Does a failure to pursue an exit amount to unfair prejudice?

The English courts are seeing an increase in unfair prejudice petitions brought by shareholders who feel aggrieved by the conduct of a company caused by the directors. The decision in Saxon Woods Investments Ltd v Costa & Ors [2024] EWHC 387 illustrates how the drafting and interpretation of a shareholders’ agreement (SHA) is crucial to establishing whether there was unfair conduct and demonstrates how contractual obligations can place a burden beyond the fiduciary duties of directors.

What was the background?

Spring Media Investments Limited (the Company) is the holding company for a group of businesses providing creative services to fashion and luxury brands. Its founder, Mr Loy, remained involved in the Company as a minority shareholder through the investment vehicle, Saxon Woods Investments Limited (Saxon Woods). A number of other investors held an interest in the Company, including two indirect investors, Mr Costa and Mr Uberoi, who were also directors of the Company.

In 2016, an SHA was entered into. Importantly, under clause 6.2 of the SHA, the parties agreed to work together, in good faith, towards the sale of the Company by 31 December 2019 (an Exit) and give good faith consideration to any opportunities for sale before that date. Failing this, they would appoint an investment bank to secure an Exit.

The chairman of the board of directors, Mr Costa, took full control of the Exit process, but little progress was ever made. Mr Costa did not want to pursue a sale by December 2019 as valuation exercises indicated the Company would be in a much better financial position to Exit in 2021. Mr Loy became concerned about the lack of progress to secure an Exit and negotiated two offers in principle to buy the Company. These were dismissed by Mr Costa, who viewed Mr Loy as hostile, and he refused to engage with either proposal.

An Exit was not achieved by 31 December 2019. By this point, the directors had instructed an investment bank to explore both an Exit and a potential capital fundraising instead. The instructions to the bank were limited, with no reference made to the original 31 December 2019 deadline nor any other timeframe communicated.

Subsequently, the onset of the Covid pandemic resulted in the share value of the company plummeting.

Basis of petition

Saxon Woods’ case was that the Company did not work in good faith towards an Exit and after the deadline passed, it did not engage an investment bank to secure an Exit. In a petition under s.994 of the Companies Act 2006, Saxon Woods claimed that Mr Costa’s conduct in causing the Company to be in breach of the SHA led to unfair prejudice to Saxon Woods.

The Court noted that this matter was proceeding an unfair prejudice petition rather than as a claim for breach of contract due to a specific provision in the SHA. Petitions for unfair prejudice under s.994 require that:

• The petitioner is a member of the company,
• There is conduct of the company which was caused by the respondent,
• Conduct was unfair,
• The conduct was prejudicial, and
• The Court should exercise its discretion to order relief.
  
  

Was there unfair conduct?

The judgment provides useful guidance on directors’ obligations under exit clauses. In order to decide whether the Company breached its obligations under the SHA, the Court considered four points:

• Can there be a breach of fiduciary duty to proceed with the exit clause? The respondent director, Mr Costa, submitted that he was obliged to reject a poor deal when the company would achieve a better valuation in later years. He argued that pursuing the deal today rather than waiting would potentially be a breach of his fiduciary duties. The Court dismissed this argument as unsupportable. A breach of fiduciary duty would only occur where directors are faced with two competing bids at different prices that they would likely be in breach if they opted for the lower option.
• Was it commercially reasonable to defer the sale under the exit clause? The Court dismissed the submission that the SHA obligation to work in good faith towards an Exit date was satisfied by the fact that Mr Costa engaged in preparing for an Exit before that date. There was a specified and fixed date by which an exit was required.
• What is an Exit? Mr Costa argued that the proposed sale did not constitute an “Exit” and the directors were not obliged to entertain it, the way some shareholders’ interests would roll over into the new investment vehicle would not satisfy the definition of an Exit in the SHA. The Court found that not only was this sale in the legal sense, but on the facts, the offer was within scope of the definition in the SHA. Although some shareholders would rollover some interest into a new investment vehicle, the equity structure of the new vehicle was very different to the existing set-up.
• Does the exit clause impose a timetable? Mr Costa further submitted that the Company was not bound by a timeframe in which to effect a sale after the 2019 deadline. This argument was also dismissed by the Court. Clearly time was intended to be of the essence where an initial deadline has been given and a back-up plan provided. Even where the initial deadline was surpassed, there remained an obligation to proceed as quickly as possible to implement the alternative process and achieve the underlying objective to Exit.
  
  

The Court considered whether under the exit clause, the Company and the directors, and in particular Mr Costa, worked towards an Exit by the deadline, and gave good faith consideration to any opportunities for Exit which arose at that time. It concluded that the Company had not. As such, the company breached the SHA in failing to consider opportunities for Exit, and there was no defence of overriding fiduciary duty.

Was the conduct caused by the respondent?

Mr Costa argued relief should not be ordered against him because decisions of the Company were made by the board of directors, not him alone. The Court did not agree, finding on the facts that Mr Costa controlled all aspects of the Exit process. He did not allow other board members to communicate with the investment bank and he was highly territorial over the situation. As such, in respect of Clause 6.2, the Court found he alone caused the conduct.

What did the Court decide?

The Court found that it was clear that Saxon Woods had suffered unfair prejudice, but the crucial question was whether this caused any loss. To determine the loss, the Court ordered a further hearing to consider what the value final offer would have been. If it would have been at a value that the shareholders would have accepted, there would be unfair prejudice.

Key takeaways

Importance of drafting and interpretation

The clause required good faith consideration of any Exit opportunities. This did not bind the parties to commit to a sale at any cost, merely that they had to genuinely consider the offers. When contemplating exit provisions in an agreement, be sure to understand exactly what the obligations are and the steps that must be taken to discharge those obligations fully.

There must be prejudice

This case is not yet determined. Mr Loy needs to show at a quantum hearing that he has suffered prejudice, in this case financially, as a result of the unfair conduct. Unfair conduct itself is insufficient for relief.

Adequate instruction of third parties

The Court highlighted how Mr Costa failed to apprise the investment bank of all the necessary information to progress an Exit. Director(s) should involve the main stakeholders in an exit process to ensure adequate disclosure of information and a collective assessment of the opportunities available to achieve the exit.

This case underscores the significance of clearly setting out the obligations and definitions in SHAs and serves as a reminder to ensure all parties to an agreement understand the requirements imposed by the drafting.

Many thanks to current trainee James Davies for their help in preparing this blog.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, April 2024