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Case law: Unfairly prejudicial conduct at subsidiary level can result in successful claim by shareholder of parent company

Shareholders/directors in group situations should note that unfairly prejudicial conduct in relation to the affairs of a subsidiary company in a group may also amount to unfairly prejudicial conduct of the parent company’s affairs; and the subsidiary and parent may also be part of a quasi-partnership - widening the scope for an unfair prejudice claim.

November 2019

This update was published in Legal Alert - November 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.

Three individuals set up in business together in 2007 through a limited company. In 2010 they signed a shareholders’ agreement and adopted a new constitution which said:

  • Certain decisions - ‘reserved matters’ - required the consent of all three of them, including paying bonuses, taking on senior managers and entering into compromise agreements with departing employees.
  • They would not disclose any of the company’s confidential information.
  • If any of them materially breached the agreement, the others could expropriate the offender’s shares (force the offender to transfer them to the other shareholders) for £1.

The agreement also expressly required the parties to ‘act in good faith’ and ‘give effect to the spirit and intention’ of their agreement.

The business evolved into a group of companies, comprising a parent company, holding shares in two subsidiaries (one of which was the original company set up in 2007). The three founders became the shareholders and directors of the new parent company and signed a new shareholders’ agreement (the ‘new agreement’) containing most of the clauses in the earlier agreement, except that it covered the whole group of three companies. The parent company was also made a party to it.

One of the founders (A) then fell out with the other two (B and C). Sporadic discussions about B and C buying A out so he could leave came to nothing; things got worse; and A became less active in the business. Eventually, after a disciplinary meeting to discuss ‘trust and confidence’ and whether, given his reduced contribution, he should give up his role, he was dismissed from his job with immediate effect. The group’s bank was told not to deal with him.

Dismissal as an employee is different from being removed as a director, which meant that A remained on the board.

Before the next board meeting, B emailed the group’s latest management accounts to A which showed significant reductions in profits and net assets. A emailed B, C and the group’s bank to say how concerned he was – and the bank then suspended the group’s banking facilities. B and C hastened to formally remove A from the bank mandate and required him to go through them if he wanted any information about any of the companies in the group.

Under company law, an aggrieved company shareholder 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 thinks is fair. For example, it can order those remaining in the company to buy out the aggrieved shareholder’s shares at a fair price (this is such a common remedy that the courts are reluctant to let a shareholder persist with an unfair prejudice claim if an offer to do this has been made).

A claimed unfair prejudice. One of the grounds was he had been unfairly prejudiced because B and C had breached the obligations of good faith in the new agreement, and the prohibition against carrying out reserved matters without his consent.

However, A faced a hurdle in that an unfair prejudice claim could only be brought in relation to conduct of the company of which he was a shareholder – the parent company. Yet it was the conduct of B and C at subsidiary level that he was complaining about. He therefore had to show that B and C’s behaviour amounted to conduct of the parent’s affairs, as well as the subsidiary’s, before he could bring an unfair prejudice claim.

He approached this by arguing that the circumstances following the re-organisation of the business into a group of companies were:

  • The new parent was a party to the new agreement.
  • The new agreement governed the affairs of both the parent and its subsidiaries, including the original company. It included the good faith clauses and the clauses relating to reserved matters in the original agreement.
  • The parent controlled the affairs of the subsidiary, conducting them on a group basis.

Therefore, the conduct of the affairs of the subsidiary also amounted to conduct of the affairs of the parent. So A could bring an unfair prejudice claim as a shareholder of the parent, in relation to decisions amounting to conduct of the affairs of the subsidiary - because these also amounted to conduct of the parent’s affairs.

He was therefore able to argue that B and C had breached the new agreement by failing to act in good faith and by undertaking reserved matters without his consent; and these amounted to unfairly prejudicial conduct of the affairs of the subsidiary and the parent company of which he was a shareholder.

A shareholder can also claim unfair prejudice if there are equitable considerations which warrant it (even if there has been no breach of a company’s articles, shareholders’ agreement, etc and the conduct complained of is within the powers of the board). In such a case, a court may find there are additional obligations on parties not set out in the formal documents.

For example, where a company is a ‘quasi-partnership’, regard can also be had to each shareholder’s legitimate expectations of their relationship.

Here, A claimed both the parent and the subsidiary were part of a quasi-partnership, and his legitimate expectations had not been met. His argument was that the original company (now the subsidiary in question) had originally been set up as a quasi-partnership and the circumstances of the reorganisation meant the parent company had also become part of that quasi-partnership.

He claimed that his expectations had not been met because B and C had:

  • excluded him from management of the affairs of the relevant subsidiary by keeping information from him and removing him from the bank mandate;
  • sacked him as an employee of the subsidiary to advance their personal interests;
  • taken several actions as directors of the subsidiary, which amounted to reserved matters, without A’s consent;
  • had done the above without offering to buy him out at a price set by an independent valuer.

He was therefore able to argue that his legitimate expectations – particularly, that he would be included in management decisions within the group, and whether or not he was an employee of any of the three companies, had not been met.

He asked the court to find there had been unfair prejudice and order that B and C buy his shares in the parent at a fair price.

B and C countered by saying he had materially breached the shareholders’ agreement by giving confidential information to the group’s bank, and he therefore had to transfer his shares to them for £1.

The court ruled that the actions of the subsidiary could also be treated as conduct of the parent’s affairs, and there had been unfair prejudice for the reasons A had given. The court also noted that the decision to dismiss A had secretly been made before the disciplinary proceedings started. B and C had ignored his arguments and not even considered alternatives to dismissal.

While it found A had materially breached the shareholders’ agreement when it sent the confidential management accounts to the bank, the court refused to order A to transfer his shares to B and C for £1. They had not acted in good faith and had unfairly withheld information from him. Instead, it ordered them to buy his shares at a price to be later determined.

Directors of companies at any level in a group should beware keeping information from other directors; going through the motions of a disciplinary procedure with a particular outcome already in mind; and acting improperly to avoid any risk of a dispute and an unfair prejudice claim.

Operative date

  • Now

Recommendation

  • Shareholders/directors in group company situations should note that unfairly prejudicial conduct in relation to the affairs of a subsidiary company in a group may also amount to unfairly prejudicial conduct of the parent company’s affairs; and the subsidiary and parent may both be part of a quasi-partnership, entitling a shareholder of the parent to bring an unfair prejudice claim based on actions and decisions at subsidiary level.

Case ref: Brown v Bray & Anor [2019] EWHC 2304

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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