Unfair Prejudice & Drag Along
In a recent case regarding alleged unfair prejudice on the minority, the Court of Appeal has dismissed the minority shareholder’s appeal against the High Court’s decision in Re Charterhouse Capital Ltd Arbuthnott v Bonnyman and others  EWHC 1410[i]. The case provides clarification on fundamental issues relating to:
- unfair prejudice under section 994 of the Companies Act 2006 and / or
- under the rule in Allen v Gold Reefs of West Africa[ii]
- amending Articles to insert or amend “drag along” rights into Articles of Association as part of an overall exit strategy
A “drag along” clause in a company’s constitution gives majority shareholders the right to accept an offer to buy their shares and to force the minority shareholders to accept an offer.
The decision concludes a long-running dispute regarding the sale and valuation of Mr Arbuthnott’s shares in Charterhouse Capital Limited (“CCL”). He was a founding shareholder and former director of CCL.
When Mr Arbuthnott and other founder members approached retirement, members intending to continue with the business offered to purchase all of the shares in CCL. All retiring members agreed to sell, except Mr Arbuthnott. The Court of Appeal considered the insertion of drag along provisions into the company's Articles without the consent of the minority shareholder Mr Arbuthnott, which then allowed the buyout to proceed, contrary to his wishes.
He considered the price offered to be a substantial undervaluation and the steps taken against him constituted unfair prejudice. At first instance the High Court rejected Mr Arbuthnott’s claim for unfair prejudice under section 994 of the Companies Act 2006 and / or under the rule in Allen v Gold Reefs of West Africa (1900) 1 Ch 656.
The Court of Appeal, in dismissing Mr Arbuthnott’s appeal, reiterated the founding principles, for an effective challenge to alterating a company's Articles. This included considering the proper approach to the construction of drag along rights in Shareholders’ Agreements and the Articles of Association which required shareholders to sell where an offer was accepted by a majority of the shareholders.
The Court of Appeal decided that
- the amendments to the articles were a legitimate “tidying-up exercise”
- there was no evidence of bad faith or improper motive
- the amendment to allow the sale to proceed was not inconsistent with the original arrangements entered into by the shareholders
- the agreement provided that the minority would be bound by a price with which the majority was content
- the amendments to the Articles met with "commercial common sense", aligning ownership of the company with those who worked in the business and avoiding a majority of the shares being held by retired members
- a term could be implied that, as sophisticated financial professionals, the majority would not accept a price which they did not honestly consider to be fair and reasonable
The decision in the High Court was upheld, where the ‘well-known’ principle was highlighted that ‘the exercise of the power of the majority by special resolution to alter the Articles of Association may be subject to restraint in equity if it is abused’,
The judge noted ‘Any resolution that offends the Allen principle will inevitably be unfair and prejudicial for the purposes of section 994, but an alteration of the Articles does not have to offend the Allen principle in order to amount to unfair prejudice. Unfair prejudice is a wider concept, judged in accordance with an objective standard, and gives rise to greater and more flexible remedies.’
Generally, a company is free to amend its articles. However, shareholders' powers of alteration are not completely without limit. A power to amend will be validly exercised where this is done in good faith in the interests of the company.
The Court of Appeal held on the facts that a desire to resolve a growing alignment issue in order to secure the future of the business was in what the members considered to be the interests of the company.
It is for the shareholders, and not the court, to decide what is in the best interests of the company, unless no reasonable person would consider it to be a benefit. The court will not investigate the quality of the subjective views of shareholders.
Provided the amendment does not amount to oppression of the minority or is otherwise unjust or ultra vires, the amendment will stand.
The fact than an alteration adversely affects one or more minority shareholders does not, necessarily invalidate the alteration if it is otherwise made in good faith in the interests of the company.
An alteration should not amount to oppression of the minority, it should not be unjust, and it should not be outside the scope of the power to amend.
The burden of proof lies on the party alleging invalidity of an amendment.
Read The Court of Appeal Decision here:
[i] Re Charterhouse Capital Limited; Arbuthnott v Bonnyman  EWCA Civ 536
[ii] (1900) 1 Ch 656
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.