The suitability of the relevant statutory regimes and the use of shareholder agreements for the protection of shareholders’ interests.
Introduction
Various statutory regimes such as the Company Law Act 2006, Insolvency Act 1986 along with shareholders agreements are designed to set out the member’s rights and obligations in relation to the company. These are also used to protect shareholder’s interests in the case of a breakdown between the members or directors of the Company. Conflicts between shareholders are heightened where the majority decide to make changes to the articles of association or wind up through a special resolution, where the minority have minimal decision-making power and consequently their interests are undermined. Specifically, a member may bring a derivative claim in the company’s name where loss has been suffered to the company provided that certain conditions are met. Where loss has been suffered by the individual member personally, he may want to seek relief on the grounds of unfair prejudice. The third main remedy for the shareholder is for them to seek the winding-up of company provided that it is just and equitable to do so. However, case law suggests that petitioners are opting out for unfair prejudice petitions where a derivative claim should be sought and the distinction between the two has been blurred. Likewise, shareholders agreements may include clauses which fetter out the statutory powers to protect the interests of its members in a private company.
Shareholder agreements
Minority shareholders may often want to resort to shareholders agreement to obtain protection which would otherwise be difficulty for them to achieve under statute or in the company’s constitution. The majority shareholders and directors are in a position to influence the company which leaves the minority with very little protection. A company’s shareholder agreement is a contract between the members of a company which can be drafted in a way that will bind the company. Shareholder agreements which are a pre-emptive measure aid the shareholders in guaranteeing their investment and can include provisions which state that shares must be offered to the existing shareholders rather than bringing in a new investor.
Shareholders also want to ensure that they get dividends to the extent that they can and ensure that they have a right to vote. Shareholders agreements may also determine the kind of voting rights members have. It may include clauses where a director may be removed without the use of ordinary resolution or where minority shareholders who are also the directors of the company may not require removal by a simple majority vote. Agreements which are properly drafted may include clauses in the partnership that avoid the consequences of majority rule. It should be noted that shareholder agreements become a part of articles of association when the latter are altered so that a new shareholder agreement is produced at new. Since articles of association can be amended by a special resolution, the minority shareholder has minimum protection to further their interests.
However, the drawback of a shareholder agreement is that it may work to the detriment of the minority shareholders by imposing a fetter on corporate statutory powers in an inter se private contractual agreement between themselves
For example, unfair prejudice petitions may be excluded from a shareholders agreement; “there [is] no express statutory prohibition […] excluding unfair prejudice disputes from arbitration.” Also, the insolvency regime is immune from interference by shareholders agreements as they would prejudice the winding-up which in turn affects third-parties. Courts are unwilling to uphold such a shareholder agreement where it interferes with public policy or where third-party rights are affected. Also, future shareholder’s interests are not affected by a shareholders agreement since contracts cannot be enforced against third parties.
Assuming that a shareholder transfers shares in breach of the shareholder agreement, the transferor then may be liable for breach of contract terms and the transferee will be restrained from transferring the shares further to a third-party. Lastly, directors of a company, or a shareholding majority may not use their control of the company to determine actions which would be ultra vires the company, or illegal as laid down by s 39 Companies Act 2006.
Derivative claim (Part 11 CA 2006)
Scope
Usually, the claim will be brought by a minority shareholder since there are other options majority shareholders can use, such as appointing new board of directors rather than bringing a derivative claim. Any member of a company may bring a derivative claim in respect of a cause of action vested in the company and for the benefit of the company concerning negligence, a default, and breach of duty or trust by the director of the company. The remedy is corporate, as opposed to personal. There is no requirement on the part of the claimant to have been a member when the conduct complained of took place, which can be seen from a negative aspect since frivolous cases by ex-shareholders can be brought before the courts.
Procedure
The claim involves a “two-stage test” where in the first stage the claimant on behalf of the company must provide prima facie evidence in order to get standing before the court. The claim may be dismissed in the first stage, to reduce the amount of vexatious or unmeritorious claims as soon as possible in the process. In the second stage the court exercises its discretion whilst taking into account additional factors as to give permission to the claimant based on the evidence from the first stage. Some of the factors to be considered under the second stage are whether the act or omission has been ratified by the members and whether members have not acted in good faith and if they have then the permission will not be refused. Additionally, permission will not be refused where a director acting to promote the success of the company would not want to continue with the petition.
Costs
Statute does not provide for indemnity costs to be paid to the claimant who brings the claim which may be a reason for the shareholder to not institute a claim. However, the judgement in Wallersteiner established that the court may award a pre-emptive cost order in favour of the claimant. Costs of bringing a derivative claim will result in the plaintiff being indemnified by the company provided that he or she was acting in good faith in bringing the claim. Since the remedy is equitable the courts will use their discretion to award the remedy.
A member may not pursue a remedy for any personal loss caused which would be contrary to any recovery of “reflective loss” which entails that the claimant must bring the claim before the court in order for the value of shares to be restored to the position that reflects their loss.
Unfair prejudice under section 994 of the Companies Act 2006
Scope
Petitioning for relief on the grounds of unfair prejudice may grant one of the most extensive shareholder remedies. It is a form of personal relief where a member may petition on the grounds that damage has been suffered personally due to unfair prejudice by the directors.
Procedure
In a broad sense, there are two requirements that need to be satisfied in order for a claim to succeed. Firstly, the conduct must be prejudicial in the sense of causing harm or prejudice to the interest of the members of the company and secondly the conduct must be unfair. However, extensive case law has added further requirements that courts cannot intervene just because the conduct is subjectively “unfair” and that there needs to be:
"Some breach of the terms on which the member agreed that the affairs of the company should be conducted; or some use of the rules in a manner which equity would regard as contrary to good faith i.e. cases in which equitable considerations make it unfair for those conducting the affairs of the company to rely upon their strict legal powers."
Examples of the “terms” where a petition may be brought under s 996 of the Act, as laid by Lord Hoffman in O’Neill, would include instances where the terms in the articles of association are not adhered to, or where the director’s duties are breached as laid down by statute. Any member being excluded from the management of the company’s affairs will not in itself, amount to a petition. The question that needs to be answered is whether a “quasi-partnership” exists where the shareholders are allowed to participate in the management of the company, usually taking the structure of a small private company.
Costs
The likely outcome of a section 994 CA 2006 petition is that an order for the claimant’s purchase of shares will be made by the court. The Wallersteiner indemnity for costs can be granted to the petitioners under this section as it can be done for derivative claims.
Winding up on just and equitable grounds ( IA 1986, s 122(1)(g)) which leads to validation under order under s 127 IA
Scope
Winding up on just and equitable grounds is a remedy of last resort to shareholders where the company is forced to cease its existence. The shareholder seeking to wind up must come to the court with clean hands. The majority who will also usually be the directors of the company may decide to wind up the company voluntarily or by the courts through a special resolution. It should be noted that the courts are likely to refuse permission where it is thought that an alternative remedy exists considering the facts of a given case.
Procedure
A shareholder must first establish sufficient interest in the winding up. In practice this entails that a fully paid up shareholder must evidence that there will be monetary surplus for the distribution among the members of the company after winding up. There is no easy definition of “just and equitable” for a court to wind up a company where each case is looked at from its own circumstances. The court may refuse to grant the relief because the is an alternative remedy available and it is unreasonable for the complainant not to pursue that remedy (s.125(2)). Also, the courts may refuse to grant an order for winding up if there are any other remedies available for the healthy company to not cease in its existence. Moreover, Lord Hoffmann’s speech in O’Neill v Phillips "that the winding-up jurisdiction is, at the very least, no wider than [s.994] jurisdiction". Thus the interrelationship between a derivative claim and unfair prejudice remedy “encompasses the just and equitable winding-up remedy by necessary implication.
Costs
Alternative remedies can include an offer by the respondents to buy the complainant’s shares at a fair value or the fact that the complainant might have a more appropriate remedy under s 994 of the Companies Act 2006
Benefits of unfair prejudice claims to shareholders
The advantage of seeking relief through an unfair derivative claim is that that the two-stage permission process of the statutory derivative claim is not present, and thus the expense and delay are minimized for the shareholders which will seem more attractive to shareholders. Moreover, here it is solely up to the member to seek relief and the ratification nor an authorisation is a prerequisite for the claim to be brought, while that is the scenario for a derivative claim to be brought. Fewer hurdles are in place for an individual member who wishes to take action on behalf of themselves rather the than the company which is the case for derivative claims. Also, this poses the presumption that, when commencing litigation under a derivative claim, a member, knowingly may not want to petition and will wait for another member to do so in order to escape liability and becoming a “free-rider” in the situation.
Benefits of derivative claims to shareholders
A derivative claim ensures that justice is done to the company rather than just the petitioning member to best suit his or her interest. In a derivative claim proceeding, unlike an in unfair prejudice proceedings, the petitioner does not have to prove that unfairly prejudicial conduct has occurred. Henceforth, it has been stated that cases that come before the court in unfair prejudice proceedings are less focused and the wide interpretive scope of unfair prejudice claims can be very costly and time-consuming for the petitioner. The lack of a permission stage under this section ensures that the individual petitioner’s interests are protected rather than the company’s as a whole.
The minority shareholders are recommended not to give up their right to petition in a shareholders agreement as there is extensive jurisdiction to award flexible remedies under s994 which only the courts can do and not an arbitrator if that is stated in the shareholder agreement.
A derivative claim can act as a powerful deterrent to directors when it is both well established and thought of so that they do not breach their duties. Frivolous claims are also dispensed at an early stage. An individual member cannot always be in an optimal position to make informed decision as to whether litigation is truly the best interests of the company. Rather, one could argue, most frequently the board is in such a position. Thus, the mandatory bar permission stage ensures that the directors of the company act in agreement with their duty. It can be stated that the statutory derivative claim strikes a fair balance between the interests of the minority and the company.
The authorisation and ratification by a majority aids in the protection of shareholder’s commercial incentives made in good faith and guarantees that the majority does not act in manner which is harmful to the company without there being the availability of redress for the company which includes the stakes of the minority.
It is argued that due to these cumbersome procedure and limitations, statutory derivative may not achieve the aim of serving as a check to breach of director’s duty as most shareholder’s, specifically the minority may not want to institute derivative action.
Analysis and divergence of unfair prejudice petitions and derivative claims
The circumstances of when unfair prejudice claims can be sought are widened to include claims concerning corporate loss. This has left the law on the remedies available to shareholders in a muddled state.
It has been argued that the distinction between corporate loss under the derivative claim and personal loss under the unfair prejudice petition has been blurred. The case of Clark v Cutland provides evidence for the pervious statement. The case concerned a director who had breached his duty towards the company, yet an order was made to the company to indemnify the petitioner for the costs. It can therefore be argued that unfair prejudice petitions include claims concerning corporate relief which originally should be sought under a derivative claim. Additionally, in Gamlestaden Fastigeheter AB V Baltic Partners Ltd the Privy Council awarded corporate relief where the petition was sought under s.994 of the CA 2006.
So has the distinction between corporate and personal loss been blurred? It has been argued by Hannigan that these cases are “exceptional” and were decided before the statutory derivative claim was put in place. On the contrary, A.M Gray argues that if these claims are “exceptional“ then that alone would lead to the conclusion that derivative claims are highly useful under UK company law.
The most significant limitation to a derivative claim is that the claimant has to know whether there is an alternative remedy available to him and secondly, that it is forbidden to claim for “reflective loss”. Thus, A.M Gary argues that the minority shareholder is only able to recover loss through the unfair prejudice remedy under s 994 of CA 2006 which is seen as a personal remedy and that “derivative claims are a mere superfluousness warranting abolition”.
Conclusion
Shareholder agreements are a very important in protecting the interested of the members since they lay down how the company may be run. They may not impose a restriction to contract out the statutory remedies for shareholders but rather, may impose a fetter on a shareholder agreement. Therefore, these must be drafted carefully, along with the articles of association to protect the shareholder’s interests in general.
“A narrow s.994 scope results in more genuinely meritorious and worthwhile claims proceeding to court as derivative claims”.
It should be noted the
a member pursues a cause of action “in his own right” (where the member seeks a personal claim) they will not be barred from doing. However, where all the relief that the applicant is seeking is available to him under CA 2006, s994, the courts will direct him to seek redress under that section for personal claims.
The comparatively moderate consequences of a successful derivative claim (i.e. an award of damages) mean that this will be a vastly more attractive option for minorities in a great number of cases as opposed to winding up. The remedies, it is therefore suggested, do not compete against one another for business, so to speak, as they operate to different ends in different circumstances.
Shareholders agreements may include clauses that restrict the exercise of statutory rights such as petition on the ground of unfair prejudice and or just and equitable winding up.
Unfairly prejudicial claims do not amount to a class remedy as opposed to a winding-up order which can be classified as a class remedy and may be awarded by an arbitrator.
The important role of the distinction and downside of shareholder remedies discussed above is that a shareholder may not pursue a personal loss caused as that would be contrary to the principle forbidding “reflective loss” furthermore they blurred distinction between a derivative claim remedy and unfair prejudice one may lead to shareholders seeking a derivative claim remedy only to pursue an unfair prejudice remedy to remedy their personal loss.
The remedies available to shareholders must be pursued via different vehicles to best suit their loss. However, the distinction of approaching the above mentioned remedies has become blurred over the recent years. A.M Gray argues that unfair prejudice claims are being used by members where initially a derivative claim should be sought and that the latter are “mere superfluousness warranting abolition”
Therefore, it can be concluded that the wide scope of unfair prejudice remedies are too flexible. The negative aspect of derivative claims is that, “financial cost, management time and potential reputational damage” is caused if a claim is sought under this section.
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