Shareholder Disputes Circular

Legitimate

Legitimate expectationsWhat are legitimate expectations and when will they trump written agreements? This is adifficult question to answer in the abstract, save to note that these types of arguments arecommonly run by shareholders in small companies which have been built on the basis of closefamily or social connections. At first blush, many of these types of companies are run in amanner akin to partnerships - so-called ‘quasi-partnerships’. Two cases in 2018 gave insightsinto how the Courts consider and apply legitimate expectations.Sprint ElectricA classic example of a quasi-partnership is found in the first case – Sprint Electric. The Petitionerissued proceedings after he was excluded from the company’s management and removed as adirector by the majority shareholder. He argued that the relationship between the shareholdersmade the company a quasi-partnership. The Court agreed.Central to this finding was the fact that there was a relationship of mutual trust andconfidence between the parties: the company’s business was conducted informally andboth parties understood what monies they could extract from the business. There was alsoan understanding that the Petitioner would participate in the company’s management.Consequently, despite the fact that his voting power allowed him to do so, the Court ruled thatit had been unfairly prejudicial for the Respondent to exclude the Petitioner from managementand remove him as a director.Blackpool FCSprint Electric is a text book example of a set of circumstances ripe for arguments aboutinformal understandings giving rise to legitimate expectations. But sometimes such expectationsarise in more formal commercial relationships which do not involve close personal or socialconnections.One example of this was found in Blackpool FC. The Petitioner, a 20% shareholder, wasexcluded from management of the company which owned Blackpool FC. He was a high networth individual and seemingly had access to sophisticated legal advice. Indeed, he enteredinto various written agreements relating to the company. Despite this, he still claimed to havelegitimate expectations, which were not recorded in writing, that he would have an equal sayin management of the club, and that he would acquire parity of shareholding with the majorityshareholder in due course.The Respondent denied this and specifically relied on the fact that the formal, written agreementsbetween the parties made no mention of any such expectations. The Court, however, agreed with6

the Petitioner. Despite no mention of them in the written agreements, the Petitioner did havevalid and legitimate expectations regarding his involvement in management and the eventualincrease in his shareholding. His exclusion from management was therefore unfairly prejudicial.Further, the Court found that the extraction of large sums of money by the Respondentamounted to disguised dividends. Because no equivalent payments were made to the Petitioner,this was also held to be unfairly prejudicial conduct.Consequently, the Petitioner was entitled to a buy-out of his 20% shareholding in the company intwo parts:a. £4.5M for the original subscription monies the Petitioner had paid to acquire his 20%shareholding, plus the repayment of two loans to the company made by the Petitioner’sdaughter; andb. £26.77M which was equal to the amount paid to the Respondent as disguised dividends.The second part of the buy-out order is particularly significant. As the Petitioner had legitimatelyexpected to acquire parity of shareholding with the majority shareholder (c. 48% each), the courtvalued this part of his entitlement on that basis, meaning that he was awarded his rightful shareof the disguised dividends (the £26.77M). So in this case the alleged legitimate expectations wereworth many millions of pounds.WeatherleyLegitimate expectations that arise between certain family members will not necessarily extendto other family members. In Weatherley, a mother, father, son and daughter ran a companyinformally for their mutual benefit. Legitimate expectations seemingly arose between them,including the right to ongoing employment and involvement in the company’s management.However, these legitimate expectations did not extend to the son’s wife, who obtainedhis shares upon his death, or her own son. They had not been part of the initial informalunderstanding between the four other family members and, while it was understood thatadditional family members would be given an opportunity to work in the business, they couldonly expect to be retained if they worked hard and performed well.Further:a. While the company had terminated the wife’s employment shortly after her husband’sdeath, this had been justified on a number of grounds, including the fact that she hadrecorded conversations with her father-in-law without his knowledge in the hope oftrapping him into saying something to bolster her legal position.7