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SUPREME COURT DECISION

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Directors & Trustees’ Limitation Defence Fails

The Supreme Court ruled on 28 February that on an inter-company transaction, Directors & Trustees can’t rely on a standard six-year limitation defence.[i] The claim by company Liquidators against its Directors for alleged breach of statutory and fiduciary duties was originally struck out on a summary judgment application, as being past the standard six years deadline.

  • The Supreme Court’s decision rejecting that and other lines of defence has wider implications including for Directors, Trustees and D&O Indemnity insurers regarding the way that transfer of company assets are dealt with.

Background

The decision was based on preliminary points of law of general importance, and the Defendants maintain their defence to the allegations as a whole.

This case concerned a claim by a company, Burnden Holdings which went in to administration in October 2008 and liquidation in 2009.The claim was against some of its former Directors for breach of fiduciary and statutory duty under the Companies Act 2006, including allegations that the directors failed to:

  • act in accordance with the company’s constitution and use their powers for the purpose for which they are conferred (s171);
  • exercise independent judgment (s173);
  • avoid conflicts of interest and conflicts of duty (s175);
  • declare interest in proposed transaction or arrangement (s177).

The Liquidator alleged that a distribution “in specie” (in its current form without converting it to cash) of the Claimant company’s shareholding in a subsidiary company on 12 October 2007 was unlawful and in breach of duty. The Directors were previously majority shareholders. The Liquidator contended that the claimant company did not have sufficient accumulated realised profits to make the distribution.

The claim against the Directors was issued on 15 October 2013. It was agreed between the parties that the proceedings were issued more than six years after the date of the distribution in specie on 12 October 2007. The Directors’ application for summary judgment striking out the claim was confined to the question of limitation.

Issues

  • The Liquidator relied upon s.21(1)(b) of the Limitation Act 1980, (LA 1980), which provides that no standard six years or other period of limitation applied to an action by a beneficiary under a trust to recover from the trustee trust property or the proceeds of trust property in the possession of the trustee. The Liquidator argued that this included a transfer to a company directly or indirectly controlled by the trustee. As such, no period of limitation applied to the present claim.
  • The Liquidator also claimed that questions relating to the availability of a postponed limitation period, such that those proceedings had been commenced in time, under LA 1980, s 32, on the basis that the breach of duty was deliberately concealed, could not be determined on an application for summary judgment.
  • The Liquidator’s case was that the Company’s claim was analogous to an action by a beneficiary under a trust where a beneficiary can recover trust property or trust proceeds from a trustee which has been converted to the trustees’ benefit. These types of claim can’t be barred for being “out of time”.

Decision

  1. The Supreme Court unanimously agreed, dismissing the appeal, finding that section 21(1)(b) applies to trustees who are company directors, to be treated as being in possession of the trust property from the outset.  For the purposes of section 21, the Defendant Directors are regarded as trustees, because they are entrusted with the stewardship of the company’s property and owe fiduciary duties to the company in respect of that stewardship.
  2. The company is regarded as the beneficiary of the trust under section 21. Contrary to the Defendants’ submissions, section 21(1)(b) does not become inapplicable merely because the misappropriated property has remained legally and beneficially owned by corporate vehicles, rather than having become vested in law or in equity in the defaulting directors.
  3. Section 21 is primarily aimed at express trustees and is applicable to company directors by a process of analogy. An express trustee might or might not from time to time be in possession or receipt of the trust property. By contrast, in the context of company property, directors are to be treated as being in possession of the trust property from the outset. It is precisely because, under the typical constitution of an English company, the directors are the fiduciary stewards of the company’s property, that they are trustees within the meaning of section 21.
  4. If their misappropriation of the company’s property amounts to a conversion of it to their own use, they will necessarily have previously received it, by virtue of being the fiduciary stewards of it as directors.
  5. On the assumed facts of the present case, the Defendants converted the company’s shareholding in the subsidiary when they procured or participated in its subsequent unlawful distribution. By the time of that conversion the defendants had previously received the property because, as directors of the Claimant, they had been its fiduciary stewards from the outset.
  6. Regarding the LA 1980, s 32 argument, in-depth analysis of the issue would take the court into a minefield of difficulties. It was not necessary to decide this point because of a recent amendment to the claim pleading fraud, and because of the court’s decision about the meaning of section 21, meaning the issue is unsuitable for summary judgment.

Comment

  • Where a company claims against a Director that the director has wrongfully or in breach of their fiduciary duties transferred the company’s property for their own benefit, no limitation defence will apply.
  • When considering limitation issues, it is important to assess whether LA 1980, s 21(1)(b) regarding a beneficiary’s claim against a trustee applies. If it does, then there will be no limitation period for the purposes of the claim, and the claim can’t be struck out for delay.
  • The effect of LA 1980, s 21(1)(b) can’t be avoided simply by using a corporate vehicle to receive the assets involved. The section includes a transfer to a company directly or indirectly controlled by the trustee.
  • Directors of a company are treated as having previously received all of the company’s assets, where they benefit from the transaction complained of and the assets are treated as having been converted to their benefit.
  • Regarding D&O’s indemnity insurance, this will be impacted where there is now no time limitation on claiming against directors regarding disposal of company assets.
  • On disposing of company assets, additional due diligence is required, ensuring that there is no breach of Directors’ statutory or fiduciary duties, to protect against future scrutiny from creditors seeking to reverse disposals, claw back company property or claim damages.

[i] Burnden Holdings (UK) Ltd v Fielding & ors [2018] UKSC 14.

Paul Sykes is Levi Solicitors LLP Head of Disputes Management department. For further information regarding directors’ duties, company and trust disputes, contact jpsykes@levisolicitors.co.uk

Please note this information is provided by way of example and may not be complete and is certainly not intended to constitute legal advice. You should take bespoke advice for your circumstances.

 

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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

 

 

 

 

Shareholder and Boardroom Disputes: Tips (2)

images CALM GOLDEN RULES WHITE

In the second in a series of articles, read my piece in the link below on:

http://www.luptonfawcett.com/blog/minority-shareholder-boardroom-disputes-tips-2/

  • Minority Shareholders
  • Boardroom Disputes
  • Shareholder Agreements
  • Unfair Prejudice claims

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Shareholder & Boardroom Disputes: Tips (1)

imagesCA8KW2NT GOLDEN RULES RED

In the first of a series of articles, read my piece in the link below on:

  • Minority Shareholders
  • Boardroom Disputes
  • Shareholder Agreements
  • Unfair Prejudice claims

http://www.luptonfawcett.com/blog/minority-shareholder-boardroom-disputes-tips-1/

 

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Unfair Prejudice & Drag Along

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My analysis on Court of Appeal decision in Re Charterhouse Capital Limited; Arbuthnott v Bonnyman [2015] EWCA Civ 536 :

http://www.luptonfawcett.com/blog/unfair-prejudice-and-drag-along/