Contractual Limitation: High Court narrows “consequential loss”


In Star Polaris LLC v HHIC-Phil INC [2016] EWHC 2941 the High Court considered the correct construction of the phrase

consequential or special losses, damages or expenses

in a shipbuilding contract which contained a limitation of liability clause.

Overview

The case is of wider interest as lessons can be drawn generally regarding contractual terms and conditions, and letters of engagement, it

  • shows a clear departure from traditional interpretations of “consequential loss” in contract clauses seeking to limit or exclude loss
  • introduces a new approach in considering the meaning of the phrase by taking into account the context of the contract as a whole and the intention of the parties at the time of entering into the contract.
  • demonstrates that a limitation of liability clause setting out an exclusive code of damages may be effective if drafted in clear language

Background

The Claimant, Star Polaris LLC (the “Buyer”) entered into a shipbuilding contract with the Defendant, HHIC-PHIL INC (the “Builder”) for the purchase of a bulk carrier vessel named the POLARIS STAR (the “Vessel”).

Article.XI of the contract made detailed provision for the Builder’s liability for any defects in the ship. Article.XI.1 of the contract imposed an obligation on the Builder to guarantee the Vessel for a period of 12 months against

all defects due to defective materials, design error, construction miscalculation and/or poor workmanship

Following written notification of any defects covered by the guarantee, Article.XI.3 required the Builder to make the necessary repairs or replacements at its shipyard or reimburse the cost thereof.

Most importantly, Article.IX.4(a) of the shipbuilding contract contained a limitation of liability clause which specifically excluded the Builder’s liability for “consequential or special losses, damages or expenses”.

The Vessel was delivered to the Buyer on 14 November 2011; however, on 29 June 2012 the Vessel suffered from a serious engine failure and had to be towed to STX Gosung in South Korea for repairs.

The Builder denied all liability for the incident and as a result the Buyer commenced arbitration proceedings against the Builder for breach of contract. The buyer’s claim included:

a) the cost of repairs to the Vessel; and

b) towage fees, agency fees, service fees, off-hire and off-hire bunkers caused by the engine failure.

During the hearing, the Buyer also indicated that it wished to claim for diminution in the value of the Vessel.

In summary, the tribunal ordered an Interim Final Award on 12 November 2015 on the basis that there had been a causative breach of the Builder’s express warranty of quality. However, the Tribunal found that the Buyer’s chief engineer had failed to react to various warnings to reduce the speed of the Vessel and had failed to stop the Vessel’s main engine in sufficient time. It was held that these omissions contributed to the Vessel’s damage and amounted to a break in the chain of causation and therefore not all the repair costs were recoverable by the Buyer.

When assessing the remainder of the Buyer’s claim, the Tribunal considered Article.IX.4(a) of the shipbuilding contract which contained the limitation of liability clause.

Article.IX.4(a) – “Except as expressly provided in this Paragraph, in no circumstances and on no grounds whatsoever shall the Builder have any responsibility or liability whatsoever or however arising in respect of or in connection with the Vessel or this contract after the delivery of the Vessel. Further, but without in any way limiting the generality of the foregoing, the Builder shall have no liability or responsibility whatsoever or howsoever arising for or in connection with any consequential or special losses, damage or expenses unless otherwise stated herein”.

The Tribunal’s interpretation was that the word “consequential” was intended to be used by the parties in its “cause-and-effect sense”, as meaning “following as a result or consequence”. Accordingly, the losses set out at section (b) above were not recoverable by the Buyer.

It followed that any claim for diminution in value of the Vessel would also be a claim for consequential loss and as such, would be excluded from the Builder’s liability.

High Court Appeal

The Buyer appealed against the Tribunal’s decision on the basis that the phrase

“consequential or special losses”

should be interpreted in accordance with the second limb of the classic test for recoverable loss established in the leading case of Hadley v Baxendale [1854] EWHC 9 Exch 341.

In Hardley v Baxendale it was held that damages available for breach of contract could be pursued under two separate limbs:

  1. Direct loss – those which may fairly and reasonably be considered arising naturally from the breach of contract.
  2. Consequential loss – such damages as may reasonably be supposed to have been in the contemplation of both the parties at the time the contract was made.

The Buyer maintained that at the time the parties entered into the contract, the phrase “consequential or special losses” had a very well-recognised meaning as a matter of law. Furthermore, as other authorities suggest, the fact that both the words “consequential” and “special losses” where paired together in Article.IX.4(a) was a strong indicator that the parties intended the meaning of consequential loss as set out in the second limb of Hardley v Baxendale to apply to the contract.

High Court Judgment

Sir Jeremy Cooke, sitting as a High Court Judge decided in favour of the Builder, that Article.IX of the contract provided a comprehensive code for the determination of liability. He was therefore of the view that the limitation of liability clause should be construed in the context of Article.IX as a whole, including the guarantee in relation to defects.

On an analysis of Article.IX, the judge agreed with the Tribunal that on entering into the contract, the parties did not intend the Builder’s liability to extend beyond the obligation to remedy any defect by making all necessary repairs and replacements. “In short, the parties had agreed objectively that financial loss consequent upon physical damage was excluded”.

At paragraph 39 of his judgment, the judge held that

“consequential or special losses, damages or expenses does not mean such losses, damages or expenses as fall within the second limb or Hadley v Baxendale but does have the wide meaning of financial losses caused by guaranteed defects, above and beyond the costs of replacement and repair of physical damage”

Comment

The Judge decided that the construction of the Article showed the Builders had guaranteed to repair defective items for 12 months, but excluded all other financial consequences, which were the responsibility of the Buyer.

This decision highlights the importance of ensuring that caution is taken when entering into or negotiating a contract and that the contractual terms reflect the true intention of the parties, particularly when one party is attempting to limit or exclude its potential liability.

This case suggests a move towards a more flexible approach when interpreting the meaning of limitation/exclusion clauses, rather than being bound by traditional interpretations. Courts may now be more inclined to consider such clauses on a case-by-case basis, taking into account the whole of the contract that the clause appears in and the intentions of the parties at the time that the contract was entered into. For this reason, contracting parties should also check for any inconsistencies between the limitation/exclusion clause and the contract as a whole.

The decision indicates the conventional Hadley v Baxendale approach is secondary to the wording and construction actually used by the parties.

Action Points

  • Businesses providing goods or services, including professional services, should regularly review their Terms and Conditions and Letters of Engagement to ensure they accord with current practice, law and legislative requirements.
  • Limitation clauses can be included in retainer letters or disclaimers to limit liability, including regarding third parties. A properly drafted clause could substantially affect overall liability.
  • Parties should carefully identify the type of loss that may arise from their contract, and describe clearly what liability the party accepts, and excludes.
  • The court will review the whole agreement in the event of a dispute, to decide on what the parties intended.
  • Consider reviewing your Contracts, Agreements, Terms and Conditions and Letters of Engagement (especially limitation clauses) in light of the trend highlighted in the Star Polaris judgment

Previously published at http://social.luptonfawcett.com/blog/contact-limitation-clause-high-court-limits-consequential-loss

Supreme Court: Malicious Claims Actionable – What do you think?

Does this Landmark Decision “open the floodgates” to claims from aggrieved parties?

5:4 Decision – What would you decide? (Vote at the end)

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A 9 Member panel of the Supreme Court decided 5:4 that the tort of malicious prosecution extends to civil proceedings. The Supreme Court usually sits with a panel of 5, and more rarely, 7.  The “Brexit” decision of 24 January 2017 involving a full 11 member panel is thought to have been unique. That 9 members heard this case demonstrates its high importance.

It is also an extreme illustration of assets and liabilities, specifically legal proceedings, surviving the death of a principal party.

Willers v Joyce and another (in substitution for and in their capacity as executors of Albert Gubay (deceased)) [2016] UKSC 43 and [2016] UKSC 44.

Background

Mr Willers and Mr Gubay were business associates for over 20 years. Mr Willers was a director of Langstone Leisure Ltd, a company controlled by Mr Gubay. They fell out in 2009.

Mr Willers was sued by Langstone Leisure Ltd for alleged breaches of contractual and fiduciary duties when he was a director of the company. He defended the action and issued a third-party claim for an indemnity from Mr Gubay, on the basis that he had acted under Mr Gubay’s direction. Langstone discontinued its claim against Mr Willers shortly before trial.

Mr Willers brought proceedings against Mr Gubay for the malicious prosecution of the Langstone claim against him, contending that it had been part of a campaign to damage to his reputation, health and earnings. Mr Gubay’s defence was that there was no cause of action recognised in England &Wales for malicious prosecution of a civil suit (in contrast to criminal proceedings, where it is well established).

Precedent

Mr Willers’ claim was struck out. The Judge held that she was bound by the doctrine of precedent to follow a decision of the House of Lords in Gregory v Portsmouth City Council [2000] which reiterated that the tort of malicious prosecution did not extend to civil proceedings.

However, due to a recent conflicting decision of the justices sitting in their different capacity as members of the Judicial Committee of the Privy Council (JCPC) in an appeal from the Cayman Islands (Crawford Adjusters (Cayman) Ltd v Sagicor General Insurance (Cayman) Ltd [2014]), Mr Willers was granted leave to appeal to the Supreme Court.

The High Court granted a leapfrog certificate so the scope of the tort of malicious prosecution could be resolved definitively, bypassing the Court of Appeal. As well as dealing with that issue, the court also addressed the status of Privy Council decisions in the doctrine of precedent.

The Supreme Court decision

The Supreme Court allowed Mr Willers’ appeal which can now go to trial, and held that the tort does apply to civil proceedings.

The dissenting minority of justices did not find sufficient support in historical case law, arguing that recognising the tort would be inconsistent with longstanding rules of law, and expressing concerns that the decision could spawn undesirable satellite litigation.

However, the majority held that it seemed instinctively unjust for a person who has suffered injury as a result of the malicious prosecution of civil proceedings against him to be left with no redress. Addressing the concerns about ‘satellite litigation’, the majority emphasised that to establish a claim for malicious prosecution of civil proceedings it must be proved that the original proceedings were not a bona fide use of the court’s process, e.g. where proceedings were wholly without foundation or where the party sought some extraneous benefit to which he had no right. This means that the claimant has a heavy burden to discharge, and as such successful claims are likely to be rare.

“Simple justice” dictated that Mr W’s claim for malicious prosecution should be sustainable in English law.

Lord Toulson gave the lead judgment, Lady Hale, Lord Kerr and Lord Wilson agreed. Lord Clarke delivered a concurring judgment. Lords Neuberger, Mance, Sumption and Reed dissented.

Broadly, the court approached the appeal by looking both at whether the historic cases supported the existence of a general tort of malicious prosecution and also at the policy considerations for and against permitting claims of this type. The majority recognized that the authorities stretching back to the 17th century were not conclusive, but they did show that the courts were willing to develop the tort to achieve justice in situations where a person has suffered injury as a result of the malicious use of legal process without any reasonable basis.

The minority’s conclusion however was that the tort had never applied in civil proceedings as such and the House of Lords had taken a firm stand against an extension to civil proceedings in Gregory. They were also unpersuaded that there was any general need to extend the tort as it would, in their view, create uncertainty, further anomalies and the potential undesirable practical consequences.

The policy arguments

  • Lord Toulson found the statement in Savile v Roberts (1698 12 Mod Rep 208) that

…if this injury be occasioned by a malicious prosecution, it is reason and justice that he should have an action to repair him the injury…”

to be obvious and compelling. He found that it would be instinctively unjust for there to be no recourse for a person who suffers injury as a result of malicious prosecution of civil proceedings.

  • The tort would not discourage those with valid claims
  • There is no evidence that the existing risk of indemnity costs faced by claimants pursuing improper claims has deterred the pursuit of legitimate claims
  • There is a public interest in avoiding unnecessary satellite litigation, but malicious prosecution isn’t a collateral attack on the outcome of the first proceedings
  • There might be an attack where, for example, the judge in the original proceedings refused to award indemnity costs, the malicious prosecution claim being an indirect means of challenging the judge’s refusal to penalise the claimant’s conduct
  • There is no duty of care between litigants, but a liability for maliciously instituting proceedings without reasonable or probable cause is “simple justice”
  • Anyone seeking to establish such a claim would have a heavy burden to discharge

The test to be applied

The court held that, to establish a claim for malicious prosecution, the claimant would have to prove: Proceedings had been brought against it without reasonable and probable cause. The party that brought those proceedings did so maliciously.

Guidance.

The first limb will be satisfied where the claimant does not have a proper case to put before the court; if the claimant did not believe its claim would succeed. On the second limb, a claim will be malicious if the claimant had deliberately misused the process of the court. This includes cases where it can be shown that the underlying claim was brought in the knowledge that it had no foundation: the proceedings were not a bona fide use of the court’s process.

Privy Council

The case is also of constitutional importance in deciding the extent to which Privy Council decisions made by a board formed solely of serving Supreme Court Justices and based on English law interpretation was legal precedence in England and Wales.

It was confirmed unanimously that a court should not normally follow a decision of the Privy Council if it is inconsistent with the decision of another court which would otherwise be binding on it. However, this should be subject to an exception. In an appeal to the Privy Council involving an issue of English law on which a previous decision of the House of Lords, Supreme Court or Court of Appeal is challenged, the members of the Privy Council can, if they think it appropriate, not only decide that the previous decision is wrong, but can also expressly direct that domestic courts should treat their decision as representing the law of England and Wales. This was considered expedient bearing in mind that the Privy Council panel normally consists of the same judges as the Supreme Court. This should increase the value of Privy Council judgments on English law.

Landmark Decision

The decision means that any claimant bringing unfounded proceedings for malicious reasons now faces additional potential sanctions (being sued for damages for Malicious Prosecution) on top of the usual costs and other risks. While this is a landmark decision, the issue before the court was whether this type of claim was sustainable in principle, do there has been no specific award as yet.

  • It is suggested that the decision is an overdue recognition that where there is a wrong, as a matter of principle and policy, it would be unjust to leave the claimant without a remedy for the damage caused.
  • An anomalous contradiction between civil and criminal and law has been resolved and a gap in the law filled.
  • The specifics of Malicious Prosecution, its precise boundaries, causation and the types of loss that can be recovered will be the subject of developing case law.
  • It remains to be seen how far the tort will evolve, although it is likely that successful claims will be rare, and there will be no “opening of the floodgates”.
  • There is already a tort of “abuse of process” (the abuse of civil proceedings for a predominant purpose other than that for which they were designed). The tort is rarely invoked.
  • Distinct from the tort, “abuse of process” is also a ground for striking out a claim under CPR 3.4(2)(b).
  • There already exist related torts offering protection from malicious prosecution, including defamation, malicious falsehood, conspiracy and misfeasance in public office.
  • Reflecting Lord Neuberger’s concern that it could have a chilling effect on the bringing, prosecuting or defending of civil proceedings, judges will take in to account the risk of defendants threatening malicious prosecution claims in order to deter genuine claimants.
  • The heavy burden of satisfying the test to establish a successful claim is referred to above, and emphasized in the judgment.

link to the judgment: http://bit.ly/2eFrgAl

A version of this piece was previously published September 2016 http://social.luptonfawcett.com/blog/supreme-court-malicious-claims-actionable

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BREXIT “To Do” List: Contracts & Disputes

Contract and Commercial Litigation Priorities

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Following the UK Supreme Court’s historic 8:3 ruling on 24 January  that an Act of Parliament is needed before Article 50 can be triggered –  what due diligence and risk analysis should businesses be undertaking now?


Practical steps to consider

1. Introduction

Triggering Article 50 needs Parliamentary approval rules the Supreme Court, but what does Brexit mean for you and your business?

How will your contracts and their enforceability be affected here and abroad?

The Supreme Court has upheld the High Court’s  decision that Parliamentary Sovereignty trumps the Government’s reliance on the Royal Prerogative, and Parliament should debate and decide before Article 50 is triggered. The Government says this won’t delay its timetable of serving the Article 50 notice under the Lisbon Treaty by March 2017.

Whatever the precise timetable, the withdrawal of the UK from the EU is likely to take some years, but businesses need to be fine tuning their plans now. Until the shape of a post-Brexit agreement is fixed, the precise legal implications are yet to crystallize. But, the UK’s departure will impact on fundamentals for your business like contracts, terms & conditions and potential disputes. Areas to explore from a dispute management perspective include

  • Corporate and commercial contracts
  • Competition law
  • Governing law and jurisdiction
  • Issue and service of English proceedings in the EU
  • Enforcement of English and EU judgments

2. Risk Analysis

How can you ensure your business stays ahead? Whilst some detailed plans can be left until there is greater certainty about post Brexit arrangements, considering the legal implications should be at the forefront of your strategy. A risk analysis should be implemented to ensure businesses get their ducks in a row and identify the effect Brexit will have on their rights and obligations under existing and proposed new contracts and regarding potential litigation.

As each business is different, the process should be targeted to your needs.

Below we highlight typical practical points which businesses should be addressing now, especially if you trade in the EU or have foreign customers, interests or suppliers.

3. Corporate and Commercial Contracts

Businesses should already be reviewing their existing contracts, particularly those likely to be in force at the point of Brexit. Where necessary, contractual terms and conditions intended for use from now on should be amended for when the UK ceases to be a EU Member State.

Many existing contracts and trading arrangements will be affected, referring to a range of EU laws, regulators and territories. A due diligence exercise should be carried out to identify the key contracts and consider their terms. The need for possible amendments and contingent steps should be considered.

  • Can the contract be varied to mitigate the impact of Brexit?
  • Where the contract price or payments under a contract are made or received in Sterling, Euros, Dollars or fixed to a particular exchange rate, consideration should be given as to whether the currency used is amended to reflect the recent drop in Sterling.
  • Does the governing law clause need amending?
  • Will Brexit result in a breach of contract?
  • Whilst unlikely, can force majeure or material adverse effect clauses be relied upon?
  • How can the contract be future-proofed?

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4. Existing Contracts

The impact of the UK leaving the EU may affect the operation of existing contracts, potentially beyond how the parties might expect. It is unlikely that they will have foreseen or planned for the implications when entering in to the contract.

Territorial scope. Does the contract include the EU as its territorial scope? On leaving the EU, the UK won’t be covered by that territorial description. Should the contract be amended, or can the contract be terminated by any party invoking a force majeure or material adverse change clause?

Reference to EU legislation. Analyze clauses referring to EU legislation, compliance and any changes. Contracts that refer to EU legislation may need to be amended to deal with the different circumstance.

Force majeure provisions. A force majeure clause may be drafted wide enough for a contract to be terminated. For example, if the contract depended on certain EU legislation (e.g. “passporting” under EU financial services legislation), the contract may be frustrated or force majeure might be triggered by Brexit.

Material adverse change provisions. Similarly, if a contract includes a “material adverse change” provision (MAC), this may permit termination of the contract, although this will depend on a number of factors.

These issues may well result in a dispute, and businesses should consider their existing agreements as to how they maybe impacted.

Shorter term contracts. These are less likely to be affected by the UK leaving the EU, due to the two-year negotiating window after Article 50 is triggered. This should give parties some time to consider how the terms of Brexit might affect their longer term contractual arrangements and to renegotiate where necessary.

5. New Contracts

Notwithstanding “Brexit means Brexit”, new contracts should address the impact of the UK’s departure from the EU, and provide accordingly in the contract so far as possible:

  • Do your contracts contain provisions which assume that the UK is an EU Member State? This may include references to the EU that are formulated on the assumption that this includes UK, or may be less obvious – e.g. references to rights or obligations arising from specific EU laws which currently apply to the UK.
  • Do your contracts rely on or assume the availability of free movement within the EU, or of any EU level consolidation (such as engaging an EU wide regulatory body)?
    • Prolonged Negotiations. Specific provisions could be considered on prolonged negotiations to implement the exit or the impact of new trade agreements once negotiated.
    • Termination rights. Consider whether to include termination rights in case the new trade agreements will result in an increased burden or negative effects on the intended business transaction.

Force majeure provisions

  • Expressly include or exclude the UK leaving the EU in or from any force majeure provision;
  • Consider termination rights when the UK leaves the EU (depending potentially on the terms Brexit ultimately takes); and/or
  • An alternative mechanism once the UK leaves the EU
  • Include notice terms and detailed explanation of the consequences of the right to terminate, and include justifiable Brexit definition and when it can be triggered.

Material adverse change provisions

Similarly to force majeure provisions, consider whether to include or exclude Brexit from the MAC definition. This depends on the outcome sought. Similar considerations will need to be given to how the Brexit definition is drafted and when it can be triggered. A business may wish to consider the inclusion of its own MAC clause, or even a bespoke Brexit clause. This could provide businesses with flexibility to respond to altered circumstances rather than being tied to expensive or inflexible terms. This would require heightened awareness on the part of businesses to work out the ramifications of such clauses, and to be prepared for counterparties seeking to include them also.

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6. Competition/Antitrust

  • EU law continues to apply in the UK. Substantive UK competition law mirrors EU competition law. As such, competition law continues to apply in the UK as it did before the referendum.
  • EU and UK antitrust/competition law has a significant impact on contracts and trading arrangements. Competition law compliance continues to be of prime importance. This will still apply post Brexit, but there will be changes.
  • Transitional provisions are likely for Brexit and the UK’s new trading arrangements with the EU. Businesses should be taking steps now to evaluate the impact of Brexit on competition law as it relates to them.
  • Private competition law litigation (including claims for injunctions and damages) has been increasing in the UK and Europe. It now represents a significant commercial weapon for businesses of whatever size.
  • Brexit raises significant commercial, legal and other issues for businesses. Whilst there may be understandable motives for wanting to discuss this with competitors in various forums, informally or formally, extreme caution should be employed. Confidential commercial information must remain confidential and businesses must avoid offending against anti competition laws. Discussions with competitors should be avoided until advice on competition law is first obtained.
  • As with other types of litigation, the impact of Brexit on competition litigation should be considered when planning strategy.

7. Litigation

Brexit may impact on litigation affecting your business, including current or prospective cases, such as where jurisdictional issues arise, or when it comes to enforcing a judgment post Brexit.

EU legislation governs parties’ choice of which EU member state’s courts has jurisdiction over disputes between them, and the cross-border recognition of judgments of EU member states’ courts.

The Court of Justice of the European Union (CJEU) is responsible for the rule of law within the EU. The UK’s right to appear in all cases and to appoint judges to the CJEU will no longer exist when Brexit is implemented. This should not be confused with the European Convention on Human Rights, its council and its court (the ECtHR), which are not affected by Brexit. The European Convention on Human Rights has been incorporated into UK law through the Human Rights Act, and the referendum of 23 June did not involve the UK leaving the Council of Europe either.

From the date Brexit takes effect, litigants will no longer be able to appeal cases to the CJEU and UK judges will no longer be required to follow CJEU decisions (although they may decide to do so), but they will continue to follow ECtHR decisions. Litigants are likely no longer to be able to challenge UK legislation on the basis of incompatibility with EU law alone. They would however retain the ability to mount such challenges to the ECtHR based on human rights issues.

In other respects, the court system in the UK is likely to remain unchanged, with the UK Supreme Court (formerly the House of Lords) as the final Court of Appeal.

Brexit is unlikely to affect the recognition and enforcement of judgments between the UK and EU member states, as the relevant countries are signatories to the Lugano and Brussels Conventions. However, these conventions are more limited than the Brussels Regulation, which currently governs jurisdictional issues between courts of EU member states.

Brexit may mean that the UK falls outside the scope of the Brussels Regulation which created a requirement of “judicial comity”. This means that courts relinquish cases if they are already being heard in another EU member state. Without this restriction, the English courts would be able to accept jurisdiction over more cases and, in appropriate cases, could provide anti-suit relief to restrain parties from pursuing proceedings in the courts of other EU member states. The reverse may unfortunately be propounded by the courts of different EU member states depending on how they view jurisdiction clauses. This would potentially result in considerable uncertainty.

8. Choice of Court

It is fundamental for businesses to be able to agree between themselves where and how any disputes between them should be resolved. This general freedom is subject to some obvious exceptions. The Recast Brussels Regulation sets out which courts of EU member states should have jurisdiction in disputes in civil and commercial matters, and provides for the mutual recognition and enforcement of civil and commercial judgments within the EU. The general rule is that the courts where the defendant is domiciled have jurisdiction. This is subject to a number of exceptions, including:

  • Where the parties have agreed that the courts of another member state should have jurisdiction
  • Agreements regarding the sale of land in a particular country where the domestic courts of a member state have exclusive jurisdiction
  • Contract protection for public policy reasons protecting “weaker” parties
  • Cases involving employment, consumer or insurance contracts

It is anticipated that whether the “Norwegian Model” or the World Trade Organization “WTO Model” is adopted, courts of EU member states will generally be obliged to recognise a choice of jurisdiction in favour of the English courts. However this remains uncertain.

In the absence of any international agreement with the EU, the English courts are still likely to respect provisions in contracts which confer jurisdiction by agreement on the English courts. How such clauses will be treated by EU member states will be a matter for the laws of those member states.

That would result in considerable uncertainty, depending on how jurisdiction clauses are viewed by the courts of different EU member states.

In some cases, the courts of a counterparty domiciled in another EU member state may be reluctant to cede jurisdiction to the English courts, even if that is what the parties agreed.

9. Parallel Proceedings

Parallel proceedings (i.e. where proceedings concerning the same subject matter are commenced in more than one country’s courts) are a risk in commercial disputes, particularly where the parties to a contract are based in different countries. Having to defend a dispute on multiple fronts can be time-consuming and costly.

Under current arrangements, if parallel proceedings are brought in the courts of more than one EU member state involving the same or related issues, in general, the courts of the member state first seized of the dispute decide the question of jurisdiction. One exception is that the courts of a member state that have jurisdiction under the terms of an exclusive jurisdiction clause can proceed to determine the question of their jurisdiction over the dispute in question, even if parallel proceedings are already under way in the courts of another EU member state. This greatly reduces the risk of parallel proceedings within the EU.

If the UK accedes to the 2007 Lugano Convention, this prohibition will remain, but the precedence given to the courts of the country that the parties have agreed should have jurisdiction will not apply.

That rule was introduced to the Brussels Regulation from the beginning of 2015 to resolve the so-called “Italian torpedo” problem.

This is whereby a party first issues proceedings in a country where the judicial process is relatively slow and complicated so as to delay proceedings, and tie disputes up in jurisdictional battles for years.

If the UK does not accede to the 2007 Lugano Convention, there will be no bar on parallel proceedings, provided that the courts in the countries in question are prepared to take jurisdiction over the dispute under their own rules of private international law. For example, at common law, the English courts can take jurisdiction over a dispute where the parties have agreed that the English courts should have non-exclusive jurisdiction and proceedings are pending in a different jurisdiction, on the basis that the parties must have contemplated the possibility of parallel proceedings by agreeing to a non-exclusive jurisdiction clause in the first place.

The English courts would also once again be able to issue anti-suit injunctions to prevent proceedings from being brought in other EU member states, something that they are not able to do at the moment because of the effect of the Recast Brussels Regulation (and its predecessors).

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10. Service

If the counterparty to a contract is in the jurisdiction (or has appointed an agent for service of process in the jurisdiction), it is quite straightforward to serve English court proceedings on them where a dispute arises. The position is more complex, time-consuming and expensive if proceedings have to be served abroad.

Normally under English law, the claimant commencing proceedings must apply to the court for “permission” to serve out of the jurisdiction. The claimant must persuade the English court at the start that it has jurisdiction over the matter. However, there is currently no need to apply for permission to serve out of the jurisdiction if service is to be effected in the EU, and the English courts have jurisdiction under the Recast Brussels Regulation. This provides a clear and relatively predictable basis on which proceedings can be served in the EU without permission. Similarly, EU Service Regulations also set out the procedure and mechanics of effecting service within the EU.

A similar exemption for the need to obtain permission to effect service also applies to service within the countries that are party to the 2007 Lugano Convention. However, if the UK were not to accede to the 2007 Lugano Convention when it leaves the EU, it is likely that it would become necessary again to apply for permission to serve English court proceedings within the EU. This would increase the importance in any contract of having an EU based counterparty expressly appoint an agent for service of process in England if the parties have agreed to submit to the jurisdiction of the English courts.

If parties have chosen the English courts to hear their disputes and one or more of the parties is based abroad, it is always worthwhile including an agent for service clause in a contract.

11. Recognition and Enforcement of Judgments

The Brussels Regulation provides for a streamlined method of recognising and enforcing judgments in civil and commercial matters within the EU, and the 2007 Lugano Convention contains a similar regime for the states included. The bar for refusal of recognition is very high: including judgments contrary to public policy and judgments given in default in certain circumstances. As such, a business contracting with another party elsewhere in the EU can be reasonably confident of being able to

  • issue proceedings
  • serve the proceedings
  • enforce a judgment of the English courts against the counterparty in its home member state

In the absence of any international agreement on jurisdiction and enforcement, the enforceability of judgments of the English courts within the EU would depend on the laws of each member state. This would result in uncertainty. For example, an English company dealing with a French company would need to take French law advice as to the enforceability of English court judgments in France. Potential enforcement issues may hinder jurisdiction being conferred on the English courts by agreement. There is further uncertainty on judgments of English courts being recognised by courts of member states. Money judgments may be straightforward, but the same may not apply to claims for declarations, accounts and inquiries, specific performance, injunctions and interim relief.

The corollary is that the English courts would also no longer automatically recognise and enforce the judgments of the courts of EU member states.

This would be a concern for EU based businesses dealing with counterparties based in the UK. Potential difficulties with recognition and enforcement of judgments could affect decisions by businesses as to which courts they elect to have jurisdiction over their disputes. It could also influence how parties decide to pursue dispute resolution, whether via the courts or arbitration, considering the enforcement mechanisms for arbitral awards.

12. Planning Ahead

Whilst parties negotiating contracts now can plan ahead for in case a dispute arises (e..g. by appointing an agent for service of process, and thinking carefully about potential enforcement issues), the position is different for litigation that is currently either imminent or under way. It is difficult to see how possible changes to the rules on jurisdiction would affect proceedings being issued today, because such proceedings will need to be issued in accordance with the rules currently in place.

As explained above, developments during the negotiation period under the Article 50 process may have an impact on decisions on disputes that arise during the process, for example there may be a particular date by which it will be advantageous to commence proceedings. Alternatively it may become clear e.g. that the UK will accede to the 2007 Lugano Convention.

Regarding existing litigation, depending on the circumstances, the fact that the UK will be leaving the EU may buttress reasons to seek judgment as soon as possible, taking advantage of the present recognition and enforcement mechanism in the Recast Brussels Regulation.

The impact of Brexit may also be felt indirectly in future, such as on funding for current civil litigation projects in the UK. Funding for the proposed online court may be at risk, depending on economic factors.

13. Summary

As an EU member state, the UK is a party to a framework of EU legislation which sets out the rules that courts in EU member states will apply to decide the governing law of a contract and of tort (civil wrong) claims and their jurisdiction over disputes. This framework also provides the procedure for serving legal proceedings as between member states and the mechanism for enforcing a judgment from a court in one member state in other member states. This area is therefore likely to be directly affected by Brexit, although it remains to be seen to what extent. In the meantime,

businesses should strategically review their contracts and Terms and Conditions to see how and to what extent they can be Brexit proofed, and to analyse the threats and opportunities that arise.

Issues such as Intellectual Property, Employment Law and Data Protection are amongst further areas for consideration, outside the scope of this piece.

Updated from a previously published version 4. 11.16 http://bit.ly/2fpcBcb

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Directors & Shareholder Claims: 3

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Understanding the options – 5 tips

As discussed in previous posts, Boardroom and shareholder disputes arise for many reasons. When they do, it is important to understand the legal rights of all parties and the options available. The consequences of allowing things to drift and potentially get worse shouldn’t be ignored. There are options which help make life easier.

  • If you are a minority shareholder in a company, what happens if you have a disagreement with the majority shareholder, or a group which has more control?
  • How do you solve the problem, or even avoid a dispute?
  • In the third of this series, here are five important tips:

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1] Shareholder Agreements

The House of Lords in Russell v Northern Bank Developments Corp Ltd[i] emphasised the practical utility of Shareholder Agreements. These are used for a wide variety of purposes, adding significantly to the company’s constitutional regime of Memorandum and Articles. This includes providing personal rights to minority shareholders who otherwise have no control over fundamental points.  The minority shareholder’s concerns would be more difficult to deal with unless specifically covered as an enforceable private contract between members.

These should be provided in the Shareholder Agreement, covering similar areas to partnership agreements.

The benefits include avoiding future misunderstandings and practical difficulties in running the business.

A Shareholder Agreement typically deals with issues such as:

  • restrictions on transferability of shares
  • lack of a market for sale of shares
  • establishing a purchaser
  • formulas for valuation and funding
  • pre-emption rights
  • compulsory transfer or option arrangements
  • protection of minority members by permitting a veto
  • preserving confidentiality
  • efficient transfer on death, disability, retirement
  • estate planning
  • regulating management and involvement of investors
  • mechanisms for dealing with stalemate.

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2] “Unfair Prejudice” Petition
Section 994 of the Companies Act 2006 permits a shareholder to petition the court on the basis that the shareholder’s interests have been unfairly prejudiced in the conduct of the Company’s affairs due to e.g. breach of:

  • the Articles of Association
  • the Shareholder Agreement
  • fiduciary duties by directors
  • exclusion of a minority from the running of the company in small “quasi-partnership” companies.

The Court has wide discretion to grant the relief it decides is appropriate. This is often an order that the aggrieved minority shareholder’s shares are purchased for ‘fair value’. This may include a premium on the actual value of the shares as recompense to the petitioner for any wrongdoing by the majority.

3] What is a ‘derivative claim’ – S.260 of the Companies Act 2006?

In certain circumstances a shareholder can ask the court to prevent action being taken by the Directors which is harmful to the company, or make a claim against the Directors for any loss suffered by the company as a result of their action.  The claim must be made by the shareholder on behalf of the company. The shareholder’s right to bring a claim “derives from” the company. This is a claim made in a “representative capacity” by the individual shareholder, not on the shareholder’s own behalf. It is the company which is suffering the harm.  The damage to the company may also harm the shareholder indirectly, e.g. if there is a reduction in profits or other damage suffered.

Derivative claims are relatively unusual because although it is the member who issues the court proceedings as claimant to launch the action, the court must give permission for the claim to continue to trial.  A number of tests have to be satisfied before the court will give permission.

The shareholder runs a risk on costs and at least initially has to fund the claim themselves. It is possible to obtain an order that the company indemnify the member, although they may obtain no immediate benefit themselves by launching the court case. However, if the claim succeeds, the company will have been protected. Ultimately, that should benefit the shareholder because it protects their investment in the company.

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4] What is a claim under S.122(g)  of the Insolvency Act 1996?

Any shareholder may apply to have a company wound up on “just and equitable grounds” including in quasi-partnerships, involving the shareholder’s right to manage the company – Ebrahimi  v Westbourne Galleries Ltd[ii]. The sole remedy here of winding up is draconian, available only in specific circumstances. This is the “nuclear option” in shareholder disputes – the aggrieved shareholder petitions the court for a winding up order to terminate the company.

Usually the shareholders’ differences have become irreconcilable and a ‘commercial divorce’ is the only way to move forward. When a company is wound up, if there is anything left after paying the creditors and the liquidator the proceeds are divided amongst the shareholders.

Not every aggrieved shareholder will be able to justify a winding up petition to the court. There must be compelling reasons showing that the company can no longer continue.  The aggrieved shareholder has to prove there will be a concrete benefit in making a winding up order.  If there is some alternative remedy, which would allow the company to continue, the court may refuse to make the order.

A typical scenario where a winding up may be justified is where there is deadlock or stalemate between two or more shareholders in a quasi-partnership company which can’t be resolved. Where there is an aggrieved minority shareholder, experience shows that the majority shareholder will seek to dispute:

  • the complaints by the minority that there was any “quasi-partnership” in the first place
  • the circumstances of any alleged unfairly prejudicial conduct
  • the alleged value of the business
  • the aggrieved minority shareholder’s share

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5] Finally

The sooner informed negotiations start, the more likely it is that a private business will survive a shareholder dispute. A comprehensive Shareholder Agreement can help to preserve operations and resolve matters quickly.

Expert legal advice early on could keep the process out of prolonged, expensive and destructive litigation. This is by providing the facts, insight and information to allow all parties to make informed decisions quickly. This would ultimately be to the benefit of the company as a whole and the shareholders individually.

For further information regarding minority shareholder / business disputes and unfair prejudice petitions contact Paul.Sykes@lf-dt.com

[i] [1992] 1 WLR 588

[ii] [1972] 2 All ER 492

Unfair Prejudice & Drag Along

Minority Shareholder wins Quasi Partnership claim

8 Ways to avoid a Business Dispute

Are you a Shadow or de facto director?

Service of a Claim Form on a Director

WHEN DIRECTORS FALL OUT

Disclaimer

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Directors & Shareholder Claims: 2

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Resolving Boardroom Conflict  – 5 More Tips

Disputes between shareholders of private companies are often emotional and can be as complicated as a personal divorce. The disruption to any business can be extremely damaging. Knowing what remedies are available to resolve matters quickly could be the key to survival.

  • What if the majority is taking unfair advantage of you?
  • What if you suspect co-shareholders are stealing from the company?
  • In the second of a series, here are five further important pointers to be aware of:

1/ Protecting the Minority

There is a common misconception that the complex laws and regulations relating to companies should achieve a just and fair relationship between a minority shareholder and the majority. However, there is very little law which protects the minority, unless the parties have agreed beforehand.

Differences between shareholders don’t always arise because of power struggles or personal animosity. Frequently, disputes are down to differences in approach where one party wants to retire or withdraw their investment. Disagreements may centre on

  • timing
  • valuation issues
  • the direction of the company

The public courts are unlikely to be the ideal venue for resolving shareholder disputes. Proceedings are in the public domain and the procedure can be expensive and slow.

Particularly where private companies are concerned, there are effective alternatives, including: negotiation, mediation and arbitration.

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2/ Shareholder Agreement

An effective way to address potential problems before they arise is a Shareholder Agreement. This sets out ground rules for the shareholders in given circumstances. Many potential and predictable problems can be addressed in advance in a Shareholder Agreement. This leaves the shareholders to concentrate on managing the business, rather than a future internal dispute.

Amongst other things, the agreement can cover:

  • management responsibilities
  • non-competition restrictions
  • bonus and remuneration formulae
  • approval/decision process for major corporate decisions
  • buy/sell provision – e.g. a “shotgun clause” to force a transaction
  • how a shareholder can realise his or her investment in the company
  • whether to impose any restrictions on selling shares
  • criteria on valuing the shareholding
  • exit provisions – timetable for sale
  • appointment of an independent third party to value the shares
  • a detailed dispute resolution framework

 

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3/ What is an “Unfair Prejudice” claim?

The majority shareholders are in a powerful position, even where there is a Shareholder Agreement. However, the court will protect the position of minority shareholders from being abused in certain circumstances.

Section 994 of the Companies Act 2006 allows a shareholder to apply to the Court for an order declaring that the affairs of the company are being conducted in a manner unfairly prejudicial to the minority shareholder’s interests. If the court agrees, it will usually order that the shares of the minority shareholder are bought for fair value. However, the Court has a very wide discretion as to what it can order, including:

  • purchase of the shares of any members of the company by other members or by the company itself and, in the case of the purchase by the company itself, the reduction of the company’s capital accordingly
  • conduct of the company’s affairs in the future
  • company to refrain from doing or continuing an act complained about, or to do an act about which the petitioner has complained that it has omitted to do
  • civil proceedings to be brought in the name and on behalf of the company by such persons and on such terms as the court may direct
  • company not to make any, or any specified, alterations in its articles without the court’s permission

4/ When might a court find “unfair prejudice”?

Where a minority shareholder believes that the company is being run in a way which is unfairly prejudicial to some of the shareholders, the aggrieved shareholder can make an application to the Companies Court for a remedy. Unfairly prejudicial conduct may include for example:

  • majority shareholders paying themselves excess remuneration
  • majority shareholders failing to pay dividends
  • breach of duty by diverting business to majority shareholders or their connected companies
  • directors selling or buying assets at an unfair price
  • failing to pay declared dividends
  • undertaking activities which are not permitted under the company’s Articles
  • doing something which might result in the company’s insolvency
  • failure to follow company law or proper procedure on meetings.
  • failure to issue annual accounts

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5/ “Quasi-Partnership”

In small to medium sized private companies, the court might be persuaded that a “quasi-partnership” exists. The aggrieved party may complain that there is a breach of their ‘legitimate expectations’ about what the company was set up to do, and how it would be run. E.g.

it was agreed, or a common intention is proved:

  • the company would carry on a particular business
  • all would be entitled to an equal say in how the company is managed
  • a mutual expectation of continued employment
  • the directors would be fair when deciding on the salaries to be paid, the amounts to be kept in the company to fund growth, and the dividends to be paid out

If the court decides that a quasi-partnership exists, termination of that arrangement or unfair prejudice to the minority may result in the majority being obliged to buy out the shares of the aggrieved minority shareholder. If the majority acts in breach of such

“legitimate expectations”

the court may intervene.

Where an aggrieved shareholder has cause for complaint, urgent action is required. The court may refuse to interfere if a minority shareholder let the matter slide. The court will treat this as acceptance of the action taken by the majority:

“delay defeats equity”.

The court will consider all of the background circumstances on an application, including the minority shareholder’s own conduct.

These applications are rarely straightforward and are often settled by negotiation before the court is asked to make a final decision.  Quite often, one or more of the shareholders leave with a package.

For further information regarding minority shareholder / business disputes and unfair prejudice petitions contact Paul.Sykes@lf-dt.com

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Directors & Shareholder Claims: 1

Unfair Prejudice & Drag Along

Minority Shareholder wins Quasi Partnership claim

8 Ways to avoid a Business Dispute

Are you a Shadow or de facto director?

WHEN DIRECTORS FALL OUT

Disclaimer

 

 

 

 

Directors & Shareholder Claims: 1

How to break the deadlock – 8 tips

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Boardroom and shareholder disputes can arise for many reasons. When they do, it’s important to understand the legal rights of all parties and the options available as well as the consequences of allowing things to get worse. However, there are some options which can make life easier:

  • If you are a minority shareholder in a company, what happens if you have a disagreement with the majority shareholder, or a group which has more control?
  • How do you solve the problem, or even avoid a dispute?
  • In the first of a series, here are seven important pointers to be aware of:

1/ Minimal Influence

In company law, a minority shareholder (anyone with 49% or less) has minimal influence over the management of the company or the distribution of its profits.  The standard constitution of a company and rules under the Companies Act give little protection to a minority shareholder.

Differences can and do arise as the business evolves and personal circumstances change:

  • there may be differences on strategy or the direction of the company
  • power struggles and poor personal relationships may develop
  • shareholders may wish to retire or disagreements occur on service contracts and remuneration.

There are ways in which the minority shareholder’s interests can be protected, either by agreement with the other shareholders or as a last resort by taking action through the courts.  It is easy for entrepreneurs to preference the initial brokering of a deal, and getting the new business up and running, over longer term, but equally important considerations.  But it’s always advisable to consider these scenarios at the beginning.

2/ Shareholder Agreements

A shareholder agreement is a must for a private company, especially where there are a relatively small number of shareholders who also manage the business. These don’t always arrive without (you) the minority shareholder/s pressing for one. You need to proactively pursue this as part of the start up, or failing that, you should put it at the  top of the agenda.  In a Shareholder Agreement, the majority shareholder usually gives up some rights to the minority.

The process of preparing the Agreement helps shareholders address points which could become potential problems. This encourages the key players to work through the issues early, when everyone is positive and communications are still good.

It’s much more straightforward and economic to deal with this as part of the start up, rather than risk the expense and uncertainty of going to court later.  All concerned will know where they stand where there is a Shareholder Agreements. It reduces the risk of conflicts arising or getting out of hand.

An existing businesses can certainly set up a Shareholder Agreement at whatever stage in its evolution, for example when one of the main shareholders is considering retiring or their circumstances have changed.

It is also worth remembering that a Shareholder Agreement

  • is confidential
  • doesn’t have to be filed at Companies House
  • sits behind the company’s public face
  • is a private document between the shareholders.

 

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3/ Points to Cover

A Shareholder Agreement can go a long way to ensuring disputes are avoided or at least, provide the mechanism that allows them to be settled quickly. An agreement identifies shareholders’ specific responsibilities and outlines how and where disputes are to be resolved. For example, it can specify forced buy/sell provisions during a dispute and even include a formula or other means to determine the transaction price.

Amongst other things, the Agreement can cover:

  • key objectives
  • financing and borrowing
  • dividends, directors’ fees and salaries / profit distribution
  • controls on the appointment of Directors
  • major expenditure
  • exit mechanisms – for shareholder deaths, misconduct, divorce, incapacity, etc.
  • fair valuation process for transfer of shares
  • succession arrangements – insurance of key persons
  • dispute resolution

The Shareholder Agreement gives minority shareholders a say in the business and some security. Without one, the minority would have little impact on decisions regarding the company and protecting their interests.

4/ How to enforce my rights as a shareholder?

Negotiation is the key, this should be explored first, rather than threatening legal action. However it is important to know your legal rights, and the provisions of the Company constitution.

  • How do these apply to your position and the other interested parties?
  • It may be necessary for you to obtain details or documents as part of the process, which the company is reluctant to provide.
  • Take legal advice early on as to the pros and cons, the likely outcome, and the likely timescales and costs

Even where proceedings are issued, frequently a solution is reached through negotiation. This is usually much quicker and cheaper than having a decision imposed by the court. However, it may be necessary to exercise leverage by relying on your strict legal rights to achieve any progress.

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5/ Solutions

There are various options, including:

  • proposing a resolution at a general meeting which redresses the situation
  • complaining to the police of any criminal acts
  • asking the board of directors to take action in the company’s name against an individual director (because the shareholders can’t sue in the company’s name)
  • using a mediation service to settle a dispute.

6/ Mediation

A mediator will be someone who is experienced in this area of law.  If agreement is reached with the help of the mediator, the compromise can be recorded in a legally binding document which can be enforced in the court, if one of the parties breaks it. The advantages of mediation include its relative cheapness compared to going to court, privacy (there is no public record) and speed.

If it isn’t desirable or possible to achieve an accommodation where the aggrieved shareholder stays in the company, other solutions include:

  • the other shareholders buy out the aggrieved shareholder at a fair price
  • the company buys back the aggrieved shareholder’s shares at a fair price
  • Make a reasonable offer to the aggrieved shareholder.

7/ Further Options

Where the Company refuses to cooperate, further options include:

  • applying to the court for an order that the company is acting or has acted unfairly (an “unfair prejudice” action under s.994 Companies Act 2006)
  • applying to the courts for the company to be wound up under s.122 of the Insolvency Act 1996
  • suing the directors for negligence by means of a Derivative Action under s.260  of the Companies Act 2006:

The courts encourage settlement of all disputes, including shareholder disputes. Where the majority has made a reasonable offer to the aggrieved minority shareholder to buy them out on reasonable terms, it is unlikely that the majority will have acted ‘unfairly’. Then it wouldn’t be ‘just and equitable’ to wind the company up. It is essential to take advice on the terms of any offer you make.

If you offer to go to mediation or alternative dispute resolution, you are also unlikely to have acted unfairly. However if the company is in financial difficulties a creditor may issue a petition under S.122 of the Insolvency Act, irrespective of the shareholders’ wishes.

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8/ Finally

Where the Court decides that a minority shareholder has been oppressed or unfairly prejudiced and the appropriate remedy is for the majority buy the minority shares, this is often done at a “fair value” i.e. fair market value, without deduction for a minority discount.

Where the majority gives an undertaking to buy the shares of the aggrieved minority at fair value, usually the court will adjourn the unfair prejudice petition.  However, the fundamental battle ground is frequently

  • the basis of the business valuation
  • the underlying assumptions
  • the data and criteria on which it is based.

The valuation of a private company is an area of potential significant difference between the parties. These can be quite complex disputes, but qualified and experienced legal advisors and valuation experts hired early in the process will help you through this potentially sensitive and difficult area.

paul.sykes@luptonfawcett.law

Disclaimer

LINKS

Unfair Prejudice & Drag Along

Minority Shareholder wins Quasi Partnership claim

8 Ways to avoid a Business Dispute

Are you a Shadow or de facto director?

 

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