226-425-21 THE LAW COMMISSION SHAREHOLDER REMEDIES CONTENTS Paragraph Page PART 1: OVERVIEW 1 Terms of reference 1.2 1 Scope of the project 1.4 1 Structure of the paper 1.15 6 Scottish Law Commission 1.19 6 Acknowledgments 1.20 7 SECTION A: THE PERSONAL ACTION PART 2: A SHAREHOLDER’S PERSONAL RIGHTS ARISING FROM THE COMPANY’S CONSTITUTION 8 Introduction 2.1 8 The company constitution 2.2 8 The section 14 contract and how it differs from other contracts 2.6 9 Membership rights 2.15 12 Internal irregularities 2.21 14 Transactions outside the company’s powers 2.29 17 Restraining future transactions 2.29 17 Past transactions 2.30 17 Challenging resolutions to amend the articles of association 2.31 17 Identifying enforceable personal rights in the articles 2.39 20 PART 3: OTHER CIRCUMSTANCES IN WHICH A SHAREHOLDER CAN BRING A PERSONAL ACTION 22 Introduction 3.1 22 Statutory rights 3.2 22 Shareholder agreements 3.3 22 Introduction 3.3 22 Advantages 3.4 23 Contents 3.6 23 Disclosure of agreements 3.8 24 Enforceability 3.9 24 Conclusion 3.17 26 SECTION B: THE DERIVATIVE ACTION PART 4: A SHAREHOLDER’S RIGHT TO BRING AN ACTION ON BEHALF OF THE COMPANY 27 Introduction 4.1 27 The majority rule and proper plaintiff principles 4.2 27 Fraud on the minority 4.7 29 Fraud 4.9 30 Wrongdoer control 4.12 31 iii Paragraph Page When fraud and control must be shown 4.17 33 “Independent organ” does not wish the action to proceed 4.18 34 Ultra vires transactions 4.19 35 Is the transaction ultra vires? 4.21 35 No need to show fraud on the minority 4.25 36 “Independent organ” does not wish the action to proceed 4.27 37 Breaches of special resolution procedures 4.30 38 Conclusion 4.35 40 PART 5: RESTRICTIONS ON MEMBERS’ ABILITY TO BRING ACTIONS ON BEHALF OF THE COMPANY 41 Introduction 5.1 41 Ratification 5.2 41 Ultra vires acts 5.3 42 Acts outside the powers of the board 5.4 42 Acts in breach of fiduciary duty 5.6 42 Inequitable conduct of the minority shareholder 5.18 46 Availability of other adequate remedies 5.19 47 Companies in liquidation 5.20 47 PART 6: PROCEDURE AND COSTS IN RESPECT OF ACTIONS ON BEHALF OF THE COMPANY 48 Introduction 6.1 48 Types of action 6.2 48 Determining standing as a preliminary issue 6.6 49 RSC, O 15, r 12A 6.7 50 Costs orders 6.10 51 General principles 6.10 51 Costs in derivative actions 6.11 52 Conditional fees 6.15 53 SECTION C: UNFAIR PREJUDICE REMEDY PART 7: INTRODUCTION AND HISTORY OF SECTIONS 459-461 OF THE COMPANIES ACT 1985 55 Introduction 7.1 55 History of sections 459-461 7.5 56 PART 8: RELATIONSHIP WITH JUST AND EQUITABLE WINDING UP 62 Background 8.1 62 Who may petition 8.3 62 Grounds for a petition 8.5 63 Relief under section 122(1)(g) where an alternative remedy is available 8.13 66 Pleading section 122(1)(g) and section 459 in the alternative 8.18 69 Reasons for pleading in the alternative 8.18 69 Effect of pleading winding up in the alternative — section 127 of the Insolvency Act 1986 8.19 70 1990 practice direction 8.22 71 iv Paragraph Page PART 9: SUBSTANTIVE REQUIREMENTS FOR UNFAIR PREJUDICE REMEDY 72 Introduction 9.1 72 Meaning of “affairs are being or have been conducted” 9.3 73 What constitutes “the company’s affairs” 9.5 73 Parent companies 9.9 74 Shareholder agreements 9.14 75 Meaning of “interests” 9.17 76 Meaning of “unfairly prejudicial” 9.21 77 Conduct of petitioner 9.28 80 Meaning of prejudicial 9.30 81 Meaning of “some part of the members or members generally (including at least himself)” 9.31 81 Review of the effect of different allegations brought under section 459 9.33 82 Exclusion from management 9.34 82 Failure to provide information 9.35 83 Increase of issued share capital 9.36 83 Alteration of articles of association 9.39 85 Diversion of company business and misappropriation of assets 9.40 85 Excessive remuneration and non payment of dividends 9.41 86 Mismanagement 9.44 87 Effect of pre-emption articles on a petitioner’s ability to bring proceedings under section 459 9.49 89 Instances of the involvement of shareholders of public companies in section 459 proceedings 9.53 91 PART 10: REMEDIES AVAILABLE UNDER SECTION 461 93 Introduction 10.1 93 Discretion 10.2 93 Conduct relevant to relief 10.3 94 Section 461(2)(a) 10.4 94 Section 461(2)(b) 10.6 95 Section 461(2)(c) 10.8 96 Section 461(2)(d) 10.10 96 The concept of “fairness” 10.11 97 Basis of valuation 10.13 97 Date of valuation 10.18 99 Adjustments to valuation 10.21 100 Expert evidence 10.23 101 Type of order 10.24 101 Other orders 10.26 102 PART 11: PROCEDURAL MATTERS 104 Introduction 11.1 104 The petition and procedural rules 11.6 106 Parties to the proceedings 11.12 109 Who may petition 11.12 109 Who should be joined as a party 11.15 109 Third party proceedings 11.19 110 Advertisement of petitions 11.21 111 Strike out applications 11.23 112 v Paragraph Page Costs 11.26 113 No indemnity for costs 11.26 113 Costs of the respondents 11.27 113 Recent developments 11.29 114 SECTION D: OUTLINE OF OTHER STATUTORY REMEDIES PART 12: THE COMPANIES ACT 1985 116 Introduction 12.1 116 Substantive remedies 12.2 116 Application by Secretary of State for unfair prejudice remedy 12.3 116 Requisition of meetings and resolutions 12.9 118 Challenges to resolutions 12.11 120 Miscellaneous shareholder remedies 12.19 123 Access to information 12.24 125 Constitution and registers 12.25 125 Accounts 12.28 127 Directors’ remuneration 12.34 129 PART 13: THE INSOLVENCY ACT 1986 133 Voluntary winding up 13.2 133 Compulsory winding up 13.3 134 Right of liquidator to recover company assets 13.8 135 Power of investigation 13.9 136 Summary remedy for misfeasance 13.10 136 Wrongful or fraudulent trading 13.11 136 Transactions at an undervalue 13.14 137 Transactions defrauding creditors 13.15 138 SECTION E: REFORM PART 14: DEFICIENCIES IN THE PRESENT LAW AND THE APPROACH TO REFORM 139 Problems in the current law 14.1 139 Problems in actions on behalf of the company 14.1 139 Problems in the remedy for unfairly prejudicial conduct, sections 459-461 14.5 140 Remedies for breaches of contract in the articles of association 14.7 141 Guiding principles for resolving the problems identified 14.10 142 PART 15: SUMMARY OF PROVISIONAL RECOMMENDATIONS 146 Introduction 15.1 146 Summary of possible reform package 15.2 146 PART 16: A NEW DERIVATIVE ACTION 149 Introduction 16.1 149 The need for a derivative action 16.3 149 Availability of the new derivative action 16.7 152 Should the new procedure prescribe the wrongs in respect of which the action is available? 16.8 153 vi Paragraph Page Type of duty 16.9 153 Should the new procedure be available for breaches of duty by others apart from directors? 16.10 154 Partial abrogation of the rule in Foss v Harbottle 16.12 155 Notice to the company 16.15 156 Consideration by the court 16.18 158 Issues relevant to the grant of leave 16.20 159 Threshold test on the merits 16.21 159 Summary of approach to derivative actions in foreign jurisdictions 16.23 161 Applicant’s good faith 16.27 162 Interests of the company 16.32 164 That the wrong has been, or may be, approved by the company in general meeting 16.35 165 The views of an independent organ 16.38 166 The availability of alternative remedies 16.39 167 Advantages and disadvantages of express list of criteria 16.42 167 Additional qualifying requirement 16.45 168 Court’s power to appoint an independent expert 16.46 169 Remedy 16.48 169 Multiple derivative actions 16.51 171 PART 17: CASE MANAGEMENT BY THE COURTS OF SHAREHOLDER PROCEEDINGS 172 Introduction 17.1 172 Proposals in the Woolf Report 17.3 172 Introduction to our provisional recommendations for case management 17.5 173 Case management of derivative actions 17.6 174 Stage at which discretion to grant leave to continue a derivative action will be exercised 17.6 174 Power to direct the company to convene a meeting of the shareholders 17.7 174 Costs indemnity orders 17.8 174 Addition or substitution of applicant 17.9 175 Leave of the court for compromise or abandonment of derivative actions 17.10 175 Case management of all shareholder proceedings 17.11 176 Preliminary issues 17.11 176 Security for costs 17.13 176 Power to dismiss claim or part of claim or defence which has no realistic prospect of success 17.16 177 Adjournment to facilitate alternative disposal arrangements 17.17 178 Determination of how facts are to be proved 17.18 178 Exclusion of issues from determination 17.19 178 PART 18: A NEW ADDITIONAL UNFAIR PREJUDICE REMEDY FOR SMALLER COMPANIES 180 Introduction 18.1 180 Suggested scheme for new remedy for smaller companies 18.4 180 PART 19: ARTICLES OF ASSOCIATION 185 Introduction 19.1 185 Shareholder exit article for smaller private companies — draft regulation 19.3 186 Companies to which this regulation would apply 19.3 186 Circumstances that give rise to the exit rights 19.4 186 Exit provisions 19.7 187 vii Paragraph Page Arbitration — draft regulation 120 19.12 189 Valuation procedure — draft regulation 121 19.16 190 General 19.18 191 PART 20: OTHER REFORMS 192 Introduction 20.1 192 Reform to section 14 by clarification of the types of situations that may fall within the section 20.2 193 Other reforms relating to proceedings under sections 459-461 20.5 193 Clarification of section 459 by authoritative guidance 20.5 193 Amendment of section 459 to impose a limitation period on claims under the section 20.9 195 Amendment of section 459 to make it clear that it is specific conduct, rather than the affairs of the company overall, that has to be shown to be unfairly prejudicial 20.15 198 Amendment of section 459 to ensure