Re Woven Rugs Limited

The petition under s.994 Companies Act 2006 (re‑enacting s.459 Companies Act 1985) succeeded. The court found that the director Mr Vaqar Ahmed Malik, acting for and in control of Al‑Malik Carpets (Private) Limited (AMC), caused the company to be refinanced in 2005 and applied the proceeds in ways that preferred AMC and Mr Malik over the company and the 40% shareholders (the Sharafi brothers). That conduct breached fiduciary duties and amounted to conduct of the company's affairs that was unfairly prejudicial to the petitioners as members.

The court held that repayment in 2005 of £202,000 to AMC, a later payment of £75,000 to AMC, payments of remuneration and management charges to AMC and Mr Malik, the concealment of the refinancing by delaying accounts and avoiding annual general meetings, and the failure to enforce rent against AMC were all material to the finding of unfair prejudice. The court rejected the defendants' account of a genuine trading arrangement and their defence that a binding compromise had been reached in February/March 2007.

As remedy, the court indicated it would order AMC and Mr Malik jointly and severally to purchase the petitioners' shares at a valuation date of 19 July 2005 and to pay the petitioners' loan to the company, with interest, and invited submissions as to the precise terms and rate of interest.

Background and parties: Petitioners Mohammed Mehdi Sharafi and Amir Hossein Sharafi (together trading as Sharafi & Co) held 40% of the shares in Woven Rugs Limited; AMC and Mr Malik held 60%. The petition was presented to the Companies Court alleging unfairly prejudicial conduct under s.994 Companies Act 2006 (previously s.459 Companies Act 1985).

Nature of the application: Relief under s.994 was sought. The petition originally sought a winding‑up order but was amended to seek relief under the statutory unfair prejudice provisions. The central complaint was that a 2005 refinancing and the application of the proceeds were designed to extract funds for the benefit of AMC and Mr Malik, to the detriment of the petitioners.

Key factual findings:

• The parties had long shared premises and had repeatedly operated cost and compensation arrangements on an agreed 60:40 basis (AMC:Sharafis); the company had been used to acquire Unit 10 because the bank required a clean company.
• The court rejected a late assertion by Mr Malik that his mother‑in‑law was the beneficial owner of AMC and found Mr Malik to be the effective controller and principal beneficial owner of AMC.
• In August 2005 the company entered a new loan of £620,000 without informing the Sharafis. £202,000 of the proceeds was used to repay AMC, replacing interest‑free subordinated shareholder loans with secured, interest‑bearing bank debt.
• A further £75,000 was paid to AMC in December 2005. The court rejected the respondents' account that this was a legitimate advance for rug supply and found that the documentation and oral evidence were not credible.
• Payments of remuneration to Mr Malik, management charges to AMC and payments to the company secretary were made without adequate scrutiny or proper authority and in breach of earlier understandings.
• Material accounts and annual general meeting procedures were delayed or improperly dispensed with; the court found attempts to conceal the refinancing and payments from the petitioners.
• The respondents’ contention that a binding compromise was made in February/March 2007 was rejected: the meeting produced a without‑prejudice note and subsequent correspondence and drafts showed that no concluded agreement was reached.

Issues framed by the court:

• Whether the 2005 refinancing and application of funds amounted to unfairly prejudicial conduct in breach of directors' fiduciary duties.
• Whether the payments to AMC and to Mr Malik were justifiable commercial actions for the benefit of the company or improper preferences and misappropriations.
• Whether a binding compromise had been concluded at the without‑prejudice meeting of February/March 2007.

Court's reasoning: The court applied the statutory test in s.994 and the principles in O'Neill v Phillips, finding that Mr Malik, as director and controller of AMC, had exercised powers to refinance the company and extract value in a manner that conferred no bona fide benefit upon the company and preferred AMC and himself to the petitioners. The replacement of subordinated, interest‑free shareholder loans by secured bank debt and the unexplained payments were not shown to be for the company's benefit. The court also found deliberate concealment by withholding accounts, failing to call general meetings and filing abbreviated accounts late. The respondents’ explanations, including the alleged trading arrangement and the asserted binding settlement, were disbelieved or found insufficient.

Relief and disposition: The court concluded that orders under s.996 were appropriate to remedy the unfair prejudice. It proposed an order that AMC and Mr Malik purchase the petitioners’ shares, valuing them as at 19 July 2005, and pay the petitioners’ loan to the company, together with interest. The court invited submissions on precise terms and interest rate. The earlier removal of Mr Mehdi Sharafi as director was held to have been potentially wrongful but too remote in time to be relied upon as a standalone ground.

First instance: the petition under s.994 Companies Act 2006 succeeds. The court held that Mr Vaqar Ahmed Malik and Al‑Malik Carpets (Private) Limited committed breaches of fiduciary duty and engaged in conduct of the company’s affairs that was unfairly prejudicial to the petitioners. The court directed that AMC and Mr Malik be ordered jointly and severally to purchase the petitioners’ shares, valuing them as at 19 July 2005, and to pay the petitioners’ loan to the company with interest, and invited submissions as to the precise terms and rate of interest.