Shareholder disputes

A shareholder dispute can have significant commercial and reputational consequences, particularly in owner-managed and private companies.

Some of these consequences include:

• Management deadlock: disagreements between shareholders can impede strategic decision-making within a company with knock-on delays to inward investment. Approval of budgets and spending plans can be delayed and deadlock can frustrate key business initiatives.

• Financial consequences: legal costs, management time and uncertainty can affect a business’s profitability and cash flow. Potential investors and lenders may also be reluctant to engage with a business involved in shareholder litigation due to the uncertainty it can create.

• Employee disruption: internal company disputes often create uncertainty among employees and can adversely affect morale and staff retention.

• Customer and supplier concerns: public disputes may undermine confidence in the company's stability and future direction.

• Damage to reputation: court proceedings are generally public, potentially exposing allegations of misconduct, governance failures, or breakdowns in relationships to external scrutiny, which can of course be seized upon and used by competitors.

Without doubt, the best course of action to minimise the risk of shareholder conflicts is to put a robust shareholders' agreement in place between the relevant parties. Such an agreement will:

• define decision-making processes

• include dispute resolution procedures

• address share transfers and exit rights

• set out reserved matters requiring shareholder approval.

These are the main areas where shareholder disputes arise and to have clarity over the process is highly beneficial.

In addition, other recommended actions include:

• maintaining clear constitutional documents

• ensuring the articles of association align with commercial arrangements and shareholder expectations.

• clarify relevant roles and responsibilities

• distinguish between shareholder rights, board responsibilities and management duties.

• provide regular information to the parties

• transparent reporting and communication can reduce mistrust and misunderstandings.

• establish deadlock mechanisms

• consider mediation provisions, buy-sell clauses, or escalation procedures for significant disputes.

• review governance arrangements regularly.

Lastly, make sure that as the business grows, the company’s governance structures remain fit for purpose. While disputes cannot always be avoided, businesses can substantially reduce risk through proactive governance arrangements.

There are four main areas where the Companies Act 2006 provides statutory remedies that may be relevant where disputes arise between shareholders or between shareholders and directors.

1. Unfair prejudice petitions (s.994)

   Section 994 allows a shareholder to petition the court where the company's affairs are being conducted in a manner that is unfairly prejudicial to the interests of its shareholders. The court has broad powers to grant relief. In many unfair prejudice cases, the most common remedy ordered by the court is a buyout of one shareholder's shares by another shareholder or the company. This is probably the most powerful remedy available to a shareholder.

    

2. Derivative claims (ss.260-264)

   Under Part 11 of the Companies Act 2006, shareholders may bring a derivative claim on behalf of the company in respect of director wrongdoing, such as negligence, breach of duty, breach of trust or default. Court permission is generally required before a claim can be commenced.

    

3. Removal of directors

   Shareholders may remove a director by ordinary resolution under section 168, subject to the statutory procedure and any contractual rights involved.

    

4. Enforcement of constitutional rights

   The company's articles of association operate as a statutory contract between the company and its members under section 33, allowing shareholders to enforce rights arising under the articles.

A fair shareholder buyout typically requires a structured and transparent process.

Key considerations include:

• reviewing contractual rights contained in any shareholders' agreement and the articles of association

• obtaining an independent valuation from a suitably qualified accountant or valuation expert.

• agreeing the valuation methodology (for example, earnings-based, asset-based or market-based.

• considering funding arrangements, including whether the purchase will be made by existing shareholders, a new investor or the company itself (subject to company law requirements)

• documenting the transaction carefully, including share transfer documentation and any settlement agreement

• consider tax implications before completing the transaction.

The most frequent causes of shareholder disputes in private companies include:

• Breakdown in personal relationships, particularly in founder-led and family-owned businesses.

• Disagreements over business strategy and growth plans including where and the manner in which company money is being spent.

• Exclusion from management, where shareholders had expected involvement in decision-making but are not involved.

• Dividend and remuneration disputes, including allegations that majority shareholders are extracting value through salaries or benefits rather than dividends.

• Alleged breaches of directors' duties, conflicts of interest, or misuse of company assets.

• Share valuation disputes, particularly on exit.

• Dilution of shareholdings through new share issues.

• Poor communication and failures to provide information e.g. financial information or concerns regarding transparency and governance.

• Breach of shareholders' agreements or articles of association.