An inactive or non-responsive shareholder can be a headache for a company. While shareholders are not involved in the day-to-day affairs of the business, an inactive shareholder can stall the company's affairs when their approval is required for certain key decisions. A company needs to be mindful of the process for managing an inactive shareholder to avoid potential disputes between the shareholder and the company. This article will outline what decisions require shareholder approval and how to manage an inactive shareholder in New Zealand.
Which Decisions Require Shareholder Approval
While a company's directors make most decisions for their company, certain key decisions require shareholder approval. The law requires a special resolution of shareholders, being not less than 75% approval by the shareholders, for certain key decisions such as:
- adopting a constitution;
- entering into a major transaction that comprises half, or more than half of the value of the company; or
- putting the company into liquidation.
Additionally, suppose a company wishes to raise money by issuing new shares to an incoming investor. This requires all shareholders to waive their pre-emptive rights to those shares (if pre-emptive rights apply). In practice, companies often seek to achieve unanimous approval from their shareholders when making such decisions.
Companies that do not proceed with unanimous approval can run into difficulties. Mainly, a shareholder who votes against the company's decision to enter a major transaction can invoke their minority buy-out rights to require the company to buy them out. This process can create issues for companies low on capital (such as startups) who may not wish to proceed with a minority buy-out process.
If a shareholder has become inactive, they could potentially stall any of these key decisions simply by failing to engage with the company. An example of this could be when a company needs to finalise a major transaction, such as entering into a major business contract. Likewise, a shareholder ceases to communicate and does not sign the required documents to get the contract over the line. While the company can proceed (assuming they have obtained 75% approval), they risk the shareholder engaging subsequently and exercising their minority buy-out rights.
Legal Options Available for Dealing With Inactive Shareholders
If the company has no shareholders agreement and no company constitution, there are limited options available as the shareholder can freely hold onto their shares. One potential option could be to proceed with decisions that may trigger the shareholder's minority buy-out rights and hope that they invoke these so they can be bought out. However, there are risks with this process. Importantly, the company needs to be careful that its management has not been unfairly prejudicial to that specific shareholder.
An alternative option could be to adopt a constitution with a provision for the forfeiture of shares. These provisions typically specify that if a shareholder is inactive and does not respond after three repeated notices of their shares being subject to forfeiture, the shares can be forfeited. However, take care with this process. If you fail to follow the proper process or do not make genuine attempts to contact the shareholder at their proper address and contact details, the shareholder could potentially claim against the company later on.
A third option is to ensure the shareholders' agreement covers scenarios of inactive shareholders. The agreement will typically outline events of default where a shareholder must sell their shares back to the company or the other shareholders. These events of default capture certain situations where a shareholder has become inactive, for example, the shareholder is a deregistered company, or the shareholder has lost capacity and cannot manage their own affairs. In these situations, the company can generally buy back the shares for fair market value.
We recommend seeking legal advice before proceeding with any of these options. It is possible that one option may be preferred over the other, or that a mixture of different options should be used depending on your specific circumstances.
Given that a shareholder can become inactive at any stage, look to adopt a shareholders agreement and constitution sooner rather than later. Your company can only create a shareholders agreement with the approval of all shareholders. Therefore, an inactive shareholder could simply not sign the shareholders agreement.
Additionally, best practice dictates that you should adopt a company constitution with the unanimous approval of the shareholders, and ideally, when starting up the company. While you can later adopt a constitution with 75% approval (without the approval of the inactive shareholder), this can trigger a minority buy-out process for the company if the shareholder does not agree with the constitution.
Inactive shareholders can be a headache for companies and stall certain key decisions. While there are different options which are available to a company to deal with this situation, it is recommended to proceed carefully so that the company does not create a dispute with the shareholder later on. Additionally, companies with a constitution and shareholders agreement are less likely to have their operations seriously disrupted by inactive shareholders.