Money troubles

“The company is a nominal party to the Section 459 petition, but in substance the dispute is between two shareholders. It is a general principle of company law that the company’s money should not be expended on disputes between the shareholders.” These clear words of Mr Justice (now Lord) Hoffmann in Re Crossmore Electrical and Civil Engineering Ltd (1989) are a salutory warning to directors who wish their company to become actively involved in disputes between its shareholders – a warning that has not always been heeded.

The principle that a company’s money should not be expended on disputes between its shareholders accords with a more fundamental company law principle: that powers of management conferred on directors by the articles of association of a company are to be exercised for the benefit of the company, and not just for the directors’ own benefit without regard to the interests of the company.

As Mr Justice Eve put it more than 70 years ago: “The company’s money… can only be spent for purposes reasonably incidental to the carrying on of the company’s business, and the validity of such grants is to be tested… by the answers to three pertinent questions: (i) is the transaction reasonably incidental to the carrying on of the company’s business?; (ii) is it a bona fide transaction?; and (iii) is it done for the benefit and to promote the prosperity of the company?” By “the company”, it is meant not the company as a commercial entity, but rather its shareholders.

The most common situation in which a company may be tempted to get involved in a dispute between its shareholders is in the context of a petition brought under Section 459 of the Companies Act 1985. A Section 459 petition is commonly brought by a minority shareholder alleging unfairly prejudicial conduct on the part of the majority shareholder (who may be the company’s managing director).

Participation by a company in Section 459 petition proceedings, and expenditure of its money in relation to them, is only proper when the company can demonstrate that its participation and expenditure are necessary or expedient in the interests of the company as a whole.
There is a heavy onus on the company to satisfy the court, with evidence of the necessity or expedience for such expenditure in any particular case.

The courts have determined that there are only certain limited matters where the company may properly incur costs in respect of a Section 459 petition. The three principal scenarios are as follows:

  • The first applies only in the case where the Section 459 petition is coupled with a petition for a just and equitable winding-up order. In such a case, the company may expend its monies in making an application for a validation order under Section 127 of the Insolvency Act 1986. This is in order to ensure that the company can continue to carry on business and prevent its bank accounts being frozen while the petition is pending.
  • Second, the company can incur such costs as are reasonably and properly expended on giving disclosure. After all, the company is a party to the proceedings and must disclose to all parties all relevant documents. The legal costs of doing so can be substantial.
  • Finally, the company can incur the costs of being represented at judgment on the petition. This is because the very wide-ranging remedies which the court can give in relation to a Section 459 petition can include an order that the company purchase the petitioner’s (or, conceivably, the respondent’s) shares. The company has a legitimate interest in trying to persuade the judge not to order it to pay so much money for the petitioner’s shares that it is thereby rendered insolvent.
  • But a word of caution is required. The company cannot wade in simply because one of the remedies being sought is a purchase of the petitioner’s shares by the company. As Mr Justice Harman pointed out in Re Hydrosan Ltd (1991): “An order that the shares be acquired by the company would be an order affecting the company, and yet… it could not properly be an action where the company’s finances should be employed to influence the result of the claim.”

    The issue of what remedy the court should order only needs to be determined after the court has decided whether the matter complained of by the petitioner constitutes unfairly prejudicial conduct in the first place.

    There are two adverse consequences of the improper use of the company’s resources on disputes between shareholders. One, it constitutes misfeasance on the part of the company’s directors; two, it may in and of itself constitute unfairly prejudicial conduct.

    “One starts with the proposition,” stated Justice Harman in Hydrosan, “that any material which will show that the company had been funding the defence of shareholders to a Section 459 petition must show a wrongful application of the company’s funds.” So, an overeager board that tries to get the company to help out the majority shareholder in their defence of a Section 459 petition may find that, by their very actions, they have brought about precisely that which they were trying to prevent – a finding of unfairly prejudicial conduct in favour of the petitioner.

    Where the company threatens to expend its monies actively participating in a Section 459 petition, the aggrieved party can obtain an injunction restraining the company from doing so. The court should restrain breaches of duty by directors and prevent inappropriate expenditure of the company’s resources. As Judge Howarth colourfully put it in Corbett v Corbett (1998), it is far better to keep the horse in the stable than to allow it to bolt and then hope to lure it back in the stable some time later in the day.

    A recent example of the court granting the petitioner an injunction preventing the company from spending its monies actively participating in a Section 459 petition is Re Edwardian Group Ltd (2003). In that case, Sir Francis Ferris, sitting as a High Court judge, rejected the argument that it was appropriate for the company to participate actively in the proceedings in order to enable it to tender its own witnesses, who wished not to align themselves with either of the warring parties. That factor, stated Ferris, “did not in and of itself lead to the consequence that the company has a separate and independent position which it must be allowed to put forward at its own expense in order to salve the consciences of these two individuals”.

    That decision is in line with the less relaxed approach of the courts to case management issues post-Civil Procedure Rules. The courts are anxious to avoid the additional costs and court time which would be expended were companies to profer evidence on their own behalf or be represented separately at trials of Section 459 petitions. As Judge Neuberger pointed out in Re Rotadata Ltd (2000): “Section 459 petitions can, and frequently do, involve a substantial number of allegations and counter allegations, substantial costs and a lot of court time – not to mention the strain and emotion on the parties involved. Anything which can be done fairly and consistently with justice to cut down the cost and time involved in connection with disposing of a Section 459 petition is to be applauded.”

    Daniel Lightman, a barrister at Serle Court, appeared for the petitioners before Sir Francis Ferris in Re Edwardian Group Ltd