Unfair Prejudice Petitions – The Meaning Of “Good Faith”

In the recent decision in the case of Re Compound Photonics Group Ltd; Faulkner v Vollin Holdings Ltd, the Court of Appeal has clarified the meaning of the contractual duty of good faith. In doing so, the Court of Appeal has cast doubt on previous case law on the same point.

Background

This case relates to the removal of two directors whom the minority shareholders had appointed. The company's articles of association provided that the board could not vote to remove the directors. However, the shareholders' agreement did not obligate the majority shareholders to not vote to remove the directors. Subsequently, one of the directors was forced to resign by the majority shareholders, and the second director was removed by the majority shareholders passing an ordinary resolution under the Companies Act 2006.

In the first instance, the High Court held that the minority shareholders had been unfairly prejudiced by the forced removal of the two directors. At the core of this decision was the High Court Judge's view that the majority shareholders had breached an express duty of good faith in the shareholders' agreement by not respecting the agreement to entrench the position of the two directors. As a result, the decision by the High Court was that the minority shareholder's shares in the company should be bought by the majority shareholders at a value to be determined.

The Court of Appeal's decision

The Court of Appeal overturned the High Court's decision. In doing so, the Court of Appeal examined existing case law on the meaning of the good faith obligation. One of the cases the Court of Appeal looked at was the recent case of Unwin v Bond, which summarised the meaning of good faith as the duty to:

• Act honestly;
• Be faithful to the parties' agreed common purpose;
• Not use powers for an ulterior motive;
• Deal fairly and openly; and
• Have regard for the other party's interests.  

However, the Court of Appeal in the Compound Photonics case cast doubt on whether such a formulaic approach was appropriate.  

It was the Court of Appeal's view that the meaning of good faith needs to be determined by reference to the individual facts of each case. In the Compound Photonics case, the Court of Appeal held that: 

• The duty of good faith includes a duty to act honestly; 
• The duty of good faith includes a duty not to act in bad faith, which means conduct which would be regarded as commercially unacceptable but not necessarily dishonest;
• The requirement for parties to be faithful to the parties' agreed or common purpose should be construed narrowly. The Court of Appeal decided that such a requirement would not apply to a shareholders' agreement if no express wording were included to that effect;
• The requirement for parties to deal fairly and openly should also be construed narrowly. In this particular case, the Court of Appeal decided that the majority shareholders were not under any procedural duty concerning the removal of a director which went beyond what is set out in the Companies Act 2006; and
• The Court of Appeal rejected the idea that a duty of good faith required the majority shareholders to have regard to the interests of the minority shareholders in some undefined way which is over and above any requirements imposed on shareholders to have regard to the interests of the company.