Company Law Advice: Trading Breakdown

RE: BOXMOOR MOTOR PARTS LIMITED

OPINION

1. 1. I am instructed on behalf of M Charles Perret, a shareholder and a director in the company of Boxmoor Motor Parts Limited (“Boxmoor”), to advice on the company law issues that arose due to the cessation of Boxwood’s trading in November 2005 and any possible relief that M Perret may be able to obtain under section 461 of the Companies Act 1985 (“The Act”) subsequent to a petition under section 459 of the Act for unfairly prejudicial conduct against him.

Background Facts

2. 2. Boxmoor, a private company, was incorporated in 2000 when it was agreed: (i) M Perret would provide the capital (£150,000) and Mr Ander Whitbread would manage the business; (ii) each party would have 50% of the shares in the company; and (iii) they would both be the directors and draw equal remunerations. In September 2005, M Perret became aware that Mr Whitbread had stopped working for Boxmoor; and has been conducting identical business and soliciting Boxmoor’s former customers through Hobbshill Spare Parts Limited (“Hobbshill”). Since then M Perret’s attempts to obtain records of Boxmoor’s accounts have not been very fruitful and Mr Whitbread had provided insufficient records. M Perret is concerned about the disappearance of Boxmoor’s surplus funds, Mr Whitbread’s competition with Boxmoor, the state of Boxmoor’s business since August 2005, and Mr Whitbread’s decision to change Boxmoor’s accountants and hire Mrs Whitbread as Boxmoor’s secretary without any consultation with him.

Summary of Advice

3. 3. In my opinion it is very likely that the courts will accept Mr Perret’s petition for an order on the grounds of unfairly prejudicial conduct against him under s. 459 of the Act because Mr Whitbread’s actions, e.g., competition with and mismanagement of Boxmoor, were related to the conduct of the affairs of Boxmoor, which affected Mr Perret’s interest as its member. Additionally, Mr Whitbread’s decision, such as changing auditors, electing his wife as the secretary of Boxmoor, and failure to provide adequate financial details will most likely raise equitable considerations, pursuant to which the courts will accept M Perret’s petition for an order under s. 459 of the Act. After the courts have determined that the petition is well founded, M Perret would most likely receive an order of relief, on behalf of Boxmoor, against Hobbshill, Mr and Mrs Whitbread for the recovery of assets that they have wrongfully diverted to them; or order Mr Whitbread to purchase M Perret’s shares in Boxmoor at a reasonable price.

Unfair Prejudice

4. 4. Section 459 of the Act allows a member, a subscriber of a company’s memorandum (section 22 of the Act), to petition to the courts for unfairly prejudicial conduct against them according to the procedure set out in the Companies (Unfair Prejudice Applications) Proceedings Rules, 1986, SI 1986/2000. It has been established that the section only applies to conducts, including past conducts, of the company or those who are authorised to act on behalf of the company (Re Legal Costs Negotiations Ltd [1999] 2 BCLC 171; Re Saul D. Harrison and Sons Plc [1995] 1 BCLC 14); and those conducts must be unfairly prejudicial to the interests of the members qua members (Re a Company (No. 004475 of 1982) [1983] Ch 178).

Interest of Members

5. 5. It has been established that the prejudice suffered to the interests of the members qua member should be judged objectively (Re Macro (Ipswich) Ltd [1994] 2 BCLC 354) and ‘interests’ should not be too narrowly or technically construed, i.e., it should be interpreted broadly (O’Neill v. Phillips [1999] 1 WLR 1092 at p 1105).

Meaning of ‘Unfairly Prejudicial’

6. 6. In Re Saul D. Harrison and Sons Plc [1995] 1 BCLC 14, Lord Hoffmann established that that unfair prejudice under s. 459 requires two elements: (i) the conduct that is being complained of must be prejudicial, i.e., causing prejudice or harm to the relevant interest; and (ii) it must be unfair. The prejudice must be harm ‘in commercial sense, not in a merely emotional sense’ (Re Unisoft Group Ltd (No 3) [1994] 1 BCLC 609 at 611); however, s. 459 does not seem to be limited to cases in which the value of member’ shareholders has been seriously diminished or jeopardized (see e.g., Re R.A. Noble and Sons (Clothing) Ltd [1983] BCLC 273 at 291). It has been established that a member will only be able to complain for unfairness on two grounds: (i) if the prejudicial conduct constituted a breach of the terms on which that member agreed that the affairs of the company should be conducted, or (ii) if that conduct would be regarded by equity as contrary to good faith (per Lord Hoffmann, O’Neill v. Phillips, supra at p. 1098).

7. 7. In determining whether a prejudicial conduct breached a term of agreement, the courts would ask whether that conduct was in accordance with the constitution of the company. If it was, then it would be fair; even if it was not, it may not necessarily be unfair if the infringement was trivial or technical (Re Saul, supra). It seems to have been established that diversion of corporate property and misapplication of the company’s assets by those who were in charge of the company’s affairs for their own benefit would constitute unfairly prejudicial conduct (e.g., Re Brenfield Squash Racquets Club [1996] 2 BCLC 184).

8. 8. Courts would invoke equitable considerations for determining whether a prejudicial conduct was unfair if a member has a legitimate expectation that the company’s affairs will be conducted in a particular way even though there is nothing to that effect in the company’s constitution or in the Act. Equitable constraints based on legitimate expectation would arise under certain circumstances which require: (i) the company had been formed on the basis of personal relationship; (ii) there had been an agreement that all or some of the shareholders shall participate in the conduct of the business; and (iii) the transfer of shares were restricted (Ebrahimi v. Westbourne Galleries Ltd [1972] 2 All ER 492 at 500). It should be noted that the case for giving effect to equitable considerations must be made in each instance and a simple assertion that a company is small or private is not sufficient to invoke equity (Ebrahimi, ibid). Therefore, equitable considerations would generally arise in relation to companies which are quasi-partnerships, i.e., companies based on mutual understandings amongst the members reached when they entered into the association and later promises, by words or conducts (which need not be legally enforceable), as to how the affairs of the company would be conducted (O’Neill, supra).

9. 9. It is important to appreciate that in determining these mutual agreements the court will only not take into account a belief by some members that the other will be externally constrained to act in a particular way (Re Carrington Viyella plc (1983) 1 BCC 98,951). The courts have emphasised that they will only enforce what was actually agreed, they will not try to create a better agreement (Re Postage and Denby (Agencies) Ltd [1987] BCLC 8 at 14). However, it is established that the categories of unfair prejudice are not limited to promises or agreements, and where it can be shown that the respondent was exercising his control of the company for the disadvantage of the petitioner in his capacity as a shareholder the courts would treat that infringement as being unfair (Arrow Nominees Inc. v. Blackledge [2000] 2 BCLC 167). Therefore, if the provisions of the constitution do not conflict with other rights, exceptions and understanding, a member cannot complain about conduct in accordance with the constitution, unless he can demonstrate that there is bad faith or impropriety. (Re a Company (No 004377 of 1986) [1987] 1 WLR 102 at p 110).

Remedies

10. 10. S. 461 of the Act provides the courts a wide discretion as to the choice of that may be appropriate if they are satisfied that a petition under s. 459 is well founded.

Analysis

11. 11. It is my opinion that M Perret would be very likely to obtain an order under s. 461 if he makes a petition under s. 459 because he suffered loss in his capacity as a member of Boxmoor, and Mr Whitbread’s actions were in breach of the constitution of Boxmoor and contrary to equitable considerations for unfairly prejudicial conducts.

12. 12. The fact that Boxmoor has ceased trading due to the cumulative effect of Mr Whitbread’s actions, such as, his possible misappropriation of Boxmoor’s funds, competition with Boxmoor, solicitation of its clients, election of Mrs Whitbread as its secretary, alteration of its auditors, has rendered Mr. Perret’s shares worthless. Therefore, M Perret would have locus standi to petition to the courts under s. 459 because these actions have inflicted a loss upon him qua shareholder of Boxmoor.

13. 13. It seems that Mr Whitbread’s possible misappropriation of Boxmoor’s reserve funds for the benefit of Hobbshill would constitute a breach of Boxmoor’s constitution because it would be a breach of his duties as a fiduciary of Boxmoor. Additionally, his competition with Boxmoor’s business and solicitation of its clients constituted a breach of his fiduciary duties and the terms of his employment as the managing director of Boxmoor. Thus, it is very likely that the courts would hold that these actions were unfairly prejudicial to M Perret.

14. 14. Furthermore, it is very likely that the courts will invoke equitable considerations for the determination of unfairly prejudicial conduct because Mr Whitbread’s decision to discharge Messrs Lomas, Hicks & Gartside would be in contravention of M Perret’s legitimate expectation that it would be the company’s auditor. The courts are likely to hold that M Perret had a legitimate expectation in relation to the nomination of auditor because Boxmoor would be deemed a quasi-partnership as it was a closed company, i.e., the sale of its shares were restricted; it was incorporated on the basis of M Perret’s relationship with Mr Whitbread which arose following their discussions in 2000; and they had agreed that Mr Whitbread would be the executive director of Boxmoor while M Perret would be the non-executive director. Even though M Perret may not be able to enforce the understanding that Messrs Lomas Hicks & Gartside should be nominated as Boxmoor’s auditor, he would be able to enforce them in equity. Therefore, the courts would most likely deem Mr Whitbread’s decision to nominate Seaton, Kormorant & Hillington as Boxmoor’s auditor as unfairly prejudicial to the interest of M Perret.

15. 15. Mrs Whitbread’s election as Boxmoor’s secretary would also invoke equity, even though there was no express agreement between M Perret and Mr Whitbread as to the election of a secretary and seems to be in accordance with the powers conferred on Mr Whitbread by the constitution of Boxmoor, because it seem to demonstrate bad faith on Mr Whitbread’s part. The fact that Mr Whitbread had been neglecting Boxmoor’s business and accounts, soliciting its clients and allegedly diverted its reserve funds for his benefit seems to indicate that he had elected Mrs Whitbread merely for his personal benefit, as he may have a substantial influence over her, and not for the interest of Boxmoor. Thus, it is quite likely that the courts would deem the election of Mrs Whitbread as unfairly prejudicial to M Perret’s interest.

16. 16. Once the court is satisfied of the unfair prejudice to M Perret, they may grant him an order authorizing him to take civil proceedings on behalf of Boxmoor to bring an action against Mr Whitbread for breach of fiduciary duty and then purchase the shares of Mr Whitbread at a fair price, or providing that Mr Whitbread should purchase his shares of Boxmoor at a fair price which would reflect their true value.

Conclusion

17. 17. In my opinion we should try to determine where the reserve funds had been diverted because that would definitely strengthen our case and enable us to determine the appropriate value of M Perret’s share; and file a petition for unfair prejudice as soon as possible because there is a very good chance that we shall succeed.

E. Barrister

7 High Holborn

22^nd May 2006