The oppression provisions in the Corporations Act 2010 (Cth) (Corporations Act) are among the most widely used corporate law remedies available to shareholders. A decision by the Supreme Court of Victoria involving mattress company, Sleeping Duck, underscores the complexities of shareholder relationships, the importance of clear agreements between shareholders and the matters that a Court will consider when assessing claims of oppression. A solid grasp of these issues is essential for both founders and investors to avoid complex and costly disputes as businesses mature.

Background

In simple terms, the Corporations Act prohibits conduct by which (usually) majority shareholders act against minority shareholders to deprive them of their rights and entitlements or treat them unfairly in comparison with other shareholders. If the court finds that a shareholder has been “oppressed” in this manner, then it can order the majority shareholders to cease the oppressive conduct and take steps to address any issues that arise from it, including paying compensation. The court has broad discretion under this section to make any order that it considers appropriate in relation to a company.

In 2017, BBHF Pty Ltd (BBHF), a company owned by ‘serial investor’ Dr Adir Shiffman, invested in the Sleeping Duck business, and Dr Shiffman became a mentor to the Sleeping Duck founders, Selvan Sinnappan and Winston Wijeyeratne. Subsequently, Dr Shiffman became closely involved in the operation of the business and was provided with shares in the company and paid $10,000 per month for his services. Eventually, Dr Shiffman, through BBHF, came to hold 9.4% of the shares in Sleeping Duck and options to acquire a further 10,000 shares. Despite Dr Shiffman being an active minority shareholder of the Sleeping Duck business, the parties never finalised a written shareholder’s agreement setting out their respective rights, responsibilities and obligations.

BBHF alleged that despite Dr Shiffman having helped the founders turn Sleeping Duck into a successful business, from late 2020 the founders shut Dr Shiffman out of decision-making and excluded him from the management of Sleeping Duck. BBHF alleged that the founders and Sleeping Duck:

• entered into an employee share option plan (Share Plan) with another employee without Dr Shiffman’s knowledge and on uncommercial terms, which diluted BBHF’s interest in the company;
• excluded Dr Shiffman from his role in the management of Sleeping Duck, contrary to various agreements between the parties;
• reached a common understanding with Dr Shiffman that he would have an active role in management and that any shareholder agreement that was entered into, would provide BBHF with the right to appoint a director.

Sleeping Duck and the founders denied the allegations, arguing that the Share Plan was not commercially unreasonable and that Dr. Shiffman knew of and had agreed to its terms. Additionally, Sleeping Duck argued that Dr. Shiffman’s role at Sleeping Duck was that of an advisor and mentor, which did not entitle him to a legitimate expectation of being involved in management nor were there any ‘common understandings’ between the parties that would give rise such an expectation.

The decision

In considering the test for oppressive conduct, the Court held that:

• the prohibition on “oppressive conduct” was directed at oppressive, unfairly prejudicial, or unfairly discriminatory conduct against shareholder and is concerned with commercial unfairness;
• the test is objective, focusing on the impact of the conduct on the victim, rather than the state of mind of the alleged oppressor;
• the presence or absence of a commercial justification for the alleged oppressive conduct will be relevant in assessing whether the conduct is commercially fair, however, mismanagement or poor management does not, by itself, constitute oppressive conduct;
• when assessing whether conduct is oppressive a court should consider both individual acts and their cumulative effect; and
• fairness is not to be assessed in a vacuum but in the context of what was known at the time of the conduct rather than what subsequently transpires.

Ultimately, the Court found that the allegations of oppressive conduct made against Sleeping Duck and the founders had not been substantiated. While Dr. Shiffman’s equity in Sleeping Duck was diluted by the Share Plan, this did not constitute oppressive conduct. The decision to implement the Share Plan was a management decision made by the founders based on external advice and the recommendations of the CFO and, therefore, was not commercially unreasonable. Additionally, the Court found that Dr. Shiffman was aware of the details of the Share Plan and had agreed to it. The Court concluded that when there is acquiescence to certain conduct, it is difficult to argue that such conduct is oppressive. The Court was also not convinced of Dr. Shiffman’s claim that he had a legitimate expectation to be involved in the management of the company and, in any event, found that he was not excluded from management. Finally, the Court was not convinced that the common understanding alleged by Dr Shiffman was established on the evidence.

Key takeaways

The oppressive conduct provisions in the Corporations Act provide an important remedy for shareholders against a company. The legislative provisions are drafted broadly and the courts have applied them on this basis. However, despite the broad nature of these protections, the Sleeping Duck case provides useful commentary about the way in which a court will considers ‘commercial unfairness’. Where legitimate business decisions are made by management, courts will be reluctant to intervene.

This case provides an important lesson for founders and investors when start-ups are considering capital-raising. In those circumstances, it is critical for parties to carefully consider and clearly document the relationship between them and their respective roles and control of management.