Article / 1 Jul 2023
In this month’s update we:
The High Court has summarised the test for a shareholder to bring a successful petition on the grounds that a company’s affairs have been conducted in an unfairly prejudicial manner.
Whilst “majority rule” is the default position for UK companies, this can leave the minority at the mercy of, and open to abuse by, the majority. The “unfair prejudice” remedy set out in section 994 Companies Act 2006 helps protect the minority in this situation, giving them the ability to challenge a majority decision that is in some way inequitable or unfair, even if it may technically be lawful.
In the recent case of Re Fore Fitness Investments Holdings Limited [2023] EWHC 1514 (Ch) the judge set out a useful summary of the hurdles which a person must overcome to bring a successful unfair prejudice claim:
The Fore Fitness case involved a company set up in 2019 to operate a gym franchise. H became a shareholder and director of the company which also had two other directors, L and G. Under the company’s articles of association, a director could be removed from office by a majority of the other directors.
H also entered into a consultancy agreement with the company which was terminable either on 30 days’ notice or immediately on a default event.
In late February 2021, L took steps to lock H out of the company’s IT systems. Then, on 2 March 2021, L sent an email to H stating that he had been removed as a director of the company and that the consultancy agreement had terminated “by mutual agreement”.
H brought a claim for unfair prejudice on the basis that his removal as a director was ineffective as he had not been notified, in his capacity as either a director or a shareholder, of any proposed resolution to remove him as a director or of any board or general meeting. If the removal was ineffective, H argued, then L was wrong to exclude him from the company’s IT systems, was wrong to remove him as a director and was wrong to breach the consultancy agreement by immediately terminating it.
The judge found that H had not been removed as a director. No notice of a board meeting had been given to the directors, no agenda had been circulated to them and there had been no “meeting” at which the directors had been able to communicate with each other in the manner required by the articles. If H had known about a meeting he could have attended, objected to the resolution and attempted to persuade G that L was wrong. Accordingly there was no valid resolution of the board of directors to remove H.
L’s failure to convene a properly constituted board meeting was unreasonable. It was also unfair of L to ignore the company’s constitution, to exclude H from information about the company and to terminate the consultancy agreement in breach of its terms. The judge also said that L had breached an understanding between him and H that all major decisions would be made by them jointly. All this amounted to conduct which was unfairly prejudicial to H.
The court has a wide range of remedies available to it if an unfair prejudice petition is successful but the most common one is that the majority must buy out the minority’s shares at fair value. A minority member should bear this likely consequence in mind before starting such a claim.
But an unfair prejudice petition is not the only course of action available to an aggrieved minority. They could also consider asking for the company to be wound up on the “just and equitable” ground or bring a derivative claim in the name of the company against those controlling its affairs to compensate the company (rather than the minority) for loss suffered.
The High Court has refused permission for the environmental charity, ClientEarth, to continue a derivative claim against the directors of Shell PLC for breach of their statutory duties. Although the case (ClientEarth v Shell PLC [2023] EWHC 1137 (Ch) highlights the increasing scrutiny of corporate actions in relation to climate change, it should provide some comfort to directors trying to make commercial decisions whilst also mitigating climate change risks.
In most cases under English law, where a wrong has been committed against a company, it will be the company itself that is the proper claimant (not individual shareholders), and it will be for the directors to decide whether to sue or not.
However, the Companies Act 2006 provides a mechanism for shareholders to bring a claim in their own name on behalf of the company – a derivative claim – where that claim arises from an actual or proposed breach of duty by one or more of the company’s directors.
To prevent abuse of the procedure, shareholders must apply to the court for permission to pursue a derivative claim. This was the stage that ClientEarth reached in its action against the directors of Shell.
ClientEarth alleged that the manner in which Shell’s directors were dealing with climate change risk meant that they were in breach of their statutory duties to promote the success of the company and to exercise reasonable care, skill and diligence. In particular, ClientEarth claimed that Shell had failed to implement a strategy that aligned with the Paris Agreement on Climate Change or would achieve “net zero” by 2050.
ClientEarth also alleged that Shell’s directors were in breach of six supplementary duties relating to climate risk that were “necessary incidents” to the statutory duties. These included a duty to make judgements regarding climate risk based on a reasonable consensus of scientific opinion and a duty to give appropriate weight to climate risk.
The Court refused ClientEarth’s application on the grounds that it had failed to establish a prima facie case for permission to be granted. ClientEarth’s evidence did not show that the actions taken by the directors in their management of climate risks were unreasonable and amounted to a breach of duty.
When reaching this decision, the Judge observed that there was no universally accepted methodology by which Shell might achieve its emissions reduction target. English law respected the autonomy of directors when making commercial decisions and their judgement as to the best way of achieving results in the best interests of their members as a whole.
The Court also rejected ClientEarth’s introduction of supplementary duties relating to climate risk. Not only were these duties and obligations said to be ‘inherently vague’, they were also incompatible with the well-established principle that it is for the directors themselves to determine (acting in good faith) how best to promote the success of a company. When managing the business, Shell’s directors would be required to consider a range of competing considerations and it was not for the Court to interfere with board decisions on how those considerations should be balanced.
As concerns about climate change increase, we are likely to see more shareholder activism in this area. However, this case sends a clear message that derivative actions should not be used as a method for imposing a particular shareholder’s own climate (or other) policies onto the company.
Policy decisions are for the directors to take. They decide how to deal with the risks and challenges facing their company and this case should provide some comfort to directors that a court will not interfere with board decisions when they are made in good faith and promote the success of the company for the benefit of its members as a whole.
Shell’s directors had undoubtedly weighed up many factors when deciding how best to deal with the climate-related risks facing the company. ClientEarth’s belief that the directors had adopted the wrong strategy in relation to those risks was not sufficient for the Court to interfere with the board’s decisions.
ClientEarth has now been granted an oral hearing where the decision to refuse permission for the derivative claim will be reconsidered. Although it seems unlikely that the court will change its original decision, any additional insights into how the court deals with the issues raised should be useful to both directors and shareholder activists alike.
On 15 June 2023, changes to the scope of the criminal insider dealing regime in the UK came into force.
The changes, which were introduced by the Insider Dealing (Securities and Regulated Markets) Order 2023 (the Order), broadly align the types of securities and the markets on which a criminal insider dealing offence may be committed with those that apply to the civil market abuse regime under the UK Market Abuse Regulation (UK MAR).
The criminal insider dealing offence in the UK is set out in Part V of the Criminal Justice Act 1993 (CJA). It is completely separate to the civil insider dealing offence under UK MAR.
The criminal offence applies to anyone who has inside information on securities (or issuers of securities) as an insider and then does one of the following:
Before the Order becoming effective, the criminal offence only applied to a limited range of securities listed in the CJA – mainly shares and debt securities and certain instruments related to those securities. This list had not been updated for many years and was much narrower in range than the securities that were caught by the civil market abuse regime.
The criminal offence could also only be committed on a small number of named regulated markets, as specified in secondary legislation (less than 50). This list of regulated markets was also much narrower than the relevant markets under UK MAR and was also out of date, with some markets having merged or ceased to exist.
The changes made by the Order update the criminal insider dealing regime and align it more closely with UK MAR.
Instead of being restricted to named regulated markets, the criminal offence will now apply to securities traded on any of the following:
MTFs and OTFs were not previously in scope of the criminal offence (subject to a few exceptions), and their inclusion along with the addition of other markets such as the New York Stock Exchange, means that over 400 trading venues are now in scope.
The Order also expands the types of securities covered by the criminal CJA offence in line with UK MAR. It still applies to shares and bonds (as under the previous regime), but now also includes derivatives (for example, futures, options and credit default swaps) as well as units in collective investment schemes.
The expansion of the criminal insider dealing offence is not controversial and is, in fact, long overdue. Recommendations were made for an update to the regime as far back as 2015 and since then, the Financial Conduct Authority (FCA) has issued warnings about an increasing number of suspected insider dealing cases. It will be interesting to see whether the number of criminal prosecutions by the FCA increases as a result of the much expanded regime.
First published in Accountancy Daily.
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