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Shareholders' agreements and good faith

Shareholders' agreements and good faith

The "Without Prejudice" rule and the Courts approach to admissibility

Minority shareholders may be assisted in demonstrating unfair prejudice by the presence of a requirement for all parties to act in good faith in their shareholders’ agreement

The recent case of Faulkner & Ors v Collin Holdings Ltd & Ors [2021 EWHC 787 (Ch) serves to highlight the significant effect the inclusion of express good faith obligations can have on the outcome of shareholder disputes.

The judge held that minority shareholders had been unfairly prejudiced (contrary to section 994 of the Companies Act 2006) by the actions of the majority shareholder investors who had, amongst other things, excluded the two founding directors from the management of the company. This was despite the Shareholders’ Agreement and Articles of Association including specific clauses designed to protect the founding directors’ interests and position on the board.

Of fundamental importance was a provision that “Each Shareholder undertakes to the other Shareholders and the Company that it will at all times act in good faith in all dealings with the other Shareholders and with the Company in relation to the matters contained in this Agreement”. It was this clause, taken in conjunction with a clause prohibiting removal of the minority shareholders from their positions as directors, which led to the unfair prejudice claim being successful.

In considering the parties’ arguments, Mr Justice Adam Johnson focussed on the effect of the good faith requirement. He concluded that the structure agreed by the parties was a compromise designed to “maintain an acceptable balance of power between the existing and new shareholders”. It included protections that had been agreed to ensure that the minority's position was protected against the investors' otherwise unrestricted ability to control the company. The overarching good faith obligation was intended to (and did) operate as a contractual restriction on the “otherwise untrammelled” rights of the Investors to exercise their majority power as they saw fit.

The traditional route to arguing that a petitioner’s “quasi-contractual partnership” rights have been infringed is through reliance on an equitable entitlement or agreement pursuant to the case of Ebrahimi v Westbourne Galleries [1973] AC 360. However in this case the focus was instead on the contractual bargain between the parties and the extent to which that had been breached.

The good faith obligation was analysed as an “obligation to deal fairly and openly, the need to take into account the interests of the other party as well as one's own interests”. Even though under the Companies Act the investors had a statutory power allowing them to remove the minority founder directors, they had to exercise that right in line with their good faith obligation, and failure to do so left them susceptible to a claim for unfair prejudice. 

Why is this important?

When setting up a business venture, or taking new shareholders into an existing business you should consider whether, and to what extent, it might be advisable (or not) to expressly include a good faith obligation to underpin your contractual rights. Clearly there are advantages and disadvantages in so doing.

If you have a contract or agreement which contains a good faith obligation, and you are a majority shareholder, you should be mindful of not breaching it. Whether or not a good faith obligation has been breached will depend upon the facts of the particular scenario and the precise wording of the relevant obligations. In some cases, the good faith obligation will act as a brake on the majority’s ability to exercise its statutory rights. If in doubt, we suggest you take legal advice before acting to limit the risk of strengthening the minority’s hand in claiming unfair prejudice.

 

 

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