Isaacs & Anor v Belfield Furnishings Ltd. & Ors

There are 2 principal applications before me in a Petition under section 459 of the Companies Act 1985 that was presented on the 19^th August 2004 in relation to the affairs of Belfield Furnishings Limited (“the Company”).

The first, issued on the 12^th September 2005 on behalf of Paul Isaacs and Peter Harrisson (“the Petitioners”) seeks the continuation of an interim injunction - presently in force by virtue of an order made by Mann J on the 18^th October 2005 - restraining the Respondents to the Petition from executing any share transfers on the Petitioners’ behalf or otherwise recording any changes regarding their shareholding in the Company’s register of members.

The second, issued on the 14^th October 2005 on behalf of the individual Respondents to the petition, seeks to strike out the Petition on the ground that its continued prosecution is an abuse of process in the light of offers to purchase the Petitioners’ shares in the Company that have been made both before and after the presentation of the Petition.

I propose to deal with the strike out application first - not least because if I decide the Petition should go to trial, it follows that the Petitioners will be entitled to a continuation of the interim injunction that has been in force to date. This is necessary to preserve their locus standi as members of the Company pending the hearing of the Petition.

It is common ground between the parties that the jurisdiction to strike out is one to be exercised sparingly and only in plain and obvious cases.

Mr Downes who appeared with Ms Lee for the Petitioners reminded me that in Copeland v Craddock[1997] BCC 294 - a case that concerned a petition seeking relief under s.459 and a just and equitable winding up in the alternative - Bingham LJ had this to say about the Court’s jurisdiction at p.300:

Like Bingham LJ, I too have been troubled by the fact that the Petition in the case before me is thin, if not close to the borderline where striking out would be appropriate. Nonetheless, I accept that the Petitioners are entitled to the Court’s adjudication on the merits of their Petition at trial unless the Respondents are able to demonstrate that the claims made in it could never succeed, and that as a result, the continued prosecution of the Petition constitutes an abuse of process. The onus on the Respondents in this regard is a heavy one.

The Company was incorporated on the 15^th April 2002 and commenced doing business, in the furniture industry, in the summer of that year.

On 12^th August 2002 - the same day as the Second Respondent (“Mr Millership”) signed a special resolution adopting revised Articles of Association (“the Articles of Association”) - the shares in the Company were allocated as follows:

The Petitioners were involved, as were the Individual Respondents, from the outset of the venture and they assisted, in particular, in the raising of finance. However, whilst it was always intended that the Individual Respondents would be executive directors and involved in the day to day running of the Company, the Petitioners’ role was always going to be that of non-executive directors and part time consultants.

The terms upon which the Petitioners would be employed by the Company were contained in written Consultancy Agreements, also executed on the 12^th August 2002. Although it is the Petitioners’ case that they decided to invest in the Company on the basis of an understanding (engendered by statements from Mr Millership to that effect) that they would be allowed to participate in its management for at least 3 to 5 years, and that they would be offered an opportunity of buying out Mr Millership and Mr Keely within that period, any such understanding was not reflected in the documentation that the parties executed on the 12^th August. Indeed, clause 9 of each of the Petitioners’ Consultancy Agreements states:

The contractual provisions requiring the Petitioners to resign as directors of the Company without compensation in the event they ceased for any reason to be employed as consultants were bolstered by other provisions set out in the revised Articles of Association adopted on the 12^th August 2002 - the same day as the Consultancy Agreements were executed. In this regard, Regulation 12 of the Articles provides so far as material:

Pausing there, the net effect of the provisions I have cited (which the individual Respondents stress were freely entered into or accepted by the Petitioners) was that the Company could summarily determine the Petitioners’ employment as consultants without compensation, and thereby trigger a sale of their shares whether they wished it or not at a price to be fixed by the auditors.

In fact, on the 18^th March 2004, the Petitioners’ appointments as consultants under the Consultancy Agreements were terminated, in writing in accordance with clause 9 of the Consultancy Agreements. In passing, I should point out that there is no suggestion that the Petitioners’ removal from their position as consultants was prompted by any misconduct or breach of duty on their part, nor any suggestion on the part of the individual Respondents that the Petitioners should be treated as anything other than “good leavers” for the purposes of Regulation 12.1.1 of the Company’s Articles of Association. The Petitioners however failed to resign as directors in accordance with the provisions of clause 10 of the Consultancy Agreements, and ultimately the provisions of clause 10 were utilised to effect their removal. This process was completed on the 7^th May 2004.

It is the individual Respondents case that at the moment of the Petitioner’s removal as directors (if not from the earlier determination of the Consultancy Agreements) the provisions of Regulation 12.1 of the Articles of Association were triggered, and a Transfer Notice (as defined by the Articles) was deemed to have been served in respect of the 400 shares held by each of them.

The individual Respondents further contend that it is notable that the Petitioners’ reaction to the termination of the Consultancy Agreements was not to protest that their removal was improper or contrary to their legitimate expectations as set out in the draft Re-Amended Petition produced towards the conclusion of the hearing before me. Rather, so the individual Respondents contend, the Petitioners accepted that it was in accordance with the terms of the Consultancy Agreements (see the letters from the Petitioners at pages 7-9 of exhibit “PM1” to Mr Millership’s first witness statement), and they focused instead on the question of the sale price of their shares. However, in the absence of cross-examination, I am not prepared to conclude on the basis of these letters that the legitimate expectations now relied on by the Petitioners are some recent fabrication on their part which can accordingly be ignored. Indeed, some support for the legitimate expectations now relied on can be found in Mr Harrisson’s letter to Mr Millership of the 26^th March 2004: this records the Petitioners’ initial understanding that their involvement of the Company would be over the longer term, and also provides some support for their suggestion that it was always envisaged that they would eventually buy out Mr Millership and Mr Keely.

Be that as it may, the letter dated 18^th March 2004 which had terminated their Consultancy Agreements offered each of the Petitioners £200,000 for his shares. That offer was rejected and accordingly (and after the Petitioners had been removed as consultants and directors) the Company instructed its auditors, Hacker Young, to provide a valuation of the Petitioners’ shares for the purposes of the buy-out provisions in the Articles.

The (unsigned) valuation that was provided by Hacker Young (“the First Valuation”) was sent to the Petitioners by letters dated 6^th July 2004. Thereafter the Company proceeded to implement the steps specified by Article 10 for the transfer of the Petitioners’ shares. [In passing, I should point out that it is the Petitioners’ case (supported as it happens by Hacker Young) that the First Valuation, which indicated a price for each parcel of 400 shares of £191,000, was not a certificate of the “Market Value” of the Petitioners’ shares as required by the Articles. The Individual Respondents disagree. As a result, on the 11^th November 2005 the Petitioners issued an application for summary judgment on that question. Given firstly the fact that it was clear that the principal applications with which I was concerned would overrun their time estimate and secondly, the absence of any need for the relevant question to be determined as a matter of urgency, I indicated that I would not be prepared to deal with that further application on case management grounds].

On Friday the 13^th August 2004 (in anticipation of the presentation of the Petition and before share transfer forms had been executed in relation to the Petitioners’ shares) the Petitioners obtained an Order ex parte from Mr Justice Park by which the Respondents were restrained from procuring the execution of stock transfer forms on behalf of the Petitioners so as to complete the purchase of their shares on the basis of the First Valuation.

On the 3^rd September 2004 the injunction was continued (effectively by consent) on terms that the Respondents would not execute stock transfer forms in relation to the Petitioners’ shares without first giving 5 working days’ notice in writing to the Petitioners’ solicitors. The Respondents have now given such notice to the Petitioners’ solicitors, and this has led to the Petitioners’ application to extend the injunction (referred to in paragraph 2 above). Sensibly, the Respondents have agreed that they will not take any further step to transfer the shares pending the delivery of this judgment.

Nonetheless, by letter from their solicitors dated 18^th July 2005 the Petitioners made an open offer to sell their shares at a value determined by an independent valuer acting as an expert. That offer was and is unacceptable to the Individual Respondents because they say it ignores the fact that the Petitioners are contractually obliged to sell at the price certified by the Company’s auditors. However, the fact that the offer has been made is an indication that the Petitioners accept that their involvement in the Company’s affairs is for practical purposes at an end and that in principle they should be bought out at a valuation.

Following the Petitioners’ criticisms of the First Valuation, Hacker Young produced a further valuation in accordance with Article 10.2 of the Articles under cover of a letter dated 22^nd July 2005 addressed to the directors of the Company which stated that:

Further, by a letter from the Individual Respondents’ solicitors dated 5^th August 2005 an open offer was made to the Petitioners. Each has been offered the sum of £250,000 for his 400 shares. This is a higher price than indicated by either the First Valuation (£191,000) or the Second Valuation (£227,199), and appears to have been proffered because both valuations appear to have proceeded on the mistaken basis that the proportion of the Company’s share capital respectively held by the Petitioners had been diluted by a further issue of 800 ordinary shares in favour of a Mr Steven Hampton. The Individual Respondents have also offered to pay the Petitioners’ costs of the proceedings, save for the costs of these contested applications, and to bear their own costs. This offer remains open, and, so I am told by Mr Purle QC, Leading Counsel for the individual Respondents, will remain open for a limited period of time even in the event that I decide to strike out the Petition.

The allegations of unfair prejudice made in the Amended Petition and refined in a series of running draft amendments put forward during the hearing before me can conveniently be grouped under 3 broad heads:

allegations that the Company was effectively a “quasi-partnership”, and that the Petitioners were wrongfully excluded from a role in management and an opportunity to participate in the Company’s future profitability in breach of “legitimate expectations” to that effect created as a result of statements made to them by Mr Millership prior to or at the time they decided to invest in the Company and enter into the Consultancy Agreements;

freestanding allegations about the Company’s failure to pay dividends as originally envisaged; about the way that an interim bonus of approximately £1m was paid out to the Company’s Executive Directors in May 2004, shortly after the Petitioners’ expulsion from the Company; about excessive or improper payments made by the Company to Shelgrove Limited, an entity owned or controlled by Mr Millership; and about the manner in which the Petitioners were wrongfully excluded from access to management information between December 2003 and their ultimate removal in March 2004; and

allegations about the Hacker Young valuations and the manner in which they were procured.

I need not take up time analysing the merits of these various allegations because Mr Purle QC very sensibly conceded that although the petition was thin in the extreme, it nonetheless raised a prima facie case of unfair prejudice within section 459 of the 1985 Act which would have had to go to trial but for the compulsory purchase provisions contained in the revised Articles of Association and the offers to purchase the Petitioners’ shares that have been made pursuant to those provisions or otherwise.

This brings me to the Respondents’ application to strike out the Amended Petition. In essence Mr Purle QC submits that in the light of (1) the compulsory purchase provisions contained in the Company’s Articles of Association (which he says were freely accepted by the Petitioners at the time they agreed to become shareholders) and (2) the 2 Hacker Young valuations made pursuant to those provisions as supplemented by the open offer contained in the letter of the 5^th August 2005, the continued prosecution of the Amended Petition is an abuse of process. He says that the Petitioners entered into their Consultancy Agreements and took their shares in the Company knowing that their appointments as consultants and directors could be terminated at any time and for any reason (good or bad) and that in those circumstances, they could be obliged to sell their shares to the remaining shareholders at a price fixed by the Company’s auditors. He further says that in circumstances where Mr Millership has indicated his agreement to purchase the Petitioners’ shares at the price the auditors have fixed pursuant to regulation 10 of the Company’s Articles, a concluded contract for the sale of those shares has come into being; further or alternatively, that there is no reason why the Court should relieve the Petitioners from the bargain they entered into at the time they agreed to take up their shares in the Company and executed their respective Consultancy Agreements. He further submits (relying on Jones v Sherwood [1992] 1 WLR 277) that the Petitioners’ attack on the 2 Hacker Young valuations gets them nowhere: absent any suggestion of fraud or collusion on the part of the auditors (and there is none), he says the Court will not substitute its own view as to value for that of the expert chosen by the parties - even where there is a “speaking” valuation with mistakes appearing on its face - unless it can be shown that the expert has departed in some material way from the task the parties have instructed him to undertake.

These are formidable submissions.

For his part, Mr Downes, who appeared for the Petitioners, stressed that section 459 created a statutory remedy and could not be contracted out of. While accepting that a refusal to accept an offer at a price fixed pursuant to an agreed contractual mechanism could render the continued prosecution of a s.459 petition an abuse of process, he submitted that this was only where any injustice occasioned by the conduct alleged to be unfairly prejudicial was adequately compensated for by the contractual mechanism.

By way of contrast, Mr Downes submitted that the present case was one where the contractual mechanism set out in the Company’s Articles and the 2 valuations that Hacker Young had produced pursuant to it had failed to address at least 4 of the allegations of unfair prejudice set out in the Amended Petition. These were:

the fact that, contrary to what the parties had agreed at the time the Company was established, it was clear that the individual Respondents had unilaterally decided that dividends would not be paid for the foreseeable future: in this regard, paragraph 6.6.1 of Hacker Young’s First Valuation states:

the fact that conversely, both valuations proceeded on the basis that substantial bonuses over and above their contractual entitlement to remuneration would continue to be paid to the executive directors in future years;

the fact that excessive or improper payments had been made to Shelgrove; and

the fact that the Company was in essence a quasi-partnership.

Further, Mr Downes submitted that even if Jones v Sherwood would ordinarily preclude a petitioner from successfully challenging a valuation of his shares that had been undertaken pursuant to some contractual mechanism, there were a number of factors which took the present case outside the principles laid down by the Court of Appeal - even if he could not allege fraud or collusion against Hacker Young. In particular he submitted:

that Hacker Young had departed from their instructions to a material extent by incorrectly assuming in both their valuations that the Petitioners’ shareholdings in the Company had been diluted by the further issue of 800 shares to Mr Hampton. In this regard, he relied on the following passage in Jones v Sherwood (v supra), where Dillon LJ had this to say at p.287:

similarly, that Hacker Young had departed to a material extent from their instructions by valuing the Petitioners’ shareholding “as at June 2004” rather than as at the date of their dismissal as consultants (18^th March 2004) or possibly the date on which they were ultimately removed as directors (7^th May 2004);

that Hacker Young were biased against the Petitioners by reason inter alia of a long standing prior relationship with Mr Millership, and that this bias could be demonstrated by reference to a number of aspects to their First Valuation which were indisputably unjustified and which had accordingly been modified in their Second Valuation: these were inter alia that the First Valuation had been based on current sustainable earnings rather than future sustainable earnings; that the weighting formula adopted (3:2:1) was similarly wholly inappropriate for a start up company, whose profitability was estimated to increase dramatically in future years; and that actual and anticipated profits had been artificially depressed by the assumption that substantial bonuses would be paid to the executive directors in future years. In this regard, the Petitioners rely on an expert report prepared by Mr Robert Kerr, a partner in Grant Thornton, which accuses Hacker Young of materially understating the maintainable earnings of the Company and applying an unduly pessimistic P/E ratio, with the result that their valuation of the Company is “a gross undervalue”. In a subsequent witness statement dated the 25^th November 1995 Mr Kerr expresses the further view that the extent of this undervaluation compromises Hacker Young’s independence in the case;

allied to the question of bias, that by the time Hacker Young came to undertake the Second Valuation, they were effectively disqualified from giving an independent view given that the Petition challenging the whole basis of the First Valuation was by then on foot, and allegations of negligence had been made against them; and

that the Hacker Young valuations had proceeded on the (false) assumption that no forecasts for the Company existed - presumably as a result of incorrect information supplied by the directors.

In the course of the hearing before me, I was referred to a large number of authorities in which the question of the extent to which the Petitioner was entitled to continue to prosecute a section 459 petition notwithstanding an offer to purchase his shares at a fair value was considered by the Court.

The authorities, which were not necessarily consistent and which I found difficult to reconcile, indicated that there were 2 broad approaches that judges had taken to the problem.

At one end of the spectrum were cases such as Re a Company (No 004377 of 1986)[1987] BCLC 94 and Re a Company (No 006834 of 1988) ex parte Kremer[1989] BCLC 365.

In the former case, which bears certain similarities to the present case in that it was one where a shareholder who ceased to be a director or shareholder of the company was deemed to serve a transfer notice under its Articles of Association entitling the other members to acquire his shares at a fair value as between a willing seller and a willing buyer to be certified by the auditors, Hoffmann J (as he then was) had this to say at p.101:

In the latter case, Hoffmann J had this to say at p.367:

At the other end of the spectrum are cases such as Re a Company (No 00330 of 1991) ex parte Holden[1991] BCLC 597, where Harman J refused to strike out a s.459 petition even though the relevant articles contained a mechanism which had been invoked requiring the petitioner to sell his shares at a fair value to be fixed by the auditors or at his discretion an independent person nominated by the President of the Institute of Chartered Accountants. After citing passages from Hoffmann J’s decision in Ex parte Kremer (v.supra), Harman J said this at p.602:

Similarly, Re Boswell & Co. (Steels) Ltd[1989] 5 BCC 145, where Morritt J declined to strike out a petition on the grounds that the petitioner was unreasonably refusing an offer to purchase his shares at a value to be determined by the auditor in accordance with the articles inter alia because of concerns about the valuer’s independence, stating at p.150:

Doing the best I can, I derive the following principles from the authorities:

in the usual case - where the shareholders in a company have fallen out without there being any question of serious wrongdoing by the majority - it will normally be an abuse of process for a minority shareholder who is excluded from the company to proceed with a section 459 petition in the face of an offer by the majority to purchase his shares at a fair value. This will by definition be the case where the offer provides that the valuation will be undertaken by a suitably qualified and independent professional to whom the parties will have an opportunity of making submissions after access to any relevant information and on the basis that no discount will be applied by reason of the fact that the petitioner’s shareholding is a minority stake; and where in addition it caters for any costs the petitioner has incurred in bringing any proceedings. See O’Neill v Phillips[1999] 1 WLR 1092 per Lord Hoffmann at p.1107D to 1108C. In such cases, the offer is in essence giving the petitioner all he would receive if he succeeded at trial.

The same position pertains with even greater force where (as in the present case) the petitioner has contractually bound himself to sell his stake in given circumstances and agreed a particular method for ascertaining its fair value. Accordingly, in such cases, it may be an abuse of process to proceed with a section 459 petition even if the agreed mechanism lacks features which would be necessary to constitute any offer made pursuant to it “a reasonable offer” as defined by Lord Hoffmann in the passage from O’Neill v Phillips (v. supra) to which I have referred in paragraph (1) above. In many if not most such cases, the Petitioner will be stuck with the bargain he made.

Conversely, even where the parties have agreed the circumstances in which a minority shareholder will be compelled to sell his shareholding and the manner in which its value will be ascertained, the continued prosecution of a section 459 petition in the face of an offer to purchase made pursuant to the agreed machinery will not necessarily be an abuse of process if:

That leaves Jones v Sherwood Computer Services plc (v.supra) with which I must deal. As stated above, this establishes that absent any question of fraud or collusion, the court will not substitute its own view as to value for that of the expert chosen by the parties - even where there is a “speaking” valuation with mistakes appearing on its face - unless it can be shown that the expert has departed in some material way from the task the parties have instructed him to undertake. However, whatever its applicability in other contexts, I do not read the decision as determinative of the applications before me. In reaching its decision in Jones v Sherwood Computer Services plc (v.supra), the Court of Appeal followed Campbell v Edwards[1976] 1 WLR 403 and Baber v Kenwood Manufacturing Ltd [1978] 1 Ll R 175, placing emphasis on the fact that the House of Lords in Arenson v Arenson[1977] AC 405 and Sutcliffe v Thackrah[1974] AC 727 had overruled an established line of authority to the effect that a valuer who had given a certificate as an expert was not liable to an action unless he was dishonest, and holding as a result that a new approach was justified. In this regard, if a dissatisfied party has a remedy against the valuer, one can well understand the Court’s reluctance to substitute its own view for that of the valuer or absolve the parties from the bargain they have made.

However, in the s.459 context, that rationale does not always pertain. Where (as the Petitioners contend is the case here) the valuer has reached his determination on the basis of incorrect information supplied to him by the Company’s directors which he may have no reason to doubt or because his task is to value the Company “as is” and without adding back the value of any questionable payments that have been made, the aggrieved party may well have no remedy in negligence against him. For that reason, and in such circumstances, it seems to me that the Court would not necessarily regard the existence of an agreed compulsory purchase mechanism as an absolute bar to the presentation or continued prosecution of a s.459 petition - especially if any defects in approach were in addition apparent on the face of the valuation produced pursuant to that mechanism.

Applying these principles to the case before me, I have reached the firm conclusion that it would be wrong for me to strike out the petition in this case, thin though it undoubtedly is. Having reached that conclusion, it would equally be wrong for me to express any detailed views on the merits of the various allegations in the petition that have been canvassed before me. With one exception (which I shall deal with later in this judgment), these must go to trial. Suffice it to say that on the basis of the evidence as it presently stands or having regard to the possibility of further evidence that might reasonably be expected to emerge through disclosure (inter alia of documents emanating from Hacker Young) or cross-examination at trial, it appears to me at least arguable that the Petitioners may succeed at trial in establishing inter alia:

that the 2 Hacker Young valuations are tainted by the fact that they were based on incorrect or incomplete information about the existence of the detailed financial projections and the extent of the Company’s issued share capital provided to them by the directors - one of whom, Mr Millership, stood to gain from as low a value as possible being placed on the Petitioners’ shares.

that Hacker Young were never in a position to bring independent judgment to bear on the question of the fair value to be assessed for the Petitioners’ shares

that Hacker Young’s lack of independence is evidenced by inter alia their unjustified focus on historic earnings rather than anticipated future maintainable earnings notwithstanding the fact that the Company was in a “start up” situation; by their choice of an unduly pessimistic P/E ratio; by their assumption (in particular in the first valuation) that the Company’s assets could appropriately continue to be depleted by substantial “bonuses” which bore no relationship to the executive directors’ contractual rights to remuneration; and by the resultant gross undervalue they arrived at in both valuations; and

that irrespective of the challenge to Hacker Young’s independence, none of the offers that the Respondents had made gave the Petitioners all that they could reasonably hope to achieve at trial given that they did not address the Petitioners’ complaints about the payments to Shelgrove or the bonuses that are alleged to have been taken in breach of the understanding on which the parties agreed to invest in the Company.

I shall accordingly hear further argument from the parties about the directions I should make to enable the Amended Petition to go forward to trial. In that regard, (but subject to any further limited submissions Mr Purle QC may wish to address to me on particular paragraphs of the draft pleading and subject to one exception that I will now deal with) I am minded to give the Petitioners leave to amend the Amended Petition to accord with the last of the drafts they produced in the course of the hearing before me. The one exception is paragraph 27(g)(A)(iii) of the latest draft, which states:

In addition, the injunction presently in force restraining dispositions of the Petitioners’ shares will continue until trial.

I must finally deal with the Petitioners’ application dated the 24^th November 2005 seeking to join Hacker Young as an additional Respondent to the Petition on the grounds that it is an “interested party” within CPR 19.2. In that regard, one of the further amendments to the Amended Petition that was put before me in the course of the hearing seeks declarations that neither the first nor second Hacker Young Valuations constituted a certificate of market value within regulation 10.2 of the Company’s Articles of Association.

From the terms of CPR 19.2 and from a passage to which I was taken in Re Little Olympian Each-Ways Limited[1994] 2 BCLC 420, where Lindsay J said at p.429: