In large businesses there are often streamlined procedures for resolving disputes amongst shareholders and directors. In smaller business where the directors and shareholders are often friends or family members, business is often conducted in a much more informal manner leading to a much greater potential for disputes to arise. This can be extremely disruptive and often damaging to company operations unless there is an effective system in place for resolving them.
This article looks at ways of avoiding such disputes, and ways of enabling disputes to be resolved quickly if they do arise so that their impact is limited.
The lack of formality within a private company may seem desirable at the outset. However, differences can arise as businesses evolve and personal circumstances change. Since a minority shareholder has minimal influence over the management of a company, it is advisable for minority shareholders to consider various potential scenarios at the outset.
The most important step a minority shareholder can take to avoid an abuse of power and jeopardy within the business is to ensure there is a signed shareholders’ agreement in place at the time the business first begins operations or at the time they invest. Failure to have such an agreement increases the risk of disputes ending up at court further down the line.
A shareholder agreement is confidential and does not have to be filed at Companies House.
Clauses dealing with the following issues should be included:
- Finance and borrowing.
- Major expenditure.
- Controls on the appointment of directors.
- When shareholder meetings are to take place.
- How and when shareholders can call a meeting.
- When and how shares can be sold or transferred.
- The method of valuation in the case of a share sale by private agreement of a personal shareholding. This can avoid the common arguments concerning whether a minority discount should be applied.
- What is to happen upon the death of a shareholder.
- The remuneration or other benefits payable to directors.
- The level of dividends which will be paid if there are profits.
- Whether key decisions can be made without the approval of the major shareholders.
- An agreed exit route or procedure for offering shares if a shareholder wants to leave.
- A dispute resolution clause, which might include a right for a minority shareholder to have his shares bought out, or the right to control the transfer of shares.
In addition to a shareholders’ agreement, other agreements should be put in place which dictate what everyone’s role is within the business and what the company’s goals are. Such agreements include employment contracts and service agreements. It is advisable to obtain legal advice on such agreements at the time they are drawn up to ensure they provide sufficient protection, certainty and clarity.
At the time these documents are negotiated a minority shareholder should seek an enhancement of their basic rights. There is no limit on the extent to which a shareholder’s rights under the Companies Act can be enhanced.
A shareholder with enhanced rights is in a much stronger position should any issues arise, whereas a shareholder with basic Companies Act rights is unlikely to be successful in seeking an amendment to the Articles or to a shareholders’ agreement once a dispute has arisen.
The sorts of enhancements a minority shareholder should consider seeking are:
- The right to access financial records
This will circumvent a controlling shareholder and director from being entitled to refuse to voluntarily disclose financial information, which is key evidence when it is suspected that a business is not being properly managed.
- A power of veto
A minority shareholder with a power of veto can block actions unless the minority consents. That might include expenditure over a particular limit, the sale of a substantial shareholding unless the minority are offered similar terms, business sales and mergers, and winding up or voluntary liquidation.
- Protection to avoid the dilution of shares
- A right for minority shareholders to subscribe for shares under any new share issue.
As well as enhancing minority shareholder protection, shareholders should at the outset consider potential exit routes in the event of a dispute. It is often the case that the transfer of shares to a family member or third party is restricted by the Articles, creating difficulty for a minority shareholder in the event of a dispute arising.
Conflicts between directors and shareholders can arise for many reasons and may be unavoidable, but taking steps to enhance and protect rights at the outset can make resolution of a dispute so much easier, and of course less costly.
There are various remedies for an aggrieved shareholder. They include the personal rights of a shareholder to enforce rights conferred by the Articles, the right to bring an action to prevent a transaction taking place which is outside of the power of the company or its directors, and the right to enforce rights conferred by a shareholders’ agreement. In the event these remedies do not assist, other remedies available to shareholders include the presentation of an unfair prejudice petition, a claim brought on behalf of the company against a director (known as a derivative claim), and an application for a winding up order on the just and equitable ground. The most widely used remedy is an unfair prejudice petition, which may be presented where the affairs of the company are being conducted in a manner which is unfairly prejudicial to one or all its members.
In the event a dispute does arise, the specialist team at Myerson can advise on all aspects of a shareholder or director dispute. They can advise you on your rights and explain the various options available.
Myerson recommend directors and shareholders seek legal advice at an early stage in advance of a potential dispute crystallising where possible. Seeking early advice can assist in resolving issues at an early stage, and before relations deteriorate too far.