The Lifecycle of a Business - Snubbed shareholders: what’s your recourse?
Setting up and running your own business is an amazing achievement. It requires vision, creativity, motivation and stamina. On occasion, it can even bring you fame, riches and fortune. But it can also result in reams of paperwork and cause sleepless nights. And as someone once said to me about children “It doesn’t get easier, it just changes”, so the same can be said for your business throughout its lifecycle. From setting up to exit, it will force you to consider issues that you might not previously have known anything about and it will need you to make many decisions, sometimes very quickly. What it certainly is not is mundane.
With this in mind, the corporate team at Forsters, together with some of our specialist colleagues, has written a series of articles about the various issues and some of the key points that it may help you to know about at each stage of a business’s life. Not all of these will be relevant to you or your business endeavours, but we hope that you will find at least some of these guides interesting and useful, whether you just have the glimmer of an idea, are a start-up, a well-established enterprise or are considering your exit options. Do feel free to drop us a line or pick up the phone if you would like to discuss any of the issues raised further.
We’ve already discussed various topics, including funding, employment and commercial contracts, but it’s now time to discuss when things go wrong...
Snubbed shareholders: what’s your recourse?
Shareholders don’t usually invest in a company with disputes at the front of their mind; these relationships tend to start out on a more jovial, cheery note. However, experienced investors will know that it is important to understand your rights in relation to disputes to avoid being caught on the back foot if/when things start getting prickly with your fellow shareholders or even the company itself. In this article, we will discuss the common causes of disputes and the rights and remedies available to shareholders.
Shareholder disputes can take many forms, from concerns about the company's management to disagreements over its direction or strategy or about a particular transaction. Another common example is where minority shareholders perceive that the company is being run in the majority shareholder’s interests rather than in the best interests of the shareholders as a whole. (For more information about this, see here.)
A disgruntled shareholder will generally have a bouquet of rights and remedies whether arising under the company’s articles of association, contract (such as a shareholders’ agreement) or statute. For example, the Companies Act 2006 (the CA 2006) provides that shareholders have the right to raise concerns and ask questions at general meetings of the company. However, in order to requisition a meeting, a shareholder must hold at least 5% of the company’s voting shares, and in the case of a minority shareholder, simply being heard at a meeting but then being outvoted by a majority shareholder may not provide sufficient redress. The CA 2006 also provides shareholders with a right to make a written request to the company for information on specific matters, but simply having access to information may not be enough to resolve a dispute although it could be used in conjunction with other available remedies. (For more information about statutory and contractual rights for shareholders, see here.)
In addition to the rights mentioned above, a shareholder could instigate one of several court claims, although careful consideration should be given, and legal advice obtained, before doing so:
1. A personal claim against the company or another shareholder in which the aggrieved shareholder exercises the rights under the so called ‘statutory contract’ created by the company’s articles of association or the CA 2006.
A personal claim may be brought by a shareholder to enforce their rights under the company’s article of association or the CA 2006. For example, a shareholder may bring a claim against a company where that company has issued new shares without adhering to the pre-emption provisions prescribed in its articles or the CA 2006 and has failed to follow the requisite disapplication provisions.
Such a claim can be brought in a representative capacity, i.e. where a shareholder seeks to enforce a right he/she enjoys together with the other shareholders, or in the shareholder’s own name. The directors of the company may be joined as parties if relief is sought against them as well as against the company.
2. A derivative claim whereby a shareholder seeks a particular remedy for and on behalf of a company itself.
Where a company suffers a wrong at the hands of another, it is typically the company which would bring a claim against the wrongdoer, provided that the directors (or, alternatively, the shareholders) have resolved to bring a claim.
However, where the loss is caused by, for example, a director who holds a majority of the shares in the company, it is unlikely that they would vote in favour of bringing a claim against themselves. In addition, a minority shareholder who disapproves of a particular action is barred from bringing a complaint where the majority shareholders have approved such action.
To prevent potential injustice, the CA 2006 provides a mechanism for a shareholder to ask the court for permission to bring a claim on behalf of the company in certain limited circumstances, essentially where a director is guilty of negligence, default, breach of duty or breach of trust.
If the court grants permission the claim will be brought in the name of the company to enable the enforcement of any order granted for/against it. Therefore, any damages awarded will be paid to the company (not the shareholder), although the shareholder may be able to recover the costs incurred in bringing the claim.
3. An unfair prejudice petition.
A remedy particularly attractive to minority shareholders is an unfair prejudice petition brought under section 994 of the CA 2006. This remedy allows a shareholder to petition the court for relief if the company’s affairs are being conducted in a manner that is unfairly prejudicial to the interests of some or all of the shareholders.
Going back to the example of a company issuing shares. A majority shareholder may want to force the dilution of a minority shareholder’s shareholding for various reasons (for example, to reduce their voting shares to below the threshold required for that shareholder to be able to call a general meeting). One way of doing this would be for the company to issue shares at a price or a quantity that the minority shareholder could not afford, but the majority shareholder could. Such an action could be considered as unfairly prejudicial to the minority shareholder.
To bring an unfair prejudice petition, a minority shareholder needs to successfully prove several elements. Of particular importance is that the conduct which is the subject of the claim must be both ‘prejudicial’ and ‘unfair’. Using the above example, while a dilution of a minority shareholder’s shareholding may be prejudicial, it would not necessarily be ‘unfair’ if, say, the company was in financial distress and needed an urgent injection of capital to stay in business.
If the claim is successful, the court has a wide discretion as to remedies, including ordering the company or the majority shareholders to purchase the minority shareholder's shares at a fair value, reversing certain transactions, or even changing the company's articles of association.
4. A winding up petition.
In extreme cases, a shareholder may petition the court to grant a winding up petition on so-called ‘just and equitable’ grounds. If successful, this would result in the winding up of the company and the distribution of its assets. This is typically a last-resort remedy when there is no other way to resolve a dispute or protect the interests of the shareholders. For example, a small company with two equal shareholders may experience a complete breakdown of relations, resulting in an operational deadlock. If the shareholders are unable to reach a resolution, one of them could petition the court to wind up the company on just and equitable grounds.
Shareholder disputes (large, small and somewhere in-between) are a common occurrence in the world of corporate law. The CA 2006 provides shareholders with certain rights to raise concerns and ask questions at general meetings and to request information from the company, which information shareholders can then use to address concerns about the company's management, strategy, or specific decisions, and the company’s articles of association or a shareholders’ agreement may also provide contractual protection. However, where these rights fall short of addressing a shareholder’s complaint, other legal remedies may be available. The options will depend on the specific circumstances and success may hinge on compliance with a strict legal process. As such, shareholders should seek legal advice early and before taking any action.
Disclaimer
This note reflects the law as at 26 September 2024. The circumstances of each case vary and this note should not be relied upon in place of specific legal advice.