Boardroom and shareholder disputes can arise for many reasons. When they do, it is important to understand the legal rights of all parties and the options available as well as the consequences of allowing things to get worse. However, there are some options which can make life easier.
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- If you are a minority shareholder in a company, what happens if you have a disagreement with the majority shareholder, or a group which has more control? How do you solve the problem, or even avoid a dispute?
- What if the majority is taking unfair advantage of a minority shareholder? What if you suspect co-shareholders are stealing from the company?
- If you are a minority shareholder in a company, what happens if you have a disagreement with the majority shareholder, or a group which has more control?
If you are a minority shareholder in a company, what happens if you have a disagreement with the majority shareholder, or a group which has more control? How do you solve the problem, or even avoid a dispute?
1/ Minimal Influence
In company law, a minority shareholder (anyone with 49% or less) has minimal influence over the management of the company or the distribution of its profits. The standard constitution of a company and rules under the Companies Act give little protection to a minority shareholder.
Differences can and do arise as the business evolves and personal circumstances change. For example, there may be differences as to strategy or the direction of the company - power struggles and poor personal relationships may develop - shareholders may wish to retire or disagreements occur on service contracts and remuneration.
There are ways in which the minority shareholder’s interests can be protected, either by agreement with the other shareholders or as a last resort by taking action through the courts. It is tempting for entrepreneurs to preference the initial brokering of a deal, and getting the new business up and running, over longer term, but equally important considerations. But it is always better to consider these scenarios at the beginning.
2/ Shareholder Agreements
A shareholder agreement is a must for a private company, especially where there are a relatively small number of shareholders who also manage the business. These don't always arrive without the minority shareholder/s pressing for one. You need to proactively pursue this as part of the start up, or failing that, it needs to be put top of the agenda for an established company. In a Shareholder Agreement, the majority shareholder usually gives up some rights to the minority.
The process of preparing the Agreement helps shareholders address points which could become potential problems. This encourages the key players to work through the issues early, when everyone is positive and communications are still good.
It is much more straightforward and economic to deal with this as part at start up, rather than risk the expense and uncertainty of going to court later. All concerned will know where they stand where there is a Shareholder Agreement and it reduces the risk of conflicts arising or getting out of hand.
An existing businesses can certainly set up a Shareholder Agreement at whatever stage in its evolution, for example when one of the main shareholders is considering retiring or their circumstances have changed.
It is also worth remembering that a Shareholder Agreement is confidential, doesn’t have to be filed at Companies House, sits behind the company’s publicly available documents and is private between the shareholders.
3/ Points to Cover
A Shareholder Agreement can go a long way to ensuring disputes are avoided or at least, provide mechanisms that encourage them to be settled quickly. An agreement identifies shareholders' specific responsibilities and outlines how and where disputes are to be resolved. For example, it can specify forced buy/sell provisions during a dispute and even include a formula or other means to determine the transaction price.
Amongst other things, the Agreement can cover:
- key objectives
- financing and borrowing
- dividends, directors' fees and salaries / profit distribution
- controls on the appointment of Directors
- major expenditure
- exit mechanisms - for shareholder deaths, misconduct, divorce, incapacity, etc.
- fair valuation process for transfer of shares
- succession arrangements - insurance of key persons
- dispute resolution
The Shareholder Agreement gives minority shareholders a say in the business and some security. Without one, the minority shareholder would have little impact on decisions regarding the company or protecting their interests. A Shareholder Agreement can be enforced through the courts as a private contract between the members.
4/ How to enforce my rights as a shareholder?
Negotiation is the key, this should be explored first, rather than threatening legal action. However it is important to know your legal rights, and the provisions of the Company constitution. How do these apply to your position and the other interested parties? It may be necessary for you to obtain details or documents as part of the process, which the company is reluctant to provide. Take legal advice early on as to the pros and cons, the likely outcome, and the estimated timescales and costs.
Even where proceedings are issued, frequently a solution is reached through negotiation. This is usually much quicker and cheaper than having a decision imposed by the court. However, it may be necessary to exercise leverage by relying on your strict legal rights to achieve any progress.
There are various options, including:
- proposing a resolution at a general meeting which redresses the situation
- complaining to the police of any criminal acts
- using a mediation service to settle a dispute
- asking the board of directors to take action in the company’s name against an individual director (NB. a shareholder can’t sue in the company's name)
A mediator will be someone experienced in this area of law. If agreement is reached with the help of the mediator, the compromise can be recorded in a legally binding document which can be enforced in the court, if one of the parties breaks it. The advantages of mediation include its relative cheapness compared to court proceedings, privacy and speed.
If it isn’t desirable or possible to achieve an accommodation where the aggrieved shareholder stays in the company, other solutions include:
- the other shareholders buy out the aggrieved shareholder at a fair price
- the company buys back the aggrieved shareholder's shares at a fair price
- Make a reasonable offer to the aggrieved shareholder.
6/ Further Options
Where the Company refuses to cooperate, further options include:
- applying to the court for an order that the company is acting or has acted unfairly (an "unfair prejudice" action: s.994 Companies Act 2006)
- applying to the courts for the company to be wound up: s.122g of the Insolvency Act 1996
- suing the directors for negligence by means of a Derivative Action: s.260 of the Companies Act 2006:
The courts encourage settlement of all disputes, including shareholder disputes. Where the majority has made a reasonable offer to the aggrieved minority shareholder to buy them out on reasonable terms, it is unlikely that the majority will have acted ‘unfairly’. Then it wouldn’t be ‘just and equitable’ to wind the company up. It is essential to take advice on the terms of any offer you make.
If you offer to go to mediation or alternative dispute resolution, you are also unlikely to have acted unfairly. However if the company is in financial difficulties a creditor may issue a petition under S.122 of the Insolvency Act, irrespective of the shareholders’ wishes.
Where the Court decides that a minority shareholder has been oppressed or unfairly prejudiced and the appropriate remedy is for the majority buy the minority shares, this is often done at a "fair value" i.e. fair market value without deduction for a minority discount.
Where the majority gives an undertaking to buy the shares of the aggrieved minority at fair value, usually the court will adjourn the unfair prejudice petition. However, the fundamental battleground is frequently
- the basis of the business valuation
- the underlying assumptions
- the data and criteria on which it is based
The valuation of a private company is an area of potential significant difference between the parties. These can be quite complex disputes, but qualified and experienced legal advisors and valuation experts hired early in the process will help you through this potentially sensitive and difficult area.
What if the majority is taking unfair advantage of a minority shareholder? What if you suspect co-shareholders are stealing from the company?
1/ Protecting the Minority
There is a common misconception that the complex company laws and regulations aim for a just and fair relationship between a minority shareholder and the majority. However, there is very little law which protects the minority, unless the parties have agreed beforehand.
Differences between shareholders don't always arise because of power struggles or personal animosity. Frequently, disputes are down to differences in approach where one party wants to retire or withdraw their investment. Disagreements may centre on timing, valuation issues or the direction of the company.
The public courts are unlikely to be the ideal venue for resolving shareholder disputes. Proceedings are in the public domain and the procedure can be expensive and slow. Particularly where private companies are concerned, there are effective alternatives, including: negotiation, mediation and arbitration.
2/ Shareholder Agreement
An effective way to address potential problems before they arise is a Shareholder Agreement. This sets out ground rules for the shareholders in given circumstances. Many potential and predictable problems can be addressed in advance in a Shareholder Agreement. This leaves the shareholders to concentrate on managing the business, rather than a future internal dispute.
Amongst other things, the Agreement can cover:
- management responsibilities
- non-competition restrictions
- bonus and remuneration formulae
- approval/decision process for major corporate decisions
- buy/sell provision – e.g. a “shotgun clause” to force a transaction
- how a shareholder can realise his or her investment in the company
- whether to impose any restrictions on selling shares
- criteria on valuing the shareholding
- exit provisions - timetable for sale
- appointment of an independent third party to value the shares
- a detailed dispute resolution framework;
3/ What is an “Unfair Prejudice” claim?
The majority shareholders are in a powerful position, even where there is a Shareholder Agreement. However, the court will protect the position of minority shareholders from being abused in certain circumstances.
Section 994 of the Companies Act 2006 allows a shareholder to apply to the Court for an order declaring that the affairs of the company are being conducted in a manner unfairly prejudicial to the minority shareholder’s interests. If the court agrees, it will usually order that the shares of the minority shareholder are bought for fair value. However, the Court has a very wide discretion as to what it can order, including:
- purchase of the shares of any members of the company by other members
- purchase of the shares by the company itself
- reduction of the company’s capital accordingly
- conduct of the company's affairs in the future
- company to refrain from doing or continuing an act complained about
- company to take action
- civil proceedings to be brought in the name and on behalf of the company by such persons and on such terms as the court may direct.
- company not to make any, or any specified, alterations in its articles without the court’s permission.
4/ When might a court find Unfair Prejudice?
Where a minority shareholder believes that the company is being run in a way which is unfairly prejudicial to some of the shareholders, the aggrieved shareholder can make an application to the Companies Court for a remedy. Unfairly prejudicial conduct may include for example:
- majority shareholders paying themselves excess remuneration
- majority shareholders failing to pay dividends
- breach of duty by diverting business to majority shareholders or their connected companies
- directors selling or buying assets at an unfair price
- failing to pay declared dividends
- undertaking activities which are not permitted under the company’s Articles
- doing something which might result in the company’s insolvency
- failure to follow company law or proper procedure on meetings.
- failure to issue annual accounts
In SME / small to medium sized private companies, the court might be persuaded that a “quasi-partnership” exists. The aggrieved party may complain that there is a breach of their ‘legitimate expectations’ about what the company was set up to do, and how it would be run. E.g. it was agreed, or a common intention is proved that:
- the company would carry on a particular business
- all would be entitled to an equal say in how the company is managed
- there was a mutual expectation of continued employment
- the directors would be fair when deciding on the salaries to be paid, the amounts to be kept in the company to fund growth, and the dividends to be paid out
If the court decides that a quasi-partnership exists, termination of that arrangement or unfair prejudice to the minority may result in the majority being obliged to buy out the shares of the aggrieved minority shareholder. If the majority acts in breach of such “legitimate expectations”, the court may intervene.
Where an aggrieved shareholder has cause for complaint, urgent action is required. The court may refuse to interfere if a minority shareholder let the matter slide. The court will treat this as acceptance of the action taken by the majority: “delay defeats equity”. The court will consider all of the background circumstances on an application, including the minority shareholder’s own conduct.
These applications are rarely straightforward and are often settled by negotiation before the court is asked to make a final decision. Quite often, one or more of the shareholders leave with a package. Expert legal advice could keep the process out of prolonged, expensive and destructive litigation by providing the facts, insight and information to allow all parties to make informed decisions as quickly as needed.
If you are a minority shareholder in a company, what happens if you have a disagreement with the majority shareholder, or a group which has more control?
1] Shareholder Agreements
The House of Lords in Russell v Northern Bank Developments Corp Ltd[i] emphasised the practical utility of Shareholder Agreements. These are used for a wide variety of purposes, adding significantly to the company’s constitutional regime of Memorandum and Articles. This Includes providing personal rights to minority shareholders who otherwise have no control over fundamental points.
The minority shareholder’s concerns would be more difficult to deal with unless specifically covered as an enforceable private contract between members. These should be provided in the Shareholder Agreement, covering similar areas to partnership agreements. The benefits include avoiding future misunderstandings and practical difficulties in running the business. A Shareholder Agreement typically deals with issues such as: restrictions on transferability of shares; lack of a market for sale of shares; establishing a purchaser; formulas for valuation and funding; pre-emption rights; compulsory transfer or option arrangements; protection of minority members by permitting a veto; preserving confidentiality; efficient transfer on death, disability, retirement; estate planning; regulating management and involvement of investors; mechanisms for dealing with stalemate.
2] “Unfair Prejudice” Petition
Section 994 of the Companies Act 2006 permits a shareholder to petition the court on the basis that the shareholder’s interests have been unfairly prejudiced in the conduct of the Company’s affairs due to e.g. breach of:
the Articles of Association
the Shareholder Agreement
fiduciary duties by directors
exclusion of a minority from the running of the company in small “quasi-partnership” companies.
The Court has wide discretion to grant the relief it decides is appropriate. This is often an order that the aggrieved minority shareholder’s shares are purchased for ‘fair value’. This may include a premium on the actual value of the shares as recompense to the petitioner for any wrongdoing by the majority.
3] What is a ‘derivative claim’ – S.260 of the Companies Act 2006?
In certain circumstances a shareholder can ask the court to prevent action being taken by the Directors which is harmful to the company, or make a claim against the Directors for any loss suffered by the company as a result of their action. The claim must be made by the shareholder on behalf of the company. The shareholder’s right to bring a claim “derives from” the company. This is a claim made in a “representative capacity” by the individual shareholder, not on the shareholder’s own behalf. It is the company which is suffering the harm. The damage to the company may also harm the shareholder indirectly, e.g. if there is a reduction in profits or other damage suffered.
Derivative claims are relatively unusual because although it is the member who issues the court proceedings as claimant to launch the action, the court must give permission for the claim to progress further or continue to trial. A number of tests have to be satisfied before the court will give permission.
The shareholder runs a risk on costs and at least initially has to fund the claim themselves. It is possible to obtain an order that the company indemnify the member, who may obtain no immediate benefit personally by launching the court case. However, if the claim succeeds, the company will have been protected. Ultimately, that should benefit the shareholder because it protects their investment in the company.
4] What is a claim under S.122(g) of the Insolvency Act 1996?
Any shareholder may apply to have a company wound up on “just and equitable grounds” including in quasi-partnerships, involving the shareholder’s right to manage the company – Ebrahimi v Westbourne Galleries Ltd[ii]. The sole remedy here of winding up is draconian, available only in specific circumstances. This is the “nuclear option” in shareholder disputes - the aggrieved shareholder petitions the court for a winding up order to terminate the company.
Usually the shareholders’ differences have become irreconcilable and a ‘commercial divorce’ is the only way to move forward. When a company is wound up, if there is anything left after paying the creditors and the liquidator the proceeds are divided amongst the shareholders.
Not every aggrieved shareholder will be able to justify a winding up petition to the court. There must be compelling reasons showing that the company can no longer continue. The aggrieved shareholder has to prove there will be a concrete benefit in making a winding up order. If there is some alternative remedy, which would allow the company to continue, the court may refuse to make the order.
A typical scenario where a winding up may be justified is where there is deadlock or stalemate between two or more shareholders in a quasi-partnership company which can’t be resolved. Where there is an aggrieved minority shareholder, experience shows that the majority shareholder will seek to dispute both:
the complaints by the minority that there was any “quasi-partnership” in the first place
the circumstances of any alleged unfairly prejudicial conduct
the alleged value of the business, and the aggrieved minority shareholder’s share
The sooner informed negotiations start, the more likely it is that a private business will survive a shareholder dispute. A comprehensive Shareholder Agreement can help to preserve operations and resolve matters quickly.
Expert legal advice early on could keep the process out of prolonged, expensive and destructive litigation. This is by providing the facts, insight and information to allow all parties to make informed decisions quickly. This would ultimately be to the benefit of the company as a whole and the shareholders individually.
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At last it is all at an end, and we are happy with the outcome. We would like to thank you and the team for giving control back to our lives, god knows where we would be, also for your professionalism and counselling to guide us through this horrendous ordeal we do thank you, it was worth every penny.David Haywood, Former Minority Shareholder in Haywood and Padgett Limited