Lorna MacFarlane: Unfair prejudice – guidance from the Court of Session
The Court of Session (Outer House) recently issued an opinion on unfair prejudice, in the case of Adrian Richard Hawkins OBE and Othman Akbar Rafay, petitioners, writes Lorna MacFarlane.
The petitioners sought an order under sections 994 and 996 of the Companies Act 2006 confirming that the affairs of Sustainable Pipeline Systems Limited (the company) had been conducted in a manner unfairly prejudicial to their interests. In brief, section 994 allows members to request such an order and the court has discretion under section 996 to provide such relief as it sees fit.
The company, which develops pipeline technology, is headed by Dr Andrew Stevenson (its majority shareholder, chairman and CEO). Both petitioners invested significant sums in the company from 2016 to 2020. However, their relationship with the board deteriorated from 2020 onwards. The petitioners raised three grounds in support of the requested order, which are considered in turn.
Exclusion from management
Firstly, the petitioners asserted that they have been excluded from the management of the company.
Both were offered positions as non-executive directors around the time of their initial investments. Mr Hawkins duly accepted. Mr Rafay declined, but was invited to attend board meetings as an observer and did so.
In July 2020, Mr Hawkins and Dr Stevenson disagreed on the company’s application for a Coronavirus Business Interruption Loan Scheme (CBILS) loan. The former was concerned the company was not a suitable recipient for a loan because it was trading.
All directors other than Mr Hawkins voted to proceed with the loan application. Dr Stevenson informed Mr Hawkins that a refusal to sign the loan papers would be a breach of his fiduciary duties. Mr Hawkins decided to resign. The respondents (Dr Stevenson and the remaining non-executive directors) were concerned that Mr Rafay’s conduct and views were influenced by Mr Hawkins, and no longer extended invitations to board meetings to either Petitioner.
Lord Sandison found that Mr Hawkins was genuinely concerned at the prospect of his name being associated with the CBILS application and was not convinced that his refusal to engage with the paperwork breached his fiduciary duties. However, he concluded that “voluntary resignation from the board consequent upon a disagreement with reasonable business strategies favored by the majority of the board cannot give rise to a complaint of unfairly prejudicial exclusion from the company’s management”.
Mr Rafay’s tendency to agree with Mr Hawkins was not, however, an adequate ground to exclude him from board meetings. Whilst an observer of a board has no particular entitlements in law, this status confers obvious practical advantages on investors. Accordingly, the loss of access to board meetings constituted a material detriment to his interests as a shareholder, and withdrawal of observer status of a civil and reasonable shareholder was not an equitable measure to take. Lord Sandison found that Mr Rafay had suffered unfair prejudice, but Mr Hawkins had not.
Lack of remuneration
The petitioners argued that they had not been remunerated for their work for the company. They asserted that they had acted as advisers and had performed work on an ad hoc basis. For example, Mr Rafay had organized a seminar in Muscat and Mr Hawkins’ assistance (through one of his own companies) had enabled the company to obtain a grant.
They further claimed that they were entitled to remuneration under a share bonus scheme. Dr Stevenson initially indicated that he would create a growth shares scheme to reward non-executive directors and shareholders. He planned to make further allotments of £21,000 per annum converted into shares valued at a point at which major investment was attracted to the company.
This was abandoned due to adverse taxation consequences. Dr Stevenson thereafter offered each Petitioner notional remuneration of £10,000 for all work to date, but this was refused. An alternative remuneration process was developed and was to be approved shortly after Mr Hawkins’ resignation. However, following his resignation, the board opted not to proceed.
The claim that the petitioners had suffered unfair prejudice did not succeed. The petitioners accepted that they were entitled, in terms of the articles of association, to neither an appointment to any specific role, nor to any remuneration. The remaining non-executive directors were not remunerated. The discussions concerning the bonus had simply not come to fruition and neither Petitioner had obtained a legal right to participate in or draw benefit from the scheme.
Allotments to subsequent investors
Following the petitioners’ initial investments, the company sought further capital in early 2020. Alongside the petitioners and Dr Stevenson, a new investor, Mr Christopher McCann, participated in the funding round. The petitioners consented to this allotment.
However, Mr McCann further invested £250,000 cash at £37 per share in early 2021. This was a 75 per cent discount from the price previously paid by the petitioners. The board did not invite the petitioners to make a further investment and the petitioners did not waive their pre-emption rights.
Lord Sandison found that the board had no good reason not to ask the petitioners whether they would consider investing further capital in the company, on the same basis as Mr McCann or otherwise. This demonstrated an “inequitable difference in treatment amongst members”. The petitioners’ perceived disinterest in engaging further with the company did not render fair the board’s failure to enquire as to their interest in investing further. He was not persuaded by the respondents’ assertions that the petitioners were not expressly excluded from the investment round and that they could have offered proposals despite the lack of invitation. The board’s conduct in accepting Mr McCann’s investment was accordingly unfair.
In order for the court to intervene, however, the petitioners were required to demonstrate that their position as members is “in some material sense worse than it would have been had the unfairness which has been identified not occurred”.
The court heard evidence of Mr Hawkins’ apparent disagreement with the direction of the board and Mr Rafay’s willingness only to invest on a pro rata basis with other members (which was not financially viable for Dr Stevenson). Lord Sandison concluded, on the basis of this evidence, that, had the petitioners been expressly invited to participate in the 2021 fundraising, they would likely not have done so.
Whilst both petitioners had been treated unfairly, the conduct was therefore not ultimately prejudicial to their interests.
The narrow point on which the petitioners enjoyed some success was in respect of Mr Rafay’s position as an observer. Lord Sandison emphasized that, in determining whether the court could make a finding of unfair prejudice, the court must consider “whether clearly-based understandings or expectations inherent in the nature of the parties’ relationships as members of the company have been observed or departed from”. Board members must be mindful of the expectations of passive participants in board meetings and the risks of withdrawing access to the board from such participants.
Otherwise, the judgment serves as a cautionary tale to shareholders, non-executive directors, and their advisers, demonstrating the importance of ensuring clear contractual entitlement to any remuneration or incentive schemes.
The judgment further illustrates the importance, in claims under sections 994 and 996, of ensuring that dissatisfied members can demonstrate both unfairness in their treatment by the board, as well as prejudice to their interests as shareholders. Although the judgment emphasised that unfair prejudice is fundamentally a unitary concept, it is clear that the court will seek to ascertain the actual effects of the adverse conduct, rather than award remedies on the ground of unfairness alone.
Lorna MacFarlane is an associate at Dentons