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Company Law: Where a Party is Excluded from Management by the Majority

Friday, 18 May 2012

The legal remedy of unfair prejudice seeks to protect the rights of minority shareholders from detrimental actions by majority shareholders. Provisions contained in s994 Companies Act 2006 enable aggrieved shareholders to bring an action against the company.

There is an enormous body of case law that has flowed from this statutory remedy with many of the cases relating to disputes in smaller non-public companies. One area of contention that has commonly founded unfair prejudice claims is the exclusion of a shareholder from company management.

Unfair Prejudice Petitions

The statutory provisions are worded somewhat openly which has given courts wide discretion for interpretation, Companies Act 2006 s994:

“Petition by a Member

  1. A member of a company may apply to the court by petition for an order under this Part on the ground-
    1. That the company’s affairs are being or have been conducted in a manner that is unfairly prejudicial to the interest of members generally or of some part of its members (including at least himself), or
    2. That an actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial.”

Initiating a Claim

The starting point for any action of unfair prejudice is to establish that the conduct complained of is contrary to what has previously been agreed by the parties. This may include a breach of fiduciary duty by the directors.

In the absence of a breach of agreement, it is necessary to show that the majority shareholders have acted in a way that is not in good faith.

Party Excluded from Management

It is worth noting from the outset that exclusion of a shareholder from management is not per se sufficient to bring an action for unfair prejudice. The early case of Ebrahimi v Westbourne Galleries Ltd [1973] established that an important question arises as to whether there is a relationship such as a ‘quasi-partnership’ that exists which implies that shareholders are entitled to participate in management.

Quasi Partnerships

A ‘quasi partnership’ arises in circumstances where the parties who formed a company intended it to operate it in a partnership-like manner whereby each would be employed within it as a director. A well known case, O’Neill v Phillips [1990], stated that quasi-partnerships entail a bargain between shareholders that they are entitled to be involved with management. Lord Hoffman stated in O’Neill that the proper test was whether equitable principles would make it unfair for them not to be involved. Many small companies are considered quasi-partnerships in this context.

There is also considerable authority for the position that joint venturers have a legitimate expectation to be involved in company management. However, it is not an automatic expectation. Joint ventures are often structured so that one party is explicitly responsible for its management while the other is excluded such that the quasi-partnership cannot exist.

Unfair Exclusion

Where a quasi-partnership or similar relationship is established and exclusion from management is apparent, a minority shareholder still cannot claim unfair prejudice unless there is an actual element of unfairness. Clearly a shareholder who left the management of a company voluntarily by their own choice is not unfairly excluded.

What constitutes ‘voluntary’ in the circumstances has been specifically considered by the courts due to the significant number of cases where the relationship between the parties has broken down without the presence of unfairness. This is a fine line that courts judge on the facts in each case.

A minority shareholder may have left management of their own accord without it being considered voluntary if the actions of the majority essentially forced them out. A common defence to this argument is that the majority were acting in the best interests of the company and making bona fide business decisions in taking those actions.

An additional issue might arise where the minority shareholder’s own behaviour led to the majority excluding him from management. There are a number of cases such as Re R A Noble & Sons (Clothing) Ltd [1983] where the majority have successfully relied on this as a defence to an unfair prejudice claim.

In general, the courts are likely to conclude that the exclusion of a minority shareholder from management of a small private company where substantially all the shareholders are directors is unfair prejudice unless there is a fair and reasonable offer to buy that minority shareholder’s shares.

Where a majority wishes to exclude a minority shareholder from management and there is a risk of it being unfairly prejudicial, it is always open to them to offer to make a fair and reasonable offer to buy the minority’s shares.

In the event a minority shareholder is successful with an unfair prejudice petition, this is the most likely remedy that the court will apply.

It is important that the rights and responsibilities of shareholders and directors are understood and properly incorporated into the business relationship at the outset. Rollingsons has lawyers who can assist you with this process; for more information please contact James Crighton via e-mail or by telephone on 0207 611 4848.