Clearing a path to the best result – the difficulties in getting the desired remedy in an unfair prejudice petition
The decisions that are taken about the running of a company will, on occasion, benefit the majority. Those choices may be detrimental to minority shareholders whose opinions may not be consulted on the decision. Relationships can break down and hostility may develop.
In certain circumstances a shareholder may petition the court for a remedy. The Companies Act 2006 (section 994) provides protection for shareholders who are being unfairly prejudiced by the conduct or omission, or proposed conduct or omission, of the company’s affairs.
Establishing whether there has been unfair prejudice
In assessing whether there has been unfair prejudice, the court will look at:
- The provisions of the articles of association.
- The provisions of any shareholders’ agreement (if one exists).
- In the context of quasi-partnership companies, where the owners are likely to have an equal shareholding in the company, and an expectation to be involved in its management, the court will look at the historic understanding and dealings that existed between the shareholders as to how the company would be run, and therefore whether the relationship of trust and understanding has also been breached.
Relief is more straightforward in quasi-partnership companies than it is in companies that have a complicated constitution or equity structure. This is because usually, in a more complex company, the dealings between the shareholders will be governed either by the articles of association (particularly if they are bespoke) or the shareholders’ agreement, which are likely to provide a remedy in the event of any conflict.
What can the court do if unfair prejudice is proven?
Where unfair prejudice is proven the court’s discretion to grant relief is extremely wide, and the court can do almost anything to regulate the affairs of the company.
However, for practical purposes, and on the basis that there is likely to have been such a fundamental breakdown in the relationships between the petitioning shareholder and the other shareholders, a buy-out is the usual remedy. This particularly occurs in smaller companies with relatively straightforward equity and constitutional structures. Such companies are known as “quasi-partnerships”. In these companies the directors will deal with each other on the basis of a mutual relationship of trust and understanding.
The Cardiff City Football Club dispute
Recently, Mr Isaac, a minority shareholder and director in Cardiff City Football Club’s holding company, brought a claim against the holding company and its majority shareholder. He alleged that a dilution of his share percentage was designed to “squeeze” him out and was motivated by personal animosity towards him (Re Cardiff City Football Club (Holdings) Limited [2022] EWHC 2023 (Ch)).
Mr Tan, the majority shareholder in the Cardiff City dispute, is a wealthy businessman who had provided substantial financial support to the club. The foundation of the petition bought by Mr Isaac was based on a debt for equity swap that Mr Tan entered into with the club’s holding company. Prior to the transaction, Cardiff City Football Club had very high levels of debt and that was restricting its ability to recruit new players. In turn, those restrictions were making it very difficult for the club to develop.
It was therefore proposed that Mr Tan would increase his shareholding in the holding company from 94.22% to 98.3%. In return, Mr Tan would write off £67 million worth of personal debt that the company owed to him. The board of directors approved the transaction. The effect of this was that Mr Isaac’s shareholding was reduced from 3.97% to 1.18%.
Mr Isaac’s claims
Mr Isaac alleged that the transaction was not entered into for a proper purpose. He cited the significant breakdown in relations between him and Mr Tan which proceeded the transaction. He said that the transaction was motivated out of spite rather than entered into in the best interests of the company. He also claimed that the board had ratified the transaction not because it was in the best interests of the company (and therefore he alleged that the directors had breached their duty to exercise independent judgment) but because they were, in effect, doing Mr Tan’s bidding for him.
Mr Tan’s defence
Mr Tan’s potion was that the transaction was for a sound commercial purpose. He admitted that he had a poor relationship with Mr Isaac but that the dilution of his shareholding was not motivated out of spite or to be vindictive. The prime objective of the transaction (and indeed, the eventual outcome) was an improvement in the company’s balance sheet and consequently the club was able to start to develop by acquiring new playing talent. Therefore, Mr Tan said that the transaction was demonstrably in the best interests of the company (and the club) and therefore was permissible.
The court’s ruling
Mr Isaac’s unfair prejudice petition failed. The court said that the transaction was arguably unfair in a moral sense, and it accepted the evidence that there had been a significant breakdown in the relationship between Mr Tan and Mr Isaac. However, the court also determined that the primary purpose for the transaction was not to prejudice the position of Mr Isaac, but instead to improve the financial position of the company and to enable the development the club. The court also heard evidence that the board had not just simply given effect to Mr Tan’s wishes. It appeared that they had analysed what was proposed and had ratified the debt for equity swap after some debate. Such an approach was, in the court’s view, justified.
The court also indicated that whether the conduct of the majority shareholders is unfairly prejudicial should be read in the context of the company’s constitution. Clear breaches of the articles of association and/or a shareholders’ agreement in a complex company, or breaches of the mutual relationship of trust and understanding between the directors in a quasi-partnership, would constitute unfairly prejudicial conduct. However, acts which were arguably unfair, but did not also constitute a breach of the company’s constitution would not form the basis of an unfair prejudice petition.
Specialist legal advice
The case demonstrates that relief for unfair prejudice under the Companies Act 2006 is highly nuanced, and each case is determined on their own facts.
It is therefore important to obtain specialist advice at the earliest possible stage if you believe your rights as a minority shareholder are being prejudiced, before embarking on an unfair prejudice petition.
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