Birchfield – unfair prejudice remedy is not (quite) an appraisal right

For some weeks since the Court of Appeal decision came out at the beginning of September, I have been wondering if Birchfield tells us anything new about unfair prejudice claims by a minority shareholder.

The reason for that hesitancy is that a glance at the background to the decision shows a difficult family squabble.  Like most family breakdowns, the backstory is long and convoluted.  By contrast, the decision seems unsurprising – that, even if the minority shareholder has an unfair prejudice claim, they don’t have a different remedy to that which is in the table, in the shape of a buy-out offer for their shares.

However, the Court of Appeal decision does shed some light on what happens if the unhappy minority shareholder does not want to be bought out.

Background

Sadly, the background in Birchfield is all too familiar.  By appearances, a successful and quite large family-owned business was disrupted by a falling-out between siblings about the conduct and direction of the business.  As a result, one of the siblings (who held a minority stake) brought proceedings under section 174 of the Companies Act 1993, claiming that the affairs of the business (a group of companies) were being conducted in a manner that was oppressive, unfairly discriminatory or unfairly prejudicial to them. 

As a result, they sought wide-ranging orders reinstating the claimant as a director of the companies and regulating the future conduct of the business.

Section 174 – the unfair prejudice remedy

Section 174 of the Companies Act enables a shareholder (or former shareholder) who considers that the affairs of a company have been, or are being (or are likely to be) conducted in a manner that is / have been / or are likely to be

oppressive, unfairly discriminatory, or unfairly prejudicial to him or her in that capacity or in any other capacity

to apply to the [High] Court for an order under that section.

Section 174 provides the prejudiced shareholder with a wide range of remedies, including setting aside actions taken by the company or the Board in breach of the Companies Act or the company’s constitution.  Most importantly, it contains a buy-out remedy – which the company (or any other person) can be ordered to acquire the prejudiced shareholder’s shares.

Buy-out offer

In Birchfield, after the claimant had been removed by his siblings as a director, the company made a buy-out offer for his shares – at fair value to be determined in accordance with the company’s constitution.

The claimant rejected the buy-out offer and brought his section 174 claim.

Whilst that claim sought a range of remedies – the claimant did not seek a buy-out order for his minority stake.

The response of the company was to seek a Court order (by means of summary judgment) that its buy-out offer cured any unfair prejudice – alleged to stem from the claimant’s exclusion from the conduct of the company’s business.

The company’s buy-out offer was also tweaked – including by offering to have the fair value of the claimant’s share determined by an independent expert, and to waive its claim for costs that it said had been incurred by the company as a result of the claimant’s conduct.

The High Court granted that summary judgment application.

Sidebar – appraisal rights

Appraisal or buy-out rights are a remedy available to minority shareholders.  The concept is borrowed from North America and enables shareholders who dissent from specified decisions (special resolutions) to exit the company – by requiring it to purchase their shares at a fair and reasonable value.  The decisions that trigger appraisal rights were described by the Law Commission as involving “fundamental” changes to the nature of a company or changes to the rights attaching to their shares. 

The decisions are special resolutions to approve a major transaction, a long form amalgamation, a change to the constitution to impose or remove a restriction on the company’s activities (and a special resolution of an interest group that alters the rights attached to the shares of that group).

Enter the Court of Appeal

The claimant argued that the buy-out offer did not provide a complete answer to the unfair prejudice claim for 8 reasons.  The Court of Appeal found that none of the 8 (noting that the buy-out offer was tweaked slightly after the claim was lodged) was sufficiently material to be a barrier to summary judgment. 

Importantly, the Court said it was inconceivable that the Court would have made the [reinstatement] orders in relation to the future management of the company of the kind sought.  Also, liquidation of the company would make no sense – so that, in light of the facts and circumstances of the case, a buy-out offer would likely have been the only relief available to the claimant.

The decision did not conclude that a buy-out offer will always “cure” an unfair prejudice claim.  Instead, borrowing from the 2019 UK Court of Appeal decision in Sprintroom, the Court found that it is a question of fact which is “highly sensitive” to the facts and circumstances of each case – and an assessment of the nature and terms of the buy-out offer.

Again, referring to Sprintroom, the Court of Appeal identified a number of factors that (in many cases) will be relevant to the Court’s assessment of the reasonableness of a buy-out offer (and the reasonableness of the rejection of that offer):

• The value offered, or the means proposed for valuing the shares.  An offer inviting the claimant to join in the appointment of a mutually acceptable independent expert with full access to the company’s documents is more likely to be a fair offer than a fixed figure presented on a ‘take it or leave it’ basis.

• The ability of the claimant to satisfy themselves if the buy-out offer is reasonable before they accept or reject the offer.  A fixed price offer will rarely be “fair” if the claimant or their advisers are not provided with access to company documents necessary to see how the buy-out price has been calculated and to determine whether it is reasonable.  Similarly, an offer to instruct an independent expert will not be reasonable if the majority is not prepared to open the company’s books to that expert.

• The substance of the unfair prejudice claim – and its implications on fair value.  So, for example, an allegation that the majority have diverted business from the company or misapplied company assets, it may not be just to expect the minority to accept an expert valuation without determination of the claim.

• The likelihood of the majority to implement the buy-out offer.

• The proximity of the buy-out offer to (unfairly prejudicial) conduct complained of.

The Court of Appeal also provided examples of facts and circumstances of a case where it is unlikely that a buy-out will cure the unfairly prejudicial conduct complained of:

• Where the conduct alleged has arguably had a material effect on the company’s value.

• Where it is arguable that the company has not kept proper accounting records – and that this would have a material effect on the ability of an expert to assess fair value.

• Where the buy-out offer is made on terms which prevent the prejudiced shareholder from accessing information to satisfy themselves that the basis on which the offer is made is fair.

• Where the company can fairly be described as a ‘quasi-partnership’ – particularly where the shareholders work full time in the business, the unfairness that would result from exclusion from that business may not be cured by a buy-out offer.

Timing is critical for summary judgment

Noting that this was a case based on a summary judgment application (for which there must be no arguable defence) the Court accepted a summary judgment application can only be made by a defendant that seeks to answer an unfair prejudice claim with a buy-out offer where the offer has been made before summary judgment is sought.  Summary judgment will be granted only if the Court is satisfied that any arguable unfairness has been cured by the buy-out offer.  The buy-out offer must have been open for acceptance for a reasonable period of time (before the summary judgment application).

Also, there cannot be any material defects in the buy-out offer identified in the course of the summary judgment process.  However, minor adjustments to the buy-out offer can be made during the course of the proceedings (tweaks were made to address a costs issue).

Takeaways (for commercial lawyers)

The key points to be taken from the Court of Appeal decision are:

• A buy-out offer is not a cure-all where the minority bring an unfair prejudice claim.

• There is scope for tweaking a buy-out offer even once summary judgment proceedings are on foot (here the Court was quite pragmatic about a tweak affecting costs – noting that the costs in question were arguably immaterial in the context of the likely value of the claimant’s stake) – which seems to be coupled with the point that minor matters that will not materially affect the valuation of the company will not call into question the reasonableness of a buy-out offer to be assessed by an expert.

I am also very dubious about the scope for a disaffected minority seeking a remedy other than buy-out (or liquidation in some very limited cases).  Despite the prevalence of SMEs in New Zealand, many of which have significant elements of family ownership, I believe that a minority seeking reinstatement, even in what they claim is a quasi-partnership in which they have been involved full time should think long and hard about any buy-out offer.  Whilst they may wish to “talk up” the terms of the offer – the risk of damaging evidence of dysfunction and/or impracticality may mean that their remedy is (in economic terms) little different from an appraisal right.  And that they may be financially better advised to extract their capital and do something else with it.

Further information

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