UK: England and Wales: unfair prejudice - improper accounting and removal of an auditor

Judgment was given today in Kohli v Lit & Ors [2009] EWHC 2893 (Ch), a case in which a shareholder successfully sought relief for unfairly prejudicial conduct under sections 994 to 996 of the Companies Act (2006). The allegations were wide-ranging but of particular interest are those concerning the preparation of accounts and the non-disclosure of directors' remuneration, which the trial judge (HHJ Purle QC, sitting as a High Court judge) held established unfair prejudice. The trial judge also discussed Section 994(1A) and this would appear to be the first time that this new provision has been judicially considered. 

In the case, the remuneration of the highest paid director was not, as required, disclosed and had been included in an amount for "administrative expenses".  It was argued that this did not matter because a shareholder could have asked a question at an annual general meeting in order to elicit further information. The trial judge rejected this position, observing that (para. [218]): 

Transparency demands that the unvarnished truth should be revealed by the accounts, not hidden, and not left to the shareholder to ask questions at a shareholders' meeting".

Although the trial judge found that there was no deliberate plan to conceal the truth from the petitioning shareholder, it was, he observed (para. [224]):

... readily understandable that the improper accounting should cause her to lose all confidence in the competence and integrity of the board, or (which is probably a more realistic appraisal of the situation) that such possibility that there ever was that she should regain trust and confidence in the board has been destroyed".

It would appear that this finding was an important factor in the trial judge's finding of unfair prejudice.  In reaching this decision, HHJ Purle QC briefly considered the knowledge of accounting to be expected of individual directors (para. [220]):

It would be wrong to expect individual directors to be on top of the detail of the accounting requirements of successive Companies Acts and allied regulations. It is their duty, however, to read the accounts carefully before their approval and query anything that strikes them as odd, or questionable".

Elsewhere in his judgment, when exploring the extent to which breaches of companies legislation should be unfairly prejudicial, he referred to Section 994(1A) - inserted by Regulation 42 of the Statutory Auditors and Third Country Auditors Regulations 2007 - and which provides that "a removal of a company's auditor from office - (a) on grounds of divergence of opinions on accounting treatments or audit procedures, or (b) on any other improper grounds - shall be treated as being unfairly prejudicial to the interests of some part of the company's members". HHJ Purle QC observed that the effect of Section 994(1A) was that (para. [20]): 

[there must] be a finding of unfair prejudice even though the effect of the conduct complained of has no necessary impact on the value of the complaining shareholders' investment. Moreover, a board acting in good faith may genuinely, and correctly, disagree with (say) the accounting treatments, but removal of the auditor on those grounds will be unfairly prejudicial, reflecting the importance the law attaches to absolute standards of behaviour in the accounting process. Whilst this particular provision is new, I regard it as declaratory (except as to its mandatory application) of the kind of conduct that can amount to unfair prejudice, both today, and in a case concerning events before 2008, as this case does. Having said that, it does not follow, even where unfair prejudice is established, that the Court will necessarily grant relief. There will be cases where the Court concludes that the unfair prejudice is not sufficiently serious to justify its intervention, or its intervention may be limited".