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A good faith provision helped the High Court to find in favour of minority shareholders in a recent shareholder dispute

June 10, 2021

In a recent High Court decision two minority shareholders were successful in pursuing an unfair prejudice petition. The judgment provides guidance on how the inclusion of a good faith provision in a shareholders agreement can impact on the majority’s right to remove a director under section 168 of the Companies Act 2006.

Facts

In Re Compound Photonics Group Ltd [2021] EWHC 787 (Ch), two individual minority shareholders (the Petitioners) brought an unfair prejudice petition under section 994 of the Companies Act 2006.

Compound Photonics Group Limited (CPGL) was formed by one of the Petitioners in 2004, using his academic research to develop a business vision aimed at revolutionising the projector market. The Petitioners argued that they had been unfairly prejudiced because it had been agreed with the majority shareholders (the Investors) that the Petitioners would remain involved in the management of CPGL, but both had been removed as directors of the company in 2016. They maintained that the Investors had ignored the constitution of CPGL, as set out in its articles and shareholders agreement.

The Investors denied these allegations. They claimed that at all times they and their nominee directors had acted in good faith, and so were not in breach of any provisions of the relevant shareholders agreement or, in the case of the directors, of the articles or any Companies Act duties. They maintained that:

  • in respect of one Petitioner, they had invested significant sums in the business over many years, but after long delays and a series of failures, they had lost faith in the Petitioner and entirely reasonably asked him to resign, which he had agreed to do; and
  • they had removed the other Petitioner from the business by exercising a majority vote after it became clear that his role as director and Chairman of CPGL was redundant and he had begun to behave in an erratic and unpredictable manner which was damaging to CPGL.

Decision

Mr Justice Adam Johnson held that the Investors had ignored CPGL’s constitution, which he interpreted as (i) providing that the Petitioners would remain central figures in the management of the business and (ii) having protections in place to ensure that they could not be removed as directors. He further held that this was unfair in the sense that, in breach of the obligation of good faith, the Investors had exerted their power to exclude the Petitioners in a manner expressly designed to override the carefully constructed constitutional balance. It was therefore prejudicial because the effect was to deprive the Petitioners not only of the benefit of their technical expertise, but also of the protections which their presence on the CPGL board was designed to achieve.

Mr Justice Johnson found that it was intended that the good faith obligation would impose a contractual restriction on the rights of the Investors to exercise their majority power under 168(1) of the Companies Act 2006 as they saw fit. They were bound to act with fidelity to the bargain, and that meant respecting the balance of power achieved by the overall constitutional structure. Critical parts of that were the special positions occupied by the Petitioners, and these could not be swept away at will. It was held that while the Investors could still effectively exercise their majority power to remove the Petitioners, this would simultaneously constitute a breach of contract as between the shareholders, entitling the disadvantaged shareholders to claim a remedy – as they had done in this case.

Key takeaways:

  • Where a company’s constitution has been constructed around the sustained involvement of key figures, a good faith provision in a shareholders agreement may serve to restrict the majority’s right to remove directors under the Companies Act by creating a simultaneous breach of that constitution.
  • When contemplating removing a figure who is deemed central to the operation of the company, careful consideration will be needed of the impact of such a loss on the business.

With thanks to Isobel Whitby for her assistance with this post.