Companies' Internal Dispute

Shareholders are often subject to disputes within the Companies they are members of. When shareholders wish to complain against perceived irregularities within the Company, there are three main methods they may pursue such purpose: (i) via the contractual rights deriving from the company’s constitution; or (ii) via a statutory remedy such as (1) Derivative Action or (2) Unfair Prejudice claim.

1. Contractual rights.

Section 33 Companies Act 2006 (‘CA’) states that “The provisions of a company’s constitution bind the company and its members to the same extent as if there were covenants on the part of the company and of each member to observe those provisions”.

The importance of this section is that the company’s constitution (defined by section 17 of the Companies Act 2006 as its Articles of Association and its Resolutions) binds the company to each of its members and the members of the company to each other. It shall be noted that Section 33 of the Companies Act 2006 applies only if it relates to shareholders’ membership rights (i.e.: the right to a dividend once declared; the right to vote at meetings; the right to share in surplus capital on a winding up; the obligation to pay for shares issued).

That said, in case of a claim arising from the non-observance of a membership right, the action will be brought by the shareholder on the grounds of breach of contract and any order obtained by the member will be enforceable by him and bind the company.

Hence, where there is no membership’s right being disputed, section 33 shall not be relied upon. In Beattie v E. and F. Beattie Ltd [1938] Ch 708 the claimant was both a director and a shareholder of the company and it was held that a dispute between a director and the company in respect of the repayment of sums paid improperly to the director was not a dispute related to the director’s capacity as a shareholder, but as a director only. Thus, he could not enforce a provision within the Articles of Association requiring the use of arbitration for settling disputes between the Company and its members.

2. Statutory Remedies:

1. Derivative Action

On the other hand, when the company has suffered a wrong a shareholder may seek redress on the company’s behalf.

Historically a shareholder was frequently unable to sue where a wrong was done to the company because (i) the company is a separate legal entity, distinct from its members - therefore the company would have to be the claimant when a wrong has been done to it; and (ii) the decision as to sue or not would need to be taken either by the directors or by the company’s members in a general meeting. Thus, a minority shareholder was always in a weak position and unable to sue against the wrongdoer by himself, unless he had either a majority in a general meeting or the support of the Board.

The exception to the above-mentioned rule was developed through case law and in certain circumstances the Courts allowed a shareholder to sue the wrongdoer on behalf of the company, even without the approval of the Board or the members. This type of action was known as ‘derivative action’ as the shareholder’s right to sue derived from the company’s right to sue. Accordingly, if the company failed to sue for any reason, the member would have a mechanism to litigate against the wrong on the company’s behalf.

Derivative actions are now codified in the Companies Act 2006 (Ch. 1, Pt 11). Section 260(3) establishes that “a derivative claim may be brought only in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty, or breach of trust by a director of the company.”

Although it may be inferred that a shareholder may bring a case for any breach or default by a Director, Claimants must apply to the Court for permission to pursue a derivative claim and he must show a prima facie case to have the processing of the claim permitted. The Court will consider, amongst other things, whether or not a person acting to promote the interest of the company would or would not continue the claim; the good faith of the shareholder bringing the claim; any prior authorisation or ratification of the act or the possibility of subsequent ratification by the company; the views of the shareholders with no interest, direct or indirect, in the matter – See Companies Act 2006, Section 263(3)(4).

2. Unfair Prejudice

Along with section 33 and derivative claim, an unfair prejudice claim is also available to shareholders of a company. The statutory remedy is codified in Sections 994–999 of the Companies Act 2006.

Section 994 states that “a member of a company may apply to the court by petition for an order …on the ground (a) that the company's affairs are being or have been conducted in a manner that is unfairly prejudicial to the interests of members generally or of some part of its members (including at least himself), or (b) that an actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial.”

Therefore, if a Claimant demonstrates that he has suffered unfair prejudice arising from the way in which the affairs of the company were being conducted or from an actual or proposed act or omission by the company and the prejudice affected the interests of at least some of the members of the company, the Court will consider the appropriate remedy to be granted to such Claimant. Note that Section 996(1) gives wide powers to the Court, as it states it “may make such order as it thinks fit for giving relief in respect of the matters complained of”. Also, Section 996(2) gives a non-exhaustive list of remedies to the Court.