The Court confirms the Legal Costs Principle in Shareholder Disputes

21 May 2021

In the case of KOZA LTD and HAMDI IPEK –v- KOZA ALTIN IŞLETMELERI AS [2021] EWHC 786 (Ch), Mr Justice Trower awarded an injunction restraining Mr Ipek, Koza Ltd (“KL”)’s sole director, from causing KL to use its funds to pay legal costs in the litigation, which was in reality a shareholder dispute between Mr Ipek and Koza Altin Işletmeleri AS (“KAI”).  The decision upholds the ‘legal costs principle’ in company disputes, which provides that a company’s money should not be spent on disputes between shareholders.

Background

KL is an English company. Mr Ipek is its sole director. It has 60 million ordinary shares held by KAI and two “A” shares held by Mr Ipek and his brother. KAI is a listed Turkish company, shares in which are held by Mr Ipek and members of his family, and also by members of the public.  

The “A” shares in KL were created in September 2015, and its Articles were also changed at that time so that, amongst other things, consent of the “A” shareholders would be required for any amendment to KL’s Articles, or for the appointment or removal of any director of KL (meaning Mr Ipek would have to consent to his own removal as a director). These changes were made at a time when Mr Ipek was facing (what he considered to be a politically motivated) criminal investigation into the Koza group. This investigation eventually resulted in the Savings Deposit Insurance Fund of Turkey appointing all members of KAI’s board of directors (“the Trustees”).

The proceedings

Proceedings in England were commenced by KL seeking an injunction against KAI preventing it from calling a general meeting of KL to seek Mr Ipek’s removal as a director on the basis that a) the authority of the Trustees should not be recognised by the English Court and b) the consent of KL’s “A” shareholders had not been obtained in respect of a resolution for Mr Ipek’s removal, as required by the Articles.

An interim injunction was granted by Mrs Justice Asplin against KAI, subject to the provision of undertakings from KL, including one that it would not dispose of funds other than in the ordinary and proper course of its business. In the course of the ensuing litigation, the issue of the use of funds by KL for the purpose of funding the proceedings arose on several occasions.

KAI applied for orders restraining Mr Ipek from causing KL to continue to pay for the legal costs both of the existing proceedings and a further set of proceedings intimated by Mr Ipek challenging the authority of the Trustees. KAI argued that the continuing (and past) payment of such legal costs would be a misuse of KL’s funds in the context of a dispute over who had the right to control KL. It was further argued that such expenditure of KL’s funds was not in the ordinary and proper course of its business. Mr Ipek argued that the regime imposed by the earlier order of Mrs Justice Asplin envisaged that Koza would be participating in the proceedings as an active protagonist and would be funding the claimants’ costs pending trial.

The decision

In deciding the application, the Judge noted that it was a well-established principle of company law that a company’s money should not be spent on disputes between shareholders and that its controlling shareholders should be restrained by injunction from permitting it to incur expenditure on legal or other professional services, both for the purposes of such litigation or any other aspect of the dispute – this is the ‘legal costs principle’. As such, the court needed to identify the true nature of the proceedings to determine if the legal costs principle is engaged. If the real contest is between parties other than the company itself, it would be a misfeasance for the company’s directors to spend the company’s funds on legal costs.

The Judge had no doubt that the real and substantive contest was between Mr Ipek and KAI, in their capacity as holders of the two different classes of shares, as to the control of KL. The Judge was also not convinced that KL had a sufficient interest in the litigation to participate at its own cost, or that preventing it from using its own funds would stifle the proceedings.  

Mr Ipek argued that he could not afford to fund the litigation from his personal resources, however the Judge the noted that the inability of one party to fund a dispute over the control of a company provides no justification for the company to incur the cost of making that party’s case. The Judge further agreed with KAI that arguments from an obviously interested party that the funding of proceedings is in the best interests of a company are unlikely to be persuasive.

The Judge went on to consider various discretionary factors as to whether it was appropriate to grant the injunction sought by KAI. By way of example, the Judge found it compelling that KL had incurred substantial expenditure on legal costs in the proceedings, whereas there was no evidence that Mr Ipek had made any contribution in his own right. KAI, as the 100% ordinary shareholder in KL, was the entity that would be far more prejudiced than Mr Ipek by KL’s use of its own funds in the litigation. Further the effect of not restraining the use of the company’s monies would be to permit the controlling shareholder to continue to use the company’s assets in funding that shareholder’s side of the contest, giving it a significant cash flow advantage to the exclusion of the other.

In the light of the above, the Judge granted KAI’s application, ordering an injunction restraining Mr Ipek from causing KL to spend its funds on the legal costs of the proceedings.

Comment

The decision in Koza upholds the well-recognised principle that a party to a shareholder dispute should not be permitted to use the company’s funds to finance their own legal costs. If a company met one party’s costs of a shareholder dispute, this would have the effect of the other party bearing those costs to an appreciable extent through the proportionate reduction in the value of their shareholding in the company. Moreover, where the controlling shareholder is also a director it would likely be a breach of their director’s duties if they utilised the company’s funds to advance their own personal interests.

There may nevertheless be instances where a company could be justified in participating in shareholder proceedings, and to use its own funds in doing, however there will always be a heavy onus on the company to show the necessity of doing so.

 

Further information

Further information is available on our Shareholder and Boardroom  Disputes web page.

If you would like to discuss any of the topics raised in this blog, please contact the author or a member of our Shareholder and Boardroom Disputes team.

 

About the author

Richard Clayman is a Senior Associate in our Dispute Resolution team.  Richard’s experience covers a broad range of commercial disputes, acting for claimants and defendants, often in complex, multi-jurisdiction and high value claims. Through his civil fraud practice, Richard has gained considerable experience in obtaining and resisting orders for a variety of interim remedies, including worldwide freezing orders, injunctions, security for costs and disclosure orders.

 

 

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