Module 9 – Tutorial Answers
1. What is the principle of majority rule and what are its justifications?
Majority rule is the concept that
2. What is a derivative action? In what circumstances might a shareholder bring one?
3. Explain the remedies that a minority member of a company may be able to use if he or she claims
unfairly prejudicial treatment by the directors.
4, James is a minority shareholder in Snake Oil Ltd. Lorna is the managing director, Tom is the chairman of
the board of directors and Tom’s wife Susan is one of the directors. Lorna, Tom and Susan are all
shareholders and each hold 25% of the shares in the company with James holding the remaining 25%.
(a) The company has not declared a dividend since James acquired his shares two years ago, but
Lorna received £120,000 and Tom £60,000 per annum in directors’ fees and salary during that
period and Susan received £10,000 in fees.
(b) The company purchased an industrial site last year, in order to build a factory, but having changed
its ideas on development, it has recently sold the site to Susan at a price less than a third of what
was paid for it originally.
(c) Snake Oil Ltd engaged Sir William Bloggs as public relations director at a salary of £75,000 per
annum. One of the terms of his contract is that, in the event of his death, his widow will continue
to receive his salary by way of a pension for the rest of her life.
James seeks your advice in respect of the above matters, to which he objects very strongly. Lorna, Tom
and Susan, on the other hand, are insisting that nothing improper has occurred.
Advise James on all of these matters. Also advise him as to whether he might be able to force the
company to buy his shares from him, and if so, as to the rules for purchase of shares by a company.
Issue (a): Can James compel the company to pay a dividend, through using s. 994 of the Companies Act
2006?
Rule:
Section 994 allows for a member to apply to the court to get relief if the company's actions are unfairly
prejudicial to him or him as a class of members. In Re Sam Weller & Sons Ltd, a minority shareholder won
an action against the majority shareholders and Directors for not declaring dividends despite good profits,
while they were paying themselves well for Director duties. Members of a company have no automatic right
to a dividend. This only becomes a debt due by the company when it is recommended by the directors and
declared by the company at a general meeting. Failure to declare a dividend would not normally be
regarded as unfairly prejudicial conduct, since, on the face of it, it affects all shareholders equally.
Application:
James is a minority shareholder who has not seen a dividend, dispute the directors and managing directors
being paid handsome sums. If J launches a s. 994 claim for unfairly prejudicial conduct he will likely win. In
he case of Re Sam Weller and Sons the court found the failure to pay a dividend was unfairly prejuidicial.
Conclusion
In Re Sam Weller & Sons Ltd, it was held that a failure to pay dividends or keeping dividends artificially low
when the directors who controlled the company were receiving high salaries could amount to unfairly
prejudicial conduct, under what is now s.994 CA 2006 but £20,000 per annum is not excessive for full-time
directors (if that is the case here) and James probably would not succeed with a petition under s.994 CA
2006.
Issue (b): Can James seek a remedy for the breach of Directors duties in relation to the sale of the industrial
site?
Rule:
The rule in Foss v Harbottle (1843) 67 ER 189 states that the proper pursuer for the breach od Director is the
company. In the circumstance where the Directors may also have majority voting in a company this could
prevent an action from being brought. A remedy that developed through the courts, and them was codified
in the CA 2006 is the derivative action (s. 265-269). A derivative action can be brought by a minority
member or members in the name of the company against the directors for negligence, if the board of
directors or the majority members refuse to raise an action. It is necessary to obtain the court’s permission
to bring such a case, and the pursuer must establish a prima facie case and be in good faith before the court
will allow it to be brought.
Alternatively it might be possible to petition the court on the grounds of unfairly prejudicial conduct –s.994
CA 2006, and seek the court’s approval to raise an action against Susan under s.996(2)(c) CA 2006.
Application:
The sale of the site at an undervalue to Susan, one of the company’s directors, could be negligence on the
part of the directors, (see s174 CA 2006). In this circumstance, it is unlikely that the company will bring an
action, as the wrongdoers are majority shareholders in the company. As such, it is possible that James could
bring an action under s. 265, however he will have to prove a prima facie case in order to be successful
(Wishart v Castlecroft Securities Ltd 2009 SLT 812; 2010 SLT 371; ICU (Europe) Ltd v Ibrahim [2016] CSIH 62).
James can also petition the court on the grounds of unfairly prejudicial conduct (s.994 CA 2006), and seek
the court’s approval to raise an action against Susan under s.996(2)(c) CA 2006.
Conclusion:
If James meets the requirements he could pursues the claim as a derivative action, or an unfairly prejudicial
conduct.
Issue (c): Does James have any remedy for the arrangement with William Bloggs?
Rule:
Directors have a duty to exercise their powers in the way they consider, in good faith, would be most likely
to promote the success of the company for the benefit of its members as a whole –s.172 CA 2006. However,
even if the decision was not in the best interests of the company it can be approved by the members in
general meeting by ordinary resolution, which would render the decision unchallengeable. There were old
cases in which courts struck down such arrangements as being ultra vires, but by s.31 CA 2006, the default
rule now is that companies’ objects are unrestricted.
A minority shareholders’ main remedy against the majority is now unfairly prejudicial conduct under s.994
CA 2006. The most common remedy is for the company or one of the other members to purchase his
shares at an agreed price or one set by the court. If the shares are bought by a shareholder, there will be a
transfer of shares. Alternatively, shares can be purchased by the company under s.690 CA 2006. A company
is allowed to do this unless the articles restrict it from doing so. The shares must be fully paid up, then must
be cancelled on purchase. The company makes a contract for an off-market purchase, authorised by special
resolution by the members. The contract must be available for the members to examine for at least 15 days
prior to the meeting and at the meeting. The company must fund the purchase either out of the proceeds of
a fresh issue of shares made for the purpose, or out of distributable profits. If it uses distributable profits, it
must create a capital redemption reserve and credit it with an amount equal to the amount of the price that
came from distributable profits, in order to achieve capital maintenance. A return must be made to the
registrar of companies of the details of the purchase by the company of its own shares, and the transaction
must be disclosed in the next annual accounts.
Application:
The term in William Bloggs’ service contract allowing his widow to receive his salary for the rest of her life
might appear to be contrary to the company’s interests, and might be challengeable on that ground.
However, the question does not say whether it was approved by the members in general meeting by
ordinary resolution, which would render it unchallengeable.
If James petitions the court under s.994 CA 2006, the most likely remedy he would seek is for the company
or one of the other members to purchase his shares at an agreed price or one set by the court. If the shares
are bought by a shareholder, there will be a transfer of shares. A contract of sale has to be made between
James and the shareholder. James will complete a stock transfer form with the details of the transaction.
The shareholder pays James the price and has the form stamped to show stamp duty has been paid by him.
The stock transfer form and the share certificate will be sent to the registrar or company secretary of Snake
Oil Ltd. The purchasing shareholder will then have his name entered in the register of members, and
James’s name will be removed. At this point the transfer of ownership takes place.
Snake Oil Ltd may also buy the shares from James in terms of s.690 CA 2006. The company is allowed to do
this unless the articles restrict it from doing so. The shares must be fully paid up by James before the
purchase. The shares must be cancelled on purchase by a private company such as Snake Oil Ltd. The
company makes a contract for an off-market purchase with James. It must be authorised by special
resolution by the members. The contract must be available for the members to examine for at least 15 days
prior to the meeting and at the meeting. The company must fund the purchase either out of the proceeds of
a fresh issue of shares made for the purpose, or out of distributable profits. If it uses distributable profits, it
must create a capital redemption reserve and credit it with an amount equal to the amount of the price that
came from distributable profits, in order to achieve capital maintenance. Since Snake Oil Ltd is a private
company it is allowed to fund the purchase out if capital, but only as a last resort, and provided it passes a
special resolution and the directors issue a declaration of solvency. A return must be made to the registrar
of companies of the details of the purchase by the company of its own shares, and the transaction must be
disclosed in the next annual accounts.
Conclusion:
James can make an application under s. 994 for unfairly prejudicial conduct, but it is most likely that the
remedy he will get is his shares compulsory purchased.