Re R & F Computers Systems Limited
1.I am instructed on behalf of Mr. James Ferguson, who was a managing director of R & F Computer Systems Limited (‘the Company’), to advice on whether he has any remedy against the other directors of the company by way of unfair prejudice or otherwise by virtue of being a shareholder in the company.
2.The Rosenthal Computer Systems Limited produce a range of computers built from components from a number of manufacturers, mainly from the Far East. Their models were based on one type of processor. Moreover, there were new processors coming onto the market and that they would have to start producing two types of system or they would cease being able to compete. Therefore, former members of the company needed finance to expand the company. Mr Ferguson was then offered to join into business. He entered into a shareholders’ agreement with the former members of Rosenthal with a condition that a new company would be formed and he would contribute $1,280,000 of fresh capital, of which $40,000 was for his shares in the new company plus $80,000 by way of share premium, and that the existing shareholders in Rosenthal would sell their shares to the new company. The new company, R & F Computer Systems Ltd, would then start producing both types of system using the old Rosenthal trade name and the new business would be up and running at the beginning of September 2001.
3.Mr Ferguson became the managing director, and he entered into his service agreement with R & F on 1st September 2001. Mr Rosenthal, Mr Wiseman and Mr Harland were also directors, and they entered into similar agreements with the company on about the same date. However, he had been running the company very well until 10th September last year. On that date the other three directors summarily dismissed him on the ground of allegedly diverting contracts from the Company to a company run by his brother-in-law, Bailey (Hemel) Computers Limited (‘Bailey’).
Summary of advice:
4. In my opinion it is likely that Mr Ferguson would have a good claim under s 459 of the Company Act 1985 against the other directors of the company by way of unfair prejudice or otherwise by virtue of being a shareholder in the company. His claim against the other directors of the company due to the summarily dismissal on a perfectly innocent incident while retaining his very sizeable loan will have a greater prospect of success. Moreover, Mr Ferguson will have to show to bring a petition under s 459 that a company’s affairs are being, or have been, conducted in a manner unfairly prejudicial to the interests of himself or its members generally or some part of its members. If the court is satisfied that Mr Ferguson’s interests have been unfairly prejudiced by the conduct of the company’s affairs, it has wide powers for granting relief under s 461.
5.Mr Ferguson can make an application under the Company Act 1985, s 459 being a member or being a person to whom shares in the company. S 459 (1) and (2), which, in their current form, provide as follows:
(1) A member of a company may apply to the court by petition for an order under this part on the ground that the company’s affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of its members generally or of some part of its members (including at least himself) or that any actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial.
(2) The provisions of this part apply to a person who is not a member of a company but to whom shares in the company, have been transferred or transmitted by operation of law, as those provisions apply to a member of the company; and references to a member or members are to be construed accordingly.
6.Mr Ferguson will have to show to bring a petition under s 459 that a company’s affairs are being, or have been, conducted in a manner unfairly prejudicial to the interests of himself or its members generally or some part of its members. There is no statutory definition of the term ‘unfair prejudice’, which has been left by the legislature as a deliberately wide concept, which can be applied by the courts so as to give relief where it is just to do so. Nevertheless, six basic propositions can be derived from Re Bovey Hotel Ventures Ltd decision and that in Re DR Chemicals Ltd (1989):
- The test of unfair prejudice is objective.
- It is not necessary for the petitioner to show bad faith.
- It is not necessary for the petitioner to show a conscious intention to cause prejudice.
- The test is one of unfairness, not unlawfulness.
- The alleged conduct must affect the petitioner as a shareholder.
- Laches (i.e., delay) may bar relief under s 459.
7.Further, Hoffmann LJ said the starting point in an s 459 cases is to consider whether the conduct complained about was in accordance with the articles of association of the company. Even if the letter of the articles has been complied with by the majority, their conduct may be unfairly prejudicial if either:
- the majority have failed to use their fiduciary powers as directors for the benefit of the company as a whole; or
- the petitioner can show that some legitimate expectation not formally expressed in the constitution of the company has been infringed.
8.In O’Neill v. Phillips (1999) Hoffmann LJ said that the court has to apply two principles to decide the concept of fairness. One is that the articles and other express terms on which the shareholders have become associated must be respected. The other is that equity will intervene where the respondents have not acted in good faith. It is for this reason that successful unfair prejudice petitions are those based either on breach of the terms on which the parties became associated, or where those terms are used in a manner which equity would regard as contrary to good faith.
9.The company is a private company limited by shares in which four members have invested their capital on the footing that dividends were unlikely to be declared, but that each would earn a living by working for the company and drawing remuneration as a director. In this case, it can be said that Mr Ferguson had a legitimate expectation of continued employment as a director by the company and so dismissal from office may constitute unfairly prejudicial conduct: Re a Company (No 00477 of 1986). Further, the company effectively controlled by Mr Ferguson had contributed $1,280,000 of fresh capital, of which $40,000 was for his shares in the new company plus $80,000 by way of share premium in order to provide working capital for a quasi partnership, became the managing director and the chairman of the company. Later, problems arose between Mr Ferguson and the other directors, who then summarily dismissed him without consultation and without any discussion about the future of the loan capital. Following, R and H Electic Ltd v. Haden Bill Electrical Ltd (1995) it can be said that Mr Ferguson had a legitimate expectation of being able to participate in the management of the quasi-partnership company for at least as long as the lending company and he were closely associated with it. Accordingly, even though Mr Ferguson’s conduct was open to criticism his removal was held to be unfairly prejudicial to his interests as a member.
10.It is therefore clear that Mr Ferguson’s fellow directors have seized on a perfectly innocent incident in order to remove him from the company while retaining his very sizeable loan. Therefore, it would raise a successful petition as this is based on past conduct, which has a continuing unfairly prejudicial effect.
11.If the court is satisfied that Mr Ferguson’s interests have been unfairly prejudiced by the conduct of the company’s affairs, it has wide powers for granting relief under s 461. Subsection (1) and (2) provide:
(1) If the court is satisfied that a petition under this part is well founded, it may make such order as it thinks fit for giving relief in respect of the matters complained of.
(2) Without prejudice to the generality of subsection (1), the court’s order may-
(a) regulate the conduct of the company’s affairs in the future,
(b) require the company to refrain from doing or continuing an act complained of by the petitioner or to do an act which the petitioner has complained it has omitted to do,
(c) authorize civil proceedings to be brought in the name and on behalf of the company by such person or persons and on such terms as the court may direct,
(d) provide for the purchase of the shares of any members of the company by other members or by the company itself and, in the case of a purchase by the company itself, the reduction of the company’s capital accordingly.
12.The court nevertheless may make an order under s 459 to purchase of the shares of one side by the other. Usually, it is clear that it will be the majority who will be ordered to buy out the minority. Often it will be the majority who will have been running the business in the period leading up to the final disposal of the proceedings, and generally they will find it easier to buy out the smaller number of shares owned by the minority rather than the other way around. However, the usual position can be displaced by other factors, with each case turning on its own facts. Factors can include who founded the business, the respective roles of the parties in building up the company’s business, any special qualifications needed for running the business successfully, and any dishonesty or breach of fiduciary duty established against either side. In cases where there are majority shareholders in control of the business it will therefore be very rare for the court to order them to sell their shares to the minority.
13.Mr Ferguson shares would be valued at a price that is fair. Outside the area of unfair prejudice it is clear that a fair valuation of shares representing a minority interest in a private company will have to take into account the fact that such a holding does not carry with it control of the company and that the minority shareholder is therefore subject to the whims of the majority regarding dividend policy and management decisions. There will therefore be a substantial minority interest discount when determining the value of minority shares.
14.The court may order the majority shareholders to pay Mr Ferguson’s loan $80,000. In Re Nuneaton Borough AFC Ltd (No 2) (1991) it was held that s 461 was wide enough for the court to make an order for the transfer of shares to be made conditional on the party buying the other side out repaying loans made by the outgoing shareholders to the company. On the facts it was held that it would have been unjust to allow the company to retain the loans after the outgoing shareholder had been bought out.