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Extension of director’s fiduciary duty – to include minority shareholder

by Stephen on July 3rd, 2015


A recent Court of Appeal decision , has confirmed an earlier High Court finding that a director had breached his fiduciary duty to a minority shareholder.

On inspection, it seems unlikely that the decision is a signal of an opening of the floodgates or a breaking down of the understandings that directors’ duties are owed primarily to the company and not to shareholders. Instead, like Coleman v Myers almost four decades earlier, it is likely to be confined to the specific facts. That is, whilst directors generally do not owe fiduciary duties to shareholders, on the special facts of the case the directors of a closely held company may owe a fiduciary duty of disclosure to individual shareholders when acquiring shares from them and/or advising them on shares.

However, unlike the Coleman v Myers and arguably the more recent Thexton v Thexton decision (2002), such findings are not just confined to matters involving closely-held family companies.

Facts and context

Mr Holmes, an experienced businessman in the forestry industry, acquired the Lambert Group of companies in 2006. Kiriwai was the vehicle through which his friend Mr Emmens had been providing contract management services to the Lambert Group.

In 2007 Kiriwai took a 10% minority shareholding in Holmes’ acquisition vehicle (HVL) – which was linked to Mr Emmens employment with HVL through the terms of a shareholders’ agreement. Under the shareholders’ agreement, Kiriwai could be forced to sell its shareholding if Mr Emmens ceased to be an employee and, as an added incentive for Mr Emmens to remain as an employee, Kiriwai was only entitled to fair value for the shares after a period of 5 years.

The relationship between Mr Holmes and Mr Emmens broke down in 2012, and as a result Mr Emmens’ role with HVL was disestablished in September 2012.

On 5 November 2012, without preamble and despite the fact that there had been some earlier discussion about the provision of financial information to form a basis for determining the fair value of Kiriwai’s stake, Holmes’ lawyer telephoned Mr Emmens’ lawyer with an offer of $1 million for the shares. No financial information was available and, without it, Mr Emmens’ advisers were not prepared to recommend he accept the offer

Then, on 14 November 2012, Holmes’ lawyer sent an email renewing the offer of $1 million, this time on a “take it or leave it” basis – to be accepted by 4 pm the following day (or the offer would be withdrawn).

Kiriwai (Emmens) reluctantly accepted the offer on 15 November 2012, because he did not believe the figure of $1 million represented fair value – saying his “gut feel” was that the shares were worth between $2.5 million and $3 million. But, he was also worried that Mr Holmes might behave irrationally, in particular that he might move assets or even liquidate the company.

On 31 January 2013, HVL sold one of its subsidiaries to Port of Tauranga Limited or $34 million. The negotiations leading up to this deal had commenced in early November 2012 immediately before Mr Holmes made his offer to Kiriwai and that if the sale were to be taken into account in fixing the value of the shares, the shares would have been worth significantly more than $1 million.

The claim

Kiriwai brought a claim against Mr Holmes alleging a breach of section 149 of the Companies Act 1993. Section 149 is designed to address the problem of insider trading arising where directors buy or sell shares when armed with information that might affect the value of the shares. Kiriwai also claimed a breach of fiduciary duty by Mr Holmes for not disclosing the price sensitive information (i.e. the negotiations with port of Tauranga) prior to acquiring Kiriwai’s shares.

The High Court found in favour of Kiriwai on both counts and, whilst Mr Homes appealed the decision, Kiriwai also appealed the High Court’s assessment of the “fair value” of its shares under section 149.

Finding – fiduciary relationship

The Court of Appeal upheld the High Court’s finding on the existence of a fiduciary duty owed by the director (Mr Holmes) to the minority shareholder (Kiriwai). This finding is said to be fact-based rather than status-based.

The Court of Appeal said that, whilst not precise, the hallmarks of a fiduciary relationship are said to be that:

“… it is a relationship in which there are elements of reliance, confidence or trust between the parties often arising out of an imbalance of power or vulnerability in relation to the exercise of rights, powers or the use of information affecting their respective interests. One party has a legitimate expectation or is entitled to rely on the other not to act in a way that is contrary to the other’s interest.”

The Court of Appeal upheld the decision of the High Court that the circumstances did give rise to a fiduciary duty on the part of Mr Holmes to disclose the information about the prospective sale to the Port of Tauranga on the basis that:

• HVL was a small company (having effectively only two shareholders) over which Mr Holmes had complete control.
• There may not have been family relationships but importantly there was an employment overlay with Mr Emmens – meaning that not only were there were duties of good faith as between HVL and Mr Emmens, but Mr Holmes also had the power to compel Kiriwai to sell its shares by terminating Mr Emmens’ employment.
• This gave Mr Holmes the power to end Kiriwai’s access to company information as well as curtailing Mr Emmens’ remuneration and therefore impacting on his negotiating power over the sale of the shares.
• Mr Holmes knew that the sale of the shares was a significant transaction for Mr Emmens / Kiriwai – and he also knew that that Mr Emmens was seeking financial information as a basis for valuing the shares.
• These factors, combined with the steps taken by Mr Holmes to pressure a quick sale of the shares in the knowledge that he was in possession of material information gave rise to a fiduciary duty – which was breached by Mr Holms’ failure to disclose the fact of the negotiations with the Port.

As a result, Mr Holmes, was liable to pay Kiriwai the difference between the price it received for its shares and the price it should have received had he disclosed the fact of the negotiations.

The section 149 claim

As the Court of Appeal had found in Thexton, section 149 does not require the director to disclose the confidential information. Instead, it requires the director to abstain from dealing with the shares unless at fair value.

On appeal, there was no dispute over the meaning of “fair value”. Fair value is what is fair as between vendor and purchaser in all the circumstances, taking into account all material information known to the director (Mr Homes) at the relevant time. There was also no dispute that in assessing fair value the Court must take into account any risk factors which might materially influence the value of the shares.

However, the Court of Appeal allowed Kiriwai’s cross appeal, concluding on its assessment of the evidence that, at the time of the purchase of Kiriwai’s shares, the likelihood of the sale to Port of Tauranga going ahead proceeding was sufficiently high that it was a material factor that should have been taken into account in assessing fair value of Kiriwai’s shares. The Court also recognised that the transaction was not certain and there were contingencies (it might not go ahead or not go ahead at the figure known to Mr Holmes). Accordingly, a discount of 5% was applied to reflect those possibilities.

Concluding comments

This decision, like Coleman v Myers and Thexton before it, show that if special factual circumstances are shown to exist, the Courts are willing to find that special (fact-based) fiduciary duties are owed that extend to a wider range of relationships. As a result, some care needs to be taken in a wider range of closely-held businesses to determine whether there are disparities of power and access to information – with perhaps the additional overlay of good faith obligations that is added to the mix if the parties are also in an employer/employee relationship.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.

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