Wed 24 Aug 2016

Company Law Update: Unfair Prejudice Petitions

The Inner House of the Court of Session gave its decision yesterday in the petition of Nigel Gray & Others. This petition was brought under sections 994 and 996 of the Companies Act 2006 and alleged that the petitioners were subjected to unfairly prejudicial treatment.

The action went to proof before Lord Tyre in October 2015 and, after 24 days of evidence, Lord Tyre found that the petitioners' interests had been unfairly prejudiced and ordered that the petitioners' shares be bought by the company. However, despite the value of the petitioners' holdings being £20,614,400 out of a total value of £32,000,000 Lord Tyre ordered that the shares be bought for their subscription value of £2,444,000 because he considered that the first petitioner was a "bad leaver" in terms of the Articles of Association of the company. Inevitably the petitioners reclaimed this decision to the Inner House on the basis that the effect of the Lord Ordinary's decision was to reward those guilty of prejudicing the petitioners while materially prejudicing the petitioners further by devaluing their shareholding. They separately argued that there was no basis in evidence for the Lord Ordinary finding that the first petitioner was a bad leaver. Finally, they argued that the bad leaver provisions of the articles fell foul of the penalty rule.

The Extra Division was split in its disposal of the reclaiming motion. However, the court was in agreement as to the principles that applied to such petitions. They started by outlining that the exercise of its powers under section 996 involves a wide discretion by the court and that that discretion is to be exercised for the purpose of providing the petitioner with "relief" or a "remedy" under the section. They also held (contrary to the petitioners' submissions) that this discretion extends beyond choosing a remedy. So, once the Lord Ordinary had decided that the appropriate remedy was the purchase of shares by the company he still had a wide discretion to determine the price at which the shares should be purchased. It was not, according to the court, the case that he had completely unfettered discretion. Rather he had to exercise his discretion "rationally and judicially, in accordance with settled legal principle, upholding any legal agreement between the parties and on the basis of the evidence before him, not on the basis of supposition or conjecture". At that point, however, Lord Menzies disagreed with the approach taken by Lord Malcolm and Lord Brodie.


Lord Menzies took the view that there was no evidence that the bad leaver provisions had actually become applicable and, therefore, on that basis, it was an unreasonable exercise of the Lord Ordinary's discretion for him to have made the order that he made. He failed to give proper relief in respect of the matters complained of. However, Lord Brodie and Lord Malcolm held that the Lord Ordinary correctly had regard to the bad leaver provisions because the first petitioner's misconduct had meant that his employment would have been terminated and that the bad leaver provisions of the articles would have been invoked. That was, of course, a hypothetical question (given that the provisions had not actually been followed) but it was a "hypothetical question of fact" which entitled him to answer the question in the way that he did. Accordingly, the Lord Ordinary's decision was upheld by the majority of the court.

The Inner House also addressed the issue of whether the bad leaver provisions could be regarded as an unfair penalty and again the bench was divided. Lord Menzies considered that the bad leaver clause was a secondary contractual obligation (contrary to the respondents' submission that it was a conditional primary obligation). Applying the Supreme Court's decision in Cavendish Square Holding BV v Makdessi [2015] UKSC 67 Lord Menzies held that the provisions in the bad leaver clause obliging a bad leaver to transfer their shares at subscription price was an exorbitant or unconscionable provision having regard to the company's interests in the performance of the contract. Indeed, Lord Menzies considered that he was "unable to ascertain a legitimate interest in the company requiring the first petitioner to give up his shares at subscription price rather than for value. The company has no legitimate interest in requiring the first petitioner to forfeit whatever value has been built into the shareholding since he subscribed for his shares". Lord Brodie and Lord Malcolm were again unpersuaded. Neither of them considered that the clause was an unfair penalty. Its penal nature (or otherwise) had to be judged as at the date it was entered into and not when it fell to be implemented. The first petitioner's conduct had been sufficiently bad that it was damaging to the interests of the company and that, therefore, it was neither exorbitant or unconscionable for the court to require him to relinquish his shares at par.

It will be interesting to see whether this matter goes any further. It emphasises once again the wide discretion that the court has in unfair prejudice petitions and is the first serious application of the Cavendish rule in the higher courts in Scotland. The clarification of the penalty rule by the Supreme Court will, no doubt, be the subject of much litigation in this jurisdiction. Whether something in exorbitant or unconscionable is a matter of opinion and as any litigator knows, some judges are more censorious than others.

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