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Commercial Write - Summer 2011

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It is no coincidence that successful companies have harmony at both board and shareholder level.

In our experience the most common causes of dispute at board and shareholder level arise in relation to:

• a company's strategy;
• the level and mix of dividends and remuneration;
• lack of working capital;
• disproportionate contributions of money and/or time;
• conflicts as between the company and other businesses owned by one of the shareholders and/or directors;
• power struggles and poor personal relationships;
• concerns as to whether the board is meeting its legal responsibilities;
• a change in the personal circumstances of one of the parties.

Invariably, individuals involved in a company will face differences of opinion be it at board or shareholder level.

Indeed, it is often crucial to the smooth and efficient running of the company that each party's varying views are aired, given due consideration and then decisions made swiftly. However, there are occasions when disputes can arise and it is normally paramount that any disputes are dealt with efficiently and conclusively.

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It is preferable to minimise the likelihood of any dispute between the directors and/or shareholders and there are several ways of doing this. The main way is by having a shareholders' agreement and tailored articles of association (see below). These will clearly set out the expectations, rights, responsibilities and obligations of all the relevant stakeholders and will also normally provide a framework for resolving disputes.

It is always open to the parties to resolve their dispute by mutual consent, perhaps by mediation. If this does not succeed, then it will be necessary to enforce any relevant provisions of a shareholders' agreement and the company's articles of association.

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If there is no shareholders’ agreement or specific constitutional arrangement in place, then often the only way to resolve a dispute is to consider the use of statutory shareholder remedies.

The "just and equitable" winding-up remedy
Under the Insolvency Act 1986 a company may be wound up by the courts if "the court is of the opinion that it is just and equitable that the company should be wound up". A petition can be presented by a shareholder, creditor, director or even the company itself.

As the only action the court may take under such a petition is to wind up the company, it will often be more prudent to seek an alternative remedy that will cure rather than kill. If the court considers that there is a suitable alternative remedy and that the person bringing the application is acting unreasonably, it will refuse such a winding-up order.

This remedy tends to be more useful where the physical net assets of a company have high value relative to the value of a company if it were sold as a going concern. It therefore might be a useful remedy to pursue if a
shareholder in a property or farming business wants to realise his/her investment.

A derivative claim
A derivative claim is a claim brought by a shareholder in the name of a company against a director in respect of an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust on his part. No such claim can be brought unless the court gives a shareholder leave to bring such a claim in the name of the company. A court can make an order requiring the director against whom a breach of duty has been established to pay compensation or restitution to his company. Derivative claims can only benefit a company directly.

If a shareholder's main complaint is that a company is being mismanaged, the courts have said that the remedy of protection from unfair prejudice is more appropriate.

Protection of shareholders against unfair prejudice
The Companies Act 2006 provides that "a member of a company may apply to the court ... for an order... on the ground (a) that the company's affairs are being or have been conducted in a manner that is unfairly prejudicial to the interests of members generally or of some part of its members (including at least himself), or (b) that an actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial".

The alleged prejudice will be regarded as unfair if a hypothetical bystander would believe it to be unfair. The courts will look at the terms of any shareholders' agreement and the articles of association in considering fairness.

Once conduct has been demonstrated to be unfair, the petitioning shareholder must then show that the conduct complained of results in their interest as a shareholder being prejudiced. The most common examples of prejudice are the failure of the company to make payment of a dividend, unjustified bonus payments, diversion of business to another company in which the majority shareholder holds a greater interest and exclusion from management decisions.

If a court is satisfied that the claim of unfair prejudice is well-founded, it may make such order as it thinks fit for giving relief of the matters complained of. This may include:

• a requirement that the company refrains from doing or continuing the act complained of or to do an act that the petitioner has complained that it has omitted to do;
• authorisation of civil proceedings to be brought in the name of or on behalf of the company by such persons and on such terms as the court may direct;
• the purchase of the shares of any members of the company (including that of the person who has been subject to the unfair prejudice) by other members or by the company itself. In practice, this is the most common remedy awarded.

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Statutory remedies can be expensive as they all involve litigating matters in court. Decisions made by a court are often unsatisfactory to all parties concerned and much time and expense can be wasted as a result.

It is therefore often more sensible to cater for any likely disputes by having an appropriate shareholders' agreement complemented by tailored articles of association.

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As prevention is always better than cure, a well-organised company should have a good, relevant and robust shareholders' agreement and suitable articles of association. A shareholders' agreement will deal not only with resolution of a dispute (for example, referring the matter to an independent expert) but may also regulate other issues, such as general conduct of the company’s affairs at board and shareholder level, setting out an agreed dividend policy and any restrictive covenants to be placed on the shareholders.

Companies ideally suited for shareholders' agreements are typically SMEs with up to 10 shareholders where the
majority of the members of the company are also directors or have appointed directors on their behalf. One of the principal benefits of shareholders' agreements is the ability to include provisions that would otherwise be unenforceable if contained in the company's articles of association.

A good shareholders' agreement and complementary articles of association should normally deal with the establishment of the company, the operation of the company once established and arrangements for individual or general shareholder exits. Provisions included in such documents typically include:

• funding arrangements;
• an agreement on the business/venture to be operated together with arrangements concerning the company's business plan and annual budget;
• setting specified levels of board/shareholder consent for certain reserved issues;
• granting certain rights (for example, to dividends and voting) to different classes of shares;
• pre-emption rights and procedures in relation to the issue and transfer of shares (including circumstances in which shareholders must offer shares to other shareholders based on an agreed valuation mechanism - often a distinction is made when valuing shares depending on whether a shareholder is a good or a bad leaver);
• arrangements for the giving of guarantees;
• provisions dealing with general shareholder exits including tag-along and drag-along rights (these allow a majority to force an exit and a minority to participate in an exit by a majority).

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Recent case law has scrutinised whether limitation of liability clauses can exclude the possibility of recovering certain types of losses.

Where there has been a breach of contract and a party suffers loss or damage, the loss or damage is recoverable, provided it is not too remote. Historic case law has established that losses falling into the following two categories will be recoverable:

• loss arising naturally from a breach, (direct loss); and
• loss that is in the contemplation of both parties at the time they made the contract, also known as special knowledge loss (indirect/consequential loss).

Traditionally, it is the second category of loss that parties to a business-to-business contract will try to normally limit and/or exclude in contracts. However, following the recent Court of Appeal case of GB Gas Holdings v Accenture (UK) Limited and others (2010), also known as Centrica v Accenture, businesses need to review, consider and most likely amend these standard exclusion clauses in their contracts. Accenture agreed to design, supply, install and maintain a new IT system (which included a billing system).

Shortly after work began on the system, problems arose between the parties, resulting in Centrica taking over
completion of the final stages of the project itself. By the time the billing system was operational, substantial
problems had emerged with it, including:

• millions of customers being undercharged, overcharged or simply not charged at all; and
• Centrica having to raise thousands of invoices manually resulting in a large backlog of workload.

Centrica sued Accenture for damages and was successful in recovering the following losses (despite the contract containing an exclusion clause excluding consequential loss):

• £18.7 million in gas distribution charges overpaid by Centrica to wholesale gas distributors due to overestimates of gas usage as a result of a lack of automated meter readings;
• £8 million in ex gratia payments made to customers in an attempt by Centrica to limit damage to its reputation;
• £2 million in additional borrowing charges as Centrica incurred additional borrowings due to late billing or non-billing of customers;
• Over £300,000 in costs wasted in trying to enforce debts that weren't actually due;
• Over £100,000 in stationery and correspondence costs.

The Court's view was that the losses referred to above were direct losses and not indirect consequential losses
and were therefore not excluded by the general exclusion of consequential/indirect losses within the Accenture contract. For example, the compensation payments to customers were treated as a direct loss because the Court found that Centrica had intended the billing system to improve its services and customer relations and therefore the failures with the billing systems had damaged this and Accenture had assumed responsibility for such failures (which in turn included responsibility for payment of compensation to ensure good customer relations). The gas distribution charges were found not to be indirect losses (although they were dependent upon contracts between Centrica and its suppliers, which Accenture was not a party to), as such charges arose directly from Accenture's breach and not as a result of any special arrangements between Centrica and its suppliers. Also, although the exclusion of liability clause did set out a list of various losses that the parties would not be liable for the Court did not think these had been specifically tailored to the circumstances surrounding the contract.

This case highlights that the distinction between "direct" and "indirect" loss is no longer clear-cut. There is no
simple way to determine whether a particular category or type of loss will be direct or indirect and whether it will come within the scope of an exclusion of consequential loss clause. Therefore, rather than simply excluding liability for consequential loss, a supplier should in some instances consider and provide for the types of loss that they foresee might arise from a breach of contract and then agree those they are prepared to accept responsibility for and those types of loss that they are not prepared to accept liability for.

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The use of the terms "best" and "reasonable" endeavours are often debated when negotiating contracts. But practically what do these terms mean and what is the difference between them? The case of CPC Group Limited considered this issue.

The Court held that "all reasonable endeavours" does not equate to best endeavours and does not always require a party to sacrifice its own commercial interests. The High Court, however, has recently added further
confusion. In the case of jet2.com Ltd v Blackpool Airport Ltd 2011, it rejected Blackpool Airport's argument that a duty to use all reasonable endeavours did not require it to act against its own commercial interests.

What is apparent from this case is that the Courts will consider all circumstances surrounding the matter in question. Here the parties had agreed that "best endeavours" meant the same as "all reasonable endeavours". It also reminds us that parties to a contract should set out clearly what they require the other party to do in relation to a particular obligation.

As a general rule, by adding any element of endeavours to an absolute obligation, you are watering down such an obligation from a strict obligation to one where a party can to a certain extent take their own commercial interests into account along the basis of the following sliding scale:

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Entire agreement clauses are provisions which seek to prevent parties from relying on any statements or representations that are not expressly set out in an agreement and can therefore be a method of limiting or excluding a party's liability. The recent Court of Appeal case of AXA Sun Life Services plc v Campbell Martin Ltd, considered entire agreement clauses and their effectiveness to exclude or limit liability.

Following this case, a general statement in a contract which states “the agreement constitutes the entire agreement between the parties and supersedes all prior agreements, understandings, negotiations and discussions, whether oral or written, between them” will not have the effect of excluding liability for negligent
misrepresentation (a statement of fact made in discussions concerning a contract that does not itself appear  in the contract). In order to do so, your agreement must clearly state that liability for misrepresentation is excluded. Also, entire agreement clauses that specifically exclude implied terms may not prevent those terms that are necessary to give the contract business efficacy but would exclude other implied terms.

As a result of the recent changes in case law, detailed above, you should review and if necessary update your contracts to ensure they are sufficiently robust to protect your business.

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The articles in this newsletter are for guidance only and do not constitute legal advice.
The firm is regulated by the Solicitors Regulation Authority

In This Edition

Bridging the Gap: Board and Shareholder Disputes

• Common causes of dispute
• Role of shareholder agreements
• Statutory remedies
• Avoiding the expense of pursuing a statutory remedy
• Shareholders' agreements

Commercial Contracts Update

• Limitation of liability clauses
• Best endeavours or reasonable endeavours
• Entire agreement clauses

The articles in this newsletter are for guidance only and do not constitute legal advice. The firm is regulated by the Solicitors Regulation Authority

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