I have been advising companies and shareholders in relation to shareholder disputes for over twenty years, and in that time, I have seen pretty much everything a lawyer can expect to see and more. Accordingly, I thought I would put everything down in one place and share this with my contacts. If you are not familiar with shareholder disputes but they are potentially relevant to your practice, or your clients might be interested, you may consider keeping a link to this article in a safe place. The information in this article applies to English and British Virgin Islands companies.
Do shareholders need to worry about shareholder disputes?
It's quite surprising how few directors appreciate the extent of the fiduciary and other duties they owe their companies. This is the case notwithstanding the fact that breaching those duties can lead to civil and criminal liabilities. Similarly, shareholders fail to appreciate how, by the simple act of holding shares, they can end up embroiled in bitterly contested and expensive shareholder disputes. This article looks at how shareholder disputes arise, why shareholder disputes are so damaging, how to spot the signs of a shareholder disputes, the steps that can be taken to try and avoid them, what remedies are open to aggrieved shareholders, and how it might be possible to squeeze them out.
How do shareholder disputes arise?
Shareholder disputes arise in many ways but typically they arise where there is a disagreement between the minority shareholders and the majority shareholders over money, the value of the company or the direction in which the company is being taken. They may also arise where a minority shareholder wishes to realise the value of his shares and there is no provision in the company's Articles of Association or any shareholders' agreement providing for an exit. Shareholders often argue that they have been unfairly prejudiced by the company, acting through its board of directors or shareholders, with a view to seeking an unfair prejudice remedy from the Courts.
Why are shareholder disputes so damaging?
Not only do shareholder disputes often result in shareholders incurring considerable legal costs, but conflicts between shareholders with the attendant disruption that this can cause at board level, can have a significant negative impact on the company's management, reputation and performance, resulting in a loss of bank and customer confidence at parent and subsidiary level. Such disruption is never in the best interests of the company's stakeholders and, accordingly, all possible steps should be taken as soon as possible to resolve such conflicts to minimise this potential damage.
What are the signs that there may be a dispute between shareholders?The following are some of the signs that may indicate significant shareholder issues:
- The Articles of Association being amended without authority.
- Shareholder voting deadlock.
- Shareholders complaining that they are being prejudiced.
- Disruptive behaviour at director and/or shareholder meetings.
- Directors/shareholders refusing to speak or meet.
- Overly legalistic emails and/or correspondence.
- Insisting that meetings are rescheduled for no apparent reason.
- Insistence on board/shareholder minutes being overly detailed or prescriptive.
- Using legal language and terminology, or claiming legal rights in meetings.
- Excluding directors/shareholders from meetings.
- Failing to declare or pay dividends.
- One shareholder being appointed to speak for other shareholders.
What can you do to try and avoid shareholder disputes?The following steps can be taken to try and reduce the risk of shareholder disputes arising:
- The inclusion of a deadlock clause in a shareholders' agreement. There are a variety of such clauses: see this link to an article that I published reviewing such clauses.
- Ensure the Articles of Association of the company are up-to-date and conform with a carefully worded shareholder agreement, to remove as much scope for conflict as possible. Often companies are set up quickly and cheaply without legal advice, at minimal cost with standard Articles of Association and without a detailed shareholder agreement.
- Ensure that the directors of the company are fully conversant with their fiduciary and other duties as directors of the company, by undergoing specific training, if necessary.
- Make sure that shareholders and directors are given plenty of notice of meetings and that the minutes of those meetings are full and accurate.
- Make sure that all decisions that are taken by the company are decisions that fall within the scope of the Articles of Association, especially if they relate to potentially contentious issues.
- Seek legal advice from specialist corporate dispute counsel as soon as there is any indication of a substantive dispute between shareholders, or between shareholders and the company.
- Make sure, as far as possible, that the aggrieved shareholder has realistic expectations when it comes to the true value of her shares and the potential outcome of proceedings, which can be as difficult to predict as they are to manage.
- As far as possible try and deal with any shareholder factions, groups of shareholders that often share unrealistic, collective expectations about outcomes and legal costs.
- Invite the shareholders and, as relevant, the directors, to air their grievances before an independent third party, who may or may not know them, but who can give them an opportunity to try and resolve the disputed issues without the need for Court proceedings.
- It may be possible to resolve a dispute by calling a general meeting of the company's shareholders (shareholders can usually request directors to call general meetings), to discuss and vote upon issues that are relevant to the dispute.
- If one of the company's directors is causing the dispute, it may be possible and it may make sense to remove that director by calling a general meeting and voting to remove him. Legal advice should, ideally, be taken before attempting to remove a director.
- Appoint a professional, third-party, impartial and experienced mediator who has been trained to assist parties to settle their claims on a without prejudice basis. Mediators are very good for finding cost-effective and timely solutions to shareholder disputes. Sometimes the shareholder agreement will provide for disputes to be mediated or arbitrated.
- If an aggrieved shareholder is willing to sell his shares, the other shareholders, directors and/or the company may be prepared to buy them. An option here might be, for example, to make the aggrieved shareholder a sleeping partner with a different category of shares.
- It may also be possible for the shareholders to agree to sell the company as a going concern to an existing shareholder or to a third party.
Is it possible for an aggrieved shareholder to bring proceedings?
- The answer to this question is yes, it is certainly possible, although the proceedings will be time-consuming and expensive, and may result in significant harm to the value and reputation of the company which, in turn, may impact the value of the aggrieved shareholder's shares. There are three causes of action open to shareholders, depending on the relevant factual circumstances:
- Unfair prejudice proceedings: if the aggrieved shareholders believes that the affairs of the company are causing her prejudice, she may be able to issue a statutory claim for an unfair prejudice remedy. To do this she will need to demonstrate, in evidence, that the company's affairs have or are being conducted in a manner that is unfairly prejudicial to her interests as a shareholder, or that an actual or proposed act or omission of the company is, or would be, prejudicial to her interests. Such a claim might be possible where, for example, there has been a failure to consult with the aggrieved shareholder or to provide her with information; where the company's business or assets have been misappropriated; where there has been a breach of the Company's Articles of Association; where there has been a failure to pay a dividend; or where there has been an improper allotment of shares or rights issues. Unfair prejudice claims are expensive and time-consuming and often the threat of such proceedings will be sufficient to encourage the parties and the company to agree settlement terms.
- If the aggrieved shareholder succeeds with her claim, the Court can make any remedy it thinks but will typically make an order requiring the aggrieved shareholder's shares to be purchased by the other shareholders or the company at fair value with or without a discount for the fact that the shares are minority shares. Indeed, because this is the usual remedy, the Courts can be persuaded to stay unfair prejudice proceedings where the majority shareholders agree to purchase the aggrieved minority shareholder's shares based on an independent, third-party valuation. The Court can also make an order regulating the conduct of the company, and an order winding the company up on the just and equitable ground.
- Just and equitable winding up proceedings: In extreme cases, where certain conditions are satisfied and where there is no other appropriate remedy (such as an unfair prejudice remedy), it may be possible to for an aggrieved shareholder to persuade the Court to appoint a liquidator of the company on the basis that it is just and equitable for a liquidator to be appointed. The liquidator's job is to 'get in' the company's assets and realise their value for the purposes of making a distribution to the company's unsecured creditors and, if there is any surplus, to the company's shareholders. The appointment of a liquidator almost invariably sounds the death-nell for the company and, as a consequence, the Court will only make such an order in extreme circumstances, such as when the purpose for which the company was formed has failed, where a shareholder has been excluded from management, where the directors have awarded themselves excessive remuneration whilst refusing to pay dividends to the company's shareholders, or where the company is deadlocked and, as a consequence, incapable of being managed.
- Very often a shareholder petition for the appointment of a liquidator will be met with a cross-application for a stay of the winding up proceedings, based on an agreement by the majority shareholders to purchase the aggrieved shareholder's shares at an independent valuation. Given that the appointment of a liquidator will almost certainly have a significant and negative impact of the value of the aggrieved shareholders' shares, and an independent valuation and a buy-out order will give the aggrieved shareholder true value for her shares, the Court will usually be prepared to grant the requested stay in the best interests of the company and all of the company's stakeholders (including employees and creditors).
- Derivative claims: where a company's directors breach their fiduciary duties and cause loss to the company, the proper claimant to proceedings to recover those losses is the company and not the shareholders, whose loss is merely reflective of the loss the company has sustained. It can happen that the directors that caused the company loss are not prepared to cause the company to issues proceedings against themselves to recover those losses, and it may not be possible for minority shareholders to replace those directors because the directors own, can influence or otherwise control a majority of the company's shares. In these circumstances, it is possible for aggrieved shareholders to seek the Court's permission to bring derivative proceedings against the errant directors on behalf of, and at the expense of, the company to recover the losses the company has suffered. In this way, minority shareholders can take action to protect the value of their shareholdings where the company's directors refuse to assist.
What about arbitration proceedings?
Arbitration is an alternative form of dispute resolution to formal Court proceedings, and the decision of the arbitrator is final and binding. The location, governing law and procedure for arbitration are usually a matter of contract, agreed between the parties. Arbitration proceedings are usually confidential and can be much faster and cheaper than traditional Court proceedings, although that is certainly not always the case. Before issuing unfair prejudice proceedings or winding-up proceedings, it is important to check the company's constitutional documents and any shareholder agreement to make sure that there is no contractually agreed dispute resolution clause that provides for arbitration. If there is and Court proceedings are issued, this can result in the proceedings being stayed with the Claimant facing significant legal costs, adverse costs orders, and delays.
Is it possible to squeeze-out a minority shareholder?
The answer to this question is yes. Following a takeover offer for a company, it is possible for the bidder to acquire minority shareholdings of the company on a compulsory basis if it has acquired or unconditionally contracted to acquire not less than 90% in value of the shares to which the takeover offer relates, and not less than 90% of the voting rights carried by the shares to which the offer relates. A minority shareholder that has not accepted the offer has a right to be bought out. It is possible, therefore, in appropriate circumstances, to use this procedure to remove shareholders for fair value, where they are threatening unfair prejudice, winding up or other proceedings.
Shareholder disputes are not just expensive in terms of legal fees, they stand to damage the value and reputation of the company (impacting the value of all the shares of all the shareholders), and the parties will often have no option but to incur not inconsiderable professional fees working with valuation experts. There may also be interim skirmishes that will result in further legal fees and the possible exposure to adverse costs orders. Although the outcome of shareholder disputes can be relatively simple to determine, it is far more difficult to anticipate what an aggrieved shareholder will walk away with in financial terms. The takeaway is to try and avoid shareholder disputes at all costs.
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.