Key takeaways

Shareholder disputes can often turn on contract interpretation. It is important to receive legal advice in respect of any agreement under a shareholder-company relationship to avoid ambiguity in the terms. Prejudice can come in many forms, even where a shareholder is, on its face, given choice in the matter. Therefore, directors must ensure that their conduct is evenhanded and take into account the interests of all of their company’s shareholders.

What was the background to the dispute?

Magic Investments SA (“Magic”) was a minority shareholder in The Greater Good Fresh Brewing Co Limited (“the Company”). Mr Broadbent was a co-founder and the CEO of the Company. Magic held shares on behalf of a South African courier and logistics business, the RAM Group. South African exchange control regulations require that a South African company hold a board seat in any foreign company for the duration of its investment in that company. In this connection, a letter agreement was signed alongside the investment agreement, entitling Magic to ‘nominate someone to the board’.

Following the agreement, Magic nominated a director, and the Company accepted the nomination. However, the nominee resigned after several months. When Magic sought to nominate a new director, Broadbent resisted the new nomination because he did not believe that the nomination would add to the board’s expertise.

Seeking an injection of capital after one of the Company’s products failed, Broadbent proposed a new share issue at a £6 million valuation and allowed other investors to buy shares proportionate to their existing stakes. Magic opposed and refused to participate. As a result, its shareholding was diluted.

Unfair prejudice petitions under the Companies Act 2006

Magic presented a petition under the Companies Act 2006 on the ground that the Company’s affairs had been conducted in a way that was unfairly prejudicial to shareholders generally and Magic specifically.

Magic’s argument was that the nomination agreement entitled it to have its nominees appointed to the board of the Company. Therefore, Mr Broadbent denied it this right. Additionally, Magic claimed that the new investment was done at an undervalue. Thus, the share dilution prejudiced its rights as a shareholder.

Mr Broadbent’s counter was that the nomination agreement only allowed Magic to put forward a name which could be legitimately rejected by the Company. On the dilution of shares allegation, he claimed that there was no prejudice because Magic itself chose not to participate in the new round of investments and had its shares diluted as a result.

Mr Broadbent applied to have the petition struck out for lack of a reasonable prospect of success, and the application was successful. Magic appealed without success. The lower courts interpreted the word ‘nominate’ literally: it only entitled Magic to propose a candidate which could be rejected by the Company. Magic appealed the decision to the Court of Appeal.

Read our article on shareholder litigation and remedies in disputes between shareholders for a broader overview of strategic options in shareholder disputes.

Board nomination rights in shareholder disputes

The appeal raised two questions:

1. What does the word ‘nominate’ mean under the agreement and could the refusal to nominate Magic’s candidate amount to prejudice?

2. Could the dilution of Magic’s shares constitute prejudice?

Contract interpretation in shareholder-company agreements

The Court of Appeal applied the principles of contract interpretation found in Wood v Capita Insurance Services Ltd [2017] UKSC 24. Contract interpretation must be carried out in the context of the entirety of the agreement and can take into account the facts surrounding the agreement’s conclusion and common business sense, so as to give effect to the objective meaning of the agreement between the parties.

Read our article on why boilerplate clauses matter for related analysis on why contractual wording, context and apparently standard provisions can become critical when disputes arise.

Share dilution and unfair prejudice

Turning now to the question of prejudice in share dilution, a string of cases suggests that share dilution can be prejudicial towards a minority shareholder unless there was a good reason to dilute the shares in the circumstances, taking into account the directors’ fiduciary duty towards shareholders.

This was central to Magic’s case. The question was not simply whether Magic had been offered the opportunity to participate in the new investment round. The issue was whether the circumstances of the share issue, including the alleged undervalue, meant that the choice presented to Magic was itself prejudicial.

Read our article on whether majority shareholders can suffer unfair prejudice for related analysis of how unfair prejudice arguments can arise in different shareholder contexts.

Court of Appeal decision in Magic Investments

The Court of Appeal allowed the appeal by Magic, dismissing the application to strike out the petition, and the case will now proceed towards trial.

It found that the word ‘nominate’ meant that Magic was entitled to have a seat on the board. The full wording of the clause ‘to nominate someone to the board’ presupposes that the right is not merely a right to propose a candidate.

Additionally, interpreting the agreement to give a right to propose a candidate would give nothing of value to Magic because it would have this right anyway. Therefore, the lower courts’ interpretation goes against common business sense, as it is unlikely to have been the parties’ intention.

Finally, the fact that a seat on the board was required by South African regulations indicated that the parties had contemplated Magic having a right to appoint a director. Therefore, the Court found that denial of that right may have constituted prejudice, and Magic had a real prospect of success on this allegation.

Share dilution at undervalue: why choice may still be prejudicial

On the share dilution allegation, the Court found that the fact that Magic did not participate in the new investment was not fatal to its argument. It may have been the case that the shares were issued at an undervalue and the choice given to Magic effectively amounted to coercion into either investing more funds or suffering a loss of its shareholding rights.

Therefore, Magic had a real prospect of success in relation to this point too.

Shareholder disputes: what should shareholders and companies take from this case?

Shareholders and companies should pay attention to the wording of any agreements between them to avoid any ambiguity. Where there is a dispute as to the interpretation of the contract, parties should be mindful not to rely only on their contract, but also consider that the wider context of their agreement can be used by the courts to give it objective meaning.

Directors should also be careful to govern companies evenhandedly. Even where a choice is being presented to a shareholder, directors must ensure that the options given do not unfairly prejudice that shareholder’s rights.

This is particularly important where minority shareholders have negotiated board rights, information rights, consent rights or other protections as part of their investment. Those rights should be treated as substantive protections, not technicalities.

If you are facing an allegation of prejudice as a company director or are being subjected to prejudicial treatment as a shareholder, our Dispute Resolution team advises clients on shareholder disputes and Companies Act petitions. For more information, please contact Yulia Barnes to discuss how we can support you.