When entering into a corporate relationship, the last consideration for the involved parties is the possibility of an acrimonious split. Nevertheless, relationships can deteriorate, leading parties to find themselves in a situation where a previously harmonious business association has become troubled.
In such scenarios, minority shareholders may seek to extricate themselves from the arrangement by selling their shares or gaining increased influence over the company’s operations.
One method through which a minority shareholder can assert their rights is through filing an unfair prejudice petition. This legal recourse, often likened to a corporate divorce, serves as a statutory remedy for minority shareholders whose interests are adversely affected by a majority shareholder.
In this article, we provide insights on the necessary elements for bringing an effective unfair prejudice petition and discuss the process of filing such a claim.
What Constitutes Unfair Prejudice?
A shareholder may file a petition with the court alleging unfair prejudice if they believe the company's affairs are being managed in a way that disadvantages them. However, for the claim to have any prospect of success, the shareholders’ interests must have been adversely affected in a way that is considered unfair. The intention behind this legal remedy is to safeguard minority shareholders from potential abuses of power by the majority.
Such situations typically arise when the majority shareholders exert control at the board level, leading to the company being run solely for the benefit of the majority shareholder, to the detriment of the minority shareholder. Common instances of unfair prejudice include the misappropriation of company funds or the unfair exclusion of minority shareholders from management, particularly when they had a reasonable expectation of participation.
Legal Criteria for a Valid Unfair Prejudice Claim
Section 994 of the Companies Act 2006 provides statutory protection for shareholders who are unfairly prejudiced by conduct or inaction related to the company’s affairs.
To successfully establish an unfair prejudice claim, the following criteria should be met:
- The company’s operations are conducted in a manner that causes prejudice or detriment to the shareholder, or there must be an actual or proposed act or omission that is prejudicial.
- The prejudice or harm claimed must be deemed unfair
- The conduct must result in a tangible disadvantage to the shareholder, meaning that the shareholder must have suffered a loss due to the unfair prejudice. If the shareholder bringing the petition is not adversely affected by the alleged conduct, the claim will not succeed.
Typically, prejudice to a shareholder’s interest involves some form of financial detriment. Examples of unfair prejudice may include:
- Unjustified non-payment of dividends
- Issuance of additional shares in the company, thereby diluting the holdings of existing shareholders, without a shareholder resolution
- Significant mismanagement of the company
- Issues regarding the valuation of member shares
- Concerns that a director is prioritising personal interests over the company’s welfare
- Non-compliance with the company’s articles of association
The court will evaluate whether the conduct complained of is unfairly prejudicial from the perspective of a reasonable person, rather than concentrating on whether the majority was aware that their actions would negatively impact a member of the company. It will decide whether the action giving rise to the claim is both ‘unfair’ and ‘prejudicial,’ on a case-by-case basis.
Who is Eligible to File a Petition?
Any shareholder or member of a company has the right to file an unfair prejudice petition in court. The individual who files the petition is known as the petitioner. Although the Companies Act 2006 technically grants majority shareholders the right to initiate a claim for unfair prejudice, such claims are likely to succeed only in rare situations, such as where the majority shareholder lacks voting control. Typically, a majority shareholder is positioned to exert control over the company’s operations and decisions, a privilege not extended to minority shareholders. This disparity is why most unfair prejudice petitions are brought by minority shareholders.
The Petition Process
Court proceedings concerning claims of unfair prejudice start with the submission of a petition to the court. The petition must clearly outline the claim, the basis for its presentation and the type of relief sought by the petitioner.
The shareholders or directors accused of engaging in unfair conduct should be identified as respondents in the petition, and the company itself is usually included as a respondent as well. Additionally, a third party who is not a member of the company may be added as a respondent if the requested remedy could impact them or if they were directly involved in the alleged unfairly prejudicial conduct.
Service on the Respondent
Subsequently, the court will arrange a hearing, referred to as the ‘return day,’ during which both the petitioner and all respondents must appear before the registrar or district judge. At this hearing, procedural directions regarding the petition will be provided. Upon establishing the return day, the court will issue sealed copies of the petition to the petitioner, each marked with the return day and the scheduled time of the hearing.
The petitioner is obliged to serve a sealed copy of the petition on every respondent listed in the petition. This requirement is mandatory and must be fulfilled at least 14 days before the return day. Noncompliance may lead to the petition being dismissed or the court’s refusal to hear the case.
The purpose of this service is to ensure that all parties involved are aware of the claim and have adequate time to prepare their responses.
The Hearing
On the designated return day or subsequently, the court will issue appropriate directions as it considers necessary and may grant interlocutory relief to protect the interests of the petitioner and the respondent until the petition is adjudicated.
During the hearing, the petitioner is required to provide evidence substantiating their claim, which must include proof of the prejudicial conduct and resulting harm. In this context, disclosure is essential because the majority shareholder typically possesses control over the physical documents and electronic data relevant to the case. Additionally, expert valuation evidence plays a crucial role in determining the worth of the minority’s shares, since a common remedy in a successful petition is an order for the majority shareholder to acquire the petitioner’s shares at a fair value.
Available Remedies
The courts possess a broad discretion under Section 996 of the Companies Act 2006 to issue any order it deems fair to address unfairly prejudicial conduct, without being confined to the specific remedies requested by the petitioner.
Typical outcomes may include:
- establishing a code to govern future company operations
- prohibiting the company from executing or continuing a specific action
- mandating that the company refrain from modifying its articles without court approval
- permitting civil proceedings to be initiated in the name and on behalf of the company by designated individuals under terms specified by the court
- ordering the other shareholders to buy the claimant’s shares at fair value, as determined by the court
- directing the winding up of the company
Defending an Unfair Prejudice Petition
Company directors frequently find themselves personally named as the respondents to an unfair prejudice petition - a situation that poses significant risks. Unfair prejudice claims can be challenging to settle, primarily because the remedies sought are often non-monetary. Furthermore, with limited exceptions, directors are prohibited from using company funds to defend against such claims.
A typical remedy involves a court order requiring the petitioner’s shares to be purchased by the majority shareholder at a fair value, thereby allowing for a separation on terms favourable to the petitioner. Consequently, in response to an unfair prejudice petition, a respondent may propose to buy the petitioner’s shares at a price determined by an independent expert valuer. Should the petitioner not accept this offer, the respondent might be able to get the claim dismissed on the grounds that he has already offered all that the petitioner may reasonably expect to receive if the claim were to proceed to trial.
It is important to recognise that unfair prejudice petitions should be regarded as disputes amongst the company’s members, rather than a conflict with the company itself. As such, directors are not permitted to use company funds or assets to finance their defence. Engaging in such actions could constitute a breach of a director’s duties and may itself be considered unfair prejudice. Consequently, the implications for directors defending an unfair prejudice claim are significant. Failure to mount a defence could lead to a default judgment while defending the claim involves covering legal costs personally unless they are adequately insured.
The risks associated with unfair prejudice petitions highlight the importance of Directors’ & Officers’ (D&O) insurance, which safeguards company directors and officers from personal liability in the event of legal claims stemming from their actions or decisions. In the absence of such insurance, company directors and officers may be compelled to engage in lengthy and expensive legal proceedings, either at their own expense or without legal representation.
A D&O insurance policy may provide coverage in response to a petition for unfair prejudice petition, provided that the respondents are directors or officers, and the allegations concern actions taken in their official roles. However, if the claims are solely related to their responsibilities as shareholders, such as a breach of a shareholders’ agreement, the policy may not apply. If the policy does apply, while the insured individuals may still encounter a lengthy dispute, they can at least find reassurance in knowing that their expenses will be covered.
Our Team is Ready To Assist You
Our expert corporate lawyers possess extensive experience in representing businesses across a wide array of legal matters. Whether you are a minority or majority shareholder or a company director, our team is well-equipped to help you prevent and resolve shareholder conflicts and disputes as they arise. Contact us today on 0300 303 2071 or email us to see how we can assist you.
