Farming companies: Unfair treatment by fellow shareholders

Many farming and other businesses operate through the structure of a limited company, which is owned by its shareholders, who hold shares in agreed percentages. Although this provides plenty of advantages for the owners, what happens when a shareholder is treated unfairly by their fellow shareholders?

Unfair prejudice petition

A shareholder (A) of a company may find themselves in a position in which some of the other shareholders (typically those who own a majority %, but not always) are also directors who are conducting the affairs of the company in a way which is unfair and prejudicial to shareholder A’s interests – or to the shareholders of the company more generally.

Conversely, shareholder A may be a shareholder or director-shareholder who is the subject of another shareholder claiming they are being unfairly treated.

In such circumstances, it may be open to the aggrieved shareholder(s) (Petitioner) to bring what is known as an Unfair Prejudice Petition (UPP) under section 994 of the Companies Act 2006 against the shareholders accused of treating the Petitioner unfairly (Respondent).

A vital starting point is that, whilst shareholders are entitled to assume the company is being managed properly, and there is no statutory time limit, they must not delay in bringing a petition. The Court will not allow a UPP to be used to rake “over old grievances” and delay can be fatal – so seeking advice and understanding the position from the outset is the first step.

What must be established to bring a successful unfair prejudice petition?

Akin to its name, the aggrieved shareholder must establish that the conduct complained of is both unfair and prejudicial. However, conduct by the directors and/or other shareholders can be unfair without being prejudicial and vice versa. A petition will be unsuccessful should a petitioning shareholder fail to establish both elements.

The Court will ask: would a reasonable person regard the conduct as having unfairly prejudiced the Petitioner’s interests as a shareholder?

Unfairness

The key starting point is the express formal legal documents of the company such as the articles of association and any shareholders’ agreement(s), as well as the requirements of the Companies Act 2006. The conduct complained of need not be unlawful, but it must be
inequitable.

The Court will ask: is the conduct complained of contrary to (i) the company documents and/or (ii) what the parties agreed?

Prejudice

Though financial loss is not an absolute requirement, without financial loss it will be more difficult for the shareholder to establish prejudicial conduct.

The Court will ask: can the Petitioner show he or she is substantially in a worse position as a result of the allegedly unfairly prejudicial conduct?

Typical examples of unfair prejudice

• Exclusion from management: It is only in special circumstances that a shareholder has a right to be involved in management. Management is the realm of the company directors. Where a shareholder is also a director (as is common in privately held companies), failure to notify the director-shareholder of board meetings, unjustified removal of a director, or denial of access to company information could all constitute grounds for a UPP.
• Breach of duty by the directors: Although directors’ duties are owed to the company, where the breaches cause the shareholder loss, a UPP can be brought.
• Excessive remuneration and inadequate dividends: Directors (who are often shareholders) paying themselves excessively frequently causes concern for minority shareholders as, subsequently, funds available for dividends are reduced. The failure of a board to recommend dividend payments is also a common unfair prejudice allegation.
• Share dilution, sales, and takeovers: Majority shareholders may create additional shares to allow them greater control or to diminish the minority shareholders’ value. Where takeovers or bids arise, directors should be careful to advise the shareholders fairly – particularly if they have an interest in the outcome.
• Serious mismanagement or procedural irregularity: i.e. failure by those in control of the company to observe the rules of the articles of association, shareholders’ agreement, or legal requirements under the Companies Act 2006.
• Refusal to bring a claim on behalf of the company: e.g. against a third party in relation to wrongdoing against the company.

What might the court do if a petition is successful?

The court has very wide discretionary powers to make “such orders as it thinks fit” even if the Petitioner has not requested it. The most common remedy is a share purchase order or “buyout” where shareholder(s) (or the company itself) are ordered to purchase the shares of any other shareholder(s) at “fair value”. Valuation is a complex area of law and accounting and needs to be carefully considered with experts.
The court may also:

• regulate the conduct of the company’s affairs in the future (e.g. order a meeting or confirm that a person is a director);
• require the company to:
  • refrain from doing or continuing an act complained of (e.g. prevent the removal of a director)
  • carry out an act that the Petitioner has complained it has omitted to do (e.g. declare a dividend);
• authorise civil proceedings to be brought in the name and on behalf of the company (e.g. where the company refuses to bring certain claims); or
• prevent alterations to the company’s constitutional documents (note: injunctive relief can be sought in support of a UPP to “hold the ring” whilst a claim is resolved).

What can the Respondent do?

As mentioned above, the most common remedy for a successful UPP is a “buyout”. If the relationships are irreparable, it is in all parties’ interests to enter into dialogue about settlement or an exit without the need for costly and stressful court proceedings. The court may strike out a UPP where the Respondent makes a qualifying offer to buy out the Petitioner. To qualify the offer:

• must be at fair value determined by a competent independent expert;
• allow mutual access to the valuation information; and
• include an appropriate offer regarding legal costs.

Buyouts can however be tricky in agricultural disputes as farms need a certain amount of scale and may not be able to support the leverage or generation of liquid assets to fund a buyout.

The Respondent could also:

• consider alternative exit and buyout options in the company documents (and wording such as bad leaver provisions);
• argue the Petitioner has: (i) delayed in bringing its claim, or (ii) been complicit in the conduct being complained of; or
• contend that the exclusion from management or removal of a director was justified evidence that the Petitioner has committed serious misconduct such as transacting with rival businesses, lying or fraud).

The financial risks associated with a UPP are high as the default position is that the “loser” of a claim will be ordered to pay the legal fees and expenses of the “winner”. There are a host of options available to both parties for legal costs protection and funding.

Breaking deadlock

Where relationships have broken down, it is common to find companies in voting deadlock – preventing legitimate company meetings from being called. It is possible in such circumstances for a director or shareholder to ask the court to order a meeting of the company in accordance with the Companies Act. The court could also confirm that one shareholder’s presence at the meeting constitutes a quorum, enabling management of the company to continue.

To avoid the costs of making such an application to court, shareholders should not disregard the importance of a well-drafted shareholders’ agreement which, among other things, contains sensible provisions to resolve deadlock.

Consider the inter-play with derivative claims

Derivative claims are claims brought by a shareholder in the name of the company (often against a director for breach of duty, negligence or breach of trust) to recover damages or secure other relief where the company has been wronged. The shareholder must apply to the court for permission to bring proceedings in the name of the company.

There is overlap between a derivative claim and UPP and a derivative claim can form part of a UPP.

A distinction is that derivative claims are designed to deal with obtaining relief for the company as a whole, whereas UPPs are typically brought seeking relief which is more personal in nature for shareholders.

Quasi-partnerships

Quasi-partnerships (QP) may well arise where agricultural businesses are concerned. To establish a QP, there must be something special about the personal nature of the relationship between the shareholders to move it away from one that is purely commercial. QPs are built on trust and confidence where there is often an understanding that some or all shareholders will participate in management.

If this so-called “special relationship” can be established, rules from the law of partnership can be introduced, such that the shareholders in a quasi-partnership may be held to owe each other a duty of good faith.

A QP may also give rise to an expectation that QP shareholders are entitled to be involved in the management of the company.

This makes it easier for the excluded member of the QP to establish a UPP – even where the constitutional documents (if there are any) do not expressly require shareholders’ involvement in management.