Directors of closely held companies often assume that as long as they comply with the company’s constitution and obtain the support of the majority shareholders, their decisions will be immune from challenge. That assumption can be risky and ultimately costly if challenged in the High Court.
Section 174 of the Companies Act 1993 (Act) gives shareholders a powerful remedy where the affairs of a company are conducted in a manner that is (or is likely to be) oppressive, unfairly discriminatory, or unfairly prejudicial to them. If the Court considers it just and equitable to do so, it may make any orders it thinks fit. Those powers are broad and often include orders requiring the compulsory acquisition of shares, the payment of compensation, the setting aside of company actions and, in extreme cases, liquidation.
Importantly, the Court of Appeal has confirmed that the provision says nothing about the defendant’s state of mind or whether the perpetrator acted dishonestly, in bad faith or even unlawfully. The question is whether their conduct has caused unfair prejudice to a shareholder. The courts have repeatedly emphasised that the remedy is a broad and flexible one designed to address conduct that results in unjust detriment to shareholders.
While every case turns on its own facts, there are recurring categories of conduct that directors should avoid. Avoiding these minimises the risk of a prejudiced shareholder claim against the company and the directors themselves. We explore five of those categories below.
One: Excluding Director-Shareholders from Management
One of the most common sources of prejudiced shareholder claims arises where a shareholder is effectively frozen out of the business and its decision-making. This is particularly common in closely held companies where shareholders have joined the venture on the understanding that they will participate in management, governance, or the day-to-day operation of the business.
A useful example is Greymouth Holdings Ltd v Jet Trustees Ltd, where one director effectively sidelined the other directors. That director failed to report on company operations, made decisions without approval, and excluded the other directors from meaningful participation in the company’s affairs. The High Court found that this conduct was oppressive and unfairly prejudicial to the interests of shareholders, and the Court of Appeal upheld that finding.
Directors should be cautious about excluding directors from decision-making processes, removing them from management roles without proper justification, or otherwise shutting them out of the affairs of the company. Such conduct may undermine a shareholder’s legitimate expectation of involvement in the business and give rise to a claim under section 174.
Two: Withholding Information
Transparency is critical to maintaining shareholder confidence. Directors should avoid withholding financial information, management reports, company records, or explanations regarding significant business decisions from shareholders.
While not every shareholder is entitled to participate in management, shareholders are generally entitled to understand how their investment is being managed. A lack of transparency can create a perception that the company’s affairs are being conducted for the benefit of some shareholders at the expense of others.
In Re Environmental Products (New Zealand) Ltd, certain shareholders failed to respond to requests for an audit of the company’s financial position and failed to make available the company’s primary accounting records. The High Court found that the effect of this conduct was to shut other shareholders out of the business and prevent proper accounting from taking place. That conduct was held to be unfairly prejudicial.
While a prejudiced shareholder claim was made against another shareholder in this case, it serves as a reminder that directors should approach requests for financial information and company records with care. Otherwise, a lack of transparency may ultimately be viewed as unfairly prejudicial conduct.
Three: Issue of Shares for an Improper Purpose
Directors should exercise caution when using company powers in a manner that disadvantages minority shareholders. One of the clearest examples is the issue of new shares. Although issuing shares is an ordinary corporate power, it may become unfairly prejudicial where it is used to dilute a minority shareholder’s influence or alter the balance of control within the company.
In Aspinall (NZ) Ltd v Thomas, the company proposed issuing additional shares that excluded the minority shareholder from participating in the share issue. The Court intervened and granted relief preventing the share issue from proceeding. The case illustrates that directors should ensure share issues are undertaken for proper commercial reasons and not as a mechanism for reducing the influence or bargaining position of minority shareholders.
Four: Self-Interested Transactions and Conflicts of Interest
Directors owe fundamental duties to act in good faith and in the best interests of the company under section 131 of the Act, and to exercise their powers for a proper purpose under section 133. The Act also imposes specific obligations in relation to self-interested transactions, including the duty to disclose interests (section 140). Additionally, it provides that transactions in which a director is interested may be avoided by the company unless it has received fair value (section 141).
Where directors engage in transactions that benefit themselves or their associated persons at the expense of the company or its shareholders, such conduct is particularly likely to give rise to a prejudiced shareholder claim. Breaches of directorial duties and excessive remuneration are among the most common complaints in this area. Other examples include the unauthorised appropriation of company funds or assets, entering into contracts on terms favourable to a director’s personal interests, or causing the company to make loans or payments to related parties without proper authorisation.
Five: Exclusion from or Failure to Give Notice of Shareholders’ Meetings
Directors should ensure that shareholders are afforded the rights of participation in the governance of the company. Failing to provide notice of shareholder or director meetings, making significant decisions without following prescribed procedures, or otherwise excluding shareholders and director-shareholders from important discussions may provide the foundation for a prejudiced shareholder claim.
While such conduct can sometimes appear procedural in nature, the courts frequently treat these failings as evidence of broader unfairness in the management of a company’s affairs. For example, in Norager v Charles Norager & Son Ltd, a shareholder who was also a director was removed as managing director following a directors’ meeting of which he had not been given notice. The Court held that the failure to give notice of the meeting, and the resulting exclusion from the decision-making process, constituted oppressive conduct.
Summary
Directors can significantly reduce the risk of a prejudiced shareholder claim by ensuring that:
- company affairs are conducted transparently;
- shareholders are treated fairly;
- proper processes are followed; and
- decisions are made in the interests of the company rather than for personal advantage.
In closely held companies in particular, where shareholders often have an expectation of ongoing participation in the business, fairness, consultation, and transparency are frequently the best safeguards against costly and disruptive litigation.
Ultimately, the key lesson for directors is that a prejudiced shareholder claim is not confined to dishonest conduct or obvious wrongdoing. While this article considers some common examples, the broad statutory wording of section 174 allows the Court to grant a prejudiced shareholder claim in a range of varied circumstances.
Contact our Disputes and Litigation team for practical advice on shareholder rights and disputes.
