Management of Shareholder Disputes

Posted onJanuary 30, 2018

Some directors are so busy dealing with the management of the company and so acclimatised to shareholder grumblings, that they risk potentially becoming complacent or underestimate the potential disruption that shareholders can cause if they feel seriously aggrieved and opt to take formal legal action.

Both majority and minority shareholders can threaten or bring disruptive legal action, either personally or on behalf of the company, if they become sufficiently disgruntled or feel prejudiced. Claims might arise from a personal vendetta without merit, but may latch onto a genuinely unlawful act or procedural issue.

Even small shareholder claims with dubious merits that are being used artificially as leverage, can reveal and bring to the fore serious issues of company governance and constitution. They may reveal that there is a bigger commercial problem within the company that is not being addressed.

Whilst structured meetings and fair voting processes might quell some disputes early on, if shareholders still feel aggrieved or that the decision is unfair and threaten a claim, this can pose a real risk to company governance and stability, and takes time away from company business.

This article outlines: 1) some common claims shareholders can bring to disrupt company governance; 2) tell-tale signs that a serious issue might be bubbling away; and 3) some points you can consider to try and minimise risk.

Waiting until a shareholder dispute fully crystalizes is often a bad idea and pro-active steps can often be taken to minimise risk. Early legal advice is of real benefit and can offer a tactical commercial advantage.

At Saunders Law we are empathetic and attuned to company governance issues and the pressures that arise from shareholder disputes. If you are affected, please give us a call to discuss how we can assist on 0203 811 7541.

There can be a real imbalance of power within companies, that although directors are appointed to deal with managing the company, the shareholders have statutory power under the Companies Act 2006 (CA 2006) to remove directors. Disgruntled shareholders can therefore be a powerful force and influence the direction the company takes.

Shareholder involvement in a company can extend far beyond simply requiring healthy dividends on investment. The CA 2006 requires shareholder approval for certain corporate activities. Ordinary resolution (a simple majority) for example is required to approve a loan to a director. Special resolution (75%), is necessary for, for example, amending articles of association. A shareholder, or group of shareholders with at least 5% of voting rights can request the directors call a general meeting to decide key issues.

The rights conferred upon shareholders can vary widely between companies, as set out in its articles of association. Shareholder rights can depend for example on which class of shares they hold. Shareholder voting rights can be weighted, or waived by agreement. Voting power can be affected by whether a shareholder holds a majority share or not.

Even if a majority of shareholders agree a proposal, it may be that a large proportion disagree. If decisions are repeatedly made in such a way that the minority shareholders feel majority shareholders are purposefully making decisions which causes minority shareholders loss unfairly, this may entitle them to bring a claim for unfair prejudice.

Unfair prejudice

S.994 of the Companies Act 2006 outlines a shareholder can apply to court if a company's business is being conducted in a way which is unfairly prejudicial to the interests of members generally or some lesser number of members (provided it includes at least him or herself) or that an actual or proposed act or omission of the company is or would be prejudicial.

What amounts to "unfair" is subject to interpretation with regard to commercial context. Bad management may not be sufficient to amount to "unfair" prejudice, but a breach of the powers permitted by the articles may be unfair, but not necessarily. Each case turns on its own facts and early legal advice is sensible.

A second aspect is whether the members' interests have been prejudiced or not. Interest may not necessarily be restricted to financial or strict legal considerations, but might extend to a shareholder's legitimate expectations or understandings that they would be included in management, for example.

Common grounds which may lead to a shareholder bringing an unfair prejudice petition include if a majority shareholder awards themselves unreasonable financial benefits to themselves; if shareholders are excluded from management decisions where the shareholder could be expected reasonably to partake; if business is diverted away from the company to another in which a majority shareholder has an interest, etc.

The conduct of the alleged wrongdoer and petitioning member may be a crucial additional factor.

Whilst there are strict legal tests to be met for a shareholder to be able to bring an unfair prejudice claim, as it can be brought by the shareholder in a personal capacity, the board is not able to prevent them from doing so as a matter of company governance. Although it is more common for minority shareholders, it could also be brought by majority shareholders. For that reason, a s.994 petition can be a powerful means of shareholders applying pressure and leveraging negotiation for a more favourable buy out.

Some other common legal actions a shareholder can potentially bring are below:

Derivative claims

If a wrong has been committed by a director of a company of which the shareholder is a member, whether by an act or by omission, and whether as a result of negligence or a breach of duty, a member can potentially bring a claim under Part 11 / s.260 of the Companies Act 2006 on behalf of the company as claimant. If any award is made, it is made to the company, rather than the shareholder personally.

The shareholder can issue a claim in court, but the court's permission is required for them to pursue the claim, and which allows the court to assess whether or not there is merit and whether or not it is avoidable.

The court may refuse permission on various grounds, if it considers the shareholder is not acting in good faith, if the action would be better brought personally by the shareholder as claimant, if the claim would go against promoting the success of the company, whether a proposed or former act complained of, if not already authorised, would likely be authorised by the company in any event, whether or not the company has considered but already decided not to pursue the claim sought, etc.

The court can put the claim on hold to allow other members of the company to decide whether or not they will authorise the matter, provided the matter complained of is not beyond the company's power and is not unlawful.

Petition for the winding up of a company

Provided a shareholder has held their shares for a minimum period, if a shareholder considers a company is being mismanaged or a deadlock has arisen or the shareholder has been excluded from management, which results for example, in significant loss of confidence and the company cannot be effectively run, a shareholder can present a petition under s.122(1)(g) Insolvency Act 1986 to wind the company up, and the court may agree where it is "just and equitable" to do so.

As this ties closely with unfair prejudice considerations, it is common that petitions for winding up are sought in conjunction with unfair prejudice petitions.

Whether or not the court agrees, depends on the facts of the case and is discretionary. A court is unlikely to agree to the petition if alternative measures are available, and may prefer that the complaining party's shares are bought out. This may lead to further disputes as to the value of the shares, but is seen to be a more practical workaround and may allow an otherwise healthy company to continue.

Disputes as to valuation of shares

As an alternative to shareholder legal action above, a company may be able to negotiate either a buy back of the complaining shareholder's shares, or agree that a third party or existing shareholder can buy them. Difficulties can arise if the company cannot afford to buy the shares, in which case legal advice can assist in outlining potential solutions, or if the alleged value of shares appears grossly inflated by the shareholder, expert determination may be required to determine a fair price.

Signs suggestive of a dispute

The above outlines potential claims that can arise when a shareholder has already pressed the big red button or set out formally that they will do so. However, waiting until this point before taking legal advice, may increase liability and costs. There may some subtle, or very obvious, tell-tale signs if and when a shareholder means to cause trouble legally and being attuned to the signs, the potential claims and taking early legal advice may help to reduce risk.

For example, if a shareholder:

starts alleging rights beyond those in the company constitution, but based on historic expectation which has recently changed
complains they are being purposefully excluded from meetings unlawfully
very vocally disagrees with the direction the company is taking
is habitually disruptive at meetings or in correspondence
constantly alleges prejudice and unfair decisions as minority shareholder
points fingers at individual directors and talks in terms of breach of duties
alleges problems of lack of performance by directors or other shareholders
has poor personal relations with other members
puts themselves forward as spokespeople for a group of shareholders
starts using legalistic terms linking to technical aspects of claims above
constantly calls for or tries to arrange general meetings to fit their preferences
requests the company buy back shares or sell to a third party but requests a ridiculous price, and then goes quiet
threatens to involve their solicitors
is suspiciously quiet following a decision you would expect them to complain about

whilst they above do not necessarily mean a legal claim will follow, these could all be potential signs, when taken as a whole and if repeated over an extended period, that a shareholder, or group, may be building up to bring a claim. If the allegations are unfounded, it may be a staunch response with reference to technical constitutional provisions, or that due process has been followed, is sufficient. If it is clear the matter is likely to escalate, or directors are concerned the complaints touch on a genuine procedural error or potential breach of duty, or consider they have limited express protection in their constitution documents than ideal, it is sensible to take early legal advice.

Potential for higher risk

A company may be at particular potential risk when a shareholder dispute is alleged, if its articles of association are very simplistic, very old, not sufficiently clear or comprehensive, if there is no shareholders agreement, there are no express provisions dealing with dispute resolution, or what happens in the event of a deadlock.

Additionally, director owned businesses are at particular risk if a quasi-partnership exists and one of the partners expects to be involved in management decisions, but one party is likely to want to separate from the other controversially, but has equal rights on paper; this may likely result in deadlock. Again early legal advice can assist.

Alternatives to litigation

Quite often, even if a shareholder brings a claim, the matter is frequently referred to mediation and mediation may be a formal requirement set out in the company constitution documents.

Mediation is not legally binding however without amicable agreement, and is not an exact science, and much comes down to negotiating a deal. Early legal advice and expert determination can greatly assist to assess merits and value and in providing a more stable environment to negotiate and to finalise the deal.

Very often shareholder disputes are settled with regard to prevalent commercial factors, rather than strict legal rights, and so early commercial negotiation may be sensible. It can be sensible to involve lawyers who can discuss matters "without prejudice" or off the record, which might minimise risk later on.

Steps to prevent disputes

Points that companies can consider to try and avoid shareholder disputes, may include:

Take early legal advice, in advance of a potential dispute crystallising where possible.
Ensure constitution documents are clear and comprehensive
Consider whether constitution documents need amending or updating and check how
Ensure shareholder agreements are in place and provide sufficient certainty and clarity
Check that constitution documents do not go further than statutory limits (they may be unenforceable)
Ensure issues in dispute are correctly voted on procedurally
Ensure directors are aware of their duties under the CA 2006 and decisions are carefully considered
Take early legal advice if repeated allegations of prejudice are made by shareholders
Consider obtaining valuation advice if share value is disputed
Consider whether to buy out a particularly troublesome shareholder if requested
Deal with negotiations via solicitors who can use off the record correspondence where necessary and provide a more stable and secure environment in which to negotiate

Saunders Law is situated opposite the Royal Courts of justice, in the heart of the legal district with ties to expert mediators and counsel who can assist in the event of a shareholder dispute. We stand up for client's rights and have decades of negotiation experience. We take pride in client care and satisfaction and providing peace of mind.

If you are effected by any of the issues above, please give us a call on 02076324300 to see how we can help.