The Sleeping Duck case offers valuable insights into shareholder rights, particularly regarding the boundaries of ‘oppressive conduct’ under the Corporations Act. This case highlights how courts assess shareholder oppression claims when disputes arise over management roles, share dilution, and the expectations of minority stakeholders. For shareholders, it underscores the importance of having clear, documented agreements on roles and rights within the company. Through examining the recent decision in Sleeping Duck, this article outlines key lessons for shareholders seeking to safeguard their interests, navigate management expectations, and understand the commercial implications of share dilution in privately held companies.

Background

In Part 1 of the Insight series: Shareholder oppression, we discussed the importance of the prohibitions in the Corporations Act 2010 (Cth) on oppressive conduct in providing remedies to (usually) minority shareholders where the conduct of majority shareholders is unfair or deprives them of their rights and entitlements.

The decision in Sleeping Duck confirmed that the provisions governing oppressive conduct under the Corporations Act are to be read broadly and outlined several matters that the court will consider when determining that a shareholder has been ‘oppressed’. Specifically, two issues that the Court decided were:

• Whether Dr Adir Shiffman, owner of minority shareholder BBHF Pty Ltd (BBHF), had been excluded or removed from his role in the management of Sleeping Duck in circumstances where there was a common understanding between Dr Shiffman and the Sleeping Duck founders, Selvan Sinnappan and Winston Wijeyeratne, that Dr Shiffman would have an active role in the business; and
• whether BBHF’s shares in Sleeping Duck were diluted.

BBHF alleged that both it and Sleeping Duck proceeded on the basis of a ‘common understanding’ that Dr Shiffman and BBHF would only be willing to invest in the company if Dr Shiffman was able to play an active strategic, ‘hands on’ role in the management of Sleeping Duck. Further, that this common understanding gave rise to a legitimate expectation that Dr Shiffman would be involved in the management of the Company. Consequently, Dr Shiffman’s exclusion from his role in the management of Sleeping Duck from November 2022 and the grant of employee share options to another employee on uncommercial terms without Dr Shiffman’s knowledge constituted oppressive conduct. Sleeping Duck and its founders denied these allegations.

The decision

Exclusions from management

Oppression may arise due to the exclusion or removal of a person from a company's management where that person has a legitimate expectation of being involved in management. In considering the test for whether such an expectation exists, the Court will take into consideration:

• the company’s constitution;
• if appropriate, the shareholder’s agreement and the parties’ objective understanding when they entered into that agreement; and
• the actual activities undertaken by the shareholder and whether those activities could be characterised as management activities.

In Sleeping Duck, its constitution did not include any provisions outlining the role of the shareholders. Similarly, the founders and BBHF never finalised a written shareholder’s agreement setting out their respective rights, responsibilities and obligations. Therefore, in assessing whether Dr Shiffman had a legitimate expectation of being involved in the management of Sleeping Duck, the Court had to consider the communications between Dr Shiffman and the founders before BBHF’s investment into the business. The Court found that none of those initial communications discussed Dr Shiffman's involvement in the company's management. The Court also found that Dr Schiffman’s activities were merely advisory and did not constitute management activities. Consequently, the Court found that Dr Shiffman was entitled only to expect that he would mentor and advise the Founders in exchange for equity in Sleeping Duck.

Ultimately, the Court found that BBHF had not been treated oppressively as Dr Shiffman could not establish that he had a legitimate expectation to be included in management activities and, in any case, could not prove that he had been excluded in any meaningful way. The evidence only showed that Dr Shiffman was frustrated at how the business was being operated and with decisions being made. However, the decisions with which he disagreed concerned business issues on which reasonable minds could differ. As such, they did not amount to exclusion from management.

Share dilution

In considering whether the issue of options to another employee amounted to a dilution of BBHF’s shares in an oppressive way, the Court applied the commercial bystander test. Under that test, the Court considers whether, in the eyes of a commercial bystander, BBHF had been subjected to commercial unfairness because of the share issue. In this case, the Court found that there was no commercial unfairness on the basis that:

• Dr Shiffman (as sole shareholder of BBHF) was not a director of Sleeping Duck and, therefore, his consent to the Share Plan was not required;
• Sleeping Duck’s decision to offer the Share Plan was in accordance with expert advice received by it and, therefore, the terms of the Share Plan were commercially reasonable; and
• Dr Shiffman had knowledge of, and had acquiesced to, the granting of the Share Plan making it difficult for BBHF to maintain that the conduct was oppressive.

The Court ultimately held that, whilst BBHF’s shareholdings in Sleeping Duck had been diluted following the issue of the options to another employee, the dilution was not commercially unfair and, therefore, did not amount to oppression.

Key takeaways

• Companies should ensure that agreements are clearly documented and outline parties’ roles, responsibilities, and any expectations regarding management participation. Without documented expectations, the Court will look to the pre-agreement communications between the parties to determine their objective intention.
• Shareholders should be aware of the distinction between advisory and managerial roles. If involvement in decision-making is desired, this should be explicitly agreed upon, as advisory roles don’t equate to management rights.
• When employee share options or other actions impact shareholdings, shareholders should clarify their consent rights, especially if they are not directors. A failure by a shareholder to object to a share issue once they have knowledge of it could imply consent and weaken any claims of unfair treatment.