Judiciary winding up

Judiciary winding up on the ‘just and equitable’ ground

You can download Companies Act 2006 here: http://www.legislation.gov.uk/ukpga/2006/46/pdfs/ukpga_20060046_en.pdf

You can download Insolvency Act 1986 here: http://www.legislation.gov.uk/ukpga/1986/45/pdfs/ukpga_19860045_en.pdf

Section 122(1)(g) of the Insolvency Act 1986 provides that a company may be wound up by the court if the court is of the opinion that it is just and equitable that company should be wound up. The effect of it is that the petitioner is asking the court to wind up the company and distribute the remaining assets to the shareholders.

This petition is a measure of last resort. If the petitioner is acting unreasonably in seeking to have the company wound up instead of seeking an alternative remedy, the petition may be struck out (section 125(2)  Companies Act 2006).

This provision derives from partnership law where the court had equitable jurisdiction to dissolve a partnership where relations had broken down between the partners and the only alternative was to dissolve the business.

Small companies which are akin to partnerships, which is termed as quasi-partnership, has such a remedy because the personal relationship between the members (who generally have a number of roles, for example as both shareholders and employees) are so crucial to the effective operation of the company’s business that if confidence breaks down between them the company is effectively disabled.

Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 

In Ebrahimi v Westbourne Galleries Ltd, the company was established to take over the partnership run by the respondent (Nazar) and the petitioner (Ebrahimi) for over a decade. They were the equal shareholders and the only directors. They took the profit by way of director’s remuneration rather than dividends for tax reasons. A few years later, the respondent’s son was appointed to the board of directors and some shares were transferred to him. The petitioner was then became a minority both within the board and at the general meeting. The petitioner was not consulted on the running of the business and did not receive the dividends. Subsequently he was also removed from his directorship in the general meeting.

House of Lords held that it was just and equitable that the company should be wound up. The petitioner and the respondent has agreed to the formation of the company on the basis that the essence of the business relationship would remain the same as with their prior partnership, the petitioner therefore had an legitimate expectation that he has a right to take part in the company’s management. Thus, it was therefore just and equitable to wind up the company because the exclusion of the petitioner from the company’s management was clearly in breach of the understanding between the petitioner and the respondent.

Besides, House of Lords held that it was proper to have regard to wider equitable considerations and not just the parties’ strict legal rights in circumstances such as those mentioned by Lord Wilberforce, and granted him a winding-up order.

Lord Wilberforce stressed that the court was entitled to superimpose equitable constrains upon the exercise of rights set out in the articles of association or the Companies Act  if it is necessary to do so. The term ‘quasi-partnership’ may be not be helpful or even misleading sometime, therefore equitable consideration can be superimposed where the association has personal characteristics and rests on a relationship of trust and confidence, and all member are expected to take an active part and share transfer are restricted.

In fact, he was of the opinion that the individual members have rights, expectations and obligations inter se which are not necessarily submerged in the company structure, at this point a limited company is more than a legal entity, therefore the equitable considerations may superimposed to balance the interest between the company and the individual members.

In short, Lord Wilberforce has listed the typical elements in petitions brought under the just and equitable ground:

(a) The basis of the business association was a personal relationship and mutual confidence (generally found where a pre-existing partnership has converted into limited company)

(b) An understanding that all or certain shareholder (excluding ‘sleeping’ partners) will participate in management

(c) There was a restriction on the transfer of members’ interests preventing the petitioner leaving.

Provided that the three elements are present, Lord Wilberforce suggested that if the petitioner can prove that all the members within the quasi-partnership are under some special underlying obligation, in good faith or confidence, that as long as the business continues the petitioner shall be entitled to the management participation, then the company must be dissolved if the so-called agreement has broken.

Lord Wilberforce also stated that the remedy conferred a wide discretionary jurisdiction on the court. It is wrong to create categories or heading under which the cases must be brought if the so-called conditions are met. Besides, the general words should remain general and not be reduced to the sum of particular instances.     

Lord Cross In Ebrahimi mentioned that the petitioners under section 122(1)(g) Insolvency Act 1986 should come to court with ‘clean hands’. If a petitioner’s own misconduct led to the breakdown in relations relief will be denied.

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The following are illustrations of the grounds which will support a petition under section 112(1)(g) Insolvency Act 1986.

(i) The company’s substratum has failed

The petitioner will need to establish that the commercial object for which the company was formed has failed or has been fulfilled.

In Re German date Coffee Co (1882), the company was incorporated for the purpose of manufacturing a coffee substitute out of dates. In order to do this, it was the first object of the company to acquire a German patent. It turned out that the German Empire would not grant the patent to the company. It was held that the company had been set up with the aim of working a specific patent and that once that failed, the shareholders were entitled to say that they were not interested in carrying on any other business. The company was accordingly wound up. The court approach the issue on the basis that a member subscribes to a company on the understanding that it will engage in a particular business venture, so that if it fails to do this, the member is entitled to recover his investment.

This ground is now of much less importance especially in the light of section 31(1) CA 2006 which has reformed the law governing a company’s objects clause (an object clause is now not required and no longer necessary).

(ii) Fraud

Where the company is formed to perpetrate a fraud and winding-up represents the best means for its shareholders for recovering money invested by them from its promoters.

In Re Thomas Edward Brinsmead & Sons (1887), the respondents left the company and formed a new a new company, for carrying the same business of manufacturing piano. Following a fraudulent promotion the public had subscribed for shares in the new company. It was held to be just and equitable to wind up the company.  

(iii) Deadlock

If the relationship between the parties has broken down with no hope of reconciliation, the court may order dissolution.

In Re Yenidje Tabacco Co Ltd (1916), two tobacco manufacturers formed the company in order to merge their businesses. They were the sole shareholders and only directors in the company, with equal rights of management and voting power. Relations between the two became acrimonious and they refused to communicate with each other. All communications between them were made through the company secretary. Although the company was enjoying substantial profitability the court ordered it to be wound up. There is a complete deadlock in the management with no hope of reconciliation, the court therefore considers that it is just and equitable to wind up the company. It shall be noted that the court was also influenced by the fact that there has been a relationship of partnership between the parties.

(iv) Justifiable loss of confidence in the company’s management

Winding up may be ordered where there is lack of confidence in the competence or probity of its management, provided that the company is, in essence, a quasi-partnership.

In Loch v John Blackwood Ltd (1924), the majority shareholder dominated the board of directors. He regarded the business as his own and, in order to induce the minority shareholders to sell their shares at an undervalue, refused to declare dividends. Further, general meetings were not called and accounts were not published. The Privy Council held that the company should be wound up.

According to Lord Shaw, the lack of confidence must be grounded on the conduct of the board, not in regard to their private life or affairs, but in regard to the company’s business. Furthermore the lack of confidence must not be a reflection of the petitioner being outvoted on the business affair or internal affair within the company, but in a case where it is a reflection of a lack of probity in the conduct of the company’s affairs then it is just and equitable that the company should be wound up.

(v) Exclusion from participation in a small private company where there was a relationship based on mutual confidence

A classic example is the case of Ebrahimi v Westbourne Galleries Ltd (1973). It shall be noted that the Ebrahimi’s removal is totally valid and enforceable under the Companies Act, nevertheless Lord Wilberforce stressed that the court was entitled to superimpose equitable constrains upon the exercise of rights set out in the article of association or Companies Act.

The principles promulgated by Lord Wilberforce have been extended beyond section 122(1)(g) Insolvency Act 1986, in particular to the derivative action, which has now been put into the statutory footing under section 994 Companies Act 2006.

In Clemens v Clemens Bros Ltd (1976), the claimant owned 45 per cent shares and her aunt owned 55 per cent of the shares in the company. The AA contained a pre-emption clause and the claimant therefore expected to gain total control of the company upon her aunt’s departure. The board, which was comprised of the aunt and four non-shareholder directors, later decided to increase the company’s share capital by issuing new shares to the directors and to an employee’s trust. This was passed in the general meeting by virtue of the aunt’s shares. The claimant’s shareholding was then reduced to below 25 per cent. The court has reversed the resolution and set it aside.

Foster J stated the general voting rights of the aunt were subject to equitable considerations which make it unjust to exercise it in a particular way. He did not deny the aunt’s agreement that she was genuinely like to see other directors to have shares in the company and a trust set up for the benefit for the long service employees, but it also cannot be denied that the resolutions have the effect to make the aunt and the other directors gain complete control of the company and to deprive the claimant of her existing rights as a shareholder.

Foster J’s reasoning has been reconsidered by the House of Lords in O’Neill v Phillips (1999). Interestingly, it shall also be noted that Plowman J in Bentley Stevens v Jones (1974) stated that the Ebrahimi principles should be confined to their statutory context under section 122(1)(g) Insolvency Act 1986. 

You can read the majority rule and overview of shareholder's remedies here: http://thewallyeffect.blogspot.my/2017/10/the-majority-rule-and-shareholders.html

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