It is often the case that disputes arise between shareholders and company directors. Those involved may have different opinions in respect of the direction of the company, be concerned about the level or risk or debt being taken on or believe that decisions are being made that are not in the company’s best interests. In many cases, the shareholders are also directors of the company.
The area of shareholder rights is a complex one and will vary from case to case depending on the provisions of the company’s Articles of Association. Many companies also have shareholders’ agreements, which set out further rights and powers for each type of shareholder.
If a dispute arises, it can be damaging and disruptive to a business, both in respect of its operation and its reputation. You are strongly advised to speak to an expert shareholder dispute solicitor as soon as possible. Early intervention is crucial in resolving a dispute before the situation deteriorates.
It is also essential to understand your rights as a shareholder. These stem from a range of areas, including:
Disputes can arise over a very wide range of issues, but common causes of contention include:
- Shareholders feel that they have been treated unfairly to others
- Shareholders disagreeing with decisions being taken by the company directors
- Concerns that company directors are exceeding their powers
- Concerns that company directors are not acting in the best interests of the company
- Shareholders not being advised of meetings or being kept in the dark in respect of issues that they have a right to know about
- Directors acting with a conflict of interest
- Shareholders’ rights are not being observed – for example, those of minority shareholders
Disputes are common between directors and shareholders, but can also arise between shareholders themselves, for example, between majority and minority shareholders who both have an interest in the company but who have different rights.
Regulations in articles of association
If you are experiencing difficulties as a shareholder, you need to understand the extent of your rights and where these stem from. Every company has articles of association, and these will set out some of the rights that shareholders have.
When setting up a company, the balance of power between directors and shareholders should be considered. The articles of association and shareholders’ agreement should accurately reflect what was decided upon. If you have not had a bespoke document drafted, then there will be default provisions that will also confer a number of rights on shareholders.
Articles of association are filed at Companies House and are available publicly. The company is legally bound to follow the terms and conditions set out in the articles, which form a contract between the company and the shareholders.
Shareholders’ rights contained in articles of association include:
- The different types of shares that will be issued and the rights attaching to each of them
- Voting rights for each type of share
- How shares will be issued and sold or transferred
- Drag-along and tag-along rights
The first stage in dealing with a shareholder dispute is to check carefully exactly what rights you have as a shareholder, taking into account the type of shareholding you have and the percentage holding you control.
Because articles of association are available publicly, companies often prefer to include much of the details of shareholders’ rights in a shareholders’ agreement, which is a private document.
Ideally, every company should have a comprehensive shareholders’ agreement going into detail with respect of shareholders’ rights as well as setting out procedures for resolving shareholder disputes.
The document can improve on the articles of association by providing more information and a higher level of detail. This can be helpful both in preventing disputes and resolving them.
Rights included in a shareholders’ agreement often include:
- What rights shareholders have, including the rights attaching to each type of shareholding and percentages needed to call meetings and block decisions taken by directors
- Processes for removing and appointing directors
- Sale and acquisition of shares
- How disputes will be resolved
- Protections for minority shareholders
The most commonly used power for shareholders in a dispute is the right under section 994 of the The Companies Act 2006 to make a claim of unfair prejudice.
If a shareholder believes that the affairs of the company are being conducted in a way that unfairly prejudices all or some of the shareholders, it can ask the court to step in.
The Companies Act 2006 does not include a definition of either unfair prejudice or the affairs of the company, but there is case law supporting shareholder claims across a wide range of issues.
Examples of unfair prejudice include:
- Majority shareholders routinely failing to observe minority shareholder rights
- Minority shareholders are blocked from having information they should have received
- The company is being mismanaged
- Creating new shares that dilute existing shareholders’ rights
- Minority shareholders are not consulted when they have the right to be
- Company assets have been misappropriated
- No dividends are paid to shareholders, but the directors have taken large sums themselves
- A company dispute means that the company is not operating effectively
If you bring a claim for unfair prejudice, you will need to establish both that prejudice exists and that it is in some way unfair. Prejudice alone is not sufficient to secure a remedy.
The court has wide discretion to make any order it feels is warranted. This could be requiring one party to buy out another. The court will stipulate the amount to be paid and can take into account issues such as directors having taken excessive salaries in the past.
Under section 260 of the Companies Act 2006, a minority shareholder can bring a claim in the name of the company. This is known as a derivative claim, as the power is derived from the company’s rights and not a shareholder’s rights. This means that the remedy will be made in favour of the company and not personally to a shareholder.
A derivative claim may be possible if a director has taken an action which was:
- In breach of their duties
- In default
- A breach of their position of trust within the company
The permission of the court is required to bring a derivative claim.
If a derivative claim is successful, then the court has a wide range of options open to it in remedying the situation. Shareholders will not directly benefit. Examples include:
- Removal of a director
- A director to pay damages to the company
- Reversal of transactions entered into by a director
- An injunction against a director, preventing them from acting in a certain way
The court can also require a director to pay the shareholders’ legal costs if it upholds the derivative claim.
The most drastic option is to ask the court to wind up the company. Under section 122 of the Insolvency Act 1986, if the court is of the opinion that it is just and equitable that the company should be wound up, it has the power to do so.
This should be considered a last resort and should not be undertaken lightly. A shareholder will usually need to have held shares in the company for at least 18 months. There also needs to be sufficient funds in the company to pay to shareholders following winding up.
The definition of ‘just and equitable’ arises from case law and the court will consider each case individually. Generally, it requires a material failure to comply with the company’s articles of association or shareholders’ agreement, with the failure being unfair to the minority shareholder or shareholders.
Examples of just and equitable grounds that have warranted winding up a company include:
- Breaches of directors’ duties that unfairly prejudice minority shareholders
- Transferring shares that should have been offered to minority shareholders first
- Dishonesty in dealing with the company’s affairs
- Incompetence on the part of directors that prejudices minority shareholders
- Failure to pay dividends when funds are available for this
- A deadlock within the company that means that it cannot function
To bring a successful claim, it needs to be shown that:
- The company carried out the unfair actions complained of
- These actions prejudiced the interests of a minority shareholder
- The actions were unfairly prejudicial to some or all shareholders
It is often the case that company directors are also shareholders, meaning a potential conflict of interest. Directors need to take care when making decisions that they are acting within their powers as a director and not taking decisions purely to benefit their position as a shareholder.
Where necessary, you may need to take legal advice before taking major decisions where there is a potential for allegations of a conflict of interest. It is also crucial to communicate relevant information in the way required under the articles of association and shareholders’ agreement to make sure that you are meeting your obligations and keeping everything clear and above-board.
If half of the shareholders entitled to vote on a company decision disagree with the other half, the company will be deadlocked. This can be exceptionally damaging and could spell the end of the company.
It is a relatively common occurrence, particularly where a company has been set up with two directors who have taken half of the shares each.
Once a state of deadlock has been reached, having professional help to try and find a solution is crucial. Without this, a profitable company might be unable to continue.
An alternative is to bring in a third party to direct the company, generally as a non-executive director. However, both directors would need to agree on the choice of individual, so this is not always a straightforward option.
Another way of dealing with matters is to appoint an expert in the sector to advise. They could either be given shares with voting rights attached or the parties could simply agree to be bound by the decision that is reached.
Where the parties are not able to agree on a way forward, the next option is generally to go through some form of alternative dispute resolution. This could be mediation, where a mediator works with both parties to look at the various options, or arbitration, where an arbitrator rules on the matter. The decision reached in mediation would be agreed upon by both parties and you would not have a decision imposed upon you. Arbitration differs in that the decision reached is legally binding.
Options commonly used to deal with a shareholder deadlock include:
- The company buying out one of the directors. This means that one director leaves, but the other does not have to find the funds to buy them out. This is only an option if the company has sufficient reserves to pay the departing director.
- An external buyer could be sought for the shares of one party. This is not always straightforward as the buyer would need to be prepared to act in a way to break the deadlock. In some circumstances, the articles of association or shareholders’ agreement may prohibit this course of action, or the remaining director may oppose it, although they will always have a duty to act in the best interests of the company.
- Applying to the court for directions or for the company to be wound up. Again, winding up should be a last resort and the courts will always consider what other options are available.
It is often the case that an expert shareholder dispute solicitor will be able to set out options that resolve a dispute amicably without the need for legal action. Having an outside opinion and being able to discuss the potential way forward can often help both sides to work together to resolve matters.
As minority shareholder, how can I enforce my rights?
Shareholder remedies: How can I resolve a shareholder dispute?
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If you would like to talk to one of our expert legal team about any queries you may have, contact the author, Dipesh Dosani, or call the team today on 020 3968 6030 and we’ll be happy to help.
The above information is for general guidance on your rights and responsibilities and is not legal advice. If you need more details on your rights or legal advice about what action to take, please contact a legal advisor.