Unfair prejudice: flexible but unpredictable?

Articles
21/06/2021

The core features of successful unfair prejudice petitions are well established – in short: conduct in the management of a company’s affairs that causes unfair prejudice to the petitioner’s interests as member.  What is more difficult, because of the range of factual scenarios seen in practice and the breadth of the court’s discretion, is predicting whether those features are present in certain cases.  This round-up looks at the following themes and lessons from the following five recent unfair prejudice decisions: (1) the nature of a concession; (2) quasi-partnerships; (3) relevance  of subjective intentions and motivations; (4) unfairly prejudicial conduct (including director’s duties, conflicts and diversions, exclusion and self-exclusion); and (5) valuations.

Cases covered in this article

These cases amply demonstrate the breadth of factual situations in which unfair prejudice can arise:

  • Re Cintep Development [2020] EWHC 3210 (Ch) – a JV company established between an inventor of a recycling shower and an investment company that later sought to ‘kill off’ the enterprise;
  • Re Euro Accessories Ltd [2021] EWHC 47 (Ch) – a dispute over the approach to valuing an exiting member’s shareholding in a company manufacturing concrete-pouring accessories;
  • Re Gallium Fund Solutions Group Ltd [2021] EWHC 765 (Ch) (31 March 2021) – a shareholder taking control over an investment support services company from his co-shareholder and lifelong friend;
  • Re Mansfield Hotel Ltd [2021] EWHC 630 (Ch) – a falling out over participation and dividends between founding members of a hotel business from a Coptic congregation; and
  • Re Stratos Club Ltd [2020] EWHC 3485 (Ch) – a director asset-stripping (pun intended) a lap dancing company.

There are lessons to be learned from each, but the overall message is that unfair prejudice remains a flexible remedy offering justice in a wide range of cases but, perhaps for that very reason, can be unpredictable and requires particularly thorough consideration.

1. Concessions

The first lesson concerns a somewhat philosophical question over the difference between a concession and agreed directions.  In Gallium agreed directions had been given for a ‘valuation only’ trial but at the PTR the respondent raised that it wished to contest liability.  The petitioner argued that unfair prejudice had been conceded.  Instead ICC Judge Jones treated the point as a case management issue: the respondent was resiling from a case management agreement, not a formal concession in its pleaded case.  Directions were ultimately varied after the petitioner (commendably candidly) accepted that they could be ready for trial on liability.  In a sense, this was all a bit academic: even if unfair prejudice is admitted generally, relief cannot be determined in a vacuum.  Unless there is no material factual dispute – unlikely – findings on the underlying facts will almost always be required so that the remedy can be sculpted to remedy the unfair prejudice.

2. Quasi-partnerships

One of the themes running through the cases is quasi-partnership in the Re Westbourne Galleries Ltd [1973] AC 360 sense.  This is an increasingly common basis on which petitions are brought because it widens the lens through which the court can see unfair prejudice – frustrated equitable and personal expectations not merely strict constitutional breaches – and introduces a rebuttable presumption that the petitioner will be bought out without a minority discount[i].  This introduces difficulties: in cases not involving partnerships the expectations for the management of the company are generally set out in black and white in the company’s constitutional documents; quasi-partnership cases ask questions about the very basis upon which the members formed the company.

Quasi-partnerships arose in Stratos through a long-standing relationship between the petitioner and her husband’s old friend and business associate, the respondent; in Mansfield Hotel from the relationship “based on trust and confidence” between the founder members of the business, who “felt no need to record their business arrangements (inter se) in writing”; in Gallium where two childhood friends went into business together.  By contrast, in Cintep the quasi-partnership arose not from a personal relationship but from an implied duty of contractual good faith arising in a product development joint venture between inventor and investor, arising from the heads  of terms and a subscription agreement underlying the joint venture.  Quasi-partnership is, nevertheless, often a bit of a stretch; in Euro Accessories the claim that an employee who came to be 24.99% shareholder five years later after starting employment had become a quasi-partner was described as “most unusual given that [the petitioner] was never involved in management”.  Often the quasi-partnership plea is reverse-engineered to accommodate the respondent’s conduct.

3. Intention & Motivation

Cintep usefully illustrates the flexibility of unfair prejudice in complex contractual situations.  To summarise a complex set of facts, the two inventors had agreed heads of terms with an investment company, leading to a subscription agreement between the investor and the JV company.  The investor and majority shareholder was obliged to provide £122k initially, with a further £1m by a longstop date, and enter into a deed of adherence to the subscription agreement by way of shareholders agreement with the inventors.  The investor decided against providing the further funds.  The deed of adherence had never been signed, leaving the inventors without a direct remedy.  The only remedy lay through the company, but the minority inventors could not pursue it without the unfair prejudice jurisdiction.  The unfair prejudice alleged in Cintep was far reaching: including (avoiding too much detail) – the company’s failure to sign the deed of adherence in breach of the subscription agreement, a provocative decision by the investor to move the product prototype from Australia to the UK without consultation and contrary to a prior consensus, an attempt by the majority to ambush the minority with an ultimatum threatening the withdrawal of funding unless the company agreed an indefinite extension to the funding long stop date on the threat of withdrawing funding, the unilateral decision the investor company to withdraw funding, voting down a resolution to take legal action against the investment company for failure to provide funds.

An interesting point that arose in Cintep was motivation: how far should a court consider the reasons said to justify the majority’s conduct?  For example, the inventors built a case as to the reasons behind the unfairly prejudice conduct – desire to take control, lack of resources – which the court described as irrelevant.  Tellingly, however and though not strictly a relevant feature, the court acknowledged that “it might, tactically, assist”. It was irrelevant because unfair prejudice is judged against an objective standard (save perhaps for a carve out for the subjective element involved in deciding breach of director’s duties).  On the other side, the investor argued that it had been duped into investing in a less promising product than had been marketed, posing the question whether the alleged “false picture” presented by the inventors was “material conduct … which renders what might otherwise be unfairly prejudicial conduct … not unfair”.  Again, the court took an objective approach; regardless of the petitioners’ intention, any misunderstanding by the investor was not objectively engendered by the petitioner’s conduct.

In Stratos, on the same theme, there was an insufficient nexus between the unfair prejudice alleged by the petitioner and the petitioner’s own conduct: a wild lifestyle that put the company’s licences at risk, passing information to the respondent’s competitors after the assets had been taken from the company, pressuring potential witnesses not to participate.  The test was: “either a strong connection … or … so egregious that it needs to be weighed against the unfairly prejudicial conduct”, citing Interactive Technology Corp v. Ferster [2016] EWHC 2896 (Ch), Morgan J.

Cintep leaves open the question whether an alleged deception could ever have justified the majority’s conduct, particularly absent a plea in misrepresentation. Applying the Interactive Technology test, if the alleged Cintep deception had been sufficiently egregious, it would follow that the unfairly prejudicial conduct might have been found justifiable – presumably it would take a very strong set of facts.  A slightly more nuanced point was also well made in Stratos: on the right facts, a petitioner’s conduct which doesn’t justify the conduct might nevertheless cause a breakdown in trust and the end of a quasi-partnership, after which unfair prejudice should be measured against the written company’s constitution only, without the “overlay created by a good faith relationship”.

4. Unfairly Prejudicial Conduct & Directors

Another consistent theme is for alleged unfair prejudice to consist of breached director’s duties[ii].  These duties – specifically conflicts of interest – were at the heart of the petitioner’s case in Stratos.  The company used to own two lap dancing clubs through subsidiaries.  One was purchased from the company (for £10k as against fair value found to be £813k) by a company owned and run by the first respondent (the company’s controlling director), the other was closed and its business – assets, dancers, trade – transferred to another premises for no consideration (an undervalue, even though it avoided redundancy losses of around £55k through TUPE).  Thereafter the company was a shell.  It was found that the transfers were improperly carried through, and further that an acquisition of the new premises was an opportunity diverted away from the company, constituting failure to exercise reasonable care skill and diligence (s. 174) and transactional and non-transactional conflicts of interest (s. 175 & 177).

One lesson comes from the respondent’s argument that the company could have not have taken up the diverted opportunity.  That may have been right as a matter of reality, but Nicholas Thompson J’s approach was based on the company’s hypothetical financial position “tak[ing] the approach that most benefits the Company” and stripping out the effects of the breaches of duty and unfair prejudice.  From that hypothetical standpoint, the company in Stratos would have had ample resources to take up the opportunity.  Even if it had not, it was a commercially valuable opportunity that the director should have communicated to the company[iii].  The hypothetical standpoint similarly applies to achieving fair valuations on quantum, Gallium at para. 74.

Director’s duties were also at issue in Cintep.  In particular, the case involved so-called nominee directors.  The term is something of a misnomer – even if a joint venturer is entitled to nominate a director to the joint vehicle the nominated director still owes all the usual duties, and owes them to the company, not the nominator.  There is a potentially complex issue: most if not all director’s duties can be qualified by unanimous consent of the shareholders.  In Cintep that had not happened; in fact the court found that, in a quasi-partnership situation, the directors, in addition to their duties to the company, ought to have had in mind the best interests of their quasi-partners, not themselves.

Another key species of unfairly prejudicial conduct was exclusion from management.  On the one hand, in Gallium the argument concerned whether the petitioner had resigned as a director during an informal conversation in a pub.  The court found not.  It followed that it was unfairly prejudicial for the respondent to have subsequently notified Companies House that the petitioner was no longer director, and “gained and exercised absolute control … without reference to the [petitioner’s] rights and interest”.  On the other hand, in Mansfield Hotel the petitioner alleged exclusion unsuccessfully – it was, rather, a case of ‘self-exclusion’, as in Larvin v. Phoenix Offices Supplies [2003] B.C.C. 11, para. 57 to 80.  Likewise the majority’s decision to treat the petitioner’s drawings as loans not dividends was not unfairly prejudicial, especially since all directors’ drawings were treated the same, commercially sensible way (unlike Grace v. Biagioli [2006] 2 BCLC 70, which the court distinguished).  The matter had been consensually delegated to accountants, consistent with the informal nature of the quasi-partnership company.  The petitioner could have challenged any matter in the petition at any time, but had failed to so.  His position was tantamount to a plea to “save me from myself”.

5. Relief

The final theme in the cases, unsurprisingly, is valuation: notwithstanding the wide range of available relief, unfair prejudice petitions most commonly seek ‘buy outs’ under s. 996(2)(e) which leads to arguments as to the value of the shareholding.  Much of the argument tends to be fact specific and expert-led, giving little by way of precedent.  A key dispute over the principles tends to be whether a minority shareholding should be valued pro rata against the company’s value as a whole, or discounted as a minority shareholding.   The petitioners’ preference for a pro rata valuation met with success in Cintep, Gallium, Stratos – all quasi-partnership cases following the rebuttable presumption outlined above – without particular difficulty, although in Cintep only on an indicative basis.

In Euro Accessories the petition was really an interpretation battle dressed up as an unfair prejudice petition.  The issue was the meaning of “fair value” in amended articles giving the majority shareholder the right to purchase the minority shareholding: did it mean pro rata or discounted?  The difference in practical terms was between £545k and £245k.  Snowden J held, following the Privy Council’s reasoning in Shanda Games Ltd v. Maso Capital Investments Ltd [2020] UKPC 2, that “fair value” in an instrument permitting compulsory acquisition, unless there are contrary indications, does not entitle the transferee to demand a pro rata value.  The petitioner sought to rely, as contrary indications, on a typical background factual matrix: the nature of the company, the parties’ relations, the reasons behind their breakdown. The court refused to take these into account.  The reasoning for the refusal is an important reminder of the principles for interpreting articles: “unlike a private contract, the articles of association … have to be understood by anybody who inspects the register at Companies House”.  Background facts that the objective reader would not know, such as those the petitioner hoped to rely upon in Euro Accessories, are inadmissible.

The reality of this case seems to be tactical.  Circling back to matters mentioned above: the company was not a quasi-partnership and therefore the only hope of selling at a pro rata value was a favourable interpretation of the amended articles.  A buyer on the open market would only realistically offer a discounted price.  The petitioner therefore made no complaint about the – on the face of it unfair – amendment to the articles that led to his shareholding being expropriated.  The petition sought to preserve the certainty of a sale and take the chance of that sale being at pro rata value.  If a successful case could have been built on quasi-partnership and the complaint targeted at the amendment a more favourable outcome might have followed.

Conclusions

Flexibility is a fundamental strength of the unfair prejudice jurisdiction: applying to a vastly disparate range of circumstances for all manner of minority shareholders, as the cases discussed above demonstrate, and offering remedies in scenarios where the usual causes of action are unavailable, such as in Cintep.  This flexibility is a strength for the jurisdiction but a difficulty for legal teams assessing the strength of a petition.  The answer, as is often the case, is a thorough analysis of the key issues at as early as stage as possible.

 

Jack Dillon, June 2021.

 

Footnote references

[i] See Strahan v. Wilcock [2006] 2 BCLC 555, Arden LJ, para. 67.  The presumption is discussed at Gallium, para. 71 and Euro Accessories, para. 67.

[ii] See Re Tobian Properties [2013] BCC 98, Arden LJ, para. 22.

[iii] See e.g. Bhullar v. Bhullar [2003] BCC 711, also Davies v. Ford [2020] EWHC 686 (Ch), Adam Johnson QC in the context of an insolvent company.

Author

Jack Dillon

Call: 2012

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