Eldwick Law

Tag: commercial litigation

  • Deadlock, Valuation and Director Misconduct Disputes

    Deadlock, Valuation and Director Misconduct Disputes

    1. Deadlock and stalemate disputes

    Deadlock happens when equal shareholders cannot agree on key decisions, paralysing business operations. Disputes can arise in relation to major decisions, such as whether to pursue expansion, hire key personnel, approve significant expenditure, or sell the business. Without a controlling shareholder, day-to-day operations grind to a halt as neither party can force through their preferred strategy. In 50:50 joint ventures, neither party commands the 75% majority required for special resolutions, creating gridlock that can destroy company value.

    Possible resolution mechanisms

    Shareholders agreements often anticipate deadlock and provide contractual mechanisms to break the impasse.

    • Casting vote provisions grant the chairman a pre-determined casting vote in tied decisions.
    • Independent arbitration allows the shareholders to appoint a neutral expert to resolve specific disputes.
    • Russian Roulette clauses enable one shareholder to offer to purchase the other’s shares at a set price, with the receiving shareholder able to reverse the transaction and buy the offering shareholder’s stake at the same per-share price, ensuring the offer is fair.
    • Texas Shootout involves sealed bids from both shareholders, with the highest bidder acquiring the company at that price.

    Where no contractual mechanism exists or both parties reject settlement, shareholders can petition for just and equitable winding up under section 122(1)(g) Insolvency Act 1986. The courts will dissolve a solvent company with deadlocked ownership, allowing an independent liquidator to distribute proceeds according to shareholding. However, courts treat winding up as a last resort and will refuse the petition if alternative remedies exist or the petitioner has acted unreasonably. Additionally, the petitioner must have held shares for at least 18 months.

    2. Breaches of shareholder agreement disputes

    Shareholders agreements set out the ground rules for how shares can be transferred, how voting decisions are made, and what happens when a shareholder wants to exit. Breaches typically involve selling shares without offering them to existing shareholders first, voting against agreed terms, or ignoring agreed exit procedures.

    Pre-emption rights require that shares be first offered to existing shareholders before any external sale. Breach occurs when a shareholder attempts to sell to a competitor or outsider without following this procedure. Voting covenant violations arise when a shareholder votes against agreed reserved matters, such as major capital expenditures or changes to the business plan. Exit procedure failures occur when shareholders attempt to exit without following contractually-mandated timelines or negotiation steps.

    Possible resolution mechanisms

    • Damages – i.e. monetary compensation for quantifiable losses
    • Injunctions – preventing threatened breaches or compelling specific performance
    • Forced share transfer – if the breach has the potential to destroy the working relationship
    • Without prejudice negotiations – settlement discussions to avoid litigation costs

    It is important to bear in mind that pre-action protocols require parties to exchange letters of claim, documents, and consider mediation before starting court proceedings.

    Share valuation disputes

    When shareholders cannot agree on what their shares are worth, disputes can quickly become expensive and adversarial. The disagreement often centres on which valuation method should apply and whether the shares should be discounted because they represent a minority stake.

    The courts recognise several valuation approaches depending on the company’s circumstances. Discounted cash flow (DCF) values a business based on its projected future earnings, making it suitable for profitable companies with steady cash flows. EBITDA multiples compare the company to similar businesses that have recently sold or are publicly traded. Net asset valuation simply adds up what the company owns minus what it owes, which works best for property-holding or investment companies. Fair market value represents what a willing buyer would pay a willing seller in an arm’s-length transaction.

    Resolving valuation disputes

    In recent years, we have observed that parties are increasingly opting for expert determination rather than court battles. An independent accountant or valuer examines the company’s finances and provides a binding valuation, usually within weeks rather than months or years. This approach saves substantial legal costs and maintains greater confidentiality than public court proceedings. Courts increasingly favour expert determination over adversarial expert evidence as it provides faster, more cost-effective resolution.

    Director misconduct disputes

    Directors owe several statutory duties under the Companies Act 2006, including the fundamental obligation to promote the success of the company. When directors breach these duties, shareholders often seek remedies ranging from removal to financial compensation. Misconduct takes many forms:

    • Misuse of company assets occurs when directors divert business opportunities or funds to personal benefit, such as self-dealing transactions or competing ventures.
    • Breach of fiduciary duties happens when directors act in conflicts of interest without proper disclosure to the board or shareholders.
    • Fraudulent or wrongful trading involves continuing to trade the company while insolvent or with intent to defraud creditors, a particularly serious breach.
    • Poor governance includes failure to exercise reasonable care, diligence, and skill in decision-making.

    Possible resolution mechanisms

    Shareholders have multiple options for addressing director misconduct. The simplest and most direct is removal by ordinary resolution (51% vote) under section 168 Companies Act 2006. This requires no court involvement, a shareholder resolution at a general meeting can remove a director immediately, though the director is entitled to speak in their own defence.

    Beyond removal, shareholders can pursue damages claims, recovering losses suffered by the company or individual shareholders. These claims require proof of the breach and quantifiable loss, making them more complex than removal votes. Injunctions prevent directors from continuing wrongful conduct, such as misusing company assets or pursuing competing business ventures. For more serious breaches affecting the company as a whole, shareholders can also bring derivative claims on behalf of the company to recover losses.

    Final Words

    Shareholder disputes rarely resolve quickly or cheaply. The sooner you seek legal advice when warning signs emerge such as unresolved disagreements, breaches of agreement, or unexplained director conduct, the better the outcome is likely to be. Most disputes that reach commercial litigation could have been settled at a fraction of the cost through early negotiation or mediation. If litigation becomes unavoidable, understanding which remedy applies to your circumstances allows you to pursue the most efficient resolution. Well-drafted shareholders agreements with clear deadlock provisions, pre-emption rights, and exit mechanisms prevent many disputes from arising in the first place.

    FAQs

    What is the cheapest way to resolve a shareholder dispute?

    Early negotiation and mediation is almost always the cheapest and fastest way to resolve a shareholder dispute. Pre-action protocols require ADR consideration anyway. For valuation disputes, an independent expert can provide a binding decision in weeks rather than months of court cases.

    Can I force a director out without going to court?

    Yes, you can remove a director by ordinary resolution (51% shareholder vote) at a general meeting under section 168 Companies Act 2006. This requires no court involvement, though the director is entitled to speak in their own defence before the vote.

    What happens if I breach a shareholders agreement?

    The other party can seek damages for losses, obtain court injunctions forcing compliance, or pursue forced share transfer if the breach is serious enough. Courts enforce shareholders agreements as binding contracts. You will also be required to engage in pre-action mediation, and failure to do so results in cost sanctions against you in any subsequent litigation.

    To discuss any points raised in this article, please call us on +44 (0) 203972 8469 or email us at mail@eldwicklaw.com.

    This article does not constitute legal advice. For further information, please contact our London office.

  • Claims against a Director for Breach of Duties

    Claims against a Director for Breach of Duties

    If a director breaches these duties, it may be possible for shareholders to bring a claim. Contact one of our solicitors.

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    What are the directors’ duties?

    The general duties of a company director are found in sections 171-177 of the Companies Act. They are:

    • A company director must act per the company’s constitution and only exercise their powers for the purposes for which they are given (section 171).
    • A company director must act in good faith and promote the success of the company for the benefit of its members (section 172 (1)).
    • A company director must exercise independent judgment. They may take on board the advice or opinion of others, the ultimate decision must be theirs (section 173).
    • A company director must exercise reasonable care, skill, and due diligence when undertaking their duties (section 174).
    • A company director must not place themselves in a position where there is a conflict, or possible conflict, between the duties they owe the company and either their personal interests or other duties owed to a third party (section 175).
    • A company director must not accept any benefits which are conferred on them due to their position as a company director (section 176).
    • If a company director has an interest in a proposed transaction or arrangement with the company this must be declared to any fellow directors (section 177).

    Examples of breach of directors’ duties cases

    • In 2019, ClientEarth sued, as a minority shareholder, Polish energy company Enea alleging that the company’s strategy to build a 1GW coal-fired power station in northeast Poland as part of a joint venture with another Polish energy firm, Energa posed an indefensible risk to investors in the face of rising prices for carbon and growing demand for renewables. Moving forward with the project would constitute a breach of the board of directors’ fiduciary duties of due diligence and acting in the best interests of the company and its shareholders.
    • In Fairford Water Ski Club v Cohoon [2021] EWCA Civ 143 the director of a company that owned a lake and surrounding land was ordered to repay £350,000 after failing to declare his interest in a water skiing school that operated on the lake at a particular directors’ meeting.

    Breach of directors duties penalties

    What can be imposed?

    There are several sanctions the court can make if a director is found to have breached their duties, including:

    • Damages – if the director has been negligent in performing their duties they may be required to pay damages to the company.
    • Injunctions – an injunction order can be made to prevent a director from conducting a breach or continuing to breach their duty.
    • Restoration of property and/or profits – the court can order a director to return property and/or repay any profits gained through the breach.
    • Reversing of a contract – if a director signs an agreement that goes against the company’s intentions it can be rescinded.

    Can the company ‘forgive’ a director for a breach of duty?

    Yes, section 239 regulates the company’s right to ratify (forgive) conduct by a director amounting to negligence, default, breach of duty, or breach of trust in relation to the company. The ratification decision must be made by resolution of the members and neither the director nor anyone connected with them can be part of the resolution.

    Most importantly, a breach of duty that results in a decision that threatens the solvency of the company or causes a loss to its creditors cannot be ratified.

    In cases of negligence, default, breach of duty, or breach of trust claims, the court can relieve a director of liability in whole or in part if:

    • They acted honestly and reasonably, and
    • Having regard to all the circumstances of the case, the court believes it is reasonable to excuse the director.

    Concluding comments on breaching directors duties

    Civil litigation in cases involving directors’ duties is a highly complex area of law and requires the involvement of commercial disputes solicitors.

    Take for example the Enea case mentioned above which concerned shareholders bringing a claim against the board for, in broad terms, failing to consider environmental and climate change matters in their decision making.
    These types of directors’ duties claims are guaranteed to rise as the science around the impact of company actions on climate change becomes clearer.

    This, and other types of directors’ duties claims, such as conflicts of interests or negligence, can involve cross-border and joint venture elements, adding to the complexity of the matter.

    If you are facing a regulatory or criminal investigation or prosecution, seek experienced legal advice immediately.

    To discuss any points raised in this article, please call us on +44 (0) 203972 8469 or email us at mail@eldwicklaw.com.

    Note: The points in this article reflect the law in place at the time of writing, 19 January 2024. This article does not constitute legal advice. For further information, please contact our London office.

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  • Reflective Loss: A Clarification by the Supreme Court

    Reflective Loss: A Clarification by the Supreme Court

    On the 15th July 2020 the Supreme Court handed down its judgment in the case of Sevilleja v Marex Financial Ltd [2020] UKSC 31. In this case the court grappled with the history and development of the ‘Reflective Loss’ principle and was tasked with clarifying the width of its applicability.

    Facts of the Case

    The original case was brought by an investment company, Marex Financial Ltd (‘Marex’). This was against Mr Sevilleja, the owner and controller of two companies incorporated in the British Virgin Islands. Marex had obtained judgment against the two companies, which were vehicles through which Mr Sevilleja conducted foreign exchange trading. Mr Sevilleja was accused of moving the two companies’ assets out of the jurisdiction, into accounts under his personal control. This was done in such a way as to deprive Marex of being able to enforce the judgment. Marex issued against Mr Sevilleja personally for the judgment sums, interest and costs of pursuing him. Mr Sevilleja resisted their action, contending that Marex could sue him for the losses incurred to the BVI companies, which have been placed in voluntary insolvent liquidation and relied on ‘Reflective Loss’.

    What is Reflective Loss?

    The principle has emerged from a line of cases spawned from the ancient judgment in Foss v Harbottle (1843) 2 Hare 461. In that case it was decided that the only person who can seek relief for an injury done to a company, where the company has a cause of action, is the company itself.

    This case was followed by that of Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204 which applied the principle in a modern context. It was held that in a situation where a company suffers loss, which in turn affects the value of shares held by a shareholder, the principle in Foss applies to prevent the company and its shareholders both suing for the loss. Only one of those two claims can proceed and Foss makes clear that it is the company that should be preferred.

    It is at this point that the Lord Reed, in the present case before the Supreme Court, determined that things went wrong. The court in Johnson v Gore Wood & Co [2002] 2 AC 1 made several determinations that purported to follow Prudential but, in the view of Lord Reed, misinterpreted the core of that judgment. It was held by Lord Millet in Johnson that the basis of the decision in Prudential was a desire by the court to avoid double recovery. This led to a focus, by the benches that followed, on avoiding circumstances whereby anyone connected to a company, that had a right of action in a dispute, could recover for their loss – even in circumstances where the company chose to do nothing about their right of action. The latter circumstance was justified with reference to a secondary desire expounded by Lord Millet to preserve company autonomy. It was held in Johnson that a company’s refusal to prosecute its right of action in such a way as to compensate its creditors or shareholders was, in a sense, a novus actus. It wasn’t the original defendant who had resulted in the shareholder/creditor not being able to recover their losses by remedying the original wrong done to the company, but the company itself.

    How was Johnson Wrongly Decided?

    Lord Reed was respectfully critical of Lord Millet’s interpretation of the reasoning in Prudential and concluded that he had departed too far from the very limited scope that Prudential was intended to have. Lord Reed determined that there were two fundamental assertions that gave rise to Lord Millet’s misadventure. The first being a misjudgement of what shareholding in a company actually represents. He described a share as representing “a proportionate part of the company’s net assets” and that “if these are depleted the diminution in its assets will be reflected in the diminution in the value of the shares”. Lord Reed disagreed, instead concluding that shares are simply “a right of participation in the company on the terms of the articles of association”. He goes on to highlight that it is an “unrealistic assumption that there is a universal and necessary relationship between changes in a company’s net assets and changes in its share value”. Lord Reed also determined that to view Prudential, and therefore Foss, through the lens of ‘double-recovery’ was to mischaracterise the nature of legal loss. By linking the value of the loss to the company intrinsically to the value of the shares, Lord Millet is conceding that the shareholder has suffered a legal loss – albeit one that he then denies them recovery for. Lord Reed concludes that this is a perversion of Foss and entirely not what Prudential intended. He concluded that those two cases, when read together, in fact do not recognise the reduction in value of a company’s shares (as a result of a wrong done to it) as being a legal loss at all.

    Lord Reed, in support of his conclusion, highlighted the principal logical inconsistency with the fact that Lord Millet’s approach to Reflective Loss was based upon avoiding ‘double-recovery’ but led to situations where neither the company nor its shareholders had recovered for an actionable loss.

    Conclusion

    Lord Reed concluded in Sevilleja that “the critical point is that the shareholder has not suffered a loss which is regarded by the law as being separate and distinct from the company’s loss, and therefore has no claim to recover it.” This is contrasted against creditors or employees, who may have other rights of action that arise separately from any shareholding, and does not prejudice those parties from pursuing their cases, as the law would otherwise allow. Thus it can be said that the rule on ‘Reflective Loss’ has been narrowed to account for what Lord Reed would suggest was a wrong-turn at Johnson that opened the door to the principle from Foss being more widely interpreted than the judgment in Prudential intended.

    It is important that those wishing to invoke the exception to the rule against reflective loss carefully explore whether claims can be brought by the company, rather than shareholders or creditors. It is crucial that legal advice is obtained early on to clarify the claimants position. At Eldwick Law, we are experts in commercial law. Contact our commercial lawyers today for a consultation.