In the case of Re: Compound Photonics Group Ltd  EWCA Civ 1371, the Court of Appeal has recently considered the scope of the “duty of good faith” in the context of shareholders in private limited companies.
The original case related to an unfair prejudice petition which was brought by a number of minority shareholders (“the Minorities”) against parties who had heavily invested in the company and owned a 93% shareholding collectively (“the Investors”).
The Minorities claimed that they had been unfairly prejudiced as a result of the fact that two directors (who had been appointed by the Minorities) were forced to resign / removed by the directors.
The initial Judge accepted that, in excluding the two directors, the Investors had acted in breach of the terms of a shareholders’ agreement relating to the Company. This was on the basis that:-
- the company articles included a “constitutional agreement” that the directors were “entrenched in office” and if the Investors sought to remove them and/ or seek control of the board of directors, the Investors would be in breach of contract; and
- there was a good faith clause in the shareholders agreement.
The Judge ordered that the Investors to buy out the shares of the Minorities.
Grounds for Appeal
The Investors appealed the decision on the following grounds:-
- The good faith had been interpreted too widely
- The decision to remove the directors could be justified commercially and they were therefore not in breach of the good faith clause.
Court of Appeal judgment
The Court of Appeal Judges ultimately allowed the Investors’ appeal. Interestingly, the Court of Appeal Judges cast doubt on whether the formula on the meaning of good faith is set out in the previously leading case of Unwin v Bond  EWHC 1768 (Comm) was still good law.
In Unwin v Bond the Court provided a bullet point summary of the factors that would be applied when assessing duty of good faith:-
- to act honestly
- to be “faithful to the parties agreed common purpose”
- to not use powers for an ulterior motive
- to deal fairly and openly
- to have regard to the other party’s interests
The view of the Court of Appeals Judges was that a more holistic and fact driven approach should be taken. The key points that Court of Appeal Judges made were as follows:-
- the duty of good faith definitely does include a duty to act honestly;
- the duty of good faith goes beyond just a duty to act honestly, and also includes a duty not to act in bad faith;
- they rejected the suggestion that a “good faith” clause should be interpreted as requiring the majority shareholders to have regard to the interests of the minority shareholders. The clause only obliged the shareholders to act honestly, without “bad faith” and to have regard to the interests of the company.
- the court took a narrow view of good faith requiring the parties to be “faithful to the parties agreed or common purpose”. The Court took the approach that in order for that interpretation to be applied, express wording should be included to that effect in the shareholders agreement.
This judgment has left a question mark as to whether the factors set out in Unwin v Bond can be relied upon. The Court of Appeal Judges were very keen to emphasise that the Court should avoid taking an overly formulaic approach.
To avoid disputes arising in respect of good faith clauses, if there are any specific agreements between the shareholders, these should be expressly set out in both the company documents and any shareholder’s agreements.
For example, in order to ensure the position of directors appointed by one set of shareholders, it is necessary for there to be a specific provision in the shareholders agreement whereby all shareholders agree not to vote to remove those directors.
This article was co-written by Toby Claridge, Partner and Team Leader in our Dispute Resolution team, and Laura Stanley, Associate in our Dispute Resolution team. If you have any further inquiries with duty of good faith please feel free to get in touch with our Dispute Resolutions Team.