Help for minority shareholders
being shut out or treated badly

Unfair Prejudice Petitions and Derivative Claims

The following is not intended to be legal advice. You must not rely on it in anyway. You should seek your own legal advice if you think the issues raised in the article are relevant to your situation. If you would like such advice, I would be delighted to be instructed by you to provide you with the relevant advice.

Introduction

1.         A minority shareholder(s) who is being oppressed by a majority shareholder(s) can ask a court to order the Company to be wound up. The relevant statutory provision for this is Section 122(1)(g) of the Insolvency Act 1986. A Court may agree to this if it considers that it would be just and equitable to do so.

2.         However, that may not be in the minority shareholders interests or the shareholders overall. This is especially true if the company is viable and profitable.

3.         There may be a solution to this problem for a minority shareholder. This may be to ask (petition) the Court to find that they are being “unfairly   prejudiced”. The relevant statutory provision for this kind of claim is Section 994(1) of the Companies Act 2006 (“the Companies Act”).

What is an Unfair Prejudice Petition?

4.         An unfair prejudice petition is a form of specific form or request, or claim, made to a Court. It is one of the key tools that a minority shareholder may use if they can show that they are being oppressed by a majority shareholder or a group of shareholder acting as a majority. They are particularly useful for shareholders in smaller companies such as unlisted small and medium sized enterprises (‘SME’).

5.         An unfair prejudice petition can be issued by an equal or larger shareholder where where a minority has a controlling position. If the shareholder can resolve the situation on their own, by raising the relevant resolutions and then approving them by their shareholding.

6.         The grounds for bringing a petition are that:

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

7.         There are therefore two grounds for an unfair prejudice petition:

7.1.      Conduct of the affairs of the company in an unfairly prejudicial manner; and

7.2.      A corporate act or omission which is or would be unfairly prejudicial.

A petition may succeed on either ground, although often both elements will be present. Proposed acts are relevant, but mere fears are insufficient.

Who can bring an Unfair Prejudice Petition?

8.         A member may bring an unfair prejudice petition. Ordinarily this means being a shareholder. Another way of saying this is that only the “legal” owner of share can bring a claim. The “beneficial” owner of the shares, such as if they are held on trust, cannot bring a claim directly. However, a beneficial owner may be able to ask or compel the trustees of any shares held on trust for them, to bring a petition on their behalf.

9.         There must have been conduct that is unfairly prejudicial to the interest of some or all of the members of the company    for a petition to be successful, including the petitioner’s interests.

10.       An example of such conduct amounting to unfair prejudice might be the exclusion of a member from the board of directors.

What is Unfair Prejudice?

11.       The test for unfair prejudice is an objective one. It is not a subjective test. That means that the person bringing the claim, the petitioner, must prove that a reasonable person would regard the conduct has having unfairly prejudiced the minoritiy’s interests. It doesn’t directly matter if the petitioner, thinks the conduct is unfairly prejudicial although that might be useful assistance. Nor does it directly matter whether or not the majority shareholders knew, or deliberately, acted in an unfairly prejudicial manner.

9.         If the alleged conduct has been agreed to or acquiesced by the petitioner, then the claim is unlikely to succeed.

10.       There are two essential ingredients to an unfair prejudice petition. First unfairness. Second prejudice. Conduct may be unfair but not prejudicial. Or it may be prejudicial but not unfair. In either of these scenarios, a claim would fail. Both must be present.

11.       The prejudice must also substantial relative to the remedy   (sum or resolution) claimed. If the remedy is trivial, a Court is unlikely to agree to the claim.

Legitimate Expectations

12.       The courts call the interests that shareholders seek to protect “legitimate expectations”. For example, the courts are likely to accept that shareholders have a legitimate expectation that a Company will be run and managed lawfully. This is likely to mean in accordance with the Company’s articles or the duties that the Companies Act imposes on directors.

13.       Informal and unwritten arrangements about the management of a Company may still amount to legitimate expectations, but may be harder to prove, or harder to convince a court of. They larger the company the harder this may be.

14.       Unless it is an obvious breach, such as a breach of director’s duties, the assessment of legitimate expectations will usually involve a court considering the existence of agreements, promises or undertakings reached among shareholders at the outset of the company’s existence or later and that members relied on them.

Derivative Claims

15.       The claimant or petitioner in an unfair prejudice claim, normally seeks compensation for any loss or damage they have suffered themselves.

16.       However, sometimes, it may be that the best course of action, that the company itself is compensated for any damage or loss that it has been caused as a whole, perhaps by directors, those people running the company on a day to day basis, breaching their duties.

17.       If the concerned shareholder has sufficient control of the board of directors or is able to mobilise sufficient of the shareholders to pass the relevant resolutions, it may simply be that they can bring proceedings against the errant directors in the name of the Company.

18.       However, often that is not possible, due to there being insufficient control of the board or not having sufficient votes to pass the relevant shareholder resolutions. Or it may be that there is a difference between the voting powers of different classes (kinds) of shareholdings.

19.       In this scenario, a Court (and only a Court) can order that a claim is brought against the directors who may have wronged the company. This is called a “Derivative Action”. The relevant statutory provisions are Sections 262 and 265 of the Companies Act. A Claimant, such as a minority shareholder, would therefore make an application to the Court for permission to allow them to bring proceedings in the Company’s name. Similarly such an order may flow from a successful unfair prejudice petition.

Remedies

20.       The Court has very wide powers, if it agrees that there has been unfair prejudice towards one or more shareholders. A Court can make any “such order as it thinks fit for giving relief in respect of the matter complained of”.

21.       This may include:

•          Regulating the management of the company’s affairs in the future;

•          Requiring the company to stop doing an act or omission that the petitioner has complained of;

•          Authorising civil proceedings to be brought in the company’s name by such persons and on such basis as the court may direct (such as a Derivative Action – see above);

•          Requiring the company not to make any or any specified alterations to its articles without the Court’s permission;

•          Requiring the one or more shareholders to buy from or sell to one or more other shareholders their shares of any members of the company by other members or even the Company itself (s996(2)), such as by way of a share buyback.

22.       The most common remedy is for the Court to order that the Petitioner’s shares in  the Company be bought by the majority shareholders.

23.       Therefore the valuation of the Company’s shares is a very important part of an unfair prejudice petition. It will require expert evidence from business valuation experts.

a)         Generally, shares of a minority shareholders are be valued at a discount of around 50% to the overall valuation. This reflects the minority’s lack of control. This is not very different from a normal valuation in a normal share sale. Regardless of any dispute, it may prove difficult for a minority to shareholder to find a buyer for a minority holding with little or any real control.

b)         If the conduct of the majority shareholders has adversely or negatively affected the value of the company, for example by extracting money from the company using illegitimate means, (paying their children’s private school fees using company funds for example), the court may order that the shares of the minority are bought at a   price that reflects the valuation of the company prior to that wrong doing.

c)         The relevant date for assessment of the value of the Company will generally be the  date of the hearing and not the date of the petition or the wrongdoing or unfairly prejudicial conduct.

d)         The court may also take into account conduct that has occurred after the complaint has been raised, or the petition  has been presented.

How to bring an Unfair Prejudice Petition

24.       As with most cases, the Civil Procedure Rules apply to  unfair prejudice petitions. In addition, there are specific requirements for unfair prejudice petitions. These are set out in the Companies (Unfair Prejudice Applications) Proceedings Rules 2009, SI 2009/2469.

25.       Unfair prejudice claims, under Section 994 of the Companies Act, require that a “petition” be filed at Court and served on the other parties. This is a mandatory requirement that cannot be remedied.

26.       The petition must specify the grounds on which it is made and the nature of the remedy which the Petitioner is seeking.

27.       The court must fix a date for an initial hearing. This is known as the ‘return day’. At this hearing, unless otherwise ordered by the court, the petitioner and any respondent, including the company, must   attend in order that directions are set for the conduct of the case.

28.       The petitioner must, at least 14 days before the return day, serve a sealed copy of the petition on the company and every respondent named in the petition.

29.       Interim measure may be available to protect the Company’s and the Petitioner’s position pending the hearing of the petition. Such measures might be an interim injunction forcing one or more parties to do something or not to do something until the matter is decided.

Respondents

30.       Generally the respondent to a petition will be the majority shareholder who, the minority shareholder says is acting in an unfairly prejudicial manner towards them.

31.       However, the range of potential respondents is much wider. These include a former shareholder, a director or current shareholder, or someone who has knowingly received benefit from the wrongdoing or has improperly assisted in the wrongful dissipation of the assets of the company.

32.       The Company may also be named as a respondent. This is because sometimes it is the Company that is ordered purchase the relevant assets or shares.

Limitation

33.       Whilst there is no specific limitation period applicable to unfair prejudice petitions, where there has been excessive delay, a  court may be less likely to grant the requested resolution.

Preliminary hearings

34.       Preliminary hearings in unfair prejudice petitions are likely to involve directions relating to disclosure and expert valuation evidence. Disclosure will often be an important feature of the case, because they will often have physical or electronic control of the relevant documents and data which is relevant to the case.

Conclusion

35.       Unfair prejudice petitions often involve companies with a small number of shareholders. They may often be family businesses. In many cases the shareholders previously got on well, but have now fallen out.  They tend to be complex disputes, often involving complicated factual and legal issues. They may also be emotive. Unfair prejudice claims are often dealt with by specialist lawyers and barristers so are often expensive and may be high risk, even higher risk than the value of the business or the shareholder’s total net worth. They may also be a significant distraction to the good ongoing management of the Company.

36.       For all of the above reasons, unfair prejudice petitions should therefore be treated with great caution.

37.       Because of that whilst the Companies Court may well encourage Alternative Dispute Resolution such as mediation, those embarking or considering embarking on, or defending, an unfair prejudice petition, should very strongly consider the benefits of this course of action. If they have not considered it, or have refused it, they should be prepared to explain to the court, with compelling evidence and grounds, why not, to avoid very unpleasant cost sanctions even if they are successful in the main claim.