Excessive directors’ pay and unfair dividends – what can a minority shareholder do?
Owner / managers of businesses are entitled to be paid for their management role but this pay must not be unfair in relation to shareholders who are not managers
A common situation is that there will be shareholders who have management roles and shareholders who do not. In most such companies the shareholders and directors will agree a fair split. This can be achieved in different ways. In some companies the shares may be split into different classes and different levels of dividends paid for each class relating to wider contribution to the company from the members in that class. In other words, those who are the managers get bigger dividends. Alternatively, where there is only one class of shares then managers may be rewarded by payment of salaries, such payments then dictating what profits are available for pro rata distribution via dividends to shareholders.
However, there is always the risk that the interests of the managing shareholders and the non-managing shareholders will diverge. In those situations the managing shareholders may use their powers on the board of directors to increase their salaries and / or reduce dividends payable (either generally or to a specific class of shares). In the absence of a shareholders agreement regulating this or restrictions in the articles of association of the company, what can the other shareholders do?
If the non-managing shareholders hold the majority of the shares then they may be able to remove and add directors to change the board. However, often the managing shareholders control a majority of the shares which means that this is not possible. Where does this leave the minority shareholders?
The starting point is that in the absence of an agreement between them shareholders do not have a legitimate expectation of being paid dividends. The directors can quite properly decide that it is in the interests of the company to not pay dividends.
However, a 2017 case illustrates how the court can assist. The company in question was a family owned recycling business. The directors were the majority shareholders. Over a long period the company stopped paying any dividends, the directors’ salaries increased to what was found to be above reasonable market rates and the directors used company money to purchase a fleet of luxury cars and a yacht to which they, but not the minority shareholders, had access to. The minority shareholders did receive offers to buy them out but these offers were well below any realistic market valuation of their shares.
The minority shareholders petitioned under s.994 of the Companies Act. The court found that they had been unfairly prejudiced as the directors had breached their duties under the Companies Act in relation to both their remuneration and the policy not to pay dividends. What they did was held to be in their personal interests and not the interests of the company. As a result the majority shareholders were ordered to buy out the minority shareholders at a fair value.
Whilst the facts of this particular case are quite extreme, it is clear that the court can step in where directors who are also majority shareholders turn off the dividend tap by increasing their salaries. Where this amounts to a breach of statutory duties then such actions will be unfairly prejudicial to the minority shareholders.
The case referred to is  EWHC 457 (Ch) – In the matter of CF Booth Ltd.