Director and Shareholder Disputes
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Director and Shareholder Disputes

The laws that govern the majority of boardroom and shareholders disputes are often very complicated and technical. In addition to the pure legal aspect of the matter, they often reflect changes in established relationships, which can result in challenging confrontations between the parties. Each situation that arises is unique to its own facts, so it is always advisable to consult with an independent solicitor for the appropriate advice when a dispute arises. This is essential to prevent any conflicts of interests your company’s solicitors may have.

There are often common factors in most situations which can be extracted and condensed as set out below. This article summarises the key legal concepts that are relevant to director and shareholder disputes, hopefully in a way that is immediately clear.

The main types of disputes that can materialise are as follows:

• conflicts of interest (when a director has interests in another business or the company’s interest has been sided by the management)

• concerns about the board’s management and whether it is meeting its legal responsibilities, including fiduciary duty

• differences of opinion about the direction and development of the company

• difference of opinion on how to address regulatory or industry changes

• unstable personal relationships

• a lack of performance by a shareholder or director

• terms of directors’ service contracts

• directors paying themselves high salaries and preventing cashflow to the shareholders when shareholders require a dividend to be paid out

• minority shareholders causing procedural difficulties

Shareholder Constitutional Documents

The first document that regulates the parties’ interactions are the Articles of Association. These set out how a company is run and the functions of the directors. The rights of directors can be restricted by the Articles of Association or in a shareholder’s agreement. Directors have a number of duties to the company under common law, as well as those set out in the Companies Act 2006.

To summarise, these duties require directors to act in good faith and with the best interests of the company in mind. It is often the breach of these duties which gives rise to boardroom or shareholders disputes. It is important to note that any claim will arise from the company and not the other shareholders or directors.

Even though directors have the day to day control of the company, the shareholders hold the ultimate power. Shareholders can remove and replace directors in accordance with the powers set out in the shareholders’ agreement, which is a binding contract between the company and its shareholders. A shareholders’ agreement can be tailored to identify what actions must be taken by each director and shareholder, which could help anticipate risks for any unforeseen events thereby saving valuable time, money and aggravation, if drafted well. These are

usually drafted at a time all parties are positive about the new venture and sometimes tend to underestimate dealing with the difficult questions and issues that occur once a company begins operating and problems are to be faced.

It is possible to make provision in the constitutional documents for preventative measures and remedies should an event or dispute arise. A common example of a remedy for disputes are for the aggrieved shareholders to have the right to require the others to buy them out at a fair price.

A good alternative dispute remedy could be mediation. An independent mediator could be instrumental in ensuring that disputes do not escalate. If mediation fails, the constitutional documents will set out other mechanisms to resolve matters.

Claims

A claim can be brought by the shareholders in the name of the company. This is called a derivative claim because the shareholders’ right to claim derives from the company’s right to claim. The proceeds of any derivative claim belongs to the company and not the shareholders.

A new type of statutory derivative claim was introduced by the Companies Act 2006. This has made the remedy less restrictive in scope but has introduced 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.

The nuclear option is set out under S.122(1)(g) of the Insolvency Act 1986 whereby 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”.

A shareholder is entitled to apply for a winding up where they have a sufficient interest in the winding up. A fully paid up shareholder must show that there will be monetary surplus after winding up for distribution amongst the company’s members as well as showing that shares have been held for at least 18 months (S.124(2)(b)).

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 improperly disqualified from management;

• the majority shareholders have constantly disregarded the rights of the minority;

• the directors have granted themselves excessive remuneration whilst refusing to pay dividends to shareholders;

• there is deadlock within the company and no decisions are capable of being made.

This is an equitable remedy which is at the Court’s discretion. This means that a person seeking the remedy must come to the Court with “clean hands” i.e. in good faith. If they are partially the author of their own misfortune, then the Court is less likely to assist.

The other crucial 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 available alternative remedy and it is unreasonable for the complainant not to pursue that remedy (s.125(2)). A Court is unlikely to wind up an otherwise healthy company and will therefore look closely at any such alternatives before granting an order for winding up.

Alternative remedies can include an offer by the respondent to buy the complainant’s shares at a fair value or the complainant might have a more appropriate remedy under unfair prejudice, which is set out under s.994 of the Companies Act 2006.

The most powerful weapon for 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. Other situations where unfair prejudice has been found include:

• a failure to contact the complainant or to provide information;

• misappropriation of company business or assets;

• mismanagement of internal company affairs;

• the withholding of information;

• the failure to pay reasonable dividends; and

• improper allotments of shares and rights issues.

It doesn’t matter how damaging certain actions may be, a complainant will only have a remedy if the actions are found to be unfair.

Unlike a petition for a just and equitable winding up, a petition under s.994 (as per above) does not require a complainant to come to the Court with “clean hands”. However, the absence of clean hands is something that the Court may consider, which may impact the sort of remedy it is willing to grant.

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 purchase of the wrongdoers’ shares is the most commonly sought after and granted remedy. If the Court makes an Order to this effect, then it will be necessary to valuate the shareholdings and disputes often arise on these grounds. It is common that shares are valued without a discount (in other words, pro rata to the value of the entire shareholding). However, where this would result in an unjustified windfall for the shareholder, the Court may apply a discount to reflect the true commercial value of a minority holding. Adjustments may also be made to any valuation to ensure that it is a fair one. This may include, for example, adding back in the value of excessive remuneration paid to a majority shareholder or considering other wrongful acts that have reduced the value of the company. The fact that a party may not be able to afford to buy out the shares at this value will not prevent the Court making such an Order. Other factors that may affect the amount paid for the shares include the date on which the valuation is made. This can have a significant impact on the overall valuation and the Court has a wide discretion to determine the appropriate date, having regard to all the circumstances. The most usual date for the valuation is the date on which the shares are ordered to be purchased.

If a boardroom or shareholder dispute arises, take early advice, and instruct a solicitor to draft your constitutional documents and to deal with any disputes should they arise from therein.

Why Us

ASV Law is an independent high-profile litigation firm based in London, and servicing clients worldwide. Our business is the law and we make it our business to challenge all offending parties’ when disputes arise. Please contact info@asvlaw.com with any queries and we will be happy to assist you.