Winding-up a company as a means of resolving a shareholder dispute: Chu v Lau

25 March 2021

In a significant judgment for both British Virgin Islands and English companies, the Privy Council has clarified the law applicable to a just and equitable winding-up of a company and/or quasi-partnership.

In Chu v Lau [2020] UKPC 24, the Privy Council examined the relationship between the jurisdiction to wind a company up because of an irretrievable deadlock in its management, and the rules relating to companies operating as quasi-partnerships. Affirming the decision in Ebrahimi v Westbourne Galleries Ltd [1973] AC 360, the court held that where a company is a quasi-partnership, there are two “related but distinct” grounds upon which it can be wound up: i) to resolve a functional deadlock; and ii) as a response to an irretrievable breakdown in trust and confidence.

The facts

In 2009, Mr Chu and Mr Lau, both experienced businessmen from Hong Kong, established a joint venture. This was conducted through a BVI company, Ocean Sino Ltd ("OSL"), in which they each owned 50% of the shares, and of which they were the sole directors.

OSL had a wholly owned subsidiary, PBM Asset Management Ltd ("PBM"), which in turn owned 49% of Beibu Gulf Ocean Shipping (Group) Limited (“Beibu Gulf”) with the remaining 51% owned by a state-owned entity of the People’s Republic of China ("PRC Holdco"). Mr Chu and Mr Lau were the sole directors of OSL and PBM, and executive directors of Beibu Gulf, a majority of whose directors were appointed by the PRC Holdco.

In or around 2014, the relationship between Mr Chu and Mr Lau subsequently broke down, leading them to attempt to sever their business relationships and to multiple sets of proceedings in various jurisdictions. As a result, Mr Lau applied to the BVI Commercial Court to wind-up OSL on a just and equitable basis alleging: (i) an irretrievable breakdown of trust and confidence between him and Mr Chu, and (ii) functional deadlock in the management of OSL (and therefore PBM) both at board and shareholder level.

At first instance, Justice Roger Kaye QC, held that there was a functional deadlock in the management of OSL and an irretrievable breakdown in the relationship between the parties and made the winding-up order sought, noting:

“I have no hesitation in finding that OSL (and thereby PBM) is in a completely hopeless state of irretrievable deadlock at board and shareholder level. Having seen and heard the two of them in the witness box and having regard to the evidence as a whole I can see absolutely no real prospect of Mr Lau and Mr Chu ever getting on together again in the future. They are hardly on speaking terms (save perhaps with a grimace). It is a true irretrievable breakdown. All trust and confidence between them has gone.”

The Court of Appeal of the Eastern Caribbean Supreme Court (the "Court of Appeal") reversed that decision, ruling that there had been no deadlock in OSL and, even if there had been, a winding-up was not appropriate. The Court of Appeal found that, in ordering OSL to be wound-up Justice Roger Kaye QC had made the following errors:

He had taken into account the disagreements between the parties arising out of their management of Beibu Gulf, which were not relevant to whether the management of OSL was deadlocked;
He had taken into account events which had occurred after the winding-up petition was filed;
The winding-up of a company is a remedy of last resort. Mr Lau had alternative remedies available to him which he should have pursued instead; and
The parties were able to sell their shares to a third party as a means of loosening the deadlock.

The Privy Council's decision

The Privy Council¹ reversed the Court of Appeal's decision, and ordered that OSL be wound-up, holding that two distinct, albeit potentially overlapping, grounds for a just and equitable winding-up arose in this case: (1) a functional deadlock in the management of OSL; and (2) an irretrievable breakdown in trust and confidence between what it considered were quasi-partners in the company. The latter of the grounds only applies in cases of quasi-partnership, by contrast to the former, which is of general application.

The parties' relationship

In making this determination, the Privy Council held:

Applying Ebrahimi v Westbourne Galleries Ltd [1973] AC 360, OSL was indeed a quasi-partnership.The Privy Council did not accept Mr Chu's submission that OSL could not be a quasi-partnership by virtue of there being no restriction in OSL's constitutional documents on a shareholder's ability to sell their shares; a quasi-partnership can still exist even if all of the factors set out in Ebrahimi² are not present;
Where a company is a quasi-partnership, no aspect of the parties' business relationship is likely to be irrelevant in determining whether there has been an irretrievable breakdown in trust and confidence. Accordingly, Justice Roger Kaye QC was therefore correct to take the disagreements at the Beibu Gulf level into consideration, in relation both to the deadlock in the management of OSL and the evaporation of mutual trust and confidence between the quasi-partners; and
As to whether the parties' relationship had deteriorated sufficiently to engage the jurisdiction to order a just and equitable winding-up on these two grounds, the Privy Council relied on Justice Roger Kaye QC's finding highlighted above, and considered this to be the case.

What facts should be taken into account in determining the petition?

The Privy Council held that the facts relevant to a just and equitable winding-up of a company were those prevailing when the petition is heard, and that there is no rule that states this must be confined to the facts prevailing as at the date of the winding-up petition being filed. This was a form of discretionary relief and so Justice Roger Kaye QC was entitled to consider facts arising after the date the petition was filed. In the Privy Council's view, which echoed that of Justice Roger Kaye QC, those facts indicated that: "rather than demonstrating continued co-operation between the two men, they just made matters worse."

Exclusion from management

Indeed, taking these additional facts into account, Lady Arden considered a further basis for winding-up OSL arose, namely, the exclusion of Mr Lau from its management, and that of its subsidiaries and its affiliates. In her view, Mr Chu had "hi-jacked" the business venture that was intended to benefit both parties, rendering it "effectively impossible" for Mr Lau to participate in the management of the business.

Alternative remedies and Unfair Prejudice

The Privy Council held that the Court of Appeal was wrong to determine that it had jurisdiction to make an order that Mr Lau's shares be purchased. Such relief was only available pursuant to an unfair prejudice petition, not a winding-up petition.

The Privy Council also confirmed that pursuant to BVI Law a respondent bears the burden of proving that an applicant was unreasonable in bringing a winding-up petition and that it is for the respondent to identify the alternative remedies that should have been sought. On the facts, the Privy Council considered that none of the alternative remedies which had been proposed were suitable or would provide a clean break. In particular, Justice Roger Kaye QC's finding that a buy-back of Mr Lau's shares by Mr Chu was unrealistic was correct. Mr Chu was reluctant to engage in such a transaction and had failed to demonstrate that he had the means to purchase these shares at fair value.

In commenting on this issue, the Privy Council also helpfully identified that it is not necessary in winding-up petitions to prove the same standard of impropriety/unfairness necessary to succeed in a claim for unfair prejudice noting:

"unfair prejudice in the management of a company is a different allegation from either deadlock or breakdown of trust and confidence. It is not lightly to be assumed that an applicant who can prove the latter will equally be able to prove the former".

Share sale to a third party

A member of a company would only be expected to sell their shares in order to break the functional deadlock if they could expect to do so on fair terms. The Privy Council found that Mr Lau’s freedom to sell his shares in OSL was effectively only theoretical. In particular, the Privy Council emphasised:

The shares did not confer any right to be appointed to the board, which would leave a purchaser with Mr Chu as sole director, which in turn was likely to be a significant obstacle in agreeing any sale;
Mr Chu had also demonstrated a reluctance to provide financial information about Beibu Gulf to Mr Lau which any purchaser would require as a prerequisite to any acquisition; and
The notoriety of the dispute between Mr Chu and Mr Lau would have obvious deleterious consequences on the potential demand for any shares.

Clean hands

The fact that Mr Lau could be seen as partially responsible for the breakdown in his relationship with Mr Chu, and the deadlock in OSL, did not bar him from bringing a petition to wind-up the company. Relying once again on Ebrahimi, the Privy Council confirmed that the equitable doctrine of clean hands would only bar Mr Lau in this way if he was solely responsible in this regard. In this case, the Privy Council considered that Mr Chu was the more responsible of the two.

Practical considerations

Shareholder disputes often give rise to various and potentially overlapping claims (winding-up petitions, unfair prejudice petitions, derivative actions, claims to appoint receivers, claims for breach of fiduciary duty, etc). The Privy Council's decision provides some welcome clarification of the circumstances in which it is reasonable to petition for the winding-up of a company as opposed to seeking alternative relief.

In light of the Privy Council's findings, in some cases, seeking to wind-up a company may be a simpler way of securing a desired outcome (for example, by avoiding the need to prove the elements of unfair prejudice) but careful consideration must be given as to whether the alternative forms of relief available by pursuing different causes of action would be more appropriate in all the circumstances.

Whilst Privy Council decisions are not binding precedent in English proceedings, they are persuasive authority. Accordingly, the English Court is likely to follow the Privy Council's guidance when considering winding-up petitions pursued on the just and equitable basis (not least as, as Lord Briggs noted, relevant BVI jurisprudence was primarily based on English authorities). Accordingly, parties considering such applications should bear in mind that:

In cases of quasi-partnerships, disagreements linked to the management of a subsidiary are likely to be considered relevant when assessing the functional deadlock of its parent company or the parties' relationship generally;
A quasi-partnership can exist in circumstances where there are no restrictions on shareholders transferring their shares in the company;
The facts relevant to a petition are those prevailing at the time it is heard, not at the time the petition is filed;
The winding-up of a company will only be prohibited if a petitioner is solely responsible for the breakdown in the parties' relationship and not where the petitioner is merely partially responsible; and
Although winding-up is a remedy of last resort, a petitioner will only be expected to pursue alternative remedies (or alternatives generally such as the selling of their shares) where it is reasonable for the petitioner to do so, and those alternatives are realistic rather than just purely theoretical.

¹ Leading judgments were provided by Lord Briggs and Lady Arden.

² Ebrahimi at pp 379-380: "The superimposition of equitable considerations requires something more, which typically may include one, or probably more, of the following elements: (i) an association formed or continued on the basis of a personal relationship, involving mutual confidence—this element will often be found where a pre-existing partnership has been converted into a limited company; (ii) an agreement, or understanding, that all, or some (for there may be ‘sleeping’ members), of the shareholders shall participate in the conduct of the business; (iii) restriction upon the transfer of the members' interest in the company—so that if confidence is lost, or one member is removed from management, he cannot take out his stake and go elsewhere."