Minority shareholders can enforce their rights in a number of ways. Each case is different and brings not only legal points but in practice personality issues. Here we describe cases that demonstrate the choices and possibilities that minority shareholders can use to enforce rights.
How minority shareholder rights have been enforced
Overview of the framework minority shareholders need to consider
An individual can carry three different hats all giving rise to different rights and responsibilities:
- A director registered at Companies House – known as a statutory director. This role carries fiduciary responsibilities.
- An employed director (who may or may not be a statutory director). This role carries employment law obligations.
- A shareholder. This role is completely different from the role of a director. There is the potential for a conflict of interest.
The view of the court
The courts recognise that shareholders have an interest in maintaining the value of their shares.
In considering the value of a minority shareholding, in the absence of articles and/or a shareholders’ agreement setting out how the shares will be valued, the court will make a number of assumptions:
- Share values will be arrived at on a pro rata basis of the minority shareholding compared to total issued share capital;
- The value for a particular shareholding will take into account the power or influence that the shareholder possesses. For example, if a key player is departing the court may consider the departure negatively impacts the shares’ value;
- Profits fluctuate so averaged earnings should be taken into account;
- The court is reluctant to accept that shareholders are partners sharing business profits and losses equally.
Enforcing minority shareholder rights
Minority shareholders have many solutions to combat a director’s wrongdoing, or a majority shareholder’s abuse of the company. In practice, few cases ever reach court. Normally, we procure a settlement, to avoid costs and save time. Nevertheless, we often need to address legal points in order to achieve a good settlement for a minority shareholder.
Majority shareholder buys out minority shareholder
A leading case is Irvine & Ors v Irvine & Anor. Here a minority shareholder director brought an action against the majority shareholder director for the acquisition of the minority’s shareholding. The minority shareholder held just under 50% of the company’s shares. The minority shareholder claimed he was excluded from managing the company’s affairs. He was not given financial information nor included in business decisions. The minority shareholder’s claim was based on the right in the Companies Act to claim unfair prejudicial treatment of a minority shareholder.
The outcome for the minority shareholder
The court agreed with the minority shareholder. The court stated the company was a quasi-partnership, due to
- The limited number of shareholders;
- Both shareholders being employees and company directors.
The court’s quasi-partnership conclusion meant that the majority shareholder:
- Should have acted as if the minority shareholder was a business partner;
- Was obliged to consult on decisions and provide information.
The court ordered the majority shareholder to buy out the minority shareholder. The court instructed an expert to value the minority’s shares. The experts valuation included a 30% discount on the price per share to reflect the minority shareholding. That meant the minority shareholder received 70% of the whole company value per share.
Other conduct that could amount to unfair prejudicial treatment of a minority shareholder
In other cases the courts have determined that the following acts could amount to unfair prejudicial conduct:
- A profitable company refusing to pay a dividend;
- Issuing shares to individuals “connected” with the majority shareholders, e.g. family members;
- The majority shareholder’s mismanagement of the company’s finances;
- The majority shareholders’ excessive remuneration.
It is unusual, but the court can order that the majority shareholder sells his shares to minority shareholders.
Force company winding up
In the case of Re Brand & Harding Limited, the company’s management was deadlocked. The company’s shareholders could not pass any shareholder resolutions. The directors could not meet to hold a board meeting.
One shareholder petitioned the court to wind up the company. This was on the grounds that the company was deadlocked. This shareholder alleged a complete breakdown in trust and confidence between the parties. The shareholder who brought the action had himself acted improperly and it was found that this had contributed to the breakdown.
The court’s decision
Notwithstanding the petitioner’s misconduct, the court ordered the company to be wound up on just and equitable grounds.
Wider implications of the decision
Deadlock decisions can be avoided if the articles or shareholders’ agreement have been thought out. For example, it is possible to include deadlock provisions such as:
- Issue voting shares to an external independent adviser;
- Appoint a non-executive director; or
- Agree to mediation.
- Include buy out provisions to break the deadlock.
Breaking the deadlock
Buy out provisions can take a variety of forms such as:
Russian roulette buyout
Here, shareholder 1 serves notice on shareholder 2. The notice states shareholder 1’s price for selling its entire shareholding to shareholder 2. Shareholder 2 can either buy the shareholding or sell its shareholding to shareholder 1 at that same price.
Texas shoot out buyout
Here, each shareholder submits a “sealed bid” to the company’s accountant, or other expert. The shareholder that submits the highest bid purchases the company at that price.
Return of lost profits
In the case of Cook v Deeks, the company’s directors obtained, for themselves, a contract which the company could have performed. If the company performed the contract, the company earnt profits, rather than each director. The shareholders claimed against the directors for breach of duty and breach of trust.
The outcome for the company
The court determined that the company was entitled to the contract’s profits. The directors held the benefit of the contract on trust for the company.
Dismissal and disqualification of a director
In the case of Re Sevenoaks, the court ordered a director’s dismissal and disqualification. The minority shareholders claimed the director had:
- Not prepared proper accounting records;
- Used company funds for his own personal benefit;
- Failed to send the required returns and accounts to Companies House; and
- Failed to submit the company’s corporation tax return.
The director was forced by the court to resign immediately.
Wider implications of the decision
It could have been easy to avoid this issue. For example, the articles or shareholders’ agreement could have included powers to force a director to resign if a majority of shareholders vote in favour. A power of attorney included in the documentation would have given the company the right to sign the resignation on behalf of the director being ousted.
Employment contracts can include provisions that ensure if a director’s employment terminates, the director automatically resigns the directorship.
Unfair valuation of the shares
The general rule is that if the articles or shareholders’ agreement deals with how the shares are to be valued and if this is fair the court will uphold the agreement.
The courts are usually prepared to accept that a different mechanism for determining value can apply to different categories of shareholders. For example, it is common to carve out the process for fair value determination when a founder leaves, from the formula applied when an employee or director who in addition to shares has received a salary leaves.
The way that the valuation to be placed on shares is most commonly handled is under good and bad leaver provisions set out in the shareholders’ agreement.
The courts do not substitute their view of fair value if an independent expert has reported on the value. However, if there has been no independent expert appointed, the courts do order the appointment of an expert. The order usually includes that all parties will be bound by the share value arrived at by the expert.
Examples of what can make a valuation unfair for a minority shareholder
The following circumstances demonstrate when the court deemed a minority share valuation unfair:
Inappropriate behaviour by the company which affects the value of the shares
In North Holdings Ltd v Southern Tropics Ltd the relationship between various shareholders disintegrated. A minority shareholder then insisted that the company purchased the shares and the court should determine the share value. A minority shareholder claimed that the directors acted in breach of their fiduciary duties they owed to the company by using its assets to purchase shares from an existing shareholder.
The court observed that where directors behave in breach of their duties to the company, and this diminishes the value of the business, the subsequent depressed share valuation can be deemed unfair.
The method of valuation permits inappropriate minority shareholder discount
In Virdi v Abbey Leisure Ltd the court held that the shareholder did not act unreasonably in refusing a valuation of his shares by the company’s auditor, as provided in the articles, on the basis that the shares might be discounted in circumstances where a discount was inappropriate. The court accepted that it would be just and equitable to disregard the articles where the valuation method was unfair.
Expert not independent
In Re Benfield Grieg Group plc the court rejected a share valuation based on the fact that the company’s auditor valuation differed from the earlier valuation of shares carried out by them for tax purposes for the same period. It was held that the auditors had failed to act independently when valuing the former director’s shareholding, having already compromised their independence by previously advising the company.