SMP Problem Ans BAB

Q1. Fairways Ltd has two shareholders: Investortec plc (which owns 51 per cent) and
Assetrich plc (which owns 49 per cent). The company has two directors: Petra (appointed by
Investortec) and Russell (appointed by Assetrich). Fairways’ articles say that any contract
over £50,000 must be approved by both directors of the company. It was also agreed,
informally, between Investortec and Assetrich that all profits from Fairways would be paid
out as dividends to the shareholders. In January 2019, Petra’s son, Trevor, was working as an
intern for Fairways. He went to one of Fairway’s suppliers, Veronica, to purchase a new
machine for Fairways, for £80,000. Veronica was concerned whether Trevor was authorised
to make the contract. She telephoned Petra. Without consulting Russell, Petra assured
Veronica that Trevor had full authority. The contract was then made. A week later, Russell
discovered what Trevor had done. Russell reminded Petra that he never approved the
purchase of the machine, which he says Fairways does not need. He also complains that no
dividends have been paid by Fairways for three years, even though it has made substantial
profits. Advise Russell whether: a) Fairways is bound by the contract entered into with
Veronica; and b) Assetrich could successfully take proceedings under section 994 Companies
Act 2006 and, if so, what remedy the court would award. (2019 Zone B)

Answer
Considering the facts, it is to be perceived that Fairways Ltd has primarily two shareholders
Investortec plc owning 51% of shares and Assetrich plc who owns 49% of the shares, and
both shareholders has appointed their respective directors, namely Petra and Russell. We note
in the course of company affairs certain actions has been occurred, we shall discuss each
circumstance individually.
(a)
Pursuant to the Articles of company, it is clear any expenditure above £50,000 will required
to be consulted by both directors, in our case Trevor, an intern, bought a new machine worth
£80,000 with the consent of Petra, whereas Russel had no knowledge of such purchase, in
addition to that the machine bought was not even productive for company. Our primary task
is to determine whether the contract formed is valid or not and whether Trevor has authority
to initiate such contract.
In respect of above, the issue is of whether a contract can be formed without the internal
authority and compliance of Articles of Association (AoA) in this regard previously there
was a concept of constructive notice, where the contract with the third party cannot be formed
if it’s not in accordance with AoA, however this rule was repealed by Indoor Management
Rule introduced by Lord Denning wherein the contract can be created between third party
and person not having authority according to AoA, the rationale behind this change is the
person entering into contract without authority is internal issue of company and company has
role to create management better then why should third party suffer due to the
mismanagement of the company. The indoor management rule was further enshrined in S.40
of Companies Act 2006, it was held under S.40 contract will be formed if signed without
internal authority if he deals with board of directors or authorized person and acting in good
faith, the S.40(b)(ii) further clears that good faith is presumed unless symptoms of bad faith
proven i.e., active dishonesty (EIC Services v. Phipps 2004). We note that in our case Trevor
entered into a contract with Veronica on behalf of company although he never had the
internal authority, but Petra assured to Veronica that Trevor contains full authority of
purchase, furthermore there are no elements of bad faith hence the contract will be binding
and in accordance with the S.40.
(b)
A company in itself has a legal rights / standing the decisions of company are decided /
approved by shareholders and the approval of shareholders is not necessarily required to be
unanimous approval of all the shareholders of the company rather decision making is
dependent upon approval of ordinary (51% of shareholders) or special (75% of shareholders)
resolution i.e., majority shareholders and among the shareholders whose opinion is
disregarded will be considered minority shareholders, hence it can be constituted that even if
the decision is opposed but gets majority approval then the minority is bound to follow that
decision. This concept of majority rule was initially introduced in Foss v. Harbottle (1843)
wherein it was held that allowing a claim by minority shareholder would frustrate the wishes
of the majority.
In order to avoid injustice with minorities the law has to step in, and therefore the Parliament
has enacted S.996 of the CA’06, wherein it’s stated that “A member of a company may apply
to the court by petition of an order ... on the ground”. There are primarily three requirements
on which a petition can be made by shareholder – the initial requirement is of conduct of
company’s affairs, the courts have applicated this rule in broad manner it’s applicable
wherever a shareholder has been affected from the unfair prejudicial conduct of company’s
affairs, the broadness of this rule can be witnessed in the case of Nicholas v. Soundcraft
Electronics 1993 where the Court of Appeal held that omission will also result of unfair
conduct of the company’s affairs.
The second requirement of S.994 is interest of its members, where the claimant is required to
prove that his interest has been unfairly prejudiced, under this rule courts have interpreted
word ‘interest’ in broad manner by believing that it is legislative intent as the statute has used
the word ‘interest’ rather than ‘rights’, therefore this ground will be interpreted broadly this
was established in the case of Re Sam Weller & Sons Ltd (1990) by Peter Gibson J.
Lastly, the petitioner is required to prove that unfair prejudice has been done upon him as a
shareholder, this again has been kept a wide rule where the courts has seen unfair prejudice
objectively (Re Bovey Hotel Ventures 1981), in context of unfair prejudice courts have to the
extended limits in order to provide justice to minority shareholders it can be witnessed in the
case of Re Ringtower Holdings plc 1988 where Peter Gibson J held that the conduct may be
lawful but unfairly prejudicial which means even if the act is accordance with the law but if
it’s being unfair prejudice to shareholders it will result in the breach of S.994 of CA’06.
In our case, the minority is in disadvantage due to certain act firstly machine has been bought
without compliance of articles and in addition to that minority has not been granted dividends
even though the company is in profit, hence under the provision of S.994 a claim can be
initiated and infringement will be proved if three points are met.
In context of first requirement i.e., there has to be a conduct of company affairs, we note the
first act of company can be seen where the company has entered into a contract to buy
machine from Veronica and the second act of not distributing dividend will result in omission
of the company, hence conduct of company is proven.
The next requirement for infringement of S.994 is that interest of company members should
be affected, the interest is widely defined and generally arise either from statue, AoA or
contract. Pursuant to the case facts, we note that it’s written in Article that any contract above
£50,000 needs to be approved by both directors, hence it affects the interest of minority. In
addition to that minority shareholder didn’t get any profit and the right of shareholders profit
is significant right and generally mentioned in AoA, therefore the interest of shareholder is
also affected in context of not receiving profits.
The last requirement is to prove unfair prejudice, the third condition requires fact-based
analysis. Perceiving the facts, we note a machine is bought worth £80,000 which shows non-
compliance of articles. Although, in shareholder level the Assetrich plc is considered as
minority since they own 49%, but it’s fundamental to notice that both companies have
appointed their separate directors, which explains that in directorship right both directors
have equivalent standing, moreover it’s evidential from AoA that any contract form above
£50,000 will be considered massive contract, since it requires approval of both directors.
Therefore, it can be constituted that the act of buying machine which is not productive for
company without even consenting Russell is unfairly prejudicial. In context of no dividends
paid by company to minority, it can be argued that in commercial context the dividend is
often retained of shareholders for the further development of company in future and this act
of retaining lies under the ambit of commercial understanding, however there are no evidence
of any sort of development and despite company making profits yet the company failed to
distribute dividends for substantial period will surely result in unfair prejudice, hence all three
requirements of S.994 is met.
Since, infringement is proven the next aspect is of remedies, the remedies available under
S.996 of CA’06 are also favorable for the minority shareholders, since the courts has set out a
criterion of non-exhaustive remedies which means all sort of remedies are available
depending upon the form of loss suffered by shareholder. The courts can order company to
pay immediately dividends of the minority shareholder and can order to resell the machine
bought also the remaining expense to be paid to company. However, we note the
shareholding percentage of company was 51% and 49%, and after the intervention of legal
conflict it’s merely impossible to run the company together in such circumstance the courts
propose the most prudent remedy wherein courts can order either of the shareholder to buyout
or sellout other shareholder entire shares (Grace v. Biagioli) wherein the courts will
determine the valuation of shares and no discount will be applied (Re Addbins Ltd).
The courts can ask either of the shareholder to buyout or sellout since the difference of
shareholding percentage is minimal, however if buyout or sellout of company cannot occur
due to the differences then the last resort remedy is under S.122(1)(g) of the Insolvency Act
1986 where courts can order winding up of the company.
Extras
 Wherever conflict b/w S.168 and contract / AoA, statute will prevail (s.168 – right to
remove director), however person can sue company for the breach of contract under
contract law but has to leave directorship
 If someone has inherited shares not bought, then this fact will be reflected while
valuation of shares
 Right of Pre-emption (this right often exist in AoA, where if one shareholder has to
sell his shares, he’s required to offer shares to remaining existing shareholders)
 S.21 can alter amendments of Articles on 75% shareholding, however can be
challenged on bonafide grounds where minority has burden of proof that amendment
is not for benefit of company as whole.
 Under Quaisi partnership initial understanding b/w party is to open and run business
together, and if one partner removes another from business it’s unfair prejudice, for
Quaisi breach of informal / oral agreement will be considered breach.