Before attempt to answer this it is necessary to discuss about old law, which protect the right minority shareholders, the principle Foss v Harbottle & the exception of this case. It is also necessary to discuss, whether the rights of minority shareholders have been improved by the enactment of the Companies Act 2006. This Act should only be clarifying & codifying the existing law, rather than creating anything new.
Since 1948 it has been recognised that minority shareholders need protection going above and beyond their rights under constitution of the company and established principles of the company law. There are always risks that majority shareholders will make use of their dominant position so as to vote themselves large remuneration packages and prevent the company from distributing much to the shareholders in the from of dividends on the shares. In this way the majority can ensure that most or all of the spare cash in the company goes to themselves, and that the minority shareholders see little or none of it.
In a company’s affairs the maxim ‘majority rule’ prevails. This means that dissatisfied shareholders rarely can act if they feel the company is badly managed to their detriment. The case of Foss v Harbottle clearly indicated that if a wrong done to a company then the company is the proper claimant to right that wrong. In this case two shareholders brought an action against five directors alleging misrepresentation of property by them.
The court held that as the injury was to the company, the company was the proper claimant and shareholders were not competent to bring the action. It did acknowledge that this rule could be departed from but only if there were reasons of a very urgent character.
In Mozley v Aston, two shareholders sought an injunction to restrain the board from acting until four of the directors who ought to have retired by rotation to allow four others to be elected did so. It expressly alleged that a majority of the shareholders supported the action to prevent the company from instituting an action. Such an action would be free from objection as it would be a body legally authorised to represent the shareholders generally.
In Edwards v Halliwell, where members of a trade union sought a declaration that an increase in union dues was invalid on the ground that a rule which required a two-thirds vote on a ballot had not been followed the rule in Foss v Harbottle was analysed as having two aspec6s, first the proper claimant principle and secondly the majority rule principle. The reasons for exceptions to the rules are the subject of much academic debate. The convectional method of dealing with the exceptions is to classify them under the four headings set out in Edwards v Halliwell and these are personal rights, illegal or ultra vires acts, special majorities and fraud on the minority.
The statutory grounds for the compulsory winding up of a company provided for by the Insolvency Act 1986, s. 122(1), and is that ‘the court is of the opinion that it is just and equitable that the company should be wound up.’ However, winding up on the just and equitable ground suffers from the drawback that only one from of relief can be granted if the position is successful. There is judicial reluctance to winding up successful companies, which is reflected in stronger cases being required where the company is than if it were struggling. As Nicholls LJ said in Re Walter L. Jacob & Co. Ltd, the compulsory winding up of an active company is a seriou7s step, and a petitioner asking the court to do this must put forward and establish reasons which have a weight justifying this remedy being granted.
The Companies Act 1948, s. 210, was enacted to enable minority shareholders to obtain relief without winding up the company. It provided that a member could complain where the affairs of the company were being conducted in a manner ‘oppressive’ to some part of the membership of the company, including the petitioner.
Section 459(1) of the Companies Act 1985 (as slightly amended by the Companies Act 1989) provides 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 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.”
If a petition under s. 459 of CA 1985 is successful, the court is given by s.461 wide powers t5o act as it thinks fit for granting relief against the matters complained of. The most common form of relief is to provide for the purchase of the shares of the minority shareholders by the majority at a fair valuation. Section 461 empowers the Secretary of State to apply where, having received a report; it appears to him that there is unfair prejudice.
Matters amounting to unfair prejudice:
Exclusion from management:
Over two-thirds of all petitions presented under s. 459 in 1994-95 alleged exclusion from management. In Re Tottenham Hotspur plc (1994) Terry Venables, the chief executive of the ‘Spurs’ football club, a quoted public company, was dismissed from office. He brought a petition claiming unfair prejudice, but it was held that he could have no legitimate expectation of remaining in control of the company. The Vice Chancellor took the view that nothing had been disclosed to the company’s other shareholders which would suggest that the appointment of Mr Venables would be regulated by anything other than the company’s constitution and the formal legal documents.
In Re a Company (No. 00477 of 1986) Hoffmann J said the exclusion from management of a managing director of a large public limited company who happens to hold a few shares (perhaps as share qualification for being a director) would not be able to petition for relief under s. 459 in the event of being removed from his office as a director.
On the other hand, the same is not true of small private companies in which two or three members have invested their capital on the footing that dividends were unlikely to be declared, but that each would earn a living by working for the company drawing remuneration as a director. In such cases if it can be said that the members had a legitimate expectation of constitute unfairly prejudicial conduct.
Exclusion from management resulting in loss of control over capital invested in a company by a person connected with the excluded director may, in appropriate circumstances, affect the excluded director as a shareholder. Thus in R and H Electric Ltd v Haden Bill Electrical Ltd, Court held that the petitioner had a legitimate expectation of being able to participate in the management of the quasi-partnership company for at least as long as the lending company and the petitioner were closely associated with it. Accordingly, even though the petitioner’s conduct was open to criticism his removal was held to be unfairly prejudicial to his interest as a member.
Payment of inadequate dividends:
This is commonly combined with exclusion from management and/or with allegation that the directors have paid themselves excessive remuneration In Re Sam Weller and Sons Ltd the ground said to amount to unfair prejudice was that the company has paid ‘the same derisory dividend’ of 14p per share for the past 37 years, and that the most recent accounts showed that net profits had covered the dividend declared by 14 times. On an application to strike out the petition as disclosing no reasonable grounds for bringing a claim it was held that the allegation could amount to unfair prejudice.
Improper allotments of shares:
Re D.R Chemicals Ltd was regarded as a blatant case of unfairly prejudicial conduct. This was a company with two shareholders, one holding shares and the other holding 40 shares. The shareholders split up, with the majority shareholder continuing the business. The majority shareholder then used his position as director and majority shareholder allot himself a further 900 shares at par without informing the petitioner of what he was doing. It was found that he did this for the wholly improper purpose of diluting the shareholding of the petitioner (reducing his interest to 4 percent).
Discriminatory rights issue:
A right issue operates by the company offering to sell new shares to the existing shareholders in proportion to the number of shares they hold at time to offer. In Re a Company (No. 0007623 of 1986), Hoffmann J said that if the majority knows that the petitioner does not have the money to take up his rights and the offer is made at par when the shares are plainly worth a great deal more than par as part of a majority holding (but very little as a minority holding), it seems to me arguable that carrying through the transaction in that form could, viewed objectively, constitute unfairly prejudicial conduct.
Diverting business opportunities:
Breach of fiduciary duty on the part of the directors can amount to unfairly prejudicial conduct even in the absence of any breach of the items of the articles of association. One of the most common complaints is that directors in control of one company have diverted business opportunities away from a company in which the petitioner holds a minority interest to another company where the directors hold all the shares. [Re London School of Electronics Ltd]
Preventing the company recovering its property:
In Whyte, Petitioner (1984) (Court of Session), the petitioner held 49 percent of the shares of the company, the other 51 percent being held by the subsidiaries of R Ltd. It was held that this amounted to unfair prejudice of the petitioner, and an injunction was granted.
Allegation of Mismanagement on the part of those in control of a company will not, on their own, generally amount to unfair prejudice. The reason as stated by Roger Kaye QC in Re a Company (No. 002015 of 1996), is that managerial decisions are just as they imply, decisions by management. The courts are ill-equipped to resolve disputes about whether given management decisions were or were not proper, let alone to characterise them as amounting to unfair prejudice.
Totality of conduct:
In some cases a number of complaints, none of them in themselves sufficient to amount to unfairly prejudicial conduct, may, when taken together, be held to satisfy the test in s. 459. An example is Re A company (No. 00314 of 1989), where the respondents had made proposals for removing the petitioner as a director, proposed the appointment of new directors, proposed altering the memorandum and articles of association, and had offered to purchase her shares without providing her with information relevant to ascertaining their value, in total constituted unfairly prejudicial conduct.
Although s. 461of CA 1985 provides that either party may be ordered to buy the other side out, usually it is clear that it will be the majority who will be ordered to buy out the minority. The purpose behind s. 461of CA 1985 is to grant relief in respect of the matters complained about the petition Re A company (No. 00314 of 1995). In cases where there are majority shareholders in control of the business it will therefore be very rare for the court to order them to sell their shares to the minority. The most difficult cases are those where both sides hold an equal number of shares, an example Re A company (No. 003096 of 1987).
A different approach is often taken in unfair prejudice cases. In Re Bird Precision Bellows Ltd, the Court of Appeal, approving the judgement of Nourse J at first instance, said a different approach was required where a minority shareholders share were ordered to be bought after a finding of unfair prejudice, because the minority shareholders could not be regarded as voluntary sellers. Instead, the general rules are:
(a) The shares held by the quasi-partner should not be discounted for minority interest, but should b valued on a pro-rata basis according to the value of the shares as whole.
(b) If the minority shareholder had acted so as to deserve his exclusion from the company the price should be appropriately discounted to reflect that fact.
(c) In cases where delinquent majority shareholders in quasi partnership company are ordered to sell their shares to the minority the price should not generally include a premium to reflect the fact the their shares carry majority control.
(d) Where shares in a quasi partnership company were acquired by the petitioner as an investment at a price which as discounted because the represented a minority holding, any sale order would most probably be at a price incorporating a minority interest discount.
In Elliott v Planet Organic Ltd the company had ordinary shares which were owned by quasi partner, and a number of preferred shares. It was held that the preferred shareholders, were in effect voluntary sellers and their shares were valued by the court subject to a30 percent discount The ordinary share were valued on a going-concern basis using the figure for maintainable profits multiplied by a price earning ratio of 11.5 based on figures published by Acquisitions Monthly and BDO Index (reflecting the optimistic future of the business), and adding the cash in the business. A lower factor of 3.5 was applied in the RE Eurofinance Group Ltd where there was a risk of future departure of key personnel.
Law Commission Proposal
The Law Commission’s Consultation Paper No. 142 (1996) and its ensuring report, No 246 (Cm 3769, 1997), which was considered in chapter ten in relation to informing the derivative action, also encompassed statutory shareholder remedies.
With respect to s 459, the principle concern of the Law Commission was not directed towards the substantive remedy itself but rather towards the length and cost of typical unfair prejudice action and the destructive effect such proceedings had on small private companies. The Consultation paper gave a number of examples to highlight this problem. For instance, it found that the trial in Re Elgindata Ltd spanned some 43 days with cost of ₤ 320,000 while the shares in the company, originally purchased for ₤ 40,000, fell in the value to ₤ 24600. In Re Macro Ltd the hearing of the petition and a related action lasted 27 days and the cost claimed came to some ₤ 725,000.
This did not include appeal costs The Law Commission, taking the Woolf Civil Justice Reform as its back drop, therefore recommends that the difficulties of length, cost and complexity of s 459 proceedings should be addressed by active case management by the courts. More particularly, the Commission take the view that the courts should make greater use of the power to direct that preliminary issues be heard, or that some issues be tried before others; to impose costs sanction; and to have the power to dismiss any claim or part of a claim or defence thereto which, in the opinion of the courts, has no realistic prospect of success at full trial.
It is noteworthy that the length and costs of such proceeding are not the only problem of which the courts and prospective parties to such proceeding need to be aware. As Vinelott J observed in Re a Company, ex p Burr, there is also the damaging effect, which the courts and presentation of the petition may have on the business of a company, even if it is not advertised.
The commission noted from its statistical survey that the majority of petitions were brought by minority shareholders in a small private companies seeking to have their shares purchased on the basic of exclusion from management. In order to obtain the objectives to providing such petitioners with a speedy and economical exit route, the Law Commission recommends that ss. 459-461should be amended so as to raise rebuttable presumptions that where a shareholder has been excluded from participating in management:
a. the affairs of the company will be presumed to have been conducted in a manner which is unfairly prejudicial to the petitioner; and
b. If the presumption is not rebutted and the court is satisfied that it ought to order to buy out of the petitioner’s shares, it should do so on a pro rata basis.
The presumption would only apply where the company is a private limited company in which the petitioner held shares in his sole name giving him not less than ten percent of the rights to vote at general meetings, and all, or substantially all of the members of the company were directors. The petitioner must have been removed as a director or prevented from carrying out all or his functions as a director.
However, The Companies Act 2006 received Royal Assent on 8 November 2006. Department of Trade and Industry (DTI) assist the reader in understanding the Act. They do not form part of the Act and have not been endorsed by Parliament.
Now it needs to discuss Companies Act 2006. One of the core objectives of the Companies Act 2006 was the change of the rights of minority shareholders and to make directors more liable to the shareholders they represent. However, if they fail in their duties, the introduction of enhanced rights for a shareholder at present means that they can take definite action against them.
The Act makes a range of significant changes to shareholder rights, which thread through the different areas that the Act covers. Now the Companies will be allowed to check on whether or not the beneficial owner wishes to retain information rights on an annual basis. Any failure to respond to such a check within 28 days will mean that the company can assume that the rights have lapsed.
For the first time, all the duties owed by directors to their company have been set out in statute, in Part 10 (ss.170–181) of the new Act. The general duties are duty to act within powers, duty to promote the success of the company, duty to exercise reasonable care, skill and diligence, duty to exercise independent judgment, duty to avoid conflicts of interest, duty to declare interest in proposed transaction or agreement, and duty not to accept benefits from third benefits etc. if they do not follow this section minority shareholders can take action against directors. So it can be said, that the rights of minority shareholders have been improved by the enactment of the Companies Act 2006.
In Irvine and others v Irvine and another the High Court decided that, for the purposes of a buyout ordered following a successful petition under s.459 of the Companies Act 1985, a shareholding of 49.96 per cent was to be valued as any other minority holding, and that no premium should be attached to the shares simply because the buyer was the majority shareholder who would gain control of the whole of the issued share capital.
The Court also held that where the parties had agreed a method for valuing the shares that made no distinction between the various assets of the company, the valuation of the cash surplus held by the company was also to be subject to the minority discount, and was not to be treated as having been notionally distributed to the shareholders prior to the buyout order.
When valuing a minority shareholding in a limited company following a buy-out ordered by the court under s 459 of the Companies Act 1985, the shares should be valued on a discounted basis unless there were exceptional circumstances.
Blackburne J so held when determining that the petitioners, Mrs Patricia Mary Irvine and Mr Michael Cleobury Thatcher (as trustee of a settlement for the benefit of Mrs Irvine’s children), who had together owned together 49.96% of the shares in the second respondent family company, Campbell Irvine (Holdings) Ltd, were not entitled to a pro-rata, non-discounted value for their shareholding, after the first respondent, Mr Ian Charles Irvine, had been ordered to buy-out the petitioners’ shareholding under s 459 of the Companies Act 1985, on the ground that the company’s affairs had been conducted in a manner unfairly prejudicial to the interests of the petitioners.
The first respondent owned merely one more share in the company than the petitioners. In this case Blackburne J followed Re Bird Precision Bellows Ltd case.
From the above discussion it can be said that minority shareholders can protect their rights under s 459 of the Companies Act 1985 for unfair prejudice, and Insolvency Act 1986, s. 122(1) for winding up the company. The rights of minority shareholders have been improved by the enactment of the Companies Act 2006, though this Act should only be clarifying & codifying the existing law, rather than creating anything new. The Law Commission recommends that ss. 459-461should be amended.
- Company Law Review Steering Group, Modern Company Law for a Competitive Economy: Developing the framework (DTI, March 2000),
- J. Lowry & A. Dignam, Company Law, 4th edition, (2007) Oxford University Press
- Lowry ‘Mapping the Boundaries of unfair Prejudice’ in John de Lacy, the reform of UK Company Law (London, Cavendish 2000)
- Gower, L.C.B. and P.L. Davies Gower and Davies’ Principles of Modern Company Law. (London: Sweet & Maxwell, 2003) seventh edition [ISBN 0421788208]. 8th edition due April 2007 [ISBN 0421949007].