Farm failure and family fallout leads to Supreme Court ruling on prejudiced shareholders provision

Baker v Hodder [2018] NZSC 78 deals with important company law issues, and at the highest level.  In a sadly familiar set of facts, the case concerned a farming business run on land owned by a family company which was unsuccessful and ultimately became insolvent, forcing the sale of the farm.  It is worth noting as it is the first decision by the Supreme Court on the ‘prejudiced shareholders provision’, a widely relied upon provision in the Companies Act 1993 ("the Companies Act"). 

Background

Kadd Farm Limited (the Company) was a family company with its shareholders being Wallace and Ann Hodder (70%) and Duncan and Kathryn Baker (30%).  Kathryn Baker is Wallace and Ann Hodder’s daughter.

The Company owned a farm known as Heron Creek.  The farm was run by the Bakers and the Company leased the farm to Mr Baker’s company, DB Contracting Agriculture Ltd (DB Contracting).  Unfortunately, the Bakers were unsuccessful in their enterprise and DB Contracting defaulted under the lease causing the Company to default under its mortgage.

The farm was ultimately put on the market and offers were received.  The shareholders did not agree on an appropriate counteroffer to those offers.  The Hodders made a counteroffer on behalf of the Company without consultation or agreement by the Bakers.  An agreement for sale and purchase was signed.  As the sale constituted a major transaction for the Company, the agreement was conditional on the necessary approval of at least 75% of the shareholders required by section 129 of the Companies Act (a special resolution).  The Bakers refused to sign a special resolution approving the sale. 

High Court decision

The Hodders sought relief under section 174 of the Companies Act alleging that the Bakers’ refusal to sign a special resolution was oppressive and/or unfairly prejudicial to the Hodders and the Company.

The High Court truncated the timetable for the proceedings on the basis that the matter was urgent (though it was acknowledged that there may have been some artificiality to the urgency given that the proposed purchasers were already in possession of the farm).  It held that the refusal to sign constituted prejudicial conduct and ordered the Bakers to sign a special resolution allowing the sale of the farm.  Further to this, the High Court refused to stay its decision to allow the Bakers to appeal it.

The Bakers signed a resolution in compliance with the Court order and Heron Creek was sold.

Court of Appeal decision

The Bakers unsuccessfully appealed to the Court of Appeal.  The Court of Appeal held that the appeal was moot as the farm had already been sold.

Supreme Court

The Bakers sought leave to appeal to the Supreme Court. 

Although the Supreme Court accepted that the appeal was moot in the sense that the farm had been sold it decided that the Court of Appeal should have heard the appeal on the basis that:

• The award of costs may be reversed on appeal;
• The High Court decision raised important questions about the interaction between sections 129 and 174 of the Companies Act; and
• The truncation of the process in circumstances where the outcome was final, rather than interlocutory, was unfair.

Unfair process

The Supreme Court held that:

• the truncation of the process;
• the High Court’s order requiring the Bakers to sign the special resolution was not a matter that had been the subject of pleading or advance notice; and
• the final determination made by the High Court might stand in the way of any future proceedings by the Bakers against the Hodders,

all which unfairly affected the Bakers’ presentation of their case.

Prejudiced shareholders provision

Commonly, applications of prejudicial conduct arise in the context of small, family owned companies.  In these companies there is often an understanding that all shareholders will take part in the business and it transpires that either a shareholder is excluded from the management of the company, or its corresponding director fails to pull his or her weight.  Courts have very wide powers to make an order to remedy the prejudicial conduct, though such orders are usually in the form of liquidation or forced share sales. 

In the High Court the Hodders argued that the Company’s position and their position as shareholders were unfairly prejudiced by the Bakers’ refusal to sign a special resolution.  The High Court confirmed that they were prejudiced in their capacities as directors and shareholders on the basis that unless the farm was sold, the Company’s debts would increase with no prospect of repayment.  It took full advantage of the wide powers available to it to remedy the prejudicial conduct in ordering the Bakers to sign a special resolution under section 129 of the Companies Act.

The Supreme Court disagreed with the High Court’s decision.  As part of its discussion of the prejudiced shareholders provision, the Supreme Court referred to the Law Commission’s report recommending company law reform (Law Commission Company Law: Reform and Restatement (NZLC R9, 1989) along with the explanatory note to the Companies Bill 1990.  It confirmed that in most circumstances, including voting on major transactions, shareholders can vote according to self-interest and they are not subject to the obligations imposed on directors.  This is a fundamental principle of company law.  

The Supreme Court rather sensibly held that the Bakers were merely exercising their rights as shareholders by withholding their approval under section 129.  It confirmed that the Bakers did not owe any statutory duty to the Company or to the Hodders in relation to the sale of the farm (meaning there was no prejudicial conduct in refusing to sign the special resolution).

Relationship between sections 129 and 174

The Supreme Court confirmed that the language in section 174 was not properly suited to the Bakers’ case, where the oppression complained of consisted of a shareholder invoking the right to decline to approve a major transaction under section 129.  However, it noted section 174(3) which allows an order to be made against a person other than the relevant company, including a shareholder, suggesting that section 174 could apply. 

Company members must take care when drafting documents such as constitutions or shareholders agreements to ensure that no unintended duties are created which might give rise to an action under section 174 (and conversely any intended duties are accurately recorded).  In some relief, the Supreme Court issued a cautionary note confirming that the power to make an order against a person other than a company under section 174 should be exercised very carefully.

The Court’s decision is sound and ensures the fundamental principles of company law protecting shareholders are maintained. 

Conclusion

Ultimately the Bakers were successful in their appeal.  The Supreme Court confirmed that the Court of Appeal should have heard the Bakers’ case and the order made under section 174 was quashed. 

Amanda is an Associate in our Commercial Team, specialising in Company Law,  and can be contacted on 07 958 7451.