Bree Taylor explains how a court ruling will embolden shareholders who claim they have been unfairly prejudiced


The Court of Appeal's recent decision on a strike-out application in Gross v Rackind [2004] EWCA (Civ) 815 has broadened the scope of cases in which unfairly prejudiced shareholders may petition for relief under section 459 of the Companies Act 1985.



This is a blow for the corporate veil principle and will present some interesting opportunities for shareholders of group companies who wish to 'exit' their investments on favourable terms.


In the case, the Gross family and the Rackind family were equal shareholders in a holding company that had two wholly owned subsidiary companies, Citybranch and Blaneland. The business of the group, or more specifically, the business of the two subsidiaries was property investment. The relationship between the two families broke down with various disputes arising in connection with the running of the two subsidiaries.


The Rackind family sought to have the holding company wound up on the 'just and equitable' ground pursuant to section 122(1)(g) of the Insolvency Act 1986, thereby effectively achieving a winding-up of the whole group. The Gross family presented a section 459 petition in respect of the holding company.


The family's complaints were mainly about certain things allegedly done by Mr Rackind in relation to the subsidiaries, and the general breakdown of the relationship between the two shareholder factions. They sought various forms of relief including, unusually, an order that the Rackind family sell its shareholdings in the holding company to the Gross family. This is unusual because section 459 petitioners usually seek the right to sell on favourable terms, not the right to buy out the other shareholders. In any event, the relief sought was for the purpose of bringing to an end the whole 'venture' with the Rackind family shareholders. The Gross family essentially made five allegations as a basis for the section 459 petition:


- Mr Rackind caused an irrevocable breakdown in trust and confidence between himself and the Gross family;


- Mr Rackind threatened the winding up of the parent to try to pressure the Gross family to sell their shares to Mr Rackind;


- Mr Rackind breached his fiduciary duties to the parent and/or Blaneland by obstructing attempts to raise finance to allow Blaneland to make a payment of corporation tax due to the Inland Revenue;


- Mr Rackind improperly used the offices of Citybranch and drew consultancy fees even though he was not working for Citybranch or any other company in the group; and


- Misappropriation of funds from Citybranch.


The Rackind family sought to strike out the section 459 petition. Judge Weeks QC dismissed the Rackind family's striking-out application and the Rackind family appealed to the appeal court.


In court, the Rackind family had two main arguments as to why the section 459 petition should be struck out:


- None of the allegations forming the subject matter of the section 459 petition was capable in law of constituting an allegation as to the affairs of the company in respect of which the petition had been presented (namely, the holding company). The conduct complained of was actually the conduct of the subsidiary companies and, in some cases, the conduct of shareholders themselves; and


- In relation to some of the allegations, namely, Mr Rackind's alleged wrongs against the subsidiaries, even if the conduct complained of was regarded as the conduct of the holding company, such conduct was not capable of prejudicing the shareholders' interests as shareholders of the holding company. The alleged wrongdoing caused an indirect form of prejudice to the shareholder of the subsidiaries, namely, the holding company itself not the shareholders of the holding company, who are a further step removed.


Section 459 provides as follows: 'A member of a company may apply to the court by petition for an order under [part XVII of the Act] on the ground that the company's affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of its members generally or of some part of its members (including at least himself)...'



In relation to the first issue, the court found that the phrase 'affairs of the company' in section 459 should be given a broad interpretation to include the affairs of companies in the same group, where there are directors in common between the group companies. As can be seen from the provision, it is clearly a member of the company in question that has a right to apply for relief, not members of other companies. However, Lord Justice Nourse found English authority for the proposition that a parent company could be said to control its subsidiary, thus entitling the court in a section 459 case to regard the affairs of the parent as the affairs of the subsidiary (Nicholas v Soundcraft Electronics Ltd [1993] BCLC 360).



Lord Justice Nourse held that the existence of directors in common meant that in a case like the present one, the converse would hold; the affairs of the subsidiary could be regarded as the affairs of the holding company because of the control exercised by the common directors.


In relation to the second issue, the court found that the shareholders of the holding company (namely, the Gross family) would potentially be prejudiced by Mr Rackind's alleged wrongdoing in relation to the subsidiaries because the value of the Gross family's shareholdings in the holding company could be prejudiced.



Aside from the fact that shareholders cannot, as a matter of general law, claim for 'reflective loss' under the rule in Foss v Harbottle (1843) 2 Hare 461(although query whether section 459 overrides this principle), the present case involves a claim for reflective loss not by the shareholders of the company allegedly suffering damage, but by the shareholders of the shareholder (in other words, the shareholders of the holding company).



It should be noted that the truth or otherwise of the allegations was not in issue on the strike-out. As a result of the appeal court's decision, the claimants will be required to prove those allegations at trial.


The court's decision represents a broadening of the scope of cases in which relief may be claimed under section 459.


On one hand, this represents a fairly fundamental departure from the clear words of the section as drafted, and probably does not reflect what was intended by parliament. It also pierces the corporate veil that exists between companies in a group, which were presumably incorporated as separate entities for some reason devised by the shareholders.


On the other hand, this is a way of short-cutting the usual procedure for complaining, as a shareholder, about a director's alleged wrongdoing.


The usual procedure would be to bring a derivative action under an exception to the rule in Foss. That procedure allows shareholders to procure the company to bring proceedings against a director to redress the wrong done to the company and to recoup loss. It is potentially more cumbersome than the section 459 procedure and, where successful, means that the company obtains a judgment against the director - this does not result in any change to the respective shareholder rights/shareholdings. A successful section 459 petition, on the other hand, will usually result in to the right to be bought out of the company at fair value, without any discount. This is always going to be a more desirable outcome for shareholders than a judgment in favour of the company. The fundamentally different outcome for the shareholders of a section 459 petition vis-à-vis a derivative action is not something the court appeared to consider in any detail.



Bree Taylor is a senior associate in the dispute resolution department at City law firm Baker & McKenzie