The High Court was presented with a case with lengthy facts, many allegations, and a lot of “he said, she said” in the bitter end to a property development dream.
Background:
Mr. Song and Mrs. Zhao (the petitioners), Chinese citizens residing in the UK, and Mr. and Mrs. Smith (the respondents), are equal shareholders and directors of the third respondent (the company), incorporated in August 2020. The company, in turn, owns all the shares in five other companies, including SGR Estates (SGR) Ltd., incorporated by Mr. Song, and Kestral Construction Ltd. (KCL). The business of these companies involved the acquisition of properties in Cardiff, Newport, and Barry, and their conversion into residential flats.
Mr. Smith left school early and has always worked in the construction industry. The two men were first introduced in 2016 when Mr. Song was looking for a builder to convert a building in Cardiff into residential flats. In July 2018, Hafod – a housing association – purchased Provincial House from SGR for £900,000 and engaged that company to carry out the conversion works for just over £3m. The initial project on Provincial House was completed in 2019 and brought a return on investment (ROI) in the region of 30%.
Mr. and Mrs. Smith were, at this time, looking for a home to buy and found one, which was purchased by Mr. Song through an interest-only mortgage to be paid by Mr. and Mrs. Smith. The purchase was completed in October 2018, and in December 2018, a declaration of trust was drawn up. At around the same time, Mr. Song made Mr. Smith a director of SGR. In March 2019, SGR purchased property in Cathedral Road and engaged KCL to carry out works to convert it into 17 flats for sale to private purchasers.
From 2020, Mr. Song and Mr. Smith ran the business as a joint venture, whereby the company and its subsidiaries would be run as a quasi-partnership between Mr. Song and Mr. Smith with mutual duties of good faith.
In July 2022, Mr. Song and Mr. Smith fell out and neither wanted to work with the other again. By 8 July 2022, both men had instructed solicitors, and by a letter on that same day from Mr. Smith's solicitors, he offered to buy Mr. Song's shares in the company for £200,000, an offer which was declined.
The petitioners now accuse Mr. Smith of fraud and/or breach of his duties as director, by wrongly making cash withdrawals, unexplained transfers, payments and purchases, excessive salary and mileage payments, employing family members, and working on his own projects. They also allege that, after the split, Mr. and Mrs. Smith diverted business from SGR/KCL to their newly set-up companies, constituting fraud, breach of fiduciary duty, or breach of a joint venture agreement, unfairly prejudicing the petitioners as shareholders under Section 994 of the Companies Act 2006. There were also allegations that Mr. Song made a cash withdrawal of £22,500 and an unexplained £250,000 transfer.
Decision:
The High Court dismissed the claims. The Court found no cogent evidence to substantiate the claims of fraud or breach of fiduciary duties by Mr. Smith and “even if he was, it does not follow automatically that that amounts to unfair prejudice.” The Judge also noted that Mr. Song was entitled to withdraw funds from SGR.
Regarding the offer to purchase Mr. Song’s shares, it was found to be at a fair valuation. The Judge noted, “In this case, the offer was significantly more than the companies' accountants' valuation of SGR and KCL. It was made within days of the breakdown, before any significant costs had been incurred.” The rejection of this offer could negate claims of unfair prejudice.
Regarding the property in which Mr. and Mrs. Smith reside, Mr. Song’s evidence concerning the trust declaration was inconclusive, and the Judge ordered the transfer of the property into Mr. Smith’s name.
Implications:
This case, focusing on allegations of unfair prejudice under Section 994 of the Companies Act 2006 and directors' duties within a quasi-partnership, has several significant implications. This decision underscores the need to provide sufficient evidence to support allegations of fraud or breaches of fiduciary duty.
This decision highlights the need for good faith and the fact that, even in incorporated companies, such a duty plays a central role. Payments that might seem very high on a prima facie basis might not be considered fraudulent after poring over the evidence.