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Case law: Directors’ refusal to approve share transfer can be ‘unfairly prejudicial’

Directors deciding whether to approve a transfer of shares should consider whether a refusal to approve it may breach their company law duties, and amount to acting in an unfairly prejudicial way to shareholders, a ruling makes clear.

November 2018

This update was published in Legal Alert - November 2018

Legal Alert is a monthly checklist from Atom Content Marketing highlighting new and pending laws, regulations, codes of practice and rulings that could have an impact on your business.

Two shareholders owned 70% and 30% of the shares respectively in a company. The 70% shareholder (‘M’) planned to buy a further 5% from the other shareholder (‘O’), and negotiated to sell the remaining 25% to a third party. The third party thought M was acting on O’s behalf but, in fact, O knew nothing about the negotiations.

The third party agreed the price it would pay per share, and M told shareholder O what was happening – but did not reveal who the third party buyer was, or the price per share the third party was willing to pay.

M then changed tack. It offered to buy the whole 30% from O, but at a much lower price per share than the price the third party was prepared to pay (O was unaware of this).

If that deal had gone through, M would have been able to sell a 25% stake to the third party at the higher price – making a $17m profit.

But things went awry for M: the third party decided to approach O direct, and offer the higher price per share that it had been prepared to pay M. As a result, O agreed to sell direct to the third party.

However, the company’s articles of association required any transfer of shares to be approved by the board of directors. Unfortunately for O, three of the four directors had been appointed by M.

The board met and resolved to set up a committee, made up of two directors appointed by M, to consider whether or not the transfer should be approved. The committee recommended refusing to approve the transfer, based on:

  • an incorrect account of the previous negotiations between M and the third party; and
  • an insider trading issue involving the ultimate owner of the third party.

When the board acted on the recommendation and refused the transfer, O claimed unfair prejudice. There is unfair prejudice if a company’s affairs are conducted in a way that is unfairly prejudicial to some or all of the shareholders, for example, because the directors have acted in breach of their duties to the company. If a court finds unfair prejudice, it can choose from a wide range of orders to put things right.

O claimed that there was unfair prejudice because the other shareholder, through its directors, had deliberately blocked the sale to the third party – even though it had previously tried to negotiate the sale – because it would no longer make a profit from it.

However, M argued that the directors had made their decision in good faith, and that it was reasonable given the insider trading issue.

The High Court said that the purpose of a power vested in the directors to refuse to register a transfer of shares was to protect the interests of a company’s shareholders as a whole. They should exercise that power honestly and in good faith, and not arbitrarily, capriciously, perversely, irrationally or unreasonably. However, in this case the reason the directors had exercised their power was to "disrupt and, if possible, prevent" the direct sale of the shares to the third party, to benefit M.

The directors had therefore breached their duty under company law to promote the success of their company for the benefit of its shareholders as a whole.

Furthermore, the directors had:

  • established the committee as a delaying tactic;
  • taken into account information they knew, or should have known, was inaccurate;
  • given undue importance to the third party owner’s involvement in an insider trading issue, which had been peripheral and had not involved any bad faith on his part, and which had happened eight years ago;
  • not taken into account that the third party’s owner’s influence over the third party would have been limited in any event.

The directors had, therefore, also breached their statutory company law duty to act within their powers. Overall, the conduct of the company’s affairs by M and its directors had been unfairly prejudicial.

Usually, the remedy for unfair prejudice is for the shareholder who has acted in an unfairly prejudicial way to buy their victim out. However, the Court ordered the board to approve the transfer of shares to the third party at the price agreed, ie, it forced them to agree to a new shareholder coming in.

Operative date

  • Now

Recommendation

  • Directors deciding whether to approve a transfer of shares should consider whether a refusal to do so may breach their company law duties, and amount to acting in a way which is unfairly prejudicial to a shareholder.

Case ref: Re Last Lion Holdings Ltd v Moore Frères & Co LLC, 2018-000840 and CR-2018-00305

Disclaimer: This article from Atom Content Marketing is for general guidance only, for businesses in the United Kingdom governed by the laws of England. Atom Content Marketing, expert contributors and ICAEW (as distributor) disclaim all liability for any errors or omissions.

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