The unique challenges in shareholder disputes

21 July, 2017
This article has been reviewed and is up to date as of 23 August, 2017

The blood ties within family businesses can be a source of great strength and vitality, but they can also be the source of tension and create particular problems when boardroom disputes arise.

 

How problems arise

Typical underlying causes of internal company disputes are:

  • differences of opinion on the fundamental strategic direction of the company
  • concerns about another shareholder / manager not pulling their weight
  • fears that a majority group of shareholders are acting in their own interests and colluding to damage or dilute the interests of the minority
  • a general breakdown in personal relationships.

In relation to the first of these, family businesses are probably no more, or no less, likely to suffer from this than other businesses.

The second situation is quite common within family businesses as it can be the case that somebody owes their position mainly to the fact they are family, rather than as a result of their own skills or ability. This can cause significant tension with others who got there on merit or who are being paid the same or less than somebody who is perceived to be underperforming.

The issue around a majority group of shareholders potentially acting in their own interests is a common scenario within family businesses, particularly in second or third generation businesses. If shareholdings pass to different branches within a family, then any falling out between the branches or a distancing of one branch from others, can often be reflected within the control of the business.

Finally, whilst family businesses may often be able to better handle relationship issues as part and parcel of family life, if things do sour then the breakdown can be much worse than if it was merely a commercial relationship.

 

Resolving shareholders disputes in family businesses

The first step is to be clear about the legal structure and context. The informal nature of many family businesses can mean that legal formalities may not always be followed. Establishing the constitution of the company (for example its articles of association), who is properly appointed as a director, and what the shareholdings are, is an important step.

Next, it should be clarified whether there is a shareholders agreement or other document governing how the company is run or the relationships between shareholders. The importance of such a document will be discussed in more detail below.

In light of the established legal position, informal routes to resolving the problems should be explored first. These can include:

  • informal round table meetings
  • the use of a trusted family adviser as an intermediary
  • engaging in a formal mediation process (click here for our guide on mediation).

If these fail then the formal legal options will need to be explored. The best route will always depend upon the individual facts of any dispute.

 

Derivative claims

One option is to bring what is called a derivative claim. The claim is brought by the shareholder in the name of the company and an important point to note is that the proceeds of any claim belong to the company and not the shareholder.

This is a two stage process, the first stage of which is to obtain the permission of the court. In practice this remedy is unlikely to be the most attractive route to resolve most disputes and minority shareholders will probably look instead at the other statutory remedies that are available.

 

Just and equitable winding up

Under S.122(1)(g) of the Insolvency Act 1986 a company may be wound up by the court if: “the court is of the opinion that it is just and equitable that the company should be wound up”.

This is the nuclear option where relations between directors / shareholders in a company have hit rock bottom.

There is no easy definition of what circumstances make it “just and equitable” for a court to wind up a company. Each case is looked at on its own merits.

Situations where winding up orders have been made include where:

  • a minority shareholder was wrongly excluded from management
  • the majority shareholders consistently ignored the rights of the minority
  • the directors awarded themselves excessive remuneration whilst refusing to pay dividends to shareholders
  • there was deadlock within the company and no decisions were capable of being made.

It should be noted that this is an equitable remedy which is in the court’s discretion. This means that a person seeking the remedy must come to the court with “clean hands”. If they are partially the author of their own misfortune as a result of their own actions, then the court is much less likely to assist.

The other critical point to note is that even if a case for winding up on equitable grounds is clearly established, the court may refuse to grant the relief on the basis that there is an alternative remedy and it is unreasonable for the complainant not to pursue that remedy (s.125(2)). A court is unlikely to relish winding up an otherwise healthy company and will therefore look closely at such alternatives before granting an order for winding up.

Alternative remedies can include an offer by the respondents to buy the complainant’s shares at a fair value or the fact that the complainant might have a more appropriate remedy under s.994 of the Companies Act 2006 (see below).

 

Unfair prejudice – the statutory remedy

The most powerful weapon in the armoury of an aggrieved minority shareholder is the statutory remedy available under s.994 of the Companies Act 2006.

A shareholder may petition the court where the affairs of the company are being conducted in a manner that is unfairly prejudicial to all, or part, of its members.

There is no simple definition of what constitutes “the affairs of the company” or “unfair prejudice” and a large body of case law has developed over the years. The four examples of what might be grounds for winding up on just and equitable grounds that are cited above, are also typical grounds for the court to find that unfair prejudice has been established. However, the terms “unfair prejudice” are considered by the court to be “general words” and the court has a wide discretion in their application.

Other situations where unfair prejudice has been found include:

  • a failure to consult the complainant or to provide information
  • misappropriation of company business or assets
  • mismanagement of internal company affairs
  • the failure to pay reasonable dividends
  • improper allotments of shares and rights issues.

One key point to note is the equal weighting given to the two words. No matter how prejudicial certain actions may be, a complainant will only have a remedy if the actions are found to be unfair. This can mean that in family businesses there may be actions taken which prejudice a group of shareholders, but are commercially justified and therefore not “unfair”.

However, family businesses will often be seen as being a “quasi-partnership”. What is meant by this is a company where there are certain understandings or expectations between the members, which go beyond their strict legal relationships. In such a case the exercise of strict legal rights that adversely affect another member, whilst wholly proper as a matter of law, may be seen as “unfair” for the purposes of the statute.

It is worth noting that s.994 does not provide a mechanism for “no-fault divorce”. Without the key element of “unfair prejudice” being present, a party’s petition to the court will inevitably fail.

In terms of remedies, the court has a very wide discretion under s.996 of the Companies Act 2006 which states that “if the court is satisfied that a petition … is well founded, it may make such order as it thinks fit for giving relief in respect of the matters complained of”.

The section goes on to list various possible orders, including an order for the shares of any party to be purchased by another party or the company itself. The purchase of the complainant’s shares by the wrongdoers is the most commonly sought and granted remedy.

 

How to avoid shareholders disputes in the first place

Shareholders disputes within any company can be very damaging. In family businesses, the additional family connections can make such disputes personally as well commercially destructive.

In addition, the costs of the formal dispute resolution procedures can be very high, in cash terms (legal and accountancy fees) and also in terms of the time which will have to be devoted which could otherwise be spent on promoting the business.

Things which will reduce the chances of a dispute happening or help prevent it escalating include:

  • careful succession planning when passing shares from one generation to another
  • establishing a family “constitution” or entering into a shareholders agreement that sets out rights and responsibilities amongst shareholders and mechanisms for dealing with problems
  • employing trusted non-family members in key roles who can provide impartial and objective counsel.

What can be a real strength of family businesses, the emotional and personal ties that bind, can also be the cause of problems. The best run family businesses will plan for succession and put structures in place to help prevent disputes or nip them in the bud.  There is no one size fits all approach and advice should be sought from professionals who understand the unique dynamics of such businesses.