Shareholder Disputes (and How to Resolve Them!)
Shareholder disputes have the potential to cause significant damage and disruption to a company’s commercial interests. Taking effective steps to resolve shareholder disputes can be business-critical.
There are a number of reasons why a dispute may arise between company shareholders or shareholders and directors. Some common causes of shareholder disputes include:
- Poor performance by a shareholder or director
- Accusation that the board is failing to meet its’ legal obligations
- Disagreement over the company’s direction and development
- Conflict of interest, for example of a director has interests in a competitor
- Dissatisfaction with the terms of directors’ service contracts
- Money not reaching the shareholders and being paid in dividend due to directors keeping it in the company or paying themselves high salaries
The law surrounding shareholder disputes is however complicated. Each case will turn on its own facts, with critical factors including the type of dispute in question, whether you are a minority or majority shareholder, the nature of the company’s Articles of Association and any shareholders agreement that is in place.
We look at some of the key considerations when looking to resolve a shareholder dispute.
Shareholder powers & rights in relation to disputes:
A company’s Articles of Association should set out the rules for how the company is to be run and how power is conferred.
If a company has a Shareholders’ Agreement, this should direct how the relationships between shareholders and directors are managed, including how the company will handle disputes.
Although specific rights and responsibilities are outlined in the aforementioned documents, there are also some general statutory rights for common shareholders directly influencing their position in disputes. These include:
- The right to call for and vote in the company’s general and annual meetings. Major changes in a public company must be voted on before they can be implemented and shareholders have the right to vote either personally or via proxy. When disputes arise over issues relating to the direction of the company, sharing out of profits or behaviour of directors, calling a general meeting and voting on issues is one of the most effective means of resolving a dispute. The Articles of Agreement and Shareholders Agreement can sometimes cap or extend the influence of individual shareholders.
- The right to share in the businesses profitability through division of profits. One of the most common disputes between directors and shareholders is how the company profits are distributed. As directors have control of the day to day running of the company, they are able to withhold profit shares from the shareholders either through re-investing the profits in the company and paying their own salaries. However, the shareholders right to expect a share of company profits puts them in a strong legal position when disputing the director’s management of company profits.
- The right to buy new shares. Should new shares become available existing shareholders have the right to buy up to a certain amount before they become available to the public. Usually each share is equivalent to one vote so majority shareholders will have greater influence than minority shareholders. The right to increase their share ownership therefore gives shareholders greater powers to, for example, dismiss or appoint directors and vote in general meetings putting them in a stronger position when it comes to disputes.
- The right to influence company management through electing the company’s board of directors, who deal with the daily running of the company and are usually minority shareholders themselves. When shareholders have disputes with directors over the running of a company, the right to elect and dismiss directors gives the shareholder a strong position in negotiating as well as a potential resolution should the director be acting irresponsibly.
- The right to call a general meeting to discuss and resolve issues through agreement or vote. Shareholders are able to call a meeting which other shareholders and directors must attend in order to discuss and try to resolve an issue.
- The right to sue the company if it has committed wrongful acts. Companies exist in their own right, separately from the shareholders. An individual shareholder who believes their rights have been violated can sue either the company through a class action lawsuit or an individual shareholder by issuing a single shareholder complaint.
- The right to bring a claim in the name of the company, known as a “derivative claim”, against persons they believe are guilty of wrongdoing. Examples of wrongdoing would be directors committing equitable fraud against the company. Under the Companies Act 2006 this is a two-step process requiring court permission and the shareholder is acting on the behalf of the company.
- Personal hostilities and negative relationships between shareholders and directors
Resolving shareholder disputes:
Resolving a shareholder dispute will require use of dispute resolution procedures. A qualified legal professional will be able to advise on the options open to you to resolve your issue.
Calling a general meeting: A first point of call when disputes arise between shareholders and/or directors is to call a general meeting to discuss and try to resolve the issue. Shareholders have the right to call a general meeting and discussing any issues with the other shareholders and directors can diffuse the situation without the need for further action. Professional commercial mediation: The articles of agreement and/or shareholder agreements may require mediation as an approach in resolving disputes. An independent and neutral mediator can help avoid escalation of the dispute and talk the shareholders in question through possible resolution options.
Buying out or transferring shares: Should mediation fail, the articles of agreement or shareholders agreement should lay out the process for a shareholder to leave the company. There may be a clause requiring the other shareholders to buy the aggrieved shareholders’ shares at a fair price. If the dispute is between two sides then the process may involve both parties offering to buy out the other with the highest offer acquiring the shares. Depending on the specific clauses of the Articles and Shareholder Agreement, shareholders could be defined as good or bad leavers. Whether the departing shareholder is a good or bad leaver can affect their ability to sell or transfer the shares privately to an individual outside of the company and the price at which they can sell their shares. If sale or transfer of shares appears to be the route of the shareholder dispute legal advice is recommended to ensure our rights are protected.
Derivative claims: In cases where the shareholder believes one or more of their co-shareholders or directors are responsible of crimes against the company, such as committing fraud, they can bring a claim against those individuals on behalf of the company. This is known as a derivative claim and if successful any resulting proceeds would go to the company. Under the Companies Act 2006 statutory derivative claims were introduced, widening the breadth of this approach but requiring a two-step process the first being to obtain court permission. Given that is can be a complex and drawn out legal process with all proceeds going to the company, derivative claims are rarely the best option for minority shareholders.
Personal claims: As a last resort, a shareholder can take a fellow shareholder to court if they feel the opposing party is in breach of the law or their responsibilities to the company. An example would be in casas of unfair prejudice. Litigating a business partner should only be considered if the business relationship has become irreparable and is damaging the company and interests of shareholders. A law suit itself can often damage the business in general and still may not produce the desired result. It is critical that you take legal counsel prior to starting a court case against a shareholder and only if all other attempts at resolution have failed.
Winding up: Where negotiations and company procedure fail to resolve disputes, a possible last resort is for a shareholder to apply to the courts for the company to be wound up. Section 122(1)(g) of the Insolvency Act 1986 enables the court to wind up a company if it determines that course to be just and equitable. Effectively this means the shareholder will need to prove that winding up the company would leave a monetary surplus to be shared out between its members. Usually shareholders will need to have held shares for at leat18 months in order to call for the company’s winding up.
Winding up a company is at the courts’ discretion and the court will rule against it if it is felt an alternative remedy is possible and should be pursued or if the complainant is felt to be partially responsible for their situation. However, circumstances which may lead to a successful application for winding up a company include:
- Minority shareholders’ rights being consistently ignored by majority shareholders
- The wrongful exclusion of a minority shareholder from company management
- Company deadlock between parties making it impossible to move forward and make company decisions
- Directors excessively remunerating themselves to the expense of shareholder dividends
If looking to remove a shareholder or director, or looking to leave through sale of your shares, it is important to check the articles for any special rules such as specific individuals, (usually a majority shareholder or founder) having the right to appoint or remove directors without the board’s approval.
Ensure you are following the required protocol as prescribed in the AoA – Before attempting to make any changes, such as removing a shareholder or director, through voting in a board meeting it is critical you ensure the correct number of members and key individuals are present at a meeting of the members.
Other complicating factors relate to the employment rights of shareholders. Should you be an employee of the company as well as a shareholder it is important to check the shareholders Agreement or Articles for clauses conferring rights on those who control the company to require a departing employee to sell their shares, and to take advice on how to negotiate buy back options.
When and Why to Seek Legal Advice:
The law surrounding shareholders rights and dispute resolution is particularly complex. There are a number of variables at each stage in a dispute which could affect your chance of obtaining the outcome you want. The nature of the dispute, whether you are a minor or major shareholder, whether you are a company director, how many shares you own and whether you have control of the board, what the company’s articles or shareholder agreements dictate, etc. With so many factors which could influence the resolution process, and your shares being such a high value asset, it is always best to seek legal advice as soon as possible.
Prevention is however always better than cure and having a clear framework for how to handle shareholder disputes is recommended for all businesses through a well-drafted Shareholders Agreement.