S14 Companies Act 1985 (s33 Companies Act 2006)

When disagreements occur in a company, which cannot be resolved amicably, shareholders will usually look to the constitutional documents of the company for a remedy [6]. Minority shareholders can enforce the terms of the articles as part of the contract of association based on s 14(1) of the Companies Act 1985, now s33 Companies Act 2006 [7]. It provides that the memorandum and articles, when registered, bind the company’s members to the same extend as if they had each signed and sealed them and they contained a covenant by him or her to observe all provisions contained therein. The section creates a contract which forms the basis of legal relations, between the company and it's members, and between the members inter se [8]. Any breach is therefore in principle actionable. The normal contractual remedy of damages for breach of contract is available and injunctions may be obtained [9]. A member does not have a personal right to enforce all the provisions of the articles, for example, where there are breaches of the articles which are ratifiable he has no such right [10]. Ultimately what constitutes a personal right must depend upon the terms of the articles and the event giving rise to the alleged breach [11]. For the right to be personal, the court must be satisfied that, properly construed, the right has accrued to the member individually and not simply to him in common with other shareholders. Funding is often a consideration for shareholders bringing a claim. Where capital payments or unpaid dividends are sought using the statutory contract of membership to bring a ‘direct claim’ is an attractive option, because conditional fee agreements are available. Claims in damages for breach of contract would likewise render such claims amenable. When the remedy sought is an injunction or a declaration on the other hand, conditional fee agreements are not available, which serves to make this option perhaps less attractive to shareholders [12].

The Derivative Action

A derivative action is concerned with recovering damages, property or funds which belongs to the company, for wrongs done to it [13]. Under the rule in Foss v Harbottle, the company was the proper claimant for any wrongs done to it, and companies were not required to act at the request of their shareholders, even to pursue the company's rights in relation to an alleged wrong [14]. “What [a shareholder] cannot do is to recover damages merely because the company in which he is interested has suffered damage, Prudential Assurance v Newman [15]. The first of two principles in the Foss v Harbottle rule is that, where a wrong has been done to a company, only the company, not the individual member can take action, this is referred to as the ‘proper plaintiff’ principle [17]. Allowing a third party to bring an action in relation to wrongs done to another, could lead to multiple actions being brought against a single defendant, in relation to a single wrong, and a defendant could face as many actions as there are shareholders[18]. The second principle is that the will of the majority of the members of the company should in general prevail in the running of its business. This is known as the “majority rule” principle. The existence of the rule is justified by the need both to prevent double recovery and to provide protection for the company's creditors, who might be prejudiced if the shareholder's claim were to succeed, Johnson v Gore Wood [19]. This meant, that in order to bring a derivative claim, a shareholder had to fit his case into one of the exceptions to the rule in Foss v Harbottle namely: 1) that the company was controlled by the wrongdoers causing fraud on a minority; or 2) that the actions of the majority were ultra vires; or 3) that the personal rights of the members had been infringed and that the breach could not be rectified by a simple majority vote. An example of types of cases, within the boundary of the exceptions to the rule, are cases involving fraud on the minority, as in Cook v Deeks [20], [21].

Historically minority shareholders faced hurdles establishing their case, when relying on the ‘fraud on the minority exception,’having had to show not only serious non-ratifiable breach of directors’ duties, but also that wrongdoers still legally controlled the company. In a small private company, this may not cause any difficulty in practice, but in a public listed company, with a large share capital and numerous shareholders, where shares are held by nominees and trustees, it is very difficult for an individual shareholder to show who controls the shares [22]. Another major problem with a derivative action under the old law, was that the ratification of the conduct of the directors, by the majority of the members, was a bar to bringing a derivative action, thus circumstances in which a shareholder could bring an action, to enforce a cause of action, vested in the company, were often limited.

The rule in Foss v Harbottle was criticised by both the Cohen and Jenkins Committees [23],[24]. Later the extensive inquiry by the English Law Commission, resulted in recommendations to abolish the rule in Foss v Harbottle, and its exceptions, at least in part, and to replace the existing derivative procedure with a new form of derivative action [25],[26]. From the Law Commission’s report it is evident, that it was conscious of the need to achieve a balance between the ability of the company to function effectively on a day to day basis, without the unnecessary interference of challenges from shareholders, and the need to protect minority shareholders and enhance shareholder confidence, by providing shareholders with a route for redress in certain circumstances.

The new rules are found in sections 260 to 264 of the 2006 Act. Claims can be made in respect of acts or omissions, negligence, default or breach of duty by a director or a third party. They may be brought by any member regardless of membership status at the time of the alleged breach. Indeed, claims can be brought by a person in respect of breaches alleged to have occurred before shares were purchased [27]. The act provides notable changes in that in ratification under s239, no vote by either the director or member, whose conduct amounts to negligence, default, breach of duty or trust, or any member connected with him, will count. Where the wrongdoing has been authorised or ratified, the court can disregard it if it has been authorised or ratified by way of the votes of the accused directors. However minority shareholders have not been given a carte blance to sue the majority, in that considering whether to give permission to bring an action, the court must take into account s263(3), in particular whether the shareholder is acting in good faith in seeking to continue the claim. It is a two stage test, requiring the shareholder to obtain the court’s permission to continue a claim. Firstly, the court must bring proceedings to an end if there is no prima facie case; and secondly the court has a discretion to refuse, or grant leave to continue a claim, taking account of specified matters such as whether directors acting in accordance with their new duty to promote the success of the company would not seek to continue the claim; or the matter complained of has been authorised in advance or has been ratified subsequently.

The new provisions appear to offer more protection for shareholders. Part 11 of the Act gives shareholders, for the first time, a statutory right to sue directors in a derivative action, [28] even if the directors concerned have not benefited from their negligence. This is a significant change from the Common Law position, Pavlides v Jensen [29]. However, concerns raised, that the changes to the derivative action regime could lead to increased tactical litigation against directors from activist shareholders, have been unfounded [30]. Thus, the act does not formulate a substantive rule to replace the rule in Foss v Harbottleas hoped by some, but rather a new procedure for bringing actions based on the existing rules, according to the Attorney-General, Lord Goldsmith. He said, it is a fail-safe mechanism, rather than a weapon of first resort, and was at pains to make it clear that it is not expected there will be a significant increase in the number of derivative claims. Courts will continue to retain a wide discretion over whether a derivative claim may proceed. It is important to remember that damages are paid, not to individual shareholders, but to the company itself, and yet it is the shareholder, who brings the action, who may be required to bear heavy legal costs [31], thus the practicalities of financing shareholder litigation will remain a major obstacle to minority shareholders wishing to bring claims [32]. A dozen years ago, Professor Sealy predicted that, even if Parliament provided a statutory remedy, the courts would reinvent just as effective way of saying ‘go away’ [33],[34]. In view of the Companies Act 2006 Act, and recent case law, this seems a remarkably accurate prediction. There is nothing in the new procedure that will convince a rational shareholder he should be better off litigating the case on behalf of the company, rather than selling his shares. Regrettably, the common law position on costs of derivative claims has not changed significantly either, and costs and fees rules need to be re-evaluated if any real change is to occur [35]. The availability of alternative remedies for an aggrieved shareholder is an important factor in determining whether the court will grant permission to continue a derivative action. The court will look at the bigger picture of what is best for the company, as well as what is best for the member. In cases where a company is controlled by wrongdoing directors, who are also major shareholders, it is likely that an action under S.994 will be more appropriate. This means it may only be in limited cases that the new derivative action will be a useful tool for activist shareholders, who want to apply pressure on directors. They will instead be directed towards an action under s994. This means, that any legal action will have to be personally financed by the member, and the most likely remedy will be a buyout of shares at a fair value, which in the case of a very small minority shareholding may not be worth pursuing [37]. Nevertheless, s459 plays an important role in balancing the rights of the minority shareholder against those of the majority. Without it, minority shareholders would find their investments protected only by the magnanimity of the majority [38].

Unfair prejudice

While derivative actions are still proving difficult under the 2006 Act, claims by minority shareholders for unfair prejudice have been unaffected by the 2006 Act. Sections 994-996 largely replicate the provisions in the 1986 Act and provide as follows: "A member of a company may apply to the court by petition for an order under this Part on the ground 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).." [39]. Both petitioner and respondent will be shareholders, and typical grounds for unfair prejudice will include breach of a legal bargain between the shareholders (such as a shareholders agreement or the company's articles of association), breach of fiduciary duty (by a director who is also a shareholder) and breach of an equitable agreement or understanding, exclusion of a minority shareholder from management and a misappropriation or diversion of corporate assets. Other typical allegations include failure to provide information, improper increases in share capital, excessive remuneration and non-payment or payment of inadequate dividends [40],[41]. The court has a wide discretion in relation to remedies, and can make an order as it sees fit as it could under s996(1) but the usual order will be that the respondent purchases the petitioner's shares at a value that takes account of the unfair prejudice suffered. Usually a plainly reasonable offer to buy out the minority shareholder [42], at an appropriate price, will provide a defense to a claim based on alleged unfair prejudice, precisely because excluding a shareholder from the company's affairs is only unfair if it is exclusion without a reasonable offer, O'Neill v Phillips [43],[44]. Until 1947 the only protection that shareholders in the United Kingdom had, against oppressive behaviour by those in control of the company, was the remedy of just and equitable winding up. ‘The remedy under section 122(1)(g) of the Insolvency Act 1986 of winding up on just and equitable grounds is important to the consideration of s459, for two main reasons. Firstly, it is common for section 122(1)(g) to be pleaded in the alternative to s459. Secondly, the principles developed by the courts in construing the meaning of “just and equitable” in this context have, to a certain extent, been imported into their consideration of the requirements of s459’ [45]. The court may make an order to wind up a company under section 122(1)(g) of the Insolvency Act 1986 if it “...is of the opinion that it is just and equitable that the company should be wound up”. Strong grounds need to be shown before the court will make a winding up order at the instance of a minority shareholder, Ebrahimi v Westbourne Galleries [46]. It is worth noting that, section 125[2] of the Insolvency Act stipulates that the dissolution curative will not be available if there is an availability of another remedy other than the remedy of dissolution. On recommendation of ‘the Cohen Committee’ in it’s report from 1945 s9 of the Companies Act 1948 was introduced offering relief to minority shareholder under the presence of oppression [47], [48]. In 1962 ‘the Jenkins Committee’ recommended a widening of the provision to include complaints of unfair prejudicial conduct [49], this was subsequently to become ss.459- 461 of the Companies Act 1985[50], today the 994-996 Companies Act 2006. It provides that if the court is satisfied that a petition is well founded, it may make such order as it thinks fit for giving relief in respect of the matters complained of. The court may make all or any of a number of orders specified in subsection 2, including orders regulation the future conduct of the company’s affairs, requiring the company to do or refrain from doing some act and an order providing for the purchase of petitioner’s shares by other members of the company or the company itself. The aim of the Jenkins Committee was to afford more effective protection to minority shareholders and they were anxious that the section extended to cases “... in which the acts complained of fall short of actual illegality“. In Saul D Harrison [51], the Court of Appeal laid down guidelines as to when conduct will be “unfairly prejudicial”. In that case, Hoffmann LJ accepted that the test of unfairness was objective, but he considered that rather than referring to a “reasonable bystander” it was more useful “... to examine the factors which the law actually takes into account in setting the standard” [52]. Hoffmann LJ also held that conduct could be unlawful but, nevertheless, might not be unfairly prejudicial, so it followed that “...trivial or technical infringements of the articles were not intended to give rise to petitions under section 459” [53]. However, as opposed to New Zealand, Australia and Canada where different criteria for determining unfair prejudice are provided, in UK provisions a definite definition of Unfair Prejudice has not been given by the courts [54]. The Company Law Review decided that it would not update the unfair prejudice provisions for the Companies Act 2006. It had examined various proposals that the Law Commission had made, but was unenthusiastic. Examples of unfair prejudice are, failure to provide information regarding the operation of the company, improper manipulation of shareholding, breaches of director’s duties, excessive remuneration Re a Company, Alteration of articles of association Allen v Gold Reefs of West Africa Ltd [55]. Non-payment of dividends and mismanagement Re Elgindata Ltd [56], not to mention perhaps the most common allegations in petitions under section 459; that the petitioner has been excluded from the management of the company, but lack the exit strategy in the form of a market for their shares [57], Saul D Harrison. Even where continued involvement in the management of the company may be regarded as part of the petitioner’s legitimate expectations, his exclusion will not necessarily be unfair. The court will look at the conduct leading up to the exclusion to see if it was justified and, more importantly, at the terms on which the exclusion was effected to see if they were fair [58]. Exclusion will often constitute unfair prejudice where it breaches the company constitution or where it breaches a common understanding between members that has led to a legitimate expectation of participation. In O’Neill v Phillips however [59], the House of Lords stated that the minority has no legitimate expectation of a harmonious relationship [60] and that the majority in such a situation is under no obligation to make a fair offer for the shares held by a minority wishing to leave the company [61]. Another obstacle to the disgruntled minority shareholder seeking a remedy under 459 is the question of expense. While the application of s994-996 certainly suffers from certain problems, O’Neill v Phillips provided clarification as to the correct interpretation of unfair prejudice. It did however fail to provide a solution to the labyrinthine nature of s994-996 litigation, with its incumbent costs and expenditure of court time. The Law Commission in its report concluded that the proceedings were not only time consuming but also complex and costly. For instance, in Re Elgindata Ltd [62], the court hearings prolonged for 43 days and it resulted in an expense of £320,000. Further, in Re Macro [Ipswich] Ltd [63] case, the litigation lasted for 27 days and finally the parties to the disputes claimed that they were eligible to recoup the cost of £725,000. In an effort to minimize costs of prolonged litigation and of highly realistic litigation on unfairly prejudicial conduct, the U.K Law Commission advocated, for the Companies Act 2006, the employment of rebuttable assumption that a shareholder who has been prevented from management be regarded as a casualty of unfairly detrimental conduct to apply if the petitioner held at least 10% of the voting rights of the company and had been bumped off from the directorship or has otherwise been thwarted from carrying out the directorial responsibilities [64]. This was rejected by the Company Law Review. The court has no jurisdiction in proceedings under s459, unlike derivative actions, to grant the petitioner an advance order requiring the company to indemnify him as to costs. Petitioners under s459, in contrast to shareholders who bring a derivative action, are, however, eligible for legal aid [65].

[1] How should U.K. and U.S. minority shareholder remedies for unfairly prejudicial or oppressive conduct be reformed? By Miller, Sandra, American Business Law Journal, , p. 1.

[2] Derivatives Claims inder the Companies Act 2006; Much Ado about nothing? Arad Reisberg

[3] Ibid p 2

[4] now enacted in the Companies Act 2006

[5] New rules but Little Action, John Sykes, Partner and Lynne Gregory, Associate, Charles Russell, 18 May 2009, p. 1

[6] Kemp Little LLP, Andy Moseby, I’m a Minority Shareholder get me out of here

November 2003, p.1

[7] minority shareholder’s Remedies, A.J. Boyle, p.13

[8] Ibid, p.15

[9] Ibid p 54

[10] Ibid, p.13

[11] The Law Commission, Shareholder Remedies p. 20

[12] minority shareholder’s Remedies, A.J. Boyle, p. 59

[13] minority shareholder’s Remedies, A.J. Boyle, p.7

[14] New rules but Little Action, John Sykes, Partner and Lynne Gregory, Associate, Charles Russell, 18 May 2009, p. 1

[15] [1982] 1 Ch 204 at 210. [1916] 1 AC 554

[16] 1843 2 Hare 996; ER 189

[17] (no 2) 1882 Ch 204,210

[18] The Law Commission, Shareholder Remedies p. 31

[19] [2002] 2 AC

[20][1916] 1 AC 554

[21] The Law Commisssion, Shareholder Remedies p. 31, 32

[22] Ibid p.32

[23] minority shareholder’s Remedies, A.J. Boyle, p.11

[24]. minority shareholder’s Remedies, A.J. Boyle, p.11

[25] procedure‘with more modern, flexible, and accessible criteria for determining whether a shareholder can pursue the action

[26] The Law Commission, Shareholder Remedies p.5

[27] New rules but Little Action, John Sykes, Partner and Lynne Gregory, Associate, Charles Russell, 18 May 2009, p. 1

[28] on behalf of the company for negligence, default and breach of duty or breach of trust.

[29] [1956] 1 Ch 565).

[30] There have been very few reported cases of a derivative claim having been brought under the 2006 Act. In one of the first reported decisions, Franbar Holdings Ltd v Patel and ors (2008), the High Court refused an application under section 261 of the 2006 Act for permission to continuea derivative claim. The principal reason for the court’s decision appears to have been the availability of a remedy under S.994 of the Companies Act 2006

[31] Derivatives Claims under the Companies Act 2006; Much Ado about nothing? Arad Reisberg p.14

[32] minority shareholder’s Remedies , A.J. Boyle, p. 10

[34] minority shareholder’s Remedies , A.J. Boyle, p. 10

[35] Andy Moseby, I’m a Minority Shareholder get me out of here p.1

[36] Derivative Actions, Published by The Information Network For Legal Professionals, Written by Ed Weeks, p.1

[37/38/39] How should U.K. and U.S. minority shareholder remedies for unfairly prejudicial or oppressive conduct be reformed? By Miller, Sandra, American Business Law Journal, p. 10.

[40] A number of allegations concern conduct which, prior to the introduction of the oppression remedy, might have been the subject of a derivative action or a personal action under section 14 of the Companies Act 1985

[41] The Law Commission, Shareholder Remedies p.62

[42] [1999] UKHL

[43] Keemp LLP, Andy Moseby, I’m a Minority Shareholder get me out of here, p1

November 2003 p.3

[44] [1999] UKHL

[45] The Law Commission, Shareholder Remedies p.73

[46] Ltd [1973] AC 360

[47] A criticism of the contractual approach to unfair prejudice, Paul Paterson, The Company Lawyer Vol. 27 No 7 p. 204

[48] Ibid p. 204

[49] Ibid p. 204

[50] The Law Commission, Shareholder Remedies p.62

[51] [1995] 1 BCLC 14.

[52]Ibid p.85

[53] Ibid p.85

[54] A criticism of the contractual approach to unfair prejudice, Paul Paterson, The Company Lawyer Vol. 27 No 7 p. 205

[55] [1900] 1 Ch 656

Shareholder Remedies p.92-93

[56] The Law Commission, Shareholder Remedies p.94

[57]A criticism of the contractual approach to unfair prejudice, Paul Paterson, The Company Lawyer Vol. 27 No 7 p.206

[58] Law Commission, Shareholder Remedies p.89-90

[59] A criticism of the contractual approach to unfair prejudice, Paul Paterson, The Company Lawyer Vol. 27 No 7 p. 206

[60] Ibid p. 209

[61] Ibid p 212

[62] Re Elgindata Ltd [1991] BCLC 959

[63] [1994] 2 BCLC 354.

[64] How should U.K. and U.S. minority shareholder remedies for unfairly prejudicial or oppressive conduct be reformed? By Miller, Sandra, American Business Law Journal, Tuesday, June 22 1999, p. 1.

[65] The Law Commission Report, Shareholder remedies p. 120