What happens to shares where a director is removed or resigns?

Reputation is key.  What can you do when a director who is also a shareholder brings the business and fellow colleagues into disrepute or has otherwise acted in a way which is damaging the company? Conversely, what are your options if you are a director unhappy with the strategic direction other directors favour or do not want to be associated with potential legal issues which may be brewing.

In many cases a director is also a shareholder. Assuming that a director shareholder does not sell voluntarily the company will have to find a way to compulsorily acquire the shares assuming they can manage sufficient shareholder approval.

Can shareholders remove a director?

Generally, the answer is yes. The first thing to do is to check your company’s articles and any shareholder agreement. If these do not make specific provision (in the case of company articles this would mean standard table a articles having been amended), company law also includes a process which we cover on our page about director removals.

A director may also be persuaded to resign.

What if a director doesn’t want to sell their shares?

The starting point is always whether the company has amended it’s articles of association and/or has a shareholder agreement which anticipates scenarios where the company may want to not only remove the director but also ensure that the director no longer has shares.  Without such provisions, there are difficulties and complications.

Check the articles of association of the company and any shareholders agreement. Are there any provisions which require shares to be compulsorily transferred following the occurrence of a particular event? Note that standard articles won’t help you.

For example, common alterations to standard articles and provisions in a shareholder agreement will require a shareholder to transfer shareholdings in a company where the company has been brought into disrepute or the shareholder is being currently investigated for criminal wrongdoing. These provisions could provide the other shareholders with some assistance.

Can you force the sale of shares when a director resigns or is removed?

In private companies the model articles  do not deal with the compulsory transfer of shares on ceasing to be a director and/or employee. The unwanted director cannot be forced to sell his shares. Forced share sales are only possible if the articles or shareholder agreement makes specific provision or there is consent.  Most people are surprised to learn that the Companies Act is of no assistance when it comes to compulsory transfer.

In deadlock situations usually where the directorship and shareholder is split 50:50 it is possible to apply to the court for an order to force a shareholder to buy out the other shareholder. The courts would want to see efforts made to resolve the dispute before making an order such as mediation.  The court can order a sale of the shares in other cases but the court powers are limited unless the articles permit forced sale.

What are the options if a departing director agrees to sell shares?

There are many ways in which the shares can be acquired from the unwanted director by consent.  The director should not resign until agreement for the shares is reached.  Apart from the commercial leverage that may be secured by remaining a director there can be tax savings.

Choices if the unwanted director wants to sell  shares are:

• Transfer the shares to existing shareholders – this choice may not be a good idea if it means that shareholder control shifts in unintended directions;
• The company buys back the shares and cancels them – this means that shareholder control remains in place. There are various ways to approach a company buy back which can lead to a tax efficient position for the director depending upon the circumstances. If the company wants to buy back the shares from the unwanted director but does not have sufficient cash to pay for the shares in one payment it is possible to structure share buy backs whereby payment is made in stages;
• Setting up an employee benefit trust – funded by the employer to purchase the shares and hold them for the benefit of other employees;
• Buy back the shares and hold them in treasury until a purchaser is found;
• Restructure – the business could be re-structured and divided up into new groups using existing shares. Some re-organisations can be tax neutral and HMRC do provide clearance.

Negotiating exit with a shareholder director

In practice the power of negotiation will depend upon commercial factors such as the value of the shares.  For example, if the unwanted director is a bad leaver having committed gross misconduct the articles may stipulate that the shares are bought back at no premium.   In other cases the value of the shares will need to be agreed between the parties which is difficult in private companies where there is no market. An independent valuation may break the deadlock.

Well drafted articles anticipate the complications for dealing with unwanted directors and shares and set out the choices as a process to follow.  The process then gives certainty which is important if the Company is to move on.

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