What protection do I have as a shareholder?
All shareholders in UK companies have certain rights in relation to their shares and in relation to the company. Whilst the precise rights that a shareholder enjoys will vary depending on the size of their shareholding (the larger the shareholding, the greater the number or rights enjoyed by the shareholder), certain basic rights and protections apply regardless of the number of shares held.
Some of those rights are straightforward – including the right to inspect certain information relating to the company, and to receive notice of (and vote at) shareholder meetings. But what can a shareholder do if his or her interests are being damaged by the way the company is being run?
One of the most important rights which all shareholders enjoy, and also one of the most complex, is the right to apply to the court for protection against unfairly prejudicial behaviour – commonly referred to as an unfair prejudice petition.
Disputes between shareholders are common (particularly so where the directors and shareholders in the company are the same people, as with many SMEs) and it is important to be able to recognise circumstances where the behaviour of the directors or your fellow shareholders might entitle you to seek a remedy from the court.
What is unfair prejudice?
Section 994 of the Companies Act 2006 (‘the Act’) provides that a member (shareholder) of a company may apply to the Court for a remedy:
“… on the ground (a) that the company’s affairs are being or have been conducted in a manner that is unfairly prejudicial to the interests of the members generally or some part of its members (including at least himself), or (b) that an actual or proposed act or omission of the company… is or would be so prejudicial.”
In essence there are two considerations as to whether behaviour is unfairly prejudicial:
- The conduct must be prejudicial – i.e. it must cause prejudice or harm to the interest of the shareholder(s) such that they are in some way worse-off; and
- The conduct must be unfair.
Prejudice can be shown if the shareholder can demonstrate that the economic value of his or her shares has significantly decreased, or is put at risk by the conduct they are complaining about. However, prejudice need not necessarily be economic in nature and might include, for example, the exclusion of a shareholder from participating in the management of the company where the shareholder had a legitimate expectation to be involved (such as in a ‘quasi-partnership’).
Conduct will not necessarily be prejudicial simply because it concerns a breach of some obligation – some examples are given below but a complaining shareholder will not be entitled to relief if they cannot show that they are worse off as a result of the conduct complained of – trivial technical breaches of the company’s rules will not generally give rise to a valid complaint.
The test for unfairness is objective – would a reasonable bystander believe the conduct complained of to be unfair? It is not necessary to show any bad faith on the part of the ‘offending’ party, or to show any intention to cause prejudice.
Much will depend on the basis upon which the complaining shareholder agreed to become a member in the company (including the company’s Articles, and the terms of any shareholder agreements or similar). Whilst trivial technical breaches of the company’s Articles will generally not be actionable, conduct is more likely to be viewed as unfair if it is contrary to the terms of the commercial relationship between the company, its directors and its shareholders
Unfairly prejudicial conduct – examples
There is no definitive list when it comes to unfairly prejudicial conduct but examples of some of the most commonly-encountered complaints are set out below.
Breach of fiduciary duty
Breach of fiduciary duty by a director is not, in and of itself, unfairly prejudicial – but if real prejudice has been suffered as a result then this can give rise to some of the most obvious examples of unfairly prejudicial behaviour, such as:
- Misappropriation of company assets
- Procuring an allotment of shares to dilute a minority shareholding
- Damaging the relationship of mutual trust and confidence
Diluting minority shareholdings
This is frequently seen by businesses as an option for overcoming objections from a minority shareholder, but allotting further shares in the company for the purpose of improperly diluting the shareholding of a minority shareholder is an obvious example of unfair prejudice.
Failure to declare dividends
Lack of dividends is not, of itself, unfair prejudice since the decision as to whether or not dividends can or should be declared is a commercial one – often a company simply cannot afford to pay them.
The courts will not lightly interfere with commercial decisions of that nature, however unfair prejudice may occur where (for example):
- The shareholder has received less in dividends than was agreed as part of his or her decision to become a shareholder
- The directors have neglected their obligation to pay dividends, or have refused to do so for an improper purpose
- The company cannot afford to pay dividends because the directors have drawn excessive remuneration (see below)
Payment of excessive remuneration
Again, remuneration is a commercial matter and it is not generally something with which the courts will interfere, though there are exceptions:
- Where the drawing of remuneration constitutes a breach of an agreement or understanding that the directors will not be remunerated
- Where remuneration is excessive by reference to the true value of services provided, and/or is instead in reality a disguised dividend payment
- Even where remuneration is a reward for service, unfair prejudice may arise if that remuneration is objectively excessive, whether by reference to comparators or because of the financial condition of the company (and approving remuneration in those circumstances may well be a breach of fiduciary duty by the directors)
- Where remuneration has not been approved by the board, the shareholders or according to the Articles. Here the court will look at whether the remuneration is appropriate, considering the responsibility and duties of the director.
Breach of the Articles or any shareholders’ agreement
Generally this will mean a breach of the terms on which the shareholder subscribed for his or her shares and may result in unfair prejudice occurring (though, again, trivial or technical breaches where no real prejudice is caused will not justify a petition).
This might also include breaches of the Companies Act 2006 – examples may include:
- Failure to hold annual general meetings
- Failure to provide accounts
- Failing to disclose interests in transactions with the company
- Registering new members in breach of restrictions within the Articles
‘Deadlock’ refers to a situation in which the company is effectively unable to make decisions, due to no conflicting party having the requisite majority at board and/or shareholder level to enable decisions to be passed.
Often this occurs due to a breakdown in relationships which has not been caused by any unfair prejudice – whilst this will generally mean that an unfair prejudice petition cannot be justified, it may be that in the circumstances it would be ‘just and equitable’ for the company to be wound up, and an application could be made to the court for that purpose.
Who can present a petition?
An unfair prejudice petition may be presented by:
- Members (shareholders whose names are registered on the register of members) of a company
- Non-members to whom shares have been transferred
- Non-members to whom shares have been transmitted (such as the trustee in bankruptcy of a bankrupt member, or the personal representative of a deceased member)
This means that where a shareholder has purported to transfer his or her shares, but the company refuses to register the recipient as a member, both the transferor and transferee would be entitled to present a petition in relevant circumstances.
The respondents to a petition will be the shareholders or directors who are alleged to have engaged in unfairly prejudicial conduct, as well as all members of the company whose interests have been affected or who would be affected by a court order. Generally, the company itself is also a respondent.
What are the remedies?
Section 996 of the Act sets out certain types of orders which the court may make if unfair prejudice is established, though the court has a general and wide discretion to make any order it thinks fit. For instance the court can:
- Regulate the conduct of the company’s affairs in the future
- Require the company to refrain from an act, or to carry out an act it has failed to do
- Authorise civil proceedings to be brought in the name and on behalf of the company
- Require the company not to amend its Articles without the court’s permission
- Provide for the purchase of the shares of any member(s), either by other members or by the company itself
In practice, and often because the circumstances giving rise to a petition mean that the parties cannot realistically continue in business with one another, the most common order made by the court on a successful unfair prejudice petition is that the member(s) guilty of the unfair prejudicial conduct must purchase the minority shareholding of the aggrieved member.
In certain (albeit rare) circumstances an order may be made for the majority member(s) to sell their shares to the minority – for example where the conduct of the majority demonstrates that they are unfit to be involved in running the company.
Where the parties have the same or similar shareholdings and cannot agree who should buy the other out, the court will determine the appropriate order based on the specific circumstances of the matter.
Where a purchase order is made, the court will order that the shares be purchased for ‘fair value’. This will usually require expert evidence being produced by both sides.
Valuation can be highly complicated and various factors will be taken into account by the court, but in broad terms the effect of the unfairly prejudicial conduct on the value of the petitioner’s shares (i.e. the reduction in their value caused by the conduct complained of) will be disregarded.
Fair offer to purchase
Where a petition is presented and the likely outcome, if successful, is a purchase order being made by the court, a respondent ought to give early and serious thought to making a fair offer to purchase the petitioner’s shares, on the basis that this is equivalent to the relief that would be granted by the court.
Where a fair offer to purchase has been made but ignored or rejected by the petitioner, the court may view the continuation of the petition as an abuse of process and it may be struck out. An early and properly-calculated offer of purchase would also have the effect of limiting any potential adverse costs liability for a respondent – a particularly important consideration given that, due to their nature and complexity, unfair prejudice proceedings are notoriously expensive.
Disputes between shareholders, and unfair prejudice in particular, are highly complex areas of law and this note is only a broad overview of some of the most important principles and considerations. The nature of disputes between shareholders is that proceedings can quickly become complicated by large numbers of allegations and cross-allegations – taken together with the frequent need for independent expert evidence, the costs of dealing with disputes can escalate sharply and it is important to seek specialist advice at the earliest possible stage.
We have substantial experience of dealing with all manner of shareholder disputes, including unfair prejudice on behalf of both petitioners and respondents – if you have any queries or concerns, require advice or would like to discuss any of these issues, we will be pleased to assist.