‘No Dividends’ Policy And High Directors’ Salaries Were Unfairly Prejudicial To Minority Shareholders
Directors operating a ‘no dividends’ policy risk shareholders claiming the policy is ‘unfairly prejudicial’ to them under company law, particularly if the directors pay themselves high salaries relative to what they do, unless the company can justify the policy.
Three family shareholders held a minority 27.4 per cent of a family company’s shares between them. Other family shareholders held a majority 65 per cent of shares, and five of them were also directors.
From 1949 to 1985 the company paid out significant dividends. However, it made a loss in 1986, and the directors introduced a ‘no dividends’ policy on grounds that the company needed to plough profits back into the business. However, the no dividends policy continued after the company returned to profitability, becoming a policy of not paying dividends in any circumstances. This was despite the directors increasing their own salaries very significantly in the period from 2005 to 2015. Directors (and their spouses) also benefited from the use of expensive cars and a £1.73m company yacht.
In 1991, a minority shareholder complained about the directors’ excessive remuneration and the no dividends policy. The directors offered to buy him out, but he rejected their offer. In 2012, the directors offered to buy out the other two minority shareholders for £50,000. They also rejected the offer after their accountant valued their shares at between £843,359 and £1,125,142.
Under UK company law, a company shareholder can go to court if they believe their company’s affairs are being conducted in a way which is ‘unfairly prejudicial’ to them in their capacity as a shareholder. If a claim is successful, the court can order a wide variety of remedies, such as ordering the company to buy back the shareholder’s shares at a fair price.
Unfair prejudice claims usually arise in the case of a breach of an agreement between the shareholders about how the company is to be run. For example, a breach of the company’s articles or of company law, or there has been some failure to meet the shareholder’s legitimate expectations given the parties (often tacit) agreement on how the business should be run and/or the relationship between the shareholders.
Here, the minority shareholders argued that there was unfair prejudice because:
- The directors were awarding themselves excessive remuneration at the shareholders’ expense
- The no dividends policy was being operated to persuade the minority shareholders to sell their shares to the majority at a knock down price
The majority shareholders argued that:
- The unfair prejudice claim was an abuse of process because there was a fair alternative open to them under the company’s articles (whereby the minority shareholders could have offered their shares to the other shareholders and received a fair price for them, determined by the company’s auditors) which the minority shareholders had failed to take advantage of
- The no dividends policy was justified because the nature of the company’s business meant it always needed to retain significant working capital, as shown by its £20m overdraft
- The company had operated the policy for 25 years, so the minority shareholders’ claims were ‘stale’
The High Court found that:
- Applying objective, commercial criteria, the directors’ remuneration was outside the bracket that a reasonable director would consider to be fair, given their duties and responsibilities. The court considered evidence from the minority shareholders’ accountant and a survey on salaries in similar businesses from a major accountancy firm when reaching this conclusion#
- The directors’ levels of remuneration and the company’s expensive cars and yacht contradicted their claim that the no dividends policy was needed to keep significant working capital in the business. If that was so, the directors could have paid themselves less, and economised
- The policy was unfair because it was a breach of three directors’ statutory duties under company law because:
o The directors could not possibly have considered the no dividends policy to be likely to promote the success of the company for the benefit of its members as a whole
o The directors’ exercise of their powers to decide on a no dividends policy had been exercised for an improper purpose, ie. to benefit them rather than their company
o They had not exercised independent judgement when deciding on the policy
The court also found that the way the company’s articles were drafted meant the minority shareholders would become legally bound to transfer their shares to the other shareholders before they knew the price they would receive for them, as determined by the auditor. The majority shareholders, on the other hand, could wait to find out the auditor’s valuation before deciding whether to buy the shares. This was not fair in the circumstances. The court also observed that the auditor’s valuation could have taken into account the no dividends policy which would, of course, have reduced the value of the minority shareholders’ shares. Bringing an unfair prejudice claim before going through the process provided for in the articles was not, therefore, an abuse of process.
The court ruled that the company’s no dividend policy was both unfair and prejudicial. It decided that it would not be possible for the parties to agree a suitable alternative dividend policy, and ordered the company to buy back the minority shareholders’ shares, valued as if the directors’ excessive remuneration had never been paid.
- Directors operating a ‘no dividend’ policy risk shareholders claiming the policy is ‘unfairly prejudicial’ to them under company law, particularly if the directors are paying themselves high salaries for what they do, unless the company can justify the policy as being likely to promote the success of the company
Case ref: Donald Booth & others v Clarence Kenneth Fredrick Booth & others