Court Of Appeal Guidance On Good Faith Obligations In Shareholders' Agreements

• Published date: 25 November 2022
• Subject Matter: Corporate/Commercial Law, Corporate and Company Law, Directors and Officers, Shareholders
• Law Firm: Cooley LLP
• Author: Ms Alex Radcliffe and Andrew Love

Introduction

In its judgment in Re Compound Photonic Group Ltd¹, 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...