Shareholder vs director dispute
- John Deane
- Updated: Fri, 17th Feb 2017
The shareholder vs director dispute is not uncommon. It can get nasty quickly leaving the shareholder feeling his investment is declining in value. To help shareholders decide how to handle the dispute we plot a likely road map for dissatisfied shareholders to consider.
Shareholder vs director – common questions
- What rights do shareholders have in private companies if there is a director dispute?
- How can shareholder vs director disputes be resolved out of court in practice?
Based on our practical experience of dealing with shareholder and director disputes we address the questions commonly raised.
Rights of a shareholder in dispute with a director
The choices available to shareholders depend upon:
- The nature of the director dispute;
- The terms of the director’s service agreement;
- Rights of shareholders under the articles and shareholders’ agreement; and
- The Companies Act which regulates rights for shareholders.
Armoury available to shareholders
By way of summary the armoury available in a shareholder vs director dispute includes:
Easy step – rely on written agreements
The best position for a shareholder dealing with a director dispute is to rely on documentation which enables the shareholder to force a director to resign and if he is a shareholder sell his shares. However, in many cases we see such documentation does not exist which is why the dispute exists.
Next step – use of the Companies Act
It may be possible for a shareholder to force the director to resign the office of director by using his powers under the Companies Act. Under the Companies Act on a vote of 51% of shareholders the director can be forced to resign from office. The Companies Act may have been over ridden by the articles and or shareholders’ agreement placing a higher percentage of shareholder votes required to force a director out. We do check this point out.
Director is also an employee
The problem with the Companies Act route is it gets the director out as acting as a director but does not terminate the employment. The employment contract can only be terminated by the company acting under its directors. Shareholders do not have the power to terminate the employment contract.
Some director employment agreements provide that if the directorship is terminated the employment is automatically terminated. However, many shareholders do not have the benefit of such provisions. Either there is no written director agreement or it is silent on this point.
Director is also a shareholder
A further problem often encountered by shareholders is that the director is also a shareholder controlling sufficient shares to be able to block ordinary or special resolutions. Shareholders cannot force another shareholder to sell shares unless express rights are reserved in the articles and or shareholders’ agreement.
Litigious step – shareholder claims against directors
If the shareholder finds himself powerless to resolve a dispute using easy steps they will have to consider court action. We outline how this works below.
Shareholder vs director court claims
Where a director is guilty of a breach of fiduciary duty and the company fails to act the shareholders can step into the shoes of the company. The shareholders have two potential claims to consider:
- It is open to shareholders whose position is being prejudiced by the company’s inaction to bring an unfair prejudice claim.
- Another route is a “derivative” claim under the Companies Act.
The outline position is as follows.
Unfair prejudice claim brought by a shareholder against the company
An unfair prejudice claim is where the shareholder claims to have been unfairly prejudiced. An unfair prejudice claim is usually brought by minority shareholders although there is no legislative requirement to hold a minority interest.
An unfair prejudice claim may work where the shareholder vs director dispute involves a director who is also a controlling shareholder and who is taking steps which de-value the minority’s share value.
The likely result of a successful unfair prejudice claim is for the court to order the purchase of shares from the party the court determines is at fault. Alternatively, a company buy back of shares could be ordered by the court. The court can direct that the price for the share sale is determined by an independent valuer so that there is fairness. The outcome is very fact specific.
Risk to the shareholder under an unfair prejudice petition
In bringing an unfair prejudice claim, the shareholder would have to front his own legal costs. If the claim is successful the court will usually order that the losing director pays the winning shareholder(s) legal costs. However, the winner will never recover all of his legal costs.
Risk of bankruptcy for the director
The financial position of the director needs review before embarking on a claim. An inability to pay legal costs if he loses adds additional expense for the shareholders in practice. But an unpaid costs order can cause the shareholders to make the director bankrupt – something many directors will fear. The threat of bankruptcy can lead a director to settle the matter.
Derivative claims brought by a shareholder against the company
A derivative claim is essentially the shareholder stepping into the shoes of the company to take action that the company should have done. A common example is dismissing a director. What constitutes a breach of fiduciary duty can be difficult to establish. There is often never a clear cut case but typical examples include not devoting sufficient time to the business, conflicts of interest and dishonesty.
By pursuing a derivative claim the shareholders could obtain a court order forcing the removal of a director. If the director is also a shareholder the can order that the director is forced to sell his shares. The usual remedy in a deadlock situation is for the sale of shares as the company is moribund.
Less risk for shareholders
A successful derivative claim is regarded as for the benefit of the company. As such, the company is liable for the legal costs. But, in practice, derivative claims are fairly rare. That is not to say they do not make an effective threat used to settle the shareholder vs director dispute.
Shareholder vs director dispute can result in winding up the company
Shareholders can wind up a company which is solvent and divide the assets in proportion to the shareholdings. Invariably this means that the goodwill value of the business is lost. If the business were sold as a going concern the price achieved by shareholders includes the goodwill. Often the main value of the business is its goodwill where it has a strong trading history but not much in the way of capital assets.
The winding up petition requires 75% of shareholders to vote in favour. Therefore in many cases a solvent winding up is not an option.
If the company was insolvent it has to be wound up and put into administration or liquidation. Pre-pack arrangements are a possibility where the business is bought from the administrators.
Risk to shareholders if company is insolvent
The administrator dealing with an insolvent winding up has to sell to the highest bidder. The risk is the shareholder may not be the highest bidder.
Shareholder vs director disputes – ideas for resolution out of court
It is always preferable to seek a negotiated agreement. If a settlement agreement can be agreed with the director under which, in return for a pay off, the director resigns and all claims the director may have are extinguished. The size of the pay off depends upon the director’s contractual rights and conduct. Based on past experience we provide guidance on suitable pay offs.
Sale of shares
We do deal with settlement agreements which are linked with the departing director being forced to sell his shares. If the parties can agree on a sale price there are many ways of structuring the sale to cater for payment terms, conditions and timing. This may be painful but usually not as painful as litigation. The basis of valuation of a company where there is no formula provided for in the articles of association or shareholders agreement is seldom free from argument. Valuation of shares in private companies is another area where we can provide guidance.