OPINION
Introduction:
1. I am instructed on behalf of Mr. David Fisher, a shareholder and former director in the company of Metcalf Lock Co. Limited (‘MLC’), to advise on whether there are grounds for petitioning for the winding up of the company on the ground of its insolvency, and whether he can force Metcalf Locksmiths Inc. (‘ML Inc’) to buy back his shares in MLC.
2. MLC, trades in security locks imported from the United States, is a subsidiary of ML Inc, which is incorporated in New York. In July 1999, Mr. Fisher purchased 4,000 ordinary shares at £1.00 each in the capital of MLC, representing 20% of the total share capital of that company at a purchase price of UK £100.000. Likewise, Mr. Watkins and Mr. Eyre, who are both ML Inc nominees on the board of MLC, are holding 1 share each and the rest of the shareholding in MLC is ML Inc.
3. Mr. Fisher was invited to become a director and then entered into a Service Agreement that he would, be paid a starting salary of £53,000, payable monthly in arrears on the final day of each month, plus a year-end management incentive of 5% of the net profit of MLC during the period of his employment.
4. On 1st March 2004, MLC ceased trading and all its employees were transferred to Metcalf Security Locks Limited (‘MSLL’), a new company incorporated this year, whose shares are wholly owned by ML Inc. Mr. Fisher was made redundant, and accepted a £60,000 redundancy package. ML Inc, on the other hand, wanted to keep the existence of MLC in the companies register in order to ensure the other companies in the Metcalf Lock group can keep MLC as a debtor in their accounts, even though there is no prospect of them ever being paid, now that MLC has ceased trading.
Summary of Advice:
5. Mr Fisher would have a good claim against ML Inc under both s 459, CA 1985 and s122 IA 1986. He therefore will almost certainly obtain an order for ML Inc to buy his shares at a fair price, in relation to unfair prejudice. Alternatively, Mr. Fisher could obtain an order for just and equitable winding up of the company.
Nature of the Company:
6. Courts dealing with unfair prejudice claims and petitions for just and equitable winding up, invariably take into account whether the Company is a quasi-partnership. The leading case on this type of company and situation is Ebrahimi v. Westbourne Galleries Ltd (1973) AC 360, where Lord Wilberforce has explained the features of the quasi-partnership, which are as follows: a personal relationship involving mutual confidence between the members; an agreement that some or all of the members shall participate in the company’s business; and restrictions on share transfers. Although he quoted in the above case that a quasi-partnership would typically have one or more of the three elements, he then described, subsequent cases, such as O’Neill v. Phillips (1999) 1 WLR 1092, HL which have tended to look for all three elements before deciding whether a company can be categorized as a quasi-partnership.
7. It is highly likely in considering these factors, that this company would be held to be a quasi-partnership. MLC is a company in which there was an understanding that the participants would be concerned in the management of the business, although it appears that Mr. Fisher had never played an active rule in the management. Moreover, both the shares transfer Agreement and Service Agreement are clear that the joint intention was that Mr. Fisher would be involved in the running of the business as a Director, and Clause 1 of the Service Agreement shows the intention that he would continue in that position. In contrary, the parties entered into a formal share transfer Agreement, and that Mr. Fisher had a service agreement, points against a finding that this was a quasi-partnership, although this does not preclude the Court from finding that the intention was that the company would be run on the basis of mutual trust and confidence.
8. It is a relatively small company with 3 directors and will be limited by 5 in accordance with Clause 9 Articles of Association. The following Clause also aimed at ensuring Colin James Watkins and Trevor Giles Eyre founders will remain in post as directors. Furthermore, Clause 1 of the share transfer Agreement noted that ML Inc is shareholders of MLC (quasi-partners), which point towards a quasi-partnership. Clause 3 also excludes Mr. Fisher’s right to sell or otherwise transfer or encumber his shares in MLC. Otherwise, the shares of the company will not be freely marketable, thus locking a disappointed shareholder into the company
Grounds for Winding-up of the company:
9. Mr. Fisher could possibly be able to proceed a petition to wind up MLC under the Insolvency Act 1986, s. 122 (1) (g), on the ground that it would be just and equitable to do so, although it would only be succeed if the court considers that the problem can not be resolved in any other way. The ground most commonly relied on is ground (f), that the company is unable to pay its debts, which can be proved under s. 123 (2), as seems to be the case here, to the satisfaction of the court, that the value of the company’s assets is less than its liabilities, taking into account its contingent and prospective liabilities. At the balance sheet date, on 31st December 2003, the company’s liabilities exceeded its assets by £2,407,382, although this deficit is entirely made up of transactions involving other companies in the Metcalf group, which I have described elaborately in Paragraph 15. If the court is satisfied with the above statements, they may consider that the shareholders have justifiably lost confidence in the management (Loch v. John Blackwood Ltd (1924).
10. The court may further find, under s122 (1) (g), that the breach of the equitable obligations have been arising in this case, being a quasi-partnership. The leading case is Ebrahimi v. Westbourne Galleries Ltd (1973) AC 360, where a minority shareholder/ director removed from office by the other two-shareholder/ directors was awarded a winding-up order. In other cases it has been held that the company should be wound up because the substratum of it has failed: Re German Date Coffee Co Ltd (1882) 20 Ch 169. Therefore, it is in my view likely that the court would find it is just and equitable to wind-up the company
11. Despite this, in my opinion a winding –up order is very unlikely to be made. This is because the court must not wind a company up on this ground if there is some other remedy available to the petitioners and they are acting unreasonably in asking for a winding up: Insolvency Act 1986, s. 125 (2). Here there is a reasonable alternative remedy in the Companies Act 1985, s. 459.
Unfair Prejudice:
12. A less drastic and perhaps more attractive ‘alternative’ would be for Mr. Fisher to seek an order under s459 Companies Act (CA) 1985 for ML Inc to buy out his shareholding. In order to be eligible for this, Mr. Fisher would have to show that the affairs of the company were being conducted in a manner unfairly prejudicial to him, as he is part of the membership. There is no statutory definition of the term ‘unfair prejudice’, but the court can apply their discretion powers to give relief where it is just to do so: Re Bovey Hotel Ventures Ltd decision and that in Re DR Chemicals Ltd (1989). Moreover, the refusal of ML Inc to purchase Mr. Fisher’s shares at the fair price would give rise unfair prejudice due to various reasons, namely the restrictions on the shares. Mr. Fisher, due to Clause 3 of the Shares Transfer Agreement, does not have any right to sell or transfers his shares in MLC except upon the terms of and conditions set out in regulation 7 of the Articles of Association of MLC. On 15th March 2004, by writing the letter to ML Inc in order for asking them whether they will buy back his shares, he satisfied the notice requirement of regulation 7, although they refused to buy back his shares. Following the two principles of the concept of fairness in O’Neill v. Phillips, ii is in my opinion that ML Inc is a breach of the express terms on which the shareholders have become associated. Therefore it gives rise successful unfair prejudice for failing to buy back his shares.
13. Since MLC ceased trading in February 2004, his shares in MLC have been rendered worthless. As a result, the court may take the view that he was unfairly prejudiced, whether that was the intention of the company or not, that is, mala fides is not required although lack of mala fides may render prejudicial conduct ‘fair’ (Re A Company (No oo7623 of 1984. On the other hand, all its employees have been transferred to Metcalf Security Locks Limited (‘MSLL’), a new company incorporated this year, which shares are wholly owned by ML Inc. ML Inc, in the same time, wish to keep existence of MLC in the companies register in order to ensure the other companies in the Metcalf Lock group can keep MLC as a debtor in their accounts, even though there is no prospect of them ever being paid now MLC has ceased trading. Clearly, it shows that ML Inc has been deliberately acted to cease MLC’s business, which makes his shares worthless.
14. The court may conclude that Mr. Watkins and Mr. Eyre, who are both MC Inc nominees on the board of MLC, have acted unfairly for failing to use their fiduciary powers as directors for the benefit of the company as a whole: O’Neill v. Phillips. Firstly, they have been invoiced at excessive figures for the services rendered to MLC by other companies in the group for the sum of £1.1 million. Secondly, they had not been invoiced for about 3 years for the goods and services provided by MLC to other companies in the group for the sum of £2.4 million. Both transactions were justified on the company’s policy grounds. Thirdly, they might have misguided him as they insured him that invoices were merely being delayed rather than not being raised at all. Consequently, their conduct have been constituted a breach of directors’ duties, as recognized by Arden J, in Re BSB Holdings Ltd (No 2): The standards of corporate behaviour recognized through s 459 may in an appropriate case thus not be limited to those imposed by enactment or existing case law. It was further held in Elder v. Elder and Waston (1952) that unfairly prejudicial conduct could exist where there was a: …visible departure from the standards of fair dealing and a violation of the conditions of fair play on which every shareholder who entrusts his money to a company is entitled to rely.
15. The court may further consider that the above allegations against Mr. Watkins and Mr. Eyre were due to serious mismanagement would constitute unfair prejudice. Namely, the intra-group transactions were entered in the books at prices grossly disadvantageous to MLC and the failureness to invoice other companies in the group for goods and services provided by MLC. In Re Elgindata (1991), the court stated that the serious mismanagement of a company’s business constitutes conduct that is unfairly prejudicial to the interests of minority shareholders. Mr. Fisher could again claim that he legitimately expected that the company would be properly managed therefore that mismanagement is rendered unfairly prejudicial to him. Certainly, mismanagement allied to attempts to do down a shareholder has been held to be unfairly prejudicial (Scottish CWS Ltd v. Meyer 1959), a case decided on the old s210), as has mismanagement linked to breaches of company law (Re A Company ex p Shooter 1990).
Remedies for Unfair Prejudice:
16. Once unfair prejudice is established the Courts have very wide powers to make such orders as are thought fit for giving relief (s.461, Insolvency Act 1986). The primary remedy is share purchase. Moreover, MLC here ceased trading and all its employees have been transferred to Metcalf Security Locks Limited (‘MSLL’), a new company incorporated this year, which shares are wholly owned by ML Inc. Consequently, in my opinion there can be no doubt the court will order ML Inc to buy Mr. Fisher’s 4,000 shares rather than the other way around. Mr. Fisher should receive a fair value for them, which, provided the court finds this is a quasi-partnership company, means their fair market value at the date of judgment with no discount for his minority interest. If, contrary to expectations, the court finds company is not a quasi-partnership, the usual rule is that a fair valuation must reflect the fact that the petitioner’s shares only represent a minority interest. This can have a devastating effect on the value of the shares.
17. Expert valuation evidence from an accountant will be necessary on this issue. It would in my view be appropriate to seek to agree with the other side for the appointment of an independent jointly instructed expert. This could be done in the pre-action stages after the
Further Evidence:
18. A number of inquiries should be made at this stage before contacting the prospective defendants. Mr. Fisher will need to provide a full statement to my instructing solicitor dealing with the circumstances leading to his acceptance of the redundancy package, and in particular whether the undertaking, that MLC would not be prejudiced by ML Inc polices, is written. Mr. Fisher should also be asked be to give a full explanation about ML Inc marketing policy. In addition, he will need to provide copies of correspondence with the other directors and ML Inc regarding his shares.
19. The instructing solicitors is required to obtain the explanation from the company accountants or the directors as to why net liabilities, and the profit and loss account was not added in the balance sheet on 31st December 2003. He will also be asked for a full explanation about the item ‘accumulated losses brought forward £ 1,525385’ in the profit and loss account.
20. It is not entirely clear from my instructions about the item in the balance sheet ‘Creditors: amounts falling due after more than one year £2456876’ whether it is for 1 year. If possible, it would be extremely useful if Mr. Fisher could provide copies of balance sheet since 1997 to 2001 to analyse the financial circumstances of the company. He also should be asked whether the new company MSLL runs a similar business as MLC. It seems that MLC has remained in the companies register book; therefore he will be asked whether he has any correspondence evidence on this issue.
21. Mr. Fisher will need to confirm the actual date when MLC ceased trading. He mentioned in the letter dated 15 March 2004 that the business had folded on 1st March 2004, whereas my instructions state February 2004. He will further be asked to confirm about the number of ML Inc subsidiaries and where they all trade. Finally, how long ML Inc has been in business? Mr. Fisher has accepted a redundancy package with no explanation as to whether he was forced to accept it. He should also be asked to give a full explanation about the sum £1.1 million on his 15th March letter.
Joinder
22. Joining applications for unfair prejudice relief with prayers for just and equitable winding up is often undesirable, but could be justified on the facts of this case as winding-up may be the appropriate relief in considering that the company’s liabilities exceeded its assets by £2,407,382. In Re Copeland and Craddock Ltd (1997), where an alternative prayer for winding up was allowed to remain.
Conclusion:
23. Subject to the results of further inquiries, I would advice that Mr. Fisher has a strong case against ML Inc for either relief for unfair prejudice or for a just and equitable winding up. A letter of claim should be sent before issuing proceedings. The inquiries I have mentioned above should be undertaken in the near future.
If I can be of any further assistance, please do not hesitate in contacting me.
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ICSL Chambers
2 0th May 2004.