Sharafi & Anor v Woven Rugs Ltd & Ors

Mohammed Mehdi Sharafi and his brother Amir Hossein Sharafi apply to the court for relief under s.994 of the Companies Act 2006 in respect of what they say has been the unfairly prejudicial conduct of the affairs of Woven Rugs Limited (the company) by Al-Malik Carpets (Private) Limited (AMC) acting for the most part by the third respondent Vaqar Ahmed Malik. The Sharafi brothers, trading as Sharafi & Co, hold 40% of the shares of the company, while AMC and Mr Malik hold the balance of 60%.

The petition was presented on 16 March 2007 by the Sharafis as contributories and the claim was confined to an order to wind up the company on the just and equitable ground. By an order of Mr Registrar Rawson made on 8 November 2007, the claim for a winding-up order was struck out and permission was granted to amend the petition to seek relief under what was then s.459 of the Companies Act 1985.

Section 994 re-enacted s.459 of the Companies Act 1985 without substantive amendment and came into force on 1 October 2007. A member of a company may seek relief on the grounds 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 some part of its members (including at least himself)”. The court may make such order as it thinks fit for giving relief in respect of the matters complained of.

Business dealings between the Sharafis and Mr Malik and AMC began in 1993 or 1994 when AMC accepted the invitation of the Sharafis to share business premises within a large commercial property at 53/79 Highgate Road, London (the Highgate premises). Both carried on business as dealers in oriental rugs, the Sharafis dealing wholesale in Persian rugs and AMC dealing wholesale and retail in Pakistani and Afghan rugs. This reflects their national origins, the Sharifis coming from Iran and Mr Malik coming from Pakistan. They were not in direct competition, and an advantage in the sharing arrangement was perceived to be that wholesale customers would see carpets and rugs of both types in one visit.

The property at Highgate is divided into units all of which are occupied by dealers in oriental rugs and I was told that it is the largest such property in London. There is an issue as to the cost-sharing terms between the Sharafis and AMC. Like a number of issues which arise in the period covered by the late 1990s and early 2000s, it is not one of the grounds of complaint in the petition but is relevant to those grounds. From 1998 to 2000, the Sharafis and AMC were engaged in litigation and negotiations with their landlord, the costs of which were shared on a 60:40 basis between AMC and the Sharafis respectively. The upshot was an agreement made in April 2000 whereby they surrendered their interests in the Highgate premises for a payment of £330,000.

The Sharafis and AMC decided to put the payment towards the purchase of other premises which they would continue to share for their respective businesses. They identified Unit 10, Towers Business Park, Fourth Way, Wembley, Middlesex (Unit 10) and agreed to buy it for £630,000 plus VAT. They negotiated with Royal Bank of Scotland (the bank) for a 15-year term loan of £400,000 to fund both the purchase price to the extent not covered by the compensation of £330,000 and the construction of a mezzanine floor.

Initially the Sharafis and AMC envisaged purchasing Unit 10 in their joint names, but the bank required the purchase to be made by, and the loan to be made to, a “clean” company. Mr Malik suggested that the company be used for this purpose. The company had been incorporated on 21 January 2000 and was owned in association with AMC. It had not traded or done any business and therefore met the bank’s requirement. Unit 10 was purchased on 28 April 2000 by and in the name of the company and the bank’s term loan was made to the company. The bank also provided an overdraft facility of £110,000 to enable the VAT on the purchase price to be paid, and the overdraft was supported by personal guarantees given by Mehdi Sharafi and Mr Malik.

The initial director of the company was Amir Khan, an employee of AMC. Mehdi Sharafi was appointed a director on 1 March 2000. The share capital, comprising 100 shares, was issued to and held by AMC and Mr Malik and by the Sharafis in the proportions 60:40. The sum of £330,000 was provided to the company by way of unsecured loan on interest-free terms, subordinated to the bank loan.

There is an issue between the parties as to who provided the loan and on what terms, which itself raises an issue as to the terms on which they had agreed to split the compensation monies. The Sharafis say that it was agreed to split the compensation on a 60:40 basis between AMC and the Sharafis respectively and that it was lent to the company on the same basis. This is disputed by AMC and Mr Malik, whose position in these proceedings is that the compensation was paid to AMC on terms that a percentage as yet to be determined would be payable to the Sharafis and that the loan to the company was made exclusively by AMC.

The company leased Unit 10 to AMC and Sharafi & Co at a rent for which they are jointly liable, designed to meet the monthly payments due to the bank under the term loan. There is an issue as to the division of responsibility for payment of the rent as between AMC and Sharafi & Co. The Sharafis say that it was agreed to be divided on a 60:40 basis, which in fact reflected the approximate occupation of the property when they moved into it. AMC and Mr Malik say that each would pay the proportion which reflected the extent of their occupation from time to time. On this basis, they agree that it started on the basis of a 60:40 apportionment.

A further issue is whether it was agreed and understood that the sole purpose of the company was to purchase and hold Unit 10 and to lease it to the parties. The Sharafis say that it was, while AMC and Mr Malik say that it was envisaged that it would trade in order to raise additional income to meet any shortfall in its outgoings. It is common ground that there was no other business carried on by the company until mid-2005. AMC alleges that at that point the company made an agreement with it for the future supply of Pakistani rugs.

From an early stage following the move to Unit 10, the parties’ relationship has been mired in disputes and litigation. In November 2000 AMC commenced proceedings against the Sharafis in the High Court, later transferred to the Central London County Court (the 2000 proceedings). These proceedings were prompted by notice given by the Sharafis to AMC to vacate the Customs bond in their name in Unit 10, but ultimately a wide variety of claims and counterclaims relating to their occupation of Unit 10 and associated costs were raised by AMC and by the Sharafis. The 2000 proceedings ended with an order dated 22 May 2002 following a 5-day trial, giving judgment for £53,115 on AMC’s claim and for £54,441 on the Sharafis’ counterclaim. In 2005 the company on the instructions of Mr Malik brought proceedings against the Sharafis in the Willesden County Court, seeking £2228 in respect of service charges alleged to be due (the Willesden proceedings). Judgment was given on 17 October 2006 following a trial, for part of the claim. The Sharafis’ objections to some of the service charges were held to be well-founded.

AMC and Mr Malik took steps to take control of the board. In February 2001 AMC requisitioned a meeting of shareholders, with a view to removing Mr Mehdi Sharafi as a director and appointing Mr Malik who until then had not been a director. The Sharafi brothers refused to attend a meeting convened for that purpose, with the result that it was inquorate and could not proceed to business. AMC accordingly applied to the High Court for an order under s.371 of the Companies Act 1985 convening a meeting with a direction that one member could constitute a quorum.

The application was heard by Mr Anthony Mann QC, sitting as a deputy judge of the Chancery Division, and he made the order sought: see Re Woven Rugs Ltd [2002] 1 BCLC 324. The application was resisted by the Sharafis, principally on the ground that there was an express agreement between the parties to the effect that each of AMC and Sharafi & Co. should have one director on the board. Mr Malik and Mr Amir Sharafi gave oral evidence, and it was the latter’s evidence that the agreement was reached in a discussion which he had with Mr Malik. Mr Malik denied that there was such an agreement. The judge rejected the defence, finding that while there may have been some casual conversation about directorships, it was insufficient to give rise to a binding agreement and was not treated by any of the parties as doing so.

An alternative defence was that the relationship between the parties was such that it would be unfairly prejudicial to exclude the Sharafis from participation in management. The judge concluded that the evidence before him was insufficient to enable him to conclude that it would be unfairly prejudicial. The judge said that he was in part hampered by the refusal of AMC to respond to requests to give reasons for its course of action or its plans once it obtained board control. He said at para 30:

“I think that Miss Roberts suggested that AMC may have nothing further specific in mind at present — they just wanted to exercise the rights that they had. If that is the suggestion then I have to say I do not accept it. I think it very likely that AMC has some further specific step or steps in mind once it has board control and it is choosing not to disclose them. However, whether or not that is unattractive, I do not think that that stance is sufficient to enable me to say that it should not be able to enforce its rights as majority shareholder.”

As to future prospects for relations between the parties the judge observed at para 32:

“That evil day is the day of the commencement of proceedings under s.459. I can see that, if the parties do not resolve their disagreements shortly, such an application is more or less inevitable. That does not deter me from exercising the discretion in favour of Miss Roberts' client any more than it deterred Morritt J in the Opera Photographic case (see page 637). It may well be that the removal of Mr Sharafi from the board will be the trigger for those proceedings; but while no one would want to encourage the start of such notoriously expensive and difficult proceedings as those, such proceedings do seem to me to be the proper forum for adjudicating on a question of whether, in the circumstances, and in the absence of a shareholders agreement as to directorships, it is unfair to remove the Sharafi representative from the board and/or appoint additional directors, and if so what the appropriate relief is. If there has to be a forum for resolving the corporate dispute between the parties, then that seems to me to be it. Much of what Mr Chivers submitted to me in this hearing amounted to an invitation to embark on that sort of inquiry on the basis of something less than the full picture that will doubtless be presented to the court hearing a petition, and without the flexibility of the sort of remedies available in such proceedings. While determining petitions on full evidence and with a full range of remedies is bad enough, determining them on insufficient evidence (which is what the evidence in the present hearing amounted to) and with only a blunt instrument at the court's disposal is even worse.”

Following the judgment, the Sharafis’ solicitors stated in correspondence that, in the absence of agreement on open offers exchanged between the parties, proceedings would be brought under s.459. Agreement was not reached but the removal of Mehdi Sharafi and the appointment of Mr Malik did not in the event trigger an unfair prejudice petition. However, in the present petition, Mehdi Sharafi’s removal is relied on as one of the grounds of unfairly prejudicial conduct, as being in breach of the understanding between AMC and the Sharafis that, among other things, each side would be entitled to board representation and to participation in the management of the company. There is of course no challenge to the finding in the earlier case that there was not a binding agreement to this effect. I consider on the evidence in the present case that both sides did expect that each would be represented on the board and be involved in the company’s management. In particular this follows naturally from the reasons for their involvement together in the company. However, as I indicated to Mr Potts, counsel for the Sharafis, at an early stage in the hearing, I consider it to be now too late for the Sharafis to rely on it as being by itself a ground for relief. Mr Sharafi was removed from the board in January 2002 and proceedings were not commenced until over five years later. The Sharafis acquiesced in the situation created by Mehdi’s removal. Its significance lies more in creating the circumstances for the subsequent events and conduct on the part of AMC which, the Sharafis allege, amount to unfairly prejudicial conduct of the company’s affairs.

By June 2005 the company’s liability on the bank loan had been reduced to £235,956. In August 2005, Mr Malik caused the company to enter into a new loan agreement with the bank for £620,000. This was done without reference to or the knowledge of the Sharafis. Mr Malik relied on the undoubted power of the directors under the company’s articles of association, incorporating the standard provisions of Table A, to manage the business of the company and on the absence of any requirement in the Companies Acts or under the articles to inform or seek the approval of shareholders.

The additional funds raised, in excess of the sum required to repay the existing indebtedness to the bank, were applied as follows. £202,000 was paid to AMC in or towards repayment of the debt due to it. The Sharafis allege that this constituted unfairly prejudicial conduct, because, first, it replaced a non interest-bearing, unsecured, subordinated debt with a secured, interest-bearing debt and, secondly, by making no payment to reduce the amount due to them, Mr Malik preferred the interests of AMC to theirs. A further sum of £75,000 was paid to AMC. The Sharafis were not aware of this payment until late August 2009, when bank statements showing the transfer were produced pursuant to an order for specific disclosure. Mr Malik’s explanation in evidence was that it was an advance payment for rugs to be supplied over the following five years. The Sharafis allege that it was simply a misappropriation of company funds. Further sums were paid by way of management charges to AMC and by way of salary to Mr Malik and Mohammed Saeed Zafar, an employee of AMC and the secretary of the company from 28 February 2002.

The Sharafis contend that the refinancing was a breach of fiduciary duty by Mr Malik and unfairly prejudicial conduct, as it greatly increased the company’s indebtedness to the bank, not to further the interests of the company but to enable substantial sums to be extracted from the company for the benefit of AMC and Mr Malik.

The Sharafis complain also that steps were then taken to conceal the re-financing and payments to AMC from them. No mention was made of them in the accounts for the year to 30 June 2005 sent out in March 2006 or at the annual general meeting held on 20 April 2006. Mr Malik caused the company to extend the financial year end for the next year, which included the re-financing, from 30 June 2006 to 31 December 2006. The accounts for that period were due to be filed at Companies House by 31 October 2007 but were not filed until 12 March 2007. The Sharafis allege that no copy of those accounts was provided to them, and only abbreviated accounts for the following year, to 31 December 2007, were provided. No annual general meeting was held in 2007 or thereafter. AMC says that an extraordinary general meeting was held on 17 August 2006 at which it was resolved to dispense with annual general meetings and the laying of accounts and reports before general meetings. The Sharafis deny receipt of any notice of such meeting and say that in any event a valid elective resolution for such purpose required, in accordance with s.379A of the Companies Act 1985, the unanimous approval of members entitled to vote.

In March 2007 AMC vacated Unit 10. It continued to pay rent for the following three quarters but has paid no rent since then. The Sharafis allege that the failure of Mr Malik on behalf of the company to demand rent from AMC and pursue it for non-payment is a breach of fiduciary duty, designed again to favour AMC against the company and the Sharafis.

In July 2007 Mr Malik caused the company to enter into a further loan agreement with the bank, re-financing the loan taken out in 2005. The new loan was for 13 years and required monthly payments of £6,430, commencing in December 2007. A further fee of £6,200 was paid to the bank. The Sharafis allege that this re-financing was also a breach of fiduciary duty. In my view, which I indicated in the course of the hearing, it added little to the Sharafis’ case. As the 2007 re-financing did little more than replace the 2005 re-financing and did not generate additional funds, their case depended on establishing that the 2005 re-financing and the application of the funds raised by it constituted unfairly prejudicial conduct. If they failed on the 2005 re-financing, it was hard to see how the 2007 loan could be impugned.

The company made no monthly payments under the 2007 loan agreement. The Sharafis had continued to pay 40% of the rent but without any further payment from AMC, there were insufficient funds to service the new payments to the bank. On 28 April 2009 the bank, as a qualifying floating charge-holder, appointed administrators.

A further issue arose on the respondents’ amended points of defence. They alleged that at a without prejudice meeting held in February 2007, attended by Mr Malik and the Sharafis, a binding agreement was made by which all their disputes were compromised. The respondents allege that this provides a complete answer to the petition. While the meeting and settlement discussions, and indeed an agreement in principle, are admitted, it is denied that a contract was in the event concluded. Although resolution of the issue as to whether a binding agreement had been made involved evidence of without prejudice discussion and documents, the parties did not object to the issue being heard by me as part of the trial.

The central issue is whether the 2005 re-financing and the application of the funds raised by it amounts to unfairly prejudicial conduct of the company’s affairs. In order fully to determine this issue, it is relevant to determine the issues arising from the earlier periods.

The principal witnesses were Mehdi Sharafi and Mr Malik. Amir Sharafi did not give evidence. The only other witness was Mr Zafar.

Mr Sharafi is an intelligent man, who gave clear and considered evidence. I am satisfied that he was a truthful witness. Mr Malik is also intelligent, but I regret to say that I found his evidence to be highly unsatisfactory. In a number of important respects, to which I will later refer as they arise in the narrative of facts, I disbelieved his evidence. I have concluded that it is difficult to place any weight on his uncorroborated evidence.

I should record that I was told by counsel for the respondents at the start of the trial that Mr Malik was not in good health and there was said to be doubt as to whether he would give evidence. I made clear that steps would be taken to accommodate any problems. In the event, he did attend and started his evidence in the afternoon of day 5 of the trial. He appeared somewhat weak that day, but thereafter, apart from once complaining of a headache, did not appear to be suffering the effects of any ill health and appeared well able to give evidence.

I will now deal in more detail with the evidence as it relates to the issues in the case.

There is no dispute that the business arrangements relevant to this case were between Sharafi & Co and AMC, and until a very late stage there was no dispute as to the control and ownership of AMC. This case and earlier proceedings had proceeded on the basis that Mr Malik was the controller and majority shareholder of AMC. However, in his witness statement served in mid-October 2009, Mr Malik asserted that his mother-in-law, Mrs Zohra Nazir, had at all times been the sole investor and beneficial owner of AMC.

In paragraph 3 of the points of claim, it was pleaded that Mr Malik was the effective owner and controller of AMC. This was admitted in the points of defence dated 8 February 2008, which were verified by a statement of truth signed by Mr Malik.

This was consistent with evidence in earlier proceedings. In the 2000 proceedings, a witness statement was made on behalf of AMC by Naveed Yousaf, a director and holder of 15% of its issued shares. He stated, “The effective managing director is a Mr Vaqar Ahmed Malik. He and his wife Mrs Saira Vaqar Malik are the principal shareholders” (para. 2). He explained that he was making the statement rather than Mr Malik because the latter was in Pakistan.

In a witness statement made on 8 April 2002 in the same proceedings, Mr Malik stated that in 2000 the shares in AMC were held by himself (30%), his wife (30%), Naveed Yousaf (l5%), Saeed Khan (15%) and Amir Nawaz Khan (10%), and that the shareholdings changed in September 2001 so that the shares were held by himself (60%), his wife (30%) and Amir Nawaz Khan (10%). He said that he was the chief executive of AMC and divided his time between London and Pakistan.

In his judgment given on 3 December 2001, in the proceedings under s.371 of the Companies Act 1985, Mr Mann QC said, without any suggestion that this was controversial, that AMC “is effectively a vehicle of Mr Malik” (para.4).

In the present proceedings, re-amended points of claim, repeating paragraph 3 of the original points of claim, were served on 1 April 2009. Re-amended defences of AMC and Mr Malik were served on 2 June 2009, with Mr Malik’s points of defence adopting those served by AMC. The response to paragraph 3 of the points of claim was amended to the following:

“Denied. At the time of purchase of the property the board of directors of AL-Malik Carpets PVT LTD, the SECOND RESPONDENT, comprised of Mr Saeed Khan, Mr Amir Nawaz Khan (chief representative officer), Mr Naveed Yousaf and Mr Vaqar Malik. All of the directors were also significant shareholders of Al-Malik Carpets Pvt Ltd. The company’s main base of operation is in Pakistan and it is in Pakistan where the control of the company lies.”

Mr Malik’s witness statement in these proceedings was not served until mid-October 2009 and was made, he states in paragraph 1, on behalf of AMC and himself. Paragraphs 2 to 4 read as follows:

“2.The Second Respondent is a company incorporated in Pakistan in 1987 under the name and style of Al-Malik Carpets (Pvt) Ltd. The company was incorporated on the instructions of Mrs Zohra Nazir in or around March 1987. Mrs Nazir is the sole investor in the company and at the time of formation Mrs Nazir had caused the shares to be put in the names of 3 individuals Mr Amir Nawaz Khan, Mr Saeed Khan and Mr Naveed Yusuf. These shares were held on trust for Mrs Nazir and the term commonly understood in Pakistan is ‘Benami’.

3.

The Second Respondent started working as a cottage based industry with the principal aim of manufacturing and exporting oriental carpets from Pakistan. Whilst the shares were allocated to the above persons there was no contribution in the capital subscription of the company by these people as all of the capital came from Mrs Zohra Nazir.

4.

The Third Respondent [Mr Malik] was invited to participate in the company by Mrs Nazir and in 1990 was also allotted some shares on the basis that the beneficial owner of the company would be Mrs Nazir and that the shares were held in trust. The concept of Benami is very widely used in Pakistan and almost all family run companies are constituted in this manner. The main purpose of this is to ensure that whilst the ownership rests with the investor the managers are given an opportunity to conduct business with confidence.”

This evidence that Mrs Nazir has always been the beneficial owner of the shares of AMC is inconsistent with the evidence in earlier proceedings and the original points of defence in these proceedings. Until this witness statement, there had been no mention of any interest of Mrs Nazir in AMC, still less that she was the sole investor and beneficial owner. In cross-examination, Mr Malik’s explanation was that she did not want it to be known. He said that the admission in the original points of defence in the present proceedings was a mistake. However, even when paragraph 3 of the points of claim was denied in the re-amended points of defence, the assertion was that at the time of purchase of Unit 10, there were four directors all of whom were “significant shareholders” of AMC. There was no suggestion of a different beneficial owner and no mention of Mrs Nazir. All that was said was that control of the company lies in Pakistan. Mr Malik’s explanation was again that Mrs Nazir did not want her name to be known. When asked why he was now naming her, he said that although he had tried very hard to keep the company afloat, there had been no appreciation of his efforts from head office in Pakistan. Enough was enough, he said.

I have no hesitation in rejecting Mr Malik’s evidence. When set against the consistent stance taken by AMC and Mr Malik in various proceedings since 2000, including the present proceedings, it is implausible. He had no satisfactory explanation as to why he should have given a personal guarantee of the company’s overdraft of £110,000 if he was not a beneficial owner of shares in AMC. No documents were disclosed which evidenced or suggested that Mr Nazir was the beneficial owner of the shares; none existed, said Mr Malik. I consider that Mr Potts was correct in his suggestion to Mr Malik that it is an untrue story put forward as a basis for contending that, if the petition succeeds, any order should be made against AMC, not Mr Malik personally.

There is a good deal of common ground. Sharafi & Co were from 1991 the tenants of unit F2.3 at the Highgate premises with a floor area of about 2936 square feet. In 1993 or 1994 Sharafi & Co offered AMC storage space within Unit F2.3 and shared use of its Customs bond. AMC accepted and, after an initial period, the parties agreed to share the costs on a 50:50 basis. In 1995 AMC took a lease of an adjacent unit, F2.3, with a floor area of 4976 square feet, and the parties agreed to share occupation of the two units. Partition walls were partially removed to create a single storage space as required by the Customs bond. Because AMC was occupying a larger area, the parties agreed to share occupation costs, including rent, rates and service charges, on a 60:40 basis between AMC and Sharafi & Co respectively. Further shared expenses were paid on the same basis. Subsequently, AMC, requiring further space, took a lease of a unit on the same floor, unit F2.1 with a floor area of about 6,000 square feet. It was solely responsible for the rent of this unit.

The arrangements were clearly spelt out by Mr Malik in a witness statement he made in the 2000 court proceedings on 8 April 2002:

“The costs of shared warehouse employees at the Highgate premises were shared in the proportion 40:60 with Sharafi & Co paying 40% and Al-Malik Carpets paying 60%. I have already made clear that the arrangement at the Highgate premises involved the sharing between Al-Malik Carpets and Sharafi & Co of a number of facilities. Apart from the expenses relating to Unit 9, which were paid for solely by Al-Malik Carpets (although from which Sharafi & Co derived a considerable benefit) it was agreed that the expenses would be shared. I sat down with Mehdi Sharafi soon after Unit 10 was acquired to agree on the split. We discussed the matter and arrived at the 40:60 ratio referred to above. I cannot now remember the route by which we arrived at this figure, but I think it was roughly related to the respective benefit we derived from the floor area of Units 10 and 11 (excluding Unit 9 where Sharafi & Co had stated they were unable to contribute).”

On 25 February 1998 the landlord served notices to quit, requiring them to vacate by September that year. Mehdi Sharafi and Mr Malik agreed that AMC and Sharafi & Co would resist this and share legal costs on a 60:40 basis. Proceedings were brought by AMC and Sharafi & Co in the Central London County Court under the Landlord and Tenant Act 1954 and were compromised by consent orders made in March 1999. Under the terms of the consent orders AMC and Sharafi & Co agreed to surrender their existing tenancies on terms that a lease of premises on the ground floor of the Highgate premises be granted to them jointly for a term of nine years from 25 March 1999.

Although their obligations were to be expressed in the new lease as joint and several, paragraph 2 of the consent order provided that the landlord would simultaneously provide a side letter, binding on the landlord and its successors in title but personal to AMC and the Sharafis, under which the landlord would separately demand rent, insurance and service charges from AMC and the Sharafis on a 60:40 basis.

Disputes soon arose with the landlord in relation to works to be carried out to the Highgate premises. AMC and the Sharafis commenced proceedings against the landlord in the Chancery Division and again agreed to share costs on a 60:40 basis. The proceedings were compromised by a consent order made on 5 November 1999. The landlord agreed to pay £47,000 to AMC and the Sharafis, which they agreed to divide between them in the proportions 60:40 respectively. This sum was paid to their solicitors and applied in the payment of outstanding fees. The order made further provision for execution of the new lease and delivery of the side letter required by the earlier consent order.

The evidence clearly establishes, and it is largely common ground, that the costs of occupation of units F2.2 and F2.3 at the Highgate premises were split on a 60:40 basis, as were the costs of litigation with the landlord and the compensation of £47,000 paid by the landlord. Similarly, it was agreed that the costs of occupation of the ground floor premises which were to be let under the new lease would be split in the same proportions.

Following the settlement of the Chancery Division proceedings, the landlord indicated in discussions that it would be prepared to pay compensation for the surrender of the interests of AMC and the Sharafis in the Highgate premises. The landlord had obtained permission for an advantageous change in use of the premises. Negotiations were conducted by Mehdi Sharafi on behalf of AMC and the Sharafis and agreement was reached on a figure of £330,000. An agreement was signed in April 2000, whereby AMC and the Sharafis agreed to surrender their existing leases of units F2.1, F2.2 and F2.3 and their rights under the consent orders to a lease of the ground floor premises. The landlord agreed to pay £330,000 plus VAT to Cooke Matheson as solicitors for AMC and the Sharafis.

In late 1999 and early 2000, while discussions continued with the landlord, Mr Malik and Mehdi Sharafi were looking for alternative premises. They found the freehold premises at Unit 10 in Wembley, which they agreed to purchase, subject to contract, for £630,000. As the sales memorandum prepared by the vendor’s estate agents and other documents show, it was at first envisaged that Unit 10 would be purchased in the joint names of AMC and Sharafi & Co.

It was necessary to raise funds to pay the balance of the purchase price over the compensation to be paid by the landlord of the Highgate premises. Under cover of a letter dated 14 March 2000 addressed to Mehdi Sharafi, the Royal Bank of Scotland (the bank) sent indicative terms for a term loan of £400,000. The letter stated:

“I should emphasise that the facility letter assumes that the purchase is made through a new Limited Company which will be owned 60:40 by Al-Malik and Sharafi & Co. Evidence of this will be required.”

The indicative terms defined the borrower as “Newco owned on a 60:40 basis by Al-Malik Carpets (pvt) Ltd and Messrs Sharafi & Co.”

Mr Malik suggested, and the Sharafis agreed, that the company should be used as the purchaser of Unit 10. Although owned on the AMC side and having a name which had been used by a company associated with AMC for trading in rugs, it was a dormant company which had not traded or done any business. It answered the bank’s requirement for a new or clean company.

The company’s records and formal documents in evidence suggest that the necessary steps had already been taken to allot the shares in the company on a 60:40 basis. The annual return for 2002 states that Mehdi Sharafi was registered as the holder of one share on 21 January 2000. A handwritten minute of a board meeting stated to be held on 28 February 2000 states that the issue of 59 shares to AMC and of 39 shares to Mehdi and Amir Sharafi jointly was approved, with the addition of a note that the parties will hold the shares, as to 60% by AMC and 40% by the Sharafis.

Whatever the precise sequence of events, the position was reached by April 2000 that the company was owned in the 60:40 proportions, with shares registered as follows: AMC 60 shares, Mehdi and Amir Sharafi 39 shares, Mehdi Sharafi 1 share. Mr Malik was registered with one share when he became a director in January 2002.

The proposal, as discussed with the bank, was that the monthly repayments to the bank should be financed by rent paid under a lease of Unit 10 to be granted by the company to AMC and Sharafi & Co.

The loan agreement was made in April 2000. Its purpose, as stated by cl.1 of the agreement, was to assist in the purchase of Unit 10. One of the pre-conditions was that a lease acceptable to the bank was in place. Repayment was to be by 179 monthly payments of £3,924.88 with a final payment of £3,925.47. Clause 11 contained undertakings by the company, one of which was that the company would not make any change in the nature of the business conducted. As security, the company granted a legal mortgage over its interest in Unit 10 and fixed and floating charges in standard terms.

On 28 April 2000, the purchase of Unit 10 was completed and the bank loan drawn down for that purpose. On the same day the lease of Unit 10 by the company to AMC and the Sharafis was executed. It was for a term of 15 years, matching the term of the bank loan, at an initial yearly rent of £50,000 payable quarterly in advance.

There are three areas of dispute arising out of these arrangements. The first relates to the basis on which the compensation of £330,000 was provided to the company and applied to the purchase of Unit 10. The second concerns the basis on which the rent payable under the lease of Unit 10 would be split. The third concerns the purpose or purposes for which the company would be used.

As to the payment of the compensation to the company, the Sharafis’ case is that it belonged to AMC and the Sharafis in the 60:40 proportions and was advanced by them respectively in those proportions to the company. This was consistent with the prior arrangements involving a 60:40 division of the litigation costs, the 60:40 division of the liabilities under the new lease to be granted to them of premises on the ground floor of the Highgate premises, and the 60:40 split of the sum of £47,000 paid by the landlord under the consent order in November 1999. Mehdi Sharafi gave evidence of a discussion with Mr Malik while they drove to view possible alternative premises. They agreed that the compensation should be split 60:40, subject to Mr Malik receiving any statutory compensation for unit F2.1. In fact the agreement reached with the landlord did not involve the payment of any statutory compensation, so the sum of £330,000 fell to be divided in the 60:40 proportions. The Sharafis rely on the 60:40 division of the shares of the company as being consistent with this agreement.

AMC accepts that there was discussion in the car on the way to view an alternative property as to the division of any compensation which might be paid by the landlord and that there was agreement that subject to statutory compensation there would be a 60:40 split, but on certain terms. In further information of AMC’s particulars of claim in the 2000 proceedings against the Sharafis, it was put as follows:

“Vaqar Malik told Mehdi Sharafi that if he continued to make timely payments of his share of the litigation expenses, and provided the parties’ trading arrangements continued in terms of co-operation and joint marketing of goods, then Al-Malik Carpets Ltd would agree to allocate each unit its statutory compensation, and for the remaining premium to be divided in the 60:40 ratio. Mehdi Sharafi agreed to this, expressing his satisfaction, and saying that this would provide both parties with a good opportunity to continue to work together with greater enthusiasm.”

The same agreement is pleaded in the present proceedings, together with an assertion that the allotment of shares in the company to the Sharafis was subject to the same conditions.

As to the allotment of shares, AMC and Mr Malik plead that the purchase of Unit 10 “was made to serve the interest of the group of companies led by [AMC] and the only reason why [the Sharafis] were invited to participate in the shareholding of [the company] was to ensure the continued promotion of [AMC’s] trading interest”. It was said in closing to be their case that the issue of shares was conditional on a continuation of a mutually beneficial relationship.

It is AMC’s case that the Sharafis failed to fulfil the conditions, and that therefore the agreement to split the compensation on the 60:40 basis, and presumably the allotment of the shares, are no longer effective.

Somewhat confusingly, AMC also pleads that the compensation of £330,000 was paid to AMC on behalf of both parties, but with no agreement at that time as to how it should be split between them. An alternative basis of division is put forward. It points out that as it was the sole occupant unit F2.1 comprising 6,000 square feet, as well as being responsible for 60% of the combined rent for the other two units, it surrendered leases of substantially larger areas than the Sharafis at the Highgate premises. It pleads that “Therefore, the interest of each party in these compensation monies is reflected as stated in paragraph above [83% for AMC, 17% for the Sharafis], in a proportionate manner to the space rented. This is an accepted principle in property compensation and it would have been an implicit term of any agreement that would be reached between the Landlord, [AMC] and [the Sharafis]”.

I am satisfied that the agreement as regards the division of the compensation was as stated by the Sharafis. It is entirely consistent with the previously agreed division of litigation costs, liability for the proposed new lease on the ground floor of the Highgate premises and the payment of £47,000. It is consistent too with the allotment and issue of shares in the company.

It is supported by the contemporaneous evidence. On 20 September 2000, Mr Malik sent a long email to Mehdi Sharafi dealing principally with the occupation and costs of Unit 10. At the end of it he added:

“There were questions in Amir Sharafi’s mind as to how the premium was to be split up. On this, I am quite clear that we had this discussion in the car when we were going to see the “bicycle stand” and we agreed upon a formula according to which the premium would be dealt with. I had said that although the premium should be split in accordance with the relevant areas occupied we had also taken into consideration the fact that the legal fees were being split in the 60-40 ratio. Therefore, what we agreed upon was that each unit would get its statutory compensation which it would be entitled to in any event. In case a higher amount of money was obtained from the landlord i.e. “The Premium”. Then this surplus amount would be split in the 60/40 ratio. This is due to the fact that the legal fees were being split in that ratio as well as the expenses for the two joint units.”

There is no reference to any conditions.

In the company’s ledgers maintained by its accountants, the advance to the company funded by the compensation was shown as split 60:40 between AMC and Sharafi & Co. Mr Malik queried this in a letter dated 8 February 2001 to the accountants:

“Please refer to your ledger related capital account. In this ledger you have divided the sum of £62,000 received from Cooke Matheson in a capital ratio of 60:40 and credited ‘Sharafi & Co’ and ‘Al-Malik Carpets (Pvt) Limited; capital account respectively.

There is an inherent error in the way you have distributed this amount. You have been aware for some while that these funds have included the statutory compensation received from our previous landlord at Highgate Road.

You are advised that both ‘Sharafi & Co’ and ‘Al-Malik Carpets (Pvt) Limited’ should first be credited with the statutory compensation received in respect of their respective units and the balance divided in a 60:40 ratio as had been previously agreed with Mehdi Sharafi.”

Again, there is no mention of any conditions.

In the re-amended particulars of claim served by AMC in July 2001 in the 2000 proceedings, AMC pleaded:

“an agreement to divide the additional compensation payable by the landlord for the parties vacating 53/79 Highgate Road, London NW5 (above the statutory compensation payable under section 37 of the Landlord and Tenant Act 1954) in the proportions 60:40 rather than in accordance with the respective rateable values of Al-Malik Carpets’ and Sharafi’s holdings;..”

I also take into account in reaching my conclusion further inconsistence in the versions of events put forward by AMC and Mr Malik. In his witness statement dated 13 October 2009 in the present proceedings, Mr Malik stated:

“33.

Agreement was reached on the sum of £330,000 to be paid as compensation for all three units on the Highgate Road complex. However this money was paid to the Second Respondent as the principal beneficiary of the compensation monies. This was with the agreement of the First and Second Petitioners. The Second Respondent alone raised an invoice in favour of the landlord under the terms of the agreement. It is acknowledged that this sum of money also includes the entitlement on Unit F2.3 which was rented by the Petitioners. This invoice was raised with the agreement of the First and Second Petitioners because the Petitioners recognised that the principal entitlement to this money was that of the Second Respondent and additionally because the Petitioners had not been making their contributions to the litigation expenses thereby placing an additional financial burden on the Second Respondent. The maximum entitlement of the Petitioners to this compensation is 17% or less. This calculation is based on Ross Jaye’s evaluation of the units while taking into account the floor area of each unit.

34.

As the Second Respondent needed to have an alternative premises to house its large collection of rugs it used the compensation monies to give a loan to Woven Rugs Ltd for the purchase of a Warehouse in Wembley. Although the Second Respondent had been interested in purchasing the warehouse in its own name, being a foreign based company it found the financial assistance from UK banks to be difficult.

35.

As a consequence of the Sove [sic] the Second Respondent decided to purchase the property in the name of its sister concern, Woven Rugs Ltd.

36.

It was always intended that Woven Rugs Ltd would trade in the retail market as well as holding the property in its own name. The sum of £330,000 was given as a loan by the Second Respondent to Woven Rugs Limited, to enable the First Respondent to buy the warehouse in Wembley. The Second Respondent retained the right to use part of the money for settling the considerable outstanding litigation costs.

37.

At the time of the payment of the compensation monies there was no clear agreement as to how the money was to be split between the First and Second Petitioners and the Second Respondent. In this context Ross Jaye had already carried out a survey in 1999 of the capital enhancement values. Therefore it would be reasonable to expect that the compensation monies would be split along those lines as well. What was never in doubt was that the compensation monies were paid to the Second Respondent through its solicitors and was taken into the books of accounts by the Second Respondent. The account maintained by the solicitors in which the money was received was solely in the name of the Second Respondent all the instructions given with regard to the final disposal of these monies into the account of Woven Rugs Ltd was given solely by the Second Respondent.

38.

The compensation monies were given to the Second Respondent with the agreement of the First and Second Petitioners. There can be no confusion on this account as the First and Second Petitioners had never prepared an invoice or indicated that they would need part of the monies to be paid in settlement of their invoice. … A conditional offer was made to the First Petitioner that if he continued to work for the benefit of the Second Respondent under the working relationship then the Second Respondent would be prepared to grant a larger share than the Petitioners entitlement in the compensation monies that the Second Respondent had received. This offer was made to encourage the First Petitioner to assist with the marketing effort of the Second Respondent. Upon the occupation of the Wembley premises the First Petitioner breached this very important term and started to work against the interest of the Second Respondent.”

This account is entirely inconsistent with the documents in 2000 and 2001 which I have earlier quoted and with the stance adopted both in pleadings and witness statements in the 2000 proceedings.

I reject Mr Malik’s statement that the provision of the compensation money to the company was an advance by AMC alone. It pre-supposes that the Sharafis had no interest at all in the compensation, which is little short of absurd. In his closing speech, Mr Macpherson acknowledged that the compensation was paid for both AMC and the Sharafis, but in indeterminate amounts. He submitted that AMC received the totality of the compensation, for which it alone issued a VAT invoice, and lent it to the company, but on terms that AMC would pay the Sharafis their share once it was agreed or determined. While it is the case that the VAT invoice was issued to the landlord by AMC alone, I accept Mehdi Sharafi’s evidence that this was done at the suggestion of Mr Malik as the easiest means of dealing with the VAT. The compensation was paid to Cooke Matheson who were instructed jointly by AMC and the Sharafis in their dealings with the landlord, as the agreement with the landlord provided and as AMC itself pleaded in the particulars of claim in the 2000 proceedings. AMC also pleaded that AMC and Sharafi & Co purchased Unit 10 at a price of £630,000 plus VAT and that the registered title was transferred into the name of the company: a substantially, if not strictly, accurate statement. These allegations were admitted by the Sharafis and I do not think that AMC gets any support from the Sharafis counterclaim in the same action for an account of the compensation money.

An advance by AMC alone is inconsistent with the treatment of the loan in the ledger accounts which I have mentioned. It is inconsistent also with its treatment in the audited accounts for its first accounting period, ended 30 June 2001, and for the following four years. The notes show that there is included in the creditors falling due after one year both the bank loan and “Shareholders capital account” of £329,025 and state that “the shareholders loans as stated in note 7, are subordinated loans and are not to be paid before the final settlement of the bank loans”. The use of the plural, shareholders and loans, was in my judgment deliberate and accurate.

In February 2008, AMC issued proceedings against the Sharafis in the Chancery Division seeking a declaration as to the division of the £330,000 and claiming that the Sharafis’ share was £30,000. In the particulars of claim, verified by Mr Malik, it is pleaded that the compensation was paid to AMC which in turn lent it to the company. It is also pleaded, quite wrongly, that the loan has always been recorded in the company’s accounts as “a loan from its shareholder”. The particulars of claim continue:

“The parties have never determined how much the Claimant owes the Defendants from the £330,000 and the Claimant seeks a declaration as to the same so as it may fairly determine its relationship with the Defendants.

The Claimant contends that since it was the much larger business of the two agreeing to leave the premises and occupied the most space, negotiated the settlement and received the monies that the £330,000 was paid to it as a premium to depart but accepts that part of those monies are due to Sharafi & Co.”

This is inconsistent with AMC’s stance in the 2000 proceedings and with its own ledger accounts in 2000/01 which showed compensation of £93,716 due to Sharafi & Co. It is also inconsistent with its position in the petition. The figure of 17% on which Mr Malik relies in his witness statement and re-amended points of defence in the petition produces about £56,000. When asked how he came to a figure of £30,000, he said that under a side letter with the landlord, AMC was entitled to occupy a further 2,500 square feet of corridor space on the second floor of the Highgate premises. This was not referred to in the consent orders or agreement with the landlord nor in any pleading or witness statement. Whether or not there was such a side letter, it provides no basis for the claim made in AMC’s proceedings and no explanation for this further inconsistency.

In conclusion, therefore, on this issue I am satisfied that, as agreed between AMC acting by Mr Malik and the Sharafis, the compensation of £330,000 was treated as split 60:40 between them (there being no statutory compensation) and that it was lent by them in those proportions to the company.

The next issue to consider is the terms on which the AMC and the Sharafis agreed to be responsible for the rent and other outgoings on Unit 10. Under the terms of the lease, the obligations were joint and several, as was to be expected of a lease made for the purpose of financing the company’s repayments to the bank and made on terms which had to be acceptable to the bank. There is no inconsistency with this if AMC and the Sharafis agreed as between themselves to divide responsibility. Nor is there any inconsistency if, as the only shareholders, they agreed that the company would in practice require payment of the rent from them in the agreed proportions, provided that it did not release the joint and several obligations of AMC and the Sharafis which would require the consent of the bank.

The Sharafis say that it was agreed that the rent and other outgoings should be shared on the familiar 60:40 basis. AMC and Mr Malik say that it was agreed that each party would contribute in proportion to the occupation of the premises by each party. They say it was to be a flexible arrangement, intended to continue for as long as it suited both parties. If either party were unwilling to continue to share the premises, the other party would take over the premises completely or the lease would be offered for sale or surrendered.

Invoices rendered by the company to AMC covering the period from 28 April 2000 to December 2005 for rent and for service charges consistently refer to “your agreed share of 60%” or similar expressions. Equally, invoices sent to Sharafi & Co refer to their 40% share as agreed. A split of rent and service charges in these proportions was proposed by Mr Malik in his email of 20 September 2000 and the first invoices, referring to the agreed shares, post-date the email.

In the Willesden County Court proceedings, AMC’s claim for service charges was confined to invoices for “the agreed 40% share”. The claim was heard by DDJ Ashworth. Written and oral evidence was provided by Mr Zafar for the company and by Mehdi Sharafi. Both sides were legally represented. In the judgment the judge said:

“At the time the arrangements were entered into it was intended the Claimant would be responsible for all outgoings incurred by the tenants in their occupation and use of the property to be paid for by the tenants in the ratio 60% to Al-Malik Carpets and 40% to Mr M and Mr A Sharafi.”

I find that it was agreed between the parties that the rent and other outgoings on Unit 10 be split 60:40. It is consistent with the previous arrangements between the parties and with their respective interests in the loans to the Company and its share capital. It is borne out by the invoices and the proceedings in the Willesden County Court. There are, moreover, obvious difficulties with the arrangement said by AMC and Mr Malik to have been agreed. How was rent to be shared if, for example, AMC reduced its occupation of Unit 10 without entirely vacating it? If it did vacate Unit 10, how was the rent to be split pending a sale of the lease? It could hardly be supposed that the Sharafis would be responsible for the entire rent and other outgoings while continuing in occupation, pending sale, of only part of it. How was the rent to be split if no sale could be achieved? If the lease were sold, how would any residual liability of the tenants for rent be split if the assignee defaulted? As for a surrender of the lease, it would not be possible without the bank’s consent.

The final issue from this period relates to the purpose of the company as intended or agreed by the parties. The Sharafis’ case is that it was the parties’ intention that it should be used exclusively for acquiring and holding Unit 10 and leasing it to AMC and Sharafi & Co. AMC and Mr Malik say that there was no such intention and that whether it should transact any other business was simply a matter for the board in the usual way, acting under the general powers conferred by the company’s memorandum and articles of association.

It is clear, as AMC and Mr Malik accept, that the company was used as the purchaser because the bank wanted Unit 10 to be purchased by a clean company, rather than by AMC and the Sharafis as originally intended. The company had not then done any business. The bank stated its requirement in its letter dated 14 March 2000 to which I have earlier referred. This is accepted by AMC and Mr Malik in the re-amended points of defence (para 6).

Nonetheless, AMC and Mr Malik plead that the bank and Mehdi Sharafi were aware that the company was “a trading company and a sister concern of” AMC, that “It was always intended that Woven Rugs Ltd would also trade and would also acquire additional properties depending on the evolving market conditions and business opportunities”, and that its articles of association “make it quite clear that Woven Rugs Ltd is a general trading company”. In his witness statement, Mr Malik said that “It was always intended that Woven Rugs Ltd would trade in the retail market as well as holding the property in its own name”. In his oral evidence, Mr Malik said that Mehdi Sharafi knew that this was the intention.

If this was the intention, it was not acted on, even on Mr Malik’s version of events, for over five years. AMC and Mr Malik do not suggest that the company undertook any retail or other business, apart from holding and leaving Unit 10, until 2005 at the earliest. Even then in the witness statement dated 14 December 2005 in the Willesden County Court proceedings, Mr Zafar as secretary of the company stated:

“The company is a non trading company and reliant on the income it receives from rent and service charge which are used for repayment of loans and settling debts. WRL pays for the utilities and services on behalf of the tenants and this money is collected from the tenants. This practice is in place ever since the inception of the lease.”

In support of his case that the company was not to be confined to holding and leasing Unit 10, Mr Malik alleges that without some other activity the company would become insolvent. The rent at £50,000 p.a. was sufficient to meet the repayments to the bank totalling a little over £47,000 p.a. Reference to the audited accounts shows that there were other costs which exceeded the difference by some way. By way of example, the accounts for the year to 30 June 2002 show costs of £10,000 relating directly to Unit 10, general administrative costs (excluding depreciation which is not a cash flow item) of about £1,750, professional and insurance costs of £6,700 and corporation tax of £4,700. In my judgment, it is clear from the arrangements between the parties that these items, all of which directly or indirectly flow from the company’s ownership of Unit 10, were to be by management charges paid on a 60:40 basis. That there might be disputes as to whether certain expenses were properly incurred does not detract from this finding. There was no need for the company to become insolvent, nor any expectation that it would do so.

I am satisfied that the parties’ intention was to use the company for the sole purpose of acquiring, holding and leasing Unit 10. It was only used at all because of the bank’s requirement for a clean company, and the share capital was issued in the 60:40 proportions because it reflected the parties’ respective interests in the compensation money and their intended interest, through the company, in Unit 10. Each had its own trading business, and there is no reason why either would have wanted the company to start dealing in rugs or doing any other business. It is accepted that no other business was conducted for a number of years, and no evidence beyond that of Mr Malik that it was ever intended.

I accept that this was not the subject of specific discussion or express agreement between the parties, but it was in my judgment too obvious to require discussion. I accept also that when originally incorporated, AMC and Mr Malik may well have intended that it would be used or available to be used as a company trading in rugs, as evidenced by its name. But any such intention was overtaken by the decision of AMC and the Sharafis to use it for Unit 10. Some reliance was placed on an email in which Mr Malik said that an advantage of buying Unit 10 was that if things went wrong it could easily be let, but this is evidence at most of contingency planning not of an intention to carry on any other business.

I have earlier referred to the attempt by AMC to remove Mehdi Sharafi as a director, its successful application under s.371 of the Companies Act 1985 and the subsequent removal of Mr Sharafi. In my judgment the circumstances in which the parties came to use the company and become shareholders in it, and its intended purpose, demonstrate that it was part of the arrangement or understanding between the parties that each of them would participate in the management of the company through an appointee on the board. I consider that the removal of Mr Sharafi breached the arrangement or understanding, such as would have justified the Sharafis in bringing unfair prejudice proceedings under s.459 of the Companies Act 1985. Whether AMC and Mr Malik would have had legitimate grounds of defence by reference to any conduct on the part of the Sharafis is not an issue which I have examined, although I am bound to say I see little sign of it. However, as I mentioned earlier, too much time has now passed between his removal and the presentation of the petition for it now to form a ground for relief.

The central ground for the Sharafis’ claim for relief is the 2005 re-financing, the use of the funds raised and the steps taken, so it is alleged, to conceal these matters from the Sharafis.

By June 2005 the company’s liability to the bank on the term loan had been reduced to just under £236,000. On 18 August 2005, the company entered into a new loan agreement with the bank for a term loan of £620,000. Interest only was payable in the first two years and thereafter monthly payments of £5,723.50 were required. It is not suggested that the additional funds were required for any purpose connected with Unit 10. The monthly rental payments under the lease were sufficient to meet the monthly payments under the original bank loan, but were insufficient for the monthly repayments under the new loan once the interest-only period had ceased. Mr Malik on behalf of the company had sought in March 2005 to increase the annual rent under the lease from £50,000 to £75,000. The Sharafis objected and in March 2006 a rent review determined a new rent of £56,700 with effect from 25 March 2005.

Barclays Bank made a formal offer of a loan of £610,000 on 3 June 2005 but in July 2005 the company’s existing bankers Royal Bank of Scotland (the bank) indicated interest in making a new loan of £620,000. The Sharafis were not informed or consulted, as Mr Malik’s consistent position is that as shareholders, but not directors, they had no entitlement to information or consultation and therefore he would not involve them at all.

However, the bank required a survey of Unit 10 and on 18 July 2005 Mr Zafar wrote to Sharafi & Co, saying simply:

“The company’s bankers or their agents will be surveying the premises this afternoon. You are requested to kindly allow unfettered access to all parts of the premises.”

Mehdi Sharafi suspected that this was for the purpose of raising a new loan and in a letter dated 19 July 2005, and copied to the bank, wrote:

“We hope that this has nothing to do with the company failing to meet its obligations to the bank regarding the mortgage or an attempt on your part to raise funds using our property as security without our consent. We must ask you to:

1.

state the reason for this inspection;

2.

confirm that there are no arrears of payments due to the Royal Bank of Scotland, and;

3.

expressly confirm that you will not further charge the property without our consent.

For the avoidance of doubt, in the event that we do not receive your clear and unequivocal response to these questions, we intend to apply to the Court to restrain your activities and to impose all and any necessary sanctions to protect our interests.”

Mr Zafar replied the following day:

“We confirm that there are no arrears of payments due to the Royal Bank of Scotland. A valuer instructed by company’s bankers wished to inspect the property in connection with a proposed application by the company to consolidate its borrowing, thereby facilitating consolidation of the company’s debts and repayment of the company’s loans from its shareholders. This can hardly be described as unfairly prejudicial to your interest.”

It will be noted that he referred to the repayment of “the company’s loans from its shareholders”, in the plural.

The Sharafis replied on 1 August 2005, making clear their objection to any new borrowing, but observing that “if there is a genuine basis on which funds need to be raised there certainly is no prohibition to you disclosing all the relevant facts to us and, if necessary, obtain our consent”. A further letter, setting out their objections, was sent on 11 August 2005.

The new loan agreement was made on 18 August 2005. Its purpose as stated in the agreement was, as to £285,000 to repay the outstanding indebtedness under the existing loan and as to £335,000 “for working capital”. This does not accord with the purpose as stated in a letter from the bank to Mr Malik dated 11 August 2005, stating:

“The specific purpose of the loan is to repay the existing facility and the outstanding directors loans. Again this is to be specified within the terms of the facility letter.”

Some indication of what Mr Malik had told the bank as to his plans appears elsewhere in the same letter:

“The loan is for two years, on an interest only basis, as we initially agreed that this would allow you sufficient time to resolve the issue with Sharafi & Co and either find a new tenant or sell the premises.”

It was put to Mehdi Sharafi that as a result of the correspondence referred to above, he knew that the company was taking out a new loan from the bank. His evidence, which makes sense and I accept, is that he assumed that the proposal for a new loan did not proceed, because Mr Zafar told him that the purpose was to repay the shareholders’ loans and the loan from Sharafi & Co was not repaid. Certainly, neither Mr Malik nor Mr Zafar nor anyone else made any effort to inform the Sharafis that a new loan had been made.

The first drawdown of the new loan, on 19 August 2005, was used to pay £202,000 to AMC. It is the case of AMC and Mr Malik that this was a part repayment of the loan of £330,000 made by AMC alone to the company, that no loan had been made by the Sharafis, and that this payment of £202,000 was entirely proper.

I have earlier found that the sum of £330,000 was provided as loans by AMC and Sharafi & Co in the proportions of 60:40, as Mr Malik well knew. The loans were interest-free and, as appears from the notes to the audited accounts, a number of which were signed by Mr Malik, they were subordinated to the bank loan.

In my judgment, the repayment of the loan made by AMC and the raising of a new loan from the bank for that purpose was commercially unjustifiable and involved a clear preference by Mr Malik of the interests of AMC over the interests of the Sharafis. The replacement of interest-free, subordinated debt due to AMC with interest-bearing, secured borrowing from the bank provided no benefit to the company or to the Sharafis, but was damaging to the interests of both. It had, as I find, no purpose other than to benefit AMC at the expense of the company and the Sharafis, and it was achieved by the exercise by Mr Malik of fiduciary powers vested in him as a director. It was a clear breach of his fiduciary duties and amounted to conduct of the company’s affairs which was unfairly prejudicial to the Sharafis as members. It was also prejudicial to them as lenders, but this is a case in which their positions as members and as creditors are in substance indistinguishable: Gamlestaden Fastigheter AB v Baltic Partners Ltd [2007] Bus LR 1521.

AMC and Mr Malik seek to rely on what they say was legal advice from Cooke Matheson, but this amounts to a short letter dated 18 July 2005 produced pursuant to a requirement by the bank for “confirmation that there are no Companies Act implications to consider”. The solicitors’ letter, forwarded on the same day to the bank, stated simply:

“I refer to our telephone conversation of even date and to the Royal Bank of Scotland’s letter to you dated 13 July 2005.

I confirm that in our view there is nothing unlawful in a company borrowing funds on commercial terms in order to repay shareholder loans. As you know, this advice is given upon the basis that it will be relied upon by you, but not any third party who should seek their own legal advice.”

This short advice is correct as far as it goes. It is the case that there is nothing intrinsically unlawful in a company borrowing funds on commercial terms in order to repay shareholders loans. But it does not follow that in all circumstances it will be a proper exercise of the directors’ powers. I have not heard any evidence from Cooke Matheson nor is there evidence of what they were told about the transaction. Mr Malik cannot rely on this short letter, confined as it is to a general proposition, as a green light for what he did.

On 6 December 2005, the company drew down the last tranche of the new facility and on 9 December 2005 instructed the bank to transfer £75,000 to AMC. In the instruction to the bank, Mr Malik wrote “The transaction may be shown as “Loan to AMC”. In the company’s ledgers it was shown as an amount owed by AMC.

The Sharafis contend that there was no commercial purpose in the interests of the company in making this payment, and that its only purpose was to provide funds to AMC.

Because the existence of this payment did not come to light until the respondents complied in September 2009 with an order for specific disclosure made on 25 August 2009, it is not specifically addressed in the statements of case. In his witness statement dated 13 October 2009, Mr Malik said only that the new bank facility “allowed [the company] to set aside £75,000 for trading purposes which would increase the earning potential of the company.”

In June 2009, the respondents disclosed a document on the company’s headed paper entitled “Minutes of the Meeting of Board of Directors duly convened and held on Friday 2 December 2005 at 10.00 a.m. at Unit 10” and showing as present Mr Malik as director and Mr Zafar as secretary. The minutes, signed by Mr Malik, read as follows:

“1.

To take steps to start selling rugs to increase company income

The Board reviewed company’s source of income and felt that company’s income is dependent upon the rent recovered from the tenants. It was also considered that one of the tenants M/S Sharafi & Co is a habitual late payer and the company cannot rely on its income. This results in late payments to creditors which brings bad repute on the company in addition to paying extra interests on certain borrowings.

It was also considered that Al Malik Carpets Pvt Ltd has started production of oriental handmade rugs on a large scale. The business is growing. It would be in the interest of the company to start selling rugs in a joint venture with Al Malik Carpets. This will help generate extra income sufficient to meet its financial commitments.

The company presently has funds available and can utilize these funds for investment in Rugs business to generate income. M/S Al Malik Carpets were contacted who have agreed to produce oriental design hand knotted woollen rugs to order however it will take some time as special production measures will have to be taken by Al Malik to make extra production. Al Malik Carpets has also requested for advance payment on account which will be adjusted to the goods supplied. Once the production starts the lead time will become shorter gradually. In any event the money advanced to AMC will be repayable if AMC fails to supply made to order rugs.

After due consideration of all the circumstances and on being satisfied that it is for the benefit of the Company and in the interest of the Company for the purpose of carrying on its business to enter into a business agreement with Al Malik Carpets. It was also resolved that an amount of £75000 be paid to Al Malik Carpets as advance payment for production of special order rugs. Al Malik will supply special order rugs and complete the order within five years from the date of advance payment. At the end of this period the balance of the monies after deductions of the value of rugs supplied will be repayable in lump sum.

The advance will be repayable if Al Malik Carpets fails to supply the special order rugs in 5 years.

2.

Any Other Business

There being no further business the Meeting closed.”

There are no other documents which evidence this trading arrangement between the company and AMC, save for two invoices and airway bills to which I later refer. Mr Malik’s evidence in cross-examination was that it was all dealt with orally. He said that designs for the rugs and their quality were agreed, but there was no agreement on quantity, prices or delivery dates. Prices, he said, would be agreed when production costs were known. No firm orders were placed or agreed. He confirmed that there was a five-year limit, so that if no orders had been placed or fulfilled by then, AMC was liable to repay the sum of £75,000. He confirmed that no interest was payable by AMC. Mr Malik said that there were three elements. First, if the company needed money, it could take the cash; this is, however, inconsistent with the terms of the minutes which I have set out. Secondly, delivery of the rugs was expected after about two years, when the company would expect to achieve a profit margin of 100%. Thirdly, the payment of £75,000 was a rolling credit. Mr Malik said that from a commercial point of view, it made perfect sense.

Mr Malik said that the minutes of the meeting on 2 December 2005 were prepared by Mr Zafar. Mr Zafar did not in terms confirm this, but he gave evidence that Mr Malik discussed the arrangements with him. Mr Malik told him that the company would face cash flow problems unless it received additional income, AMC had new popular designs and that Mr Malik decided to invest funds for the production of rugs, which would keep the company afloat.

Two copy invoices and copy airway bills were disclosed. The invoices are dated 5 April 2008 and 29 May 2008 and purport to be from AMC to the company, relating to consignments of rugs in the sums of $13,406.25 and $17,767.05 respectively. The airway bills are also addressed to the company and dated 5 April 2008 and 29 May 2008. They relate to consignments from Pakistan.

In evidence Mr Malik said that the rugs in these consignments were put in a shop in Berkeley Street in London but did not sell and so were taken back by AMC not more than four or five months later. The company was re-credited with the purchase price. There were no receipts, and any documents would have been destroyed as soon as the rugs were returned. The company’s ledger accounts show a debit in AMC’s favour of £6,750.72 on 5 April 2008 and a credit in the company’s favour of the same amount on 31 December 2008. There are no entries for the transaction to which the invoice dated 29 May 2008 relates. There is a nominal account in AMC’s name, on which there is shown amounts due from AMC and both debit and credit entries, but none tally with either of the invoiced transactions.

It was submitted that trading in rugs with AMC was a natural and obvious way in which the company could make the profits and generate the cash flow needed to remain solvent. In circumstances where the financial position of the company has severely deteriorated as a result of replacing subordinated interest-free liabilities with interest-bearing bank debt, this is an implausible explanation, even before the “terms” on which the payment of £75,000 was made to AMC are taken into account.

I have to say that I do not believe a word of Mr Malik’s evidence on this subject. Even if it were true, the arrangements would lack all commercial sense from the company’s point of view. A payment of £75,000 was made, it is said, as an advance against the future delivery of rugs where no order had been placed and no terms as to quantities, prices or delivery dates agreed. If no orders were placed or rugs delivered at the end of five years, the company would be entitled to a repayment of the advance but without any interest.

I am satisfied, however, that there were no genuine arrangements as described by Mr Malik. The whole story is implausible, indeed almost incredible. In his witness statement given in the Willesden County Court proceedings on 14 December 2005, which I have earlier quoted, Mr Zafar stated that the company was a non-trading company, reliant on its income from rent and service charges. This was only days after the alleged board meeting approving the arrangement with AMC and the payment of £75,000 to AMC. When Mr Malik or his solicitors prepared a draft compromise agreement in March 2007, recital D referred to Unit 10 as the company’s only asset and to its occupation by the shareholders under a 15-year lease and continued, “The Company’s business concerns the ownership of the Premises and the collection of rent and services charges from the letting of the Premises”. Yet, if Mr Malik is to be believed, the company had over a year earlier entered into a long-term supply arrangement with AMC, pursuant to which consignments of rugs were shipped over a year later. The payment was at best no more than an interest-free loan from the company to AMC, which was beneficial to AMC but conferred no benefit on the company.

I have grave doubts that the minutes were produced in or around December 2005, but if they were, I am satisfied that they were a smokescreen to cover Mr Malik’s real purpose of making an interest-free loan to AMC. There is little evidence to support the transactions in 2008, but in any event they occurred long after the petition had been presented and some months after it had been amended to claim relief under s.994. Again I have grave doubts as to whether there were in truth any such transactions, but to the extent that the paperwork is genuine I am satisfied that the relevant transactions were created by Mr Malik as cover for his actions in causing the original payment of £75,000 to be made.

The balance of the funds drawn down from the new loan facility were used to make a variety of payments. Starting in July 2005, remuneration at a gross rate of £525 per month was made to Mr Malik, making a total of £23,500. Management charges were invoiced by AMC to the company. The first invoice, for £14,400 plus VAT, was dated 30 November 2005, and in all invoices totalling £65,398 were rendered between then and January 2009. Starting in September 2005 and continuing until December 2008, Mr Zafar was paid £1,100 per month, totalling £45,170. This total included some variable amounts paid earlier in 2005.

As regards Mr Malik’s remuneration, the Sharafis say that at a meeting on 26 October 2000, it was agreed that remuneration would not be paid to the directors. Handwritten notes of the meeting, prepared by Jutinder Singh then the company secretary, and typed-up minutes are in evidence. Mehdi Sharafi’s evidence was that he prepared the typed minutes shortly afterwards. I accept Mr Sharafi’s evidence.

The meeting was held against the background of a notice served a few days earlier by the Sharafis on AMC, requiring it to vacate the Customs bond at Unit 10. It was attended by the directors at that time, Mehdi Sharafi and Amir Khan, and by Mr Singh, Amir Sharafi and Naveed Yousaf representing AMC. It was a meeting designed to reach agreement on the way forward for the parties. AMC and Mr Malik accept that the meeting took place but deny that it was a board meeting. As all the directors were present, and all the shareholders were present or represented, it makes no difference in my view whether it was formally convened as a board meeting.

The handwritten notes, and the minutes, record that there was to be no directors’ remuneration, (the minutes add “unless specifically agreed”) and I accept that this was agreed. Given the purpose of the company as the vehicle through which Unit 10 would be held, this agreement is not in the least surprising.

When Mr Malik unilaterally decided that the company should pay him remuneration at a rate of £500 per month, he was breaking the arrangement agreed in 2000.

Moreover, there was no proper justification for Mr Malik awarding himself this remuneration, in light of the company’s limited purpose. When asked what he was doing for it, he replied that he was trying to develop and expand the business, but even if true, which I reject, this was clearly outside the purpose of the company as agreed and understood by the shareholders.

The invoices rendered by AMC for service or management charges included items such as use of office equipment, computers, photocopiers, office stationery, office staff and even “basic utilities, i.e. heating and electricity”, with numbers of hours spent (for example 200 hours over 36 weeks). There is in evidence a minute of a board meeting of the company on 14 July 2004, at which Mr Malik as sole director resolved that AMC be appointed to provide management services to the company at not more than £80 per hour. Quotations are recorded from outside agencies, at between £90 and £160 per hour.

Whether or not there was any justification for the appointment of agents, there does not appear to have been any process for scrutinising and, if appropriate, challenging charges levied by AMC.

Mr Zafar was employed by AMC as a general manager, at a salary of £12,000 p.a. There is a minute of a board meeting of the company on 27 January 2007 at which Mr Malik as sole director appointed Mr Zafar as a consultant to deal with all company matters under Mr Malik’s guidance, at remuneration of £1,100 per month.

The regular payments to Mr Zafar did not start until September 2005, because, Mr Malik said, the company did not until then have the money to make them. The effect was to double Mr Zafar’s salary. Mr Malik’s explanation as to why payments were made to both Mr Zafar and AMC was that the former were for Mr Zafar’s services and the latter were for the provision of facilities to enable him to perform his duties. Again, there was no scrutiny of whether it was right for the company to engage Mr Zafar and, if so, the proper rate for his services.

Audited annual accounts were prepared for each financial year ended 30 June up to and including 30 June 2005. They were sent to shareholders and laid before annual general meetings of which notice was given to shareholders, although Mehdi Sharafis had complaints that answers were not given to his questions on them. The accounts for the year to 30 June 2005 were sent to shareholders on 24 March 2006. The annual general meeting was held on 20 April 2006, which neither of the Sharafis attended. There was no reference in those accounts or the directors’ report to the 2005 re-financing or the loan re-payment to AMC, nor was there any other notification of them to the Sharafis. These were clearly material events, which Mr Malik says were in the best commercial interests of the company. They could, and perhaps should, have been referred to in the accounts to 30 June 2005, but Mr Malik justified the absence of any reference on the grounds that the accounts related to a year which ended shortly before the re-financing. He said he took legal advice and was told that the Sharafis did not have a right to be informed. Mr Malik said in evidence that because the Sharafis always used information against him and AMC, and he was trying to resolve difficulties with the Sharafis, he saw no point in giving them the information and thought that he was acting in the best interests of both parties in not doing so.

Mr Malik said that the company’s auditor had the bank statements and full access to the company’s records, but he could not say whether the auditor knew about the re-financing when auditing these accounts and confirmed that he had not discussed with the auditor whether it should be disclosed in the accounts.

The re-financing and repayment of the loan to AMC would need to be disclosed in the next year’s accounts, to 30 June 2006 which had to be filed and sent to shareholders by 30 April 2007: s.244 Companies Act 1985. On 5 January 2007 Mr Malik signed and filed a form 225 changing the accounting reference date, and extending the financial year, from 30 June 2006 to 31 December 2006, which extended the time for laying and filing the accounts to 31 October 2007. Mr Malik’s explanation in evidence for this was that they were having difficulties finalising the accounts. Mr Zafar said that some documents, such as some bank statements and some invoices, were not available as a result of the move out of Unit 10 in March 2007, although why that should be so was unexplained. As the extended deadline of 31 October 2007 approached, Mr Malik wrote on 18 October to the registrar of companies requesting an additional 60 days for filing, which was granted. The reasons given were as follows:

“1.

We have moved offices which involved the movement of large number of files including matters relating to accounts. All the files have not yet been identified and located.

2.

The minority shareholders (M/s Sharafi & Co) have removed some of the company record by apparently entering our old offices illegally and without our authority. We have requested M/S Sharafi to explain their position and specify exactly what papers particularly invoices etc are in their possession. Our solicitors M/S Hodders have written to M/S Sharafi and we are still awaiting to get satisfactory response from them. Our solicitors have written to M/S Sharafi on two occasions i.e. on 3^rd August and 8^th October 2007.

3.

The removal of our record is also the subject of a police complaint which is recorded under crime reference No: 1924668/07 with Wembley Police Station.

It is necessary for the above matters to be concluded before we are satisfied that we have complete financial record of the company from which the accounts for the period ending 31^st December 2006 can be finalized.”

The two letters referred to in paragraph 2 of the letter, dated 3 August and 8 October 2007, referred to a single invoice dated 30 September 2006 from AMC to the company for £6,486 in respect of management charges. Mr Malik accepted that the company still had this invoice and that AMC had it on a computer. There is no basis for the suggestion that the Sharafis had removed company records or entered premises illegally. They had a copy of the invoice because it was attached as a supporting document to an invoice sent by the company to the Sharafis in December 2006. This explanation for the need for more time to prepare the accounts was entirely spurious. There is little or no evidence to support the assertion in paragraph 1. AMC moved out of Unit 10 in March 2007, presumably taking the company’s files with it. Why by October 2007 it was still unable to prepare accounts for the period to 31 December 2006 is not properly explained, and I see no reason to give credence to paragraph 1 in view of the untrue contents of paragraph 2.

Mr Malik gave evidence that the same grounds for further extensions were given in letters dated 24 December 2006 and 27 February 2008, neither of which was disclosed. Successive extensions were agreed to 14 March 2008. Accounts for the period to 31 December 2006 were finally sent to the registrar of companies on 12 March 2008. They were not, however, full or audited accounts but abbreviated accounts, prepared in accordance with the special provisions of Part VII of the Companies Act 1985 relating to small companies. These accounts disclosed only the total amount due to creditors falling due after more than one year, but no breakdown was given to show the increase in bank debt and the reduction in shareholders’ loans.

The abbreviated accounts for the period to 31 December 2006 were not sent to the Sharafis, in breach of ss.238 and 238A of the Companies Act 1985. They discovered the existence of these accounts from a search at Companies House and then raised questions about the overall increase in long-term liabilities but received no satisfactory answers. In April 2008 the Sharafis served notice under s.249B(2) that they required the accounts for the periods to 31 December 2006 and 2007 to be audited. Audited accounts were not approved until December 2008 and even then were not sent to the Sharafis, who did not obtain them until July 2009 through disclosure in these proceedings.

No annual general meetings were held after 2005. On 12 November 2007, the company filed with the registrar of companies a document purporting to be an extract of the minutes of an extraordinary general meeting held on 17 August 2006 at Unit 10, which read as follows:

“It was observed that the minority shareholder Mr Amir Hossein Sharafi did not attend any AGM. The other minority shareholder Mr Mohammad Mehdi Sharafi has not attended last two AGMs held in 2005 and 2006. It was noted with concern that the attitude of the minority shareholders is non co-operative and they take negative interest in the company affairs. This was also felt that they willingly abstain themselves from important meetings of the company to create hindrances in its smooth working. Annual accounts of the company for the last year were approved by the majority members without the participation of the minority shareholders who did not turn up despite having adequate notice of the meetings. It was therefore felt that holding of AGM for the purposes of company’s annual accounts were serving no useful purpose. Under the Companies Act a private company may elect to dispense with the annual meeting and laying of accounts and reports before general meeting.

It was therefore RESOLVED that the company should elect to dispense the annual meeting and with laying of accounts and reports before general meeting.”

The power, by elective resolution, to dispense with annual general meetings and the laying of accounts was contained in s.366A of the Companies Act 1985 (introduced by the Companies Act 1989). To be effective, an elective resolution had to be passed at a meeting of which 21 days’ notice stating that an elective resolution was to be proposed and stating its terms was given, and had to be agreed unanimously by all shareholders entitled to attend and vote at the meeting: s.379A(2). A copy of an elective resolution was required to be sent to the registrar of companies within 15 days after it was passed: s.380.

On any footing, the purported elective resolution of 17 August 2006 was ineffective, as it was not agreed by the Sharafis.

Mehdi Sharafi’s evidence that he was not given notice of the purported meeting on 17 August 2006 was not challenged. There is in evidence what purports to be a notice of the meeting dated 27 July 2006, signed by Mr Zafar as secretary and addressed to all the shareholders, including the Sharafis at Unit 10. Also in evidence are what purport to be a proxy form for AMC, dated 1 August 2006 and signed by Mr Malik, and minutes of the meeting.

Mr Zafar’s evidence was that he prepared these documents and that he thinks the notice was delivered to the Sharafis by hand, either by himself or a warehouse boy, although he has no recollection of its delivery. It was not signed for by Mehdi Sharafi, as he often did, nor is there any record of service. Mr Zafar said that he was told about elective resolutions in a conversation with Companies House, but he did not appreciate the need for unanimous agreement or filing within 15 days.

I am satisfied that the notice was not delivered to the Sharafis. It is highly unlikely that they would not have reacted to it. Mr Sharafi would probably have endorsed and dated its receipt and I have no reason to doubt his evidence or to suppose that he would not have disclosed it in these proceedings if he had received it.

Mr Potts put it to Mr Zafar that these documents were a later afterthought. This was denied by Mr Zafar but I find the allegation to be true. There are a number of suspicious circumstances about this alleged meeting. First, while the company’s annual general meetings from 2002 to 2006 were held at Cooke Matheson’s offices in Gray’s Inn, or in 2005 at the offices of a firm of accountants, the alleged meeting on 18 August 2006 was supposedly held at Unit 10, without any advice from the company’s solicitors. Given that this was a novel and technical step for Mr Malik and Mr Zafar, it is surprising that while involving their solicitors with annual general meetings they should not be involved with this meeting.

Secondly, the resolution was not filed until November 2007. When asked why it was filed then, Mr Zafar said that every now and then he would speak to Companies House, but he cannot remember the reason for the call in which he was told of the need to file it.

Thirdly, when asked how he had learnt about an elective resolution to dispense with annual general meetings, he said that he was told by Companies House that it could be done “under new legislation”. But in August 2006, it was not new legislation. As I earlier mentioned, the power was first introduced by the Companies Act 1989. However, s.366A of the Companies Act 1985 was replaced by new provisions of the Companies Act 2006 with effect from 1 October 2007. In a conversation weeks or days before the alleged resolution was filed, there could well have been reference to new legislation.

These serial breaches of the requirements of the Companies Acts would in themselves be a legitimate ground for complaint and proceedings by the Sharafis, but in my judgment it goes much further. I am satisfied that Mr Malik was determined to conceal from the Sharafis the facts about the re-financing in 2005 and the payments to AMC and himself. His plan was to try to reach a final agreement with the Sharafis without ever telling them the true position. As the bank’s letter dated 11 August 2005 to Mr Malik evidences, he had told the bank that the interest-free period of two years on the new loan would allow “sufficient time to resolve the issue with Sharafi & Co and either find a new tenant or sell the premises”. In AMC’s points of defence, it is stated that the compromise said to have been agreed with the Sharafis in February 2007 “was principally to ensure that financial information in relation to [the company] and [AMC] remained confidential”.

Although Mr Malik’s plan to reach a final agreement with the Sharafis failed, he persisted in his efforts to keep the true facts from them. Mr Potts said, without contradiction from Mr Macpherson, that this extended even to refusing to give disclosure of financial information in these proceedings on the grounds that it was privileged.

The financial difficulties created by Mr Malik through the 2005 and 2007 re-financings were greatly exacerbated by AMC’s failure to pay any rent after 2007. As AMC and the Sharafis were jointly and severally liable for the entire rent under the lease, it was a breach of fiduciary duty on the part of Mr Malik as a director of the company not to seek payment from AMC. It would not, however, be a breach of which the Sharafis could complain in these proceedings if the arrangement between them and AMC for the payment of rent was on the basis of occupation asserted by Mr Malik. I have, however, rejected his evidence on this, and accepted the Sharafis’ case that it was to be paid in the 60:40 proportions. On that basis, Mr Malik was acting contrary to the arrangement and his failure to demand or enforce the payment of rent from AMC was a breach of fiduciary duty, which constituted conduct which was not only damaging to the company, but unfairly prejudicial to the interests of the Sharafis as members.

In its amended points of defence, AMC relied on what it said was a binding agreement made at a meeting in March 2007, attended by Mr Malik and the Sharafis, shortly before the petition was presented by the Sharafis. It is accepted by the Sharafis that the meeting took place, albeit on 24 February 2007, with a view to agreeing terms if possible and that a handwritten statement of terms was prepared and signed at the meeting. They say, however, that the meeting was without prejudice and that there was no binding agreement.

The handwritten document has endorsed on it the words “without prejudice subject to agreement” but the circumstances in which they were written are the subject of strong dispute between the parties. I shall consider that issue later, but I will first set out the largely uncontentious facts.

On 20 February 2007 Mr Malik suggested to Amir Sharafi that he and the Sharafis should meet and try to agree a compromise. On the same day Mr Malik met both the Sharafis at their offices. They agreed to meet at a neutral place, and at Mr Malik’s suggestion without lawyers. Mr Malik suggested, and the Sharafis agreed, that the discussion should be without prejudice and that any matters discussed could not be used in litigation. The next day Mr Malik sent them a short written agreement, which they all signed, providing that “any documents or information disclosed in these discussions will be completely without prejudice and confidential” and, in particular, that any knowledge acquired during the discussions would not be used in any court proceedings involving the parties. It could not, I think, be suggested that this agreement would prevent enforcement of an otherwise binding agreement if one were made at the meeting.

Mr Malik and the Sharafis met by prior arrangement in the early afternoon on Saturday 24 February 2007 in the cafe off the lobby in the Hilton Hotel, Shepherds Bush.

Following discussions between them, and while they were still present, the handwritten note was prepared and signed by each of them. It read as follows:

“1^st Agreement

2^nd 60 days from date of Agreement or before Sharafi to vacate the warehouse

3^rd Total expenditure of £3000 for re-decoration and cleaning on a 60:40 basis agreed.

4^th

Agreed: if the warehouse sold for £1000000 Sharafi gets 250k and whatever more or less on a 40:60 basis of the difference.

Surveyors Fees 40% to be deducted from the 250k.

If warehouse not sold after 4 months after date of agreement Sharafi will contribute £1500 a month towards re-payment to RBS or to be deducted from the 250k.”

The explanation given by Mehdi Sharafi for the payment of £250,000 to the Sharafis out of sale proceeds of £1m is that Mr Malik represented that the debt to the bank stood at about £350,000, so that the net proceeds of sale after expenses and repayment of the bank would be about £625,000, of which £250,000 was approximately 40%. This was denied by Mr Malik, but I accept Mehdi Sharafi’s evidence.

On 5 March 2007, Mehdi Sharafi sent an email headed “without prejudice” to Mr Malik in which he wrote, “As agreed last week I have asked my lawyers to prepare a draft agreement along the lines that we discussed. In the meantime, there are a number of matters that are causing some concern to us”. Five matters were listed. Mr Malik replied on the same day in an email also headed “without prejudice”. In the course of commenting on the five points, Mr Malik wrote:

“Your point No 3, I can assure you that there are many matters on which our lawyers are very concerned and if I were to try to change the agreement made with you, based on their advice, then this would entail further litigation rather than resolution. ..”

He continued:

“I hope that all of your points have been dealt with fully. However there is still the matter of the capital gain tax for which you said you have received advice and about which an undertaking will need to be incorporated in the agreement that Sharafi & Co will be responsible for their share of the capital gain tax. ..”

Mehdi Sharafi replied on the same day:

“Further to our subsequent conversation, my solicitors have expressed the view that you appear to have a better grasp of the way in which the proposed agreement should be framed. It would appear that you have also worked out a way in which the Bank will make the payment to me etc.

In the circumstances it would be better if your side were to prepare the first draft of the agreement for our consideration.”

On 6 March 2007, Mr Malik sent an email headed “without prejudice”, stating:

“As promised please find enclosed a draft agreement. Please let me have your response on this.”

The attached draft agreement was headed “without prejudice”. While it included the matters set out in the handwritten document signed on 24 February 2007, it also included several additional matters of substance. The recitals included a declaration that the Sharafis “shall not be involved in the day to day running of the Company” which “rests with” AMC. Clause 1.2 provided that Unit 10 would be sold to the highest unconnected bidder, but cl.1.4 (iii) provided that if the bid price were less than £900,000 then AMC would have the first right to purchase the property. This picked up on a point made by Mr Malik in his email of 5 March 2007 in which he wrote:

“We will obviously have to agree that the warehouse cannot be sold for example below a certain price i.e. £900,000 or thereabouts and if we are in that kind of a situation then either one of the present shareholders would be entitled to purchase the warehouse.”

This had not previously been discussed or agreed and the draft agreement did not fully reflect Mr Malik’s email. On the point of capital gains tax, to which Mr Malik referred in his email of 5 March 2007, cl. 1.5 provided that the shareholders would be individually responsible for the payment of capital gains tax in respect of payments to them from the proceeds of sale of Unit 10.

This draft was never agreed, nor was any other draft produced. The Sharafis presented their petition on 16 March 2007. AMC and Mr Malik did not raise or rely on the alleged agreement in their pleadings or evidence in the petition for a very considerable time. They promptly applied to strike out the petition, but not on the grounds that there was a concluded settlement. No mention was made of the agreement by Mr Malik in his witness statement in support of the application, which was based on the ground that, if the Sharafis’ case was established on the facts, a buy-out order under s.459 was a more appropriate remedy than a winding-up order. Nor was it mentioned in their first points of defence served in February 2008. It was only in correspondence, in April 2007, that the point was raised by AMC’s solicitors and then only to say that AMC “reserves the position that there has been agreement on an exit strategy between the company and the shareholders”, to which the Sharafis’ solicitors said that the discussions were without prejudice and inconclusive. The separate proceedings for a declaration as to the split of the compensation money paid in 2000, issued on 14 February 2008, are inconsistent with a binding settlement agreement in February 2007. The first mention of it appears to have been in the amended points of defence served in January 2009, which were expanded in the re-amended points of defence served in June 2009.

Looking at this sequence of events, it is in my judgment impossible to conclude that a binding agreement was reached on 24 February 2007. The subsequent exchanges of without prejudice emails discussing various points of substance, and the preparation of a draft written agreement by Mr Malik with his invitation to the Sharafis for them to let him have their response on it, are in my view inconsistent with the existence of any binding agreement. The first item in the document signed on 24 February 2007 is “1^st Agreement”. Particularly when taken with the subsequent correspondence, it is obvious that this refers to the need for a formal agreement, and I so find. Mr Malik denied this. He said it meant “This is an agreement”, which I am satisfied he knew to be untrue. The absence of any reliance on it by AMC or Mr Malik in these proceedings for nearly two years, and the issue by AMC of its separate proceedings in January 2008, are inconsistent with a belief that a binding agreement had been made.

I turn now to the events of 24 February 2007. The important issue is whether Mr Malik knew and agreed the endorsement “without prejudice subject to agreement”. The Sharafis say that it was included at Mr Malik’s insistence and that he certainly agreed to it. This is denied by Mr Malik, who points out that, while all three of them signed the one page document, the endorsement is initialled only by Amir Sharafi. Mr Malik accepts that the endorsement appeared on the document which he took away from the meeting, but he says that he was given it in an envelope and that he did not look at the document until Monday 26 February 2007. He says that when he first saw the endorsement he rang Amir Sharafi and asked him “what is this?” He says that Amir Sharafi told him not to worry and just tell the lawyers to prepare the agreement.

The Sharafis’ position was that, as the discussions were without prejudice and, they considered, no binding agreement had been made, these were matters which should not be before the court on the hearing of this petition. Quite properly, therefore, they had not dealt with it in their written evidence. Following my decision to deal with the issue, Mehdi Sharafi provided a supplemental witness statement. He exhibited a copy of the handwritten document, saying that it had been written out and signed, with the endorsement, and then photocopied by Amir Sharafi in the hotel reception. Copies were then distributed. His oral evidence was different. He remembered that his brother took the document to the hotel lobby to photocopy it but found the photocopier was broken and so then wrote it out a second time. The case put to him in cross-examination was that his brother took the entire written document and photocopied it and, while doing that, added and initialled the endorsement. Mr Macpherson accepted that I was entitled to assume that this case was put on instructions. Mehdi Sharafi denied the endorsement had been added in this way.

Mr Malik’s written evidence on this issue was confined to saying that the document had been “altered” by Amir Sharafi without Mr Malik’s knowledge or agreement. In cross-examination, he said that the top half of the document had been written and both the Sharafi brothers photocopied it. The further terms, from “Surveyors fees” to the end, were written separately on each sheet. These documents were then signed and taken away for photocopying. The Sharafi brothers returned, and said that the photocopier was not working. They handed Mr Malik’s document to him in an envelope. The Sharafis kept the other for themselves.

It is important to note that when this evidence of Mehdi Sharafi and Mr Malik was given, only one copy of the document was in evidence. Subsequently, each side produced from its own files the original document which Mr Malik on the one hand and the Sharafis on the other had taken away. It is clear from these original documents that the top half of one document (excluding the endorsement) was written in blue ink by Amir Sharafi and then photocopied. The rest of the text from “Surveyors fees” to the end was written in black ink on each document. Each document was separately signed at the foot of the page by Mr Malik and the Sharafis. On each document, in the top right corner, Amir Sharafi has written and initialled in black ink “without prejudice subject to agreement”.

Following disclosure of these documents, Mehdi Sharafi produced a further short supplemental witness statement. He said that his recollection in relation to the photocopying was unclear but he remembered that the document was produced in two stages and that after both documents had been signed by the three of them, the endorsement was added by his brother at the insistence of Mr Malik. At the end of the meeting Mr Malik and the Sharafis each took a signed document away with them, and there was no envelope. Mr Sharafi was recalled, confirmed his further statement and in cross-examination adhered to his evidence. He accepted that he did not have a clear recollection of the entire meeting, including the photocopying, but among the events he did recall was the addition of the endorsement at the insistence of Mr Malik.

I prefer the evidence of Mehdi Sharafi to Mr Malik’s evidence, for a number of reasons. First, Mr Malik’s conduct after he says that he discovered the endorsement when he looked at the document on Monday 26 February is not consistent with a surreptitious addition of the endorsement by the Sharafis. He said in evidence that he rang Amir Sharafi in Dubai, who told him not to worry and just tell the lawyer to prepare the agreement. It is surprising that he did not record his protest in a letter or email, in view of the depth of distrust between the parties, and that he then corresponded with the Sharafis as to the terms of the agreement on a without prejudice basis.

Secondly, Mr Malik’s account of the sequence of events at the meeting is improbable. It is clear that the first half of the document was written out and then photocopied. There was no reason to think that the additional second half could not also be photocopied. But according to Mr Malik the second half was written out twice, both documents were signed, and only then were they taken away for photocopying. This makes no sense. Who writes out terms for a second time when, as before, the parties think the first version can be photocopied? And why bother to photocopy the completed document when there is a signed version for each side? It is far more likely that the second half was written out on the original document and taken for photocopying before signing. On finding the photocopier broken, Amir Sharafi returned with the original and wrote the second half on the existing photocopy. All parties then signed both versions. On this sequence of events, there was no opportunity for Amir Sharafi to write and initial the endorsement on each version without Mr Malik’s knowledge or agreement. Mr Malik had to give an account which involved both the whole signed documents being taken away in order to make possible his case that the endorsement was added without his knowledge.

Mr Macpherson relied on the fact that Mr Malik’s document has been folded in two, thereby supporting Mr Malik’s evidence that it was given to him in an envelope. This is not a significant matter. It is equally consistent with Mr Malik just folding it when he left; perhaps more so as the document shows clear signs of someone having at least started to fold it again. The Sharafis’ document has also been folded, lengthways in fours.

Thirdly, I have found Mr Malik to be a thoroughly unsatisfactory witness as regards a number of important matters in the case, while I have found Mehdi Sharafi to be a careful and truthful witness.

Fourthly, I am not concerned that Mehdi Sharafi’s recollection as to the detail of the document’s production and photocopying changed during the course of the trial. He was candid about the limits to his recollection and I am satisfied that he was doing his best to assist the court. Mr Malik’s version of events also changed during the trial, as a comparison of his case put in cross-examination of Mehdi Sharafi with his own evidence shows. Mr Malik relies on the fact that Amir Sharafi but not Mr Malik initialled the endorsement. If, as I find, the endorsement was instigated by Mr Malik, Amir Sharafi initialled it as an acknowledgment in favour of Mr Malik. The fact that Mr Malik did not want lawyers present at the meeting is not a weighty factor in his favour, given that he himself conducted the subsequent correspondence and provided the draft agreement, all headed “without prejudice”.

I conclude therefore that, for the reasons given earlier in this section of the judgment and because of the endorsement, no binding settlement agreement was made at the meeting or thereafter.

There was no dispute as to the legal principles applicable to the concept of unfair prejudice under s.994, which are for the most part set out in O’Neill v Phillips [1999] 1 WLR 1092.

The facts as I have found them establish a clear case of unfairly prejudicial conduct on the part of AMC and Mr Malik. The re-financing in 2005 was financially damaging to the company and was undertaken by Mr Malik acting for the company for the sole purpose of making payments from the company to AMC, at the expense and to the detriment of both the company and the Sharafis. There was no bona fide justification for the re-financing or for the payments. While the payment of £202,000 repaid a debt due to AMC, it was unnecessary and damaging to the company because, first, the debt was subordinated to the existing bank debt so that AMC was not then entitled to payment and, secondly, unsecured interest-free debt was replaced by secured indebtedness carrying interest at a commercial rate. It was detrimental to the Sharafis because they too were creditors of the company on the same terms as AMC. Mr Malik’s action had the purpose and effect of preferring the interests of AMC, and hence his own interests, over those of the company and the Sharafis. The payment of £75,000 to AMC was, as I have found, a misappropriation without any benefit to the company. It was a deliberate breach of duty by Mr Malik as a director, and his account of a trading arrangement between the company and AMC was a dishonest attempt to provide a justification. If it were true, it was so one-sided an arrangement as to amount to a breach of duty on his part. In addition, further sums by way of unjustified salary and management charges were paid to himself and AMC.

The subsequent manoeuvres by Mr Malik to delay accounts, to avoid holding annual general meetings and to provide, very late, only abbreviated accounts involved not only breaches of statutory requirements designed to protect shareholders, such as the Sharafis, but also a successful attempt to conceal what he had procured the company to do by way of the re-financing and payments to AMC. Likewise, his repeated refusals to provide information to the Sharafis on the grounds that as shareholders they had no rights to require it, did not represent principled adherence to the rules of company law and the constitution of the company, but was motivated solely by a desire to conceal his activities.

In his evidence Mr Malik frequently said that the company was a sister concern of AMC and was to be run as a member of the group of which they formed part. If transactions were in the interests of that group, they could properly be undertaken by the company, without a separate consideration of the interests of the company and the Sharafis as its 40% shareholders. What was in the interests of the group was in the interests of the company. If this had been Mr Malik’s understanding, it would still have provided no justification for his conduct, as shown by the decision of the House of Lords in Scottish Co-operative Wholesale Society Ltd v Meyer [1959] AC 324. I do not however accept that this was Mr Malik’s belief. I find he knew full well that what he was doing was unlawful. Perhaps motivated by a belief that AMC should have received a larger proportion of the compensation paid by the landlord, he set about using the equity in Unit 10 to raise funds for the benefit of AMC and himself at the expense of the company and the Sharafis.

Earlier I cited a passage from the judgment of Mr Anthony Mann QC in the application under s.371 of the Companies Act 1985 in which he expressed his view that Mr Malik had an undisclosed purpose in seeking the removal of Mehdi Sharafi as a director. In these proceedings Mr Malik gave evidence that in 2002 the company sought to raise further borrowing from the bank but could not then do so because there was insufficient equity in Unit 10. By 2005, there was sufficient equity to enable Mr Malik to commit the company to the 2005 re-financing and to extract most of the surplus funds raised for the benefit of AMC. Mr Malik’s evidence and these later events vindicate the view taken by the judge in the earlier case.

Mr Malik’s conduct, and that of AMC for whom he acted and which he controlled and largely owned, was in breach of fiduciary duty as a director of the company, in breach of the arrangements on which he, AMC and the Sharafis had agreed to use the company and was unfairly prejudicial to the Sharafis as members of the company.

The Sharafis therefore establish their case for relief under ss.994 and 996 of the Companies Act 2006.

AMC and Mr Malik rely on three offers as grounds for resisting the petition. The first was made in a letter dated 5 January 2001 from their solicitors and offered to purchase the Sharafis’ shareholding at a price equal to 40% of the market value of the company as a going concern as determined by an independent chartered accountant. This offer was rejected in a letter dated 23 February 2001.

This offer pre-dates by some years the unfairly prejudicial conduct which I have held to be established. It cannot be relied on as a remedy for conduct yet to occur. Mr Malik appears to think that such an offer gives him carte blanche to behave in the future as he wishes. In any event, it is hard to see why the Sharafis can be criticised for refusing an offer which would have resulted in them being the tenants of a company wholly-owned by AMC and Mr Malik, when the common venture was for joint occupation of a jointly-owned property.

The second offer on which AMC and Mr Malik rely was contained in letters sent in the last quarter of 2006. AMC offered to assign its interest as lessee in the lease to the Sharafis or to take from the Sharafis an assignment of their interest as lessees, in either case at a price of £1. Both offers were rejected. AMC then suggested that the lease should be offered for sale in the market, while at the same time rejecting the Sharafis’ suggestion for a marketing of the freehold and leasehold interests. A further offer was made to purchase the Sharafis’ shares at 40% of the net asset value of the company, as determined by an independent expert.

This second group of offers provides no grounds for argument by AMC and Mr Malik. The suggested alternatives for assignments of the parties’ interests as lessees were plainly inadequate as either the Sharafis would cease to have any right of occupation of Unit 10 or they would become liable for the full cost of Unit 10, and in either event they did not deal with the Sharafis’ position as members. The offer to purchase their shares was made at a time when Mr Malik had procured the 2005 re-financing and the payment of £202,000 to AMC. A price linked to net asset value would be fixed after those transactions had taken place, but AMC and Mr Malik neither informed the Sharafis of them nor made any proposals for redress. If the Sharafis had been given full access to the company’s records, as the offer provided, they would have discovered the transactions and the present litigation would simply have been accelerated.

The third offer, or offers, relied on were made after presentation of the petition. A letter dated 20 July 2007 contained an offer to purchase the Sharafis’ shares at a price determined by an independent valuer. In their first points of defence, AMC and Mr Malik offered to purchase the Sharafis’ shares at a price equal to the amount which they would receive in a liquidation.

Both these offers suffered from the same basic defect as before, they provided no information on, nor any redress for, the 2005 re-financing and the dissipation of the funds raised by it.

I conclude therefore that none of these offers provides any basis on which AMC and Mr Malik can resist the present petition.

The Sharafis seek orders against AMC and Mr Malik jointly and severally that (i) they purchase the Sharafis’ shares at a price equal to 40% of the value of the entire share capital at 19 July 2005 and (ii) they pay to the Sharafis an amount equal to the loan of £132,000 made by them to the company in 2000.

The provisions of s.996 of the Companies Act 2006 are deliberately drawn in broad terms, such that the court has “the widest possible discretion to make such order as it thinks fit to remedy the unfair prejudice”: Re a Company (No 005285 of 1985) [1986] 1 WLR 281 at 283. There can in my judgment be no argument but that an order for the purchase of the Sharafis’ shares is an appropriate order. The fact that the company is now in administration, as a result of the unfairly prejudicial conduct of Mr Malik and AMC, is no bar to such an order. It does however suggest that the date for the valuation of the shares should not be the date of the order. While the date of the order is taken as a starting point, there have been numerous cases in which the just result requires the choice of an earlier date. In this case, an earlier date will enable the Sharafis to be compensated for the damage inflicted by the conduct of Mr Malik and AMC. The suggestion made on behalf of the Sharafis that the date should be 19 July 2005 would enable the company, and the Sharafis’ shares, to be valued in a convenient way without the effect of the 2005 re-financing and subsequent dissipations of funds. One of the assumptions would therefore also be that the loan made by AMC out of the compensation money was still outstanding, as it was the 2005 re-financing which enabled it to be paid.

Mr Macpherson submitted that it was not appropriate to choose a date as early as 19 July 2005, because it took no account of changes to property values, and in the value of Unit 10, since then. There is no evidence before the court of how the value of Unit 10 has changed, upwards or downwards, since July 2005. Different dates may well produce larger or smaller values than that in July 2005. It would, of course, be possible to choose a separate date for the valuation of Unit 10, on the basis that without the unfairly prejudicial conduct the company would have continued to own it and to have reduced the bank debt. An obvious date for this might be the date when the amended petition seeking relief under s.994 was served. This might produce a higher value than as at July 2005, which has not been sought by the Sharafis.

Mr Macpherson objected also that a buy-out of worthless shares was a penalty. It is not a penalty, but the means by which AMC and Mr Malik will compensate the Sharafis for the damage caused by their wrongful conduct.

I consider that a valuation as at 19 July 2005 is appropriate. I also consider it appropriate to make the order for purchase against AMC and Mr Malik jointly and severally. Not only is Mr Malik a member, but he was personally responsible for the unfairly prejudicial conduct and he is, as I have found, the controller and principal beneficial owner of AMC.

Finally, I consider it appropriate to order AMC and Mr Malik jointly and severally to pay to the Sharafis the amount of their loan to the company. It was, as I have earlier stated, inextricably bound up with their position as members of the company. It was the means by which they and AMC chose to make their financial investment in their jointly-owned company. The Sharafis have no prospect of recovering it from the company, as a result of the conduct of AMC and Mr Malik, while the same conduct involved the repayment of the loan made by AMC.

I also consider it appropriate that interest should be paid on the purchase price since 19 July 2005 and, as AMC and Mr Malik procured the repayment of the loan to AMC, on the amount of the Sharafis’ loan since the date of repayment of AMC’s loan.

I will invite submissions as to the appropriate rate of interest and, generally, the terms of the order, to the extent that they cannot be dealt with by agreement.