Court of Appeal clarifies scope for unfair prejudice petitions to address company losses

Last week the Court of Appeal issued an important judgment clarifying the circumstances in which unfair prejudice petitions can be used to seek relief for damage which has been inflicted by a director on a company, in addition to its shareholders. Ntzegkoutanis v Kimionis & Coinomi [2023] overturns a previous decision which held that it was only in "rare and exceptional" cases that a court should permit claims relating to a company’s loss to be dealt with under the unfair prejudice jurisdiction and procedures.

Very broadly speaking, shareholder claims arising out of director misconduct fall into two categories:

1. Unfair prejudice claims, where the directors have caused the company’s affairs to be conducted in a manner which is unfairly prejudicial to its shareholders, or
2. Derivative actions, where the directors have breached their fiduciary duties to the company causing it to suffer a loss, and the shareholders initiate legal proceedings on the company’s behalf.
   
   

In practice, it is often arguable that director misconduct has damaged the company and simultaneously unfairly prejudiced its shareholders, raising the question of which procedure is the more appropriate.

But this is not a neutral decision. Derivative actions are generally regarded as significantly more difficult to get off the ground as the court must, at an early stage, exercise its discretion to allow the claim to proceed. It should do so by referencing considerations such as (i) whether the claimants can show a prima facie case that the company has a good cause of action and that the claim is brought in good faith; and (ii) that litigating the claim would generally promote the success of the company, bearing in mind multiple factors (ie the strength of the claim, the likely costs, the impact of litigation on the company and the possible consequences of losing).

The potential procedural and substantive difficulties posed by the derivative action permission test leads to claimants trying to formulate their claims so as to fit into the unfair prejudice jurisdiction.

In Ntzegkoutanis v Kimionis & Coinomi [2023], Mr Ntzegkoutanis alleged that he had been excluded by his co-director (Mr Kimionis) from a joint venture (Coinomi Limited) set up to exploit a cryptocurrency wallet app which he had devised. It was further alleged that Mr Kimionis had transferred the joint venture assets (including the Coinomi source code and intellectual property) and its business to other companies held solely in Mr Kimionis’s name.

Mr Ntzegkoutanis petitioned for relief from unfair prejudice under s.994 of the Companies Act. He asked for the “usual” unfair prejudice remedy (namely that Mr Kimionis should be ordered to buy his shares at a value which took account of the damage done to the company) but also sought orders that the companies which had received the Coinomi assets should be held directly liable for knowing receipt and dishonest assistance, and that the Coinomi assets in their possession should be held on trust for Coinomi Limited (the "Company Claims"). These remedies reflected losses suffered by Coinomi Limited itself, and were therefore sought on behalf Coinomi Limited rather than Mr Ntzegkoutanis in his personal capacity.

At first instance, the judge struck out the Company Claims on the basis that they should have been brought through derivative proceedings. He referred to a decision of the Hong Kong Court of Final Appeal in Re Chime Corp Limited (2004) as authority for the principle that “It is a rare and exceptional case which the court will permit to proceed by way of an unfair prejudice petition when it would otherwise be brought by way of a derivative claim, because [to do so] subverts the regime … which imposes limitations on bringing derivative claims”. The judge also expressed the view that the Chime approach could be qualified at the margins for exceptional cases, but that there was nothing exceptional in the facts of Re Coinomi.

The Court of Appeal wholeheartedly rejected this approach.

It pointed to numerous prior authorities which confirmed that the court’s very wide discretion to do what it considered fair and equitable to correct unfair prejudice included the award of redress to benefit the company as opposed to the shareholders directly. (Section 996(2)(c) specifically confers the power to authorise civil proceedings to be brought in the company’s name). It also analysed the background to the derivative act legislation, and found that matters such as the threshold permission test were not intended to cut across the scope of the court’s discretion in unfair prejudice claims.

The Court of Appeal indicated that it was unlikely to allow petitions which seek relief solely on behalf of the company (with no separate remedy for shareholders), or in which the petitioner has no genuine interest in a personal remedy and is clearly attempting to bypass the filter which would otherwise be applicable to what is in substance a claim on behalf of the company. However, Re Coinomi did not fall into these categories. Mr Ntzegkoutanis was exercising his personal entitlement, as a member of Coinomi Limited, for relief in his own right in respect of the actions of Mr Kimionis and the companies which received Coinomi assets. As such, he did not meet the requirements for bringing a derivative claim on behalf of Coinomi Limited.

In direct contrast to the “rare and exceptional” test devised by the judge at first instance, the Court of Appeal held that it would ordinarily not be appropriate to strike out unfair prejudice petitions seeking dual shareholder and company relief, where the petitioner has a genuine interest in the latter. It also noted the practical difficulties in trying to insist on separate claims, for example where it would make sense for a petitioner to seek both an order to buy or sell shares and an order for payment to be made for breach of duty by the respondent.

This claimant-friendly judgment will be welcome news to those bringing complex shareholder claims, and should cut-through many pre-action and satellite disputes about the appropriateness of the procedure chosen by the claimant and the availability of the relief sought.

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

© Farrer & Co LLP, December 2023