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Fraud Insights: Protecting shareholder rights through unfair prejudice petitions

Posted on 30 September 2019

Fraud Insights: Protecting shareholder rights through unfair prejudice petitions

Where the affairs of a company are being or have been conducted in a manner that it is unfairly prejudicial to the interests of a shareholder, or an actual or proposed act or omission would be so prejudicial, a shareholder can apply to the Court under section 994 of the Companies Act 2006 through what is commonly known as an unfair prejudice petition.

Unfairly prejudicial conduct can encompass a wide range of scenarios including (i) diluting a shareholding, (ii) paying excessive remuneration to the directors, (iii) failing to pay dividends in certain circumstances, and (iv) breaches of fiduciary duty that damage trust and confidence between the parties. Whilst the list is not exhaustive, the conduct complained of must be both prejudicial and unfair. Prejudice can be shown where the financial position of the shareholder is damaged. Unfairness is an objective assessment and ordinarily requires an examination against the background of the relationship between the parties, any agreements they have entered into and the corporate structure under consideration.

Where the Court is satisfied that the petition is well founded, in accordance with section 996 of the Companies Act 2006, it may make "such order as it thinks fit for giving relief in respect of the matters complained of". The Court has a wide discretion and is permitted to make orders (i) regulating the conduct of the company's affairs, (ii) requiring the company to refrain from doing or continuing an act complained of or to do an act it has omitted to do, (iii) providing for the purchase of the shares of any shareholder of the company by other shareholders or by the company itself. The share purchase is the most common remedy and often involves the majority shareholder buying the minority shareholder's shares.

Kathryn Garbett, a Partner in the Fraud Defence and Business Disputes team says: 

"Unfair prejudice petitions provide shareholders (invariably those with a minority holding) who have suffered prejudice and unfairness to seek a remedy from the Court and in turn protect the value of their shares. Those minority shareholders who do not have an active role in the management of the company, or who have been excluded from management by the majority shareholder, will often have no alternative but to issue a petition to protect the value of their shares. We are seeing an increase in the number of enquiries and instructions on unfair prejudice petitions, particularly involving allegations of fraud, dishonesty and wrongdoing between the parties. This inevitably raises the stakes and entrenches positions in the litigation. Our team has significant experience of dealing with fraud cases on behalf of claimants and defendants enabling us to provide expert advice on the best strategy to pursue when such allegations arise."

Mehmet Karagoz, a Managing Associate in the Fraud Defence and Business Disputes team says:

"A minority shareholder in an unfair prejudice petition is often likely to seek an order for the purchase of his or her shares. Whilst this may be the preferred outcome providing a clean break for all parties, there is likely to be considerable dispute on the mechanics which would enable a share sale to take place. The Court will consider how best to value the shares, whether a discount should be applied for the lack of control in a minority shareholding, and even whether certain sums should be added back which were not appropriate to be spent by the company, for example excessive directors' remuneration, bonuses or benefits. Questions on valuation methodology, discount and add-backs are likely to be extremely contentious and hard fought as they often have a considerable impact on the amount to be paid for the shares in question."

Shona Coffer, a Managing Associate in the Fraud Defence and Business Disputes team says:

"Estera Trust (Jersey) Ltd v Singh (2019) highlights just how important it is to correctly identify the precise nature of the relief being sought.  In this case, the Petitioners very belatedly realised that a purchase of their shares by the company rather than by the individual Respondent, as granted by the Court, would result in very unfavourable tax treatment. The Court declined to intervene and amend the quantum order in a way which would be significantly more financially favourable to the Petitioners. It is of utmost importance that Petitioners consider, at a very early stage, precisely what relief they are seeking and, if necessary, obtain tax advice on the proposed relief."

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