Shareholder disputes – what is the test for unfair prejudice for a minority shareholder?

An unfair prejudice petition is a legal mechanism, pursuant to Section 994 of the Companies Act 2006 (“CA 2006”), which allows a shareholder to seek redress when a company’s affairs are conducted in a way which unfairly harms their interests or those of a section of the company’s members.

This article examines the test for unfair prejudice petitions as outlined in the CA 2006 and relevant case law. The petitioner must show:

1. That the complaint relates to the way in which the company’s affairs are managed or conducted, and;
2. That the way those affairs are managed or conducted unfairly impacts the shareholder.

The latter requirement is not narrowly or technically construed; it can and does include a wide range of issues, especially when relating to quasi-partnerships. However, it’s not appropriate to bring an unfair prejudice claim for personal grievances unrelated to the company’s business.

The unfair prejudice test

For a petition to succeed, the affairs of the company must have been conducted in a way which is unfairly prejudicial to the interests of a shareholder (known as the petitioner).

The petitioner will need to prove both prejudice and unfairness in respect of the conduct they’re complaining of. This can be a single act or omission, but more often consists of a series of complaints. The fact that the respondents have caused prejudice to a petitioner does not always mean that there has been unfairness. Conduct by those in control of a company may be deemed unfair and reprehensible but not prejudicial. The relevant test is an objective one which applies long-established equitable principles; the courts will regard the prejudice as unfair where a hypothetical reasonable bystander would have regarded it so.

Testing for prejudice

Any prejudice complained of must impact the shareholder’s interests specifically as a member of the company (rather than as an employee or in another capacity). However, ill-treatment of a shareholder as an employee and/or director, can be highly relevant.

The conduct must cause tangible harm or disadvantage to a shareholder’s interests, such as where a shareholder suffers financial loss due to the share value being reduced or where a shareholder has been excluded from the company’s decision-making. It’s not necessary for a petitioner to show that the persons who have control of the company have acted as they did in the conscious knowledge that it was unfair to the petitioner or that they were acting in bad faith; the test is whether a reasonable bystander observing the consequences of their conduct, would regard it as having unfairly prejudiced the petitioner’s interests.

The prejudice must be relative to the remedy sought. A respondent will not be required to buy out the petitioner’s shares at a fair price, which is the usual remedy sought but not the only one available, if the prejudice experienced is relatively trivial.

Testing for unfairness

The court will consider the specific circumstances of the petition, along with any legitimate expectations of the petitioner. This test is applied even if the majority shareholders acted within their strict legal rights.

Fairness or unfairness will be judged in the context of a commercial relationship and will consider any contractual terms set out on the Articles of Association and/or in any shareholder agreement (if one exists). Members of a company have a legitimate expectation that a company will be run lawfully, in accordance with its articles and the duties of its directors. A section 994 petition enables the court to give full effect to the terms and understandings on which the members of the company become associated but not to re-write them.

Unfair prejudice and quasi-partnerships

If a company is managed like a quasi-partnership (based on principles of fairness and equity), the court will also consider whether the conduct is equitable within that specific context.

In a quasi-partnership company, a justifiable loss of confidence by the petitioner in the other quasi partner(s) which leads to a breakdown in the relationship may amount to sufficient prejudice even if there is nothing more tangible by way of prejudice. However, a mere breakdown of trust and confidence among quasi-partners will not be a basis for a successful petition. The breakdown must relate to conduct which is unfair and prejudicial.

Some examples of unfairly prejudicial conduct include:

• Breaches of fiduciary duties which damage the parties relationship of trust and confidence
• Failure to pay dividends (or a certain level of dividend) to which a shareholder is entitled without proper justification
• Misuse or misappropriation of company assets
• Allotting further shares in the company to dilute a minority shareholder’s shareholding
• Causing the irrevocable breakdown of trust and confidence in a quasi-partnership
• Abuse of power or breach of Articles of Association.

In summary, the court will look at whether the actions of the company or majority shareholders placed a shareholder at an unfair disadvantage. In doing so, the court will consider both the objective fairness of the conduct complained of and the circumstances of the company (and its members).