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Going Dutch? Who foots the bill in section 459 petitions?

Michael Lower.

Solicitor and senior lecturer in law at Liverpool John Moores University. M.L.Lower@livjm.ac.uk

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Summary

There have been many decisions arising out of applications under section 459 of the Companies Act 1985 for relief on the grounds of unfairly prejudicial conduct. These decisions have been extensively commented upon. Issues concerning the procedural aspects of section 459 proceedings have, inevitably, had less attention paid to them. One procedural issue of considerable practical importance is whether the company itself can be made to pay some or all of the costs of fighting the section 459 petition. Whether or not the company can play, and fund out of corporate assets, an active role in section 459 proceedings was considered in Re a Company (No 001126 of 1992) and Re Milgate Developments Limited. The judgment in the former sets out the basic legal test to be used in this situation. This test is applied in Re Milgate Developments Limited. The latter decision also considers whether a petitioner can obtain an injunction to prevent a company from playing an active part in section 459 proceedings. The decisions must, of course, be viewed in the broader context of the decisions and academic comment concerning the funding of litigation by minority shareholders.

Contents

Introduction
The facts
Can the company incur the costs of an active role in section 459 proceedings?
The procedural aspects
Conclusion

Introduction

Many petitions for relief under section 459 of the Companies Act 1985 are presented by shareholders in quasi-partnership companies. A description of the quasi-partnership company was given in the speech of Lord Wilberforce in Ebrahimi v Westbourne Galleries ([1973] AC 360 at 379). In essence, the association between the members is based on personal relationships involving mutual confidence. Joint venture companies are a frequently encountered example. Since the decision in Ebrahimi, the courts have been prepared to look beyond the terms of the memorandum and articles of a quasi-partnership when asked to grant relief under section 122 of the Insolvency Act 1986 or section 459 of the Companies Act 1985. The courts will give redress in respect of legitimate expectations of members of a quasi-partnership which have been disregarded by other members of the company. Section 459 is now frequently invoked in a number of different situations (1) and it is possible to glean some clear principles on substantive issues from the ensuing decisions. On the procedural side, it is clear that the company must be named as one of the respondents by virtue of the requirements of the Companies (Unfair Prejudice Applications) Proceedings Rules (SI 1986 No 2000). It is important, though, to know whether a respondent who is in control of the company can cause it to take an active part in the proceedings. If so, the cost to the company as a result of the petition will be increased. Indirectly, these costs are being partly financed by the petitioner himself. If there were no restriction on the company's ability to side with the other respondents then would-be petitioners might be frightened off. Their petition might lead to depletion of the company's funds. As a result, the petitioner's own interest in the company might become less valuable. If the petitioner is seeking an order for the purchase of his interest in the company, presentation of the petition might be self- defeating. The principal question, then, is whether there are any limits on the company's ability to participate in section 459 proceedings. We will see that in some, but not all, circumstances the company may play a part in section 459 proceedings relating to it. That being the case, certain subordinate tactical questions might arise concerning the circumstances in which the company might participate and the terms of the participation. First, is there any merit in an application to the court by the company seeking the court's leave for it to participate actively in the proceedings? The reason for doing so would be to obtain the court's confirmation that the proceedings in question are of the type in which the company's active participation is lawful. This is likely to be important to the directors of the company who otherwise might be applying the company's property to some improper purpose. Secondly, if the petitioner fears that the company intends to participate, and assuming the court has not given leave for it to do so, will the petitioner be able to obtain an injunction restraining the company from taking an active part in the proceedings? It is logical to suppose that the petitioner can sometimes obtain an injunction in these circumstances. Otherwise, the respondent/directors might be tempted to ensure that the company plays an active role and, thus, relieves them from some or all of the costs of the proceedings. They may be aware of the risk that this is a breach of fiduciary duty and that they may subsequently be called to account. This would, however, be another set of legal proceedings for the petitioner to fund. Prevention is clearly better than cure! On the other hand, if an injunction were to be granted too easily then the respondent company might suffer an injustice because of its inability to take steps to put forward its point of view. These issues were explored in the recent cases of Re a Company (No 001126 of 1992) ([1993] BCC 325) and Re Milgate Developments Ltd ([993] BCLC 291).

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The facts

The company in question in the first of these two cases was controlled by a consortium of investors. The petitioner was a minority shareholder in the company. Complex refinancing arrangements involved the restructuring of the company. The section 459 petition alleged that these arrangements worked to the prejudice of the minority shareholders by excluding them from participation in the company's business. It asked for relief which would redress the unfairness. This required action by the respondents other than the company but not by the company itself. The company sought leave from the court to enter a defence and generally participate in the proceedings and an order that the cost of such participation should be payable out of the company's funds.(2) The company would be closely involved in the proceedings in the sense that its affairs would come under scrutiny. It would, therefore, necessarily incur some cost. Could it, though, incur the costs of active rather than passive participation? The matter came before Lindsay J. In Re Milgate, C, the petitioner, presented section 459 petitions against Milgate Developments Ltd. ("Milgate") and against Kent and Provincial Investment Co. plc ("Kent"). Kent owned eighty per cent of the shares in Milgate. C owned ten per cent of the shares in Milgate and around fifteen per cent of the shares in Kent. One of the respondent shareholders, S, owned ten per cent of the shares in Milgate and seventy five per cent of the shares in Kent. The relief sought by C was an order for his shares to be bought by the other shareholders. It was feared, however, that by the time of the hearing of the petitions the only available course of action would be to wind up the two companies. With that in mind, C was concerned that the assets of the company should not be depleted by involvement in the section 459 proceedings. Accordingly, C sought an order that the individual shareholders should not, until after judgment on the petitions, cause or procure the companies to be represented on the hearing of the petitions or of any application therein or to be otherwise involved in or about the petitions save in respect of any application for relief pursuant to section 127 of the Insolvency Act 1986. The application came before Mr. Edward Nugee QC sitting as a deputy judge of the High Court.

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Can the company incur the costs of an active role in section 459 proceedings?

Hoffmann J, in his judgement in Re Crossmore Electrical and Civil Engineering Ltd ([1989] BCLC 137 at 138) said:

"It is a general principle of company law that the company's money should not be expended on disputes between the shareholders: see Pickering v Stephenson."

If this were taken at face value then a company could rarely, if ever, participate in section 459 proceedings. Lindsay J, in Re a Company (No 001126 of 1992), reviewed the authorities beginning with Pickering v Stephenson ((1872) 14 Equity Cases 322). He pointed out that this statement could rest on either or both of two propositions. The first of these is that such participation is ultra vires the company. Alternatively, it may be that, although intra vires, it is beyond the power of the directors to cause the company to participate. Lindsay J's review of the authorities lead him to doubt that the true principle was as all-embracing as Hoffmann J seems to have believed it to be. He concluded his review with the following statements of principle:

"Those, then, are the authorities to which I was referred. As a body they suggest to me the following. Firstly, that there may be cases (although it is unlikely nowadays when wide objects clauses are the norm) where a company's active participation in a s. 459 petition as to its own affairs is ultra vires in the strict sense. Secondly, leaving aside that possible class, there is no rule that necessarily and in all cases such active participation and such expenditure is improper. Thirdly, that the test of whether such participation and expenditure is proper is whether it is expedient in the interests of the company as a whole (to borrow from Harman J in Ex p Johnson). Fourthly, that in considering that test the court's starting point is a sort of rebuttable distaste for such participation and expenditure, initial scepticism as to its necessity or expediency" ([1993] BCC 325 at 333).

In other words, there may be cases where it is lawful for the directors of a respondent company to cause it to play an active part in section 459 proceedings. If such participation is challenged, however, the onus will be on the directors to show that it was in the company's interest to participate.

Lindsay J. saw the decision in Re Milgate Developments Ltd as being an application of this test. In substance the question there was whether there was any justification for the involvement of the companies in the applications. Counsel for C contended that there was no such justification since the dispute was in essence one between shareholders. No-one, other than the members of the company, was affected by the outcome of the petitions. Counsel for the respondents tried to persuade the court that the interests of the companies were not necessarily the same as those of the respondents. They had the interests of employees to consider, for example. On the facts, the judge was unable to agree that there was any justification for the companies taking an independent part in the proceedings.

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The procedural aspects

In order to succeed in its application for an injunction, the petitioner in Re Milgate had not only to persuade the court that there was no justification for the involvement of the company in the proceedings but also that an injunction was the correct way of dealing with the problem. In principle, the court could have permitted the company's involvement leaving the apportionment of the costs to be dealt with after the event. One possible mechanism for achieving this is to take the costs into account when making a share purchase order under section 461. This approach is consistent with the conclusions reached by Lindsay J in Re a Company (No 001126 of 1992). In principle, the directors of a respondent company are, as we have seen, free to cause it to play an active part in the proceedings. Their action in doing so will be subject to challenge after the event and they will have the burden of proving that they acted in the company's interests. The problem with this essentially laissez-faire approach has already been outlined. Part of the costs burden falls indirectly on the petitioner since the value of his stake in the company will fall as the costs of litigation rise. The respondents other than the company may be inclined, in cases of doubt, to involve the company in the proceedings in any event. The company will be helping to fund the costs of the immediate proceedings. It may be worth their while to take the risk that the company will not subsequently call them to account for their breach of fiduciary duty. It is clear, therefore, that it must in certain circumstances be possible to obtain an injunction preventing the company from playing an active part in section 459 proceedings.

The judge in Re Milgate pointed out that the injunctive relief sought by the petitioner was novel. The criteria governing the grant of interim injunctions are set out in the judgement in American Cynamid Co v Ethicon Ltd ([1975] AC 396). The first hurdle for the respondents, in resisting the application for the injunction, was to show that there was a serious question to be tried. That is to say, they had to show that there was some legitimate reason for the involvement of the company. They failed to discharge this burden and the injunctive relief was granted.

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Conclusion

As a result of the decision in Re a Company (No 001126 of 1992) it is now clear that, provided the company's objects clause permits it, the respondent company can play an active part in section 459 proceedings. Its directors must assure themselves that such participation is "expedient in the interests of the company as a whole" (to quote from Lindsay J's third proposition set out above).

What about the situation where the interests of the respondent director/shareholders coincide with those of the company? On the face of it, the directors should be free to procure the active involvement of the company. After all, that involvement would, in the circumstances envisaged, be for the benefit of the company as a whole. Logically, it must be the petitioner who is fighting to protect some personal right of his own. Yet it may be that the respondents would fall foul of the "initial scepticism as to its necessity or expediency [referring to the company's involvement]" which Lindsay J also spoke of. In Re Milgate, for example, it seems to have been accepted that the respondents needed to establish some independent interest of the company. In other words, the advantage lies with the petitioner who objects to the company's involvement in the section 459 proceedings. The judgment in Re a Company (No 001126 of 1992) imposes upon the respondents the burden of proving a need for such involvement. It seems from Re Milgate that the test to be satisfied is quite onerous. It is not enough to show that the company will benefit from active involvement. The respondent must show that this benefit is not one which is shared in any way with the other respondents.

Footnotes

1. It has been suggested that the cases fall into clear categories such as exclusion from management, improper share allotments and self-dealing by the directors (Farrar, Company Law 1991, p 467). Back to text.

2. In the light of the comments made above, it is interesting to note that the relief sought in this case was for the shares issued during the refinancing to be offered to other shareholders including the petitioner. As a result, the petitioner was inevitably concerned that the value of the shares should not be depleted by the incurring of substantial legal costs. Back to text

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