INTRODUCTION
Shareholder disputes are an inevitable aspect of corporate life, stemming from underlying tensions between different parties in a company, with their respective interests and visions of what the corporation should be. As businesses grow and evolve, the potential for conflict among shareholders tends to increase.
Shareholder disputes can significantly affect the financial health and stability of a company at times even threatening the company's very existence. For shareholders, particularly those in the minority, these conflicts can result in a loss of value and control, as well as legal and financial burdens. For the company, prolonged disputes can lead to operational inefficiencies, loss of investor confidence, and damage to its reputation.
This article dives into the multi-angled world of shareholder disputes, examining their causes, legal frameworks, and resolution mechanisms so that stakeholders can better prepare for and manage these conflicts and foster amore harmonious and productive corporate environment. While there are several aspects involving shareholders in a public (listed) company and a private limited company, this article provides only an overview of key elements.
RIGHTS OF SHAREHOLDERS
The Companies Act, 2013 ("the Act"), provides several important rights of shareholders- allowing these parties to participate in important company decisions, protect their investments, and seek remedies for any wrongful acts. In a developing nation, like India, there are some key shareholder rights that protect investor's interests which we have discussed below:
- Ownership in the Company: As owners, shareholders hold a stake in the company's profile and assets, which entitles them to receive a share of the company's profits (dividends), based on the number of shares they hold. Furthermore, ownership is not solely to collect one's entitled sum of money, but also allows shareholders to influence major corporate policies and decisions.
- The Right to Attend and Vote at Shareholder Meetings: The equity shareholders of a company are entitled to vote on important corporate matters, such as election and removal of directors, approval of financial statements and dividends, and so on. The voting doesn't just empower the investors to influence the governance of the company, but also helps build trust among members of the organization which is extremely important for efficiency.
- The Right to Transfer Ownership: Shareholders of a company have the right to freely transfer their shares to whomsoever they deem fit, unless subjected to any restrictions, in the company's article of association(mostly in private limited companies) or any shareholder agreements (especially when they become part of articles of association of a company). This right ensures liquidity of assets, enabling investors to sell their shares and withdraw from their corporate funding.
- Entitlement to Dividends: All shareholders are entitled to dividend on their shares when the company decides to share its profits. Although the declaration of dividends is at the discretion of the board, shareholders expect a fair distribution of profits, especially if the company is performing really well. Consistent dividend payments are also often associated with a company's positive financial health and stability.
- The Right to Sue for Wrongful Acts: If any investor in the company discerns a sense of a wrongful act taking place that can harm their interests, or feels they are being mistreated by the management or directors, they are allowed to take legal action against the parties alleged of wrongdoing. It is important to note that although most cases of shareholder mistreatment are due to acts of directors, other fellow shareholders can be guilty of harming their fellow shareholders' interests as well. Shareholders can seek relief from the National Company Law Tribunal ("NCLT") for issues such as shareholder oppression and mismanagement.
- The Right to Inspect Corporate Documents: Transparency is important in any business model, but many corporations desist from providing their employees, or even investors, with crucial statistics or other documentation that results in the latter parties both functioning blindly. Shareholders are allowed to inspect books and records to verify the accuracy of the company's financial statements and assess its compliance with statutory requirements.
CAUSES OF SHAREHOLDER DISPUTES
All around the world shareholder disputes can arise due to a variety of reasons. For the purpose of this article, we would be discussing a few major grounds, accompanied by case laws (as relevant for India), on why shareholder disputes may arise in a company, which would help in identifying and preventing potential disputes by putting in place mechanisms to address them.
- Shareholder Oppression: Shareholder oppression is when actions of majority shareholders of a company harm the minority shareholders of that company and is more common in private limited companies. If a majority shareholder reduces the voting power of minority shareholder or excludes them from decision making process or violates other such rights, then a minority shareholder (s)[1] can go to NCLT to file for protection of its rights.
Vikram Bakshi & Ors. vs. Connaught Plaza Restaurants Ltd. (2016)
In the case of Vikram Bakshi & Ors. vs. Connaught Plaza Restaurants Ltd. (2016) the NCLT had identified whether the termination of Vikram Bakshi's position as managing director of Connaught Plaza Restaurants Pvt. Ltd. (CPRL), which operated the McDonald's restaurants in Northern and Eastern India, was justified. The dispute centred around provisions in the Joint Venture Agreement ("JVA") between Bakshi and McDonald's India Pvt. Ltd. Following his termination, in 2013, Bakshi alleged shareholder oppression, mismanagement, and breach of shareholder agreement under Sections 397, 398, and 402 of the Companies Act of 1956.
The tribunal had to resolve two main issues in this case- whether Vikram Bakshi's position as managing director was terminated justly, and whether CPRL and/or McDonald's India were accountable for breaching an agreement they made with Bakshi when he was selected to be the managing director of CPRL.
The tribunal found fault with both CPRL and McDonald's India for their actions against Vikram Bakshi throughout and after his tenure as the company's managing director. It was revealed that McDonald's India had tried to pressure Bakshi into selling his shares for USD 5 million in 2007-2008, despite the company beginning to see modest profits. Bakshi argued that Article 26 of the JVA required adherence and demanded compensation for these actions, but McDonald's India refused without providing a valid explanation.
Furthermore, the NCLT ruled in favor of Vikram Bakshi, asserting jurisdiction based on the integration of the JVA's terms into the Articles of Association of CPRL. The tribunal rejected McDonald's India's arguments against NCLT's jurisdiction, emphasizing that the actions against Bakshi were oppressive and against public interest, especially affecting employee's dependent on CPRL.
The case set a precedent in Indian corporate law, affirming the tribunal's role in addressing issues of oppression and mismanagement, even when rooted in private contractual disputes within joint ventures. This reaffirmed protections for minority shareholders and upheld corporate governance standards in India.
- Breach of Fiduciary Duties: Shareholders (when individuals) of a company may sometimes also serve on the board of a company and in such a capacity have fiduciary duty towards other shareholders of the company. When such a shareholder in power misuses its powers or breaches its fiduciary duties the company and shareholders may suffer harm and losses as a result.
Reliance Industries Limited vs. Securities and Exchange Board of India and Ors. (2022)
In the case of "Reliance Industries Limited vs. Securities and Exchange Board of India and Ors. (2022)", the Supreme Court of India dealt with significant allegations of insider trading and market manipulation brought by SEBI against Reliance Industries Limited (RIL).
SEBI accused RIL and its senior executives of deliberately using unpublished price sensitive information related to the company's stock buyback plans, which were not yet disclosed to the public. This, according to SEBI, allowed RIL to manipulate the stock prices to its advantage, undermining the fair and transparent functioning of the securities market.
The Supreme Court's judgment upheld SEBI's findings, confirming that RIL had indeed engaged in insider trading and market manipulation. The court imposed stringent penalties on RIL, including substantial fines and mandated compliance with regulatory norms to avert similar breaches in the future.
The decision served as a stern warning to corporations about the severe legal and financial consequences of engaging in fraudulent activities. By emphasizing the enforcement of fiduciary duties and the necessity of transparent market practices, the case reinforced the regulatory framework governing corporate behavior in India.
- Breach of Shareholder Agreements: Shareholder agreements serve as pivotal documents to safeguard the rights and expectations of stakeholders. Unfortunately, no model is ever perfect and a company may be exposed to instances of shareholder oppression or breaches of these agreements which can fracture trust and jeopardize the delicate balance of power within a company. By violating the provisions of shareholders agreements, a shareholder has breached the shareholders agreement and can give rise to shareholders disputes. Such disputes highlight the vulnerabilities inherent in corporate structures and underscore the critical need for clear, enforceable guidelines to protect shareholders' interests.
Ramesh Kumar & Anr. vs Mandeep Singh & Anr. (2013)
The petitioners and respondents were shareholders in a pharmaceutical company. The dispute arose from a SHA executed on 2 November 2006, where the respondents, Mandeep Singh and another party, agreed to sell their shares in the company to the petitioners. The payment was to be made in five installments through post-dated cheques. The respondents were accused of breaching the SHA by not fulfilling their obligations, including the transfer of shares and resignation from the Board of Directors.
The counsel for the respondent argued that the petitioners were to transfer the shares simultaneously along with receipt of instalments and the petitioners failed to transfer number of shares equal to the consideration received in two instalments. Since the petitioners had failed to transfer shares proportionate to the amount received, the respondent No. 1 was constrained to stop payment of the rest of the instalments.
The SHA provided that in case the buyer fails to arrange necessary funds required for clearance of post-dated cheques, the sellers will have the right to take necessary legal proceedings against the buyer.
Thereafter, disputes having arisen between the parties, the petitioners invoked the arbitration clause and sole Arbitrator was appointed. The Arbitrator passed the award and ordered the petitioner to pay INR 119.39 lac in total to the respondents, i.e. INR 91.50 lac as per the SHA against installment Nos.3, 4 and 5, for which post-dated cheques were issued and which were dishonoured; interest @ 12% p.a. from respective date of installment due to the date of Award to the tune of INR 27.14 lac; and costs of arbitral proceedings to the tune of INR 0.75lac. The interest was also awarded to the respondents from date of the arbitral award to the date of payment.
- Dividend Distribution: Receiving dividends in return for their investments is one of the most crucial rights of shareholders. There can be difference of opinion in relation to treatment of profits among shareholders which can cause dispute.
Inox Leisure Ltd. vs. Inox Benefit Trust (2022)
Inox Leisure Ltd. is a public limited company, in the entertainment industry, operating a chain of multiplexes across India. Inox Benefit Trust is a private trust created for the benefit of the employees of Inox Leisure Ltd. The dispute arose regarding the distribution of dividends and the control over a substantial number of shares held by Inox Benefit Trust. Inox Leisure Ltd. sought a declaration that the shares held by Inox Benefit Trust were under the control of the company and that the dividends on these shares should be distributed according to the company's decisions. Inox Benefit Trust contested this claim, arguing that the trust was an independent entity with the discretion to manage the shares and the dividends as per its terms.
The court examined the nature of the relationship between Inox Leisure Ltd. and Inox Benefit Trust. It held that the trust, being a separate legal entity, had independent control over the shares. The court found no evidence to suggest that Inox Leisure Ltd. had any overriding control over the trust's decision-making process.
The court upheld the independence of Inox Benefit Trust in deciding how to utilize the dividends from the shares it held. It ruled that the trust deed clearly granted the trustees the discretion to manage the dividends, and Inox Leisure Ltd. could not dictate terms regarding their distribution.
The Bombay High Court dismissed the claims of Inox Leisure Ltd. The court reinforced the legal independence of Inox Benefit Trust in managing its affairs, including the control over shares and the distribution of dividends. This case underscores the principle that trusts, even if created for the benefit of employees of a particular company, retain their independent legal status and discretion in managing their assets. It clarifies the boundaries of control that a company can exert over a trust, emphasizing the importance of the trust deed in determining the rights and duties of trustees.
RESOLVING SHAREHOLDER DISPUTES
Resolving shareholder disputes within an organisation, requires a structured approach that combines legal, governance, and negotiation strategies. The framework provided by the Act, and other relevant laws plays a crucial role in addressing these disputes. In order to better understand how shareholder disputes, in general, can be resolved, we delve into how the four causes in question are opposed.
- Breach of Shareholder Agreements can naturally result in significant heated conflicts inside a company that can negatively impact efficiency, growth, and financial performance. The first step in resolving such conflicts is to conduct an internal review and engage the involved parties in negotiations to resolve the conflict amicably and without external interference, however third-party mediation may be required if direct negotiations fail to reach a healthy conclusion. Many shareholder agreements include arbitration clauses, in which case the dispute may be referred to arbitration to find a resolution without the parties having to resort to litigation. As a last resort, the parties may file a lawsuit for breach of contract under the Indian Contract Act of 1872, seeking enforcement of specific damages.
- Shareholder Oppression, one of the most common causes of shareholder disputes, can manifest in the form of exclusion from management, unfair dividend distribution, or the misuse of a company's funds. Resolving such disputes requires collecting important evidence of oppressive acts and attempting to resolve the issue through internal discussions and mediation. If these efforts fail to yield results, which is more often not the unfortunate case, investors may file a petition with the NCLT in accordance with the Act, seeking relief against the oppression and mismanagement. The NCLT has authority to provide a number of remedies, including regulating the company's affairs in the future, appointing new directors, or ordering the purchase of shares of the oppressed investor by other members of the company.
- Dividend Distribution disputes often stem from differing expectations, among shareholders, regarding the allocation of profits. The board of directors play a crucial role by explaining the rationale behind dividend distribution to shareholders and help build trust between the parties. Mediation and negotiations should be put in place to allow aggrieved shareholders and the board to reach a mutual understanding. If any of these steps fail to resolve the issue of dividend distributions inside a company, then the investors have the option to approach the NCLT, in accordance with the Act, seeking relief on the grounds of oppression and mismanagement.
- Breach of Fiduciary Duties can often be suspected when a shareholder suspects the management, or directors are not acting in good faith or responsibly for the investors' best interests. Directors and the management sector of a company are bound by their duty to care and prudence which ensures a company function efficiently. Failing to do so may urge the shareholders to conduct a thorough investigation to establish facts, which can then be discussed in a shareholder or board meeting called to explicitly demand explanations and accountability from the parties involved. If the board fails or refuses to act accordingly, investors have a right to initiate a derivative action in accordance with the Act, on behalf of the company. In exceptional circumstances, shareholders can also seek removal of a particular director that was involved in a breach through a resolution in a general meeting.
If the NCLT fails to reach a satisfactory resolution, shareholders are allowed to contend the case in National Company Law Appellate Tribunal (NCLAT)- which was most recently seen in the high-profile case of Tata Consultancy Services Ltd. v. Cyrus Investments Pvt. Ltd. (2021).
CONCLUSION
In summary, a company can prevent or avert shareholder disputes by implementing certain simple policies and procedures:
Regular meetings to discuss and resolve issues are crucial in maintaining a peaceful relationship among shareholders, if all else fails, seeking legal advice early ensures that all parties understand their rights and obligations, helping to prevent potentially monumental disputes.
Implementing strong corporate governance policies, including procedures for resolving disputes, can prevent many issues from arising in the first place.
Clear communication is the cornerstone of resolving shareholder disputes. Establishing open lines of communication among investors allows for the discussion of problems and potential solutions before conflicts escalate.
Encouraging the use of alternative dispute resolution (ADR) mechanisms like mediation and arbitration can also help resolve conflicts without resorting to simply suing the parties involved, providing a quicker and often less adversarial path to resolution.
Originally published by Lexology, August 7 2024
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
