Don’t be a minority shareholder without a shareholders agreement for protection

For many years, Machiavelli Ristorante Italiano in the Sydney CBD was the place for the business and political elite to be seen and to talk business.

More recently, the Supreme Court of New South Wales was the place for the new owners of the Machiavelli Ristorante to be seen to litigate their partnership disputes.

The case is In the matter of Bicher & Son Pty Ltd [2020] NSWSC 711 (9 June 2020) (Black J).

The hearing lasted 6 days, culminating in an anticlimactic decision by the Court to not intervene:

“In the result, the parties will be left within their existing relationship.” And “each party must pay their own costs” which are said to be several hundred thousand dollars each.

In this article we examine how the disputes arose, find out why the minority shareholder failed to prove he was entitled to members’ rights and remedies for oppressive conduct by the majority shareholder, and how a well-drafted shareholders agreement might have made all the difference.

How the disputes arose

In July 2015, Mr Bicher engaged Mr Pellarini, an accountant to assist in the purchase of the Machiavelli Ristorante. The agreed price of $850,000 was payable as to $400,000 under a Contract for Sale and as to $450,000 in cash to a person associated with the vendor, Ms Toppi. The Contract price was satisfied by vendor finance of $200,000 and by Mr Pellarini who provided a loan of $200,000. Both loans were later repaid out of the business. Mr Bicher paid the cash payment of $450,000 from “gambling winnings and borrowings from other gamblers”.

Bicher & Son Pty Ltd was the purchase vehicle, with the shareholding split being 80% held by Mr Bicher and 20% held by Mr Pellarini. Mr Bicher was the sole director.

The purchase was completed on 1 November 2015. The management responsibilities were divided. Mr Bicher operated the restaurant, while Mr Pellarini monitored the financial and banking records, helped with payment of the staff wages, and prepared financial accounts.

Large cash transactions abounded – the vendor of the business was paid in cash for stock, employee wages were paid in cash (without tax withheld), not all cash received by the business for food and wine sales was banked, and a builder was paid in cash. Two sets of books and records were kept, one for tax purposes, the other the true position which included the cash receipts and payments. As we will see, the Court took a dim view of the cash transactions and was reluctant to exercise its discretion to intervene.

Subsequently, partnership disputes arose. Mr Pellarini said he paid $300,000 to purchase another 30% share to become an equal shareholder, which Mr Bicher disputed. Mr Pellarini alleged he made a number of loans which have not been repaid.

Before Mr Pellarini left for a holiday in Italy on 16 September 2018, he had discussions with Mr Bicher about buying each other out of the business. These came to nothing.

On 17 or 18 September 2018, Mr Bircher removed Mr Pellarini’s access to the Company’s documents containing management information, stating that: “I’ve got to the stage of being highly concerned of his accuracy and fairness as the accountant for the business where he is one of the shareholders”.

Mr Bicher appointed a new accounting firm.

The legal proceedings were instituted by Mr Pellarini in March 2019, after he had unsuccessfully sought to be appointed a director of the Company.

Members’ rights and remedies for oppressive conduct

The usual remedy for a minority shareholder is relief for oppression under section 232 (d) or (e) of the Corporations Act 2001 (Cth) which provides that the Court may make a winding up order or a share buy-out order under s 233 if:

“(a) the conduct of a company’s affairs; or
(b) an actual or proposed act or omission by or on behalf of a company; or
(c) a resolution, or a proposed resolution, of members or a class of members of a company;
is either:
(d) contrary to the interests of the members as a whole; or
(e) oppressive to, unfairly prejudicial to, or unfairly discriminatory against, a member or members whether in that capacity or in any other capacity.”

The Court adopted this formulation of the test to be applied:

“(1) The test of oppression is an objective one of unfairness ...
(2) The court must look to determine whether on the balance of probabilities the objective commercial bystander would be satisfied that the affairs of the company were being conducted unfairly …”
[Munstermann v Rayward [2017] NSWSC 133 at [22] per Stevenson J]

The Court’s conclusions upon the principal allegations of oppression were:

  • Removal of Mr Pellarini’s access to information on 17 or 18 September 2018:
    “It seems to me that the restriction on Mr Pellarini’s access to information and of his involvement in management in this period do not rise to the level of oppression, alone or together with other matters, given Mr Pellarini’s previous conduct and the fact that read-only access to the Company’s financial information was subsequently restored, although he was not given any further role in its management.” [paragraph 91]
  • Complaint that Mr Pellarini was not appointed as a director:
    “It seems to me that, having regard to Mr Pellarini’s conduct in respect of the Company’s accounts, involving plainly false entries and the deception of taxation authorities, and irrespective of whether Mr Bicher had tolerated or permitted that conduct, Mr Bicher could rationally form the view that it was not in the Company’s best interests to appoint Mr Pellarini as a director of the Company in January 2019.” [paragraph 93]
  • Dealings with cash receipts:
    “I am not persuaded that these matters warrant the relief sought by Mr Pellarini, alone or together with other matters, where a practice of depositing cash receipts to the Company’s bank account has now been in place for some time, pursuant to undertakings given to the Court, and that relief would have the adverse consequences.” [to the business] [paragraph 101]

Having found no oppressive conduct, it was not necessary for the Court to decide what if any orders it should make under s 233. But in accordance with accepted practice, it did so.

The Court rejected the applications made by each of Mr Pellarini and Mr Bircher that the Court order a buy-out of the other’s shares for these reasons:

  • “I am not persuaded that, where it is apparent that both Mr Pellarini and Mr Bicher were prepared to deal with cash in a way that led to non-compliance with the Company’s tax obligations, and probably also with employees’ tax obligations, an order for the compulsory purchase of shares should be made in favour of either of them.” [paragraph 121]

The Court also rejected Mr Pellarini’s application for a winding up order:

  • “It seems to me that it would not be in the public interest that the Company now be wound up, where it has self-reported the issues relating to taxation non-compliance to revenue authorities and assumed the consequential liability, and a liquidation would reduce the prospects that that liability will be met over time. It would plainly not be in the interests of employees of the Company that it now be wound up.” [paragraph 135]

How might a well-drafted shareholders agreement make a difference?

A business carried on in a corporate entity is known as a “limited liability partnership” because it protects the business owners from personal liability, unless they sign personal guarantees or expose themselves to personal liability by contravening the law.

A well-drafted shareholders agreement protects a minority shareholder. These are important topics for consideration:

  • Business Decision-making Significant decisions can be reserved for a resolution by the shareholders, with pre-determined voting thresholds such as 75% or even unanimous. Decisions such as the sale of business, changes of shareholdings, significant loans, capital expenses and raising capital fall into this category. Other decisions can be reserved for the directors.
  • Management Who is entitled to be a director, authority to make business decisions and divisions of management responsibility fall into this category.
  • Profit distributions and Salaries Policies on profit sharing, profit distribution, retention of profits, salaries and bonuses fall into this category.
  • Term and disputes An initial period can be agreed during which the arrangements are to apply. After that time, the agreement may be reviewed, a partner might be allowed to leave, and a formula might be used to calculate a value for the shares for a buy-out. There should be a disputes resolution procedure to be followed before recourse is had to the Courts.

Conclusion

A well-drafted shareholders agreement might have avoided the unfortunate outcome of In matter of Bicher & Son Pty Ltd where Mr Pellarini remains locked in as a minority shareholder in a company in which he has no say in the management and no assurance of receiving any profit distributions.
 

© Copyright 2020 Cordato Partners