Amendments to articles of association

Setting a high bar for unfair prejudice

Publication October 2015


Introduction

It is well established that an alteration to a company’s articles, even if passed by the requisite majority of shareholders, may be challenged as invalid in certain circumstances.

“So far as concerns amendment of [a] company’s articles of association, the legal power of the members to amend the articles is not without limit.”

The recent Court of Appeal decision in Re Charterhouse Capital Ltd [2015] EWCA Civ 536 provides a helpful overview of the relevant principles and highlights the difficulties with establishing unfair prejudice.

Charterhouse Capital

The petitioning shareholder was a retired partner and minority shareholder of Charterhouse Capital Limited (the Company) which, through various subsidiaries and limited partnerships, carried on a private equity business. He brought a petition for unfair prejudice against the Company and its other shareholders and directors under section 994 of the Companies Act 2006, in which he claimed that the affairs of the Company had been conducted in a manner which was unfairly prejudicial to his interests as a shareholder.

Following a management buyout in 2001, the petitioner was an original shareholder (or Founder) of the Company and entered into a Shareholders Agreement with the other founding shareholders in the Company.

The original articles contained drag provisions permitting a buyer who had acquired 50 per cent or more of the voting rights in the shares in the Company as a result of a general offer to require any other shareholders who had not accepted the general offer to sell their shares.

In January 2008, the petitioner gave notice of retirement and ceased to be a director, although he retained his shareholding in the Company. Following his resignation, a number of the other Founders retired or left the Company. Their departure gave rise to concerns about a misalignment between the identity of the Company’s shareholders and those who were actively managing the business, as this could cause difficulties with investors when raising funds.

To address this, the active executives set up a company in order to purchase the shares in the Company from its existing shareholders. In around September 2011, an offer price for those shares was finalised at £15.15 million. The offer to purchase was conditional upon a number of factors, including that amended Articles be adopted by the Company.

The key amendments to the Articles included: (i) the removal of a requirement for a ‘General Offer’ to comply with the City Code on Takeovers and Mergers; (ii) the introduction of another majority drag provision; and (iii) the alteration of the definition of ‘Founder Majority’.

By December 2011, with the exception of the petitioner, all of the non-continuing shareholders had accepted the offer. The transfer of all shares in the Company (other than those held by the petitioner) took place in February 2012. In April 2014, the petitioner presented a petition for unfair prejudice. He alleged that the offer, the amendment of the Articles and the manner in which the offer was dealt with by the Company were carried out improperly in order to expropriate the petitioner’s shares at a gross undervalue rather than for any genuine purpose.

High Court

The High Court rejected the petition, including the petitioner’s claim that he had suffered unfair prejudice by reason of the amendment to the Articles. The Judge found in particular:

  • there was no evidence of bad faith or improper motive by any of the respondent shareholders and directors
  • the compulsory transfer provisions existed in the Articles before the alteration and were also envisaged by the Shareholders’ Agreement. They formed part of the original bargain between the Founders, of whom the petitioner was one
  • the lack of alignment was a serious issue which would be an impediment to raising new funds. There was a concern to resolve the alignment issue in order to secure the Company’s future. As a result, those involved considered they were acting in the best interests of the Company as a whole to achieve its long term stability
  • it was in the best interests of a hypothetical member of the Company to vote in favour of the resolution to amend the Articles and so facilitate the sale and solve the alignment issue.

Court of Appeal

The Court of Appeal dismissed the petitioner’s appeal, agreeing with the High Court that the compulsory acquisition of the petitioner’s shares was permitted under the Shareholders’ Agreement and could also have been achieved under the original Articles given that they clearly permitted the majority shareholders, as purchasers, to acquire all the shares of the minority, provided that a majority of the non-purchasing shareholders agreed to the sale.

Taking this into account, the amendments to the Articles were more of a ‘tidying up exercise’.

The Court of Appeal extracted from previous judicial authorities the following principles of general application when considering the limitations on the exercise of the power to amend a company’s articles of association.

  • The framers of the power of a majority to bind a minority will not, in the absence of clear words, have intended the power to be completely without limitation.
  • A power to amend articles will be validly exercised if it is exercised in good faith and in the interests of the company.
  • It is for the shareholders and not the court to say whether an alteration of the articles is for the benefit of the company, but it will not be for the benefit of the company if no reasonable person would consider it to be such.
  • The court will not investigate the quality of the subjective views of the shareholders.
  • The mere fact that the amendment adversely affects, and even if it is intended adversely to affect, one or more minority shareholders and benefit others does not, of itself, invalidate the amendment if the amendment is made in good faith in the interests of the company.
  • A power to amend will also be validly exercised, even though the amendment is not for the benefit of the company because it relates to a matter in which the company as an entity has no interest but rather is only for the benefit of shareholders as such or some of them, provided that the amendment does not amount to oppression of the minority or is otherwise unjust or is outside the scope of the power.
  • The burden is on the person impugning the validity of the amendment of the articles to satisfy the court that there are grounds for doing so.

The Court of Appeal held that the first instance Judge had been entitled to find that the respondent shareholders considered that they were acting in the best interests of the Company as a whole because they were concerned to resolve the alignment issue in order to secure the Company’s future.

The Chancellor (with whom Lewison and McCombe LJJ agreed) concluded that ‘the test is not whether all reasonable people would have agreed that the amendments was in the best interests of the company. It is sufficient that a reasonable person could have thought it was in the company’s best interests. It is for [the petitioner] to satisfy the court that no reasonable person would have thought that . . . I cannot see any basis for saying that he has satisfied that requirement.’

Comment

Each unfair prejudice petition will turn on its own specific facts, but the decision in Charterhouse Capital provides a useful set of principles to bear in mind when considering the validity of amendments to articles of association. It sets a high bar for unfair prejudice petitions in such circumstances.

Particularly instructive is the Court of Appeal’s approval of the notion that an amendment will be valid where it benefits shareholders (even where the company has no interest in the amendment), provided that the amendment does not amount to oppression of the minority or is otherwise unjust or is outside the scope of the power. This, and the Chancellor’s comments, should be borne in mind whenever changes to a company’s articles are being considered.


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