The starting point for the date of valuation of shares for a buy-out order under s 996 is the date of judgment, but the court is free to choose a date that is most appropriate in the circumstances of the case. The date should be ‘that which best remedies the unfair prejudice held to be established’. Note that in O’Neill v Phillips [1999] 1 WLR 1092 HL, Hoffmann LJ noted that if the respondent (the company or majority shareholder) has made a reasonable offer to buy out the petitioner, based on an expert valuation, then the respondent may be entitled to have the petition for unfair prejudice struck out.

Question 36

1.10 Further case law examples Key case: McCallum-Toppin [2019] EWHC 46 (Ch)

Answer 36

. The majority: * Deprived the minority of dividends where there would have been sufficient reserves to pay them, but for the majority paying themselves salaries which were largely unjustified. * Used the company as a ‘personal piggy bank’, borrowing in excess of £1 million from the company for personal expenses.

Question 37

Key case: Re Sprintroom [2019] EWCA Civ 932

Answer 37

It was held that a breach of duty by a director who incorrectly claimed that the intellectual property to a piece of software vested with him personally, not the software development company, did not preclude his entitlement to a remedy as a (40%) shareholder under s 994 CA 2006

Question 38

Majority 60% shareholder unfairly prejudiced the minority 40% shareholder by:

Answer 38

* Exclusion from management. As a director, although the minority had breached s 172 and s 175 CA 2006, this was not sufficient to justify his exclusion as the dispute as to IP rights was conducted openly; whereas a more egregious breach in bad faith such as secret negotiation from competitors would justify his exclusion. * Making an offer to buy the minority’s shares which did not reflect his 40% interest (so a balancing payment was ordered).

Question 39

1.11 Summary

Answer 39

* Any member may apply to the court for relief under s 994 on the grounds of unfair prejudice. * The petitioner must show that the company’s affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of its members generally or of some part of its members (including at least themselves). * The unfair prejudice must result from the actions of the company and not shareholders personally. * In order to establish unfair prejudice, the petitioner needs to establish a breach of the articles or shareholders’ agreement or breach of an understanding. * Common examples of unfair prejudice include exclusion from management in a quasipartnership small private limited company, breach of directors’ fiduciary duties or excessive remuneration and/or refusal to pay dividends. * The court has a wide discretion as to the appropriate remedy, but the most common remedy is a buy-out of the petitioner’s shares under s 996(2)(e).

Question 40

2 Just and equitable winding up 2.1 Introduction

Answer 40

Historically, this was the only remedy available to an aggrieved minority shareholder. This remedy is set out in s 122(1)(g) Insolvency Act 1986 (IA 1986): A company may be wound up by the court if the court is of the opinion that it is just and equitable that the company should be wound up.

Question 41

Apply to be wound up

Answer 41

A minority shareholder may apply to the court (‘petition’) under s 122(1)(g) IA 1986 for the company to be wound up and the assets distributed amongst the shareholders. This remedy comes from the law of partnership, where the courts of equity had jurisdiction to dissolve a partnership where the relationship between its members had broken down.

Question 42

Draconian remedy

Answer 42

Just and equitable winding up is a draconian remedy of last resort, resulting in the end of the life of the company. The courts will therefore attempt to find alternative remedies where possible. The Companies Act 1980 introduced the remedy of unfair prejudice (now set out in s 994 CA 2006) and this is now used far more commonly in the resolution of shareholder disputes than just and equitable winding up.

Question 43

2.2 Consequences of a just and equitable winding up petition Section 127 IA1986

Answer 43

[…] any disposition of the company’s property, and any transfer of shares, or alteration in the status of the company’s members, made after the commencement of the winding up is, unless the court otherwise orders, void. Banks will freeze company bank accounts as soon as they receive notice of such a petition, since any payments made out of the company’s bank account after presentation of the petition can be set aside by the liquidator when the company has been wound up. This means that the company is in effect paralysed pending the outcome of the petition.

Question 44

2.3 Just and equitable winding up: grounds for petition Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 HL

Answer 44

Examples of this include the final three grounds discussed below: deadlock (where the parties are not able to reach a decision), justifiable loss of confidence in the company’s management and exclusion from management.

Question 45

Key case: Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 HL

Answer 45

This case concerned a rug business which had been run by E and N as a partnership for over a decade. In 1958 a company was established to take over the business and initially E and N were the only directors and equal shareholders. N’s son then joined the company as a director and shareholder, meaning that E became a minority at both board and shareholder level. The parties fell out and E was voted off the board but retained his shares. No dividends were paid to him, as all the profits were distributed by way of directors’ remuneration.

Question 46

Key case: Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 HL Judgement

Answer 46

The House of Lords concluded that although E had been validly removed as a director under the Companies Act, as the company had been formed on the understanding that E would remain in management, his exclusion was in breach of that understanding and therefore it was just and equitable to wind up the company. This company was held to be a ‘quasi-partnership’.

Question 47

2.4 Grounds for petition, 2.4.1 Substratum has failed

Answer 47

Where the petitioner establishes that the commercial object for which the company was formed has failed or been fulfilled, this will be a ground for just and equitable winding up. Note that this ground is of much less importance now as s 31(1) CA 2006 provides that a company’s objects will generally be unrestricted.

Question 48

Key case: Re German Date Coffee Co (1882) 20 Ch D 169, CA

Answer 48

In this case the company was registered with the object of acquiring a German patent for manufacturing a coffee substitute from dates. The German patent was not granted, although a Swedish patent was. The company built up a prosperous trade in the coffee substitute, but despite this the Court of Appeal made an order for the company to be wound up on the basis that the whole substratum of the company was gone. The company had been established not for the general purpose of making coffee from dates but to work a particular patent, and as that patent did not exist, the company could be wound up.

Question 49

2.4.2 Fraud

Answer 49

Where a company has been formed to perpetrate a fraud and winding up represents the best way for its shareholders to recover the money they invested, the court may grant a winding-up order.

Question 50

Key case: Re Thomas Edward Brinsmead & Sons [1897] 1 Ch 406, CA

Answer 50

In this case three men who were named Brinsmead were former employees of John Brinsmead & Sons, a renowned piano manufacturing company. They formed Thomas Brinsmead & Sons to make pianos which they passed off as manufactured by John Brinsmead & Sons. The court held it to be just and equitable to wind up the company and return the money to the shareholders since the purpose of the company was fraudulent.

Question 51

2.4.3 Deadlock

Answer 51

It is rare for there to be total deadlock in the management of a company since the chairman generally has a casting vote at board meetings. However, where deadlock does occur the court may order the company to be wound up.

Question 52

Key case: Re Yenidje Tobacco Ltd [1916] 2 Ch 426, CA

Answer 52

Here two tobacco manufacturers formed the company to merge their businesses. They were equal shareholders and the only two directors. The relationship between the two became acrimonious to the point that they refused to speak to each other and would only communicate through the company secretary. Despite the fact that the company was profitable, the court ordered it to be wound up.

Question 53

2.4.4 Justifiable loss of confidence in the company’s management

Answer 53

This ground overlaps with the deadlock ground above. Where a company is in effect a quasipartnership, the court may order it to be wound up where there is a lack of confidence in the management. For this ground to apply there needs to be a lack of probity in the way the company is being run by the majority, effectively driving the minority out so that it is unjust and inequitable to require the minority to remain shareholders, therefore justifying the winding up.

Question 54

Key case: Loch v John Blackwood Ltd [1924] AC 783, PC

Answer 54

The majority shareholder in this company dominated the board of directors, refused to declare dividends, call general meetings or publish accounts, aiming to induce the minority shareholders to sell their shares at an undervalue. The Privy Council ordered the company to be wound up.

Question 55

2.4.5 Exclusion from participation in a small private company where there was a relationship based on mutual confidence Ebrahimi v Westbourne Galleries

Answer 55

Lord Wilberforce listed typical elements: (a) The basis of the business association was a personal relationship and mutual confidence (often where a pre-existing partnership converts into a limited company); (b) An understanding that all shareholders will participate in management; (c) A restriction on the transfer of members’ interests preventing the petitioner leaving.

Question 56

2.5 Who can bring a petition?

Answer 56

Section 124(1) IA 1986 provides that an application to the court for a winding-up order may be made by a ‘contributory’. ‘Contributory’ means any person liable to contribute to the assets of a company in the event of it being wound up, which includes every past and present member For a fully paid-up shareholder to bring a petition, they must show a ‘tangible interest in the company’. This has been held to mean that the shareholder must prove (on the balance of probabilities) that there will be a surplus among the shareholders after payment of the company’s debts, liabilities and the expenses of the liquidation (Re Rica Gold Washing Co (1879) 40 LT 531, CA)

Question 57

Achievement of disadvantage

Answer 57

If the shareholder cannot prove surplus assets, they may also establish a tangible interest by showing that they would achieve some advantage or avoid or minimise some disadvantage which would accrue to them as a member if the company was wound up (Re Chesterfield Catering Co [1977] Ch 373).

Question 58

Petitioner's own conduct

Answer 58

The petitioner’s own conduct is relevant, as this is an equitable remedy. If the court determines that the petitioner’s own conduct is the reason for the breakdown, this will be a relevant factor in determining whether the order should be made.

Question 59

2.6 Summary

Answer 59

* Any member may petition the court for the company to be wound up on the grounds that it is just and equitable to do so under s 122(1)(g) IA 1986. * Just and equitable winding up is an equitable remedy and the court has a wide discretion as to whether to make the order. * However, it is a draconian remedy and therefore will not be ordered where another remedy is available. * Typical grounds on which companies have been wound up include: - Company’s substratum has failed (rare now considering s 31(1) CA 2006) - Fraud - Deadlock - Justifiable loss of confidence in the company’s management - Exclusion from participation in a small private company where there was a relationship based on mutual confidence.

Question 60

3. Derivative claims Key case: Carlen v Drury (1812) 1 Ves & B 154

Answer 60

Lord Eldon LC stated This Court is not required on every Occasion to take the management of every Playhouse and Brewhouse in the Kingdom

Question 61

3.2 Types of shareholder actions

Answer 61

There are broadly two types of shareholder actions relating to internal disputes: (a) Claims brought by members in relation to wrongs done to them personally (not in relation to wrongs done to the company) (‘Personal claims’) These types of claims are not affected by the rule in Foss v Harbottle or the statutory procedure in CA 2006.

Question 62

(b) Claims brought by members to vindicate a wrong done to the company (‘Derivative claims’)

Answer 62

These types of claims are known as derivative claims and originally were dealt with by the courts in accordance with the rule in Foss v Harbottle. However, since CA 2006 came into force, there is now a statutory procedure for a shareholder to bring a derivative claim on behalf of the company, which replaces the common law in so far as it applies.

Question 63

3.4 The rule in Foss v Harbottle, & the proper claimant principle

Answer 63

The rule in Foss v Harbottle is clearly summarised in the case of Edwards v Halliwell [1950] 2 All ER 1064 CA as follows: (a) The proper claimant in an action in respect of a wrong done to a company is prima facie the company itself (the ‘proper claimant principle’). (b) Where the alleged wrong is a transaction which might be made binding on the company and all its members by a simple majority of the members, -no individual member of the company is allowed to maintain an action in respect of that matter ‘for the simple reason that, if a mere majority of the members of the company […] is in favour of what has been done, then cadit quaestio’ (in other words, the majority rule). This is known as the ‘internal management principle’).

Question 64

The irregularity principle

Answer 64

In addition, if the matter relates to an irregularity that the company is able to ratify or condone by its own internal procedure then no individual member may bring an action (the ‘irregularity principle’).

Question 65

3.5 Exceptions to the rule in Foss v Harbottle

Answer 65

A number of exceptions to the rule in Foss v Harbottle developed under the common law. These can be categorised as follows: (a) Where the act complained of is ultra vires or illegal; (b) Where the matter is one which could validly be done or sanctioned only by some special majority of members, or there has been non-compliance with a special procedure; (c) Where the personal and individual rights of the member have been infringed; or (d) Where what has been done amounts to a ‘fraud on the minority’ and the wrongdoers are themselves in control of the company. The generally accepted view is that only the fourth exception set out above is a true exception to the rule in Foss v Harbottle, since the other exceptions can be explained on the basis of the member being allowed to sue for breach of their personal rights.

Question 66

3.6 Derivative actions under CA 2006 Part 11 Disadvantage of derivative claims

Answer 66

Derivative claim: A derivative claim is a claim brought by a member in respect of a cause of action vested in the company seeking relief on behalf of the company. The disadvantage of derivative claims is that the relief gained is only awarded to the company, not the individual member bringing proceedings. The advantage of derivative claims are that they allow individual members to ‘right a wrong’ on behalf of the company in circumstances where the company itself does not bring a claim

Question 67

Under statutory proceedure

Answer 67

Under the statutory procedure: (a) A claim may be brought by any member - s 260(1) (b) A claim may be brought against any director and/or another person, including former directors - s 260(3)/(5) (c) The grounds for bringing a claim: any act or omission, actual or proposed, involving negligence, default, breach of duty or breach of trust by a director - s 260(3). Note that this is immaterial whether the course of action occured before or after the claimant became a shareholder.

Question 68

3.7 Application for permission to continue a derivative claim: The two-stage process

Answer 68

This is a two-step process, involving two hearings: * The court will consider whether the applicant has a prima facie case for permission to continue the derivative claim. If the application is not dismissed at this first stage (because the applicant provides evidence of a good cause of action) then it moves to the second stage. * If the application shows a prima facie case for permission under stage 1, it then proceeds to the second stage under s 263, which is the full permission hearing. The court may order the company, as well as the applicant, to provide evidence at this stage

Question 69

3.8 Stage 1

Answer 69

The purpose of the first stage is to enable the court to quickly dismiss cases that stand little or no chance of success. In practice, the parties may be able to bypass this stage where the defendant company concedes that there is a prima facie case (eg Franbar Holdings Ltd v Patel [2008] EWHC 1534) or where the court may be prepared to hear the first and second stages for permission together (eg Stimpson v Southern Landlords Association [2009] EWHC 1556 (ChD)). However, this practice has been criticised because bypassing the filtering mechanism of stage 1 may lead to unmeritorious cases proceeding to a full permission hearing (Re Severn Holdings [2011] All ER (D) 78).

Question 70

3.9 Stage 2

Answer 70

For the second stage, the full permission hearing, s 263 sets out absolute and discretionary bars to granting permission to a member to continue a derivative claim.

Question 71

3.9.1 Absolute bars

Answer 71

Section 263(2) states that permission must be refused if the court is satisfied: (a) that a person acting in accordance with section 172 (duty to promote the success of the company) would not seek to continue the claim, or (b) where the cause of action arises from an act or omission that is yet to occur, that the act or omission has been authorised by the company, or (c) where the cause of action arises from an act or omission that has already occurred, that the act or omission - (i) was authorised by the company before it occurred, or (ii) has been ratified by the company since it occurred

Question 72

3.9.2 Discretionary bars

Answer 72

Section 263(3) sets out the factors which the court must take into account when exercising its discretion to grant permission to continue a derivative claim: (a) whether the member is acting in good faith in seeking to continue the claim; (b) the importance that a person acting in accordance with section 172 (duty to promote the success of the company) would attach to continuing it; (c) where the cause of action results from an act or omission that is yet to occur, whether the act or omission could be, and in the circumstances would be likely to be— (i) authorised by the company before it occurs, or (ii) ratified by the company after it occurs; (d) where the cause of action arises from an act or omission that has already occurred, whether the act or omission could be, and in the circumstances would be likely to be, ratified by the company; (e) whether the company has decided not to pursue the claim; (f) whether the act or omission in respect of which the claim is brought gives rise to a cause of action that the member could pursue in his own right rather than on behalf of the company.

Question 73

3.9.3 Other considerations to be taken into account when the court is considering whether to grant permission to continue the claim

Answer 73

Section 263(4) also states that the court must have particular regard to any evidence before it as to the views of members of the company who have no personal interest, direct or indirect, in the matter. This follows the earlier-mentioned case of Smith v Croft (No 2).

Question 74

Approach of the court

Answer 74

The statutory procedure is similar to the rule in Foss v Harbottle in that the court will presume to dismiss a derivative claim unless one of the exceptions applies. During the course of parliamentary debate on the new statutory procedure there was concern that this new procedure would open the floodgates of litigation, given that the s 260 action allows a member to bring a claim on behalf of the company against a director for negligence, which is much wider than the old common law exceptions to Foss v Harbottle. However, this has not been the case. The courts robustly case manage such claims at the permission stage and successful claims remain rare. There are substantial disincentives to bringing such a claim since members themselves do not recover the damages (these are paid to the company where the claim is successful) and the costs of these claims are substantial.

Question 75

3.10 Case law under s 260 Key case: Mission Capital v Sinclair [2008] EWHC 1339 (Ch)

Answer 75

In this case two directors, who were also shareholders, were dismissed from the board of the company and their service contracts were terminated. The company later brought a claim against these two directors, who counterclaimed seeking reinstatement and bringing a derivative claim against the continuing directors. The court refused to give permission to continue the derivative claim under the discretionary grounds, deciding that a notional director acting in accordance with their duty under s 172 to promote the success of the company would give little weight to continuing the claim. The court were also influenced by their finding that the claimants could alternatively bring a claim for unfair prejudice under s 994.

Question 76

Key case: Franbar Holdings v Patel [2008] EWHC 1534

Answer 76

A disagreement arose about the way in which the company was managed and the operation of a shareholders’ agreement. The claimant was a shareholder in the company who brought a claim against the company and the directors for breach of the shareholders’ agreement, a petition for unfair prejudice and a derivative claim against the directors. The court refused permission to continue the derivative claim under the discretionary factors, considering that a notional director would not attach importance to the claim because the matters complained of were also covered by the actions for breach of the shareholders’ agreement and the petition for unfair prejudice under s 994.

Question 77

Key case: Iesini v Westrip Holdings Ltd [2009] EWHC 2526 (Ch)

Answer 77

In this case the court found that the directors had not breached their duties so there were no grounds for launching a derivative claim. Lewinson J in this case reviewed the statutory procedure, noting that the first stage is considered on the basis of the evidence filed by the applicant only, without requiring evidence from the defendant or the company, and at the second stage, something more than a prima facie case must be needed but the court cannot embark on a mini trial of the action.

Question 78

Key case: Stainer v Lee [2010] EWHC 1539 (Ch)

Answer 78

In this case the court granted limited permission to continue a derivative action to the end of the disclosure stage of proceedings, subject to various conditions, including a condition as to costs. The court considered that the strength of the case would be clearer after the conclusion of the disclosure stage

Question 79

Key case: Cullen Investments Ltd v Brown [2015] EWHC 473 (Ch)

Answer 79

In this case the court granted permission to continue the claim to trial. The claimant alleged that a director had exploited a corporate opportunity for his own benefit. The shareholder had assumed all the financial risks of the litigation and the court rejected the argument that no director acting in accordance with their duty under s 172 would have supported the claim.

Question 80

Key case: Bridge v Daley [2015] EWHC 2121 (Ch)

Answer 80

Here the court refused permission to continue the derivative claim. The judge accepted that the claimant shareholder was acting in good faith but since most of the allegations were unsubstantiated and the overwhelming majority of shareholders and the independent board members did not support the claim, permission was refused. The judge concluded that the complaint would be better brought as a petition for unfair prejudice under s 994.

Question 81

3.11 Costs of derivative claims

Answer 81

One issue in bringing derivative claims is the problem of costs. A member brings a derivative claim on behalf of the company, and it is the company and not the member claimant who will benefit from any remedies awarded. A major disincentive to bringing proceedings is therefore the cost involved. Rule 19.19 of The Civil Procedure Rules allows the court to order the company to indemnify the claimant against any liability in respect of costs incurred in the claim or the permission application, or both. An application for costs may be made at the same time of the permission application. This is called a pre-emptive costs order

Question 82

Wallersteiner v Moir (No 2) [1975] QB 373, CA

Answer 82

Pre-emptive costs orders were first awarded in the case of Wallersteiner v Moir (No 2) [1975] QB 373, CA where Buckley LJ concluded that a member who brings a derivative claim may be entitled to be indemnified by the company at the end of the trial for their costs, provided they acted reasonably in bringing the action. Such orders are therefore sometimes referred to as ‘Wallersteiner orders’.

Question 83

3.12 Derivative claims – overlap with s 994

Answer 83

It is clear from the case law that if the facts giving rise to a derivative action under s 260 also give rise to a claim for unfair prejudice under s 994, the court will be reluctant to grant permission to continue the derivative claim (Mission Capital plc v Sinclair, Franbar Holdings v Patel). However, this is not an absolute bar. In appropriate circumstances the discretion may be exercised the other way, and the court may hear the proceedings under s 994 and s 260 together, as was the case in Phillips v Fryer [2011] EWHC 1611 (Ch).

Question 84

3.13 Derivative claims vs s 994 - advantages and disadvantages

Answer 84

The advantages of bringing a claim for unfair prejudice under s 994 rather than a derivative claim under s 260 are that such a claim is easier to proceed (as there is no permission requirement) and also that the remedy obtained is for the member, not the company. However, a derivative action may be preferable to a claim for unfair prejudice where the aim of the claimant is not to be bought out (which is the most common remedy in unfair prejudice claims), but for the company to benefit Clark v Cutland [2004] 1 WLR 783.

Question 85

Shareholder brings a claim for unfair prejudice under s 994, s 996(2)(c)

Answer 85

Note that where a shareholder brings a claim for unfair prejudice under s 994, s 996(2)(c) gives the court the power to direct the claimant to bring a derivative claim, however it seems that it would be in very rare circumstance that this would be used.

Question 86

Key case: Paramount Powders (Badyal v Badyal) [2019] EWCA Civ 1644

Answer 86

Unfair prejudice – s 994 CA 2006: B1’s exclusion from management and dismissal as a director was justified and not unfair because B1 was in breach of s172 and s 175 CA 2006 by directly competing against the company through his son’s company (Trident) without consent of his fellow directors. There was no unfair prejudice remedy.

Question 87

Key case: Paramount Powders (Badyal v Badyal) [2019] EWCA Civ 1644

Answer 87

Just and equitable winding up – s 122(1)(g) IA 1986: The petition to wind up on ground of failure of mutual trust and confidence between B1 and the other directors failed because B1 competed with the company in breach of his duties. B1 was the sole cause of the break-down of trust and such lack of probity and good faith meant he came to equity without clean hands so winding up (an exceptional remedy in any event) was not available. The petition was also refused as it would ‘leave the field clear for Trident’.

Question 88

Key case: Paramount Powders (Badyal v Badyal) [2019] EWCA Civ 1644

Answer 88

Derivative claim – s 260 CA 2006: B1 claimed that brother 2 had breached his duty as a director to the company by setting up a competitor company but the claim failed as B1 had consented.

Question 89

3.14 Summary

Answer 89

* A derivative claim is a claim brought by a member in respect of a cause of action vested in the company, seeking relief on behalf of the company. * Prior to CA 2006, derivative claims were governed by the rule in Foss v Harbottle. * The rule in Foss v Harbottle provided that the proper claimant in an action in respect of a wrong done company is prima facie the company itself. A number of common law exceptions developed to this rule. * CA 2006 introduced a new statutory procedure in respect of derivative claims. * Sections 260–263 allow shareholders to bring derivative claims in respect of breaches by directors, however there is a two-stage permission process that is required.

Question 90

4 Personal claims and specific statutory minority rights 4.1 Introduction

Answer 90

Where a personal right of a shareholder has been infringed by the majority, the board or an outsider, the individual shareholder may be able to bring a claim to recover loss suffered under the general principles of contract law or tort law. These claims often arise from breaches of the company’s constitution (the articles) or a shareholders’ agreement. The key issue is to look at the loss suffered and whether it is ‘reflective loss’ or whether the shareholder has suffered loss to them personally in addition to the loss suffered by the company

Question 91

4.2 Personal claims for reflective loss

Answer 91

Where the alleged wrong results in a loss to the company as well as the shareholder and the ONLY loss alleged to have been suffered by the shareholder is in fact a reflection of the loss sustained by the company (eg the shareholder’s shares have decreased in value due to the wrong suffered by the company), the courts will not allow the shareholder to bring a personal claim. This is a result of the rule in Foss v Harbottle.

Question 92

Key case: Prudential Assurance Co Ltd v Newman Industries Ltd(No 2) [1982] Ch 204, CA, Court of Appeal Judgement

Answer 92

But what [a shareholder] cannot do is to recover damages merely because the company in which he is interested has suffered damage. He cannot recover a sum equal to the diminution in the market value of his shares, or equal to the likely diminution in dividend, because such a ‘loss’ is merely a reflection of the loss suffered by the company. The shareholder does not suffer any personal loss. His only ‘loss’ is through the company, in the diminution of the net assets of the company.

Question 93

4.3 Personal claims where the shareholder has suffered reflective loss but also further personal loss

Answer 93

However, where the shareholder can establish that the defendant’s conduct constituted a breach of a legal duty owed to them personally (eg in contract or tort) and that the breach of duty caused them personal loss, separate and distinct from the loss caused to the company, they will be permitted to bring a personal action. In Johnson v Gore Wood, the House of Lords emphasised that the policy reason underlying the bar on personal claims for reflective loss is the need to protect creditors. It is therefore rare that the shareholder is able to show additional loss on which to claim. However, in Giles v Rhind, the shareholder was able to show this.

Question 94

Key case: Johnson v Gore Wood & Co [2002] 2 AC 1 HL

Answer 94

In this case the claimant was a majority shareholder in a company who sued a firm of solicitors for negligence on the ground that their negligence had caused him personal loss. Proceedings for negligence brought by the company had settled. The defendants argued that the claim was a claim for reflective loss and was an abuse of process

Question 95

Lord Bingham's Three Propositions

Answer 95

(1) Where a company suffers loss caused by a breach of duty owed to it, only the company may sue in respect of that loss. (2) Where a company suffers loss but has no cause of action to sue to recover that loss, the shareholder in the company may sue in respect of it (if the shareholder has a cause of action to do so), even though the loss is a diminution in the value of the shareholding. (3) Where a company suffers loss caused by a breach of duty to it, and a shareholder suffers a loss separate and distinct from that suffered by the company caused by breach of a duty independently owed to the shareholder, each may sue to recover the loss caused to it by breach of the duty owed to it but neither may recover loss caused to the other by breach of the duty owed to that other.

Question 96

Key case: Giles v Rhind [2003]

Answer 96

In this case the company was insolvent due to a former director’s breach of directors’ duties not to compete or misuse confidential information. These duties were also express terms in a shareholders’ agreement to which the defendant and claimant were parties. The company had initiated an action against the former director, but the administrative receivers discontinued it when the defendant director applied for a security of costs order. In effect, the defendant had, by his breach of duty, rendered the company incapable of seeking legal redress against him. The claimant sought to recover losses to the value of his shareholding, loss of remuneration and loss of the value of loan stock.

Question 97

Key case: Giles v Rhind [2003] Judgement

Answer 97

The Court of Appeal held that the claimant could pursue his claim for breach of the shareholders’ agreement including his losses in respect of the value of his shareholding. The claims for loss of remuneration and losses of capital and interest in respect of loans made by him to the company did not, in any case, fall within reflective losses. A substantial sum was awarded by way of damages. The court placed emphasis on the fact that the defendant’s own wrongdoing had, in effect, disabled the company from suing him for damages

Question 98

4.4 Statutory minority shareholder rights

Answer 98

There are also a number of provisions in CA 2006 which give rights to minority shareholders in respect of particular decisions taken by the company. These are: (a) Protection against alteration to the company’s constitution (s 21) (b) The right to requisition a general meeting (ss 303–305) (c) The right to demand a poll vote (s 321)

Question 99

4.5 Protection against alteration to the company’s constitution (s 21)

Answer 99

Under s 21, minority shareholders are protected to an extent against alterations to the company’s articles, as a special resolution (75% majority) is required to make changes to the articles. You will recall that where shareholders are voting on a decision to amend the articles, the court will look at whether reasonable shareholders could have considered that the amendment was for the benefit of the company. Shareholders must vote to amend the articles in good faith (Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656) and not to undermine substantive rights of minority shareholders. If not, the court may hold the amendment invalid. It is also possible to ‘entrench’ certain provisions in the articles by providing that a higher majority is required to alter these provisions (s 22(1)).

Question 100

Russell v Northern Bank Development Corpn Ltd [1992].

Answer 100

In addition, it is possible for the shareholders in a shareholders’ agreement to agree how they will exercise their voting rights on a resolution to alter the articles, and this agreement is enforceable (Russell v Northern Bank Development Corpn Ltd [1992]).

Question 101

4.6 The right to requisition a general meeting (ss 303–305) (5% and 21 days)

Answer 101

As you know, s 303 gives the right to the shareholders to request that the directors call a general meeting of the company. This requisition can be brought by shareholders holding not less than 5% of the voting paid-up capital of the company. If the directors fail to convene a general meeting within 21 days of the requisition, or to hold the general meeting within 28 days after calling it (s 304), the shareholders may call the general meeting themselves (s 305).

Question 102

4.7 The right to demand a poll vote (s 321)

Answer 102

In general meetings, voting takes place on a show of hands unless a poll vote is demanded. On a show of hands, each member has one vote irrespective of how many shares that person holds. On a poll vote, each member has one vote per share held. Section 321 provides that a poll vote may be demanded by: * Not less than five members having a right to vote at the meeting; * Members holding not less than 10% of all voting rights that could be cast at the meeting; * Members holding shares conferring a right to vote at the meeting on which the aggregate paid up sum equals not less than 10% of the total sum paid up on such shares.