4.4.5.3.2 Limitations on seeking expectations beyond the articles

Concerns have been expressed that "a limited company, however small, essentially differs from a partnership", and "the court has no power or at least ought not to dispense parties from observing their contracts", or "too great a use of the partnership analogy would dissolve the nature of a company".1 Lord Wilberforce realized the risk and said that a company however small, however domestic, was a company, not a partnership and something more was needed to add partnership-like obligations to shareholders.2 According to him, the something more was a quasi partnership company. But it is not easy to formulate a definition of a quasi partnership. The House of Lords indicated that a quasi partnership might include one or more of the following elements: (i) an association formed or continued on the basis of a personal relationship, involving mutual confidence; (ii) an agreement, or understanding, that all, or some (for there may be "sleeping" members), of the shareholders shall participate in the conduct of the business; (iii) restriction upon the transfer of the members' interest in the company.3 Put alternatively, it is a private company in which there is a close relationship between shareholders, and the cooperative basis is to share the management of the business rather than merely making a passive investment.4 In this situation, equitable considerations are allowed to penetrate the corporate structures and subject members to partnership-like duties.

In the Saul D Harrison case,5 Hoffmann J. endorsed the reasoning of Lord Wilberforce. Whether one can look beyond the articles depends on the nature of the company. The fact that a company is a small or a private company is not enough.6 Only when the requirement of "something more" is met, i.e. only in a quasi partnership company, a "legitimate expectation" which embodies the fundamental understanding between the shareholders and forms the basis of cooperation may arise, entitling a party to contend that in certain circumstances it would be unfair for the majority to exercise a power conferred by the articles.7 In Saul D Harrison, as the judge emphasized, there was nothing more than a purely commercial entity. Neither the history of the company nor the relationship between the shareholders allowed the superimposition of an equitable fetter on the exercise of the rights conferred by the articles of association of the company.8 Thus, in the absence of "something more", the court is limited to exercising its equitable power, and the board and the general meeting can exercise powers conferred on them by the articles of as sociation.9

In O'Neill, Hoffmann J gave the understanding of unfairly prejudicial act another go in the context of breach of the articles and agreements: a breach of s. 994 not only occurs when one fails to keep his undertaking or breaches others' legitimate expectations, but a strict enforcement of what one has agreed in face of fundamental changes of circumstances may lead to unfairly prejudicial conduct as wel1.10 It resembles hardship in contract law.11 To prevent unnecessary confusion, in this case, although it was judged that the parties had not reached agreement on the terras of the litigated issues, the judge proceeded nevertheless and drew the above-mentioned conclusion for occasions with agreed terras.

Mr Philips owned a company in the construction industry and specialized in stripping asbestos from buildings. In 1983, O'Neill joined the business as a manual labourer. Because of his excellent performance, 0 was later appointed as a director and since then was in charge of the day-to-day operation of the company as the sole director. He owned 25 per cent of the shares but was entitled to half of the profits as long as he remained active in the management. In 1990, negotiations were held between the two, and P indicated that if the amount of the net asset value were to reach a certain figure, 0 would ultimately have an equal shareholding and the same voting power. It was contemplated that a formal agreement would be drafted to embody these terms. But this did not happen. Negotiations stopped at that point. Later, the market slumped, therefore the target figures could not be reached. At an acrimonious meeting in 1991, P criticised 0 and told him that he would no longer receive 50 per cent of the profits but would only be paid his salary as a director and any dividends on his 25 per cent shareholding because P planned to resume personal command of the business. 0 filed a petition onder s. 459. The House of Lords held that going back from 50% profits to the proportion of O's shareholding was not unfair. 0 could enjoy a 50 per cent profit as long as he functioned as managing director. Neither was the breaking of promises which repudiated the alleged agreement for an allotment of more shares unfair. Mr O'Neill's assertion that their relationship could not be put together again was not the result of anything wrong or unfair which Mr Phillips had done and s. 459 did not support an exit at will.12

In this case, Nourse LJ from the Court of Appeal held that, although no agreement had been concluded to give him more shares, 0. had a "legitimate expectation" of receiving them when the figures were reached, but this prospect was eliminated by P. Likewise, he had a legitimate expectation of receiving 50 per cent of the profits. It was unfairly prejudicial to his interests when these expectations were later denied by P.13 Lord Hoffmann did not agree and pointed out that Nourse LJ erred in the judgment and was misled by the concept of legitimate expectations. In his opinion, 0 did not have a right to the shares because parties entered into negotiations with a view to transfer of shares on professional advice and were aware of the condition that they were not to be bound until a forma! document had been executed and legitimate expectations could not have been established in the absence of breach of an agreed term. P had never agreed or promised to give the shares. Therefore, when he withdrew from the negotiations, it would have been too soon for the court to assen that 0 had a right to the shares and impose an obligation on P to which he had never agreed. The reasoning is that only when parties agree with each other can the basis for mutual understanding be formed from which legitimate expectations may arise and even outweigh strict legal rights. A one-sided expectation cannot be a legitimate expectation. I think, when we say "legitimate"/ "reasonable" expectations, the underlying implication is that the expectation is understood and agreed by both parties.

The same reasoning holds for the sharing of profits in this case. P had never agreed that 0 could enjoy the 50 per cent profits forever. He mentioned once that he would share the profits equally with 0 on condition that 0 managed the company and he himself did not have to be involved in the day-to-day business, which words indicated that he had deliberately retained control of the company and was entitled to re-determine O's duties and salary structure. So when he resumed the daily management, there was nothing unfair about 0 enjoying the profits in proportion to his shareholding. The legitimate expectations of 0 did not depend on the subjective intention of 0 nor of the judges.14 In this case, no agreement was reached and thus, the unfairness could not be established. Nonetheless, it was pointed out that despite agreed terras, when the circumstances fundamentally changed, it would not be fair for the court to ask the parties to keep to their agreed terras.