The commercial divorce - the rise in unfair prejudice claims

Unfair prejudice claims have risen over the last 12 to 18 months, many triggered by the impact of Covid.

What is an unfair prejudice claim?

A claim for unfair prejudice can be brought by a shareholder where the affairs of the company have been, are being, or will be conducted in a way that is “unfairly prejudicial” to shareholder interests.

Action is brought by a minority shareholder whose interests have been affected who can “petition” the Court for relief.

Whether a shareholder or a director, you should be aware of the hurdles for establishing requirements for a claim, as well as potential pitfalls.

Requirements

A claim petitioner must demonstrate:

1) What action has been, or is being threatened, which is prejudicial to their interests as a shareholder?

2) How that prejudice is unfair?

What does prejudice mean?

Prejudice is not limited to financial loss although loss in the value of a member’s shares is the most common reason for a petition. The concept can include breaching a member’s right to be involved in company management, decision making and strategy. The petitioning shareholder does not have to show that anybody acted in bad faith or with the intention of causing prejudice.

Establishing if the prejudice is unfair

Even if the action is potentially prejudicial, it must still be “unfair”. The Court will first consider the basis on which the shareholder agreed to become a member of the company, which is likely to be set out in Articles of Association and any shareholders’ agreement.

Common examples of unfairly prejudicial conduct include:

• Failure to allow a member to be involved in the management of the company or to be consulted on decisions in breach of rights under a shareholders’ agreement.

• Failure to pay dividends for no good reason

• Payment of excessive remuneration

• Misuse or misappropriation of company assets

Mismanagement by the board of directors is not commonly unfairly prejudicial conduct unless directors’ duties are deliberately flouted.

Remedies available

The Court has a wide discretion to make appropriate orders to remedy unfair prejudice. Orders can:

• Regulate the conduct of the company’s future affairs;

• Require the company to refrain from doing or continuing with an act complained of, or to do an act which the member has complained that the company has omitted to do;

• Authorise civil proceedings to be brought in the name and on behalf of the company by such person/s and on such terms as the court may direct;

• Require the company not to make any alterations in its Articles of Association without the leave of the Court; and

• Provide for the purchase of the shares of any members of the company by other members or (more rarely) the company itself.

The most common remedy sought and order made by the Court is that the majority shareholder(s) buys out the minority shareholder for fair value. Fair value will be determined by expert evidence and will be adjusted to allow for the impact of the unfairly prejudicial conduct.

The Court will also consider whether the purchase value should be discounted to reflect the shareholding’s minority interest.

Process

As with most litigation, the parties are expected to try to resolve matters without having to resort to Court proceedings. Where that is not a possible, a claim for unfair prejudice is begun by way of a petition.

These claims are complex and costly to pursue or defend and a distraction from the day-to-day running of the business. It is important to take early advice to see whether a resolution can be reached without having to issue a petition.

Top tips

• Think carefully about how Articles of Association and any shareholders’ agreement impact on the rights and interests of shareholders and make sure they’re clear and comprehensive.

• The board of directors should accurately record reasons for decisions made, particularly those which may impact negatively or disproportionately on minority shareholders.

• Seek advice at the earliest opportunity, whether you’re a shareholder (either minority or majority) or a director. Unfair prejudice claims are typically fractious and hard fought and require legal input on many different areas of law including company law, contract law and employment law. Agreeing a strategy upfront as to how the claim should be managed and resolved will help.

For more information on the issues in this article or on any other dispute query, please contact Ailsa Charlton on 0191 211 7735 or email [email protected]

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