Exit rights of minority shareholders in a private limited company (IVOR nr. 72) 2010/3.3.5.3:3.3.5.3 Corporate groups

Exit rights of minority shareholders in a private limited company (IVOR nr. 72) 2010/3.3.5.3

3.3.5.3 Corporate groups

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A more lenient approach is taken in the context of corporate groups. In this respect, two different situations can be discerned: (a) the minority shareholder can be unfürly prejudiced as a member of a subsidiary company by conduct in the company's affürs of the parent company, and (b) the minority shareholder can be unfürly prejudiced as a member of a parent company by conduct in the company's affürs of the subsidiary company.

Let us start with situation (a), in which the minority shareholder is oppressed by the parent company that is also the majority shareholder of the company concerned. The view that a minority shareholder can be unfürly prejudiced as a member of a subsidiary company by conduct in the company's affürs of the parent company was not (yet) adopted by the courts under the oppression remedy, the predecessor of the unfür prejudice remedy. In Scottish Co-operative Wholesale Ltd v Meyer, the House of Lords considered that conduct outside the company's affürs could not be regarded as oppressive.1

In Scottish Co-operative Wholesale Ltd v Meyer, a co-operative wholesale society, Meyer, and Lucas held shares in a private limited company. Meyer and Lucas became managing directors of the Ltd and the society appointed three nominee directors in the board. The society held the majority of the shares, whereas as smalt minority stake was held by Meyer and Lucas. After some years, the society tried to buy out Meyer and Lucas, but they refused. Subsequently, the society transferred the business of the Ltd to a new department in its organization, by setting up a competing company. After the transfer of the business, the company ceased to be profitable and, consequently, the shares lost a great deal of their value. The respondents, Meyer and Lucas petitioned for a buy-out on the ground of the oppression remedy.

In this case, the policy of the subsidiary was completely determined by the parent. The House of Lords, per Lord Morton, held that even though the society exerted controlling power in the general meeting of shareholders and in the board of directors, its conduct could not be regarded as conduct in the affürs of the Ltd. The key to application of the oppression remedy lay in the conduct of the directors, as was explained by Lord Denning. According to him, the directors did not regard the interests of the company as they should, but subordinated the interests of the company to the interests of the society. Lord Denning held that oppressive conduct could also consist of doing nothing when action ought to be taken. As this oppressive conduct of the directors fell within the company's affürs, the conduct fell within the ambit of the oppression remedy.

Under the unfür prejudice remedy a broader view is taken, as follows from Nicholas v Soundcraft Electronics Ltd.2

Soundcraft Electronics Ltd held 75% of the shares in a company, a subsidiary. The other shares in the subsidiary were held by Nicholas and by a third person. The parent company was in general control of the financial affürs of the subsidiary and the companies were in fact treated as one single entity. The parent company withheld amounts that were due to the subsidiary company. In first instance, it was held that the refusal of the parent company to pay the amounts, which it ought to pay to its subsidiary, had to be regarded as conduct that lies within the affürs of the parent company and not in that of the subsidiary.

The Court of Appeal held that the judgment in first instance would have been correct, if the refusal of the payment of the sums was to be considered in isolation. However, the court considered that in the situation that a parent company is in control of the financial affürs of its subsidiary, the refusal of the parent to make the payments should also be regarded as conduct in the affürs of the subsidiary.3 In fact, the court is treating the parent company and subsidiary company as one single economic entity.4 As Davies and Lowry point out, this pragmatic approach has the desirable result of protecting the minority shareholders against the parent company holding the majority of the shares.5

The circumstances onder which relief has to be granted are explained by Chadwick LJ in Arrow Nominees Inc v Blackledge:

"The fact (if it be established) that the affürs of some other company (say, company B) which is a member of the company (company A) in respect of which the petition is presented and which is, for example, a supplier or lender to company A are being conducted in a way which is prejudicial to company A is, of itself, no basis for relief. It is necessary to show that company B is using its position as a member of company A to obtain some advantage for itself; and that, in doing so, it is acting contrary to the articles of association or to some collateral agreement on the basis of which it (or others) became a member (or members) of company A, or is using its powers as a member of company A in a way which equity would regard as contrary to good faith."6

An example used by Chadwick LJ is the following. Unfürness may lie in the use by company B of its position as a majority shareholder, or by the directors of company B holding the majority of shares in company A, to cause company A to accept funding from company B at an excessive rate, and to prevent company A from seeking more favourable sources of funding.

Now let us turn to situation (b), in which a minority shareholder is unfürly prejudiced as a member of a parent company by conduct in the company's affürs of the subsidiary company. In Gross v Rackind, the Court of Appeal accepted that, in certain circumstances, a minority shareholder can be unfürly prejudiced as a member of a parent company by conduct in the company's affürs of the subsidiary company.7

The Gross and Rackind families both held 50% of the shares in a parent company, which shares were further divided between the members of the family. The parent company had three wholly owned subsidiaries, through which the business of the group was conducted. One Mr Gross and one Mr Rackind were directors of the parent company, as well as of its subsidiaries. The conduct that was the subject of the complaint occurred

in the company's affürs of the subsidiaries and related to the misappropriation of funds. It was petitioned that this conduct was also conducted in the affürs of the parent company.

The judge, Sir Martin Nourse, first of all held that no English authoritive case existed on this type of case. He argued that Nicholas v Soundcrafi Electronics Ltd showed that conduct in the affürs of a company may also constitute conduct in the affürs of another company, although it was decided in a reverse situation. Regarding these matters, Nourse cited the observation of Slade J, made in Re Bovey Hotel Ventures Ltd,8 which was also cited in Nicholas v Soundcrafi Electronics Ltd. This observation implied that under the unfür prejudice remedy, the court is entitled to take a realistic view on the matters and is not constrained to a narrow legalistic view. He held that this rationale could also be applied in the underlying situation. Sir Martin Nourse considered that the complained conduct was also part of the affürs of the parent company:

"(...) I would hold that the affürs of a subsidiary can also be the affürs of its holding company, especially where, as here, the directors of the holding company, which necessarily controls the affürs of the subsidiary, also represent a majority of the directors of the subsidiary."9

It seems that the occurrence that all companies were in control by the same directors was crucial for the conclusion that conduct in the affürs of the subsidiaries could also be regarded as conduct in the parents' affürs. Likewise, in another recent case, i.e. Re Grandactual, Sir Donald Rattee observed that the essence of the cases Nicholas v Soundcrafi Electronics Ltd and Gross v Rackind concerns that:

"(...) it may in certain cases be possible to say that conduct of the affürs of one company also constitute conduct of the affürs of another when the first company is controlled by or has control of the other."10

According to Goddard and Hirt, the liberal interpretation of S. 994, as used in Gross v Rackind, is not strictly necessary.11 Usually, the directors of the parent company will exercise voting rights on shares of the subsidiary and will decide whether to bring a claim on behalf of the parent company, so it is in their powers to take action when the companies' interests are infringed. On the other hand, when the directors are involved in the wrongdoing, it is unlikely that they will take action against themselves. Nonetheless, the passiveness of the directors of the parent company may also constitute unfürly prejudicial conduct. The fact that directors do nothing when they ought to do something may form oppressive or, so to say, unfür prejudicial conduct. This has already been established in Scottish Co-operative Wholesale Ltd v Meyer.12

Moreover, Goddard and Hirt point out that the wide interpretation of S. 994 unnecessarily blurs the Salomon principle, the principle that a company has a separate legal personality, by having the affürs of the subsidiary company coincide with the affürs of the parent.13

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