In his latest article, Mike Wilson, partner in our Litigation and Dispute Resolution team explores the key issues to consider relating to shareholder disputes.

Disputes between shareholders are on the rise. As the economic effects of the coronavirus pandemic and world events have put strain on businesses, the last two years have seen a surge in disputes and litigation between company shareholders, particularly in family-owned businesses and SMEs. It is a trend we expect to continue, with two of the most common scenarios in which we are instructed being where two equal-shareholders (or groups of shareholders) are deadlocked or where a minority shareholder has been forced out or excluded from the business.

Such disputes can often be avoided, or resolved quickly, with good communication and a clear management structure, but when they do arise, there are a number of important issues to consider:

1. What do the company’s Articles of Association say?

Every limited company has Articles of Association. They are a public document that form part of the company’s constitution and set out the rules for how the company will operate internally. Limited companies are often incorporated with a set of standard or model articles, but they may also be bespoke or modified or have been amended. The articles often contain important provisions, including on the appointment and removal of directors, how decisions are to be made by directors and shareholders, rights and restrictions on the transfer of shares, and what happens in the event of a deadlock.

2. Is there a Shareholders’ Agreement?

Companies with two or more shareholders may also have a separate Shareholders’ Agreement. This is a contract between the shareholders that outlines their rights and duties as agreed between each other and the company itself. Its main purpose is to prevent disputes among the directors, shareholders and the company itself, and to provide some protection to shareholders. Having a Shareholders’ Agreement is not a legal requirement, and many small and medium-sized businesses do not have one, but it is highly-recommended. In the event of a conflict between the Articles of Association and a Shareholders’ Agreement, the former will usually take precedence.

3. What do the shareholders want?

Sometimes what the parties on both side of a dispute really want is a way to resolve a disagreement or deadlock between them and move on, for example by making changes to the company’s constitution, shareholdings, or management structure. In cases where relationships have broken down irretrievably however, it may be necessary for one or more shareholders to exit the business with the company or other shareholders buying back their shares, or for the business to be split, restructured, or sold, or even for the company to be wound-up. These outcomes can often be achieved through communication and negotiation or by alternative dispute resolution, such as mediation, arbitration, or an early neutral evaluation of the dispute, but there are also times when legal action or litigation is needed.

In the case of shareholder disputes, legal action can take several forms.

• Unfair prejudice – a shareholder in a company can bring an action under the Companies Act in circumstances where the affairs of the company are being, or have been, conducted in a manner that is unfairly prejudicial to them in their capacity as a minority shareholder. The most common examples of unfair prejudice include paying enhanced salaries or bonuses to directors to divert profits away from non-director shareholders and the diversion of business or inappropriate use of company assets to benefit another company in which other shareholders hold an interest. The main remedy in such claims is a purchase order requiring the other shareholders or the company to buy the shares of the aggrieved shareholder on terms and at a price set by the Court.

• Quasi-partnership – a ‘quasi partnership’ is a company that has been formed based on a relationship of mutual trust and confidence between individuals, who all expect to participate in the business. Common examples of quasi partnerships are businesses that were previously run as a partnership (i.e. two or more individuals in business together) and family-owned businesses. In the case of a quasi-partnership, any exclusion from management (including removal as a director) will generally amount to unfair prejudice and the aggrieved shareholder may be entitled to have his or her shares bought for ‘fair’ value without any minority discount.

• Derivative claim – this is a claim brought by a shareholder on behalf of the company in relation to breaches of duty by its directors and can be used where a wrongful majority prevent the company from bringing such a claim itself. This may be where, for example, the directors have failed to act in best interest of company or to promote its success, or where there is or has been a conflict of interests or there are or have been breaches of the company’s articles.

• Breach of contract – a breach of a Shareholders’ Agreement may give rise to a claim by an aggrieved shareholder for damages, including for loss of share value, or for other relief, such as injunctive relief.

• Winding-up – in circumstances where a company is in a complete deadlock – for example where two individuals who are both directors and 50% shareholders are unable to agree – a shareholder or director can petition the Court to wind-up the company on the grounds that it is just and equitable. This is often a remedy of last resort.

• Directors’ claims – where an ousted shareholder is also a director and/or employee of the company he or she may be able to bring a claim for unfair or constructive dismissal in their capacity as an employee, or under a Directors’ Service Contract if there is one, and/or for compensation for loss of office.

Shareholder disputes can be a major obstacle and distraction for businesses and successfully resolving them requires not only a clear understanding of the law and available legal remedies, but a strategic approach based on sound commercial and practical advice that only comes with experience.

Mike Wilson is Partner in our Litigation and Dispute Resolution team. If Mike and the team can assist you and your business with legal advice that is tailored to your particular requirements, talk to the team today by calling 01482 325242 or email mike.wilson@andrewjackson.co.uk