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Amending company constitution to force out a minority shareholder - Staray Capital Ltd v Cha
In Staray Capital Ltd v Cha, the Privy Council determined that the amendment of the constitutional documents of a British Virgin Islands (“BVI”) company by a majority shareholder with a view to forcing a minority shareholder out of the company was valid.
Although the case concerned a BVI company, the Privy Council considered English common law authorities and the decision is instructive for constitutional amendments of UK Companies Act companies made by majority shareholders which adversely affect minority shareholders.
The company, Staray Capital Ltd., was established in March 2010 by Mr Chen (holding 80% of the shares) and Mr Cha (holding 20%) to pursue a mining venture in Canada. The relationship between Mr Chen and Mr Cha subsequently broke down, with Mr Chen claiming that Mr Cha had made misrepresentations about his legal qualifications when the pair established the venture.
In October 2011, having already caused Mr Cha’s removal as a director of the company, Mr Chen passed a special resolution amending the memorandum and articles of the company to empower the company to redeem a shareholder’s shares at fair market value where that shareholder had made material misrepresentations in the course of acquiring his shares. Shortly thereafter, the company gave notice to Mr Cha to redeem all of his shares, relying on the mechanism.
Mr Cha disputed the amendment, asserting that it was made in bad faith and was solely intended to force him out of the company. Mr Chen admitted that the resolution was directed at forcing-out Mr Cha.
The Privy Council decided the amendment was valid, despite the adverse effect to Mr Cha. On the facts, however, the Privy Council found that Mr Cha had not made material misrepresentations and that the company did not have grounds to redeem his shares under the mechanism inserted into the company’s articles of association by the amendment.
In reaching a decision on the amendment, the Privy Council considered English case law on majority shareholders amending a company’s constitution to bind minority shareholders. These authorities (including Sidebottom v Kershaw Leese and Co Ltd) suggest that the exercise of this power by the majority will only be valid if it is done in good faith and in the interests of the company.
The recent case of Re Charterhouse Capital Ltd summarised seven principles for determining whether such an amendment is valid. Of these principles, in addition to the “good faith” and “best interests of the company” elements, in Staray, the Privy Council noted that (i) it is for the shareholders to determine whether the amendment is in the best interests of the company (but their determination must not be obviously unreasonable) and (ii) the fact the amendment (intentionally or otherwise) adversely affects the minority shareholders does not, in and of itself, invalidate the amendment.
Applying these authorities, the Privy Council found that the fact the amendment was directed at Mr Cha did not invalidate it because, in making it, Mr Chen believed that he was acting in the company’s best interests and it was not objectively unreasonable for him to hold that belief. The benefit to the company of having redress against a shareholder who acquired his shares through misrepresentation was clear to the court, even if Mr Chen’s intention in passing the amendment was to create a means to force-out Mr Cha.
Implications for majority shareholders and minority shareholders
For majority shareholders seeking to introduce a “force-out” mechanism (e.g. compulsory redemption or drag-along provisions) which may prejudice minority shareholders into the articles of association of a company, the key takeaway from the Staray decision is to ensure that any such amendment has a genuine purpose that is objectively beneficial for the company and would hold up to scrutiny against that standard in court.
For minority shareholders faced with this situation, the decision in Staray highlights that the court is unlikely to interfere with the passage of such an amendment – unless no reasonable shareholder could justify it as being in the best interests of the company.
As such, minority shareholders should explore other means of protecting themselves against amendments to constitutional documents of this nature, for example by obtaining a veto right over such amendments in a shareholders’ agreement. Otherwise, as was the case in Straray, minority shareholders may have some success in arguing that the conditions for implementing the force-out mechanism have not been satisfied.