Lane v Lane: High Court upholds oral shareholder agreement

On 21 October 2024, the High Court handed down its decision in Lane v Lane [2024] EWHC 2616 (Ch) in which it upheld an oral agreement between shareholders of a family company about the treatment of shares upon death, despite the lack of written evidence and the existence of conflicting provisions in the company’s Articles of Association.

The court also dismissed a petition alleging unfair prejudice arising from the company’s use of a remuneration trust tax scheme and rejected allegations that the directors had acted in breach of their duties under section 174 of the Companies Act 2006 by entering into the scheme.

Background

The claimant and his late father were the founders of a construction company (AGM Brickwork & Stonework Ltd) in 2003. On the advice of their accountant Mr Freeman, father and son were each allotted 40% of AGM’s shares; the mother and the son’s wife were each allotted 10%. Shortly after, Mr Freeman met with the four shareholders to discuss administrative matters and give general advice.

What was said at this meeting was central to the litigation. It was the son’s case that, in response to a question from Mr Freeman about what would happen in the event of the death of the father or the son, all shareholders agreed with the father’s proposal that, if he died first his shares would go to his son, but if his son died first, the son’s shares would go to the father (the Share Agreement).  

After the initial meeting, the four shareholders agreed to set up a "remuneration trust", which involved paying the company’s profits into an offshore trust in the hope of minimising corporation tax liability and allowing discretionary loans to be paid to shareholders rather than dividends.

When the father passed away in November 2009, his shares were transferred to the son in accordance with the son’s understanding of the Share Agreement. However, the mother contested the Share Agreement, claiming that she was entitled to the father’s shares under the company’s Articles of Association.

In this context, two of the disputes which came before the court were:

• whether, notwithstanding that it conflicted with the provisions of the Articles, the oral Share Agreement was binding on the mother, either on the basis of contract, proprietary estopped and/or constructive trust; and
• whether the son and his wife had structured the company’s finances so as to exclude her from dividends. The mother sought a court order requiring the son and his wife to buy her shares, at a price adjusted to reflect the damage she said had been caused by the son’s allegedly unfairly prejudicial conduct.

What did the court decide?

The oral Share Agreement

The court ultimately found in favour of the son, recognising the validity of the Share Agreement and the transfer of the father’s shares to his son. Although there were no contemporaneous documents, the judge preferred the witness evidence relied on by the son. This notably included the evidence of the company’s accountant, Mr Freeman, who confirmed the existence of the oral agreement.

The court found that the Share Agreement constituted a binding contract. That conclusion was not undermined by the fact that the agreement had not been in writing, as it was grounded in the trust shared amongst family members at the time. Mutual promises could be classed as consideration if they were intended to have legal effect.

The court also confirmed that even if the contractual claim had failed, the son would still have been entitled to the father’s shares on the basis of proprietary estoppel. This legal remedy arises where a person is led to believe they hold an interest in property due to another's assurances, and they act to their detriment in reliance on those assurances. In this case, the father promised that if he passed away first, his shares would go to the son. The son was justified in relying on this promise; after his father’s death, he continued working in the business, believing that he and his wife held 90% of the shares. The court found that allowing the mother to dishonour that promise, and claim the shares, would be unconscionable.

The unfair prejudice petition

The mother’s petition, brought under section 994 of the Companies Act 2006, argued that the company’s use of a remuneration trust tax scheme unfairly prejudiced her rights as a shareholder in that it had caused her not to receive adequate dividends.

The judge dismissed the petition, finding on the evidence that the mother was aware of and agreed to the use of the remuneration trust (even applying to it for loans) and that she had in fact received more by way of loan than she would otherwise have received in dividends as a 10% shareholder. 

In the circumstances, the mother had not been treated unfairly, nor had she demonstrated that the alleged failure to pay dividends had caused a loss to the company which would justify paying compensation to her or an adjustment to the price payable for her shares.

Directors’ duty of care - Section 174 of the Companies Act 2006

The mother also contended that the remuneration trust was a potentially unlawful tax avoidance scheme, and that its inherent riskiness meant that the directors’ decision to use the trust was a breach of their fiduciary duties and unfairly prejudicial to the shareholders.

This was roundly rejected by the court. The judge rejected any assertion that the son and his wife had breached their duty of care, skill and diligence under section 174 of the Companies Act 2006 or that the mother was unfairly prejudiced by this breach. The directors had sought appropriate professional advice in structuring the remuneration trust scheme. Even if the trust was held to be ineffective as a means of tax mitigation, the fact of its use had not unfairly prejudiced the mother or any other member of the company.

What is the practical impact of this decision?

• An oral agreement among shareholders regarding the transfer of shares in a company is capable of being valid and binding, and may override the terms of a company’s Articles.
• To reduce the risk of disputes, informal agreements between shareholders should be captured in writing. Whilst shareholders may baulk at the idea of formally recording everything that is agreed, particularly where they have close, cordial relations, a well-drafted shareholders’ agreement will not just help to avoid future litigation, it will ensure clarity and efficiency in the day-to-day running of a business.

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

© Farrer & Co LLP, November 2024