Fair share not an option (for owners of share options)
A recent decision of the NSW Court of Appeal in Elkington v Farsands Solutions Pty Ltd has highlighted the lack of remedies available to owners of share options who suffer loss as the result of the way a company has been managed.
As the result of a successful takeover bid, Coffey acquired all the issued share capital in Farsands. Elkington, and the five co-applicants (“the Elkington parties”), acquired options in Farsands by virtue of an assignment which occurred during this period.
Coffey, now the sole shareholder, appointed its own directors to the Farsands board shortly after the takeover had been completed. The board, whose interests were now completely aligned with Coffey’s, promptly acted to sell all of the company’s assets to Coffey for little or no consideration.
Consequently, Farsands suffered a dramatic loss in value. Given that the Farsands board was wholly composed of Coffey appointees and that Coffey was the sole shareholder, it was unlikely that Farsands would seek any legal remedy.
The Elkington parties instituted proceedings against Farsands, claiming that it was an implied term of the contract under which they acquired the share options that business decisions for the company would be made by persons who did not have duties which conflicted with those they owed to Farsands.
The breach of that implied term was said to have caused damage, by way of reduction in the value of the Elkington parties' options to zero.
The Court noted that where, because of the identity of the persons managing its affairs, it is not likely that a company will prosecute for a breach of duty owed to it, sections 236 and 237 of the Corporations Act allow a member, former member, officer or former officer of the company to commence proceedings on the company’s behalf, to recover any loss which results from that breach of duty.
However, if the breach of duty results in a reduction in the value of a member’s shares, sections 236 and 237 of the Act are not strictly designed to provide a direct legal remedy to a shareholder. Recovery under these sections is based upon the fact that it is the company which has suffered the loss, and hence it is the company which is afforded the right to recover, and not the shareholder.
So if the Court recognised the implied term as contended by the Elkington parties, holders of mere share options would be placed in a more advantageous position than the shareholders themselves. Given that the contingent rights of an owner of share options is less certain than the present rights of a shareholder, this would create an absurd result. It would also upset the statutory bias toward shareholders which is made clear by the omission of option holders from the list of persons to whom a remedy is given by section 236 of the Act.
Consequently, the Court rejected the proposition that a term should be implied in the manner contended by the Elkington parties.
The disadvantaged position of owners of share options
Elkington’s case is a clear restatement that the courts are unwilling to interfere with the longstanding principle that the separate legal personality of a company means that it is the company, not its shareholders, which is the proper plaintiff for any wrongs suffered by it.
The case also highlights the fact that owners of share options do not have the same standing to seek legal redress as shareholders, and that it is virtually impossible for an options contract to effectively prescribe limitations on the company’s future activities, with a view to ensuring that the value of the company (and by extension, the value of share options) does not decline.
Ultimately, owners of share options take a risk that their value will fall, not only through fluctuating market conditions, but through adverse decisions made by the company. The unfortunate commercial reality is that persons applying for share options do so without the judicial or statutory protection which is otherwise afforded to shareholders, and these risks should be borne in mind when considering the overall risk/reward calculation.
Author: Chris McCaffery