The English Appeal Court in Mark Faulkner & Ors v Vollin Holdings Limited & Ors [2022] EWCA Civ 1371 clarified how contractual good faith clauses should be treated in the context of a dispute between minority and majority shareholders.

Case Background

The petitioners, the minority shareholders including two individuals, Mr Faulkner and Mr Sachs entered into a Shareholders Agreement (the SHA) and agreed Articles of Association (the Articles) with a group of Investors (the respondents) relating to a company, Compound Photonics Group Limited (the Company) in 2013. The Company manufactured projectors. The respondents had injected cash into the business to help bring a projector to market. Over time the respondents had invested more than $135 million and owned 93% of the Company and were majority shareholders. Mr Faulkner and Mr Sachs were both minority shareholders and directors. Part of the SHA stated that Mr Faulkner and Mr Sachs were to have a role as directors in the management of the Company.

The initial plan for the projector failed and more investment was needed. Eventually, a simplified projector was manufactured. The respondents made it known that it was time Mr Sachs stepped down as director. Feeling the pressure to do so, Mr Sachs resigned. Thereafter, Mr Faulkner and the board's relationship broke down. Mr Faulkner was removed (by a large majority vote) as a director of the company in 2016, via a resolution under section 168 of the Companies Act 2006 (the 2006 Act). Mr Faulkner and Mr Sachs argued that their removal as directors breached the express good faith provisions in the SHA and raised an Unfair Prejudice Petition under s994 of the 2006 Act.

The good faith clause in the SHA read: -

“Each Shareholder undertakes to the other Shareholders and the Company that it will at all times act in good faith in all dealings with the other Shareholders and with the Company in relation to the matters contained in this Agreement”.

At first instance, the judge decided that the minorities had been unfairly prejudiced by the defendants when Dr Sachs and Mr Faulkner were both forced to resign and removed from office as directors. The Court relied on the minimum standards of good faith set out in Unwin v. Bond [2020] EWHC 1768 (Comm) which can be summarised as:

  1. acting honestly;
  2. "fidelity to the bargain" between the parties;
  3. "fair and open dealing"; and
  4. "regard to the interests" of the party to whom the duty was owed.

    The judge determined that in excluding Dr Sachs and Mr Faulkner, the respondents had acted in breach of the terms of the SHA and Articles as those documents comprised a constitutional settlement between parties, entrenching Dr Sachs and Mr Faulkner in office as directors. The respondents had acted in breach of their duties to the Company under s 171(a) and 172 of the 2006 Act. The judge ordered the respondents to buy the minority shareholders' shares in the Company at a value to be determined.

    The Investors' appeal

    The respondents appealed on the basis that: -

    1. The Judge interpreted the good faith clause in the SHA too widely.
    2. The clause in the SHA did not mean they had given up the right to vote to remove Dr Sachs and Mr Faulkner or take control of the management of the Company.
    3. The good faith clause in the SHA did not require them to take account of the interest of the minority shareholders when deciding how to exercise their right to vote as majority shareholders.
    4. As the respondents had genuinely and reasonably believed it was necessary for Dr Sachs to stop being involved in the management of the Company, they could not have breached their obligation of good faith when they required Dr Sachs' resignation as a condition of providing further substantial investment to the Company.
    5. They were not wrongful to assume control of the management of the Company after removing Mr Faulkner as Director.

      The Court of Appeal's decision

      The Court clarified the legal test for a breach of the express obligation of good faith in contracts and reigned judges in from applying a formulaic approach. The test for breach can be paraphrased as conduct which would be regarded as commercially unacceptable to reasonable and honest people.

      Entrenching effect

      The court's judgement led by Snowden LJ determined that the SHA did not have an "entrenching” effect. The roles of Mr Faulkner and Mr Sachs were not a contractual right and so their removal as directors was not a breach of any obligation of good faith.

      Contractual Interpretation

      The Court emphasised the importance of context when interpreting an express term of good faith - an express term must take its meaning from the context in which it is used.

      The court discouraged the “formulaic” approach to interpretation by which the previous judgment had applied the minimum standards of good faith set out in the case of Unwin v. Bond and stated it should have considered other cases in analysing the standards.

      The SHA had not contained an express agreement by the respondents not to vote at any general meeting of the Company in favour of a resolution to remove Dr. Sachs and Mr. Faulkner as directors under section 168 of the 2006 Act. However, the shared aims of the parties required to be identified by interpretation of the other terms of the agreement, or by implication of terms according to the usual test outlined in Marks & Spencer plc v BNP Paribas Securities [2016] AC 742.

      Dishonesty

      Snowden LJ accepted the argument that apart from the “core” duty of honesty and (depending on the context) a duty not to engage in conduct that could be characterised as bad faith, any further requirements of an express duty of good faith must be capable of being derived as a matter of interpretation or implication from the other terms of the contract.

      Snowden LJ agreed with Lord Nicholls, who in Royal Brunei Airlines Sdn Bhd v Tan [1995] UKPC 4 said it was impossible to be specific about the meaning of 'dishonesty.' He went further to state that a finding of dishonesty does not automatically mean that good faith has been breached, nor is it a pre-requisite to finding a breach.

      Consideration to the interaction between the SHA and statutory requirements.

      The Court also referred to section 168(2) of the 2006 Act, whereby any resolution to remove a director under section 168 can be defended by the director in question by way of written and verbal representations to the company. In that regard the Court at first instance had imposed an undue onus on the defendants.

      Regard to the interests of the other party

      Snowden LJ differentiated the context of this matter which was democratic voting (specified majority votes) by shareholders at general meetings of a limited company as compared to cases concerning business decisions by one party which are capable of adversely affecting, or depriving the other party of, a commercial benefit expected to be enjoyed under that contract.

      In the context of shareholders meetings, the test to be applied by the Court is to determine whether those voting in favour honestly believe that the outcome is for the benefit of the company. There is no requirement in such a case for the shareholders voting in favour to have regard to the interests of the minority, as opposed to the benefit of the company as a whole.

      The Court pointed out that the terms of the Articles and the identity of a company’s directors are not set in stone when the company is incorporated as they can be amended and changed from time to time by specified majority votes of the shareholders. Therefore, it could not follow, that the good faith clause had been designed to prescribe how the parties should behave in unforeseen future circumstances and further have the effect of entrenching the original structure so that changes could not be made at all.

      Given that the SHA and Articles were professionally drafted, the Court was less inclined to interpret the good faith clause as imposing additional obligations on the parties beyond a textual framework.

      Key takeaways for contractual drafting and disputes:-

      1. Minority shareholders can obtain an interim interdict (injunction in England) to prevent a majority from voting on a resolution (e.g., to remove specific directors).
      2. The status quo in the articles of association and general company law can be altered by an express agreement between individual shareholders regulating how they should each vote on specific matters.
      3. Depending on the contractual context, a duty of good faith may be breached by conduct taken in bad faith. This could include conduct which would be regarded as commercially unacceptable to reasonable and honest people, albeit that they would not necessarily regard it as dishonest.

        Professional contract drafting is key when entering into Shareholder Agreements. At Brodies, we can assist with you the drafting of Shareholder Agreements and advise you in the event of a dispute.

        Contributor

        Ken MacDonald

        Partner