As many businesses are created and run in the form of limited companies, partnerships, or limited liability partnerships (LLPs), directors, partners, and shareholders may wonder what they can do if there is a dispute about the running of their company or partnership. This article provides initial insight into some of the most common company and partnership conflicts and what you can do about them.

Claims for breach of directors’ duties under the Companies Act 2006

Under the Companies Act 2006, directors (both executive and non-executive alike) owe specific legal duties to their company during their time in office. However, the company has the right to bring a legal claim against any director it believes is not adhering to their legal duties. 

The legal duties owed by directors to their companies are wide-ranging. They include duties to act within their powers, to promote the success of the company, to exercise independent judgment, to exercise reasonable care, skill and diligence, to avoid conflicts of interest, not to accept benefits from third parties, and to declare any interest in a proposed transaction or arrangement.

Knowing how these legal duties translate into practical obligations for directors is essential. The duty to act within their powers, for example, requires directors to act per the company’s constitution (including the company’s articles of association) and to only exercise powers for proper and appropriate reasons.

The director’s duty to promote the company’s success requires the director to bear in mind a host of factors. These factors include the likely long-term consequences of any decisions that the director takes, the interests of the company’s employees, the need to develop and retain business relationships with customers and suppliers, the company’s impact on the community and the environment, the need for the company to maintain a reputation for high standards of business conduct, and the obligation to treat the company’s shareholders fairly (and not to treat some shareholders better than others).

The duty to exercise independent judgment means that a director cannot risk being influenced by someone else. For example, if a director agreed with someone else to cast a particular vote on a specific board resolution, that director would still have breached their duty even if they were going to vote that way regardless. This duty does not prevent a director from being guided by legal advice as long as the director uses their own judgment to decide whether or not to follow that advice.

A director fulfils a duty to exercise reasonable care, skill and diligence where they satisfy both objective and subjective tests. The objective test is that the director takes the same care as a careful hypothetical person with the knowledge, skill and experience of someone carrying out the same functions as the director. For example, suppose the director in question is a finance director. In that case, their conduct will be judged based on what a careful hypothetical finance director would do in the same situation. The subjective test is that the director takes the same care as someone with the same knowledge, skill and experience as them.

The duty to avoid conflicts of interest means that a director must avoid any conflict between the company’s and their own personal interests. This duty also means that a director must avoid any conflict between the company’s interests and their duty to a third party (such as another company where the director is also on their board).

The director also has a duty not to accept benefits from third parties. This means that they cannot receive any benefit from a third party because of their status as a company director. Similarly, they cannot accept any benefit from a third party for either doing or not doing something as a director (such as voting a certain way on a particular resolution). The term “benefit” includes any advantage, favourable gain, or profit. 

A director’s duty to declare their interest in any proposed transaction or arrangement means that they must frankly declare the nature and extent of their interest to their fellow directors. Furthermore, the director must declare their interest before the transaction or arrangement occurs and do so without delay. They can make the required declaration in writing or orally at a board meeting.

Suppose a director has breached any of these legal duties owed to the company. In that case, the Court can provide a range of remedies, including ordering the director to pay compensation or to account for the profits they made through their breach of duty.

Any breach of duty by a director can also be grounds for terminating an executive director’s service contract, amount to unfairly prejudicial conduct for an unfair prejudice petition (refer to ‘Unfair prejudice petitions’ below), lead to the disqualification of the director from being a director, or lead to a derivative claim against the director in breach (refer to the ‘Derivative claims’ section for more information).

Unfair prejudice petitions

Where a shareholder is unhappy that how their company is being run will cause them loss or some other harm, they may be able to use an unfair prejudice petition to protect their interests. An unfair prejudice petition is a legal document you would file at Court explaining how the company runs and how that is causing you “unfair prejudice”. 

If the unfair prejudice petition is successful, then the Court can provide a range of remedies, including an order that the company stop doing a particular act, an order preventing any change to the company’s articles of association, or an order for a specific shareholder’s shares to be purchased by other shareholders or even by the company itself.

There are three main categories of people who can bring unfair prejudice petitions under section 994 of the Companies Act 2006. The first category is shareholders in the company (or, by analogy, members of an LLP). The second is non-shareholders, where company shares have been transferred to them (even if the company in question refuses to register the new owner of the shares as a shareholder). The third is non-shareholders who have received company shares through an operation of law (such as inheriting shares from a deceased shareholder). 

The conduct complained of in an unfair prejudice petition must relate to the company’s affairs. This can include behaviour where shareholders disrupt the management or the running of the company or management decisions (even those not involving the company’s board of directors). However, this does not include where other shareholders are acting in their capacity as shareholders – e.g. a shareholder selling their shares will generally not count as the company’s affairs, regardless of how that sale affects other shareholders.

An unfair prejudice petition must relate to conduct that is prejudicial (i.e. harmful) to the shareholders’ interests as shareholders. The courts have decided that there is prejudice to someone’s shareholder interests when that person becomes a shareholder because they would help run the business and the company then excludes them from doing so. Similarly, there is prejudice to someone’s shareholder interests when their loan to a company is a part of how they gain shares. However, if someone’s non-shareholder interests are prejudiced, and those interests are not connected with how they became a company shareholder, they will not be able to bring an unfair prejudice petition.

The unfair prejudice petition can be about a single act or omission, a series of acts or omissions, conduct that has already happened, conduct that is currently happening, or even potential future conduct. However, the last of those is the hardest to prove because the shareholder must provide evidence that the unfairly prejudicial conduct was imminent.

The unfair prejudice petitioner will need to show that they have suffered prejudice (i.e. harm) and that the prejudice was unfair. Examples of unfair prejudice can include additional shares being allotted by the company to dilute a minority shareholding in the company, misuse or misappropriate of the company’s assets, a failure to pay dividends that are due, paying excessive amounts to directors where such amounts are not a genuine (or market value) reward for service or the company fails to comply with its articles of association or its legal obligations under the Companies Act 2006. 

Serious mismanagement of the company can also count as unfair prejudice provided that the mismanagement is more severe and harmful than reasonable differences of opinion between shareholders on commercial decisions. 

Furthermore, to ensure that the respondent cannot successfully defend or strike out the unfair prejudice petition, the petitioning shareholder must ensure that they did not refuse a fair offer to sell their company shares, commit misconduct related to the unfair prejudice, or delay bringing the unfair prejudice petition or go along with the allegedly unfairly prejudicial conduct. In addition, the Court will not look kindly on an unfair prejudice petition where there is an express exit route in the company’s articles of association or in a shareholder agreement.

Derivative claims

Where a director or a third party commits a wrong against a company, the company is usually the appropriate claimant to sue the wrongdoer. However, there are some instances where the Court can allow shareholders to pursue claims on their company’s behalf. 

These are ‘derivative claims’ because they derive from the company’s legal right to sue for those wrongs. The three categories of people who can pursue derivative claims are:

• Company shareholders
• Non-shareholders where company shares have been transferred to them
• Non-shareholders where company shares have been transmitted to them (such as people inheriting shares from deceased shareholders)

While the Court’s permission is not needed to start a derivative claim, the Court’s permission is required to be able to continue a derivative claim.

Suppose the company (or another shareholder) has started a claim about the same issue that a derivative claim would be based on. In that case, the derivative claim cannot proceed. However, anyone who wants to bring a derivative claim can continue the existing claim as long as three conditions are met. 

The first condition is that the existing claim was started (or is being pursued) in a way that amounts to an abuse of the Court process. The second condition is that the company or shareholder that started the existing claim has yet to pursue it diligently. The third of these three conditions is that it is appropriate for the person who wants to bring a derivative claim to continue the existing claim as a derivative claim. These conditions prevent a company (or another shareholder) from bringing a claim and leaving it in limbo to avoid a derivative claim from being brought.

The Court can also refuse permission to continue the derivative claim. There are two main circumstances where this could happen. 

The first is that the Court decides that it would not promote the company’s success to continue the claim. Several factors would be considered here, including the size and strength of the claim, the cost of the claim for the company, and the defendant’s ability to satisfy any judgment. 

The second is that the act or omission that is the subject of the derivative claim has either been authorised by the company (before it happened) or endorsed (after it happened). There are limits to this, however. A company cannot support acts beyond its powers, actions of a fraudulent nature (such as the misappropriation of money or property), or acts harming the interests of the company’s creditors.

The Court can also consider several discretionary factors when allowing a derivative claim to continue. These factors include whether the person bringing the derivative claim is doing so in good faith; whether the act or omission that is the subject of the derivative claim is the type that would be likely to be authorised or endorsed; and whether the person bringing the derivative claim can already sue personally (rather than on behalf of the company).

Removal of partners from partnerships or members from limited liability partnerships (LLPs)

It is sometimes necessary to remove a partner from a partnership (or a member from an LLP, which is essentially similar). The two main ways of removing a partner are either expulsion or compulsory retirement, but how can these be achieved?

To successfully expel or compulsorily retire a partner or a member, the partnership agreement (or the membership agreement for an LLP) must expressly contain a clause allowing a partner or member to be expelled or compulsorily retired. 

If there is no such clause, then the only options are either for the business to negotiate a settlement with the partner/member for their exit from the business (which would usually involve a compromise payment to them) or to apply to the Court to dissolve or wind up the business (although there are no guarantees that the Court will do so).

An expulsion clause must state the permitted reasons for expulsion (which can include bankruptcy or incapacity) and the number of votes required to expel a partner or member. A compulsory retirement clause does not need to state the reasons for invoking it. Still, it must set out the notice period after which the partner/member is deemed to have retired and the number of votes required to pass a resolution in favour of compulsory retirement.

To ensure that the vote in favour of expulsion or compulsory retirement is valid, the business must give the partner or member notice of the vote to expel or compulsorily retire, an opportunity to respond to the case against them, and (if it is a vote to expel) reasons for the decision to expel. However, the business can eliminate the need to provide grounds for expulsion by previous agreement.

The business also needs to avoid delay in exercising its power to expel. A delay for an extended period might be interpreted as the business accepting the wrongful act. This, in turn, would amount to a waiver of the right to expel). 

Furthermore, the decision to expel or compulsorily retire a partner or member must not be taken in bad faith and involve no improper motive (for example, discrimination against a partner or member contrary to the Equality Act 2010), as this may otherwise be the basis for overturning the decision.

Kumaran Sivathillainathan is Lennons’ Head of Dispute Resolution. In 2012 Kumaran qualified as a solicitor and joined a boutique litigation firm where he spent nine years assisting clients with a range of litigation matters in county courts, the High Court and the Court of Appeal. He joined Lennons in November 2021.