Understanding the options – 5 tips
As discussed in previous posts, Boardroom and shareholder disputes arise for many reasons. When they do, it is important to understand the legal rights of all parties and the options available. The consequences of allowing things to drift and potentially get worse shouldn’t be ignored. There are options which help make life easier.
- 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?
- In the third of this series, here are five important tips:
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 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, although they may obtain no immediate benefit themselves 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:
- 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
- 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.
For further information regarding minority shareholder / business disputes and unfair prejudice petitions contact Paul.Sykes@lf-dt.com
[i]  1 WLR 588
[ii]  2 All ER 492