Protecting your position, a note on shareholder disputes
November 13, 2019
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In many SMEs and family owned businesses, there will usually be a small number of shareholders who also happen to be directors and/or employees of the company. You know how it goes. A small group of like-minded entrepreneurs decide to start a company. They all decide to take broadly equal shareholdings in the business. They all want to be directors and/or employees so that they can draw a salary, dividends, or both. Or, in the case of family-run businesses, they have had their shares passed down to them by their parents who, for tax planning reasons, or simply because they want to retire, pass their shares down to their children.
Then the shareholders (or some of them) fall out. The majority decide that one of the other director shareholders isn’t pulling his or her weight, and start to resent that individual enjoying the same profit related dividends as the others who work seven days a week to make the business succeed. Or (and this happens a lot in family-run businesses), there are family politics involved, or one party gets greedy and wants their share of the other members’ profits.
These are all real life scenarios, and shareholder disputes can and do happen frequently.
Often what happens first is that the majority sack the person who they consider is not pulling their weight. Putting aside the fact that termination of employment may or may not be unlawful (for example, unfair dismissal), just because a shareholding employee has been sacked does not automatically mean that they can be excluded from all aspects of the business. In that scenario, they are normally still directors and shareholders: you have not removed them from the business entirely. They will still be entitled to attend board meetings and vote on important decisions to be taken by the Board; they will still be entitled to payment of dividends on their shares.
Generally speaking, where one person is removed (as an employee), he may do one of two things:
(a) he may want a complete exit from the business so will ask to be removed as a director and want the remaining shareholders to buy back their shares at fair value; or
(b) he may make allegations that the continuing directors and shareholders have acted in a manner which has prejudiced his rights as a shareholder, or have acted in a manner which devalues his shares (usually the same thing).
The latter is known as minority shareholder prejudice. Section 994 of the Companies Act contains statutory protections for a person who feels he has been unfairly prejudiced. Examples of prejudice include:
- Certain directors awarding themselves excessive bonuses to the exclusion of the departing individual;
- The Board failing to award a dividend to the departing individual;
- General mismanagement of the company by one or more of the directors / shareholders;
- Breach of a shareholders’ agreement and/or the company’s Articles of Association.
It is quite amazing how often this sort of conduct goes on. Certainly more often than you would believe in the SME / family business market.
The Companies Act permits a minority shareholder to bring an action, both against the company and against some or all of his fellow shareholders for such conduct. The Court has wide powers to regulate the affairs of the company, although the usual order will be that the company, or its continuing shareholders, must buy the departing individual’s shares at a fair value.
There are lots of way you can avoid falling into the trap identified above.
The first thing is to ensure that, before you invest in any business, there is a shareholder’s agreement which regulates the conduct of the shareholders and makes provision for what would happen if a given shareholder is sidelined from the business, or wants to get out.
The second is to get legal advice at the first opportunity. Normally, although admittedly not always, you will sense a shift in the attitude of the rest of the company’s members towards you / your input into the business. Or, as pointed out above, your employment with the business may have been terminated. Or new shares may have been issued without your knowledge or agreement, thus diluting the value of your shareholding. The message to take away from this is that, if any of the above happen, go and get advice quickly.
Over the years, I have acted both for minority shareholders who are being marginalised / pushed out of a business, as well as for companies and their shareholders who face the threat of minority shareholder action. Full blown disputes end up being emotionally draining, distracting and costly. Early advice really is key.