Exit rights of minority shareholders in a private limited company (IVOR nr. 72) 2010/3.3.9.3:3.3.9.3 Tunneling and dilution

Exit rights of minority shareholders in a private limited company (IVOR nr. 72) 2010/3.3.9.3

3.3.9.3 Tunneling and dilution

Documentgegevens:

mr. dr. P.P. de Vries, datum 03-05-2010

Datum: 03-05-2010
Auteur: mr. dr. P.P. de Vries
JCDI: JCDI:ADS410754:1
Vakgebied(en): Ondernemingsrecht (V)

English courts have held several examples of tunneling1 to be unfürly prejudicial, such as the diversion of the business of the company and claiming excessive remuneration. In addition, on occasion courts have held the issue of shares when a member cannot take up his proportion to be unfürly prejudicial. Now let us turn to some cases in which examples of tunneling have been held unfürly prejudicial.

In the case of Re Cumana all these circumstances were present.2 The case concerned a company with two shareholders. The first shareholder, Bolton, held two thirds of the shares in the company, as the second, Lewis, held one third of the shares. Bolton was also a director of the company, unlike Lewis. It was informally agreed that Lewis would be informed about all major decisions in the company's affürs and that the company's profits should be divided in proportion to the shareholdings. This agreement was based on mutual trust and confidence. Bolton diverted some of the business to another company. According to Lawton LJ, there was no good commercial reason for this diversion of business. Secondly, Bolton attempted to make a share issue. He knew that Lewis was financially unable to take up his proportion, so that the effect would be that Lewis would end up with less then one per cent of the shares. Thirdly, Bolton claimed excessive remuneration and did not consult Lewis about this. All these three circumstances were held to be unfürly prejudicial to the interests of Lewis. An order for the buy-out of Lewis was given by the court.

Another diversion case is Re London School of Electronics.3 This case is about a company, London School of Electronics, which provided courses in electronics. The company had the characteristics of a quasi-partnership. Twenty-five per cent of the shares in this company were held by the petitioner, who was director of the company as well. Seventy-five per cent of the shares were held by another company, named CTC. The directors of the latter company were also directors of the London School of Electronics. At a certain time, CTC decided to transfer students from the London School of Electronics to CTC and, sub sequently, this decision was carried out. These students generated a substantial source of the company's income. Nourse J. held that the appropriation of the students was the cause of breakdown of the mutual confidence between the quasi-partners. He considered that the conduct was unfürly prejudicial to the interests of the petitioner as a member; an order for the buy-out of the petitioner was awarded.

In the case Re Brenfield Squash Racquets Club Ltd, eighty-six per cent of the shares of a company, named BSRC, were held by another company, by the name of FMR.4 The other shares were held by some minority shareholders. The directors of BSRC were also the directors of FMR. According to Rattee J, the directors failed to make a proper distinction between the affürs of the two companies. Inter alla, the directors had caused BSRC to grant a significant charge over its assets for the benefit of FMR. This was clearly not advantageous to BSRC. Furthermore, the directors entered into agreements with a third person that were advantageous to FMR and to the detriment of BSRC. The latter agreements eventually were not executed. Rattee J. held that the whole pattere of the management of the company's affürs had been to use the company to the advantage of FMR. This led to the conclusion that the company's affürs had been conducted in a manner unfürly prejudicial to the interests of the minority shareholders. The judge ordered, as was petitioned, the buy-out of the majority shareholder by the minority shareholder.

In Re Elgindata Ltd, Warher J held:

"By its very nature the misapplication of a company's assets by those in control of its affürs for their own benefit or for the benefit of their family and friends, is unfürly prejudicial to the interests of minority shareholders."5

In Re a company (No 005134 of 1986) ex p. Harries, Gibson J considered on the issue of shares resulting into the dilution of shares of a minority shareholder:

"Indeed, I cannot conceive of a more blatant case of unfürly prejudicial conduct to a member than the unilateral and secret exercise by a director of the power of allotment so as to increase his own shareholding from 60% to 96% and to reduce the other member's holding thereby from 40% to 4%."6

Toon alle voetnoten

Voetnoten

Voetnoten

For the definition of tunneling, see § 1.1.4 of this study.

Re Cumana Ltd [1986] BCLC 430.

Re London School of Electronics [1986] Ch. 211.

Re Brenfield Squash Racquets Club Ltd [1996] 2 BCLC 184.

Re Elgindata Ltd [1991] BCLC 959.

Re a Company (No 005134 of 1986) ex p. Harries [1989] BCLC 383 at 395. Another case in which a share issue was held unfürly prejudical and in which a buy-out was ordered: Dalby v Bodilly [2004] EWCA 3078.