ICAEW.com works better with JavaScript enabled.

Case law: Shareholders’ failure to complain about ‘unfair prejudice’ at the time led to claim being rejected

A director’s failure to avoid a situational conflict or to get authorisation for it was a breach of his company law duties, and amounted to unfair prejudice to minority shareholders - but the victims’ failure to complain at the time meant their claim failed.

May 2019

This update was published in Legal Alert - May 2019

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.

This was the case even though the director genuinely believed his actions were in the company’s best interests.

Four brothers and sisters had inherited shares in a company from their parents. One (A) held the majority of shares and was managing director, B was a minority shareholder and director and C was a minority shareholder and the company secretary. D was a minority shareholder and not actively involved with the company. There was also another corporate shareholder.

The two directors, A and B, spotted that another business had gone into administration, and there was an opportunity to acquire certain assets from the administrator. The existing company did not buy them and, instead, A set up a new company and bought them through the new company. The new company then hired the assets out to the existing company at an excessive rate.

B and C claimed that A had done this simply to extract value from the existing company without the other shareholders getting anything. They would have received something had value been extracted as, say, dividends.

A then approached the corporate shareholder with a view to buying all of its shares. However, the others claimed they should each be offered a proportion of those shares too, pro rata their existing shareholdings, and A should not be allowed to buy them all.

There were other points of contention between A and his siblings, including an occasion when he had asked B and C not to tell the company’s bank they were arguing with each other. The company had been in financial difficulty and A feared that such information could affect the bank’s desire to carry on supporting the company; but B and C did so anyway.

During the ongoing row, A restricted B and C’s company email access. They had previously received copies of all company emails (including A’s) but the change meant they only had access to their own emails. A and C responded by offering a small sum to the company’s IT consultant to restore their previous access. When A found out what they had done he dismissed them as employees, alleging misconduct.

Company law states that shareholders can petition the court for an order that ‘the company’s affairs are being or have been conducted in a manner that is unfairly prejudicial to the interests of members generally or of some part of its members (including at least himself)…’. The test for unfair prejudice is objective, that is, whether a reasonable person would consider the conduct of the company’s affairs to have unfairly prejudiced the petitioner’s interests

If a petition is successful, the court can grant any remedy it deems fair. For example, a common remedy is for the court to order those remaining in the company to buy out the aggrieved shareholders’ shares at a fair price.

B and C claimed that A’s behaviour in relation to the acquisition of the assets by the company A had set up was a breach of his company law directors duties and was unfairly prejudicial to their interests. They also said that their exclusion from information about the company and their subsequent dismissal had been unjustified and was also unfairly prejudicial. They asked the court to order that A buy out their shares, with no discount for the fact they each had only a minority shareholding.

The court ruled that by proposing the lease of assets to the existing company, A had put himself into a situation where his interests conflicted with those of the company (known in law a ‘situational conflict’). Directors have a duty under company law to avoid situational conflicts unless a particular conflict is authorised by the articles or, sometimes, by the board. This conflict had not been authorised, so A was in breach of that duty. A’s behaviour in proposing the arrangement therefore amounted to unfair prejudice.

It rejected A’s argument that he had honestly believed that the transaction was in the best interests of the company. This was irrelevant: he had still breached his duty to avoid situational conflicts.

However, the court also found that B and C had learned of the arrangement shortly after it had been agreed, but they had failed to act. This amounted to consent to the breach (acquiescence in it) and it was therefore too late for them to claim unfair prejudice now. The unfair prejudice claim was therefore rejected.

The court also found that D had also indirectly acquiesced in the breach by leaving it to her siblings to run the company, even though she did not know about it specifically.

On the issue of email access, the court ruled that restricting B and C’s company email access did not amount to unfair prejudice. A director’s entitlement to full information about their company’s affairs did not mean they had a right to see every email or document created in the course of the company’s business. A managing director, for example, may need to handle some issues in confidence, and not every director is entitled to know about them.

Nor was A’s dismissal of B and C as employees unfairly prejudicial because their attempted bribery of the company IT consultant had been ‘manifestly improper’ and amounted to a sufficient reason to dismiss them.

Operative date

  • Now

Recommendations

  • Directors should be aware of their duty to avoid situational conflicts unless authorised, the potential for breaches of that duty to amount to unfairly prejudicial conduct by the company towards shareholders, and that any belief that an arrangement benefits the company is irrelevant.
  • Directors should also be aware that they are not necessarily entitled to see every email, document or other information about the company’s operations.
  • Shareholders claiming unfair prejudice must act quickly to bring a claim, or risk being treated as having acquiesced in it.

Case ref: Waldron & Ors v Waldron & Anor [2019] EWHC 115

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.

Copyright © Atom Content Marketing