By Senior Associate Sylvia Yendall and Partner Rick Munro at BDB Pitmans

Shareholders who may have previously been less happy with seeing their company build up its own assets to the detriment of paying dividends are more likely now to be grateful that the company’s financial director is able to reach for the life-jacket (in the form of a “fortress balance sheet”) to help the company weather the financial storm caused by the Covid pandemic.   Shareholder activism has, many commentators concur, been quieted by the pandemic, but that activism is quiescent, with a return to normality expected once “normality” returns.

Shareholder activism is usually driven by a desire to see a change in the way a company is managed or operated, seeking financial or non-financial outcomes as a result.   The financial outcome is generally seeking to cut costs and the non-financial outcome is generally based on ethical grounds.  The exercise of a shareholder’s power can be persuasive in nature (for example, a small shareholding group with compellingly persuasive arguments) or based on a sufficiently large stake in the company’s share to carry the day at general meetings, requiring the company’s management to act in accordance with the shareholder’s wishes.

An activist shareholder is more likely to be found involved in publicly traded companies.  A shareholder in a private company is more likely to be bound by a shareholders’ agreement, or be sufficiently involved in the management of the company that it does not need to use its sway or holding to push through changes or policies that the management are otherwise unwilling to adopt.

What then, of a minority shareholder in a private company – what can he do if he feels that his position as minority shareholder is being disregarded to the detriment of himself or other shareholders?  Activism, which in this instance is the art of persuasion, may not be enough to bring about the desired resolution.

Shares in a company may be of more than one class, and different rights can attach to different classes of share.  The different rights which attach to a share will have been decided upon by the company, through shareholder meetings and enshrined in the company’s articles of association.  The shareholders are largely free to arrange how different share categories are to be arranged, what rights are allocated to the different categories and how those rights are entitled to be used.  A company’s articles of association will usually set out the rules for shareholders and its management alike in determining powers and rights.

In addition, statute has an important role to play, usually under the Companies Act 2006 (“CA 06”), providing a clear framework which sets out the requirements for, by way of example, if there is to be a redenomination of shares, an increase or reduction in share capital, a share buy-back or how a variation in class rights must be dealt with if this is not specified in a company’s own articles of association.   The CA 06 sets out clear rules on when a distribution to shareholders in the form of dividends can be made – in short there must be distributable profits or reserves, and the distribution must be justified by reference to relevant accounts.  In a smaller company, the director shareholders may be recompensed by salary, and dividends may not be distributed.  This could leave a non-director shareholder without a share of the company’s profits.  The value of the shareholding would be valued by reference to the company’s overall financial health.

A dispute over the lack of a dividend is one of the many reasons why a minority shareholder may call the CA 06 to their aid, in seeking court assistance if they can show that the affairs of the company are being run in such a way as to cause unfair prejudice to the interests of members generally or them specifically in their capacity as shareholder.   Allegations of unfair prejudice may arise from many and varied issues, the commonest being based on exclusion from management of a company, excessive remuneration of directors, conflicts of interest between a director and the company, or serious mismanagement of the company.

The prejudice need not necessarily cause financial harm, but it is essential that harm of some sort has been done.  What an aggrieved shareholder sees as prejudicial conduct against him is not the decider.  It is for the court to determine, on an objective basis, whether harm has occurred – so in an example, the shares of a subsidiary company were sold, against a minority shareholder’s wishes, but as the shares were sold for the best price no actual harm was caused, and no remedy granted by the court.  There is a continuing and constantly developing body of case law that interprets the unfair prejudice provisions in the CA 06, applying them to the facts of each case.   Recent cases include:

• An unsuccessful attempt to obtain a downward adjustment of the value of a company to reflect changes wrought on the company by Covid, after the court had already determined a (pre-Covid) valuation date for the shares (Dinglis v Dinglis [2020] EWHC 1363 (Ch)).
• An unsuccessful petition of alleged unfair prejudice arising from a majority shareholder pushing through a change to the articles of association, to deal with the valuation of shares on a “fair value” basis where the minority shareholder was obliged to sell his shares.   There was no improper conduct in the way in which the changes to the articles were brought about, and “fair value” had the usually understood meaning of the price to be paid on the sale of shares between a willing buyer and seller, with a discount being applied to take into account that the shares being valued were a minority holding (Re Euro Accessories Ltd [2021] EWHC 47 (Ch)).
• A family in dispute with various family businesses, where an allegation of unfair prejudice arose by the director/shareholder who had been the driving force in the operations for some time, but challenged steps taken by other shareholders using pre-existing constitutional company rules to limit the powers on that director, and no finding could be made of an equitable entitlement to manage the businesses despite the company’s constitution (Loveridge v Loveridge [2020] EWCA Civ 1104).
• A remedy for unfair prejudice is an order winding up the company on just and equitable grounds. An application for such an order was refused, even though there was agreement between the parties that the relationship of mutual trust and confidence between shareholders in a quasi-partnership company, and the petitioner was unable to rely on his own misconduct (Re Paramount Powers (UK) Ltd [2019] EWCA Civ 1644)

There is no “one size fits all” solution to claims for unfair prejudice – each case is fact sensitive and if the court determines there has been unfair prejudice, the court will take into account proportionality of the issues and the impact of the curative effect of the remedy, including on the company itself, in deciding how the prejudiced shareholder is to be compensated.  In general, the remedy is the buying-out of the minority shareholder, with the court setting the steps to be taken in obtaining expert valuation of the shares.  The court has very wide powers and can make such order as it thinks fit.  The company’s money must not be used by the majority shareholders to defend the claim unless the court can be convinced that it is both expedient and necessary, and in the interests of the company, for this to occur.

Given that many companies will be looking to shore up their financial position as the world welcomes in the “new normal”, managing directors and financial directors may start looking at weeding out shareholders that do not toe the (perceived) company line, or at those who do not put their weight behind a family business as they may be required to do.  Accordingly, there is a growing potential for more shareholder disputes to arise, keeping the courts even busier.