Unfairness is an essential ingredient in minority shareholder petitions. Prejudice alone is not enough. This article explores just what it is that a petitioner needs to prove to make prejudice “unfair” in order for a petition to succeed.
The Elements of a Section 994 Petition
Section 994 of the Companies Act 2006 permits a member of a company to petition the court for relief on the ground that the company’s affairs are being or have been conducted in a manner that causes unfair prejudice to the interests of members generally or of some part of its members (including at least himself).
A petitioner under section 994 must therefore establish four elements to the satisfaction of the court: (1) the conduct of the company’s affairs; (2) has prejudiced; (3) unfairly; (4) the petitioner’s interests as a member of the company. In other words the conduct must be both prejudicial and unfairly so; conduct may be prejudicial without being unfair or unfair without being prejudicial. Both elements need to be satisfied and, if either is not, the petition will not be well founded.
The Company’s Affairs
So far as the first element is concerned, it will usually be clear that the conduct about which complaint is made constitutes conduct of the company’s affairs. The expression “the company’s affairs” is of wide ambit. It encompasses all matters decided by the board of directors. That does not mean that it is not important to consider this issue, as it may be that the conduct complained of really only concerns the activities of shareholders in their personal capacity and between themselves and not corporate conduct.
The second element of “prejudice” is also a very broad term. It obviously includes financial damage to the value of the petitioner’s shares. As a general rule, therefore, where a company is insolvent, the petitioner must show that his shares would have had a value but for the wrongdoing of the respondent. But it is considerably wider than this. The court takes a wide view of prejudice suffered by a shareholder. Even if the shares are worthless, the petitioner may be held to have suffered prejudice in some capacity connected with his shareholding, such as under a loan made as part of the same investment as that which led to the acquisition of the shares. Prejudice is not even limited to financial loss. It may include, for example, prejudice caused by disregarding the petitioner’s right to participate in management.
Unfairness: What Makes the Prejudice Unfair?
However, the third element of unfairness is a rather more complicated and slippery term. In O’Neill v. Phillips, the only case on unfair prejudice to have reached the House of Lords, Lord Hoffmann observed that fairness depends on the context in which it is applied; conduct which might be fair between competing businessmen might not be fair between members of a family. As he said, all is said to be fair in love and war. This means that what is fair is heavily dependent on the background facts and corporate setting.
This makes it difficult to predict with any certainty whether the prejudice will be held to be unfair. Nevertheless, some broad guidance can be given, on the basis of the case law which has emerged in the two decades since O’Neill v. Phillips.
(1) Non-Observance of the Constitution
First, a member is usually entitled to require the affairs of the company to be conducted in accordance with the terms on which the parties, through the company, have agreed to do business together (a company being, as Lord Hoffmann said, “an association of persons for an economic purpose”). These terms are to be found in the company’s constitution – in other words its articles of association – but also in any shareholder agreements. They also include any applicable rights conferred by statute, and include by implication an agreement that any party who is to be a director will perform his director’s duties which are now codified in sections 171 to 177 of the Companies Act 2006. But not every breach of the petitioner’s rights as a member will amount to unfairness: the breach must be sufficiently serious. A mere procedural irregularity or a trivial or technical infringement of the articles would not generally be enough to found a petition.
(2) Non-Observance of Common Agreement or Understanding
Secondly, although the articles of association usually confer no right to be involved in management or to be consulted on decisions which do not have to be taken by a general meeting, such additional rights may be conferred by an agreement, or understanding, between all or some of the members, i.e. a quasi-partnership. An obvious example is an agreement that the petitioner be involved in management or be consulted before certain decisions are taken. However, not every breach of a promise to involve the petitioner in management will amount to unfair prejudice. The Court of Appeal has very recently confirmed that exclusion from management might not amount to unfair prejudice if it was done openly as a result of a bona fide dispute, even though the respondents were later found to have been in the wrong.
(3) Abuse of the Rules
Thirdly, there may be unfairness if the majority are “using the rules in a manner which equity would regard as contrary to good faith”. The conduct need not be unlawful, but it must be inequitable. This is where the concept of unfairness becomes more difficult to apply. It exposes the inherent tension between contract law and equity. Although the common law traditionally held that parties to a contract owe no general duty of good faith, it now recognises that a party who is given a measure of discretion under a contract may be required to exercise it in a way which is not capricious or unreasonable: Braganza v. BP Shipping Ltd. Equity has taken a different route, imposing additional duties (or, more accurately, restrictions) on those who are treated as fiduciaries. Partnership is a paradigm fiduciary relationship, and the duty of utmost good faith imposed on true partners has been extended to company shareholders who are in a quasi-partnership.
The test is objective: it is whether, in all the circumstances, the majority are exercising their strict legal rights in a manner which is objectively unfair, even if they are subjectively acting in good faith. (This is analogous to the reformulated test for dishonesty.) However, Lord Hoffmann confirmed in O’Neill that there is no wider doctrine of legitimate expectation, if the petitioner cannot establish breach of the articles or of a quasi-partnership. In such a case it is therefore necessary to find some extra ingredient which is sufficient to render the conduct unconscionable.
The Court’s response to some commons situations of unfairness
The Court of Appeal recently said that: “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”. Unfortunately, the courts have not succeeded in developing a general test which would enable one to link the decided cases into a coherent doctrine or predict how future cases will be decided.
Nevertheless, a large number of cases have come before the courts, both before and since O’Neill. The safest course is to adopt an incremental approach, seeing whether the situation in question is sufficiently close to a previous case, but recognising that each case will depend on its facts. Thus:
- Failure to permit the petitioner to be involved in management or to be consulted about decisions will prima facie amount to unfair prejudice, if (but only if) there is a quasi-partnership which confers these rights on the member. However, this is not a rigid rule. Thus, it is not unconscionable to exclude the petitioner from management if there has been a breakdown of trust between the parties and the majority have offered to buy out the petitioner at a fair price. Similarly, it is not unconscionable to do so if the petitioner has been guilty of gross misconduct, albeit in good faith; in such a case the majority would be acting in good faith if they regarded him as a “bad leaver”.
- Mismanagement of the company’s business by the board is not usually sufficient. However, there are a few cases which this has been held to amount to unfair prejudice. In general, these are cases where the mismanagement amounts to a breach of the directors’ duties under ss.171-177 of the Companies Act 2006. A recent example is Edwardian Group Ltd, where the company’s chief executive diverted business opportunities to himself in breach of fiduciary duty.
- Excessive remuneration or bonuses will not usually amount to unfair prejudice unless this is contrary to the articles or to an agreement or understanding between the members. However, if it is so high as to be unreasonable and to result in the majority shareholder receiving a disproportionate share of the profits, then it may amount to unfair prejudice.
- Exercise of the power to allot shares may be unfairly prejudicial, even in the absence of a quasi-partnership, if it operates unfairly and has no commercial rationale. This could be the case even if the rights issue was open to all shareholders, but the majority knew that the petitioner could not afford to take up the offer and this was the reason for making it.
David Halpern QC and Michael Bowmer
4 New Square
© David Halpern QC and Michael Bowmer. The authors assume no responsibility to any party in respect of this article. Specific legal advice tailored to specific problems should always be obtained.
About the authors
David Halpern QC and Michael Bowmer of 4 New Square specialise in commercial chancery litigation including all aspects of company law, insolvency, contentious trusts, real estate disputes and related professional negligence.
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 Re Saul D Harrison & Sons plc  1 BCLC 14 at 18, Hoffmann LJ.
 Ebrahimi v. Westbourne Galleries Ltd  AC 360, HL.
 Don King v. Warren  Ch 291 at , CA.
 Re Cumana  BCLC 430, CA.
 Re a Company  BCLC 80.