Does Good Faith Affect the Shareholders’ Ability to Remove a Director?

We review the recent Court of Appeal case (Faulkner v. Vollin Holdings Ltd [2022]) and consider to what extent the duty of good faith affects the ability of a company’s shareholders to remove a director.

Under English law, it is accepted that there is no implied duty of good faith in commercial agreements, and this includes shareholders’ agreements. However, the position might be different if the duty of good faith is expressly included in an agreement. In other words, would it make it more difficult for the majority shareholders to remove a director if a shareholders’ agreement has a requirement for all parties to act in good faith?

The case concerned an unfair prejudice petition brought by the minority shareholders against the majority shareholders for removing two directors of the company who, in this case, were also the minority shareholders of the company. The minority shareholders claimed that even though the removal of them as directors was effective, the removal was unfairly prejudicial to the minority shareholders as the majority shareholders had breached the obligation of good faith contained in the shareholders’ agreement between the parties.

What is good faith?

There is no universal definition of good faith and its meaning is dependent on the context in which it is used.  In essence it is the principle of fair and open dealing.  It may also be interpreted as one or all of the following:

• To act honestly, consistently and loyally to the parties’ common interests and purposes.
• To put “one’s cards face upwards on the table” as used in the case of Interfoto Picture Library v Stiletto Visual Programmes [1989]
• Playing fair

Majority shareholders’ attempt to remove a director

At first instance, the High Court agreed with the minority shareholders and determined that the scope of the good faith clause in the shareholders’ agreement was wide enough to require the majority shareholders to act with “fidelity to the bargain” (or in other words honouring the agreement).  This was despite the majority shareholders having the power to remove the director. Therefore, the High Court decided that by removing the directors the majority shareholders breached their obligation of good faith to the minority shareholders and therefore the removal was unfairly prejudicial.

Court of Appeal’s decision

The majority shareholders appealed the High Court decision, claiming that they did not breach the shareholders’ agreement by removing the directors. Their appeal was allowed and the High Court decision on this point was reversed by the Court of Appeal.

In considering the parties’ argument and the High Court’s decision, the Court of Appeal decided that the shareholders were entitled to cast their votes at a general meeting of the company regarding the removal of the directors. There was nothing in the shareholders’ agreement or the company’s articles of association that prevented or prohibited the shareholders from exercising their rights to remove a director.

The Court of Appeal noted the good faith clause in the shareholders’ agreement but dismissed the argument that there was no purpose of the good faith clause if the directors could be removed. The court stated that having the good faith clause did not forgo the shareholders’ rights or roles in making decisions regarding the management and commercial future of the company.

The court also determined that it was not appropriate to apply and presume a single formula of good faith in every circumstance, irrespective of the context and the terms of the agreement. In determining the term “good faith”, the court noted that it varies according to the scenarios and the wording used in the agreement. In this scenario, the court determined that the removal of the directors was dealt with fairly and openly by the majority shareholders. By dealing with the removal of directors fairly and openly, the majority shareholders had satisfied their good faith obligation which was the minimum standard of good faith set out in Unwin v Bond [2020].

The court also stated that if the parties wish to limit the power of majority shareholders, such as the right to remove a director, the court expects such limitation to be expressed “clearly and directly” in the shareholders’ agreement. However, such a limitation was not expressed in the shareholders’ agreement before the court. As such, the court concluded that the majority shareholders did not breach the shareholders’ agreement by removing the directors.

Your shareholders’ agreement and good faith clauses

The Court of Appeal’s decision shows the scope and extent of good faith are largely dependent on the wording of the relevant obligations in the shareholders’ agreement. The decision makes it clear that having a good faith clause in an agreement does not automatically stop the majority shareholders from removing a director unless the agreement expressly and clearly contains such a limitation.

Whether you are a majority shareholder or a minority shareholder, if you are able to agree the inclusion of a good faith clause in a shareholders’ agreement, you should consider what duty of good faith means to you – for example, to act fairly, to co-operate with each of the other parties or take their interests into account.  And ask yourselves if there any decisions that require the parties to act in good faith such as when removing a director. Once these are agreed with the other shareholder(s), it is important that these terms are set out clearly in the agreement.

Here to Help

For advice about shareholder agreements, removing a director or other company constitutional matters, please get in touch with our Company Commercial team.

Please note the contents of this article are given for information only and must not be relied upon. Legal advice should always be sought in relation to specific circumstances.