Company law and insolvency

Introduction:

There had been innumerable petitions under s. 459 of the Companies Act 1985 for seeking relief by the shareholders of quasi-partnership companies where there were disputes. Lord Wilberforce had laid down the characteristics of a quasi-partnership company in his judgment in the case of Ebrahimi v Westbourne Galleries[1].  Joint venture companies present a good example of the association between persons created on mutual confidence and personal relationship which is the essence of any form of organization.

After the deliverance of the judgment in the case of Ebrahimi it had been the practice of the courts to look beyond the provisions of the memorandum and articles of association of quasi-partnership companies whenever there are petitions for relief under s 459 of the Companies Act 1985 or under s 122 (1) (g) of the Insolvency Act 1986.

There had been instances where the courts had given “redress in respect of legitimate expectations of members of a quasi-partnership which have been disregarded by other members of the company. Section 459 is now frequently invoked in a number of different situations[2] and it is possible to glean some clear principles on substantive issues from the ensuing decisions.”[3]

In order to elaborate on the comparison of the reliefs under section 459 of the Companies Ac 1985 and section 122 of the Insolvency Act 1986, it is imperative that a background of issues relative to these section need to be studied which are hereunder:

Exceptions to Majority Rule:

Generally a majority rule prevails on decisions relating to the policies of the company. If a director has committed any wrong doing then the company has the right to sue the directors on the specific authority of a majority of shareholders. The decision in the case of Foss v Harbottle[4] has given rise to two general rules:

Proper Plaintiff Rule: If there is a wrong committed by anybody against the company then the company only can be the claimant.

Indoor Management Rule: “If the act which is being claimed as wrong could be ratified by a vote in a general meeting, then the company is not allowed to sue. However, if the vote has already been carried out, responded negative, and the directors acted anyway, then court action is possible”[5]

However there are exceptions to the majority rule. Under certain circumstances the minority shareholder can sue the directors either by initiating the action through the company. Alternatively there can be an action by the shareholder himself as an individual. The exceptions are:

§  Derivative Actions: Under Derivative Actions, the shareholder derives his right to sue from the right of the company.

§  Personal Wrongs: Under the Companies Act 1985, the Memorandum and Articles of Association represent the contract between the members inter se. If by any action of one member, the right of another member is intruded the party against whom the wrong is committed can claim a legal remedy. In the case of Pender v Lushington[6] when one member refused to count the votes of another shareholder then the wronged shareholder was allowed to sue against the other and get the votes counted.

§  Unfairly Prejudicial Conduct: “Under s459 of the Companies Act 1985, any member may apply to the court for remedies on the grounds that the company’s business is being conducted in a manner which is unfairly prejudiced against the shareholders generally, or against any subsection of shareholders (provided that subsection includes themselves)[7]

The meaning and circumstances of ‘unfairly prejudicial conduct’ has been defined by various courts[8]. The different circumstances are:

Exclusions from management as has been decided in the case of Ebrahimi v. Westbourne Galleries Ltd[9] Breach of pre – emption rights by allotting shares[10] Convening a  meeting of the company in a distant future date that is unreasonable[11] Failure to pay dividends properly[12] Diverting business from the company[13] Making rights issue under certain circumstances[14] Providing mis-leading information to the shareholders[15] Proposal to sell company’s undertaking at a considerably low valuation to connected party[16] and Using the assets of the company for the benefit of the controlling shareholders’ family[17] Winding Up on Just and Equitable Grounds – Under the Insolvency Act 1986:

Section 122 (1) (g) of the Insolvency Act 1986 gives a shareholder the right to apply to the court to have a company wound up on just and equitable grounds. There are three different categories that apply under this section:

On the failure of the objects of the company: In the case of Pirie v Stewart (1904) the company was formed “to be ship owners and purchase charter and work ships”. It so happened that the only ship bought by the company sank and the court ordered for the winding up of the company on the petition of the minority shareholders.

On forming the company with intent to Fraud:  In the case of T.E. Brinsmead Ltd[18]  there was a misstatement in the statement with respect to the cost of the business of the company which was using the name of another company for raising capital. The shareholders sued the company for fraud.  The previous company got an injunction to stop the new one from using the company and finally the minority shareholders got the company wound up.

On quasi – Partnerships where there are issues related to the rights of shareholders to manage the company: Case Law on the subject is Ebrahimi v Westbourne Galleries (1973) “In 1945 W and Nazar formed a partnership (a Persian carpet business). In 1958 they formed a company – E and N were directors, each holding 500 £1 shares. G Nazar (the son of N) was later made the third director, and was give 100 shares by each of E and N.

No dividends were paid to shareholders, and all profits went to directors’ wages. In 1969, N and GN removed E as a director under s303 of the Companies Act 1985. E had 400 shares but these were worthless since they paid no dividends. E petitioned to have the company wound up so he could get his fair share. The courts agreed, citing the partnership history as being important.[19] The Law relating to the Issue:

For an easy understanding the relevant statutory provisions are stated hereunder:

Companies Act 1985:

Part XVII of the Companies Act 1985 comprising of sections 459 to 461 deal with the protection of company’s members against unfair prejudice. Section 459 (1) as amended which is relevant reads:

'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 which is unfairly prejudicial to the interests of its members generally or of some part of its members (including at least himself) or that any actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial.'

Section 461 provides that if the court is satisfied that a petition under Part XVII is well founded, it may among other things provide for the purchase of the shares of any members of the company by other members of the company.

Insolvency Act 1986:

Section 122 (1) (g) of the Insolvency Act 1986 provides that a company may be wound up by the court if:

'the court is of the opinion that it is just and equitable that the company should be wound up.'

Section 125(2) of the Insolvency Act provides that, before making a winding-up order on the 'just and equitable' ground on a petition by a contributory, the court must consider whether some other remedy is available to the petitioners. This would include a remedy under ss 459 and 461.

Case of O'Neill v Phillips[20]

“In O'Neill v Phillips the House of Lords considered the nature and extent of the jurisdiction under s 459(1). In O'Neill v Phillips the petitioner (Mr. O'Neill) sought relief under s 459(1), alternatively a winding-up order under s 122(1)(g), on the ground that his co-shareholder and co-director (Mr. Phillips) had unfairly terminated an agreement for equal profit-sharing and had repudiated an agreement for the allotment of further shares in the company.

The judge at first instance dismissed the petition, finding that Mr. Phillips had never committed himself to equal profit-sharing or to giving further shares to Mr. O'Neill. The Court of Appeal allowed Mr. O'Neill's appeal, on the footing that although there was no concluded agreement that Mr. Phillips would give Mr. O'Neill further shares, Mr. O'Neill had a 'legitimate expectation' that he would do so. The House of Lords allowed Mr. Phillips' appeal, on the footing that since Mr. Phillips had never agreed unconditionally to give Mr. O'Neill further shares he had not acted unfairly in not doing so.[21]

On the question whether Mr. Phillips had acted ‘unfairly’ under s 459, Lord Hoffmann observed that it did not matter whether Mr. Phillips had acted unfairly. This is so because even if Mr. Phillips had not acted unfairly, the trust and confidence between Mr. O’Neill and Mr. Phillips on the basis of which the company was formed had broken down. Lord Hoffmann opined that under the circumstances Mr. O’Neill cannot be made to suffer as a minority shareholder by getting himself locked in the company.

In the course of his judgment Lord Hoffmann has given a detailed explanation on what constitutes ‘unfairly judicial’ under s 459 and an extract of his speech on the judgment is reproduced below:

“In the case of s 459, the background has the following two features. First, a company is an association of persons for an economic purpose, usually entered into with legal advice and some degree of formality. The terms of the association are contained in the articles of association and sometimes in collateral agreements between the shareholders. Thus the manner in which the affairs of the company may be conducted is closely regulated by rules to which the shareholders have agreed.

Secondly, company law has developed seamlessly from the law of partnership, which was treated by equity, like the Roman societas, as a contract of good faith. One of the traditional roles of equity, as a separate jurisdiction, was to restrain the exercise of strict legal rights in certain relationships in which it considered that this would be contrary to good faith. These principles have, with appropriate modification, been carried over into company law.

The first of these two features leads to the conclusion that a member of a company will not ordinarily be entitled to complain of unfairness unless there has been some breach of the terms on which he agreed that the affairs of the company should be conducted. But the second leads to the conclusion that there will be cases in which equitable considerations make it unfair for those conducting the affairs of the company to rely upon their strict legal powers. Thus unfairness may consist in a breach of the rules or in using the rules in a manner which equity would regard as contrary to good faith.

This approach to the concept of unfairness in s 459 runs parallel to that which your Lordships' House, in [Ebrahimi v Westbourne Galleries Ltd], adopted in giving content to the concept of “just and equitable” as a ground for winding up.”[22]

Case of Ebrahimi v Westbourne Galleries Ltd[23]

In the case of Ebrahimi v Westbourne Galleries Ltd, the House of Lords considered passing off or a winding up order on ‘just and equitable’ ground under section 222 (f) of the Companies Act 1948 which section carried the statute before the introduction of section 122 of the Insolvency Act 1986. This is a case where there was an expulsion where a director claimed the right to take part in the management of the company and his expulsion from the management was not in conformity with the principles that all the directors should take part in the management on which the company was formed.

Judgment of Parker J in RE Guidezone Ltd:[24]

In the case of Guidezone Ltd Parker J mainly depended on the decisions in the case of O'Neill v Phillips[25] in the judgment delivered by Lord Hoffmann and the judgment of Lord Wilberforce in the case of Ebrahimi v Westbourne Galleries Ltd.

The O'Neill v Phillips case establishes that the test for ‘unfairness’ for the purposes of section 459 of the Companies Act depends on the whether the majority has acted or proposing to act in a contrary manner to good faith; and also that whether there was application of the just and equitable principles in the act or proposed act of the majority.

The ‘unfairness’ for the purpose of this section cannot be decided by referring to the subjective notions of fairness. In the case of quasi – partnerships it is an established principle that exclusion of the minority from the management of the company contrary to the original understanding among the parties on the basis of which the company was formed can be regarded as an act done in contrary to good faith as has been decided in the case of  Ebrahimi v Westbourne Galleries Ltd.

As per the judgment of Lord Hoffman on which Parker J relied ‘unfairness’ has the following dimensions

§ 'Unfairness' may arise from agreements or promises made, or understandings reached, during the life of the company which it would be unfair to allow the majority to ignore. Applying the traditional equity principles it is not possible to hold the majority the party to an agreement, promise or understanding that can not be enforced in law. However if the minority has acted on the reliance of such agreement, promise or understanding then the majority can be held on such premises.

§   'Unfairness' for the purposes of s 459 may arise where an event occurs which puts an end to the basis upon which the parties entered into association with each other, 'making it unfair that one shareholder should insist upon the continuance of the association'. Unfairness here arises on the insistence of the majority for the continuance of the association in the changed circumstances.

Because of the above observations and also on an analysis of the various claims made by the petitioner on the basis of the facts presented Parker J decided that there is no case for the petitioner which can be treated as having a ‘unfairly prejudicial ground’ necessitating the winding up of the company.

Argument of Mr. Acton Q.C

“The just and equitable jurisdiction to wind up quasi-partnership companies as exercised by the courts for well over a century is based upon the just and equitable principles developed in relation to the court’s just and equitable jurisdiction to dissolve partnerships. As confirmed by the House of Lords in Westbourne Galleries, this means that in relation to such companies, if the conduct of the majority has been such that, were the company a partnership, it would be dissolved by the court under its just and equitable jurisdiction, then the court will equally order a winding up under such jurisdiction.

That jurisdiction is clearly in some respects wider than the jurisdiction to grant relief in relation to unfair and prejudicial conduct under section 459 particularly as that jurisdiction has been interpreted by the House of Lords in O’Neill v Phillips….Parker J’s decision contrary to the above proposition in Re Guidezone was accordingly, with respect, wrong”.

(Steven Acton Q.C, (2001) 22 Co. Lawyer 134, 139) As per Mr. Acton once it is established that the company which is under consideration is a quasi – partnership, then there is no need to look in to the provisions of section 459 of the Companies Act to arrive at a just and equitable ground for winding  up the company. According to him the jurisdiction under s 122 supersedes the jurisdiction for granting of relief under s 459 of the Companies Act. In support of his claim he relies on the judgment in the case of Re R A Noble & Sons (Clothing) Ltd [26] in which case although the petitioner had not established that there was an unfair prejudice, still a winding up order can be passed on just and equitable ground.

Conclusion of Parker J:

Parker J found the argument of Mr. Acton inconsistent under the following grounds as he has misread the judgments of both the cases of Ebrahimi v Westbourne Galleries Ltd[27] and O'Neill v Phillips[28].

1. In the case of Ebrahimi v Westbourne Galleries Ltd there is an express warning by Lord Wilberforce that a company –  even if it is a quasi – partnership – can not be treated as if it were a partnership as laid down by Lord Hoffmann in  O'Neill v Phillips.

2. Secondly it must be noted that for arriving at the decision of passing a winding up order on the just and equitable ground and under the provisions of section 459, Lord Hoffmann drew a parallel by applying the reasoning of Lord Wilberforce in the Ebrahimi’s case.

3. As per Lord Hoffmann in O'Neill v Phillips, the winding up jurisdiction is not wider in scope than the remedies available under s.459. Passing of a winding up order on a company can be equated to the passing of a death sentence on the company. Moreover s 125 (2) of the Insolvency Act 1986 clearly identifies that the winding up order should be taken only as a last resort (as per the statutory provision stated above).

4. Parker J was of the opinion that when there was no ground which is unfair under s 459 then the company need not be wound up under s 122 applying the principles of just and equitable grounds. If such an order is passed it would be inconsistent with the judgment pronounced by Lord Hoffmann in O'Neill v Phillips

Parker J also opined that if the decision in the case of Re R A Noble & Sons (Clothing) Ltd[29] is to be taken as authority for withholding the proposition that an unfair conduct which could not be established so for the purpose of s 459 can be a case for winding up on just and equitable ground, then such authority is inconsistent with the decision in O'Neill v Phillips.

Hence Parker J concluded that” if the conduct by the majority relied on by Surendra in the instant case is not unfair for the purposes of s 459, it cannot found a case for a winding-up order on the 'just and equitable' ground.”[30]

Conclusion:

Based on the argument of Mr. Acton and the comments of Parker J in his judgment in the case of ReGuidzone Ltd the following issues emerge in respect of the remedies available to the minority shareholders.

An analysis of the legal aspects of the issue of protection of the minority interests of the company is concerned exceptions to the general rule established in the case of Foss v Harbottle had been provided. It has been established that the minority shareholder can sue under the circumstances of derivative actions, personal wrongs and against unfairly prejudicial conduct.

Several circumstance and acts have been established under the law having the characteristics of unfairly prejudicial under s 459.  Under all such circumstances cases have been decided by providing appropriate remedies to the petitioners and the courts have arrived at the decision of winding up only as a last resort. Thus s 459 is having much wider scope and has been applied invariably in large number of cases to set precedence for the ‘unfairly prejudicial ground’. Hence it can be regarded that s 459 has a much wider scope than s 122.

Although s 122 of the Insolvency Act 1986 gives the power to the courts to pass the order of winding up of the company under just and equitable grounds, s 125 provides an alternative to the ultimate decision by restricting the scope for winding up by requiring the courts to investigate in to options available for mitigating the grievance of the petitioner other than winding up. Hence the intention of the statute is not to pass the winding up the order at the first instance as being claimed by Mr. Acton.

Parker J is correct in refuting Mr. Acton’s argument that simply because it is proved that the company is quasi – partnership it automatically becomes subjected to the winding up decision which is incorrect and inconsistent with the decision given in the case o’neill.  It is also incorrect to assume that though the act committed is not ‘unfairly prejudicial’ under s 459, it can be regarded as a just and equitable ground for winding up, simply because the act was committed by the majority against the minority.

Parker J is also correct in saying that Mr. Acton’s contention that S 122 of the Insolvency Act 1986 has a wider scope than s 459 of the Companies Act 1985 is not acceptable as according to the controlling provisions of s.125 provides for the search of all other alternatives before a decision for winding up could be passed and this definitely includes consideration of s 459. On this premise s 459 has a wider scope than s 122.

Parker J is relying on the judgment of Lord Hoffmann in the O’niell case that a company can not be treated as if it were a partnership even if it is a quasi – partnership as quoted by Lord Wilberforce in Ebrahimi case. Perhaps this is the foremost decision to influence Parker J in pronouncing his judgment in the case of Guidestone Ltd.  On this basis only Parker J finds the argument of Mr. Acton inconsistent with the settled law. Though there are other factors which weighed with the judgment of Parker J the fact that the company Guidestone Ltd need not be treated as a partnership is the foundation on which Parker J has made his conclusion.

Under these circumstances the decision of Parker J that  “The jurisdiction to make a winding-up order on the just and equitable ground under s 122(1)(g) of the Insolvency Act 1986 was not wider than the jurisdiction to grant relief under s 459. Accordingly if the conduct by the majority relied on by S was not unfair for the purposes of s 459, it could not found a case for a winding-up order on the just and equitable ground” can be considered as in accordance with law and natural justice.

Hence in view of the foregoing it can be concluded that Mr. Acton’s comments about the relationship between section 459 of the Companies Act 1985 and section 122(1) (g) of the Insolvency Act 1986 cannot be considered as having some validity and the interpretation of Parker J in Re Guidezone [2000] 2 BCLC 321 is absolutely tenable under law.

Bibliography:

Michael Lower ‘Going Dutch? Who foots the bill in section 459 petitions?’  http://webjcli.ncl.ac.uk/articles1/lower1.rtf

Business law notes Tim Miller ‘Corporate Management: Minority Shareholders’ http://www.economic-truth.co.uk/cima/notes/law18.pdf

[1] [1973] AC 360 at 379 [2] However the cases should fall into definite categories of instances such as lack of opportunities to participate in the management, faulty or improper allotment of shares and self dealing of directors for diversion of funds (Farrrar, Company Law 1991 p 467 [3] Michael Lower ‘Going Dutch? Who foots the bill in section 459 petitions?’  http://webjcli.ncl.ac.uk/articles1/lower1.rtf. [4] (1843) 2 Hare 461 [5] Business law notes Tim Miller ‘Corporate Management: Minority Shareholders’ http://www.economic-truth.co.uk/cima/notes/law18.pdf. [6] (1877) 6 Ch.D 70 [7] ‘n5 [8] See generally, Re a Company, [1987] BCLC 141; Re R.A. Noble & Sons (Clothing ) Ltd., [1983] BCLC 273; Re London School of Electronics Ltd., [1986] Ch 211. [9] supra [10] Re DR Chemicals, (1989) 5 BCC 39 [11] Re McGuiness & Anor., (1988) 4 BCC 161 [12] Re Sam Weller & Sons Ltd, [1990] Ch 682 [13] Re Cumana, [1986] BCLC 273 [14] Re Company No 007623 of 1984 (1986) 2 BCC 99 191 [15] Re a Company No 008699 of 1985, [1986] BCLC 382 [16] Re Posgate & Denby (Agencies) Ltd., [1987]BCLC 8 [17] Re Elgindata, [1991] BCLC 959 [18] [1897] 1 Ch. 45, 58, 61 [19] Business law notes Tim Miller ‘Corporate Management: Minority Shareholders’ http://www.economic-truth.co.uk/cima/notes/law18.pdf [20] [1999] 2 BCLC 1, [1999] 1 WLR 1092 [21] [2000] 2 BCLC 321 at 354 [22] 2000] 2 BCLC 321 at 353 [23] [1972] 2 All ER 492, [1973] AC 360 [24] {2000] 2 BCLC 321 [25]  [1999] 2 BCLC 1 [1999] 1 WLR 1092 [26] [1983] BCLC 273 [27] [1972] 2 All ER 492 [1973] AC 360 [28] [1999] 2 BCLC 1 [1999] 1 WLR 1092 [29][1983] BCLC 273 [30] [2000] 2 BCLC 321 at 358