Shareholder suffered unfair prejudice when company’s principal asset sold at an undervalue

07 May 2024

The company’s sole director was ordered to buy out a shareholder’s stake in a company after he had directed the company to sell its principal profitable asset at an undervalue to a company owned by him.

The High Court has held that a shareholder of a company suffered unfair prejudice when another shareholder, who was also the company’s sole director, directed the company to sell the company’s principal asset – its shares in a trading subsidiary – to a new holding company owned by the director.

The sale was completed for a price substantially below the real value of the shares, despite the director being advised to obtain a market valuation.

What happened?

Simpson v Diamandis and others [2024] EWHC 850 (Ch) concerned the sale of shares in a company, Tilon CG, which manufactured products from recycled composite material.

The business was originally set up in 2011 by a Mr Simpson. In 2019, a Mr Diamandis agreed to become involved in the business.

The two individuals set up a new company, AJHL, in which each of them held 47.5% of the shares, with the remaining 5% held by the company’s secretary. AJHL then acquired all of the shares in Tilon CG from Mr Simpson. Mr Diamandis became the sole director of AJHL.

Over the following years, the group sought further investment to purchase a second production line and grow its business.

After a couple of unsuccessful attempts to secure outside investment, Mr Diamandis and a friend – Mr Woollett – devised a structure to extract Tilon CG – AJHL’s most profitable asset – from its portfolio.

The structure would involve AJHL selling the shares in Tilon CG to a new holding company, Tilon Holdings. Tilon Holdings would then issue shares to Mr Simpson and Mr Diamandis, and those individuals would then transfer small parcels of those shares to new individuals prepared to invest in the business. The final position was to be for Mr Simpson and Mr Diamandis to each hold 31.5% of the shares in Tilon Holdings.

Mr Diamandis communicated the proposal to Mr Simpson. However, within a couple of days, the relationship between them began to deteriorate after Mr Diamandis asked for an advance from Mr Simpson to enable Tilon CG to meet its electricity bill, which Mr Simpson declined to make.

Over the following months, Mr Diamandis and Mr Woollett worked up several iterations of the proposed transaction structure. Each iteration saw Mr Simpson’s proposed eventual stake in Tilon Holdings reduced further and further until, in the final iteration, he was allocated no stake at all.

Eventually, in November 2021, the documentation for the restructuring was finalised. Mr Diamandis approved the transaction as the sole director of AJHL.

Because the restructuring involved AJHL selling a substantial non-cash asset to a company controlled by its sole director, the sale required approval, by ordinary resolution, from AJHL’s shareholders.

To this end, Mr Diamandis arranged for a written resolution to be circulated to AJHL’s shareholders, namely Mr Diamandis himself, Mr Simpson and AJHL’s company secretary. Mr Simpson objected to the resolution but Mr Diamandis and the company secretary, who between them held 52.5% of the voting rights, passed the resolution approving the sale.

The restructuring was implemented. AJHL sold the shares in Tilon CG to Tilon Holdings for a total price of £150,050, largely reflecting their nominal value.

Mr Simpson petitioned the court for relief. He claimed that the shares in Tilon CG had been worth substantially more than £150,050 and that the sale of those shares by AJHL to a company connected with Mr Diamandis, at such a significant undervalue and with no allocation of a continued economic holding for Mr Simpson, amounted to unfair prejudice.

For more information on unfair prejudice claims generally, see the box below titled “What is unfair prejudice?”.

What is unfair prejudice?

Under section 994 of the Companies Act 2006, a member (for example, a shareholder) of a company can petition the court for relief if the company’s affairs are being conducted in a way that is unfairly prejudicial to that person’s interests as a member.

There is no fixed list of actions or omissions that can amount to unfair prejudice, although generally this requires some breach by the directors of their duties, a breach of the company’s articles of association or a breach of any shareholders’ agreement relating to the company.

The conduct must be both prejudicial (causing harm to a member’s financial position or other interest) and unfair (breaching the agreement between members, even if unwritten or non-contractual).

Examples of behaviour that can amount to unfair prejudice include excluding a shareholder who is also a director from the management of the company, allotting shares to dilute a minority shareholder’s interest, misappropriating company funds, failing to pay dividends in certain circumstances, and deliberately failing to comply with the company’s constitution.

The scope of behaviour that can amount to unfair prejudice is wider if the company is a “quasi-partnership”. A quasi-partnership is a company where there is a relation of mutual confidence between the members and an understanding that they are entitled to be involved in running the company's business in a way similar to the partners of a partnership. Unfair prejudice may occur if a quasi-partnership’s affairs are run in a way that is inconsistent with that mutual understanding, whether or not that amounts to a breach of duty or the entity’s constitution.

The courts have very wide discretion to grant almost any remedy they think fit if unfair prejudice has occurred. The most common remedy the courts have applied is to require other members of the company (or the company itself) to acquire the injured party’s shares at a price intended to reverse the prejudice.

What did the court say?

The court agreed that Mr Simpson had suffered unfair prejudice.

The judge found that Mr Simpson and Mr Diamandis had set AJHL up on the understanding that they would both be able to participate in the business.

This was in part reflected by the fact that, although Mr Diamandis was the only official director of AJHL, he had regarded Mr Simpson as a “shadow director” whom he would involve in managing AJHL.

As a result, the court found that AJHL was a “quasi-partnership” (see box above titled What is unfair prejudice?).

The judge also found that, based on expert valuation evidence, the shares in Tilon CG had in fact been worth £2.9m, a substantial amount more than the £150,050 for which they were sold.

This had caused the value of AJHL to drop by almost £2.75m, which had caused prejudice to Mr Simpson.

Moreover, that prejudice had been unfair for numerous reasons.

  • Mr Simpson and Mr Diamandis had entered into a relationship of trust and confidence in relation to Tilon CG. By excluding Mr Simpson from discussions on the proposed restructuring and from any allocation of equity in Tilon Holding, Mr Diamandis had breached that trust and confidence. In essence, Mr Diamandis had “[deprived] Mr Simpson of almost the entirety of the value of his shareholding in AJHL”.
  • Mr Diamandis had caused AJHL to sell its principal asset at an undervalue to benefit himself. This was a breach of trust as well as Mr Diamandis’ duty as a director under section 171 of the Companies Act 2006 to use his powers only for a proper purpose.
  • Mr Diamandis had received professional advice that he should obtain a valuation for the shares in Tilon CG, but he did not do so. This was also a breach of trust as well as his duty under section 174 of the Companies Act 2006 to exercise reasonable care, skill and diligence.
  • Mr Diamandis was a “shrewd businessman” who could not reasonably have believed that the shares in Tilon CG were worth as little as £150,050. By selling at such an undervalue, he had not only broken the trust and confidence between him and Mr Simpson, but also breached his duty under section 172 of the Companies Act 2006 to promote the success of AJHL.
  • Finally, in preferring his own interests over those of AJHL, Mr Diamandis had breached his duty under section 175 of the Companies Act 2006 to avoid a conflict of interest.

The court therefore ordered Mr Diamandis to buy out Mr Simpson’s stake in AJHL.

The judge also found that Mr Woollett, though not a shareholder or director of AJHL, had been sufficiently involved with Mr Diamandis in the creation of the restructuring that it was also appropriate to make an order against him.

The court therefore imposed a secondary liability order against Mr Woollett. (The effect of this is that Mr Simpson is entitled to enforce the buy-out against Mr Woollett as well, but that Mr Woollett is entitled to recoup from Mr Diamandis.)

What does this mean for me?

This was a clear-cut example of unfair prejudice.

A key point to note from the judgment is that, although the court in this case was particularly sceptical of Mr Diamandis’ motives, the critical factor was that his actions, viewed objectively, amounted to unfair prejudice.

In other words, it was enough that the shares in question were sold at a significant undervalue, in turn reducing the value of Mr Simpson’s shareholding, to establish unfair prejudice. Whether or not Mr Diamandis had intended to cause Mr Simpson this kind of financial loss was, to a large degree, irrelevant.

Perhaps the main take-away from the case (as with any unfair prejudice case involving a quasi-partnership) is that, where individuals have set up a company with an understanding that they will both be able to participate in the business, those individuals will need to deal fairly with each other.

This will be so even if (as in this case) not all of those individuals are directors of the company.

Putting aside Mr Diamandis’ breaches of his duties as a director, the required board and shareholder approvals were given to the sale of the shares. But following the correct legal process can nonetheless give rise to a claim and liability if it causes substantial and unfair detriment to a shareholder.

Finally, where a company decides to sell any asset, the directors should consider carefully whether to establish a value based on reliable, objective evidence (such as an external valuation).

In this case, the price paid for the shares was manifestly far below market value. Conversely, a small variance between the price paid for and the market value of an asset is less likely to give rise to unfair prejudice. But a reliable valuation will enable directors to properly assess the price that should be paid for an asset and evaluate the risk of any action by shareholders in that context.

Access the court’s decision in Simpson v Diamandis [2024] EWHC 850 (Ch) that a shareholder suffered unfair prejudice when a company’s principal asset was sold at a significant undervalue