Chu v Lau [2020] UKPC 24: The Privy Council’s review of the law on just and equitable winding-up

October 16, 2020

By Giles Maynard-Connor and Jodie Wildridge

Introduction

In its Judgment handed down on 12 October 2020, [[2020] UKPC 24], the Privy Council, comprised of Lord Hodge, Lord Briggs, Lady Arden, Lord Leggatt and Lord Burrows, provided a welcomed clarification of the law applicable to the just and equitable winding-up of a company; with a particular emphasis on the alternative rules which apply to those companies having the status of a quasi-partnership.

Facts

Mr Chu (“Chu”) and Mr Lau (“Lau”) were equal shareholders and sole directors of a British Virgin Islands shipping company (“OSL”). Chu and Lau were also the sole directors of OSL’s subsidiary (“PBM”). As the corporate vehicles of Chu and Lau, OSL and PBM entered into a joint venture with a state-owned entity of the Peoples Republic of China (“Beibu Gulf”), in which PBM held a 49% shareholding; the remaining 51% being held by a corporate vehicle for the state-owned entity. Chu and Lau were also both directors of Beibu Gulf.

Following a breakdown in the relationship between Chu and Lau, Lau applied to the British Virgin Islands High Court for the winding-up of OSL on the just and equitable ground, alleging (i) an irretrievable breakdown of trust and confidence between him and Chu, and (ii) functional deadlock in the management of OSL both at board and shareholder level. In June 2017, Justice Roger Kaye QC granted the relief sought, finding that both of these allegations had been proved.

Chu’s appeal to the Court of Appeal

In January 2020, on Chu’s appeal, the Court of Appeal of the Eastern Caribbean Supreme Court unanimously reversed the first-instance Judgment and discharged the winding-up order made; on grounds that the first-instance Judge had been wrong:

• to consider, in determining whether there was deadlock in OSL, the fallings out between Chu and Lau which had occurred in their management of Beibu Gulf;
• in failing to take account of the freedom of Chu and Lau to sell their shares in OSL as a means of avoiding deadlock;
• to consider events which had occurred between Chu and Lau following the date of the filing of the application for the winding-up of OSL; and
• in failing to consider alternative remedies reasonably available to Lau, such as a buy-out, before ordering a winding-up as a last resort.

In summary, the Court of Appeal concluded that OSL was not in a deadlock situation; and even if it was, a winding-up was not the appropriate remedy in any event.

Lau’s appeal to the Privy Council

In allowing Lau’s appeal, and restoring the decision of the first-instance Judge, the Privy Council comprehensively analysed the two related but distinct, and potentially overlapping, situations in which a just and equitable winding-up may be ordered where a company’s members have fallen out.

The first such situation is where the subject company is in functional deadlock; i.e. a situation in which an inability of members to co-operate in the management of the company’s affairs leads to an inability of the company to function at board or shareholder level. If there is a complete functional deadlock then, regardless of whether the company is a quasi-partnership, a winding-up may be ordered, as, essentially, “a remedy for paralysis”.[1] Further, the Privy Council acknowledged that in assessing a purely functional deadlock situation, the Court must look specifically at the management of the company subject to the petition. In doing so, however, a consideration of the parties’ disputes as regards other business matters may be a “very relevant”[2] exercise in determining whether an apparent deadlock in the subject company is irremediable.

The second identified situation is that of a quasi-partnership company. In this regard, the Privy Council referred to the leading case of Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 (“Ebrahimi”); and Lord Wilberforce’s summary of the quasi-partnership relationship therein:

“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”.[3]

In such situation, the Privy Council confirmed that there is no requirement of a complete functional deadlock; an irretrievable breakdown in trust and confidence between the participating members may, alone, justify a just and equitable winding-up. Of course, in a two-party quasi-partnership situation, a complete breakdown in trust and confidence may well cause functional deadlock in any event. In the Court’s assessment of a quasi-partnership company, unlike a purely functional deadlock situation, the focus is upon the relationship between the quasi-partners and the extent to which the necessary basis of trust and confidence has broken down: and “[F]or this purpose, no aspect of their business relationship is likely to be irrelevant”.[4]

Relevance of the joint venture company in assessing deadlock

As regards the relationship between Chu and Lau; the Judge at first-instance found that OSL was a quasi-partnership company. This was not departed from by the Court of Appeal; however, OSL’s quasi-partnership status was raised as an issue by Chu before the Privy Council.

Chu’s argument was that OSL was not a quasi-partnership because not all of the conditions as set out by Lord Wilberforce in Ebrahimi were met: OSL’s Articles of Association contained no restrictions against dealings by the members with their respective shareholdings.

The Privy Council, in confirming OSL’s status as a quasi-partnership, clarified the existing state of the law as follows:

“In the Board’s view, it is clear from … Lord Wilberforce’s judgment … that none of the three indicia of quasi-partnership represent necessary elements, in the sense that the absence of one or more of them is fatal to such a finding. The judge found both the other indicia to be established (relationship of mutual confidence and an understanding that both shareholders would be involved in management) and there was, in the Board’s view, ample evidence to support his conclusion that OSL was a company in which the superimposition of equitable considerations was fully justified”.[5]

It followed, therefore, that:

“…all the matters upon which the judge relied which may be said to have occurred between Mr Lau and Mr Chu at the Beibu Gulf level were relevant and admissible evidence on the question whether the former relationship of trust and confidence between them had so far evaporated as to justify the winding-up of OSL on the just and equitable ground, regardless of functional deadlock”.[6]

Lack of restrictions on the sale of members’ shareholdings

In any event, the Privy Council found, in the circumstances, that OSL was, as a matter of fact, deadlocked. This was inconsistent to the finding of the Court of Appeal; which had approached the issue of deadlock in a very different way.

The Court of Appeal had treated deadlock as an absence of provisions in the Memorandum and Articles of Association of OSL to provide a means of resolving the differences of opinion between Chu and Lau. It followed that, for the Court of Appeal, the test of deadlock was not satisfied: the ability of Chu and Lau to sell their shares in OSL was a self-sufficient reason for a finding that OSL was not deadlocked. Specifically addressing this point, the Privy Council commented that in a case based purely on functional deadlock i.e. in a non-quasi-partnership company, a member may be able to extract himself from the company by a sale of his shares, but only if he could be expected to be able to do so upon fair terms.[7]

Correct point for assessing deadlock

The Court of Appeal found that the analysis of the first-instance Judge as to whether the application for winding-up was well-founded should have been by reference to the factual position prevailing as at the date of the filing of the application, disregarding matters arising subsequently, at least to the extent relied upon by Lau as demonstrating deadlock or a breakdown in trust and confidence between the parties. This was held by the Privy Council to be simply incorrect; there is no rule that an application for winding-up on the just and equitable grounds must be justified solely by reference to the position as at the date of the filing of the application.[8]

Exclusion from management

The misdirection of the Court of Appeal in this regard meant that it had failed to consider the alleged exclusion of Lau from the management of OSL. In holding that Lau had been wrongfully excluded by Chu from such participation, the Privy Council found that exclusion from management in the circumstances of a just and equitable winding-up of a quasi-partnership company was not confined to a removal from the office of director: it extended to the situation whereby, in some other way, it is made “effectively impossible”[9] for a quasi-partner to participate in company management.

Alternative remedies

The Court of Appeal took the view that it was for Lau to demonstrate that there was no alternative remedy reasonably available to him. The Privy Council found this to be “a misdirection in law”.[10]

Whilst acknowledging that a winding-up on the just and equitable ground is a shareholders’ remedy of last resort; the Privy Council was not satisfied that the mere existence of an alternative remedy was sufficient to render the remedy of a winding-up unavailable. The relevant test was set out as follows:

• Is the applicant entitled to some relief?
• If so, would a winding-up be just and equitable if there were no other remedy available?
• If so, has the applicant unreasonably failed to pursue some other available remedy instead of seeking winding-up?

The Privy Council found that though the legal burden of proof at stages (a) and (b) is on the party seeking a winding-up; it shifts to the respondent to any such application at stage (c). Accordingly, “[T]he member retains a significant element of choice in the remedy to be sought, even though the court has the last word”.[11]

Further, the Privy Council held as “wrong in law”[12] the inference made by the Court of Appeal that had the case for a just and equitable winding-up been established, the Court could, of its own motion, have ordered a buy-out of Lau’s shareholding. Such jurisdiction could be conferred upon the Court only by way of an unfair prejudice petition; which, in this case, had not been brought.

The equitable doctrine of clean hands

As an additional submission in support of the decision of the Court of Appeal, Chu contended that Lau ought to be refused relief as Lau did not come to Court with clean hands.

In referring to the “well-known, long standing analysis from the highest authority”,[13] the Privy Council, again, relied on Ebrahimi:

“People do not become partners unless they have confidence in one another and it is of the essence of the relationship that mutual confidence is maintained. If neither has any longer confidence in the other so that they cannot work together in the way originally contemplated then the relationship should be ended – unless, indeed, the party who wishes to end it has been solely responsible for the situation which has arisen”.[14]

It was found at first-instance that though both parties shared the blame for the breakdown of the relationship to an extent, Chu was the most responsible of the two. The Privy Council was satisfied that this was a proper application of the test set out in Ebrahimi.

Conclusion

As the Privy Council has re-affirmed, although the term ‘quasi-partnership’ was originally intended only as a convenient label, the importance of such a relationship in the resolution of shareholder disputes cannot be understated. A quasi-partnership status is a highly influencing factor in the approach the Court will take in granting relief between feuding shareholders; including in the Court’s considerations with regards a winding-up on the just and equitable grounds. It is also fair to conclude that the decision of Lord Wilberforce in Ebrahimi, having now been re-enforced and further clarified by the Privy Council, remains the leading case in this area.

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[1] Chu v Lau [2020] UKPC 24 ⁋17

[2] Chu v Lau [2020] UKPC 24 ⁋23

[3] Ebrahimi [380]

[4] Chu v Lau [2020] UKPC 24 ⁋25

[5] Chu v Lau [2020] UKPC 24 ⁋31

[6] Chu v Lau [2020] UKPC 24 ⁋32. Further, some of those matters were also relevant to the question of whether the management of OSL was deadlocked ⁋33.

[7] Chu v Lau [2020] UKPC 24 ⁋49

[8] In any event the first-instance Judge found that there was both deadlock and an irretrievable breakdown of trust and confidence at the time of the filing of the application.

[9] Chu v Lau [2020] UKPC 24 ⁋85

[10] Chu v Lau [2020] UKPC 24 ⁋56

[11] Chu v Lau [2020] UKPC 24 ⁋20

[12] Chu v Lau [2020] UKPC 24 ⁋56

[13] Chu v Lau [2020] UKPC 24 ⁋64

[14] Ebrahimi [383-384]