Duck, duck, proof: the risks in establishing shareholder oppression
BBHF Pty Ltd v Sleeping Duck Pty Ltd & Ors [2024] VSC 320
In oppression proceedings, oppressive conduct is often not seriously in issue, leaving the parties to argue over matters concerning the valuation of their entitlements. There are, however, occasions when the plaintiff is put to proof to establish that the conduct alleged is, in fact, oppressive. This is a case where the plaintiff failed to make out its allegations.
A. Background
Sleeping Duck (SD) is a manufacturer and online retailer of mattresses. It was founded by Mr Selvam Sinnappan and Mr Winstron Wijeyerante (the Founders).
The plaintiff was a shareholding company associated with Dr Adir Shiffman, a former practising medical doctor and self-described ‘serial entrepreneur’: [5]. For ease of reference, we refer Shiffman and his shareholding entity as ‘Shiffman’.
Shiffman provided his services to SD as a consultant. He and the Founders agreed that, for 10 months of work, Shiffman would receive 10% of the Founders’ shares in SD. Later, Shiffman was granted additional options of 10% over the Founders’ shares pursuant to a Call Option Deed: [9].
Shiffman claimed that, through his active involvement in SD’s management, he turned SD from an ‘amateurish’ start-up into a profitable business, but that, despite this, he had been excluded from management from around October 2020: [13]-[14].
When Shiffman’s relationship with the Founders started to sour, they met to agree on an exit agreement which would see Shiffman become a passive investor by way of a transaction to substantially sell down his equity. Ultimately, there was no sell down transaction that was agreed, meaning that Shiffman could not realise the value of his shareholding. He then commenced proceedings.
During Shiffman’s involvement with the company, SD had engaged another consultant, Mr Prateek Bandopadhayay. He was paid a monthly fee for his services and was offered share options pursuant to an employee share option plan (ESOP): [21].
As a result of Bandopadhayay exercising his options under the ESOP, Shiffman’s shareholding was diluted from 10% to 9.09%.
Shiffman alleged the ESOP was entered into without his knowledge and that its terms were commercially unreasonable. He alleged that the Founders lent money to Bandopadhayay so he could exercise his option under the ESOP and did so for the purposes of prejudicing Shiffman’s rights and entitlements under the Call Option Deed: [25].
Seven distinct instances of oppressive conduct were alleged, but generally speaking, Shiffman’s complaints were that:
- Shiffman was excluded from involvement in management;
- the issue of options and shares to Bandopadhayay were, by design and in effect, oppressive or unfair; and
- there were breaches of the Call Option Deed.
The judgment contains useful summaries of the law relevant to each topic.
It is also a cautionary tale for practitioners as to the risks of subsequent disclosure of without prejudice communications: a topic addressed in Part F below.
The case is also a reminder of the importance of pleadings. While oppression cases often proceed without pleadings, where pleadings are ordered, the alleged oppression will generally be constrained by the pleaded allegations. A joint list of issues will not displace the parties’ pleaded cases: [82].
B. Oppression principles
This case focused on the s 232(e) ground for relief under s 233 of the Corporations Act 2001 (Cth). Justice Delany summarised the applicable principles as follows.
First, ‘oppressive to, unfairly prejudicial to, or unfairly discriminatory against’ in s 232(e) is a compound expression, concerned with commercial unfairness. The conduct can be individual or cumulative: [64].
Second, the test under s 232(e) is objective. The presence or absence of a reasonable commercial justification for conduct is relevant in assessing commercial fairness: [65].
Third, fairness is assessed in the context of what is known at the time of the conduct: [66].
Fourth, the Court will consider the behaviour of the person making the allegation of oppression in order to balance competing interests: [67].
Fifth, the conduct need not to have occurred during the time the person was a member. In this case, pre-membership conduct could be taken into account: [68].
Sixth, oppression may arise as a result of exclusion or removal from management where the person has a legitimate expectation of being involved in management. Being involved in ‘management’ does not require the person to be a director, but involves decision-making as to the company’s direction: [69].
Seventh, exclusion or removal from a management role may constitute oppression where it takes place otherwise than in accordance with agreed processes or a member’s ‘legitimate expectation’ of participating in management: [72].
Eighth, dilutive share issues or excessive renumeration payments can be oppressive: [79].
Ninth, courts are cautious to conclude that business judgements amount to oppression: [80].
C. Involvement in management
Shiffman claimed to have held ‘legitimate expectations’ as to his participation in the management of SD. Justice Delany summarised the law in relation to the use of ‘legitimate expectations’ in the oppression context at [75]-[78].
The parties differed as to their respective understanding of Shiffman’s role and equity entitlement: [154]. Ultimately, while the Court accepted that Shiffman believed that he had been shut out of decision making ([97]), it did not accept that, objectively speaking, Shiffman held a ‘legitimate expectation’ that he would participate in the management and strategic direction of SD: [165].
The Court carefully analysed the evidence in chronological periods which matched the changes in Shiffman’s involvement in SD. The Court found that Shiffman was an adviser and a mentor, but his activities were not in the nature of management activities: [187], [283]-[284].
D. Issue of options and shares to Bandopadhayay
It was alleged that the Founders were not entitled to issue shares to Bandopadhayay while ignoring Shiffman’s minority shareholder interest. The Court did not accept there was a fetter on SD’s ability to issues shares, but held that whether the agreement to issue the shares was oppressive was a separate matter: [231].
Shiffman alleged that he neither consented to nor approved the ESOP, and also that the terms of the ESOP were commercially unreasonable.
In response, SD and Bandopadhayay claimed that Shiffman knew about the ESOP. The Court agreed. It concluded that Shiffman was fully aware that, as a consequence of the allocation of shares to Bandopadhayay, his shareholding would be diluted: [363].
The Court also found that Shiffman, in effect, acquiesced to this impact in that, when he discovered the price for the shares under the ESOP, he made no complaint: [396].
Where a party has acquiesced to a course of conduct in this way, it is difficult to maintain that the conduct is oppressive in the relevant sense: [446]. This undercut Shiffman’s reliance on this conduct to make out the alleged oppression.
As to the allegation of the commercial unreasonableness of the ESOP, Shiffman relied on matters that included: the backdating of the valuation date; the exercise (or ‘strike’) price being based on an old valuation of SD; and the fact that options to purchase shares were not tied to Bandopadhayay’s ongoing service to SD: [447].
The Court found that the valuation date was appropriate as it was selected on advice from external advisors, and that a similar approach (of selecting an earlier valuation date) had previously been taken with Shiffman’s options. The strike price for the shares was also based on external advice. In the end, the fact that the options were not tied to Bandopadhayay’s ongoing employment did not render the arrangement commercially unreasonable: [452].
E. The Call Option Deed
Shiffman alleged that, prior to entering into the Call Option Deed, SD did not inform him of a number of matters, including: (1) that Bandopadhayay had exercised his options; (2) that the Founders had funded Bandopadhayay’s exercise of those options; and (3) that dividends were to be paid following the exercise of the options: [492].
The effect of Bandopadhayay becoming a shareholder meant that Shiffman could no longer exercise his options without the agreement of Bandopadhayay: [552]. Shiffman’s pleaded case was that the Founders and Bandopadhayay acted in concert, for the purpose of prejudicing Shiffman’s rights and entitlements under the Call Option Deed. The Court applied the decision in Perpetual Custodians Ltd (as custodian for Tamoran Pty Ltd as trustee for Crivelli) v IOOF Investment Management Ltd [2012] NSWSC 1318 in concluding that evidence did not satisfy the test for two or more parties acting ‘in concert’: [564]-[574].
The Court accepted, as alleged by Shiffman, that the Call Option Deed contained an implied term that the parties to the Deed were required to do all things necessary to enable each other to secure the benefit of the Deed: [797]. But it did not accept that the action of the Founders (in proffering a draft shareholders’ agreement two weeks after the prospect of litigation had been flagged by Shiffman) amounted to a breach of such an obligation: [800].
F. Without prejudice settlement offers
A curious feature of this case is its use of without prejudice offers. Around the time the case was fixed for trial, the plaintiff made a without prejudice offer. The defendants sought to adduce the without prejudice offer into evidence under s 131(1) of the Evidence Act 2008 (Vic), saying that its exclusion would risk misleading the Court.
The dispute as to admissibility was heard by Gobbo AsJ, who ruled the offer was admissible save for certain parts.
The plaintiff appealed Gobbo AsJ’s decision and the appeal was heard by Garde J. His Honour concluded that the evidence adduced in the proceeding (and the inferences to be drawn from it) were likely to mislead the Court in the absence of evidence of the without prejudice offer (and an associated email) being adduced: [854].
Justice Delany agreed with Garde J that the offer was excessive, unrealistic and uncommercial: [875]. It made allegations that were without proper foundation, and contained threats to involve ASIC and the ATO on the basis of unpleaded allegations that should not have been made. The Court noted that the letter did not reflect well on the plaintiff: [875]. Whilst the Court considered that the letter was not in accordance with the obligations imposed under the CPA, it did not ultimately bear on the issues to be determined: [877].
G. Conclusion
Oppression proceedings often turn on their facts. Those facts can often be dense and span much of the company’s history. This is a case that demonstrates that, in those circumstances, courts will be inclined to hold the parties to their pleaded cases, in order to control the scope of issues that might otherwise be in dispute. Finally, care should also be taken in making without prejudice offers which contain threats, for as this case demonstrates, they are not always kept hidden from the Court’s gaze.
