Sharafi & Anor v Woven Rugs Ltd & Ors

Relief for unfair prejudice may be granted where directors use a company’s assets and borrowing powers to prefer one shareholder’s interests over those of the company and other members. A transaction may be lawful in itself yet still be an improper exercise of fiduciary powers. The court may consider the parties’ arrangements and understandings, including the company’s agreed purpose, when assessing unfair prejudice. Concealment, failure to provide accounts, and failure to pursue debts may form part of the unfairly prejudicial conduct. Under Companies Act 2006, s.996, the court has a broad discretion to order a buy-out and may select an earlier valuation date where necessary to compensate the petitioners for the effect of the misconduct.

The petitioners held 40 per cent of Woven Rugs Ltd, with the respondents holding or controlling the remaining interest. The company had been established to acquire, hold and lease commercial premises occupied by the parties’ businesses. The petitioners alleged that the respondents caused the company to refinance its borrowing, repay debt owed to the majority shareholder, make further payments to that shareholder and its controller, fail to recover rent, and conceal the transactions. They sought relief under s.994 of the Companies Act 2006. The respondents denied unfair prejudice and relied on an alleged compromise agreement. The central issue was whether the refinancing and subsequent conduct constituted unfairly prejudicial conduct of the company’s affairs.

1. The petitioners established unfairly prejudicial conduct and were entitled to relief under ss.994 and 996 of the Companies Act 2006.

2. The company had been used pursuant to an arrangement or understanding that its purpose was to acquire, hold and lease Unit 10, with the parties contributing rent and outgoings in 60:40 proportions and participating in management through board representation. The removal of the petitioners’ director breached that understanding, but the petitioners had acquiesced in it for too long for it alone to found relief.

3. The 2005 refinancing was commercially unjustifiable. It replaced interest-free, subordinated debt owed to both sides with secured, interest-bearing bank debt and used the proceeds to repay the majority shareholder. The transaction benefited that shareholder at the expense of the company and the petitioners. It was a breach of the director’s fiduciary duties and unfairly prejudicial conduct.

4. The further payment of £75,000 to the majority shareholder was a misappropriation. The asserted rug-supply arrangement was not genuine and, even if genuine, was so commercially one-sided that it would have breached the director’s duties. Unjustified remuneration and management charges also formed part of the unfair prejudice.

5. Failure to provide financial information, delay in preparing accounts, failure to hold annual general meetings and the ineffective elective resolution were statutory breaches and part of a deliberate attempt to conceal the refinancing and payments. The failure to demand rent from the majority shareholder was also a breach of fiduciary duty and unfairly prejudicial.

6. No binding compromise agreement had been concluded. The signed note, subsequent without-prejudice correspondence and proposed formal agreement showed that the parties remained subject to agreement.

7. The court ordered the respondents jointly and severally to purchase the petitioners’ shares, valued as at 19 July 2005, and to repay jointly and severally the petitioners’ £132,000 loan to the company, with interest. The company’s administration did not prevent a buy-out order.