Unfair Prejudice

A whistle-stop tour of Unfair Prejudice.

Venturing into business with close friends, family members or even long term acquaintances has become common practice since the rise in the popularity of limited companies. Limited companies with a small number of shareholders are ten a penny in the UK today. However, it is unfortunately common that the demise of many of these companies is as a result of internal feuds and relationship breakdowns.

What is Unfair Prejudice?

Section 994 Companies Act 2006 provides statutory protection for shareholders who are being ‘Unfairly Prejudiced’ by the conduct or omission or proposed conduct or omission of the company’s affairs.

Two elements have to be established for a successful claim in unfair prejudice:

- The conduct by the company has to cause prejudice or harm to the shareholder; and such prejudice or harm must be unfair.

- The conduct must ‘prejudice’ the shareholder.

It is important to note that a section 994 petition can only be made by a shareholder, this can be a minority shareholder or a majority shareholder. It does not limit the access to the petition on what class of shares the shareholder owns either.

Prejudice to the shareholder’s interest usually involves some kind of financial harm caused to the shareholder. If no harm has been suffered by the shareholder there can be no petition under S.994; it is not a tool for shareholders to use when votes have simply not gone their way.

For Example,

Directors A and B (who are also Shareholders) vote to allot new shares to Shareholder D which significantly reduces the value of director and Shareholder C's shares. The conduct of A and B has clearly prejudiced C as the value of his shares have reduced. The next question to ask is whether it is 'unfair'.

Is the conduct unfair?

All aspects of the company’s conduct, such as discussions in previous board meetings, contractual documents, articles of association etc. are all taken into account when determining the fairness of the company’s conduct. Once all the aforementioned is taken into account the Court will then ask what a hypothetical ‘reasonable man’ would consider to be unfair.

Just because the value of C's shares have been reduced after the allotment of new shares to Shareholder D, does not necessarily mean the conduct was unfair. If A, B and C previously discussed share capital to fund a new project, then it is unlikely that the conduct will be seen as unfair.

However, if A and B are purposefully issuing new shares without offering them to C first in contradiction of the company's articles, then it is likely this will be classed as unfairly prejudicial conduct.

The Court has a wide discretion to make any order it seems fair in order to remedy unfairly prejudicial conduct. And in making such an order it does not have to restrict itself to any remedy/order which the petitioner is applying for. Such remedies may include:

Regulating the conduct of the company’s affairs in the future (this could be done over one meeting or, more burdensome to the company, set out a code for future company business;
Prevent a company form carrying out a particular act; or
Prohibit changes to the company’s articles of association.

As mentioned above, the common cause of these applications is due to a break down in relationships between all parties involved. As a result the most effective relief is an order to make a ‘clean break.’ The most operative way of achieving this is to make a purchase order.

A purchase order usually involves the wrongdoing members to purchase the petitioners Share Holdings. There are times where a majority shareholder may be ordered to sell shares to continuing shareholders, should the majority shareholder be deemed unfit to run the company.

The Court has decided that C has been unfairly prejudiced by the conduct of the company (A & B). In C's petition he asks for the court to regulate the conduct of the company's affairs, however, C's relationship with A & B has broken down to the point that there can be no communication or agreement between them.

The Court therefore believes it is in the company's best interest that A and B purchase C's shares at market value and C breaks from the company.