Minority shareholder rights
- John Deane
- Updated: Mon, 21st Nov 2016
Often a minority shareholder is over looked. Commonly, the dispute is not limited to shares but also includes issues relating to directorship and importantly: the value of the shares. There is quite a lot that can go wrong for a minority shareholder – we step in to help.
Our experience covers all of the issues faced by a minority shareholder in private companies and owner managed businesses. We have knowledge of minority shareholders rights, how to value the shares, tax, and useful strategies to deploy for a fair result.
Our minority shareholder rights service includes:
Advising on cause of action
There will usually be a variety of ideas to explore. In all cases the first step will always be to explore settlement out of court as that will always be cheaper than court action. Sometimes, in order to settle, court action has to be threatened and followed through. At Gannons it is rare for us to litigate as we can usually find a solution before that stage. Avenues to explore can include:
- Negotiation out of court;
- Dispute resolution, by using mediation as a means to resolving the issue;
- The presentation of an unfair prejudice petition;
- The bringing of a derivative claim;
- The presentation of a petition for the winding up of a company; and
- Claims against directors.
A factual analysis of the shareholders’ rights
The best avenue will often depend upon the facts and provisions in existing corporate documentation such as the articles, any shareholders agreement and the director’s service agreements, if any. We have acted for many companies where there is no corporate documentation in place, or it is outdated and find solutions to work around the problems that this throws up. Best position is to have bespoke corporate documentation in place from the outset – this is where we advise.
Exploring alternative methods to protect shareholder rights
Before embarking on court action, we consider whether there are any other alternative methods to protect your position as court actions are expensive and time consuming. The current UK system of litigation places an emphasis on seeking out alternative actions to court – we have the commercial experience to advise you on these alternatives.
Minority shareholders – what can they do to preserve value in their shares?
The law gives shareholders of a company certain rights. However, how these rights can be used will depend upon the control and influence afforded under the shares, often incorporated in the company’s articles. A bespoke set of articles, and if appropriate, a shareholders’ agreement, can provide for an exit route in the event of a shareholder dispute – this saves you time and money.
Consequences of standard articles
Often, if the articles are standard, the minority shareholders will not be afforded any protection – a common pitfall that we help you avoid on company formation. When a dispute arises, it is too late to amend the articles, which requires 75% of the shareholders to vote in favour of the amendment. The shareholders will be in dispute, and will not be willing to pass this resolution, leaving the aggrieved shareholder with only the statutory rights. Time and cost can be saved if the correct documents are drafted on the company’s formation.
Where we add value
We deal with, and have set out below:
- A selection of the rights available to any shareholder dealing with interests of less than 5% through to more substantial shareholdings where the shareholder does not benefit from special rights built into the articles or shareholders’ agreement.
- Selecting the best approach which could range from a claim at court, winding up or often alternatives such as mediation and negotiation. Often, to achieve a result, claims are threatened to get the other side to sit up and then we negotiate for you.
- Evaluating knock on effects such as resignation of directorship, setting up new businesses, post termination restrictions and the use of company property and clients, i.e. intellectual property and know how.
- Analysis of the value of a minority shareholding where all of the company’s shares are not up for sale.
- A case study showing how our advice can be crucial in resolving a dispute over a minority shareholder’s rights.
Below is our summary of some of the key minority shareholder rights in relation to a private company limited by shares and the requisite percentage for each right.
Minority shareholders rights
Shareholding of 5% or more
- Able to require the circulation of a written resolution.
- Able to require the company to call a general meeting.
- Able to prevent the deemed re-appointment of an auditor.
Shareholding of 10%
- Able to call a poll vote at a general meeting.
- Able to require an audit.
Shareholding greater than 10%
- Able to block consent to short notice of a general meeting.
Shareholding greater than 25%
- Able to block a special resolution.
- Able to block compromise arrangement with members or a class of members.
Shareholding of 50%
- Able to block ordinary resolutions.
Shareholding greater than 50%
- Able to pass an ordinary resolution.
Shareholding of 75%
- Able to pass a special resolution.
- Able to approve compromise or arrangement with members or a class of members (also needs court sanction to be effective).
Shareholding greater than 90%
- Able to consent to short notice of a general meeting.
- Able to squeeze out minority shareholders where a takeover offer has been made.
- Right for minority shareholders to be bought out by a bidder making a takeover bid.
It is possible to override these rights by agreement (typically a shareholders’ agreement) so it always pays to check that point out first, or have the percentages reduced or increased within a shareholders’ agreement.
What if companies do not respect a shareholder’s rights?
However, companies do not always comply with their minority shareholders’ rights. Combined with our expert knowledge of general shareholder disputes, we often advise shareholders on their right to bring a claim against the company or the company officers in default, usually the company’s directors.
Can a shareholder’s rights be waived?
The general rule is that they can be, but the decision to do so must be irrevocable and properly documented. A recent High Court case has shown that a shareholder can waive their right to attend a general meeting by providing their “agreement” to vote in favour of the resolutions to be presented. The High Court held that a shareholder can provide undertakings to the company to be absent from the meeting, but consent to the matters to be voted on by the company’s shareholders. The court will adopt a flexible approach depending on the facts of each case. We tell you whether shareholder rights have been waived.
Unfair prejudice petition
Members of a company and persons to whom shares have been transferred can present an unfair prejudice petition. Where requested, the Secretary of State may also bring an unfair prejudice petition on the basis of investigations or reports.
The claimant must show an actual or proposed act or omission of the company which would or has unfairly prejudiced the petitioner’s interest in the company. Examples include:
- Breaches of a director’s fiduciary duty to the company;
- Mismanagement which is serious to the financial loss arising from the act or omission;
- Improper failures on behalf of the directors;
- Breaches of a shareholders’ agreement and/or company articles; and
- Exclusion from management or failure to provide information.
Minority shareholders rights: showing prejudice and unfairness
Both prejudice and unfairness must be shown for relief to be granted. Reduction in the economic value of shares can show prejudicial conduct. As to unfairness, the courts have not provided a definition. Rather, the courts assess unfairness on an understanding of the commercial relationship from an objective point of a view, it is determined on a case by case basis to ascertain whether any minority shareholders rights have been interfered with.
Misconduct of the petitioner may mean that prejudicial acts or omissions are not considered unfair on the petitioner. Any delay in seeking redress may also count against the petitioner in proving unfairness. However, these rules are not inflexible and certainly not shut to challenge.
Unfair prejudice: the court’s discretion
If prejudicial and unfair conduct is proven, the courts have a wide range of discretionary powers. The court can order the purchase or sale of the petitioner’s shares at a price determined by the court, can regulate the company’s affairs in the future, require the company to undertake an act or omit from taking action on a specific matter complained of, or authorise proceedings to be commenced under the derivative claim route.
Shareholders’ agreement exit route
An alternative exit route, for example in a shareholders’ agreement, may prevent the court from exercising its wide discretionary powers. If a shareholders’ agreement does not contain an exit route for the minority shareholder, then court action is often the only resolution, or the first step to initiate a resolution through negotiations which are run in the background.
Derivative claims are notoriously complex. However, a classic problem for a shareholder in a small company is the director, who is often a majority shareholder, who has acted in breach of his duty to the company but refuses, for obvious reasons, to allow the company to sue him. What can the minority shareholder do to exercise the minority shareholder rights?
Derivative claim: who sues?
With a derivative claim, the right to sue belongs to the company, not the shareholder, although the minority shareholder initiates the process. This claim differs from the unfair prejudice petition, which is taken on behalf of the shareholder.
Derivative claim: why sue?
With a derivative claim, the relief is sought on behalf of the company, as in effect, the wrong is committed by the director and the loss suffered by the company. Imagine a director siphoning off funds to a company in which he is also a shareholder, without shareholder approval, it is the company that has directly suffered loss, not the minority shareholder who has indirectly suffered loss through loss of dividend entitlements, if afforded the right to dividends.
There is no minimum holding requirement to bring a derivative claim, although the court will take this into account when deciding whether or not the claim should proceed, i.e. whether the majority would seek to exercise the action to enforce a minority shareholders rights.
Common derivative claims
Derivative claims are often sought following a director’s breach of duty to the company, breach of trust, negligence, or default. In bringing a derivative claim, the claimant must ask for the court’s permission to continue the claim. The claim must not be an abuse of process. In deciding whether the claim should proceed to a full trial, the court will consider:
- Whether it would be reasonable for the company’s directors to have pursued the claim;
- Whether the claim is for the benefit of the company or the individual seeking to bring the claim on behalf of the company; and
- Whether the company will benefit from the claim.
Should the court grant permission, the claim will proceed to a trial and if the claim succeeds, the court will order the regulation of the company’s affairs and likely sanction the officer in default.
Of the three court applications, this is the most drastic. As such, the courts have prepared strict guidance on its use.
Who can apply for a winding up?
The company, its directors, its shareholders or creditors can apply for the company to be wound up where it is just and equitable to do so. This right stems from the Insolvency Act 1986. Where a company is wound up, its creditors are paid off and the surplus, if any, is returned to the company’s shareholders.
Foreign companies can also be subject to a claim for winding up where the foreign company carries on its business within the jurisdiction, jurisdiction is conferred, and there is a reasonable possibility of benefit from the company being wound up. We can advise on these matters.
When will the court wind a company up?
The courts have provided various examples of when it is just and equitable for a company to be wound up, including but not limited to the following:
- Loss of substratum rendering the carrying out of the purpose for which the company was incorporated impossible.
- Deadlock which was not contemplated by the shareholders – this is often the case in a company with two equal shareholders as ordinary resolutions cannot be passed – a fundamental for any company’s survival. In cases of deadlock, the shareholders are often the two directors of the company and also employees; this is where our employment expertise compliments our corporate knowledge and dispute resolution tactics. Again, bespoke corporate documentation can cover for deadlock situations. “Off the shelf” documents should be avoided as they only serve to rack up litigation costs.
- Justifiable loss of confidence in management arising from serious company mismanagement on behalf of the directors – for example fraud or excessive director remuneration.
- Exclusion from management or failure to provide information in the context of a quasi-partnership or where an agreement renders such conduct inequitable.
If the applicant can show that it is just and equitable for the company to be wound up, the court will order for the company’s winding up. The court may order a staggered winding up to prevent any abuse of process. In considering whether the claim should succeed, the court will consider whether the petitioner has an alternative means of resolution – for example where a shareholders’ agreement provides for a share buyback or where the petitioner could have pursued an unfair prejudice petition in some circumstances.
It is important for a shareholder to consider tax consequences on a company’s winding up and this is where our expertise proves to be crucial. We have experienced tax solicitors and a chartered tax advisor on hand to provide bespoke advice.
Minority shareholders rights: alternative options
As with any court application, the court will consider the applicant’s conduct prior to bringing a claim. With the courts increasingly urging parties to seek to resolve disputes without the need for a court application, there are various alternative methods of dealing with minority shareholder disputes, as follows:
- Bringing in a third party (mediator/arbitrator) in an attempt to reach an amicable settlement.
- Have a continuing shareholder buy out the aggrieved shareholder.
- Have the company buy back the aggrieved shareholder’s holding.
All of the above methods can be included in a shareholders’ agreement on a company’s incorporation, or later. However, as with other methods, tax considerations cannot be ignored. This is where we differentiate; we consider the commercial consequences of any shareholder dispute and their effects.
Track record of resolving shareholder disputes
The vast majority of our matters settle without the need for court action. We achieve results by negotiation and sometimes mediation. Avoiding court means the legal costs are much lower. Examples of our recent instructions include:
- Acting for a minority shareholder seeking to wind up a digital media company following a breakdown in management/deadlock. We presented the petition for the company’s winding up and then successfully resolved the dispute, using the petition as leverage for successful negotiations.
- Bringing a derivative claim on behalf of an aggrieved shareholder following a director’s breach of duty to a leading UK electronics manufacturer.
- Successfully bringing an unfair prejudice action on behalf of a shareholder seeking to sell their shares following voting lock-out in a regional software company.
- Acting for a shareholder seeking to wind up a company following loss of substratum rendering the carrying out of the purpose for which the company was incorporated impossible.
Case study: minority shareholders rights protected
We recently acted for a minority shareholder of a regional software company and succeeded with an unfair prejudice petition. The court granted an order in favour of our client, to which our client was ordered to sell his shares to the majority on favourable terms. This entitled our client to:
- An independent valuation for the value of his shares, receiving full market value on sale.
- Compete with the company after the sale of his shares had completed.
- His full costs of presenting the petition and the costs of the independent valuer borne by the majority purchasing his shares.
Minority shareholders rights: the facts
Our client was one of three shareholders in the regional software company and an initial contributory. The company had no shareholders’ agreement, and standard form articles. The company traded successfully for a period of five years from incorporation. All of the shareholders worked in the company as employees, all with differing roles, our client responsible for customer service and business management, with the other two shareholders responsible for business development and marketing strategies. The three shareholders were also directors.
Shareholder dispute and company mismanagement
As the company’s profits grew, our client continued to provide service to customers and manage the business’s affairs. The other two shareholders, possibly through the company’s good trading, chose not to continue with their duties as employees. They also neglected their duties as directors, both choosing to focus on outside business interests, through separate corporate vehicles, all in conflict with the company – a clear breach of duty.
Shareholder dispute: offering an exit route
Our client sought our advice. We offered the two shareholders the chance to buy our client’s shares, with a 12 month post-sale restriction on our client to prevent damage to the company, and the value of our client’s shares valued by an independent valuer. After initial correspondence, it became apparent that the two shareholders had no interest in negotiations, rather intent on damaging the company through their directors’ breaches and excluding our client from discussions on the management of the company’s affairs. This correspondence was all “without prejudice save as to costs” to protect our client’s position on costs after trial – see below.
What we argued
We then advised our client to issue an unfair prejudice petition, as neither the articles, nor any shareholders’ agreement, provided for an exit and our client had offered to exit on reasonable terms. We presented the petition, asking the court to:
- Order the sale of our client’s shares to the majority.
- Have the value for our client’s shares determined by an independent valuer, on the assumption that the business would continue in the position it was before the two shareholders breached their duties as directors and employees, i.e. with our client managing customers and the business’s affairs, and the two shareholders complying with their respective duties.
- Order our client his full costs in presenting the petition, and order for the majority to pay for the valuer’s fees.
The majority argued that: firstly, their conduct was not unfair, nor prejudicial, and secondly, that our client should be bound by a restrictive covenant for a period of 24 months to protect the value of the company and prevent competition.
The court’s order
The court granted the order in favour of our client. The court held that our client had continued to comply with his duties, while the other two shareholders chose to neglect their duties as directors in a deliberate attempt to drive our client out of the company. Their conduct was both unfair on the minority, and prejudicial given our client was excluded from management.
The court rejected the majority’s request for a restrictive covenant. The court held that their conduct did not warrant a restriction, and in any event, it did not have the correct jurisdiction to impose a restrictive covenant. If the majority could show corporate documents containing such a restriction, then the court would entertain its application or vary its length: the majority could not.
Shareholder disputes and costs
The court then went on to consider costs. Our pre-action correspondence proved to be crucial. We offered a 12 month restriction in pre-action correspondence in the hope that court action could be avoided: this was rejected by the majority. The majority would have been better off to accept our pre-action correspondence offer, rather than risk the case in court. With this in mind, the court granted our client his full costs, and ordered the majority to pay the full costs of the valuation.
This case shows how dispute resolution tactics can be used to compliment corporate expertise and market knowledge to ensure that your minority shareholders rights are protected – this is where we advise.
With specialist share valuation expertise and our track record of protecting clients facing shareholder disputes, we are able to obtain the best available outcomes to advance your position and protect your minority shareholders rights.
I quickly review documents, match its relevancy to the situation and then advise on the best way forward in practical terms. Why not call me now for an informal chat, and to arrange an informal discussion.