How not to manage your business on the breakdown of a relationship

The recent case of Re Greenfrost Ltd; Davies v O'Keeffe [2023] EWHC 5 (Ch) was a successful unfair prejudice claim providing a useful example of how not to conduct business following the breakdown of a relationship. It also illustrates how conduct during legal proceedings, particularly around disclosure obligations and giving evidence, can influence the outcome.

Background

The two parties, Davies (D) and O’Keeffe (O) were both directors and equal shareholders for two companies, Greenfrost and PMO (together, the companies). In addition to their professional relationship, D and O had a personal relationship spanning 20 years. At all times prior to the difficulties arising, the companies had each been operated as a quasi-partnership and on the basis of mutual trust and confidence.

During a period of financial difficulty, with statutory demands being served on both parties and the companies, the parties decided to sell a valuable quarry lease held by Greenfrost. After a chunk of the proceeds were used to pay off debts, the remaining balance was transferred to Greenfrost. Subsequently, both parties made various withdrawals from the Greenfrost account. During this time, the parties’ relationship broke down. After the breakdown of the relationship, O dealt with a company to dispose of his share and D’s share in Greenfrost and secured loans against PMO without the knowledge of D.

D applied to the court by petition under s994 Companies Act 2006 (s994 CA 2006) for her shares in the companies to be bought by O.

What is unfair prejudice?

S994 CA 2006 provides for a shareholder of a company to apply to court by petition for an order on the grounds of unfair prejudice. That is:

1. 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
2. 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.

Here, D had claimed that there was a breakdown in the relationship, she had been excluded from running the companies and O had misappropriated assets.

Unfairly prejudicial conduct

The court carried out careful analysis of the factual background which included multiple bank transactions and loan repayments. The court heard evidence from both D and O. Many of the issues revolved around communications (or rather the lack of communication due to the breakdown in the relationship).

The performance of witnesses can prove key to a case. Here D was found to have given her evidence in a straightforward manner and made appropriate concessions under cross-examination. On the contrary, O was considered to have been less straightforward, referring to matters not covered in his written evidence and seemingly admitting to not keeping copies of relevant documents.

Three instances of unfair prejudice were identified:

• Firstly, a withdrawal by O from the Greenfrost bank account of £180,000 which virtually cleared out the bank account. The court found that there was no proper explanation of what happened to the money and it could not satisfy itself that the monies were used to pay debts or for any proper purpose of Greenfrost. This was held to be a misuse of the company funds and there had been a failure to consult/inform D about this.
• Secondly, O took steps to sell D’s share in Greenfrost to a third party and replace her as a director. This was subsequently reversed, but the very fact that this had occurred was clearly conduct relating to the affairs of Greenfrost and was unfairly prejudicial to D.
• Thirdly, O secured personal loans against PMO without the knowledge or consent of D. Again, this was another example of the misuse of assets by O coupled with excluding D from the management of PMO. This was unfairly prejudicial to D's interest in PMO. O also used PMO assets for his own company (which D had no interest in) without payment to PMO. This was also found to be unfairly prejudicial.

The remedy

Having found unfair prejudice had occurred, the court had a wide discretion as to the appropriate remedy. The usual order is a buy out of the shares of the petitioning shareholder at a fair value taking account of the unfairly prejudicial conduct (although other remedies are available). The judge was assisted by a valuation expert who had produced a report based on the information that was available. The judge noted that the expert had not been assisted by O’s approach to disclosure. Documents that might have cleared up issues were not available.

Ultimately D obtained a buy-out order for her shares in the companies at a fair valuation to the tune of approximately £840,000. She could also expect to recover a sizeable portion of her legal costs.

Practical steps when a breakdown occurs

This case raises some practical points for managing the separation of business interests following a breakdown of relationships:

• Remember your duties to the company - Not only were O’s actions unfairly prejudicial to D, but they also showed a disregard for almost all of a director’s general duties under the Companies Act. For example, withdrawing money from the Greenfrost account without using it for any proper purpose of Greenfrost was not promoting the success of the company.
   
• Ensure you follow proper process - A falling out does not mean you throw the rule book out of the window too. Proper process for each of the unfairly prejudicial actions would have required O to seek D’s input. As the company had 2 equal shareholders, O would not have been able to make a decision requiring an ordinary resolution as he could not exercise over 50% of the voting rights (he held only 50%). The threshold for special resolutions is even higher – at least 75%.
   
• Transparency and honesty - Keeping true and accurate records of decisions made and the process for the decision making is vital, as is being honest throughout the dispute process. A recurring theme in the case was O’s lack of transparency and apparent dishonesty.