Exit rights of minority shareholders in a private limited company (IVOR nr. 72) 2010/3.3.13:3.3.13 Reform of the unfür prejudice remedy

Exit rights of minority shareholders in a private limited company (IVOR nr. 72) 2010/3.3.13

3.3.13 Reform of the unfür prejudice remedy

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A major problem is that unfür prejudice proceedings are often time-consuming and costly. The open standard of the section is considered to be a cause of this problem.1 In order to show unfür prejudice, petitioners often include as many allegations as possible.2 Any incentive to limit the number of complaints seems to be absent.

"It is well known among company lawyers that although ss. 459-461 were intended to provide a fürly summary remedy for minority shareholders who have been unfürly prejudiced, proceedings under the section often become bogged down in a mass of written evidence containing numerous accusations and counter-accusations reminiscent of petitions and crosspetitions alleging cruelty under the old divorce law."3

In recent debate on company law reform attention was paid to the difficulties brought about by s. 994 CA 2006 petitions.

As we have seen above in § 3.3.1., a statistical survey of the Law Commission has revealed that 85% of the petitions under the unfür prejudice remedy involved Ltds with five or fewer shareholders. In 70% of the petitions, the pleaded allegation was exclusion of management. In about 70% of the cases, a buy-out order was requested.4 For this specific category of cases, the Law Commission recommended amending the unfür prejudice remedy, in the way that certain presumptions apply if certain conditions are met.

First, the Law Commission described the conditions that need to be present, for the presumptions to apply:

the company is a private company limited by shares;

the petitioner has been removed as a director or has been prevented from carrying out all or substantively all of his functions as director;

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 substantively all matters, and (b) all, or substantially all of the members of the company were directors.5

If these conditions are fulfilled:

(...) the affürs of the company will be presumed to have been conduct in a manner which is unfürly prejudicial to the petitioner, unless the contrary is shown.6

If the first presumption is not rebutted, a second presumption will take effect:

where the first presumption is satisfied that it ought to make an order that one or more of the respondents should purchase the petitioner 's shares, the shares should be valued on a pro rata basis unless the court otherwise orders.7

According to the Law Commission, adding this system of presumptions to the unfür prejudice remedy would establish a degree of legal certainty for petitioners, add speed to proceedings and maintain the flexibility of the unfür prejudice remedy. In its opinion, the presumptions will add a degree of legal certainty, for the reason that it will be more predictable which position the courts are likely to take. Respondents would have to give proper reasons to establish why presumptions have to be rebutted. This could limit the allegations brought by the parties that need to be considered by the court and, subsequently, could reduce the length of proceedings. The Law Commission was of the opinion that it is not likely that the flexibility of the unfür prejudice remedy would be affected by the introduction of the presumptions.8

In addition, the Law Commission considered active case management as the most effective way to make unfür prejudice proceedings less time-consuming and less costly. The Commission stated that the Civil Procedure Rules of 1998,9 which were not yet implemented at that moment, would make it possible for the court to act in a more proactive way and to apply active case management. According to the Commission, especially the possibility of dismissal of claims, which have no realistic prospect of success and the exclusion of issues from determination by the court, would contribute to this.10

The impact of the new procedural rules on the unfür prejudice remedy can be shown by means of the case of North Holdings Ltd v Southem Tropics Ltd, a case decided under the CPR.11 In the concerning case, Aldous LJ exposed the following about the CPR:

"At the heart of those rules is the requirement of the court to manage cases actively. That will require a new approach by the Registrar (...). He will need to give directions to enable petitions to come on for trial efficiently, quickly and as inexpensive as possible. (...). Ample use should be made of the power to require a joint expert or the appointment of an assessor."12

In the same case, Moffin LJ pointed out that, as in the past the court had to choose between striking out or to proceed, under the CPR the court has the power to manage cases more actively. He added:

"Where the issue is the basis of the valuation then the identification of the problem and the trial of a preliminary issue directed to it should remove that obstacle to an agreement. Where the issue is the identity of the valuer the problem often crises because the person suggested in the articles or by the majority shareholder is the auditor. (...) In such cases the obstacle may be removed by the court itself appointing an expert to value the shares (...)."13

The CLR did not sustain the Law Commission's proposal to implement the presumptions. Several respondents in the consultation performed by the CLR advanced that the presumptions would encourage litigation. The CLR also doubted whether the presumptions were consistent with 0 'Neill v Phillips judgment, which judgment was decided after the Law Commission's report.14 The CLR followed the view of its working groups on small firms and on its working group on shareholder rights:

"The clear conclusion was that the article would not be used in practice because on commercial grounds it would not be incorporated in company constitutions by well-informed founders and was inherently undesirable on grounds of lack of flexibility — it was impossible to prescribe in advance, and for the full diversity of companies, what would be a für exit regime. For ill-informed founders it would be a trap."15

Wholeheartedly, the CLR supported the opinion of the Law Commission that the new CPR should play an important role to achieve active case management.16

In the opinion of Hannigan, the O'Neill v Phillips judgment brought clarity with respect to the scope of the unfür prejudice remedy, so that in fact the position is not very unlike to that proposed by the Law Commission through the proposals for rebuttable presumptions. She opined:

"In a large number of petitions, the outcome is utterly predictable, both as to finding of unfür prejudice and as to the remedy which will be ordered. It is to everyone's advantage for the parties to appreciate at an early stage that that is the position and for incentives to be provided to encourage them to resolve the matters themselves by a für offer by the majority to purchase the shares of the minority. With the law forcing the predictable outcome in the predictable case, it may be that we have reached the optimum solution to these shareholder disputes via the case law such that further legislative reform would only unsettle the position as now established. It is therefore advantageous that no proposals for changes to the substantive law have emerged from the Company Law Review."17

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