4.4.5.4.4 Breach of director's duties

The discussion of director's duties is a popular topic. The breach of director's duties is also a closely observed and widely debated category of cases under s. 994.1 Two points will be discussed in this part. Firstly, allegations of breach of director's duties were traditionally dominated by derivative actions, but sine a wrong done to the company may also harm the interests of its members, it is also possible to petition under s. 994. What is the relationship between the two types of litigation? Secondly, what is the court's position and opinions in this case category? As we already know, the English courts do not have the tradition or willingness to intervene in corporate management. The courts feel equally unconformable if all the decisions are free from court review and rest solely on a simple majoritarianism, given the fact that the minority is thus exposed to oppressive or opportunistic conduct, particularly in close companies. We shall therefore see that the courts will ondertake the task of working out the appropriate boundaries of intervention in cases where allegations of breach of director's duties arise, and more readily so in close companies. So far the achievements in this regard are not as comprehensive and developed as in "legitimate expectations" in the event of breach of informal agreements, but it already shows "a partial revolution in judicial attitudes".2 Because of the broad scope of s. 459 (s. 994), petitions were filed under this category and some guidelines have been developed in certain situations It would be an impossible task to fully discuss the standards and requirement of court review here. The section tries to examine the court's reasoning and standing points in the situation of assets sold at undervalue and mismanagement.

When remedies for breach of director's duties are discussed, the natural response is to resort to derivative actions because derivative actions have traditionally been the only recourse in litigation against the breach of director's duties. The rule set in the Foss v. Harbottle decision laid the foundation for derivative actions: in the event of a wrong done to the company, the proper plaintiff is the company not an individual shareholder, and if the wrong could be rectified by a majority of shareholders, the wrong is considered remedied; no action is possible.3 The purpose of this rule is to bar petitions by individual shareholders from redressing a wrong done to the company. To strengthen minority shareholder protection, exceptions to the Foss rule were subsequently developed by which individual shareholders could sue for damages on behalf of the company in severely restricted situations.4 But, as the analysis in the US part shows, even though the minority is allowed to bring a derivative action, the nature of such actions prevents them from providing adequate protection to minorities in close companies because the remedy offered by a derivative action is usually limited to corporate relief.5 If however, the tree purpose of the petitioner 's complaint is to have his or her personal interests bought out at a fair price rather than to have losses restored to the company, they would not be happy with a corporate relief.6 The unfair prejudice remedy, which is able to override the rule in Foss v. Harbottle and able to recover personal losses, has therefore become popular in close companies.7

Derivative actions have not been precluded by the availability of s. 994 proceedings, and vice versa.8 Which remedy to choose is a matter of point of view. In a derivative action, the petitioner has to prove the action is unlawful. There is no need to assume the burden of proving that the acts or omissions complained of constitute unfairly prejudicial management of the company's affairs.9 Unlawful conduct does not necessarily mean unfair. So the unlawfulness of an action does not matter that much for a successful petition under s. 994. A lawful action within powers can still be unfairly prejudicia1.10 If a member 's actual complaint is about the unlawfulness of the conduct and corporate relief, it would be inappropriate to embark on proceedings under s. 994.11 In s. 994 the test for unfairness is "based upon equitable principles of good faith" instead of a faithful compliance with and enforcement of the strict legal rights.12 In a word, under s. 994, the unlawfulness of the acts or omissions is not the whole gist of the complaint.

In conclusion, the very same facts may well be brought to court by either a derivative action or a s. 994 petition. The distinction between the two does not lie in the particular acts or omissions but in the nature of the complaint and the remedy necessary to meet it.13 To be specific, the petitioner has to choose whether to prove unlawfulness or unfairness and whether to seek mainly an exit remedy or to remain in the company but ask to correct the misconduct. The unfair prejudice remedy, "like the law of divorce, is much better at bringing relationships to an end on a fair basis than at restoring partnerships which have broken down."14

There are cases under s. 994 concerning whether a sale of the company's assets at undervalue is unfairly prejudicial conduct.15 Two points need to be clarified. Is the standard for asserting undervaluation a subjective or an objective test? And is undervaluation alone enough for a successful unfair prejudice petition? Case law has established that whether or not a transaction was at an undervalue has to be assessed objectively, which means whether or not the board considers the assets transferred at a appropriate value is not a factor which prevents the court from deciding that the transfer was at an undervalue.16 Moreover, the establishment of undervaluation instead of breach of director 's duties is the first step in winning a s. 994 case as even if breach of duties can be found, the petitioner could not have suffered any unfair prejudice if the best price has been achieved.

The mere establishment of undervaluation, failing breach of fiduciary duties, however, is not enough either to rely upon on s. 994.17 As demonstrated, undervaluation may be unlawful and infringe the petitioner's legal rights but unlawfulness alone is not enough. The petitioner must prove that their interests are unfairly prejudiced.18 In my view, in the event of undervaluation, it is selfevident that every shareholder's interests are prejudiced by the act. The difficult part to prove is unfairness, and without any breach of duties, such unfairness is not easily established. It would be an obvious case if the majority had received secret benefits at the expense of the minority. In Wyatt, for instance, the transfer of the company's property to persons associate with the respondents at undervalue was ruled as unfairly prejudicia1.19 But it is difficult to assen unfairness if the undervalue is due to a breach of the duty of care, such as gross negligence. In this situation, it may be easier to achieve the preferred result by way of a derivative action by alleging the damage suffered by the company, but obtaining relief under s. 994 is uncertain. The result is hard to predict.

Generally speaking, insignificant breaches in management, such as mismanagement or poor management, are viewed as normal investment risks and the courts are reluctant to interfere.20 Prior to s. 459 (the predecessor of s. 994), courts excluded mismanagement from the types of conduct covered by the term oppression in s.210.21 So "there is linie authority on the extent to which negligent or incompetent management of a company's business may constitute conduct which is unfairly prejudicial to the interests of members for the purposes of s. 459 (s. 994)."22 Case law under s. 459 has nevertheless agreed that under some situations, mismanagement can be alleged to have been unfairly prejudicial to the shareholder 's interests as well.23

In Re Elgindata Ltd,24 Warher J said "I do not doubt that in an appropriate case it is open to the court to find that serious mismanagement of a company's business constitutes conduct that is unfairly prejudicial to the interests of minority shareholders. But I share Peter Gibson J's view that the court will normally be very reluctant to accept that managerial decisions can amount to unfairly prejudicial conduct."25 Three points can be summarized from the above words. First, serious mismanagement can be an allegation under s. 994. Secondly, the idea of a case by case examination under s. 994 is re-emphasized. Thirdly, even if a managerial decision is proved to be wrong or a failure, as a matter of commercial judgement, it is difficult to deem it as serious mismanagement under s. 994.26 What then does serious mismanagement mean? Later cases offered useful illustrations: firstly, mere disagreement between the petitioners and those in control of the company's affairs is not serious mismanagement.27 In Saul D Harrison, the company was incorporated in 1947 and engaged in the trading of rag. There were 3 different kinds of shares in the company. Class A had voting rights, but no rights to dividends nor any of the company's assets in a winding up. B and C shares carried no votes. B shares were entitled to 10 per cent of distributable profits before the equivalent dividend on C shares. The petitioner, holding 8 per cent of C shares, alleged that the directors had acted in a way contrary to the petitioner 's legitimate expectations because the directors had not acted in the best interests of the company: although the company had substantial net assets, the accounts of the company showed that the company had been making trading losses for many years. The petitioner claimed that the company's business was doomed but the directors had allowed the assets to be dissipated in losses in order to preserve their own inflated salaries and perquisites. He believed that no reasonable board of directors acting in good faith and without regard to their own interests should have continued to trade.

The court supported the evidence provided by the respondent on the profits issue. First, there was a change of business. The company was diversifying and expanding its business with a prospect of earning a level of profit in the future years which would reflect the value of the assets employed in the business.28 Second, there was a change in the accounting method. The Lords Judges therefore shared the same view with the High Court that there was no selfinterested motivation to continue the business; genuine efforts and true expectations of future success were involved.29 Consequently, the petitioner 's interests had not been unfairly prejudiced and mere disappointment of the management is not a cause to allege unfair prejudice.30

Secondly, fault or negligence in formalities and procedural issues are not included in s.994 unless they have lasted for a long time or constantly recurred. In Re a Company Ex p. Schooter,31 the company ran a football club. K had a controlling shareholding and was chairman as well as secretary. He ran the company without formal administration: failed to hold annual general meetings, did not prepare annual accounts, and called extraordinary general meetings without giving sufficient notice. In a word, he conducted the company's affairs in an "entirely irregular" manner. Having considered all the above facts, the court drew the conclusion that K was unfit to control the company and should sell his shares to the petitioner.32 In his judgment, Harman, J admitted that failing to run the company with a proper administration as K had done was wrong. K had conducted the company's affairs in breach of statutory requirements, and his behaviour was most likely unfairly prejudicial to its members. But the judge also believed that "it is not conduct of a considerable weight or gravity." His reasoning was thus in accordance with the judgment of Warher, J in Re Elgindata Ltd: "Mismanagement which does not carry enough seriousness will not be considered under section 459."33 It also accorded with the reasoning of Peter Gibson J, who held that a trivial misconduct was quite incapable of being a ground capable of being alleged to be conduct unfairly prejudicial to the interests of any member of the company.34 In this case, however, Harman J pointed out that trivial misconduct repeated for a long time and cumulatively preventing others from knowing what was going on in the company was conduct serious enough to be judged under s. 994. The judgment was respectfully followed in a later case, Re Marco Ltd, where the respondent T, a majority shareholder as well as sole director, failed to conduct effective super-vision of the company's affairs. The company made profits through collecting rental income.35 But Mr Thompson had not followed any detailed guidelines on repairs or improvements of the properties' condition. He had failed to exercise control over maintenance and improvement works; failed to supervise repairs and inspect properties regularly; wasted money by not repairing the properties since the cost would have been tax deductible, and so on. Mr Thompson's general policy was to spend as Edie as possible which lelt the company's properties in poor condition with serious depreciation in value and low rents as a result. As a general rule, the court does not concern itself with issues such as management quality, but in this case, the court stepped in because the dispute could not be solved simply by firing the director by the company's own will since the directorship was held by a majority shareholder. The court supported the petitioner's claim because it deemed that specific acts of mismanagement had been repeated over many years and destroyed the other shareholder's confidence in the respondent's ability and willingness to conduct the company's affairs in a proper way.36 The above-mentioned cases, show that claims about mismanagement in company affairs are entitled to relief under s. 994 only when they are serious enough. And to date, seriousness in this category is interpreted as repeated misconduct and omissions or utter incompetence.