The High Court has held that a shareholder in a company potentially suffered unfair prejudice when the company failed to comply with its contractual obligation to work towards an exit by 31 December 2019 and to consider any opportunities for an exit that arose in the meantime.

Unfair prejudice cases are always heavily laden with facts and so quite a challenge to summarise. We have set out the key facts below as succinctly as possible.

What happened?

The case concerns the parent company of a group whose principal business was to provide creative services to existing brands in the fashion, beauty and luxury brand sectors.

Following several rounds of fundraising and a capital reorganisation, by 2016 the company had come to be owned by several investors.

These included a Mr Loy, who had founded the business (and who held his interest through a trust), a Mr Costa and a Mr Uberoi (who invested jointly through a corporate vehicle). (There was also various minority investors who played no part in the dispute.)

In 2016, the company and its various shareholders entered into a shareholders’ agreement (SHA). That agreement contained the following clause:

“6.2. Investment Period. The Company and each of the Investors agree to work together in good faith towards an Exit no later than 31 December 2019 ("the Investment Period"). In addition, the Company and each of the Investors agree to give good faith consideration to any opportunities for an Exit during the course of the Investment Period. In the event that an Exit has not occurred upon the expiry of the Investment Period […], the Board of Directors shall engage an investment bank to cause an Exit […] at a valuation devised by such investment bank and on such terms as shall be consented to by the Board of Directors, which consent shall not be unreasonably withheld.”

The agreement defined an “Exit” as a sale of the shares in the company, or of the company’s business and assets, on arm’s length terms.

In short, the company did not achieve an Exit by 31 December 2019.

Mr Costa and Mr Uberoi instructed a financial adviser to run a process to realise value in the company. That engagement encompassed not only opportunities for an exit, but also potential fundraisings. Importantly, the instruction was not limited to pursuing an exit by the end of 2019 and did not specify any timetable or deadline for any proposed transaction.

Mr Loy became concerned that the sale process was taking too long and would not be completed within the contractual timeframe.

Over the course of 2019, Mr Loy made requests from Mr Costa for financial and other information on the company to enable him to engage with potential buyers in parallel with the process being run by the financial adviser. However, he was consistently rebuffed.

Later in 2019, Mr Loy introduced a potential buyer to the company and its financial adviser. Although an initial meeting took place between the potential buyer, Mr Costa and Mr Uberoi, ultimately the proposal was not progressed because Mr Costa and Mr Uberoi felt it undervalued the company.

Subsequently, another potential buyer emerged. However, on discovering that the new potential buyer was connected with Mr Loy, Mr Costa effectively blocked any discussions with that buyer.

During late 2019 and early 2020, both potential buyers continued to attempt to engage with the company through its financial adviser. However, for one reason or another, they were not entertained and, in January 2020, Mr Costa and the company’s financial adviser began to seek other investors.

Shortly after this, lockdowns were imposed due to Covid-19 in the various territories in which the group was operating, initially crippling its business.

What did Mr Loy claim?

Mr Loy launched a petition to the court claiming he had suffered unfair prejudice. For more information on petitions for unfair prejudice, see the box “What is unfair prejudice?” below.

He claimed that the company had breached its obligations in clause 6.2 of the SHA:

• by engaging the financial adviser with a broad mandate that was not limited to a sale and was not referenced to a specific timetable, the company had failed to work in good faith to achieve an Exit by 31 December 2019; and
• by failing to engage with the two potential bidders, it had not given good faith consideration to opportunities for an Exit.

Mr Loy claimed these breaches had been brought about by Mr Costa’s behaviour. In particular, he claimed that Mr Costa (with assistance from Mr Uberoi) had exercised almost sole control over the sale process with the company’s financial adviser and failed to involve Mr Loy and the other directors.

This, he alleged, amounted to breaches by Mr Loy of his duties as a director and had unfairly prejudiced Mr Loy as a shareholder.

Normally, a petitioner in unfair prejudice will ask the court to order one or more other, culpable shareholders to buy the petitioner out of the company by acquiring the petitioner’s shares.

Here Mr Loy sought an order against Mr Costa personally. This is interesting because, although Mr Costa had an indirect economic stake in the company, he was not himself a shareholder or subject to the obligations in the SHA.

The court was prepared to entertain this, provided that Mr Loy could show that Mr Costa was directly responsible for the allegedly unfair conduct and could justify an order against Mr Costa personally.

The court had to answer the following questions:

• Was there a breach of clause 6.2?
• If there was, was it due to Mr Costa’s conduct (such as a breach of his duties as a director)?
• If it was, did Mr Loy suffer prejudice and, if so, was that prejudice unfair?
• Finally, if Mr Loy did suffer unfair prejudice, was a buy-out order against Mr Costa personally the appropriate remedy?

Was there a breach of the shareholders’ agreement?

Yes. The SHA did not mandate a sale by a particular date. But it did require the company and its investors to work together towards achieving an Exit by a specified date. This involved taking active steps before that date, but, due to Mr Costa’s control of the process, the company had not done this.

In the court’s view, Mr Costa had sincerely believed that no offer could be procured at an acceptable price before that date. But that did not relieve the company of its duty to work towards an Exit and to seek and consider offers (even if Mr Costa thought they would be unattractive).

The company had failed to consider the opportunities presented by the two potential bidders. It did not matter that neither opportunity had matured into a full offer. They merited consideration, but Mr Costa had refused to entertain them merely because the bidders were associated in some way with Mr Loy.

Mr Costa argued that it had not been in the company’s best interests to conclude an Exit before the end of 2019, and his duty to the company to promote its success overrode any obligations in the SHA.

The judge agreed that fiduciary duties will normally override conflicting contractual duties, but there was no conflict here. If Mr Costa had been faced with two competing offers, he would have been duty-bound to recommend the higher offer. But his duties do not preclude him from pursuing a less profitable exit at an earlier point rather than a potentially more profitable exit later down the line.

The judge also rejected Mr Costa’s argument that a sale to a private equity investor would not have been a true Exit simply because certain management shareholders would have retained an indirect stake in the company by rolling their interests over into the new acquiring entity (effectively “exiting to themselves”).

However, the judge was satisfied that a full exit would be achieved by the selling managers relinquishing their stake in the company for a stake in a brand-new company with a different capital structure and leverage, new levels of structural subordination and, fundamentally, a different risk/reward profile. This is a common structure for private equity investments and it is encouraging that the court recognised this.

Was the breach due to Mr Costa’s acts?

The court rejected arguments that Mr Costa had breached his duty in section 172 of the Companies Act 2006 to promote the success of the company and his duty in section 174 of the Companies Act 2006 to exercise reasonable care, skill and diligence.

Mr Costa had reasonably believed that it was in the company’s best interests not to comply with clause 6.2 and had sincerely believed he was engaging in a course of action that was ultimately for the company’s benefit. He had not intended to actively injure the company or any of its shareholders.

The judge did, however, reject Mr Costa’s argument that he had acted reasonably by virtue of acting on the advice of the company’s financial adviser. Although acting on professional advice will often enable a director to satisfy their duty under section 174, in this case, Mr Costa knew very well that the financial adviser’s mandate did not accord with the requirements of the SHA.

But this was all by the by. The fact was that Mr Costa had controlled the sale process, limited information flow to the other directors and Mr Loy and, in so doing, led the company into breaching its obligations in the SHA and so there were possible grounds for unfair prejudice.

Was there unfair prejudice?

As a result of Mr Costa’s acts, Mr Loy had been unable to realise the value of his shares in the company in contravention of the SHA. This breached the terms on which the parties had agreed to conduct the company’s affairs and amounted to unfair prejudice.

To obtain relief, however, Mr Loy needed to show that he had suffered loss due to the unfairly prejudicial conduct.

The court noted that, under the SHA, an offer for the company had to be approved by its shareholders. If the opportunities which Mr Costa ignored would never have been acceptable to the shareholders, Mr Loy would not have been able to realise the value of his shares and so would have suffered no loss.

To rule on this, the court had to decide what level of offer was likely to have been acceptable to the shareholders. This was a thought experiment, but the judge alighted on a value based on evidence from Mr Uberoi and Mr Loy about the offer price that would have tipped shareholders in favour.

However, the court did not hear sufficient evidence on the value of offers that would have been elicited through a proper marketing and due diligence exercise. (The court was not prepared to reach a view based solely on a non-binding offer subject to due diligence.)

This will be determined at a later trial and, if an offer would have exceeded the level which the court found other shareholders would have accepted, the court will order Mr Costa to buy out Mr Loy at the price he would have received.

What does this mean for me?

This is a good example of the English courts striving to uphold an agreement to pursue an exit within a particular timeframe.

Investors in a company will usually look to realise their investment within a particular time horizon. To this end, it is common to include provisions in a shareholders’ or investment agreement requiring the parties to work towards an exit by a stipulated date.

There is always some degree of uncertainty over how enforceable these provisions can be. When the proposed exit date comes around, the parties will inevitably need to co-operate and take actions that cannot always be anticipated when the initial investment is made.

It may also be that an exit is not the best strategy at that time, in which case the parties can decide an alternative course of action, including extending their investment period.

But this case shows that parties cannot simply act in their own interests merely because an exit by the pre-agreed time does not suit them. The judge found that Mr Costa delayed acting on the opportunities that arose because he wished to sell out later at a higher price (even though the judge accepted that an investment bank with a free hand would have recommended waiting).

Whether or not that was the “right” decision commercially, it was at odds with the obligations of the company and the investors to work together in good faith to seek an exit before the end of 2019.

Controlling investors should consider the terms of exit provisions carefully at the outset, or they risk empowering a minority to force an exit regardless of commercial considerations.

The case yields the following useful points for private capital investors who are approaching the end of their contractual investment timeline.

• Examine the shareholders’ or investment agreement. Does it contain any obligations to work towards an exit? If so, what do these obligations involve? Are they merely to consider any opportunities, or do they involve actively engaging a professional adviser and seeking out an exit? Investors should ensure that professional advisers are instructed on terms which reflect any applicable terms.
• What would an exit involve? There are commonly three types of exit: a sale of the company itself; a sale of the company’s assets and undertaking; or an IPO on a securities exchange. The contract should stipulate what amounts to an “exit” and, therefore, what the parties may be required to pursue.
• Strike the right balance. Naturally, investors want the best return on their investment and so will push for the approach they feel most maximises value. This may be a particular type or exit or, indeed, delaying an exit into the future. However, an investor should not allow personal or commercial interests to dictate behaviour that runs counter to their contractual agreement with other shareholders. This could amount to a breach of contract for which the investor may be liable to pay damages. Instead, investors should engage with other shareholders as and when appropriate and advocate for their own preferred approach.
• Involve the other shareholders. It is normal that some shareholders – usually those appointed to the board (or who have a right to appoint a director) – will have more information on strategy, value and opportunities than others. Directors should not selectively disclose or hide information from other directors, and investors should not withhold information that is required to be shared under the shareholders’ or investment agreement. This is likely only to pave the way for an unfair prejudice petition or an action for breach of duty.

Access the High Court’s judgment on unfair prejudice in the context of a company exit in Saxon Woods Investments Ltd v Costa and others [2024] EWHC 387 (Ch)