As we saw in the previous article, director and shareholder disputes can arise for a number of reasons. We have looked at the best ways of avoiding disputes in the first place, and how negotiation is the best first step. But what can the parties do if a dispute does rear its head? We look at some of the options.
Mediation or other Alternative Dispute Resolution (ADR)
We saw in the previous article that negotiation can be effective in ensuring shareholder disputes don’t become unmanageable. However, if negotiation does not work, you may find that you reach settlement by using mediation or other form of ADR.
Your mediator will be someone with experience in this area of law. If agreement is reached with the help of the mediator, this can be recorded in a legally binding document which can be enforced in the court, if one of the parties breaks it. The advantages of mediation include its relative cheapness compared to going to court, privacy (there is no public record) and speed.
The courts encourage parties to attempt settlement of all disputes, including shareholder disputes. Where the majority has made a reasonable offer to the aggrieved minority shareholder to buy them out, it is unlikely that the majority will have acted ‘unfairly’. Then it wouldn’t be ‘just and equitable’ to wind the company up. We consider just and equitable winding up in further detail below. It is therefore essential to take advice on the terms of any offer you make.
Unfair Prejudice claim
S994 Companies Act 2006 allows a shareholder to apply to the Court for an order declaring that the affairs of the company are being conducted in a manner unfairly prejudicial to the minority shareholder’s interests. If the court agrees, it will usually order that the company purchases the minority shareholder’s shares for fair value (see below). However, the Court has a very wide discretion as to what it can order. We look at unfair prejudice claims in more detail in this earlier article.
When might a court find “unfair prejudice”?
Unfairly prejudicial conduct may include, for example:
- majority shareholders paying themselves too much
- majority shareholders failing to pay dividends
- breach of duty by diverting business to majority shareholders or their connected companies
- directors selling or buying assets at an unfair price
- failing to pay declared dividends
- undertaking activities that the company’s Articles do not permit
- doing something which might result in the company’s insolvency
- failure to follow company law or proper procedure on meetings
- failure to issue annual accounts
Where the court decides that a minority shareholder has been oppressed or unfairly prejudiced and the appropriate remedy is for the majority buy the minority shares, this is often done at a “fair value”. This means fair market value, without deduction for a minority discount.
Where the majority undertakes to buy the shares of the aggrieved minority at fair value, usually the court will adjourn the unfair prejudice petition. However, the fundamental battle ground is frequently:
- the basis of the business valuation;
- the underlying assumptions; and
- the data and criteria on which it is based.
The valuation of a private company is an area of potential significant difference between the parties. These can be quite complex disputes, but instructing qualified and experienced legal advisers and valuation experts early in the process will help you through this potentially sensitive and difficult area.
In small to medium sized private companies, the court might be persuaded that a “quasi-partnership” exists. The aggrieved party may complain that there is a breach of their ‘legitimate expectations’ about what the parties set the company up to do, and how they would run it. For example, that the parties agreed or could prove a common intention that:
- the company would carry on a particular business
- all would be entitled to an equal say in how the company is managed
- a mutual expectation of continued employment
- the directors would be fair when deciding on the salaries to be paid, the amounts to be kept in the company to fund growth, and the dividends to be paid out
If the court decides that a quasi-partnership exists, termination of that arrangement or unfair prejudice to the minority may result in the majority being obliged to buy out the shares of the aggrieved minority shareholder. If the majority acts in breach of such legitimate expectations, the court may intervene.
Where an aggrieved shareholder has cause for complaint, urgent action is required. The court may refuse to interfere if a minority shareholder let the matter slide. The court will treat this as acceptance of the action taken by the majority.
These applications are rarely straightforward and are often settled by negotiation before the court is asked to make a final decision. Quite often, one or more of the shareholders leave with a package.
In certain circumstances, a shareholder can ask the court to prevent the directors taking any action being which is harmful to the company. Alternatively, they may make a claim against the directors for any loss suffered by the company as a result of their action. The shareholder must make the claim on behalf of the company. This is known as a derivative claim.
Derivative claims are relatively unusual because although it is the member who issues the court proceedings as claimant to launch the action, the court must give permission for the claim to continue to trial. A claimant will have to satisfy a number of tests before the court will give permission. We look at derivative claims and the process in more detail here.
Just and equitable winding up
Any shareholder may apply to have a company wound up on “just and equitable grounds”. This includes quasi-partnerships, involving the shareholder’s right to manage the company.
Winding up is a draconian remedy, available only in specific circumstances. This is the “nuclear option” in shareholder disputes. Essentially, the aggrieved shareholder petitions the court for a winding up order to terminate the company. Usually, the shareholders’ differences have become irreconcilable and a ‘commercial divorce’ is the only way to move forward. When a company is wound up, if there is anything left after paying the creditors and the liquidator this will be divided amongst the shareholders.
Not every aggrieved shareholder will be able to justify a winding up petition to the court. There must be compelling reasons showing that the company can no longer continue. For example, if there is an alternative remedy that would allow the company to continue, the court may refuse to make the order.
The sooner informed negotiations start, the more likely it is that a business will survive a shareholder dispute. Expert legal advice early on could keep the process out of prolonged, expensive and destructive litigation. This is by providing the facts, insight and information to allow all parties to make informed decisions quickly. This would therefore benefit the company as a whole and the shareholders individually.