Bhullar v Bhullar – again!

All students of English company law are familiar with the decision of the Court of Appeal in 2003 in a case called Bhullar v Bhullar ([2003] EWCA Civ 424). That case is a good illustration of the strict (arguably overly strict) application the law relating to corporate opportunities in English law. It is much discussed, but it is a case now more than a decade old. Imagine then the surprise of a follower of recent corporate law decisions to find that in July this year Morgan J. decided a case whose name, if abbreviated in the conventional way, is – Bhullar v Bhullar ([2015] EWHC 1943 (Ch)). Whilst the Bhullar name may be a common one among the Punjabi community in the UK, this was not a situation where unrelated sets of litigants merely shared a common surname. Some of the litigants in the two cases are indeed the same people – older but perhaps not wiser – and the company at the heart of both sets of litigation is apparently the same Bhullar Bros Ltd.

The 2003 case involved a breakdown in relations between two brothers (and their wives and children), the two groups being referred to by the Court of Appeal as “Mohan’s family” (the petitioners under an unfair prejudice petition) and “Sohan’s family” (the respondents). Mohan’s family won. In consequence, a property acquired by Inderjit Singh Bhullar and Jatinderjit Singh Bhullar (on the Sohan side of the family) through the vehicle of Silvercrest Trading Ltd (which the two brothers owned) was determined to be held on trust for Bhullar Bros Ltd.

Roll forward a decade or so and a number of things have happened. First, and perhaps surprisingly, Sohan’s family have complete control of Bhullar Bros Ltd (though Sohan père, sadly, has died). The entries at Companies House suggest some sort of deal was done in 2005 whereby the Mohans exited the company. Second, Bhullar Bros Ltd has sprouted a group structure: it is now a wholly owned subsidiary of Bhullar Ltd. Bhullar Ltd has a second wholly-owned subsidiary, Bhullar Developments Ltd. Developments and Bhullar Bros appear to engage in similar forms of activity, ie property development. Bhullar Bros, we are told, holds a 50% share of Silvercrest Trading Ltd. Perhaps the court’s order in the first case was implemented by giving the Mohan family half of Silvercrest’s share capital rather than by transferring its main asset to Bhullar Bros Ltd. This is not explained because irrelevant to the litigation in the second case.

Third, and the genesis of the litigation, vesting control of the Bhullar group in a single family did not led to peace. Rather the brothers who cooperated in the events leading up to the first litigation are now at each other’s throats. Both accept that a formal split between them would be a sensible step to take, but have been unable to agree on the terms of any separation. In the meantime Inderjit (holding 22% of the shares in Bhullar Ltd) has been ousted from directorships in each of the three companies which he previously held. It is unclear whether this was done solely by the votes of Jatinderjit (holding 41%) with Rajinder, their mother, with 37% abstaining, or by the combined votes of brother and mother.

One can feel another unfair prejudice petition coming on, but this was not it. Rather Inderjit sought permission to continue a derivative action against Jatinderjit on behalf of the two subsidiary companies on the grounds that the latter was in breach of his fiduciary duties to those companies. This had occurred, it was alleged, because Jatinderjit had (a) secured payment by the two subsidiaries of large cash gifts to a company wholly controlled by him without either board or shareholder approval  and (b) procured the sale by Developments of a property to him at an undervalue. Inderjit obtained approval to proceed with claim (a), but without an indemnity as to costs from the subsidiaries.

There are three interesting aspects of Morgan J’s decision. First, this was a “double-derivative” action. Inderjit was seeking as a shareholder in the holding company, Bhuller Ltd, to obtain a remedy on behalf of the two subsidiaries against Jatinderjit. What were the substantive tests for deciding whether a “double derivative” should proceed? Second, having identified those tests, what level of evidence should be required at this interlocutory stage for their satisfaction? Third, should Inderjit be granted an indemnity against costs?

On the first issue, Morgan J’s judgement demonstrates the now un-contradicted view among first instance judges that (i) the Companies Act 2006 has not taken away the power of shareholders to bring “double-derivatives”; (ii) that the unfortunate drafting of that Act has the result that “double-derivatives” do not fall within Part 11 of the Act dealing with shareholders’ standing to bring derivative actions; and (iii) that therefore the old, unreformed common law rules (Foss v Harbottle) govern the bringing of such claims. Indeed, the contrary was hardly urged by the defendants. However, the matter has yet to be tested in the Court of Appeal. The view of the first instance judges is certainly more attractive than the view that the 2006 Act inadvertently took away the capacity to bring “double-derivatives”; the best outcome would be to bring them within the Act’s procedures, though that result would require a bold court.

So, we are back in the common law realm of ‘fraud on the minority’ and ‘wrongdoer control’ from which we thought the 2006 Act had delivered us. Although these are potentially narrow gateways to the derivative action, Inderjit managed to squeeze through them in relation to the ‘gift’ complaint. Morgan J. found there was prima facie evidence of actual fraud on the part of Jatinderjit in that he did not honestly believe that the payments were in the best interests of the subsidiaries. (This conclusion also enabled Inderjit to surmount a potential limitation problem by bringing himself within s.21(1) of the Limitation Act 1980.) This meant that the learned judge did not need to explore the alternative basis for ‘fraud on the minority’, ie breach of fiduciary duty or negligence from which the wrongdoer benefitted (though that seems likely to have been present in this case as well).

Wrongdoer control (ie of Bhullar Ltd) was potentially a problem for Inderjit because he had not made his mother a defendant, and did not want to do so, whilst Jatinderjit held less than half the shares. The judge took a realistic approach to this issue, stating: “However, the substance of his allegation against Jat implicates Rajinder in the alleged wrongdoing. I consider that enables Inder to show a prima facie case of wrongdoer control exercised by Jat and Rajinder.”

Finally, Morgan J. considered whether a ‘reasonable independent board of directors’ could (not would) reach the conclusion that the litigation should be brought on behalf of the subsidiaries. He decided this issue in Inderjit’s favour as well, but it is not clear why he regarded the views of a hypothetical board as a relevant issue. The classic common law approach to the derivative action turns on fraud and wrongdoer control, with the addition by Knox J in Smith v Croft (No. 2) ([1988] Ch. 114) that permission to proceed should not be given if the majority of the independent minority shareholders are against the suit. This latter issue was clearly irrelevant here, since Inderjit was the minority. It is possible that the ‘reasonable independent board’ test got in on the basis that the derivative action, even at common law, is a discretionary one. If so, this is an interesting example of cross-fertilisation from the statute to the common law. The views of a hypothetical board member acting in accordance with their s.172 duty (to promote the success of the company) are central under the statutory procedure (s.268) and indeed the judge quoted with approval the views of Lewison J (as he then was) in Iesini v Westrip Holdings Ltd ([2010] BCC 420), an important decision on the statutory procedure.

Second, ever since the Court of Appeal’s tetchy remarks in Prudential Assurance Co Ltd v Newman Industries Ltd (No. 2) ([1982] Ch 204), the issue of how far the judge should go into the evidence when deciding whether the claimant should be allowed to bring the derivative claim has been a controversial one. Everyone agrees today that what the claimant has to show is a prima facie case, but there is much less agreement on the implications of that test. Morgan J. took a relatively claimant-friendly approach, at least at first sight. He accepted the version of the test propounded by David Richards J (as he then was) in Abouraya v Sigmund ([2014] EWHC 277 (Ch)) that “A prima facie case is a higher test than a seriously arguable case and I take it to mean a case that, in the absence of an answer by the defendant, would entitle the claimant to judgment.” Morgan J. also accepted the self-denying ordinance that he could not resolve disputes of fact at this stage in the proceedings. This left him in the potentially awkward situation of working out how to deal with competing allegations on the part of claimant and defendant. His solution was as follows:

“It will not be unusual to find that the claimant can establish a prima facie case, if one ignores the evidence relied upon by the defendant, but yet the claimant would fail at trial if the defendant’s evidence were to be accepted. In such a case, I consider that it is still open to the court to hold that the claimant has made out a prima facie case because it would be wrong to assume that the defendant’s evidence will be accepted at the trial and it may simply not be possible to predict with any degree of confidence whether the defendant’s evidence will be so accepted.” (at [25])

This approach is favourable to claimants since it seems to require that the defendant’s evidence put forward to rebut the claimant’s case should not be subject to serious dispute. (Even on this approach the claimant’s allegation of a sale at undervalue failed because the claimant did not put forward any serious evidence that the sale had been at an undervalue.) The judge may have felt some unease about this because he immediately went on to say that the ‘reasonable independent board’ test (above) would require him “to form some view as to the strength of the case against the defendant.” So, the issue is ultimately unresolved. Whether the strength of the defendant’s evidence is considered along with the claimant’s evidence in a single-stage prima facie test or only later in the second of a two-stage test (prima facie case and reasonable board) makes little difference to the underlying problem. This is how to evaluate the defendant’s counter-arguments where the court is not in a position to resolve disputes of fact.

Third, the judge refused to make an indemnity order in favour of Inderjit at this preliminary stage of the litigation. There have long been two streams of thought in the courts on this matter. One has been hostile to the grant of an indemnity, certainly at a preliminary stage and perhaps at all, on the grounds that it is a departure from the normal costs rules and enables the minority shareholder ‘to litigate at the expense of the company’. This view was expressed trenchantly by Walton J. in Smith v Croft ([1986] 1 WLR 580) and his views have been mentioned with approval by some later courts. The opposite view, expressed recently by Lord Reed in Wishart v Castlecroft Securities Ltd ([2010] BCC 161, Inner House) is that ordinarily an indemnity order should be made at the permission stage since, by definition, the court has decided that it is in the interests of the company that the litigation should proceed and the benefit of any judgement will enure to it. Moreover, the court is able to tailor the indemnity to the emerging litigation by making staged indemnity orders or otherwise shaping the indemnity.

Morgan J. placed himself in the cautious camp. He attached particular importance (at [68]) to the fact that the ‘reasonable independent board’ test (above) is a rationality test (whether such a board could think it should bring the litigation) rather than a reasonableness test (whether a reasonable board would bring the litigation). (There can be a rational basis for taking a particular decision, even if most reasonable people would decide differently, for example, a very risk adverse person might take out insurance against the risk of a holiday being spoilt by bad weather which most people are prepared to run without insurance.) Consequently, he regarded the ‘reasonable independent board’ test as setting a low threshold. It is unclear whether his caution was confined to the “double derivative” claim and thus the common law tests for permission to bring a derivative action. For cases within the statutory procedure s.268 makes it clear that the fact that directors acting in accordance with their s.172 duties could decide to bring the litigation is not the end of the story. A positive answer to that question means only that the court is not required to refuse permission. Whether it will give permission depends on a number of addition considerations, amongst which is “the importance which a person acting in accordance with s.172 . . . would attach to” continuing the proceedings. This is really Morgan J’s reasonableness test. Although Morgan J discussed the costs cases generally, it may be that his reasoning has no application outside the common law.

In any event, the ‘could/should’ or rationality/reasonableness issue seems not to have been determinative of the judge’s negative decision on the indemnity. What seems to have motivated the judge’s decision was the fact that the derivative claim was merely a step in the negotiations about the terms on which Inderjit and Jatinderjit would divide their economic interests in the group. Clearly Inderjit would improve his negotiating stance if the value of the group were increased by the restoration of assets to it by Jatinderjit. Morgan J. did not regard this motive as meaning that Inderjit was lacking good faith in bringing the derivative claim, so as to exclude the claim entirely [at 45]. Nor did he think that the derivative claim should be refused because Inderjit had an alternative remedy, as judges have decided in some cases under the statutory procedure (for example, Franbar Holdings Ltd v Patel [2009] 1 BCLC 1; Kleanthous v Paphitis [2012] BCC 676). The judge accepted that there were cost and speed arguments for litigating the breaches of duty separately from the wider range of matters that might be raised in an unfair prejudice action [at 44]. But he did regard it as a reason for not giving an interlocutory indemnity order. Because the derivative claim was a step in negotiations for a split of interests against the background of threatened unfair prejudice litigation, the appropriate approach was to apply to the derivative claim the costs rule which would apply in an unfair prejudice petition, ie the normal costs rule. “Inder and Jat should be treated equally and each of them should be on risk as to costs. I do not consider that I should make an order which gives Inder a considerable advantage at the possible expense of Jat.” (at [70]) The implication is that an indemnity order should be refused in this case, not only at the permission stage, but even after trial and even if Inderjit won. This is a tough stance but arguably justifiable. In real terms this was a dispute between two brothers (or one brother plus mother and another brother) about the valuation of a pool of assets which was to be split between them. The underlying claims and interests were personal, not corporate, and so a personal, not a corporate, costs rule was appropriate.