Judgment - O'Neill and Another v. Phillips and Others  continued

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     "in order to give rise to an equitable constraint based on 'legitimate expectation' what is required is a personal relationship or personal dealings of some kind between the party seeking to exercise the legal right and the party seeking to restrain such exercise, such as will affect the conscience of the former."

This is putting the matter in very traditional language, reflecting in the word "conscience" the ecclesiastical origins of the long-departed Court of Chancery. As I have said, I have no difficulty with this formulation. But I think that one useful cross-check in a case like this is to ask whether the exercise of the power in question would be contrary to what the parties, by words or conduct, have actually agreed. Would it conflict with the promises which they appear to have exchanged? In Blisset v. Daniel the limits were found in the "general meaning" of the partnership articles themselves. In a quasi-partnership company, they will usually be found in the understandings between the members at the time they entered into association. But there may be later promises, by words or conduct, which it would be unfair to allow a member to ignore. Nor is it necessary that such promises should be independently enforceable as a matter of contract. A promise may be binding as a matter of justice and equity although for one reason or another (for example, because in favour of a third party) it would not be enforceable in law.

I do not suggest that exercising rights in breach of some promise or undertaking is the only form of conduct which will be regarded as unfair for the purposes of section 459. For example, there may be some event which puts an end to the basis upon which the parties entered into association with each other, making it unfair that one shareholder should insist upon the continuance of the association. The analogy of contractual frustration suggests itself. The unfairness may arise not from what the parties have positively agreed but from a majority using its legal powers to maintain the association in circumstances to which the minority can reasonably say it did not agree: non haec in foedera veni. It is well recognised that in such a case there would be power to wind up the company on the just and equitable ground (see Virdi v. Abbey Leisure Ltd. [1990] B.C.L.C. 342) and it seems to me that, in the absence of a winding up, it could equally be said to come within section 459. But this form of unfairness is also based upon established equitable principles and it does not arise in this case.

6.  Legitimate expectations.

In In re Saul D. Harrison & Sons Plc. [1995] 1 B.C.L.C. 14, 19, I used the term "legitimate expectation," borrowed from public law, as a label for the "correlative right" to which a relationship between company members may give rise in a case when, on equitable principles, it would be regarded as unfair for a majority to exercise a power conferred upon them by the articles to the prejudice of another member. I gave as an example the standard case in which shareholders have entered into association upon the understanding that each of them who has ventured his capital will also participate in the management of the company. In such a case it will usually be considered unjust, inequitable or unfair for a majority to use their voting power to exclude a member from participation in the management without giving him the opportunity to remove his capital upon reasonable terms. The aggrieved member could be said to have had a "legitimate expectation" that he would be able to participate in the management or withdraw from the company.

It was probably a mistake to use this term, as it usually is when one introduces a new label to describe a concept which is already sufficiently defined in other terms. In saying that it was "correlative" to the equitable restraint, I meant that it could exist only when equitable principles of the kind I have been describing would make it unfair for a party to exercise rights under the articles. It is a consequence, not a cause, of the equitable restraint. The concept of a legitimate expectation should not be allowed to lead a life of its own, capable of giving rise to equitable restraints in circumstances to which the traditional equitable principles have no application. That is what seems to have happened in this case.

7. Was Mr. Phillips unfair?

The Court of Appeal found that by 1991 the company had the characteristics identified by Lord Wilberforce in In re Westbourne Galleries Ltd. [1973] A.C. 360 as commonly giving rise to equitable restraints upon the exercise of powers under the articles. They were (1) an association formed or continued on the basis of a personal relationship involving mutual confidence, (2) an understanding that all, or some, of the shareholders shall participate in the conduct of the business and (3) restrictions on the transfer of shares, so that a member cannot take out his stake and go elsewhere. I agree. It follows that it would have been unfair of Mr. Phillips to use his voting powers under the articles to remove Mr. O'Neill from participation in the conduct of the business without giving him the opportunity to sell his interest in the company at a fair price. Although it does not matter, I should say that I do not think that this was the position when Mr. O'Neill first acquired his shares in 1985. He received them as a gift and an incentive and I do not think that in making that gift Mr. Phillips could be taken to have surrendered his right to dismiss Mr. O'Neill from the management without making him an offer for the shares. Mr. O'Neill was simply an employee who happened to have been given some shares. But over the following years the relationship changed. Mr. O'Neill invested his own profits in the company by leaving some on loan account and agreeing to part being capitalised as shares. He worked to build up the company's business. He guaranteed its bank account and mortgaged his house in support. In re H. R. Harmer [1959] 1 W.L.R. 62 shows that shareholders who receive their shares as a gift but afterwards work in the business may become entitled to enforce equitable restraints upon the conduct of the majority shareholder.

The difficulty for Mr. O'Neill is that Mr. Phillips did not remove him from participation in the management of the business. After the meeting on 4 November 1991 he remained a director and continued to earn his salary as manager of the business in Germany. The Court of Appeal held that he had been constructively removed by the behaviour of Mr. Phillips in the matter of equality of profits and shareholdings. So the question then becomes whether Mr. Phillips acted unfairly in respect of these matters.

To take the shareholdings first, the Court of Appeal said that Mr. O'Neill had a legitimate expectation of being allotted more shares when the targets were met. No doubt he did have such an expectation before 4 November and no doubt it was legitimate, or reasonable, in the sense that it reasonably appeared likely to happen. Mr. Phillips had agreed in principle, subject to the execution of a suitable document. But this is where I think that the Court of Appeal may have been misled by the expression "legitimate expectation." The real question is whether in fairness or equity Mr. O'Neill had a right to the shares. On this point, one runs up against what seems to me the insuperable obstacle of the judge's finding that Mr. Phillips never agreed to give them. He made no promise on the point. From which it seems to me to follow that there is no basis, consistent with established principles of equity, for a court to hold that Mr. Phillips was behaving unfairly in withdrawing from the negotiation. This would not be restraining the exercise of legal rights. It would be imposing upon Mr. Phillips an obligation to which he never agreed. Where, as here, parties enter into negotiations with a view to a transfer of shares on professional advice and subject to a condition that they are not to be bound until a formal document has been executed, I do not think it is possible to say that an obligation has arisen in fairness or equity at an earlier stage.

The same reasoning applies to the sharing of profits. The judge found as a fact that Mr. Phillips made no unconditional promise about the sharing of profits. He had said informally that he would share the profits equally while Mr. O'Neill managed the company and he himself did not have to be involved in day-to-day business. He deliberately retained control of the company and with it, as the judge said, the right to redraw Mr. O'Neill's responsibilities. This he did without objection in August 1991. The consequence was that he came back to running the business and Mr. O'Neill was no longer managing director. He had made no promise to share the profits equally in such circumstances and it was therefore not inequitable or unfair for him to refuse to carry on doing so. The Court of Appeal seems to have contemplated that Mr. Phillips might have been entitled to do what he did if he had given Mr. O'Neill notice of his intentions and treated him more politely at the meeting on 4 November 1991. But these matters cannot affect the question of whether a change in the profit-sharing arrangements was a breach of faith.

It follows in my opinion that there was no basis for the Court of Appeal's finding that Mr. O'Neill had been driven out of the company. He may have decided that he had lost confidence in Mr. Phillips and that he could no longer work with him. After Christmas 1992 Mr. Phillips said that he recognised that Mr. O'Neill had come to this conclusion and that there was no way in which he could put their relationship together again. But Mr. O'Neill's decision was not the result of anything wrong or unfair which Mr. Phillips had done.

8. No-fault divorce?

Mr. Hollington, who appeared for Mr. O'Neill, said that it did not matter whether Mr. Phillips had done anything unfair. The fact was that trust and confidence between the parties had broken down. In those circumstances it was obvious that there ought to be a parting of the ways and the unfairness lay in Mr. Phillips, who accepted this to be the case, not being willing to allow Mr. O'Neill to recover his stake in the company. Even if Mr. Phillips was not at fault in causing the breakdown, it would be unfair to leave Mr. O'Neill locked into the company as a minority shareholder.

Mr. Hollington's submission comes to saying that, in a "quasi-partnership" company, one partner ought to be entitled at will to require the other partner or partners to buy his shares at a fair value. All he need do is to declare that trust and confidence has broken down. In the present case, trust and confidence broke down, first, because Mr. Phillips failed to do certain things which, on the judge's findings, he had never promised to do; secondly, because Mr. O'Neill wrongly thought that Mr. Phillips had committed various improprieties; and finally because, as the judge said, he was "inclined to see base motives in everything that Mr. Phillips did." Nevertheless it is submitted that fairness requires that Mr. Phillips or the company ought to raise the necessary liquid capital to pay Mr. O'Neill a fair price for his shares.

I do not think that there is any support in the authorities for such a stark right of unilateral withdrawal. There are cases, such as In re A Company (No. 006834 of 1988) (1989) 5 B.C.C. 218, in which it has been said that if a breakdown in relations has caused the majority to remove a shareholder from participation in the management, it is usually a waste of time to try to investigate who caused the breakdown. Such breakdowns often occur (as in this case) without either side having done anything seriously wrong or unfair. It is not fair to the excluded member, who will usually have lost his employment, to keep his assets locked in the company. But that does not mean that a member who has not been dismissed or excluded can demand that his shares be purchased simply because he feels that he has lost trust and confidence in the others. I rather doubt whether even in partnership law a dissolution would be granted on this ground in a case in which it was still possible under the articles for the business of the partnership to be continued. And as Lord Wilberforce observed in In re Westbourne Galleries Ltd. [1973] A.C. 360, 380, one should not press the quasi-partnership analogy too far: "A company, however small, however domestic, is a company not a partnership or even a quasi-partnership . . . ."

The Law Commission, in the report to which I have already referred, Shareholder Remedies (Law Com. No. 246) (1997) (Cm. 3769) considered whether to recommend the introduction of a statutory remedy "in situations where there is no fault," so that members of a quasi-partnership could exit at will. They said, in paragraph 3.66:

      "In our view there are strong economic arguments against allowing shareholders to exit at will. Also, as a matter of principle, such a right would fundamentally contravene the sanctity of the contract binding the members and the company which we considered should guide our approach to shareholder remedies."

The Law Commission plainly did not consider that section 459 already provided a right to exit at will and I do not think so either.

9. Capacity in which prejudice suffered

The judge, it will be recalled, gave as one of his reasons for dismissing the petition the fact that any prejudice suffered by Mr. O'Neill was in his capacity as an employee rather than as a shareholder. The Court of Appeal's rejection of this reason was, I think, influenced by its view that Mr. O'Neill had been constructively expelled. In a case of expulsion, where the equitable restraint on the exercise of the power is based upon the terms upon which the petitioner became or continued as a member of the company, the prejudice will be suffered in the capacity of a member. It is the terms, agreement, or understanding on which he became associated as a member which generates the restraint on the power of expulsion. But the judge was considering only the prejudice suffered through not getting a half-share in the profits or the additional shares. It is somewhat unreal to deal with the capacity in which prejudice was suffered in these respects when there was no entitlement in law or equity in the first place. But assuming there had been a contractual obligation, I would not exclude the possibility that prejudice suffered from the breach of that obligation could be suffered in the capacity of shareholder. As I have said, the initial gift of 25 shares in 1985 did not in my view change the essential relationship between the parties. Mr. Phillips remained controlling shareholder and Mr. O'Neill remained an employee who had some shares. If at that stage Mr. Phillips had promised another 25 shares and then broken his promise, I do not think that Mr. O'Neill would have suffered prejudice in his capacity as an existing shareholder. I agree with the judge that the case would have been no different if Mr. O'Neill had had no shares and Mr. Phillips had broken a promise to give him 50. On the other hand, once Mr. O'Neill had invested his own money and effort in the company, the situation may have changed. A promise to give Mr. O'Neill more shares or a larger share in the profits may well have been based not merely upon his position as an employee but on the fact that he already had a stake in the company. As cases like R. & H. Electrical Ltd. v. Haden Bill Electrical Ltd. [1995] 2 B.C.L.C. 280 show, the requirement that prejudice must be suffered as a member should not be too narrowly or technically construed. But the point does not arise because no promise was made.

10. The offer to buy

Mr. Ralls, who appeared for Mr. Phillips, submitted that even if his conduct had been unfairly prejudicial, the petition should have been dismissed because he had made an offer to buy the shares at a fair price, which was the whole of the relief to which Mr. O'Neill would have been entitled. In view of the conclusion I have reached about the absence of unfair prejudice, with which I understand your Lordships to agree, this point does not need to be decided. Nevertheless, the effect of an offer to buy the shares as an answer to a petition under section 459 is a matter of such great practical importance that I would invite your Lordships to consider it.

The petition was presented on 22 January 1992 and points of defence were delivered on 16 March 1992. The points of defence contained no offer to buy but asked that Mr. Phillips or the company should be "at liberty" to buy the shares

     "at a fair value to be fixed by the court upon such basis as to the court shall seem just and equitable and depending upon its finding in respect of the various issues between the parties disclosed on the pleadings herein."

This plainly contemplated that the petition would go to full hearing and be decided on the merits. There was then considerable delay and a number of interlocutory hearings. On 28 November 1994, pursuant to an undertaking given to the court, Mr. Phillips made an offer in terms scheduled to a consent order of that date. The offer was to purchase at a price to be agreed or in default fixed by a chartered accountant as valuer on the basis that the value was one-quarter of the fair value of the entire issued share capital. The offer was rejected on various grounds, one being that it made no provision for Mr. O'Neill's costs. The result was that the petition went to a full hearing.

The judge, who dismissed the petition, did not find it necessary to deal with the offer. The Court of Appeal accepted the argument that Mr. O'Neill was justified in rejecting it because it did not provide for his costs.

In my opinion the Court of Appeal was right. The offer is only material to the outcome at the trial if the court considers that the petitioner is otherwise entitled to succeed. So the fact that he was made an earlier offer of the relief to which the court has now held him entitled after trial can logically go only to the question of costs. If the petitioner was offered everything to which he has been held entitled, the respondent may, as in the case of a Calderbank letter (Calderbank v. Calderbank [1976] Fam. 93), be entitled to say that the costs after the date of the offer should be borne by the successful petitioner, who ought to have accepted the offer and brought the litigation to an end. On the other hand, it seems to me that in the case of a petition which has been on foot for nearly three years, a petitioner who, we are assuming, has a well founded case will not obtain everything to which he is entitled unless there is an offer of costs. Mr. Ralls said that no such offer was made because there had been some orders for the petitioner to pay the costs of interlocutory applications in any event and Mr. Phillips took the view that on balance the petitioner would not be entitled to any costs. But Mr. O'Neill was not to be expected to guess what the results of a taxation would be. Mr. Phillips could have offered to pay the costs less any which had been awarded to him by interlocutory order. I therefore agree that the offer was inadequate.

In the present case, Mr. Phillips fought the petition to the end and your Lordships have decided that he was justified in doing so. But I think that parties ought to be encouraged, where at all possible, to avoid the expense of money and spirit inevitably involved in such litigation (See Shakespeare, Sonnet 129) by making an offer to purchase at an early stage. This was a somewhat unusual case in that Mr. Phillips, despite his revised views about Mr. O'Neill's competence, was willing to go on working with him. This is a position which the majority shareholder is entitled to take, even if only because he may consider it less unattractive than having to raise the capital to buy out the minority. Usually, however, the majority shareholder will want to put an end to the association. In such a case, it will almost always be unfair for the minority shareholder to be excluded without an offer to buy his shares or make some other fair arrangement. The Law Commission (Shareholder Remedies (Law Com. No. 246) (1997) (Cm. 3769), paras. 3.26-56) has recommended that in a private company limited by shares in which substantially all the members are directors, there should be a statutory presumption that the removal of a shareholder as a director, or from substantially all his functions as a director, is unfairly prejudicial conduct. This does not seem to me very different in practice from the present law. But the unfairness does not lie in the exclusion alone but in exclusion without a reasonable offer. If the respondent to a petition has plainly made a reasonable offer, then the exclusion as such will not be unfairly prejudicial and he will be entitled to have the petition struck out. It is therefore very important that participants in such companies should be able to know what counts as a reasonable offer.

In the first place, the offer must be to purchase the shares at a fair value. This will ordinarily be a value representing an equivalent proportion of the total issued share capital, that is, without a discount for its being a minority holding. The Law Commission (paragraphs 3.57-62) has recommended a statutory presumption that in cases to which the presumption of unfairly prejudicial conduct applies, the fair value of the shares should be determined on a pro rata basis. This too reflects the existing practice. This is not to say that there may not be cases in which it will be fair to take a discounted value. But such cases will be based upon special circumstances and it will seldom be possible for the court to say that an offer to buy on a discounted basis is plainly reasonable, so that the petition should be struck out.

Secondly, the value, if not agreed, should be determined by a competent expert. The offer in this case to appoint an accountant agreed by the parties or in default nominated by the President of the Institute of Chartered Accountants satisfied this requirement. One would ordinarily expect the costs of the expert to be shared but he should have the power to decide that they should be borne in some different way.

Thirdly, the offer should be to have the value determined by the expert as an expert. I do not think that the offer should provide for the full machinery of arbitration or the half-way house of an expert who gives reasons. The objective should be economy and expedition, even if this carries the possibility of a rough edge for one side or the other (and both parties in this respect take the same risk) compared with a more elaborate procedure. This is in accordance with the terms of the draft regulation recommended by the Law Commission: see Appendix C to the report.

Fourthly, the offer should, as in this case, provide for equality of arms between the parties. Both should have the same right of access to information about the company which bears upon the value of the shares and both should have the right to make submissions to the expert, though the form (written or oral) which these submissions may take should be left to the discretion of the expert himself.

Fifthly, there is the question of costs. In the present case, when the offer was made after nearly three years of litigation, it could not serve as an independent ground for dismissing the petition, on the assumption that it was otherwise well founded, without an offer of costs. But this does not mean that payment of costs need always be offered. If there is a breakdown in relations between the parties, the majority shareholder should be given a reasonable opportunity to make an offer (which may include time to explore the question of how to raise finance) before he becomes obliged to pay costs. As I have said, the unfairness does not usually consist merely in the fact of the breakdown but in failure to make a suitable offer. And the majority shareholder should have a reasonable time to make the offer before his conduct is treated as unfair. The mere fact that the petitioner has presented his petition before the offer does not mean that the respondent must offer to pay the costs if he was not given a reasonable time.

11.  Conclusion

I would allow the appeal and dismiss the petition.

LORD JAUNCEY OF TULLICHETTLE

My Lords,

I have had the advantage of reading in draft the speech prepared by my noble and learned friend, Lord Hoffmann. For the reasons he has given, I too would allow the appeal and dismiss the petition.

LORD CLYDE

My Lords,

I have had the advantage of reading in draft the speech prepared by my noble and learned friend, Lord Hoffmann. I agree with it, and for the reasons he has given I too would allow the appeal and dismiss the petition.

LORD HUTTON

My Lords,

I have had the advantage of reading in draft the speech prepared by my noble and learned friend, Lord Hoffmann. I agree with it, and for the reasons he has given I too would allow the appeal.

LORD HOBHOUSE OF WOODBOROUGH

My Lords,

I have had the advantage of reading in draft the speech prepared by my noble and learned friend, Lord Hoffmann. For the reasons he has given, I too would allow the appeal and dismiss the petition.

 
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