AMT Coffee Limited: How The Estate of a Deceased Shareholder Can Exercise its Rights For Unfair Prejudice under s994 CA 2006

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McCallum Toppin v McCallum Toppin & Others [2019] EWHC 46 (Ch)

In common with other practitioners in this field, I have always held the view that whilst a quasi-partnership may have terminated on thedeath of a shareholder, unfairly prejudicial conduct post the death of the shareholder could be pursued under s994 of the Companies Act 2006.  Until now the only case on point was Fisher v Cadman[2005] EWHC 377 (Ch), whereby Mrs Fisher was transferred some shares in the family company by her father prior to his death and inherited other shares on his death.  The conduct of her brothers wasfound to be unfairly prejudicial and the appropriate orders were made by the Court.  As Mrs Fisher had held shares in her own right prior to inheriting additional shares on the death of her father it was unclear if the arrangements in place in a quasi-partnership would survive the death of a member.

AMT Coffee is slightly different.  This family company was set up by three brothers (Angus, Alistair and Allan) and their father Alexander McCallum Toppin and ran kiosk coffee shops principally at mainline stations.  The shares were held equally, a quarter each.  As an early entrant into the coffee market, the business expanded quickly and was profitable and successful.  Sadly, Angus died in 2006 aged just 45.  His shares were held by his estate, the executors of which were initially his wife Lucy and his brother Allan, who later retired as executor, and was replaced firstly by a solicitor and latterly by a family friend.

Allan and Alistair between them ran the company and proceeded over the intervening years to:

  • scupper a sale that was due to take place in 2007 with offers of between £15.5m and £30m from various third parties;
  • to run up huge interest free directors loan accounts, which although were initially repaid with bonuses, were latterly not repaid causing a reduction in the Company’s profits without the compensation of interest and corresponding tax implications;
  • pay themselves (and to a lesser extent their mother Anna, who had inherited their father’s shares upon his death in 2001) excessive wages, without proper director and shareholder approval; and
  • fail to pay dividends, or even consider paying dividends, depriving the Estate of income to which it would otherwise be entitled.

In addition, there was the usual poor behaviour that makes these cases such an interesting read.

Does an Estate have standing to bring a s994 Petition?

My view on this point was always that this was a minor hurdle, which could be overcome.  Principally, only a shareholder (defined by an entry on the register of shareholders) as a member of the Company could petition the Court under s994(1): “A member of a company may apply to the court by petition for an order under this part…”.

Here HHJ Matthews held that during his life, Angus had been a member of the Company.  Therefore, he would have had standing to present a petition under s994(1).  After his death, the shares were still registered in his name and his executors were not members of the Company.   However, Angus’ shares had been transmitted to them as executors by operation of law.  Therefore, the executors had standing to present a petition under s994(2): “The provisions of this Part apply to a person who is not a member of the company but to whom shares in the company have been transferred or transmitted by operation of law as they apply to a member of a company”.

The simple answer is yes, the executors of an Estate have standing under s994(2) to issue a petition under s994 CA 2006.

Can the conduct of the majority be unfairly prejudicial to the minority shareholding held by the Estate?

Director’s Loan Accounts

In this case the directors (Angus, Allan and Alistair) had all run up minor interest free loan accounts during Angus’ lifetime. These were used for personal expenditure, and at Angus’ death his loan account stood at a little under £13,000, which Allan and Alistair decided to write off rather than ask Angus’ widow, Lucy, to repay.  In contrast, by February 2009, Alistair’s loan account was £166,459 and by the end of 2015, the Company’s accounts show that between them Alistair and Allan owed the Company a total of £1,091,091.  This was a significant credit risk to the Company, because neither Alistair nor Allan had the funds to repay the amounts they owed; and it is clear they operated their loan accounts like a piggy bank to make personal expenditure on their behalf without thought of repayment.  Furthermore, the loan accounts were interest-free and had a serious impact on the Company’s cash flow, necessitating bank borrowings as the loan accounts had withdrawn capital from the Company, which would otherwise have been available to pay down debt or enable further projects.

Lucy, Angus’ widow, had no idea of the existence or scale of the loan accounts until she saw the Company’s 2015 accounts.

The Court held that operating these type of loan accounts without repayment had not been authorised or informally ratified under the Duomatic principal.  It was not in the Company’s best interests and constituted breaches of the Companies Act ss 171, 172 and 174.  Furthermore, allowing the loan accounts to exist on such a scale and for such a long period of time amounted to unfairly prejudicial conduct to the estate.

Excessive Remuneration

In addition to the interest-free loan accounts, Alistair and Allan, and to a lesser extent Anna, paid themselves excessive remuneration, which had the effect of depriving the Company of capital, which could have been used to pay dividends if this had been considered by the directors and shareholders.

Neither brother was found competent at management and had spent many of the intervening years since Angus’ death at war with each other and completely unable to work together to successfully manage the Company.

Despite the fact that neither brother was competent they both were paid six figure sums as salary.  For example, in 2008 Alistair, Allan and Anna were paid £883,711.  The estate received nothing.  Significant payments were made year in year out to Alistair, Allan and Anna until 2016, the last year considered by the Court.

In addition, Allan’s wife drew a salary for work ostensibly as Allan’s PA.  The Court held that this was a device to increase Allan’s overall payments from the Company, relieve him of the burden of supporting his wife and were subject to a reduced rate of income tax.  The Court held his wife had not carried out work of any significant value to justify the level of payment.

The Court considered whether the remuneration drawn by the respondents was authorised by the Company’s constitution.  It held Regulation 82 of Table A, incorporated into the Company’s articles of association, required remuneration paid to directors in a non-executive capacity to be fixed by the Company by ordinary resolution.  Regulation 84 of Table A required remuneration paid to directors in an executive capacity to be fixed by the board of directors.  The Court held that the remuneration was unauthorised (due to a lack of consideration at board and shareholder level) and excessive and therefore amounted to unfairly prejudicial conduct.

Dividends

Ultimately, a solvent company should be run for the benefit of all its members.  Dividends may only be lawfully paid out of the profits or other potentially distributable reserves.  The Company enjoyed for many years substantial accumulated balances on its profit and loss account and was therefore in a position to pay dividends.

The Court did not accept Allan and Alistair’s position that there was a decided policy of not distributing profits in order to concentrate on growth.  The Court found that after Angus’ death Allan and Alistair made decisions about how best to reward themselves out of profits without regard to Angus’ estate, a major shareholder without representation on the board.  Accordingly, none of the three directors made a bona fide decision not to declare dividends but all three of them failed properly to consider whether to do so.

In Re McCarthy Surfacing Ltd [2009] 1 BCLC 622, Mr Michael Furness QC found: “69… 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… The declaration of dividends is in the discretion of its directors.  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…. 70.  That is not to say that the directors’ decisions on dividends are immune from challenge.  The Court must consider whether the directors did genuinely take a decision on the payment of dividends, and must consider whether the reasons now advanced for not having done so were genuinely the rationale for the decision at the time.”

HHJ Matthews held: “143: … the failure to make a decision in good faith on this subject, when the Company (1) had sufficient reserves to declare dividends; (2) paid out large sums by way of ‘bonuses’ to two of the directors, thereby paying out significant parts of the profits to them; and (3) had lent large sums of money to those directors on loan accounts to pay personal expenditure, leaving the Company with less cash to pay dividends, amounts to conduct unfairly prejudicial to the petitioners.”

Defences

The family tried to raise a number of defences to their actions relying upon: (1) acquiescence, whilst Angus was alive and therefore continuing after his death; (2) laches (the estate took too long to bring the claim despite there being no limitation period under s. 994); (3) and the fact that Angus, and therefore his estate via Allan as executor, had knowledge and therefore consented to the actions.  The Judge gave this short shrift: “The death of Angus changed everything in the company.  Suddenly, there was a shareholder (Angus’ estate) which was not capable of playing a part in the company and indeed because of the operation of the articles of association was not entitled to vote either.  The policies which the company may follow before Angus’ death would not necessarily be the right policies to follow in the period after his death… actions taken before his death which might not then cause unfair prejudice to a member could nevertheless do so when taken after his death.  It is not right to treat Angus’ consent given before his death as though it applied in perpetuity thereafter unless positively withdrawn.  Moreover, the actions taken, such as payment of remuneration to the directors, the policy of not paying dividends, and allowing directors to operate loan accounts, are matters which arise again and again in the life of the company, not once only.”

Ultimately, there was no defence to the unfairly prejudicial actions, which were incapable of ratification.

Fair Value – or a discount for a minority shareholding?

As expected HHJ Matthews followed the principle established by Lord Hoffman in O’Neill v Philips [1996] 1 WLR 1092 and found that the shares owned by the estate should be bought out by Allan and Alistair personally for fair value without a discount for a minority shareholding.  Fair value was distinguished from market value, which the Judge thought would generally be lower as pre-emption rights would apply and would naturally implement a discount, thereby rewarding Allan and Alistair for their misconduct by allowing them to buy the estate’s shares at a discount.

The Court held it would not be right to order the Company to buy the shares, which it could have done as it had sufficient reserves, and the appropriate order would be that Allan and Alistair, who had primary responsibility for the prejudicial conduct, be ordered to buy the estate’s shares.  Anna had already asked to sell her shares prior to the judgment.  News reports following the judgment have suggested that the price of these shares could be as high as £7.5m, which Allan and Alistair would personally have to find.  A further judgment is awaited on quantum.

Conclusion

The AMT Coffee case is a fascinating insight into a SME business run by a disorganised family that spends most of its life at odds with each other.  It is surprising that in these circumstances the company managed to thrive and turn a profit.  The case highlights the lengths that some will go to to exclude the estate of their late brother and his family from their rightful income and how in practice s994 can operate in these circumstances.  Business owners would often do well to remember the childhood saying: “sharing is caring”.

Many SME directors run significant directors’ loan accounts without ever intending to repay them and often this will cause unrest amongst non-director members or problems in the event of insolvency.  The AMT Coffee case has shown that this practice can amount to unfairly prejudicial conduct.  This may particularly be so if the loan accounts are later converted to salary to avoid repayment, thereby causing the company to incur inflated PAYE and NI liabilities to HMRC.

Finally, the case clarifies the situation where a shareholder dies and the estate finds itself treated differently to the original arrangements.  Whilst HHJ Matthews was clear that in this case the quasi-partnership came to an end, this did not affect the estate’s ability to successfully claim under s994 CA 2006 and be awarded a buy out at fair value.

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