Quasi-partnerships and unfair prejudice

Some companies formed on the basis of mutual trust and confidence are considered by the law to be quasi-partnerships. Although they are governed by the Companies Act 2006, this underlying relationship of trust between a small number of individuals means that, for all practical purposes, they operate as if they were traditional partnerships. This gives rise to additional rights and protections for shareholders.

Establishing whether a company is a quasi-partnership is therefore of significant importance. It can determine the remedies available to members in dispute, particularly in the context of unfair prejudice petitions under section 994 of the Companies Act 2006, and may affect how a departing shareholder’s interest is valued.

What is a quasi-partnership?

Quasi-partnerships are not determined by the way a business is structured; they are a question of fact. They may arise in all types of companies in England and Wales, from large PLCs and LLPs to small family-owned limited companies. The make-up of a company and its circumstances can be critical to determining what remedies are available to the company and its shareholders.

If a company governed by the Companies Act 2006 is a quasi-partnership, its members may have recourse to section 994 if they experience unfairly prejudicial conduct.

A company doesn’t become a quasi-partnership because shareholders decide that it should be. Shareholders don’t need to do anything to make it a quasi-partnership. There’s no requirement for any specific documents or other arrangements; it’s simply a question of fact: is it or is it not a quasi-partnership?

A quasi-partnership has nothing to do with partnerships or partnership law. It’s usually a limited company (or LLP) established in the same way as other limited companies (or LLPs), but it has characteristics that make it similar to a partnership.

The key concept is good faith and mutual confidence. A company that is established on the basis of mutual trust and confidence between its shareholders, and formed because of the close association between them, is more likely to be a quasi-partnership. The typical example is a family company, although this isn’t always the case as it depends on the facts. Shareholders may expect to have full involvement in the management of the company and some degree of control over who can and cannot become a shareholder.

The concept of a quasi-partnership is a good example of the law adapting to reality and recognising that a company established between family members or long-term close friends shouldn’t necessarily be regulated in the same way as an ‘arms-length’ company between two investors or a large multinational business.

The two most important elements of a quasi-partnership are considered below:

1. A personal relationship involving mutual confidence

This is arguably the most important factor. Determining whether a personal relationship does or does not exist can sometimes be straightforward and, at other times, more complicated. However, it’s always essential.

Having a small number of shareholders doesn’t make a company a quasi-partnership. The key is that there must be a personal relationship, rather than merely a commercial relationship between them. Most often, companies involving family members or friends can be quasi-partnerships.

Equally important is establishing mutual trust and confidence. The extent of that trust will vary from company to company, but it’s critical to establish trust and confidence for a company to be considered a quasi-partnership.

2. Understandings or agreements between the members

It’s also crucial to establish whether there are any agreements or understandings between shareholders.

Agreements often arise in two ways. Firstly, through a carefully drafted and negotiated shareholders’ agreement, containing detailed provisions to govern the relationship between the shareholders.

Where a written agreement exists, it can be used to establish the rights that a member has, albeit this will not necessarily always determine matters if, for example, certain situations haven’t been catered for.

Secondly, through the understanding or agreement that the parties informally reached when the company was created or when they became shareholders. Frequently, family-owned businesses have undocumented agreements as to legitimate expectations and involvement in a company, which can be difficult to prove in the absence of evidence.

Importance of being a quasi-partnership

It’s important to highlight that a company continues to be governed in the first instance by its articles of association and any express agreements between the shareholders, whether it’s a quasi-partnership or not.

However, in some circumstances, particularly concerning the protection of shareholders’ rights, other important principles apply.

The reason why quasi-partnerships are so important is that their unique characteristics mean that special rules apply in relation to the remedies available to shareholders who have been unfairly treated. For example, a shareholder who acts in accordance with the articles of association may still be found to be acting unfairly if their actions breach the terms of the quasi-partnership.

Different rules also apply to the valuation of a party’s shareholding in a quasi-partnership. In companies governed by the Companies Act 2006, the usual remedy granted by a court where unfair prejudice is established under section 994 of the Act is for a buying out order. In this case, the majority (or equal) shareholder responsible for the unfair prejudice is forced to buy the shares of the minority (or equal) shareholder. Where a quasi-partnership exists, the shares of the minority or equal shareholder aren’t subject to a minority discount when valued, which would otherwise be the case when selling a non-controlling interest in a company.

If you’re involved in a shareholder dispute, it’s vital to understand how your rights and remedies might be affected if a quasi-partnership is found to exist.