The ‘prejudiced shareholders’ provision

Corporate | Print Article

[Spring 2010]

Background

Under section 174 of the Companies Act 1993, a former shareholder, who believes he or she has been unfairly discriminated against or unfairly prejudiced by the manner in which the affairs of his or her company have been conducted, may seek assistance from the court.

A court has wide powers if a case is made out including liquidating the company, requiring a buy-out of the shareholder’s shares, payment of compensation to the prejudiced shareholder, etc.

Another section (175) provides that certain conduct, which does not comply with specific sections of the Act, is deemed to be prejudicial for the purposes of an application under section 174.

The Companies Act places the onus on a shareholder to show that the company conduct is ‘oppressive, unfairly discriminatory, or unfairly prejudicial’ to him or her.

‘Oppressive, unfairly discriminatory, or unfairly prejudicial’ conduct

 

In general

As with many legal issues, whether or not a shareholder has been oppressed, unfairly discriminated or prejudiced by company conduct depends on the circumstances of each case.

One of the most important aspects is that conduct of the company will not necessarily be prejudicial simply because the shareholder can show that, if differently managed, the company might provide greater income and pay larger dividends to the shareholder etc. Poor company management alone does not equate to prejudicial conduct. A court will not substitute its management opinion for that of the directors.

Conduct can still be prejudicial against a shareholder even if all shareholders are treated in the same way. The courts have said that fairness (to a shareholder) is not to be assessed in a vacuum from one shareholder’s point of view.

Even if the conduct in question accords with the company’s constitution, the conduct could still be unfairly prejudicial. However, if the company has correctly complied with any specific management powers in its constitution, a shareholder who is unhappy with the outcome of that management power would likely be hard-pressed to show unfair prejudice.

Reasonable expectations of shareholders

The reasonable expectations of shareholders are relevant in determining whether a company’s conduct is oppressive, unfairly discriminatory or unfairly prejudicial against a shareholder. When looking at reasonable expectations, the court will also take into account the history and structure of the company.

The courts have said that a shareholder must show that there were special circumstances that reasonably led him or her to believe the company would not conduct itself in a particular way, or that the board of a company would not exercise its powers in a particular way, and the shareholder has relied upon that belief when taking shares in the company – ultimately to his or her detriment and prejudice.

Closely-held companies

Many applications of prejudicial conduct arise from a shareholder’s exclusion from the management or operation of small, often family-based, companies, in which there is an understanding that all shareholders are to participate in the conduct of the company’s business and in which there is a restriction on the free transfer of shares.

If a shareholder is excluded from management in such a company, that shareholder is not unfairly prejudiced solely from the exclusion, but may well be prejudiced in some circumstances if the exclusion is coupled with no reasonable offer by the other shareholders to purchase the excluded shareholder’s shares.

A ‘reasonable offer’ for the purchase of shares will be an offer to purchase at a fair value without any discount if the prejudiced shareholder is a minority shareholder (i.e. does not hold enough shares to exert some control over the company). An offer would also need to provide that the value of the shares is to be determined by independent experts should there be disagreement between the shareholders over the fair value.

Loss from a bad deal

Conduct of a company is not necessarily oppressive, unfairly discriminatory or unfairly prejudicial simply because a company’s deal has gone bad or a deal is ultimately shown to have been a poor decision. This is a matter of business judgement and would be unlikely to constitute prejudicial conduct even though the shareholder has suffered loss.  The court has been reluctant to substitute its opinion for that of management.

Anticipating prejudicial conduct

A shareholder may seek relief from the court if he or she anticipates prejudicial conduct – even though such conduct has not yet occurred. However, currently there are no decisions of the court on what a shareholder would have to show or on what grounds an application could actually be made.

Inactive involvement
In closely-held family companies, the failure of some of the company members or directors to pull their weight and be involved in the day-to-day operation and management of the company, resulting in one (or more) shareholders having to expend more effort in the company, may be conduct of the company which is unfairly prejudicial to the overworked shareholder/s. An overworked shareholder may seek compensation or an order requiring the other shareholders to sell him or her their shares.

Listed companies

Shareholders of companies listed on the New Zealand stock exchange may also seek relief against prejudicial conduct.

However, the burden on a shareholder alleging prejudicial conduct will be more difficult in the case of a listed company because the prejudiced shareholder in a listed company has an ability to sell his or her shares at market value.

Conclusion

Section 174 of the Companies Act provides for a shareholder, who believes the company has conducted its affairs in a manner which has unfairly prejudiced the shareholder, to seek relief from this prejudice from the court. The court has very wide powers to make an order that should assist such a shareholder.

However, the section is not simply a form of exit strategy for the shareholder if the company is not being run in the way the shareholder would prefer. The shareholder must point to actual company conduct which is prejudicial or unjustly detrimental to him or her or show that the conduct is well outside the shareholder’s reasonable expectations of the company’s conduct. If the company or another shareholder has made a reasonable offer to buy out the shareholder, this may have relieved the shareholder’s prejudice.