Sometimes known as a “corporate divorce”, unfair prejudice petitions are a remedy available to company members by virtue of section 994 of the Companies Act 2006. This allows any member of a company to petition the court for relief where the company’s affairs are being, or have been, conducted in a manner that is unfairly prejudicial to the interests of the company’s members, including at least the petitioner.
The intention of this remedy is to protect minorities within the company from abuse of power by the majority. Normally, a petition is brought by a minority shareholder against the majority shareholder(s), and typically the majority shareholder(s) has, or have, a dominant position on the board of directors. Common examples of unfair prejudice include misappropriation of company assets, or unfairly excluding the petitioner from management in circumstances where he or she legitimately expected to be involved.
Company directors are often personally the respondents to unfair prejudice petitions. This is a particular hazard because (i) such claims can be difficult to settle, given that the remedy sought is frequently non-monetary; and (ii) they can be brought against directors or officers personally, yet no company funds can be expended on the defence of the claim. We consider these issues below.
Difficulty of settling petitions
The most common remedy is an order requiring the petitioner’s shares to be bought by the majority shareholder at a fair value, thereby facilitating the “divorce” on terms favourable to the petitioner. This is frequently offered by the respondent making an offer – known as an O’Neill v Phillips offer, named after the eponymous case in which the necessary ingredients of such an offer were clarified – to buy the petitioner’s shares at a value to be determined by an independent expert valuer, and to pay the respondent’s costs. If the offer is not accepted, it may then be possible for the respondent to get the claim struck out on the basis that he has already offered everything that the petitioner may expect to be awarded if the claim proceeds to trial.
Yet making such an offer immediately presents a problem: what is a fair value for the shares? The expert’s valuation may not necessarily settle this question. For example, the parties may disagree about the appropriate date of the valuation. Although the court will usually order the shares to be valued at the date of the prejudice itself, or the date of the petition, the court is free to choose an earlier date if necessary in the interests of fairness: for example, where the petitioner successfully argues that the value of the company has been diminished by the unfairly prejudicial conduct. The parties may also dispute whether a discount should be applied to reflect the fact that the petitioner has a minority shareholding, and therefore lacks control over the company.
Furthermore, what if the remedy sought is something else altogether? Unfair prejudice petitions can be brought against companies limited by guarantee as well as companies limited by shares. The former may include, for example, sports and social clubs, or management companies of blocks of flats. In such cases, the share purchase option is not available. A potentially limitless range of alternative remedies is available to the Court, which has a wide discretion to make such orders as it sees fit to address whatever unfair prejudice the petitioner can establish, but this can lead to disproportionate cost escalation.
For example, in a recent dispute, a former member of a golf club, who had been excluded from membership after sending abusive messages to the club’s captain, made an application to restore his name to the Register of Members (so as to have standing to bring the petition) and alleged that his exclusion amounted to unfair prejudice. The remedy sought was non-pecuniary and unacceptable to the club (making the claim exceptionally difficult to settle), but eventually a resolution was achieved after three years, with both sides each incurring costs well into six figures.
No company funds can be expended on the defence of the claim
Unfair prejudice petitions are properly viewed as a dispute between members of the company, not a dispute with the company. Although the company itself is normally named as a respondent to the petition, it is only a nominal respondent; that is to say, it is only joined so that it is bound by any orders that the court may make.
This means that, with very limited exceptions, directors are not permitted to use company monies or assets to fund the defence (or indeed the pursuance) of an unfair prejudice petition. Indeed, doing so is likely to amount to a breach of a director’s duties and may itself amount to unfair prejudice.
The impact of this on a director at the receiving end of an unfair prejudice petition is stark. They must, of course, defend the claim or else risk default judgment, but they will have to pay legal costs themselves – unless, of course, they are adequately insured.
Importance of D&O insurance
The hazards presented by unfair prejudice petitions demonstrate the value of D&O Insurance. Without it, company directors and officers may find themselves having to defend highly protracted and costly legal proceedings, either out of their own pocket or without legal representation.
If a policy is in place, it may respond to an unfair prejudice petition as long as the respondents are directors or officers, and as long as the allegations made concern acts committed by them in that capacity. If the allegations relate only to their duties as shareholders (for example, breach of a shareholders’ agreement) then this may not be the case. If the policy does respond, the insured may still face a prolonged dispute, but at least they will at least have the peace of mind – and the considerable negotiating advantage – of having their costs covered.
