Expert Insight

Court of Appeal Guidance on Good Faith Obligations in Shareholders’ Agreements .



In its judgment in Re Compound Photonic Group Ltd, the Court of Appeal has given helpful guidance on the scope of good faith obligations in a shareholders’ agreement.


The case concerned the removal of two directors by the majority shareholders, which triggered the minority shareholders to present an unfair prejudice petition. The judge at first instance found that the directors were entrenched in office and that the majority shareholders were not entitled to vote to remove them, despite the fact there was no terms in the shareholders’ agreement to that effect.


Allowing the appeal of the majority shareholders, the Court of Appeal has confirmed that the meaning of a good faith obligation must be objectively determined by the express and implied terms of the contract containing that obligation. The lack of any term prohibiting the majority shareholders from removing the directors was fatal to the petition.


The background


The facts of the case are complex and set out in over 300 paragraphs in the first instance decision. The following is, by necessity, a highly condensed summary of the most salient points.


Compound Photonics Group Limited (the ‘Company’) was a vehicle for the intended commercialisation of academic research by the CEO, Dr Sachs, into gallium arsenide and liquid crystal technology. The intention was to utilise that technology for the manufacture of very small (‘pico’) projectors.


The Company received substantial investment from three companies, which together held 93% of the shareholding (the ‘Investors’). The remaining 7% of the shareholding was held by Dr Sachs, Mr Faulkner (the Company’s chairman), and 68 other shareholders (the ‘Minorities’).


The Company’s articles of association contained the following provisions regarding board meetings:


“7.1 Subject to clause 7.3, the maximum number of Directors holding office at any one time shall be six.


7.2 The Investor shall have the right (but not the obligation) to appoint and maintain in office two of those directors (the ‘Investor Directors’).


7.3 If the Board resolves to increase the maximum number of Directors beyond six Directors, the Investor shall have the right (but not the obligation) to appoint and maintain in office one additional Director for every two additional non-Investor Directors appointed.


7.8 … the quorum for the transaction of business at any board meeting shall be three directors and shall include (insofar as they each remain a director) the [Mr Faulkner], [Dr Sachs] and, if one or more has been appointed, an Investor Director.


7.13 … resolutions arising at any meeting of the Directors shall be decided by a majority of votes provided that both of [Mr Faulkner] and [Dr Sachs] must at all times form part of that majority…”


The shareholders’ agreement contained the following provision regarding the shareholders’ dealings with themselves and the Company: “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.”


The business foundered. After several years, plans for the pico projector were eventually shelved and attention moved to a less ambitious and larger projector. When plans for that projector also became unstuck, the Investors lost confidence in Dr Sachs and presented him with an ultimatum: either resign or be removed. He chose the former. The relationship between the Investors and Mr Faulkner subsequently broke down and the Investors (with an overwhelming majority) voted for his removal.


The Minorities presented an unfair prejudice petition, claiming (among other things) that the removal of Dr Sachs and Mr Faulkner represented a breach of shareholders’ agreement, in particular the “good faith” clause, to the Minorities’ detriment as it transferred the balance of power on the board from them to the Investors.


The High Court’s decision


The High Court applied the formulation of good faith in Unwin v Bond[2], which set out “minimum standards” of conduct required by such an obligation. Those minimum standards included a requirement that a party subject to a duty of good faith must “be faithful to the parties’ agreed common purpose as derived from their agreement”.


Relying in particular on articles 7.1-7.3, 7.8 and 7.13 (quoted above), the High Court found that the parties’ agreed common purpose, or “bargain”, was that the Minorities would maintain control of the board through ‘their’ directors, Dr Sachs and Mr Faulkner, who were “entrenched” in their positions. Further, the provisions only allowing for the appointment by the Investors of one director to every two appointed by the Minorities was “expressly designed to avoid the will of the majority prevailing in matters concerned with the commercial future of the Company”. Accordingly, the Investors were required by the good faith obligation not to remove Dr Sachs and Mr Faulkner and to ensure the balance of power on the board of the Company remained with the Minorities. The Investors had breached that obligation.


The Investors appealed.


Court of Appeal’s decision


Snowden LG, delivering the lead judgment, set out instructive guidance regarding the proper interpretation of good faith obligations in shareholders’ agreements.


At the outset, he warned that when considering the meaning of a good faith obligation in a shareholders’ agreement, guidance provided by case law in other areas of law or commerce “may be of limited value and must be treated with considerable caution”.


He went on to note that while “judges have, on occasions, used the expression “the spirit of the contract” in the context of a good faith clause”, he did not read that “as an open invitation to the court to interpret a good faith clause as imposing additional substantive obligations (or restrictions on action) outside the other terms of the contract.” Obligations of good faith, he said, “could only operate to support the common purpose and aims of the parties as objectively obtained from the express and implied terms of the contract”. This was particularly true where the agreement had been carefully negotiated and drafted, prepared by lawyers and contained an entire agreement clause.


The question was, therefore, whether the common intention contended for by the claimants, namely that Dr Sachs and Mr Faulkner would not be removed, could be objectively obtained from the express and implied terms of the shareholders’ agreement. The Court held that it could not. Snowden LJ stated that, had that been the parties’ common intention, he would have expected it to be an express term. Further, such an interpretation was directly contradicted by, for example, the words “insofar as [Dr Sachs and Mr Faulkner] each remain a director” in article 7.8 in the articles of association, and provisions regarding the treatment of their shares in the event they left the Company.


The Court of Appeal accordingly held that there was no agreement that Dr Sachs and Mr Faulkner could not be removed from office and that the good faith obligation had therefore not been breached.




The High Court’s decision unsurprisingly caused significant consternations: shareholders subject to obligations of good faith were concerned that they might be blindsided by claims of breach of agreements they were unaware they had made. Calm will be restored by the Court of Appeal’s insistence that if a party is required to uphold a common intention, it must be objectively clear from the agreement what that common intention is.


Parties wishing to impose a meaningful obligation on fellow shareholders to be faithful to a common intention should set out the scope of that intention expressly to avoid reliance on implied terms that will almost invariably be subject to dispute.


By Cooley LLP - Alex Radcliffe and Andrew Love



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