SHAREHOLDERS REMEDIES [1997] EWLC 246(3) (24 October 1997)

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Introduction

3.1 In the consultation paper we put forward for discussion proposals for a new unfair prejudice remedy for smaller companies. (1) The aim of such a remedy would be to provide a more streamlined procedure for dealing with some of the most common disputes which are currently brought under section 459, thereby reducing the time and costs spent on such disputes. In this part we consider the proposed new remedy and set out our reasons for rejecting it. We then explain our recommendation for presumptions that in certain circumstances (a) conduct will be presumed to be unfairly prejudicial, and (b) where the court grants a purchase order in favour of the petitioner his shares should be valued on a pro rata basis. (2) Finally, we discuss briefly the issue raised in the consultation paper of whether there should be a remedy in certain situations in which there is no fault.

The scheme proposed in the consultation paper

(1) Where the conditions in sub-section (2) are satisfied a member of a private company may apply to court for an order under this section on the grounds of his exclusion from participation in management of the company/removal of a director (in either case) save for gross misconduct.

(2) Such an application may only be made if there are a minimum of two and a maximum of five members in the company and if:

(a) the company is an association formed or continued on the basis of a personal relationship, involving mutual confidence;

(b) before the applicants exclusion from management, there was an agreement or understanding between all the shareholders that he or she should participate in the conduct of the business.

(3) Under this section the court is empowered only to make an order that the shares of any members of the company are to be purchased by other members or by the company itself and, in the case of a purchase by the company itself, the reduction of the companys capital accordingly, but such purchase will be at fair value without a discount for the fact that the applicants shares represent a minority shareholding.

Statistical survey

3.3 The elements of the proposed scheme were based on our statistical survey of petitions brought under section 459 in 1994 and 1995. (3) Essentially, three features were identified in that survey:

(i) the vast majority of companies involved in proceedings brought under section 459 were private companies with five or fewer shareholders;

(iii) the remedy most commonly sought was the purchase of the petitioners shares by the respondent.

3.4 The new remedy was therefore directed at disputes involving these elements. But in addition, the proposal expressly set out two other aspects which arose from the case law on disputes of this kind.

Ebrahimi considerations

3.5 As we explained in the consultation paper, (4) the Court of Appeal in Re Saul D Harrison & Sons plc ("Saul D Harrison") (5) laid down "guidelines" as to when conduct might be regarded as "unfairly prejudicial". The starting point was to ask whether the conduct was in accordance with the articles of association. But the court could also consider whether the applicant had a "legitimate expectation" over and above the legal rights conferred by the companys constitution and arising out of a relationship between the shareholders which fell within the categories or analogous situations set out in the case of Ebrahimi v Westbourne Galleries Ltd ("Ebrahimi"). (6) These were:

(i) an association formed or continued on the basis of a personal relationship, involving mutual confidence - this element will often be found where a pre-existing partnership has been converted into a limited company;

(ii)an agreement, or understanding, that all, or some (for there may be "sleeping members"), of the shareholders shall participate in the conduct of the business;

(iii) restriction upon the transfer of the members interest in the company - so that if confidence is lost, or one member is removed from management, he cannot take out his stake and go elsewhere. (7)

3.6 In companies of this kind, (8) the letter of the articles may not fully reflect the understandings upon which the shareholders are associated. Wider equitable considerations might arise which may entitle a shareholder to say it would be unfair in certain circumstances for those who control the company to exercise a power conferred by the articles upon the board or the company in general meeting. (9)

3.7 Accordingly, in order for a petitioner to show, in proceedings under section 459, that his exclusion from management of the company was unfairly prejudicial, he will generally have to show that the relationship between the members of the company involved elements of the kind highlighted in the Ebrahimi case, and that he had a "legitimate expectation" of being able to continue to participate in the management. (10) In the proposal for a new remedy, we included express reference to the first two Ebrahimi elements as requirements which must be satisfied before an application could be made. (11)

Basis of valuation

3.8 We also drew attention to the difficulties involved in valuing shares for the purposes of a purchase order. One of the matters often in dispute is the basis of valuation of the shareholding. (12) This frequently turns on whether the shares should be valued on a "discounted" basis or "pro rata". We explained that a minority shareholding in a company is generally regarded as having a lower value per share than a majority shareholding. This reflects the fact that a minority shareholder may have limited voting power, and therefore limited control over the management and day to day running of the affairs of the company. Where the valuation is reduced to reflect this the shares are said to be valued on a "discounted" basis. Where, on the other hand, the shares are valued as a proportion of the value of the company as a whole, they are often said to be valued "pro rata".

3.9 In fixing a value for the purposes of a purchase order in proceedings under section 459, the overriding requirement is "fairness". (13) Nevertheless, as we explained in the consultation paper, (14) the cases show that a pro rata basis of valuation is generally ordered where Ebrahimi type considerations are present. We therefore suggested that this should be reflected in the new remedy, and that in order to reduce the number of contested issues the remedy should provide that there should be no discount for a minority shareholding.

Suggested wording

3.10 Accordingly it was proposed, for discussion, that the new remedy would be available to a shareholder in a private company with a minimum of two and a maximum of five shareholders, between whom there was a relationship such as that set out in Ebrahimi , if the shareholder could show that he had been excluded from management without good reason. (15) The only order which the court could make would be an order for the purchase of the applicants shares on a "non-discounted" basis. (16)

Our provisional view

3.11 We set out wording for consideration, but did not make any provisional recommendation in advance of consultation. We accepted that any new remedy along the lines proposed was likely to be somewhat "rough and ready". However, we considered that such a remedy could be useful if it meant that fewer issues of fact would need to be proved, thereby leading to shorter, cheaper litigation than a full blown section 459 case.

3.12 We highlighted a number of specific concerns which we considered could give rise to problems. (17) These included the specified number of shareholders; the meaning of the wording taken from the judgment of Lord Wilberforce in Ebrahimi; the grounds of the claim; and the risk of increasing litigation. However, we noted that litigation under the new remedy was likely to be more focused than much of the current litigation under section 459, and that active case management could assist in dealing with any problems of increased litigation.

Update of statistical survey

3.13 We have conducted an identical survey of petitions filed at the High Court in London during 1996. We have incorporated the new statistics into the survey and the revised statistics for the period from January 1994 to December 1996 appear at Appendix J. These show very little change to the previous figures on the most commonly pleaded allegation, and the most commonly sought remedy. (18) Also, the vast majority of companies involved still have five or fewer members. (19)

Respondents views

3.14 Views on whether there should be a new unfair prejudice remedy for smaller companies along the lines proposed were almost evenly split, with just a small majority in favour.

3.15 The main reason given by respondents who were not in favour of the new remedy was that it appeared to add little to the current section 459, but might in fact complicate proceedings. The new remedy would cover much of the same ground as the existing provision, but with the obvious limitation that the matters enabling the court to grant relief would be narrower. If the two remedies were to be cumulative, (20) shareholders were likely to invoke simultaneously the new jurisdiction and section 459, leading to further complications in already complex proceedings; if, on the other hand, the jurisdictions were to be mutually exclusive, shareholders advisers would have a potentially difficult choice in deciding whether to seek to invoke the new jurisdiction or to rely upon the existing provision.

3.16 Another aspect which concerned a number of respondents was the lack of flexibility of the new remedy. This point was made in particular about the relief which the court could grant. Several respondents indicated that they were not in favour of the new remedy because they considered that it would be wrong for the court to order the purchase of the applicants shares on a non-discounted basis in every case. In fact, it appeared that a majority of respondents who commented on the wording of the new remedy considered that it should be possible for the court to make a different order in appropriate circumstances.

3.17 A similar point about lack of flexibility was made in respect of the grounds for the application under the new remedy. Some respondents pointed out that the applicants exclusion from management may not have been unfair, for example, because the applicant may continue to receive substantial benefits from the company, and/or because his exclusion could be justified in the interests of the company even without gross misconduct.

3.18 A further point which appeared to concern a large number of respondents was the fact that the new remedy was proposed to be limited to companies with five or fewer shareholders. Several respondents simply suggested that the limit was too low. Some of these considered that 10 may be a more appropriate number, although others did not give a specific figure. A number of other respondents did not consider that there should be any limit at all. The point was made that if the remedy was limited to companies which were formed on the basis of mutual trust and confidence there was no need for a restriction on the number of members. Concern was also expressed that it would be possible for a member to divide his holding amongst a number of nominees to get round the remedy.

Our final view

3.19 We identified in our statistical survey that petitions brought by minority shareholders in small private companies (21) seeking to have their shares purchased on the grounds of exclusion from management made up the majority of petitions brought under section 459. We still consider that it would be desirable to provide a disaffected minority shareholder, who has been excluded from participation in the management of the company, with a speedy and economical exit route in appropriate cases at a fair (and, so far as possible, readily ascertainable) price. Not only is this desirable from the point of view of the minority shareholder who will wish to remove his stake in the company in order to pursue other interests, but also from the point of view of the majority shareholders (and the company) who will wish to be able to dispose of any dispute quickly so that they can concentrate on the continued running of the business.

3.20 Our proposals for an exit article were widely supported on consultation. (22) Clearly it would be preferable for the parties to make provision in the articles for what will happen if their relationship breaks down. Our proposed exit article will assist in encouraging the parties to do this. But it can only go so far, and there will continue to be many disputed cases brought under section 459 on the grounds of exclusion from management.

3.21 The proposed new remedy could have provided a quicker and cheaper alternative to section 459 for resolving many of these cases. But we accept that it is likely that parties would invoke simultaneously the new jurisdiction and section 459 (if permitted) and that this could complicate the proceedings. Even though we consider that active case management could, to a large extent, deal with any problems which might arise, (23) the approach to shareholder proceedings which we are recommending already relies heavily on effective case management and we do not wish to add unnecessarily to this task by encouraging the proliferation of remedies.

3.22 Even with effective case management, there may be circumstances in which the introduction of a new remedy along the lines proposed would simply extend the length of proceedings and add to the costs. For example, if a minority shareholder relied on both the existing provision and the new remedy, the court might, in an appropriate case, determine that the issues raised by the application based on the new remedy should be heard first, and that, in the meantime, there should be an order staying the remaining issues. If the minority shareholder is successful under the new remedy, then that should be the end of the matter and the proceedings should have been more focused, and therefore quicker and cheaper. But if the minority shareholder fails under the new remedy, he may well seek to resurrect the remaining issues relevant to the claim under the existing provision. He may have to proceed to trial on those issues, and, with the delay involved in trying the earlier issues relevant to the new remedy, the time taken to dispose of the proceedings as a whole (and the overall costs of doing so) may in fact have increased.

3.23 We are not so convinced by the concerns expressed by respondents about the lack of flexibility of the new remedy. To a certain extent this issue is an echo of the much wider debate surrounding the more general proposals put forward in the Woolf Report. The ideal may well be to have an open textured discretion as in section 459. But if a shareholder cannot afford to pursue litigation under section 459, or if the costs involved in doing so outweigh any benefit that either party will eventually obtain from the proceedings, then, however good the remedy in theory, it is of little benefit to the parties in practice. There is clearly an argument for a more "rough and ready" remedy which, although not perfect, can do substantial justice between the parties.

3.24 A remedy along the lines proposed in the consultation paper would be of much less benefit if the court retained a discretion as to the basis on which the shares are to be valued. The parties are likely to introduce many of the arguments and allegations which would otherwise have been excluded from the new remedy in seeking to persuade the court to apply a particular basis of valuation. The new remedy would therefore add little to the existing provisions of sections 459-461. A similar point can be made in response to the suggestion that the court should continue to be able to consider whether the applicants exclusion from management was "fair" (irrespective of the issue of gross misconduct).

3.25 In short, we are concerned that the introduction of a new remedy along the lines proposed in the consultation paper may lead to duplication and complication of shareholder proceedings. Also, if the remedy were to be made more flexible, as appears to be desired by many respondents, it would largely defeat its purpose and would add little to the existing provisions. For these reasons we do not favour the introduction of a new unfair prejudice remedy for smaller companies along the lines proposed for discussion in paragraph 18.4 of the consultation paper.

An alternative approach

3.26 However, there is an alternative approach which we consider goes a long way towards achieving the policy aim set out in paragraph 3.19, but which would not involve duplication of remedies, and which would retain some flexibility. It is based on a proposal put forward by two respondents. (24)

3.27 Under this alternative approach, sections 459-461 would be amended to raise presumptions that, in certain circumstances: (a) unless the contrary is shown, the affairs of the company have been conducted in a manner which is unfairly prejudicial to the petitioner; and (b) where the court orders his shares to be bought out, the appropriate order (unless the court otherwise orders) is that the shares should be valued on a pro rata basis. The details of the circumstances giving rise to the presumptions are discussed below, (25) but the main feature of the presumptions is that the petitioner has been excluded from the management of the company.

3.28 This approach has the advantages of providing some degree of certainty for the parties on the position which the court is likely to take, and in this respect it would have much the same effect as the new remedy proposed in the consultation paper. It should also mean that cases can be dealt with more quickly when proceedings are in fact issued. For example, assuming the relevant circumstances are made out, the respondent will have to show good reason why the presumptions should not apply, and this will limit the factual allegations which the court will have to consider. Alternatively, if the respondent has made (or makes during the course of the proceedings) a fair offer for the purchase of the petitioners shares without a discount, then save in exceptional circumstances (and subject to the question of costs), the petition should be dismissed. (26)

3.29 On the other hand, this proposal will allow the court the flexibility, in an appropriate case, to find, for example, that the petitioners exclusion from management was not in fact unfair, (27) or that the appropriate basis on which the petitioners shares should be valued for a purchase order is on a discounted or some other basis. Also, this approach will not involve the introduction of a new remedy, and so will not give rise to the problem of duplication highlighted above. (28)

3.30 Accordingly, we recommend that there should be legislative provision for presumptions in proceedings under sections 459-461 that, in certain circumstances, (a) where a shareholder has been excluded from participation in the management of the company, the conduct will be presumed to be unfairly prejudicial by reason of the exclusion; and (b), if the presumption is not rebutted and the court is satisfied that it ought to order a buy out of the petitioners shares, it should do so on a pro rata basis.

3.31 We now consider the details of this proposal. We begin by considering the general approach which should be taken to the conditions for the application of the presumptions. Next we examine the details of the proposed conditions under the following heads: private company limited by shares; exclusion from management; make-up of the company. We then go on to explain the content of the first and second presumptions. Finally we set out an additional pre-action procedure which we consider could usefully be included in a pre-action protocol governing unfair prejudice applications, namely a buy out notice.

General approach to conditions for presumptions

3.32 The circumstances giving rise to the presumptions need to be as easily ascertainable as possible. Otherwise the presumptions would not assist the parties in predicting the outcome of proceedings and would not, therefore, have the intended effect of encouraging settlements. Also, it could generate additional argument during the course of proceedings (on whether the presumptions in fact applied), rather than reducing the issues which would need to be litigated if agreement could not be reached. On the other hand, the presumptions should not, so far as possible, rely on arbitrary factors; rather they should be based on clear principles.

3.33 The new remedy which we proposed in the consultation paper included express reference to the first two factors set out by Lord Wilberforce in Ebrahimi. (29) A similar approach could be taken in respect of the presumptions. However, a number of objections could be made to this.

3.34 First, it could be said that the meaning of the wording taken from the judgment of Lord Wilberforce in Ebrahimi is not clear. (30) However, this may be less of a problem than might at first be imagined. There is now a good deal of authority on the wording, and it has become very familiar to courts and practitioners alike. The views of respondents on whether this might be a problem in the context of a new remedy for smaller companies were fairly evenly split.

3.35 Secondly, there is the potential for complex factual disputes of a historical nature. The point was made by the two respondents who put forward the proposal for a presumption, that conditions based on the Ebrahimi relationship focus on the past, rather than on the immediate circumstances occasioning the need for relief. It is rare for the nature of the relationship between the shareholders to be subject to a clear agreement. Generally, the court will have to infer an understanding from the events which have happened. Accordingly, the petitioner will be encouraged to delve into the past to try to justify the case coming within the concepts of "personal relationship", "mutual confidence", and "understanding ... that he or she should participate in the conduct of the business", and the respondents will be encouraged to deny those allegations. This may prevent a speedy and economic resolution to the dispute. It was suggested that it would be preferable to identify conditions which can be ascertained by reference to objective and less disputable circumstances.

3.36 Thirdly, if the presumptions simply referred to the Ebrahimi factors, this would add little to the current position since it is fairly clear from the case law what the likely result will be where those factors are present. (31) The creation of the presumption will not exclude argument as to whether a relationship of the kind envisaged in Ebrahimi exists, but will shift the onus to the party which is likely to be the stronger of the two to argue that it does not.

3.37 We are persuaded by these last two points in particular. We consider that the presumptions should be based on "structural" factors (for example the percentage holding of the petitioner and the fact that he was a director) rather than the expectations of the parties. Clearly, these matters are less open to factual disputes than conditions derived from Ebrahimi. They have the advantage of being readily ascertainable by reference to the current (or recent) state of affairs. It is true that they may be regarded as somewhat arbitrary. However, unlike the new remedy which was proposed in the consultation paper, this proposal only sets out a presumption. If a case does not satisfy the conditions for the presumption to arise, the application of section 459, as it stands without the presumption, is not affected. Moreover, even if the presumption applied, it would still be open to the court to find that the petitioners exclusion from management was not unfair, either because the petitioners conduct justified his removal, or because it was not a situation where the petitioner had a legitimate expectation as a shareholder of continuing as a director, or that his shares should be purchased on a discounted basis. The respondents would be able to call evidence to rebut the presumption. We now turn to the details of our proposed conditions.

Details of proposed conditions

Private company limited by shares

3.38 We consider that the presumptions should only apply to private companies. It is extremely unlikely that the courts would find that a shareholder in a public company (particularly a listed company) could have a legitimate expectation of being able to continue to participate in the management of the company founded on some informal agreement or arrangement. (32)

3.39 In addition, we consider that the presumptions should only apply to companies limited by shares. There are very few reported cases involving members of other types of companies (33) bringing proceedings under section 459, and none that we are aware of where the facts would fall within the terms of our presumptions. The presumptions are directed at commercial companies where an owner-manager is excluded from participation in the management of the business and seeks a purchase order in respect of his shares. Such companies are extremely unlikely to be constituted as companies limited by guarantee or unlimited companies. (34) Our intention is for the presumptions to be as simple as possible and cover the straightforward cases. (35) We do not, therefore, consider that it is necessary or appropriate to extend the presumptions to companies other than those limited by shares. We recommend that the presumptions should only apply where the company is a private company limited by shares. (36)

Exclusion from management

3.40 The presumptions should apply where the petitioner has been excluded from participating in the management of the company. By this we mean that he has been removed as a director, or has been prevented from carrying on all or substantially all his functions as a director.

3.41 In many of the reported cases, the alleged exclusion from management has consisted of removing the shareholder from his position as a director. (37) The case of R A Noble & Sons (Clothing) Ltd, (38) however, gives an example of the sort of situation where a shareholder could be excluded from participating in the management without any need to be formally removed as director. In that case, the respondent failed to consult with the petitioner on major decisions (such as the purchase of company cars) and failed to invite him to board meetings or supply any other information. We consider that conduct such as this would constitute exclusion from management of the company for the purposes of the presumptions. (In fact, the exclusion in R A Noble & Sons (Clothing) Ltd was considered fair in the circumstances because of the petitioners own disinterest in the affairs of the company).

3.42 We did consider whether the presumptions should cover situations where the person who is removed as a director (or otherwise excluded from participation in the management) is a spouse of or person nominated by the shareholder (rather than the shareholder himself). A shareholder could arrange for a spouse or nominated person to be a director and have a legitimate expectation, as a member, that the spouse or nominated person would remain as a director. However, our presumptions are directed at the relatively simple and straightforward cases. We consider that in more complicated factual situations it is appropriate that the onus should be on the petitioner to show that the exclusion (in this case of the spouse or nominated person) was unfairly prejudicial to his interests as a member. (39)

3.43 Accordingly, we recommend that the presumptions should apply where the petitioner has been removed as a director or has been prevented from carrying out all or substantially all of his functions as a director.

Make-up of the company

3.44 What we are concerned with essentially are owner-managed companies. There are two elements by which we propose to describe the make up of such companies.

3.45 The first is that the petitioner should hold not less than 10% of the voting rights. We consider that if his holding was less than 10%, it is improbable that the necessary personal relationships, agreements and understanding would be present. (40)

3.46 This requirement must be qualified, however. There may be different classes of shares, some with weighted voting rights and/or the right only to vote on certain issues. What we are concerned with is the right to vote on the companys affairs overall. We therefore propose that the provision should require the petitioner to hold 10% of the voting rights capable of being exercised at general meetings of the company on all, or substantially all, matters. (41)

3.47 In addition, we consider that, for the purposes of this 10% threshold, the shares carrying the voting rights should be held by the member in his own name. This requirement prevents a shareholder from meeting the requirement by agreeing with another shareholder that they will hold their shares jointly. It also means that a member cannot take into account shares which are vested in a nominee. We consider that in owner-managed companies a member is likely to retain a holding in his own name, and that it is a reasonable requirement for the operation of the presumption that he hold a minimum 10% stake in the company in his sole name. (42) On the other hand, we do not consider that the member should have to show that he is the beneficial owner of the shares for the purposes of this threshold. We deal with the situation of trusts below.

3.48 The second element by which we propose to describe the make up of companies to which the presumptions will apply, is that all, or substantially all, of the members are directors. As indicated above, we are trying to target owner-managed companies. In some cases, there may well be one or two shareholders who are not actually directors but the company is still in essence "owner-managed". It is for this reason that we refer to all or substantially all of the members being directors.

3.49 There is, however, a qualification in respect of this second element in respect of joint holders. Some shares may be held in joint names (for reasons unconnected with the section). (43) For instance, a shareholder may have declared a trust over some of his shares, nominating two trustees. For the purposes of determining whether all or substantially all the shareholders are directors only one of the joint holders should count. The joint holder to be counted is the first-named joint holder or, if one of the joint-holders is a director, the first-named joint holder who is also a director.

3.50 Members of private companies may place some or all or their shares on trust for their children or others. We have considered whether voting rights attached to shares in respect of which a member has declared a trust, for family members, or which he has vested in a nominee, (44) or a company which he controls, should be aggregated with voting rights attached to other shares registered in his name for the purpose of calculating the percentage of voting rights which a member has for the purposes of the first element and of calculating whether the second element is satisfied. Our view is that this would result in complexity. Provisions of that nature might be appropriate in an anti avoidance provision, but all we are proposing is a presumption. The absence of an aggregation provision will not prevent the court from granting the same relief where the presumption does not apply. Moreover, if the shares are not held in the members own name, this would tend to throw doubt on whether the company is in fact owner-managed. A shareholder who wants to have the benefit of the presumption will not be prevented from creating a trust of his shares, but if he does so he must remain sole holder at least of shares carrying 10% of the voting rights. (45) As respects other shares over which he creates a trust, it will be sufficient if he ensures that he is a trustee and becomes the first-named joint holder.

3.51 In each case, we propose that these elements should be present immediately before the exclusion from participation in management. So, for example, if the petitioner ceased to hold 10% of the shares, and then a year later was dismissed as a director, we do not consider that the presumption should apply. Indeed, we consider that even if he was dismissed a few days after he ceased to hold the necessary 10%, the presumption should not apply. The elements should be present effectively at the time of the dismissal. The reason we refer to "immediately before" is that the very removal from office of the petitioner might have the effect of removing one of the qualifying criteria (ie it may mean that not all or substantially all of the shareholders are directors). So one has to look at the situation immediately before the removal.

3.52 We did consider the possibility of imposing a limit on the number of shareholders. However, we take the view that this is unnecessary. This is because the requirement that all, or substantially all, of the members are directors will inevitably place a limit on the size of companies which come within the terms of the presumptions. We consider that any additional restriction is unnecessary and could lead to arbitrary results.

3.53 We recommend that the presumptions should apply where, immediately before the exclusion from participation in the management, (a) the petitioner held shares in his sole name giving him not less than 10% of the rights to vote at general meetings of the company on all or substantially all matters, and (b) all, or substantially all of the members of the company were directors. (For the purposes of (b), only one joint holder should be counted as a member).

The first presumption

3.54 We propose that where these conditions are present, the affairs of the company will be presumed to have been conducted in a manner which is unfairly prejudicial to the petitioner for the purposes of section 459(1), unless the contrary is shown. In other words, the onus will be on the respondent to show that the affairs of the company have not been conducted in a manner which is unfairly prejudicial to the petitioner. It is therefore open to the respondent to show, for example, that the petitioner had no legitimate expectation of being able to continue to participate in the management of the company; or that the removal was justified by the petitioners conduct.

3.55 It is not proposed that the presumption should affect any situations which do not fall within it. In particular, it should still be possible for a petitioner to show that exclusion from management was unfairly prejudicial under the current case law, even if the facts do not satisfy the conditions set out in the presumption. It is not intended that there should be any counter-presumption, that just because a situation does not fall within the conditions, exclusion from management is not unfair.

3.56 We recommend that the first presumption should provide that, where these conditions are present, the affairs of the company will be presumed to have been conducted in a manner which is unfairly prejudicial to the petitioner, unless the contrary is shown.

The second presumption

3.57 We propose that where the first presumption has not been rebutted and the court is satisfied that it ought to make an order that one or more of the respondents should purchase the petitioners shares, the shares should be valued on a pro rata basis unless the court otherwise orders. This is confirmatory of the position established by the case law under the section applicable to these circumstances. (46)

3.58 We do not consider that the legislation should go on to set out by whom the shares should be purchased. This will be a matter for the court. Purchase orders can be very complex where there are a number of respondents and we do not consider that it is possible or appropriate to bind the courts discretion in this regard.

3.59 We have referred above to the question of whether shares should be valued on a discounted basis or pro rata. (47) By providing that the valuation should be on a pro rata basis, what we are proposing is that the company as a whole should be valued, and then that value should be apportioned rateably to the individual shareholdings. In other words, a 30% shareholding would be valued at 30% of a 100% shareholding. In order to meet the point that in private companies there is often no market for a shareholding we have provided that the market value should be ascertained on the basis that the whole of the share capital is being sold, and in addition that the buyer and seller are to be presumed to be willing. We believe that this will reduce the scope for unnecessary argument and produce a fair result as the situation will be one in which the court is satisfied that unfair prejudice has occurred for which the respondent is responsible. The reference to market value enables the court to take account of a special purchaser for the company if one is known to exist.

3.60 On the other hand the court may provide for the presumption to be displaced if the only shares to be purchased are for example preference shares with limited rights to receive dividends and capital. The court may consider that some simpler method of valuation would be appropriate. We think it unlikely that there will be many cases under the new section where there will be shares other than ordinary shares. Likewise if the company has a claim against the respondent who is being ordered to purchase the shares which cannot be adequately reflected in the market value of the shares the court may order some other purchase price.

3.61 The court has very wide power under section 461(1) to give ancillary directions, and the addition of the presumption will not affect this. Thus the court could as now determine the date as at which the shares to be purchased should be valued in accordance with the presumption. If the presumption contained a date for valuation there might be less room for argument as to what that date should be but we consider that the new section cannot satisfactorily specify a single date which should be presumed to be the appropriate date for this purpose. (48) The appropriate date depends on what is fair in the particular case.

3.62 We recommend that the second presumption should provide that where the first presumption has not been rebutted and the court is satisfied that it ought to make an order that one or more of the respondents should purchase the petitioners shares, the shares should be valued on a pro rata basis unless the court otherwise orders.

Buy out notice

3.63 There is a further requirement which we consider could usefully be introduced into the procedure for unfair prejudice claims. We suggest that the petitioner should be required to serve a notice on the other members of the company and the company requiring them to purchase his shares valued on a pro rata basis if, at the time of starting the proceedings, he intends to rely on the second presumption. The purpose of the notice mechanism would be to encourage parties to settle disputes, or at least set out their respective positions on the question of a buy out, before proceedings are commenced. We do not consider that the application of the presumptions should be dependent on a notice along these lines. Instead, we would propose that the court should have the power to sanction failure to comply with the notice requirement in making appropriate costs orders.

3.64 We have already drawn attention to the proposals in the Woolf Report on pre-action protocols. (49) We consider that a notice procedure of the kind proposed above would be ideally suited to a pre-action protocol of this kind set out in a practice direction. (50) We therefore recommend that, if our recommendations for the presumptions are implemented, the Vice Chancellor should be invited to consider whether there should be a practice direction requiring the petitioner to serve a notice on the other members of the company and the company requiring them to purchase his shares valued on a pro rata basis before he starts his proceedings if he then intends to rely on the second presumption.

A possible remedy for "no-fault" situations

3.65 One of the issues raised in the consultation paper was whether there should be a statutory remedy in situations where there is no fault. (51) Several consultees commented on this issue in the course of their responses. Some suggested that it should be open to shareholders in "quasi-partnership" type companies to exit at will (as if the company was in fact a true partnership). Others suggested that there should be provision for owner-managers of small companies to leave the company in certain circumstances (eg on retirement as a director) or for their beneficiaries to sell the shares they receive on the death of the owner-manager.

3.66 In our view there are strong economic arguments against allowing shareholders to exit at will. Also, as a matter of principle, such a right would fundamentally contravene the sanctity of the contract binding the members and the company which we considered should guide our approach to shareholder remedies. (52) This guiding principle was strongly supported by a large majority of respondents. The presumptions we have proposed above are consistent with this approach.

3.67 It may be that there are particular situations where it would be useful for a shareholder to be able to dispose of his shares in circumstances where there has been no fault. We mentioned two such situations in the consultation paper: (53) those where all the parties are agreed that certain members should leave the company but it is not possible to reach agreement as to the terms of departure; and those where there is no question of fault by any officers or members, but some members have acquired their shares by transmission or operation of law and want to dispose of them. (54)

3.68 However, our view is that such situations are best dealt with in the articles of association. In Part 5 we deal with proposals for an exit provision in the articles of association.

Conclusion

3.69 To summarise, we are not in favour of a separate remedy dealing solely with exclusion from management in smaller companies. We do, however, recommend the introduction of presumptions into proceedings under sections 459-461 that in certain circumstances, (a) where a shareholder has been excluded from participating in the management of the company, the conduct will be presumed to be unfairly prejudicial by reason of the exclusion; and (b) if the presumption is not rebutted and the court is satisfied that it ought to order a buy out of the petitioners shares, the shares should be valued on a pro rata basis unless the court otherwise orders. (55)

3.70 We consider that the best way to deal with situations where there has been no fault on the part of the members, but one of them (or the successor of a member who has died) wishes to dispose of his shares, is by provision in the articles of association.

(2) See para 3.8 below for a brief explanation of the difference between a "discounted" and "pro rata" basis of valuation.

(3) See Consultation Paper No 142, Appendix E. An updated version of this survey is set out in Appendix J.

(6) [1973] AC 360. In this case, the House of Lords was considering the circumstances in which it might be "just and equitable" to order a company to be wound up under s 222(f) of the Companies Act 1948 (now s 122(1)(g) of the Insolvency Act 1986).

(8) Often called "quasi-partnerships" in the cases; see Consultation Paper No 142, para 8.10.

(10) Even so, the petitioners exclusion will not necessarily be unfair. The court will look at the conduct leading up to the exclusion to see if it was justified and, more importantly, at the terms on which the exclusion was effected to see if they were fair; see Consultation Paper No 142, para 9.34.

(11) The third element was not included because the courts have tended to focus on the other two elements, and because in practice private companies invariably have a restriction on transfer in their articles, so that the third element is almost invariably present in any event.

(12) See Consultation Paper No 142, para 10.12. Another is the date on which it is to be valued.

(13) Re Bird Precision Bellows Ltd [1984] Ch 419; see Consultation Paper No 142, para 10.11.

(18) The most commonly pleaded allegation remains exclusion from management (64%), and the most common remedy sought remains the purchase of the petitioners shares (69%).

(20) Which is what we provisionally suggested; see Consultation Paper No 142, para 18.11.

(21) Most of these were moreover alleged to be companies where Ebrahimi type considerations applied. Obviously we cannot tell from our survey whether those allegations would have succeeded.

(24) Michael Crystal QC and Simon Mortimore QC, with whom Richard Adkins QC agreed.

(26) This is in line with the current case law. See Re a Company (No 003096 of 1987) [1988] BCC 80, and see Consultation Paper No 142, paras 8.15-8.17, and para 9.51, n 136.

(30) The point was also made in the consultation paper that it could be said to be undesirable to embody words from judgments in statute as this could hamper the development of the law; see Consultation Paper No 142, para 18.7, n 9.

(35) We note, also, that s 461(2) of the Companies Act 1985 refers expressly to the purchase of a members shares in the company, but does not include express reference to the purchase of a members interest in a company limited by guarantee with no share capital.

(37) See, for example, Re Ghyll Beck Driving Range Ltd [1993] BCLC 1126; Re Haden Bill Electrical Ltd [1995] 2 BCLC 280; Quinlan v Essex Hinge Co Ltd [1996] 2 BCLC 417.

(39) For situations in which the owner-manager may declare a trust of his shares or vest them in a nominee or company which he controls, see para 3.50 below.

(40) This percentage is also consistent with other minimum share holding requirements under the Companies Acts, such as s 368(2) (power to requisition an extraordinary general meeting); s 370(3) (power to call a meeting); s 373(1)(b)(ii) (right to demand a poll), but these requirements can be met by members acting together. There are other minimum thresholds in provisions of the Companies Act, but they are also generally aggregated percentages; see, eg, ss 5, 54, 127, 376.

(41) See sched 10A to the Companies Act 1985, which deals with parent and subsidiary undertakings. The draft Bill contains provisions such as are found in that schedule to cover the case where, eg, voting rights are temporarily incapable of being exercised. This might occur where a shareholder had died and a transfer to his personal representatives had not been registered.

(42) We have reviewed all the cases reported in Butterworths Company Law Cases in the last ten years (1988-1997) where Ebrahimi was cited (these are not necessarily cases where the petitioner was claiming exclusion from management or had a legitimate expectation of continued participation). Out of 31 cases listed, there were only four where the petitioner had less than 10% of the voting rights. These were Re BSB Holdings (No 2)[1996] 1 BCLC 155 (where it was not alleged that the Ebrahimi considerations were present), Re Saul D Harrison & Sons plc [1995] 1 BCLC 14, Re J E Cade & Son Ltd [1992] BCLC 213, and Re Ringtower Holdings plc [1989] BCLC 427. In all these cases the petition failed or was struck out and in only one of them (Re J E Cade & Son Ltd) was the allegation that the Ebrahimi considerations applied regarded as sustainable. (In addition, there were four cases where the voting rights were not apparent from the judgment).

(43) We have already indicated that for the purposes of the first element, the member should have a minimum shareholding in his own name; see para 3.47 above.

(44) Compare para 7 of sched 10A to the Companies Act 1985; and s 346 of that Act. It is probably less common for shares to be vested in the name of a nominee in a private company.

(45) See n 42 above which indicates that this requirement is likely to be easily met in practice.

(50) In some cases, of course, injunctive relief may be required, and it may not be possible to comply with a pre-action notice requirement.

(54) In New Zealand the appraisal remedy provides a statutory form of buy out that allows a dissenting minority shareholder to withdraw his investment by making the company repurchase his shares at a judicially assessed fair value, upon the occurrence of certain corporate acts. There is no need to show that the action complained of was unfair or unreasonable or not in the best interests of the company. For a discussion of the relevant provisions in the New Zealand Companies Act 1993, see G Shapira, "Problems with the Minority Buy out Rights" (1994) 1 BCSLB 3.

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You are here: BAILII >> Databases >> The Law Commission >> SHAREHOLDERS REMEDIES [1997] EWLC 246(3) (24 October 1997) URL: http://www.bailii.org/ew/other/EWLC/1997/246(3).html Cite as: [1997] EWLC 246(3)

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