Common pitfalls in unfair prejudice petitions

Unfair prejudice claims are brought under section 994 of the Companies Act 2006 where conduct is alleged to unfairly prejudice the interests of the shareholders generally, or a particular group of shareholders directly.

This is a highly technical area of law where expert assistance is usually required. A generalist may be tempted to take on unfair prejudice petitions because they can generate significant fees. However, given their technical nature, it’s easy to make mistakes that affect the outcome for the client.

Common pitfalls when pursuing unfair prejudice petitions include the following.

Overlooking contractual remedies

It’s important to review the company’s constitution to determine whether a contractual remedy exists under the articles of association or any shareholders’ agreement. For example, where a shareholder exits a company, there may be a prescribed process for acquiring and valuing their shares, depending on the circumstances of the exit.

If a specified process applies, there are unlikely to be good grounds for an unfair prejudice petition unless the deployment of that process itself is unlawful. A thorough review of the company’s constitutional documents should therefore be carried out before advising a client to proceed with an unfair prejudice petition under section 994.

Standing to bring the claim

As a general rule, only members (shareholders) of the company and their nominees are entitled to bring a claim. However, there’s some authority to suggest that a former member of the company may bring a claim in circumstances where their shares have been acquired under a process that is itself unlawful and potentially unfairly prejudicial.

In those circumstances, the minority shareholder would first need to obtain a declaration from the court on the efficacy of the acquisition process. If successful, they would then be entitled to bring an unfair prejudice petition.

Someone who is not, or has never been, a member of the company would not have good standing to bring a petition under section 994.

Not identifying qualifying conduct

It’s very easy to assume that all conduct adversely affecting a minority shareholder’s position is unfairly prejudicial in nature. However, only conduct relating to the petitioner’s position as a shareholder qualifies under section 994.

For example, a director may be removed from office but be unable to sustain an unfair prejudice petition unless they can show that the removal also resulted in them being unlawfully excluded from the management of the company. If the director was historically silent, they are unlikely to have a legitimate expectation of management involvement, and an allegation of unfair prejudice may fail.

It’s also common for the conduct complained of to harm the company rather than the shareholder directly. It’s easy to confuse unfair prejudice with conduct that should instead be addressed through a breach of duty claim brought by the company itself.

To pursue such a claim, the shareholder would need to launch a derivative action in the name of the company under section 260 of the Companies Act 2006. These claims are notoriously complex and difficult, and any remedy benefits the company rather than the complaining shareholder-director. As a result, they are rarely pursued.

Unreasonable delay in bringing a claim

Recent case law has confirmed that there’s no limitation period for bringing an unfair prejudice petition. However, unreasonable delay in bringing a petition based on a particular allegation could result in the petition being unsustainable.

For example, an allegation that a shareholder has been denied a legitimate expectation of being involved in the management of the company over a period of many years is unlikely to succeed.

Identifying the nature of the company

Whether the company‘s governance allows parties to have a legitimate expectation of participation in its management is relevant when determining the remedy in an unfair prejudice petition. This is because such companies are deemed to be quasi-partnerships and, as a general proposition, unfair prejudice is easier to establish in a quasi-partnership than in a non-quasi-partnership company.

This is because equitably expectations arise between participants in the company, and breaches of those expectations may amount to unfairly prejudicial conduct.

Before proceedings are commenced, it’s important to establish whether the company has the characteristics of a quasi-partnership, which typically include:

• A relationship of mutual trust and confidence between the participants in the company
• Stakeholders participating in management
• Restrictions on share transfers, preventing stakeholders from fully transferring their shares to an unconnected third party
• The engagement of equitable considerations as a result.

Attempts are sometimes made to argue that a complicated company with a detailed equity structure and significant majority shareholder is a quasi-partnership. This argument is unlikely to succeed, and the complaining shareholder may need to refine their case or consider alternative remedies, such as those that might be available to them in the context of their employment.

Valuation

The issue of quasi-partnership is also relevant to the valuation of the shares.

The starting point when valuing a minority interest in a private limited company is that it has no market value, as there’s no market for non-controlling interests. The courts recognise, however, that attributing no value to a minority shareholder’s shares would be unfair. As a result, shares are usually valued by applying a discount to the proportionate value, depending on the circumstances.

Minority discounts can be substantial; it’s not uncommon to see discounts of up to 40% on the proportionate value.

In a quasi-partnership, however, it’s established that no discount should be applied. Determining whether a company is a quasi-partnership at an early stage can therefore have a direct impact on the buy-out remedy that might be ordered by the court in due course.

Failing to make an earlier offer to buy-out a minority shareholder’s shares

There’s a mechanism for making an offer to purchase a minority shareholder’s shares known as an ‘O’Neill v Phillips’ offer, named after a longstanding case which established the relevant principles.

An offer to purchase the minority shareholder’s shares at their proportionate value, without a discount, is the best remedy that can be achieved at court (notwithstanding the court’s wide discretion to order a variety of different remedies). A valid O’Neill v Phillips offer can therefore prevent the minority shareholder from presenting an unfair prejudice petition at all.

This can be a powerful tool for majority shareholders who want the minority to exit, particularly where the shares are of low or nominal value.

Care is required when using this mechanism in the context of a non-quasi-partnership company, where a significant discount to the proportionate value of the shares is likely to apply. The appropriate level of discount is often better addressed through mediation, where it can form part of wider settlement discussions.

However, it’s surprising how often the availability of the O’Neill v Phillips mechanism is overlooked by practitioners when advising on negotiating strategy in unfair prejudice cases. This is important, as failure to advise on an appropriate negotiating strategy at the outset may amount to professional negligence.

Conclusion

Unfair prejudice is a highly nuanced area of law that requires specialist input from the outset.

HCR Law’s Dispute Resolution team is experienced in advising on issues relating to unfair prejudice in the context of shareholder disputes.