Don’t forget minority shareholders

Mark Easton explains why directors need to be mindful of their duty to act fairly between shareholders and consider carefully the effect their decisions could have on minority shareholders.

The Corporations Act  2001 provides far-reaching remedies for oppressed minority shareholders.

Directors should exercise their powers and manage the company in the interests of all shareholders. However, majority shareholders may expect or demand that the company’s affairs be conducted in the manner most beneficial to them, even if that is detrimental to the other shareholders.

While minority shareholders often have little or no ability to influence the affairs of a company, directors must nonetheless act fairly between shareholders and ensure their decisions promote the interests of the company and shareholders generally, not just the majority.

Directors who fail to do so risk not only breaching their statutory duties, they also risk engaging in oppressive conduct. This can give rise to far-reaching remedies that can have a significant effect on the company and its shareholders.

What is minority oppression?

Minority oppression is the term generally used to refer to conduct that falls within section 232 of the Corporations Act.

That section provides courts with wide-ranging powers to grant relief to a shareholder if the conduct of a company’s affairs (including any actual or proposed act, omission or resolution) is either:

• Contrary to the interests of the shareholders as a whole; or
• Oppressive to, unfairly prejudicial to, or unfairly discriminatory against, a shareholder or shareholders whether in that capacity or in any other capacity.

Section 232 targets conduct that subjects the minority shareholder to some commercial unfairness.

The section is drafted widely and there are no defined limits on what can constitute the offending conduct. The offending conduct can be that of the company, its directors or other shareholders.

Courts assess conduct by applying an objective test based on whether the conduct would be viewed as unfair in the eyes of a reasonable commercial bystander.

That a shareholder is prejudiced or discriminated against is not enough. There must be an element of unfairness that goes beyond mere disadvantage.

While the range of circumstances in which section 232 conduct can arise is wide, proving it can be difficult, particularly where the decision or conduct had a legitimate commercial purpose.

When does oppression arise?

In practice, oppression usually arises where a minority shareholder is subjected to unfairness or prejudice by the abuse of majority power or control over the company.

While actions taken in bad faith are more likely to be found to be oppressive, conduct may be oppressive even if undertaken lawfully and in good faith if the result is a disadvantage or burden on the minority that is beyond what could be considered as commercially reasonable and fair.

It can occur even though all members of the company are treated equally (for example, a capital raising in which all members are invited to participate). Examples of conduct that has been held to be oppressive, unfairly prejudicial or unfairly discriminatory include:

• The issue of shares for the dominant purpose of diluting the minority voting rights;
• Non-payment of dividends to shareholders and excessive payments to directors where these decisions are not objectively justified in the company’s circumstances;
• Persistently refusing to call meetings of the company to prevent participation by minority shareholders;
• The application of company funds to benefit the interests of some shareholders, but not others; and
• Excluding a director representing a shareholder from the management of the company.

Most instances of minority oppression that reach the courts occur in unlisted private companies, rather than public companies. This may be because dissatisfied shareholders in a listed company can readily sell their shares, while there is often no market, or an illiquid market, of buyers for a minority interest in a private company (except perhaps for the oppressing majority shareholder).

In my experience, minority oppression is often encountered in closely held quasi-partnership companies following a breakdown in the relationship between the shareholders and directors.

The oppression usually involves one shareholder or director being frozen out of the management of the company and/or the company conducting a capital raising or share buy-back that dilutes the minority’s equity. The minority shareholder may receive no dividend, be unable to sell his or her shares and have his or her capital locked in to the company indefinitely while it is run for the benefit of others (with management paid significant salaries or bonuses).

In these situations, litigation can be the only way for minority shareholders to extract their capital.

Directors’ duties and oppression

Oppressive conduct can occur even if the directors of the company have complied with their duties. However, breach of directors’ duties will often go hand in hand with oppressive conduct, particularly the breach of the duties under sections 181 to 183 of the Corporations Act:

• To act in the best interests of the company as a whole (section 181);
• Not exercise a power to gain an advantage for the director or someone else (section 181); and
• Not to misuse company information to gain an advantage for the director or someone else (section 183).

The statutory duty to exercise powers in good faith and in the best interests of the company requires directors to act in the best interests of the company as a whole, being the best interests of all shareholders as a general body.

In practice, shareholders (or groups of shareholders) can have different or competing interests and it can be difficult or impossible for directors to act in a way that will satisfy everyone.

While many decisions of the board may have little or no direct effect on individual shareholders, some steps, such as to institute capital raisings or share buy-backs, or the appointment or removal of directors, have the potential to directly affect individual shareholder interests.

Any act that prefers or advantages the interests of one set of shareholders (or the directors) over the shareholders as a whole has the potential to breach the directors’ duties and to fall within section 232 of the Corporations Act.

Remedies

Under section 233 of the Corporations Act, the court has discretion (but is not obliged) to grant a range of remedies for the purpose of relieving the minority shareholder from the effects of the oppression. These include an order:

• That one or more other shareholders purchase the minority’s shares at a price determined by the court;
• That the company purchase the minority’s shares;
• That a receiver and manager be appointed;
• Requiring a person to do a specified act (e.g. unwind a capital raising);
• Injuncting the company or any other person from doing a specified act; and
• That the company be wound up.

In practice, the plaintiff shareholder will usually seek an order that his or her shares be purchased by the other shareholders or by the company – effectively a court ordered buy-out at a price determined by the court.

As a general principle, the court will grant the remedy that is least intrusive and will generally try to avoid winding up a solvent company.

However, where a buy-out is ordered and the majority is unable to pay the price fixed by the court, the company may be wound up.

Director shareholders who engage in oppressive conduct in breach of their duties are at risk of being ordered to buy the minority’s shares with no control over the price.

The costs and risks of litigation can be significant, particularly where expert evidence is required as to the value of shares. While these costs and risks can drive parties towards settlement (usually by way of a buy-out at an agreed price), they may exceed the value of small companies.

Awareness avoids pitfalls

Directors should consider the effect their decisions may have on minority shareholders and whether a particular decision or course of conduct would result in commercial unfairness.

As noted above, conduct can be oppressive even where there has been no breach of duty by the directors and can be constituted by the actions of other shareholders.

However, prudent directors should consider if a particular course of conduct might be unfairly prejudicial to one or more shareholders, and if so, whether the commercial objective of the company can be achieved in a way that does not cause the unfair prejudice.

Directors must also be mindful of their duty to act fairly between shareholders when shareholder interests conflict.

Failure to do so risks not only breaching the directors’ statutory duty to act in the best interests of the shareholders as a whole, it also risks engaging in oppressive conduct.

Mark Easton is special counsel in the litigation and dispute resolution group at K&L Gates in Sydney.