Corporate Law Update

This week:

• The High Court finds that a minority shareholder in a company was unfairly prejudiced when the directors appointed by the majority shareholder refused to approve its exit
• A few other items of interest

Refusal to approve share transfer amounted to unfair prejudice

The High Court has held that the shareholder of a company suffered unfair prejudice when the company’s board refused to approve a sale of its shares to a willing third party buyer. It ordered the company to approve the proposed buyer as a potential transferee.

What happened?

Re Last Lion Holdings Ltd v Moore Frères & Co LLC and another concerned Last Lion Holdings Limited (Lion), a UK company which, through its subsidiaries, provided streaming media content directly through the Internet (so-called “OTT content”).

70 per cent of the shares in Lion were held by Moore Frères & Co LLC (MFC), an American investment holding company. The other 30 per cent were held by Otello Corporation ASA (Otello), a publicly traded holding company listed on the Oslo Stock Exchange.

In 2017, MFC entered into negotiations with Mercury Software Partners LLC (Mercury) about a possible sale of Otello’s shares in Lion to Mercury. MFC purported to be acting on behalf of Otello, although it had not told Otello about the negotiations and did not have authority to represent it.

MFC and Mercury eventually agreed a price at which Mercury would buy 25 per cent of Lion’s shares from Otello, with MFC to acquire the remaining 5 per cent. In late 2017, MFC told Otello it had found a potential buyer for its shares, although it did not disclose Mercury’s identity.

However, shortly afterwards, MFC changed the proposed sale structure, telling Otello that it was looking to buy all of Otello’s shares itself. MFC agreed a price with Otello for the 30 per cent stake, which was significantly lower than the price Mercury had agreed to pay for a 25 per cent stake. The result was that, by virtue of buying Otello’s shares at a lower price and selling the majority of that stake on to Mercury at a higher price, MFC would make a gross profit of some $17m.

Ultimately, negotiations ended in December 2017 after Otello told MFC that it would need to disclose the price they had agreed to the Oslo Stock Exchange.

Subsequently, Mercury approached Otello to ask if it was interested in selling directly to Mercury. This was the first time Otello had learnt of Mercury’s interest in its stake in Lion. Mercury and Otello quickly agreed a sale in principle at the price Mercury had originally agreed with MFC.

Under Lion’s articles of association, any sale of shares needed the approval of Lion’s board. Lion’s board consisted of three directors appointed by MFC and one director appointed by Otello.

Otello’s director called for a board meeting to approve the sale. After an initial delay, the board convened a meeting and decided to task a committee with considering whether to approve the sale. The committee was to be made up of two of MFC’s appointed directors.

In due course, the committee recommended that Lion reject the proposed sale. In doing so, it relied on an inaccurate account of MFC’s previous interaction with Mercury, and on the fact that Mercury’s ultimate controller had been the subject of an adverse finding following insider trading proceedings in Canada.

When the board reconvened to consider the committee’s recommendation, all three MFC directors voted to reject the proposed sale. Only Otello’s director voted to approve it.

What did Otello claim?

Otello brought legal proceedings. It argued that the board’s behaviour amounted to unfair prejudice.

Under sections 994 to 996 of the Companies Act 2006 (the Act), if the business of a company is conducted in a way that is unfairly prejudicial to some or all of its shareholders, the court can grant relief. This can include where a company’s directors act in breach of their duties to the company.

A court is not restricted in the kind of order it can make to remedy unfair prejudice, although perhaps the most common remedy is to require the injured shareholder’s stake to be bought out at a fair price.

In this case, Otello claimed that Lion, through MFC’s appointed directors, deliberately frustrated the sale to Mercury, even though MFC had previously been prepared to facilitate a sale to Mercury, because MFC would not profit from a direct sale by Otello.

MFC argued that its appointed directors had reached their decision reasonably and in good faith. In particular, it said that the decision to reject the sale on the basis of the insider trading finding was important to protect Lion’s reputation.

What did the court say?

The judge agreed with Otello. He said that the directors’ power to reject a sale was designed to protect the interests of Lion’s shareholders as a whole.

MFC’s appointed directors, however, had not exercised this power for that purpose. Rather, they had withheld approval so as to “disrupt and, if possible, prevent” a direct sale to Mercury for “MFC’s own financial reasons”. They had put off the initial board meeting requested by Otello’s appointed director, then imposed a committee stage to cause additional delay. That committee had then reached its decision on the basis of information that it knew, or should have known, was false.

By doing this, MFC’s appointed directors had breached their duty under section 171 of the Act to act within their powers.

Moreover, by promoting MFC’s interests above those of Lion’s shareholders generally, MFC’s appointed directors had breached their duty under section 172 of the Act to promote the Lion’s success for the benefit of its members.

In addition, the Court found that the information available to the board committee regarding the insider trading decision was too limited to justify refusing approval for the sale.

In any case, the judge noted, that decision had occurred eight and a half years ago, Mercury’s controller had played only a “peripheral part” in the matter, and there had been no finding of bad faith against him. What is more, with a stake of 30 per cent in Lion and a minority of votes at board level, Mercury’s controller would not have had any “real power” over the business.

In short, the insider trading finding was not serious enough to warrant rejecting the sale.
The overall effect of these actions was that MFC and its directors had acted in a way that unfairly prejudiced Otello as a shareholder of Lion.

The Court ordered Lion, acting by its board, immediately to approve Mercury as a potential buyer of Otello’s stake in Lion. The judge also noted that, if the sale to Mercury were not to proceed, the Court may have to make an “alternative share purchase or other order”, or (as a last resort) order damages.

Why is this interesting?

The facts of the case were quite specific and so stark that the Court was only ever likely to reach the conclusion it in fact came to. But there are two aspects of the judgment we find particularly interesting.

The first is the order that the Court made. Often, where unfair prejudice has been driven by the actions of one or more shareholders, the usual remedy is an order requiring the culpable shareholders to buy the injured shareholder out at a fair price.

Here, for example, the Court could have ordered MFC to buy Otello’s shares at the price which MFC (and, later, Otello) had agreed with Mercury. This would have left MFC free to sell those shares on to Mercury if it so desired. Instead, the judge essentially ordered the company to acquiesce to the admission of a new shareholder.

The second is the Court’s approach to the insider trading finding. The judge rightly noted that Lion’s articles gave its directors discretion to refuse to approve the sale. On this basis, they had to exercise that discretion honestly and in good faith, and not arbitrarily, capriciously, perversely, irrationally or unreasonably, a principle now elegantly summarised in Socimer International Bank v Standard Bank London.

Normally, when a court finds that someone has exercised its discretion unreasonably, it will invalidate the decision and send it back for that person to reconsider. In this case, however, the court effectively made the decision for the directors. We saw this not long ago in Watson and others v Watchfinder.co.uk Limited, where the Court found that a company’s directors had acted unreasonably and ordered them to approve the exercise of a share option.

This can possibly be explained by the fact that Otello brought its proceedings as a petition for unfair prejudice. Once it found that Otello had been prejudiced, the Court had to grant an order to address the unfairness. It would have been difficult for it simply to “send the decision back”. The position is also muddied by the fact that the prejudice was also caused by the directors breaching their fiduciary duties.

Practical implications

The decision raises a few practical points and reminders:

• Directors do not have unfettered discretion to refuse share transfers. There is ample case law confirming that they have to act in good faith and in the interests of the company, and not improperly or in their own interests. When deciding whether or not to approve a transfer, therefore, directors should consider setting out in detail their reasons for reaching their decision.
• In making this kind of decision, directors appointed by a shareholder must divorce the interests of their appointor from those of the company. They are under a paramount duty to exercise independent judgment and to promote the success of the company, not that of the shareholder who appointed them.
• An injured shareholder should always consider all possible courses of complaint it may have. That may involve a simple claim for breach of the company’s articles. However, it might also include a derivative claim against the directors for breach of duty or, as was the case here, a more complex action based on a variety of grounds, wrapped up in an unfair prejudice petition. This could yield a more useful result than simple contractual damages.

Other items

• The European Securities and Markets Authority (ESMA) has updated its Q&A   on the Market Abuse Regulation (MAR). It has added three new questions (5.3 to 5.5) to clarify the circumstances in which a credit or financial institution may delay the disclosure of inside information under article 17(5) of the MAR in order to preserve financial stability.
• The London Stock Exchange has published AIM Notice 54, confirming that it has made the changes to the AIM Disciplinary Procedures and Appeals Handbook on which it consulted in July 2018 in AIM Notice 53. The Exchange has published updated versions of the Handbook. It has also made consequential amendments to its AIM Rules for Companies and AIM Rules for Nominated Advisers.
• NEX Exchange has announced that it has added the NASDAQ Capital Market, NASDAQ Global Market and NASDAQ Global Select Market segments of NASDAQ US to its list of Qualifying Markets. Companies admitted to any of these markets can now apply for a fast-track admission to the NEX Exchange Growth Market.
• The International Corporate Governance Network (ICGN) has published Guidance on Investor Fiduciary Duties. The Guidance is designed to “offer an investor perspective of how fiduciary duties and responsibilities take shape when applied to the management of financial assets”. It is designed to complement the ICGN’s Global Stewardship Principles.