briefing note - cdr - minority shareholders and their rights - jan 2009

7/28/2019 Briefing Note - CDR - Minority Shareholders and Their Rights - Jan 2009

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Minority shareholders and their rightsBriefing noteAuthor: J ohn SykesDate: J anuary 2009

Contents

Unfair Prejudice

Derivative Claims

Personal Claims

J ust and Equitable Winding-Up

In Practice

A Ltd is small owner managed business with an annual turnover of 15 20 million. It isowned and controlled by 3 old friends, business partners of longstanding who decided 10years ago to give up their day jobs and go into business together. All 3 are directors.

They agreed from the outset to take broadly equal amounts out of the company. Theshareholding however is not split equally between them. One member has 58% of theissued share capital, the other two have 21% each. All 3 directors play a full role in themanagement of A Ltd. They operate by consensus and formal board meetings are rare.

Sounds familiar? This is how many owner managed businesses and family companies

are run. All is well whilst the members get on with each other and are happy with thedirection the business is going. But what happens when clouds appear on the horizon,when the majority shareholder sees the company as his own to do with as he likes, orwhen he wants to eject a director who is also a shareholder? Surely, subject to havingsufficient voting power to carry an ordinary or special resolution, the majority rules?

A minority shareholder is not entirely impotent. The Companies Acts have alwayscontained provisions giving a minority shareholder leverage to curb the excesses of themajority.

However, generally they are little use against a majority shareholder determined to

execute his plans. In these circumstances, the minority shareholder will need to apply tothe Court for protection and relief.

Unfair Prejudice The most important protection that a minority shareholder has is the right to petition theCourt for an order under s994 of the Companies Act 2006 (formerly s459 of theCompanies Act 1985). This action is founded on an allegation that the affairs of thecompany are being conducted by the majority in a manner unfairly prejudicial to theinterests of members generally, or to some part of its members (including the applicant).

This could include breach of a legal bargain between the shareholders (e.g. aShareholders Agreement or Articles of Association); breach of fiduciary duty; breach of

an equitable agreement or understanding; or breach of quasi-partnership principles.

The relief sought is normally an order that the other shareholders (or the company itself)purchase the minority shareholding at fair value. An Order providing for a clean breakwill be preferable. However, the Court has complete discretion and if the circumstanceswarrant can even order the minority shareholder to purchase the shares of the majority.

The Court can, and will, make orders to adjust the unfair prejudice that the minorityshareholder has suffered. For example, the Court may order the company to be valuedon the basis that the benefits taken by director/shareholders in breach of fiduciary duty berepaid. The Court will also decide at what date the company should be valued and

whether there should be any discount to reflect the minority shareholding.

The Court can also make an Order regulating the conduct of the companys affairs in the


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future; require the company to do or refrain from any act and authorise civil proceedingsto be brought in the name of the company.

Derivative ClaimsIn many circumstances, a minority shareholder may be affected by a wrong done, not tohim personally but to the company by the majority. For example, diversion of contractsfrom the company to the directors personally.

The minority shareholder faces an impossible task in attempting to force directors intobringing an action against themselves. In certain circumstances, however, the Courts willallow a minority shareholder to bring a claim in the companys name.

Such derivative claims were formerly governed by the common law and were rarelybrought. However, they have now been given statutory force through ss260-264 of theCompanies Act 2006. The Act permits derivative claims arising from an actual orproposed act or omission involving negligence, default, breach of duty or breach of trustby a director. This is wider than the old common law test where the act had to amount toa fraud on the minority. Further, under the old rules a director who was also a majorityshareholder could ratify the disputed act. However, under s239 of the 2006 Act, ashareholder-director responsible for the negligent act will not be able to vote at a meetingof members called to ratify the act or omission.

It should be noted, however, that the claim is brought by a shareholder on behalf of thecompany. Any financial award accrues to the company itself (unlike the unfair prejudicepetition described above).

Personal ClaimsAll shareholders have rights that they can enforce against the company and othershareholders whether or not a formal shareholders agreement has been reached. Theseinclude objection to alteration to the Memorandum and Articles of Association, thevariation of class rights, the giving of financial assistance and the enforcement of directors duties, prevention of ultra vires transactions and in relation to certain take-overoffers.

The Memorandum and Articles of Association represent a statutory agreement betweenthe shareholders and the company as to how the company is to be run. The court willenforce a breach of that agreement. An otherwise proper attempt to vary the articles canbe actionable if it affects rights already in existence or the majority have not acted in goodfaith.

Just and Equitable Winding-Ups122(1)(g) Insolvency Act 1986 grants power to the Court to wind up the company onjust and equitable grounds. The applicant must satisfy the court that there is anadequate surplus for distribution to the members after a winding-up. He must also satisfythe Court that he has clean hands meaning that if the applicant can be blamed forsome of the matters he complains of then the Court may not grant his application.


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An application for just and equitable winding up can be used by the Court as anopportunity to look into the companys internal affairs. Although, the burden rests on theapplicant to demonstrate that the circumstances warrant intervention, the Courts arewilling to consider the motivation driving a companys actions.

The type of situations that might merit a just and equitable winding-up include theexclusion of a minority shareholder from management or the breakdown of confidence inthe management of the company.

In PracticeA Ltds members have a falling out. The majority shareholder is advised that he hassufficient voting power to exclude the others from management of the company unders303 of the Companies Act. He calls an EGM and passes the resolution. He decides totake advantage of pre-emption rights in the articles and makes a number of low offersreflecting a high discount for the fact that the shareholdings are minority holdings. Theseare rejected.

The minority shareholders say that they have an expectation of being involved in themanagement of the company; that the company was a quasi-partnership. This meansthat the way that they joined together to form the company and the way that it has beenrun since has given rise to an understanding that each of the shareholders wouldparticipate in management. They say it is unfair to exclude them. They also say that this

means that their shares should be purchased by the majority without a discount.

Who is right depends very much on the facts. It is not safe to advise the majorityshareholder that a minority discount applies in every case. Nor is it safe to advise theminority shareholder that if trust and confidence between shareholders has broken downthat their shares should be bought at fair value. There certainly is no such thing as a no-fault divorce in company law.

More information J ohn Sykes, Partner

+44 (0)20 7203 5131 [email protected]

This information has been prepared by Charles Russell LLP as a general guide only and does not constitute advice onany specific matter. We recommend that you seek professional advice before taking action. No liability can be acceptedby us for any action taken or not taken as a result of this information. Charles Russell LLP is not authorised under theFinancial Services and Markets Act 2000 but we are able in certain circumstances to offer a limited range of investmentservices to clients because we are members of the Law Society. We can provide these investment services if they are anincidental part of the professional services we have been engaged to provide.

briefing note - cdr - minority shareholders and their rights - jan 2009

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