Scottish Court of Session Decisions

The petitioner is a shareholder of, and was formerly a director of and held executive office in Gamut Technologies Limited, the company. On 3 August, 1998, the petitioner was given written notice terminating his employment with the company with effect from 7 August when he was handed a letter to that effect dated 2 August. On the same day he was given a letter dated 3 August removing him from office as director. The letter of 2 August gave no reason for the petitioner's dismissal. He was told to stay away from the company's premises and to avoid contacting staff. The petitioner states that the meeting on 3 August at which these events took place had been scheduled several weeks before. The events happened without warning. The reason given at the meeting for discontent with him was that he had made arrangements for leasing a car with which his co-directors were not happy.

On 21 August, the petitioner made an application to an Industrial Tribunal seeking compensation and reinstatement for unfair dismissal by the company. In his application, the petitioner set out his version of the background to the transaction which had been referred to at the meeting. He stated that following the end of the company's financial year, 31 December, 1997, the directors had resolved to pay themselves bonuses, in sums of £20,000 each for the three senior directors and £10,000 for the most junior. They also agreed that the bonuses could be drawn in cash or in kind "for services which would effectively be deemed as expenses incurred on behalf of the business." The second respondent, Mr George Knox, had improvements carried out at his home, and these, amounting to £10,000 exclusive of VAT by the end of July, 1998, were treated as business expenses and deducted from his £20,000. The petitioner drew £5,000 in cash, obtained sums for travel, and for a computer, and for a deposit on a vehicle, amounting in all to £14,730.71 by the time of his dismissal, and they were deducted from his £20,000. The deposit on the vehicle was £971.10. The third respondent had purchased a computer, and had drawn sums for first class travel to America, amounting to £6,400 during the relevant period. The petitioner did not know about the fourth respondent's bonus. In answers to the application, the company gave alternative explanations in respect of the several payments. On 23 November, 1998, the Industrial Tribunal continued the hearing of the application for further information about the series of transactions. The company's answers to the application add to the range of grounds for dismissal now relied on in justification of the respondents' actions. No date has been fixed for the continued hearing. It would not be appropriate to make any comment on the facts or allegations founded on by the parties before the Industrial Tribunal, given that the dispute is still in dependence. But it would appear that whether the position adopted by the petitioner or that adopted by the respondents is eventually held to be true the outcome will be of no little interest to a number of regulatory authorities. The answers to the application refer to some possible consequences.

On 31 August, the respondent directors gave notice to the petitioner requiring the sale of his shares in terms of a provision in the Articles providing for compulsory sale at par in the case of dismissal for gross misconduct or material breach of contract. There was, incidentally, an arithmetical error in the computation of the price, but that is of little consequence for present purposes. The petitioner raised proceedings in the Sheriff Court, and an order for interim interdict was pronounced to prevent further procedure on that aspect of matters pending resolution of the Industrial Tribunal case.

Before commenting on the events which led immediately to the present petition, it is necessary to say something about the history and financial position of the company. It was incorporated on 16 March, 1994. The petitioner and the second respondent were the original shareholders, holding 1,500 and 3,500 £1 shares respectively. The third and fourth respondents were transferred or allotted shares in 1994 and 1998. The resulting position is that the second respondent holds 3,148 shares, the petitioner 1,352 shares, the third respondent 500 shares and the fourth respondent 406 shares, giving a total issued share capital of £5,406. All of the shareholders held executive positions with and were directors of the company. The petitioner was the finance and legal affairs director. The second respondent was primarily concerned with sales. The third respondent was a technical director. The fourth was concerned with consultancy services. Together the executives provided an integrated range of computer services to major public and other companies. For the purposes of the hearing it was contended by the petitioner and conceded by the respondents that the company met the tests of a quasi-partnership set out in Ebrahimi v Westbourne Galleries Limited [1973] A.C. 360.

The company had a considerable trading success, but was hopelessly under-capitalised. During 1997 Messrs Pricewaterhouse Coopers were instructed to advise the company. I was not shown their report or reports, but it was agreed that they recommended that in order to sustain its existing levels of trading and to take advantage of the potential for development of its business the company required capital of £1m to £1.4m, and that external equity funding was required in the form of venture capital. If the petitioner's averments and the additional information I was given prove to be reliable, due diligence investigation, which would inevitably be instructed by potential investors, might have a bearing on the ability of the company to raise such funds. If external funding cannot be procured, the company's future must be in doubt. Without a significant injection of capital, the company, which is already practically insolvent, appears to have poor prospects of survival. I was provided with some internal financial information by the respondents from which it appears that the financial position of the company at 31 October, 1998 was as follows:

Debtors 1,006,097.50

Taxation 155,239.05

Long term creditors [7,703.50]

The company had a deficiency of current assets as against current liabilities of £443,383.71. The short term creditors were fully analysed, by the end of the hearing. There were three main items, trade creditors, many of which were overdue, of £464,759.98; accruals, mainly of licence dues, of £254,973.00, and pre-payments by customers in respect of future services of £110,429.57. I was not provided with a balance sheet at 31 December, 1997. But the information provided suggested a significant increase in dependence on creditor finance to support the business during 1998. Essentially the company's bankers, trade creditors and customers making pre-payment for services were financing the company's operations. Typically, the servicing of creditor finance, directly in the form of interest and charges, and indirectly in the cost of efforts to postpone payment, can be expected to accelerate the decline of the company into absolute insolvency if a permanent solution to under-capitalisation cannot be found. The company's bankers had already intimated on 27 October 1998 that they were not prepared to increase their exposure by raising lending limits. Prior to the dismissal of the petitioner he had been engaged in discussions with Kellock Limited with a view to arranging facilities for factoring the company's debtors to increase cash flow. One creditor balance at 31 October 1998 requires further comment, namely H.M. Customs & Excise for V.A.T.. The company had defaulted and become liable for penalties. As at the date of the removal of the petitioner, two instalment schemes for settling arrears had reached their final stages. Cheques for £69,994.14, and £120,000 were drawn on the bank account and paid to Customs & Excise on 30 October, 1998. Those payments, subject to clearance by the company's bankers, settled the arrears of V.A.T. and penalties and interest due by the company. The sum of £74,149.30 in the internal balance sheet related to the then current accounting period, due to end on 31 December, 1998, and would fall due for payment in January, 1999.

On 2 November, 1998, the second respondent wrote to its members, including the petitioner, intimating that:

The letter proceeded to show the resulting new shareholdings if the whole issue were taken up, including the petitioner's new holding of 35,013 shares at a subscription price of £35,013. Various ancillary matters were dealt with. A meeting of the company was called for 25 November to consider a resolution for the increase of the authorised capital of the company by the creation of 135,406 new shares. The petitioner objected to the proposals. Correspondence between parties' solicitors failed to achieve an accommodation, or, indeed any clear information about the intentions of the second to fourth respondents. The present petition followed.

At the hearing before me, the petitioner sought in the alternative (a) interim interdict against the respondents from holding that meeting and from considering and passing the proposed resolutions; and (b) an interim order postponing the meeting.

For the petitioner it was said that he was quite unable to take up the rights proposed, and that the respondents knew fully that that was the position. He was unemployed. He had no income. Sums to which he was entitled had been withheld by the company. The company had control of all of his financial information. If the proposal went ahead, it would inevitable result in the dilution of his equity stake in the company to his detriment. He would be deprived of any significant shareholding. There was a persuasive prima facie case that the respondents' purpose was to injure the petitioner. The proposed increase in capital could not be construed as an attempt to deal with its financial problems. It could only be seen as directed against the petitioner's interests. Further it was clear that the letter of 2 November made inaccurate representations. The V.A.T. liability had already by that date been settled. Further the alleged sum of £140,000 bore no relation to the actual liabilities which had been settled. The sum appeared to be arbitrary. It was of an amount which the petitioner could not meet, and the legitimate inference was that the respondents' true purpose was to remove the petitioner from any practical say in the company rather than to raise necessary equity capital. If the purpose of the respondents were to meet a need for cash, the same sums could be raised from the current directors by other means, such as loans. There was no intelligible explanation for the proposal. Reference was made to sections 459 and 461 of the 1985 Act, and to in re Saul D Harrison & Sons plc [1995] 1 BCLC 14, in re a Company [1985] BCLC 80; [1986] 2 BCC Ch.D. 99,453; and (as re Cumana Limited) [1986] BCLC 430. As between the alternative orders sought, interim interdict was the preferred option because of the difficulty of regulating the postponement of the meeting, and because any postponement could be circumvented by steps to hold another meeting on a fresh resolution.

For the respondents, it was contended that the court had to carry out two balancing acts, one relating to interim interdict, and one relating to the statutory orders, since in the latter case there was a requirement to consider whether it was just and equitable to make the order sought. The petitioner had to persuade the court that it would be unfairly prejudicial to him for a meeting to proceed which had been regularly called. The letter to the members explained clearly the reason for the requirement for additional capital. The V.A.T liability explained the urgency of the action taken. The petitioner had to be invited to subscribe: Companies Act, 1985 section 85. The respondents' whole actings had been carried out in terms of the Articles of Association of the company. The compulsory sale notice was issued in terms of the Articles. There was a provision for determining the sale price according to circumstances. The procedures agreed in the Articles should not be interrupted. The company's financial position was as set out in the documents provided, and the additional finance was required. The averments in the petition which linked the petitioner's dismissal and the compulsory sale notice to the proposed meeting and resolution were misconceived. The current proposals were no mere pretext to disadvantage the petitioner, nor were they part of a single scheme with the previous steps. The prospects of the parties before the Industrial Tribunal and the Sheriff were irrelevant to the present issue. The rights issue could not be regarded as unfairly prejudicial to any member. The other members might not have made up their minds whether they would take up their rights. One could not say whether their position would be affected as the petitioner forecast. (This position was departed from, in the course of the hearing, and I was informed that the continuing directors did intend to take up their shares, and that it was intended that additional shares should be issued to third parties.) The authorities did not support the petitioner. They emphasised the need to hold the parties to the Articles of Association, and to prevent interference with procedures prescribed by the Articles. The contractual provisions set an objective standard: they formed the basis of the parties' rights. There could be oppression only if what was done infringed the petitioner's rights. If the meeting proceeded, there was no disadvantage to the petitioner: his shares would be acquired at the appropriate price. Subject to the sheriff court proceedings the only issue was valuation, and there was a mechanism to determine that. The availability of such an alternative remedy should weigh heavily with the court in deciding the present issue. The authorities emphasised the need for intent to damage the complainer to be established. The respondents did not know that the petitioner could not pay for the rights issue. They had his computer, and knew that he had dealt actively in shares during his employment. He was able to deal: significant sums of money were involved, and the respondents refuted the allegation that they knew of his impecuniosity.

Counsel for the petitioner responded. He emphasised that the petitioner was unable to take up the rights. He had no income. He was unemployed. His heritage was heavily secured, to the extent of 90%. There was no equity on which he could borrow. His investments were in an investment club with others. His equity was presently valued at £8,000. The present issue did not depend on a balance such as submitted. The question was whether the petitioner's apprehensions were well founded. On the balance of convenience, preserving the status quo had a high priority. The financial information provided indicated that what was proposed was not properly a capitalisation matter. There had been a lack of clarity about the respondents' proposals. The authorities showed that there were no closed categories: the issue was of unfair prejudice and that could be manifested in various ways. The petitioner had made out a prima facie case.

I granted the order for interim interdict. It is not appropriate at this stage in the present proceedings to form or to express any concluded view on the main contentions between the parties. The issue is largely one of the balance of convenience, provided that the petitioner has a prima facie case for enquiry. If the matter depended wholly on the interpretation and application of the Articles of Association, it would have been my view that there was a case to try in the circumstances. The three transactions cannot be distinguished conclusively without further investigation. There was no dispute before me that the sheriff was entitled to relate the compulsory sale notice to the dismissal of the petitioner and his removal from office as director. The contention for the respondents was that the third step, the proposed meeting and subsequent action, was to be distinguished, and to be considered on its own merits. It was regular. Without forming any concluded view, there is, in my opinion, a stateable case that it was not independent. The respondents had been less than candid with the petitioner in correspondence before these proceedings. But, when pressed in the course of the argument, the respondents made it clear that they intended to take up their own allotments under the rights issue, and that they had in view the allotment of additional shares to third parties. The compulsory sale notice stands: it has not been departed from. The introduction of third party equity capital invariably involves either the realisation in part of the existing members' own equity, or, its expression in terms of the value put on it by the incoming investors. If the petitioner were able to take up the shares allotted, he would suffer no disadvantage unless he failed in his Industrial Tribunal application and the compulsory sale notice became effective. But he states that he cannot do that, and is entitled to proof of his averments of that fact and of the respondents' knowledge of it. If he succeeded in his application, having failed to take up his rights, his position would be seriously affected. He would benefit from the valuation implications of the venture capital injection only in respect of his original holding. The resolution of the Industrial Tribunal proceedings is therefore vital to the measurement of the value of the petitioner's economic interests in the company. If the petitioner fails in his Industrial Tribunal application, there will remain the question whether the Articles operate as a penalty: the issue in the Sheriff Court action. Again the whole issues are interrelated. In these circumstances it would require compelling evidence to support a material innovation on the status quo which might affect adversely the interests on one of the parties. The financial information with which I was provided may prove compelling when fully developed. At present it appears thin and unconvincing. The letter of 2 November is, at least, seriously inaccurate. On 27 October, 1998, the Bank of Scotland wrote to the company. The Bank refused additional facilities without further collateral security, and asked that the existing facility ceiling of £350,000 be adhered to. A copy of that letter was enclosed with the company's letter of 2 November, 1998. The clear implication of the two documents was that the company's liability to the Commissioners of Customs & Excise could not be met without an immediate injection of cash following the rights issue. Members were asked to agree to dispensation with formalities by signing a written resolution to allow the proposals to have immediate effect. At the hearing before me, there was no suggestion that the Bank had refused payment on the cheques. The internal balance sheet made up as at 31 October on 3 November showed the bank balance adjusted for the payments. There is at least an issue to try whether the letter made a false representation of the company's then current financial position

However, the authorities to which I was referred make it clear that a member may be entitled to a remedy even where everything is done strictly in terms of the members' contract. I take the statement of approach set out in the opinion of Neill L.J. in In re Saul D Harrison at pages 30-32 as a guide. One is not constrained by any narrow interpretation of the words "unfairly prejudicial". They have to be applied flexibly to meet the circumstances of the case. But one must be careful to avoid allowing them to become an instrument of oppression of the legitimate majority. The conduct complained of must be both prejudicial and unfairly prejudicial. One must have regard not only to legal rights, but to any equitable considerations. The Articles are the measure of the parties' legal rights. Head 7 of Neill L.J.'s analysis is irrelevant: one is not here concerned with managerial decisions. That, for present purposes, is the business of the Industrial Tribunal. (There is no head 8). Heads 9 and 10 are the material paragraphs in this case. There are averments of ulterior purpose. They are of sufficient substance to amount to a case to try. This was a quasi partnership: there were duties of mutual trust which went beyond the ordinary fiduciary duties of directors to the members of the company as a whole, and which will have a bearing on whether the majority and continuing directors could be held to have acted improperly even if they were held to have acted strictly in accordance with their legal rights. The case of Cumana is an illustration of how these principles may apply to an act as straightforward as the raising of fresh capital by a rights issue of shares.

The balance of convenience strongly favours the petitioner. At the end of the day the only justification offered for the proposal is an urgent need for cash. There are numerous ways in which cash can be introduced to the company. Simple loans were discussed. Convertible debentures would be another method. The need to introduce fresh capital in this case has more to do with structural deficiencies in the company's financing than with any short term cash shortage. The deficiencies have been known since at least the beginning of 1998 when Pricewaterhouse Coopers began to give advice. There may well be a need in a wider context for the existing members to introduce fresh capital as an aspect of a scheme for the introduction of venture capital funds. But that can be considered only in a proper context, on a frank disclosure of the current directors' proposals for the future of the company. There may even be a need to remove at least one director of the old regime to palliate new investors. There may be cases in which the cut of the cards is all that distinguishes the sacrificial lamb from the celebrants at the feast. Such manoeuvres are sometimes encountered. No such explanation has been tendered for the actions complained of. As matters stand, there is no persuasive counter to the petitioners' apprehensions.

I would have inclined to postpone the meeting if that had been a practical solution ad interim, but I was convinced that it would not provide an acceptable solution to the problem at this stage. The progress of the Industrial Tribunal proceedings cannot be predicted with any confidence. All that one can do is to prevent innovation on the status quo while the major differences between the parties are resolved in appropriate proceedings. For that interim interdict appeared to me to be the more effective solution. In my opinion the petitioner made out a persuasive case for interdict ad interim. I made that order accordingly.

Act: E Robertson

Henderson Boyd Jackson

Alt: Swanston, Solicitor

Maclay Murray & Spens

4 December 1998