Directors & Shareholder Claims: 3

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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:

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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.

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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.

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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

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5] Finally

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] [1992] 1 WLR 588

[ii] [1972] 2 All ER 492

Unfair Prejudice & Drag Along

Minority Shareholder wins Quasi Partnership claim

8 Ways to avoid a Business Dispute

Are you a Shadow or de facto director?

Service of a Claim Form on a Director

WHEN DIRECTORS FALL OUT

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Directors & Shareholder Claims: 1

How to break the deadlock – 8 tips

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Boardroom and shareholder disputes can arise for many reasons. When they do, it’s 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:

  • 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 first of a series, here are seven important pointers to be aware of:

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:

  • there may be differences on 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 easy 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’s always advisable 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 (you) the minority shareholder/s pressing for one. You need to proactively pursue this as part of the start up, or failing that, you should put it at the  top of the agenda.  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’s much more straightforward and economic to deal with this as part of the 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 Agreements. 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 public face
  • is a private document between the shareholders.

 

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3/ Points to Cover

A Shareholder Agreement can go a long way to ensuring disputes are avoided or at least, provide the mechanism that allows 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 would have little impact on decisions regarding the company and protecting their interests.

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 likely 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.

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5/ Solutions

There are various options, including:

  • proposing a resolution at a general meeting which redresses the situation
  • complaining to the police of any criminal acts
  • asking the board of directors to take action in the company’s name against an individual director (because the shareholders can’t sue in the company’s name)
  • using a mediation service to settle a dispute.

6/ Mediation

A mediator will be someone who is 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 going to court, privacy (there is no public record) 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.

7/ 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 under s.994 Companies Act 2006)
  • applying to the courts for the company to be wound up under s.122 of the Insolvency Act 1996
  • suing the directors for negligence by means of a Derivative Action under 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.

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8/ Finally

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 battle ground 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.

paul.sykes@luptonfawcett.law

Disclaimer

LINKS

Unfair Prejudice & Drag Along

Minority Shareholder wins Quasi Partnership claim

8 Ways to avoid a Business Dispute

Are you a Shadow or de facto director?

 

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Shareholder and Boardroom Disputes: Tips (2)

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In the second in a series of articles, read my piece in the link below on:

http://www.luptonfawcett.com/blog/minority-shareholder-boardroom-disputes-tips-2/

  • Minority Shareholders
  • Boardroom Disputes
  • Shareholder Agreements
  • Unfair Prejudice claims

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Shareholder & Boardroom Disputes: Tips (1)

imagesCA8KW2NT GOLDEN RULES RED

In the first of a series of articles, read my piece in the link below on:

  • Minority Shareholders
  • Boardroom Disputes
  • Shareholder Agreements
  • Unfair Prejudice claims

http://www.luptonfawcett.com/blog/minority-shareholder-boardroom-disputes-tips-1/

 

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Unfair Prejudice & Drag Along

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My analysis on Court of Appeal decision in Re Charterhouse Capital Limited; Arbuthnott v Bonnyman [2015] EWCA Civ 536 :

http://www.luptonfawcett.com/blog/unfair-prejudice-and-drag-along/

Minority Shareholder wins Quasi Partnership claim

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Read my piece in the link below on

  • A succesful claim establishing unfair prejudice by a petition under s. 994 of the Companies Act 2006
  • The latest Practice Direction on unfair prejudice claims, introducing Automatic Directions

http://www.luptonfawcett.com/blog/unfair-prejudice-minority-shareholders-win/

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