In (1) Donald Booth (2) Charles Robert Wilkinson (3) Jane Ann Compton v Clarence Kenneth Fredrick Booth & 9 Others [2017], the High Court held that the payment of excessive remuneration to directors amounted to unfairly prejudicial conduct where there was a policy of not paying dividends to shareholders.
Background
Donald Booth, Charles Wilkinson and Jane Compton (the Petitioners) were minority shareholders in CF Booth Limited (the Company), a company incorporated in 1949 to carry on the family scrap metal business, holding between them 27.4% of the Company. The Respondents were the majority shareholders with 65% of the shares, five of whom were also directors (the Directors). The Petitioner and the Respondents were different sides of the same family.
The Company diversified into engineering, demolition, haulage and foundry products and became one of the largest metal recycling businesses in Europe. From incorporation until 1985 substantial dividends were paid. In 1986 the Company suffered a loss and no dividends were paid. Despite the Company returning to profitability no further dividends were paid.
The non-dividend policy became a basis for animosity between the two sides of the family. In 1991 Donald Booth, one of the Petitioners, complained through his solicitors that his interests as a shareholder were being unfairly prejudiced by the no-dividend policy and by excessive Directors' remuneration. The Directors had offered to buy Mr Booth's shares but their offer was rejected by him.
In May 2012, the Directors offered to buy the shares of Charles Wilkinson and Jane Compton for £50,000. A chartered accountant, instructed by them, provided an opinion that the value of their shares was between £843,359 and £1,125,142.
Directors' remuneration until 2005 was around £275,000. It increased to £400,000 in 2005 and to £820,000 in 2006. Between 2007 and 2015 the annual average was £1,579,000.The Directors also had other benefits, including expensive motor cars and a yacht.
Petitioners' arguments
The Petitioners brought a claim under section 994 of the Companies Act 2006 that they were unfairly prejudiced by the Directors being excessively remunerated and by the no-dividend policy. The Petitioners also alleged that the no-dividend policy was intended to enable the Respondents' side of the family to acquire their shares at a favourable price, the lack of dividends having a negative effect on value and encouraging them to sell at a lower price.
Respondents' arguments
The Respondents argued that:
There had been no unfairness and that in bringing the claim the Petitioners were abusing the process of the Court. The Respondents relied on the pre-emption provisions in the Company's articles, which included transfer provisions at a fair value fixed by the auditors. Article 29 provided that a member wishing to sell must give a sale notice, which constitutes the Company the agent of the Seller for the sale of the shares to any member at the fair value. This procedure was not followed and the Respondents argued that it should have been.
The policy of not paying dividends was due to re-investing the profits in the business. It was argued that this was appropriate given the extensive working capital required for the business and the Company's large overdraft (£20 million). The Respondents therefore argued that there was no money available for distribution.
The no-dividend policy had existed for twenty five years and, whilst there was no limitation period under section 994, the claims were 'stale'.
Issues determined by the court
Was the remuneration paid to the Directors excessive?
In Irvine v Irvine [2007] the test as expressed as "whether, applying 'objective commercial criteria', the remuneration which [the respondent] took was within the bracket that executives carrying the responsibility and discharging the sort of duties that [the respondent] was, would expect to receive."
The judge, Mark Anderson QC, accepted that there was no single correct figure for reasonable remuneration and that 'reasonable remuneration' will fall within a bracket, as Blackburne J observed in Irvine v Irvine [2007]. The judge concluded that the remuneration paid to the Directors far exceeded the amount that reasonable directors could have thought fair remuneration for the work they undertook. In reaching this conclusion the judge considered evidence provided by the accountant instructed by the Petitioners and a paper published by Deloitte LLP entitled 'Directors' Remuneration in smaller companies' and median salaries in similar sized companies, both listed and non-listed.
Was the no-dividend policy fair?
The Directors control the dividend policy because the Company in general meeting may not declare a greater dividend than the Directors recommend and it was common ground that the Directors have discretion whether to recommend a distribution of profits. The judge considered paragraph 9.705 of Palmer's Company Law, which states:
"The statement that a company normally has implied power to distribute its profits to its shareholders by way of dividend does not imply that the company, while being a going concern, is bound to do so…It is at the discretion of the directors to decide what part of the profits available for distribution shall be carried to reserve, or otherwise be set aside or be carried forward, and what part shall be made 'available for dividend'."
The Respondents relied on the following passage from McCarthy Surfing [2009] (amongst other authorities):
"…the mere absence of the payment of dividends to shareholders cannot of itself constitute unfair prejudice, even if the failure to pay dividends continues for years on end…If the directors consider that no dividends should be paid for any particular period, and do so bona fide in the best interests of the company, it is not for the court to 'second guess' the directors' reasoning, or substitute its own view of what the directors ought fairly to have done."
It followed that even where there are profits available for distribution, the directors may decide not to recommend a dividend. Their decision will be impugned only if it is taken in breach of their duties, which include:
- to exercise the power to recommend or not recommend a dividend for the purposes for which the power was conferred (Companies Act 2006, s.171(b))
- to reach the conclusion (dividend or no dividend) that they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole (Companies Act 2006 s.172)
- to exercise independent judgment: (Companies Act 2006 s.173).
The Respondents submitted that the issue of whether to pay a dividend was considered by the board more than once each year, when preparing the accounts and at the AGM. On the evidence, however, the judge concluded that there was always only ever one possible answer.
The Respondents' argument that the profits were needed for the business ("cash is key in our business") was difficult to reconcile with the excessive Directors' remuneration. If there were excessive monies paid to the Directors then there should be enough to pay a dividend.
There was also evidence that the Respondents had purchased a yacht and luxury cars which the Respondents argued had a business justification, as their products were used on the yacht, which they could show to prospective customers and they used the cars to transport customers. Losses on the sale of these luxury cars far exceeded profits. The judge did not accept that this activity was, or that anyone thought it was, for the benefit of the Company. The judge concluded that the provision of these goods was inconsistent with the no-dividend policy.
The judge accepted that the Company needed cash for investment and that it did use some of its profits for that purpose. The judge also accepted that cash flow issues created the need for a large overdraft even when the Company was very profitable, and that it would have been important to the Directors to see that the overdraft was reduced. Whilst this might provide a reason for not paying dividends out of the remaining profits after the Directors' remuneration had been taken, the excessive remuneration made inevitable a finding that, in profitable years, there would have been sufficient distributable profit if that excess had not occurred. There were profits available for distribution, but they were taken by the Directors for themselves instead.
The policy which the Directors adopted of never paying dividends under any circumstances was a policy which they cannot have considered likely to promote the success of the Company for the benefit of its members as a whole. It, combined with the excessive remuneration, was a policy promoting the success of the Company for their own benefit.
Was the petition an abuse of process?
The Respondents had argued that in bringing the petition there was an abuse of process as the Petitioners had an opportunity to sell their shares under the Articles. In addition the Respondents argued that the delay in issuing proceedings was an abuse of process.
However the judge concluded that the articles committed the Petitioners to a sale at whatever price the Company's auditors deemed fair, a price which may well have reflected the no-dividend policy. Further, the auditors could have certified the fair value before the Directors made their decision whether or not to buy whereas the selling shareholders were committed. If the Petitioners established unfair prejudice, the petition could not be an abuse of process.
The Respondents further claimed that whilst there was no limitation period under section 994, stale claims were not permitted and the relevant circumstances had existed at the Company for twenty five years. The judge accepted that any remedy afforded to the Petitioners should be limited to a six year limitation period.
The judge concluded that there had been no acquiescence in the no-dividend policy. The fact that the Petitioners chose to do nothing for several years did not mean that it would be inequitable for them to complain about the failure to declare dividends in the six years leading to the issue of the petition. The Petitioners had made clear earlier that they were not in agreement with the no-dividend policy and had made clear that they thought that the policy was unfair. The petition was not an abuse on the basis that it recycled earlier complaints which had not been pursued and for complaining about matters which had existed without protest for over twenty five years
Were the petitioners unfairly prejudiced?
It was common ground that to establish a claim under section 994, both unfairness and prejudice have to be established. Conduct may be unfair without being prejudicial, and vice versa.
Unfairness usually (but not always) connotes some breach of the agreement between the shareholders and typically involves breach of the articles or of the Companies Act. Here the judge found that the Directors had not acted in accordance with their statutory duties.
The remuneration and no-dividend policies were prejudicial because the Petitioners were denied a return on their investment and the balance sheet had been diminished by the excessive remuneration. It had been unfair because the Directors had taken the Petitioners' share of the profits.
All three statutory duties referred to above were breached. Since the remuneration policy was the result of a breach of directors' duties, both it and the no-dividend policy were unfair in the relevant six year period.
Valuation and remedy
The Court held that the purchase of the Petitioners' shares was the only possible remedy. Devising a proper dividend policy would be impossible.
The Company had made losses in 2014, 2015 and 2016. A turnaround was now being achieved in 2017 and the Company was near to breaking even. In determining the date of valuation, the Court looked to the case of Profinance Trust SA v Gladstone [2002], which established the principle that an interest should be valued on the date on which it was ordered to be purchased, although in many cases fairness required the court to take another earlier date. The Respondents resisting the petition meant that the Petitioners were locked into a business which, during that period, was loss-making and hence losing value, but this should not in the circumstances result in 27.4% (their combined shareholding) of the loss being suffered by the Petitioners. The loss in value of the Petitioners' shares should be borne by the Directors or by the Company itself. The date for valuation was held to be the date of the petition.
It was just and equitable, when valuing the Petitioners' shares, that the balance sheet be adjusted to add back the excessive element of remuneration taken by the Directors in the six years to 31 July 2015. Any right to a remedy beyond that period was stale.
The Petitioners had argued that there should be no discount to the value of the shares to reflect the misconduct in not paying dividends over so many years. However this was rejected by the Court which held that the value of the shares should be discounted to reflect a minority holding in a private company, but not on any other basis. The appropriate minority discount was one third of the value of the shares as at July 2015. However, the judge was not in a position to determine the final valuation at this point.
The Respondents responsible for paying the Petitioners' fair value, when ascertained, were four of the Directors. However, if the Company was prepared to acquire the shares, after observing the required procedures, then that is what should happen.
The judge added that the conduct of the Respondents would probably justify an order to wind up the Company on the just and equitable ground were it not for the alternative and more appropriate relief available under section 994.
