Re Saul D Harrison & Sons plc

In deciding what is fair or unfair for the purposes of s. 459, it is important to have in mind that fairness is being used in the context of a commercial relationship.^[1] The articles of association are just what their name implies: the contractual terms which govern the relationships of the shareholders with the company and each other. They determine the powers of the board and the company in general meeting and everyone who becomes a member of a company is taken to have agreed to them. Since keeping promises and honouring agreements is probably the most important element of commercial fairness, the starting point in any case under s. 459 will be to ask whether the conduct of which the shareholder complains was in accordance with the articles of association.

The answer to this question often turns on the fact that the powers which the shareholders have entrusted to the board are fiduciary powers, which must be exercised for the benefit of the company as a whole. If the board act for some ulterior purpose, they step outside the terms of the bargain between the shareholders and the company. As a matter of ordinary company law, this may or may not entitle the individual shareholder to a remedy. It depends upon whether he can bring himself within one of the exceptions to the rule in Foss v. Harbottle (1843) 2 Hare 461. But the fact that the board are protected by the principle of majority rule does not necessarily prevent their conduct from being unfair within the meaning of s. 459. Enabling the court in an appropriate case to outflank the rule in Foss v Harbottle was one of the purposes of the section. So in Re a Company No. 00370 of 1987 (1988) 4 BCC 506, where the complaint was of a consistent refusal by the board to recommend payment of a dividend, Harman J said that such conduct could make it just and equitable to wind up the company. He did so by reference to the seminal judgment of Lord Wilberforce in Howard Smith Ltd v. Ampol Petroleum Ltd [1974] AC 821 on the principles by which the court decides whether the board has acted within its fiduciary powers and said that on the facts alleged it was arguable that the board had exceeded them. This seems to me in principle the correct point at which to start the inquiry into both whether the conduct in question could justify a just and equitable winding up and also whether it is unfair for the purposes of s. 459. It seems clear that but for a technical objection which was removed when the section was amended in 1989, Harman J would have allowed the petition to proceed on both grounds, as Peter Gibson J did before the amendment in Re Sam Weller & Sons Ltd [1989] 5 BCC 810. I should however add that while I respectfully think that Harman J was right in asking himself whether the board had abused its fiduciary powers, I would not necessarily subscribe to the theory of corporate hubris on which he decided that it arguably had.

Although one begins with the articles and the powers of the board, a finding that conduct was not in accordance with the articles does not necessarily mean that it was unfair, still less that the court will exercise its discretion to grant relief. There is often sound sense in the rule in Foss v. Harbottle. In choosing the term 'unfairly prejudicial', the Jenkins Committee (at para. 204) equated it with Lord Cooper's understanding of 'oppression' in Elder v. Elder & Watson 1952 SC 49 at p. 55: 'a visible departure from the standards of fair dealing, and a violation of the conditions of fair play on which every shareholder who entrusts his money to a company is entitled to rely.' So trivial or technical infringements of the articles were not intended to give rise to petitions under s. 459.

Not only may conduct be technically unlawful without being unfair: it can also be unfair without being unlawful. In a commercial context, this may at first seem surprising. How can it be unfair to act in accordance with what the parties have agreed? As a general rule, it is not. But there are cases in which the letter of the articles does not fully reflect the understandings upon which the shareholders are associated. Lord Wilberforce drew attention to such cases in a celebrated passage of his judgment in Re Westbourne Galleries [1973] AC 360 at p. 379B which discusses what seems to me the identical concept of injustice or unfairness which can form the basis of a just and equitable winding up:

'The words [just and equitable] are a recognition of the fact that a limited company is more than a mere legal entity, with a personality in law of its own: that there is room in company law for recognition of the fact that behind it, or amongst it, there are individuals, with rights, expectations and obligations inter se which are not necessarily submerged in the company structure. That structure is defined by the Companies Act and by the articles of association by which the shareholders agree to be bound. In most companies and in most contexts, this definition is sufficient and exhaustive, equally so whether the company is large or small. The "just and equitable" provision does not, as the respondents suggest, entitle one party to disregard the obligation he assumes by entering a company, nor the court to dispense him from it. It does, as equity always does, enable the court to subject the exercise of legal rights to equitable considerations; considerations, that is, of a personal character arising between one individual and another, which may make it unjust, or inequitable, to insist on legal rights or to exercise them in a particular way.'

Thus the personal relationship between a shareholder and those who control the company may entitle him to say that it would in certain circumstances be unfair for them to exercise a power conferred by the articles upon the board or the company in general meeting. I have in the past ventured to borrow from public law the term 'legitimate expectation' to describe the correlative 'right' in the shareholder to which such a relationship may give rise. It often arises out of a fundamental understanding between the shareholders which formed the basis of their association but was not put into contractual form, such as an assumption that each of the parties who has ventured his capital will also participate in the management of the company and receive the return on his investment in the form of salary rather than dividend. These relationships need not always take the form of implied agreements with the shareholder concerned; they could enure for the benefit of a third party such as a joint venturer's widow. But in Re Westbourne Galleries Lord Wilberforce went on to say:

'It would be impossible, and wholly undesirable, to define the circumstances in which these considerations may arise. Certainly the fact that the company is a small one, or a private company, is not enough. There are very many of these where the association is a purely commercial one, of which it can safely be said that the basis of association is adequately and exhaustively laid down in the articles. The superimposition of equitable considerations requires something more...' Thus in the absence of 'something more', there is no basis for a legitimate expectation that the board and the company in general meeting will not exercise whatever powers they are given by the articles of association.

In this case, as the judge emphasised, there is nothing more. The petitioner was given her shares in 1960 pursuant to a reorganisation of the share capital which vested the entire control of the company in the A shareholders and the board whom they appointed. This scheme is binding upon her and there are no special circumstances to modify its effects. Although the petition speaks of the petitioner having various 'legitimate expectations', no grounds are alleged for saying that her rights are not 'adequately and exhaustively' laid down by the articles. And in substance the alleged 'legitimate expectations' amount to no more than an expectation that the board would manage the company in accordance with their fiduciary obligations and the terms of the articles and the Companies Act. Thus it seems to me that in this case one can be a good deal more precise than to ask in general terms, as Mr Purle suggested, whether a bystander would think that the board had been unfair. As there are no grounds for saying that it would be unfair for the board to act in accordance with the bargain between the petitioner and the company, the very minimum required to make out a case of unfairness is that the powers of management have been used for an unlawful purpose or the articles otherwise infringed. Hence the allegation in the petition that the board acted in bad faith, carrying on the business in order to provide themselves with salaries rather than because they genuinely thought that it was in the interests of the shareholders as a whole.

Mr Purle said that it was not necessary for this purpose that the petitioner should have to show that the board was motivated by self-interest. It would be sufficient that the decision to continue the business was irrational: one which no reasonable board of rational businessmen could have thought was in the interests of the company. There may be cases in which this distinction makes some sense but in this one it does not. If no rational board could honestly have thought that carrying on the business was in the interests of the company, the conclusion must inevitably follow that the board acted from some improper motive of their own. The petition recognises this and squarely alleges bad faith. In my judgment the claims for relief under s. 459 and winding up stand or fall by whether this allegation can be made out.

(4) The application to strike out

The respondents applied to strike out the petition under RSC, O. 18, r. 19 and the court's inherent jurisdiction on the grounds that it disclosed no cause of action or was frivolous, vexatious or otherwise an abuse of the process of the court. The first ground was not seriously pursued: the allegations of bad faith on the part of the directors and A shareholders plainly disclosed a cause of action. The real attack was that the petition was an abuse of process because the incontrovertible facts showed that the allegations of bad faith could not succeed and that without them the petition was bound to fail.

The petition largely confined itself to the general allegations which I have summarised and did not go into detail. This is in accordance with the modern practice, by which after service of the petition there is a return day at which the registrar gives directions for the filing of evidence and, if appropriate, the delivery of particulars of claim and defence: see r. 5 of the Companies (Unfair Prejudice Applications) Proceedings Rules 1986 (SI 1986/2000) and r. 4.22(3) of the Insolvency Rules 1986 (SI 1986/1925). The result was that the first statement in any detail of the facts concerning the company's business came in the affidavit of Mr Alan Harrison, chairman of the company, in his affidavit in support of the application to strike out. A full statement of the petitioner's case emerged from the evidence sworn in answer and depended almost entirely upon the expert opinion of Mr Simmons, a chartered accountant who had examined the company's financial statements. Further exchanges of evidence followed and the judge gave his decision on 9 March 1992. In this court leave was given to both sides to adduce further evidence exhibiting financial statements which have since come into existence.

Mr Purle reminded us that the court's power to strike out a petition under RSC, O. 18, r. 19 or the inherent jurisdiction should be exercised only in a plain and obvious case. He referred us to a well-known passage in the judgment of Danckwerts LJ in Wenlock v Moloney [1965] 1 WLR 1238 at p. 1244B:

'... this summary jurisdiction of the court was never intended to be exercised by a minute and protracted examination of the documents and facts of the case, in order to see whether the plaintiff really has a cause of action. To do this is to usurp the position of the trial judge, and to produce a trial of the case in chambers on affidavits only, without discovery and without oral evidence tested by cross-examination in the ordinary way.'

I entirely accept that the court cannot ordinarily resolve disputes of fact on affidavit and I agree with Mr Purle that the filing of an affidavit in reply by the applicant (as happened in this case) is usually a symptom of the existence of issues which can be resolved only at a trial. In this case, however, the primary facts concerning the company's history and financial performance are not in any serious dispute. The question is whether those facts could arguably support an inference that the directors had abused their powers.

Mr Purle said that similar questions of inference as to motives arose in Cayne v Global Natural Resources plc [1984] 1 All ER 225 where the court was concerned with whether the company's board had agreed to issue shares for the improper purpose of maintaining itself in office. Eveleigh LJ said at p. 230c:

'The plaintiffs' evidence, as I have said, clearly pointed to the inference which they asked the court to draw. Global's evidence, if true and accepted, of course clearly destroyed that inference. But the great question that has to be determined is whether the defendants' case is accepted or not. The mere fact it is deposed to does not make it incontrovertible. Therefore, when the evidence is not accepted by the plaintiffs, I am left in doubt as to the outcome of the trial on that issue.' Kerr LJ said at p. 236d:

'Admittedly, the plaintiffs have strong inferences about the defendants' real motives on their side. There are considerable grounds for suspicion. But Global has strong evidence on oath on its side, and, when this is read together with the exhibits, it is quite clear that Global has a fully arguable case, which it is entitled to have tested on its merits at a full trial.' So Mr Purle said that in this case, the board's denial of improper motive could not be regarded as conclusive. It was not accepted by the petitioner and the issue could therefore be determined only after discovery and cross-examination at the trial.

I do not think it is very useful to reason from what was said about the facts of another case. Clearly in Cayne the court thought that the plaintiffs had a strong prima facie case, considerable grounds for suspicion. There was a case to answer. But the question in this case is whether on the evidence taken as a whole and assuming in favour of the petitioner any disputed questions of primary fact, there is any case to answer. Of course it is always possible that discovery and cross-examination may produce some written or oral confession that the board were indeed acting in bad faith. But I do not think that the petition can be allowed to proceed to trial simply in the hope that something may turn up.

In exercising his discretion to strike out the petition, the judge referred to the damaging effect of the presentation of a petition under s. 459 and the burdensome nature of the proceedings, which may involve a lengthy and detailed investigation of the company over a long period. Mr Purle said that this was not a proper consideration to take into account. If the petitioner had a statutory cause of action, she was entitled to have it tried, whatever the consequences for the company.

I accept that the notoriously burdensome nature of s. 459 proceedings does not lighten the burden on the respondent who applies to have the petition struck out. He must still satisfy the court that the petitioner's case is plainly and obviously unsustainable. But I think that the consequences for the company mean that a court should be willing to scrutinise with care the allegations in a s. 459 petition and, if necessary, the evidence proposed to be adduced in support, in order to see whether the petitioner really does have an arguable case. This is particularly so when the petition rests on allegations of bad faith akin to fraud: see Sir George Jessel MR in Re Rica Gold Washing Co (1879) 11 ChD 36.

(5) The primary facts

The judge had audited accounts for the years ending 31 March 1986-1991 and unaudited management accounts for the six months to 30 September 1991. The supplementary evidence consists of the audited accounts for the years ended 31 March 1992 and 1993. Mr Simmons makes certain criticisms of the accounting methods but there is no challenge to the underlying financial facts which the accounts reveal. For convenience I shall summarise in tabular form the essential primary information disclosed by the accounts for the years ending 31 March 1986-1993.

The petitioner's case before the judge was that the company's trading activities had made losses in every year since 1986. It had in some years reduced those losses and in others converted them into a net profit only because it had 'other operating income' which consisted principally of rent from letting part of its premises and investment income. But this income would accrue to the company whether or not it continued to trade. The company's trade showed steadily declining gross margins and nothing to suggest that they were likely to recover. Furthermore, the accounts did not charge against profits a commercial rent for the premises which the company owned and occupied. In assessing the viability of the business, one should take into account the opportunity cost of not letting the premises to someone else or selling them and investing the proceeds. On this basis the company's business was wholly uneconomic. In the light of these facts, the petitioner said that the proposed compulsory purchase of the Stronghold Works had been an ideal opportunity to cease trading.

(a) Changes in the company's business

The company's financial record must however be seen in the light of other facts deposed to by the respondents and not challenged by the petitioner. Until their deaths in 1987, Lionel Harrison (the founder's last surviving son) and his nephew Seymour (son of the founder's eldest son Alfred) had been the senior directors. Upon their deaths, Lionel's son Alan (who had previously been a director) became chairman and his son Stephen and cousin David (both young men) were appointed to the board. In his affidavit in reply sworn in January 1992, Mr Alan Harrison said that there had been a change of emphasis in the company's business. The original business of manufacturing industrial cleaning and wiping cloths from waste textiles now constituted only 35 per cent of turnover. It was exceeded by the sale of Johnson & Johnson J-Cloths, which accounted for 36 per cent. Of the remaining business, 23 per cent arose from export sales of second-hand clothing and six per cent from the sale of paper and ancillary wiping products. The most expanding part of the business was the J-Cloths, sales of which had increased from £709,000 in 1988-9 to £1.3m in 1990-1 and were forecast to reach £1.6m in 1991-2. Alan gave reasons why the directors were optimistic about this side of the business although it was highly competitive and margins were relatively low. He said that in his view the company's business was viable and capable of expansion. He produced management accounts for the six months to 30 September 1991 which showed an increased turnover and a trading profit of £13,745 without taking into account compensation for disturbance which was due to be paid by London Regional Transport.

(b) Gross profit margins

Mr Alan Harrison also pointed out that the decline in gross profits over the period 1988-1991 had not been as steep as the figures in the table would suggest. In each of the years 1988-1990 there had been changes in accounting practice by which costs previously taken 'below the line' were treated as costs of sales and deducted from gross profits. This had led in each year to a restatement of the previous year's gross profit, so that for example in 1990 the previous year's figure of £535,000 had for purposes of comparison been restated as £492,000, which would produce a gross profit margin of 18 per cent for that year's as against 19 per cent in 1991. Similar adjustments had to be made to earlier figures. Mr Harrison also said that the overall gross profit margin had been affected by the changes in the sales mix. The expanding sectors such as the J-Cloths and clothing had lower margins than the manufactured rags.

(c) The move to Hackney

Mr Harrison also explained what had happened when the company moved to Hackney. The Stronghold Works was an outdated building which had value only as a site for redevelopment. But in 1990 the value of redevelopment sites in London was notoriously on the slide. When the Jubilee Line extension proposals were announced, the company faced a potentially lengthy period of uncertainty while it waited to see whether the bill passed and then whether London Regional Transport would obtain the money to carry out the scheme. No one could predict when the compulsory purchase powers would be exercised or what the value of the site would then be. The board therefore decided to petition against the bill as a negotiating tactic with a view to securing an early agreement with London Regional Transport. The outcome was the agreed sale of the Stronghold Works, but the contract shows that it was a condition of that sale that the company should have acquired new premises into which it would move. Mr Harrison said that London Regional Transport made it clear that they had power to buy the premises in advance of the passage of the bill only in order to enable the company to relocate its business. If the company had decided to cease trading, it would have had to wait for the compulsory purchase powers to be exercised. The premises could not have been sold because they were blighted by the Jubilee Line proposals.

The terms of relocation are accepted to have been very favorable. The company acquired new premises for the same price as it sold the old ones and London Regional Transport paid the cost of fitting them out and compensation for disturbance. It also allowed the company nine months' free occupation of the old premises to enable the move to take place without pressure. Mr Harrison says that throughout the transaction the company was advised by various professionals such as surveyors, management consultants, accountants and solicitors. As a result, said Mr Harrison in January 1992, the company had newly equipped and modern premises in which it could expand its business. The petitioner's solicitor Ms Paradise says on affidavit that she does not accept that London Regional Transport would not have bought the premises for just as much even if the company had decided to cease trading. Nor does she accept that it would not have been better to wait for the compulsory purchase to go through. But these are simply expressions of opinion which do not challenge the underlying facts or offer any additional evidence to support the allegation that the board was motivated by self-interest. Where the respondents have offered such explanations, it cannot be sufficient for a petitioner simply to say that she does not accept them and wants to cross-examine.

(d) The employees

The importance of having regard not only to the petitioner's allegations but also to the primary and unchallenged facts put in evidence by the respondent is shown very clearly by the evidence about the company's employees. Mr Alan Harrison said that one of the matters which the board took into account was the interests of the company's employees. This is a matter to which they are required to have regard by s. 309 of the Companies Act 1985. Ms Paradise dismissed this claim with the sentence: 'I am informed by the petitioner and verify believe that almost all the employees, except for the directors, are very badly paid and rarely start with the company for any significant period of time.' In answer, Mr Alan Harrison went into some detail about the employees. There were over 100. The average length of service of the sales staff was over 22 years and that of the 30 labourers, textile cutters and graders over nine years. Some of the labourers were educationally sub-normal and would find it difficult to get other jobs. They were paid in excess of the Wages Council recommendation. In reply, Ms Paradise said that she 'did not accept' this evidence. But in my view this is not good enough and highlights the way in which the petitioner's case has been presented.

(e) The directors' remuneration

The allegation is that the directors have preferred their interests as salary earners to the interests of the shareholders. One is however bound to observe that the two younger directors have between them 109,454 C shares to the 87,563 held by the petitioner and that the siblings of the younger directors have 197,018 more. While this does not remove the possibility that they may be deliberately prejudicing their own interests as shareholders, it makes such an inference rather less plausible. When one turns to the salaries they earn, the inference is even less plausible. In the year to 31 March 1990 Mr Alan Harrison as chairman was paid £46,890 and the two younger directors £26,250 each. In the case of Mr Alan Harrison and Mr David Harrison, a part of their earnings was paid in the form of a salary to their wives. It is said that the wives rendered no services for this salary or for the modest cars which they were also allowed at the company's expense. This is a common enough practice in small companies and may or may not pass muster with the Inland Revenue. But given the scale of the overall earnings in relation to a company employing 100 people with a turnover of over £3m a year, the payment to the wives does not being to form the basis of a claim of unfairly prejudicial conduct. The same can be said of the other subsidiary complaints made in the petition which the judge rightly dismissed as of no account.

(6)Conclusion

Looking at the matter in March 1992, six months after the company had moved into its new premises in Hackney, the judge said that the petition was 'at the very lowest' (by which I think he meant 'at best') premature. He said (at p. 484) that in the light of the evidence it was: 'simply perverse to allege that the board have carried on the business with no or no substantial expectation that they will succeed in making a profit reflecting the value of the assets employed and only with a view to furthering their own interests in preference to the interests of the company and its shareholders ... The major change has just taken place. In time no doubt the directors will have to revise the position and the future profitability of the company but that time has not arrived.' I agree. It follows that the petition as presented was on the evidence before the judge an abuse of process and was rightly struck out.

(7) Postscript

Is this conclusion affected by the evidence of subsequent events? The latest financial statements put before the judge were, as I have mentioned, the management accounts for the six months ended 30 September 1991. Since then, the audited accounts for the year to 31 March 1992 have become available and these showed, as appears from the table, a trading profit of £40,000 and a net profit of £71,000. Mr Simmons has criticised these accounts and explained why in his view they should be restated to show a trading loss of £199,914. For example, he says that £66,262 received from London Regional Transport should be excluded, even though the money was compensation for loss of profit caused by disturbance. I do not propose to debate the accounting niceties because I do not think that they matter. The issue is whether the directors acted improperly in carrying on the business and for this purpose they must in my opinion have been entitled to rely upon their audited accounts.

Finally, the accounts for the year ended 31 March 1993 show that that year was a financial disaster. Mr Simmons says that this only confirms the predictions he was making earlier, as reported by Ms Paradise. It may indeed show that Mr Simmons was better at predicting the future than the board. But it does not retrospectively cast doubt upon the motives of the board in carrying on the business in earlier years. It has led to the reappraisal which Vinelott J predicted. The company has ceased the manufacture of industrial wiping rags and is concentrating on its other forms of trade. Mr Alan Harrison has retired with effect from 31 January 1994 and Mr David Harrison has given up his employment with the company and become a non-executive director. In other words, the members of the board appear to have responded to the crisis and taken what they considered to be appropriate measures. There is nothing to show that the board have acted unfairly in relation to the petitioner. I would dismiss the appeal."