The continued troubles faced by Tesco provides food for thought for shareholders

The bad news keeps coming for supermarket giant Tesco with the latest reports stating a record annual pre-tax loss of £6.4bn, a stark contrast to its previous year’s figures which showed annual pre-tax profits of £2.26bn.

By John Flint, commercial litigation partner at Linder Myers Solicitors.

The once ever rising star and dominant supermarket brand has also recently admitted that it overstated its half-year profit forecast in the Summer of 2014 by no less than £263m.

In Tesco’s own words, every little helps, and while some of this loss has been attributed to the reduced footfall as discount stores increasingly attract price conscious shoppers and the value of Tesco’s estimated 3,000 stores plummeting, it begs more than a few questions in relation to the vast disparity in figures and the steps taken by its directors both past and present.

Currently subject to an investigation by the Serious Fraud Office (SFO) and with rising potential legal action by its shareholders with allegations that its overstated profits have caused a crash in the value of its shares, Tesco’s surprise demise can perhaps provide lessons for all company shareholders.

While the law in this country provides some protection for shareholders, this can be limited in practice.

Generally, investing in a company only provides shareholders with the following rights in the UK: attending and voting at general meetings; sharing the company's profits; winding up (i.e. liquidating) the company if supported by three quarters of the shareholders (unless the required figure differs in its constitution); receiving a final distribution if and when the company is wound up; receiving a copy of the company's annual accounts; an entitlement that the company is run lawfully i.e. in accordance with the Companies Act, the general law and the company's own constitution; changing the company constitution with a three quarter vote by shareholders (unless a higher figure is stated within its constitution); vetoing any sale of a significant percentage of company assets; and vetoing by a majority any restriction on the ability to freely trade their shares Legal action by Tesco’s shareholders is mounting with a US based firm representing a number of its shareholders in a class action on the other side of the pond with similar action being planned in the UK if enough support is secured amongst its biggest shareholders.

The UK's Companies Act includes provision which would allow Tesco’s shareholders to take action in this country if it can be proven that: the company’s affairs have been conducted in a manner that is unfairly prejudicial to the interest of its members or an act or omission by the company is or would be unfairly prejudicial to its shareholders To succeed in their claim, there are two required elements to prove that there has been unfair prejudice, namely: the conduct must be prejudicial in the sense that it has caused actual prejudice or harm to the shareholders; and it must be objectively unfair – it is not necessary to show any bad faith or intention to harm. Instead, the court will decide whether the individuals named in the petition have acted unfairly if a reasonable bystander would believe it to be unfair. The fairness of those actions would be judged within the context of a commercial relationship, the contractual terms within its Articles of Association and any pre-existing agreements with its shareholders.

If it is found that the conduct has in fact been in accordance with its constitution, as previously agreed by its shareholders, it would be difficult to prove unfair prejudice in any petition.

The courts will however, also consider wider shareholder rights which may not necessarily be included in the Articles of Association or any additional agreements. This could extend to the shareholders legitimate expectations. For example, the right to know the state of the company’s affairs.

Generally speaking however, there is no protection for any shareholder against its directors simply making bad commercial decisions.

With in excess of 8 billion shares and an estimate that any claims against the retail giant could be in the region of between 50 – 70p per share, it’s a case worth watching. Tesco remains in a potentially precarious position given that any legal action will certainly prove costly and may result in significant further damage to its already tarnished reputation.