Dealing with boardroom and shareholder disputes

Boardroom and shareholder disputes can arise for many reasons. When they do it is important to understand the legal rights of all parties and the options available as well as the consequences of allowing things to get worse. However, there are some options which help to ease the pain.

Types of boardroom and shareholder dispute

Disputes can arise for many reasons eg disagreements over the direction and development of the company, poor personal relationships, conflicts of interest (because a director has interests in another business), a lack of performance on the part of one shareholder/director, the terms of directors’ service contracts, or concern over whether the board is meeting its legal responsibilities. They can also arise because directors are stopping money getting through to the shareholders by paying themselves high salaries, or keeping money in the company (for a rainy day) when shareholders think it should be paid out as dividend.

Anticipating disputes and catering for them in advance

Anticipating and providing for disputes in your articles of association or a shareholders’ agreement in advance can save you a great deal of time, money and aggravation. Even if you don’t have an agreement it is often helpful to discuss in advance how the company is to be run and what each shareholder can do in various situations in the future. This can highlight potential difficulties at an early stage.

Articles or agreements usually say that in the event of a dispute mediation should be used first. Mediation, using an independent neutral, can help avoid a dispute escalating and do away with the posturing and position taking which can get in the way of a solution which protects the business and kills the harmful dispute. If mediation fails, the articles or agreement may also set out a mechanism for the shareholders to part company. Common examples are for the aggrieved shareholder to have the right to require the others to buy him out at a fair price; or each side must offer to buy the other out, and the one offering the highest price can buy out the shares of the other.

Take early advice

Disputes escalate because the parties don’t find out exactly what their legal rights are at the outset, and don’t understand the options for enforcing these. The longer you put off taking advice, the more time and money you will eventually spend sorting it out, and the more it will damage your business. Act at once. You may need to instruct a solicitor who has not acted for the company.

Understand the differences between being a shareholder, a director and an employee

A shareholder/director who works in the business may also be an employee even if there is no written contract of employment. Therefore, he will have employment rights just like any other employee. If someone is making a fuss be clear about their role within the company before taking any action against them.

Know your legal rights

Key questions are:

1. Are you (and your colleagues) in control of the board? Most decisions in a company are made by the directors, by majority vote, with the chairman having a casting vote if there is a tie (although always check your articles of association to make sure). The majority on the board can therefore force through any decision that is made at board level (provided they turn up to board meetings).

Sometimes the shareholders agree that these normal rules do not apply and that some or all important decisions by the Board or shareholders need to be passed unanimously. Make sure you know what documents apply. If in doubt, take advice on what you can and cannot do.

2. Have you acted properly as a director? If you forced through a decision at board level, it could be challenged if you have acted improperly. You have legal duties and responsibilities, owed to your company. eg there is a duty to act in the best interests of the company. Breach them, and you could be made personally liable to pay over any profit you have made to the company, and reimburse it for any losses it has made. You may be covered by Directors’ and Officers’ Liability insurance, or your company may have agreed to indemnify you, against certain liabilities, but the best strategy is to act properly in the first place.

You would be breaching those duties if:

• you use company property for personal use
• you divert a contract that your company could have won to another business you own (or there is any other sort of conflict between your personal interests and those of the company), without approval of the shareholders or of the independent directors on the board (ie those directors who are neither directly nor indirectly involved)
• you fail to meet the minimum threshold required of someone with your functions in the company - for example, if you are the finance director, but you fail to keep proper accounting records or monitor the company’s solvency
• you don’t comply with your company’s articles of association, or you fail to comply with the Companies Act - for example, you don’t declare any direct or indirect personal interest you have in a proposed contract or other dealings your company intends to have with a third party, to the board

3. Are you in control of shareholders’ meetings? Even if you control the board, you will be vulnerable unless you also have control at shareholders’ meetings. Some matters can’t be decided by the directors but have to be referred to the shareholders for a decision. Different shareholder decisions require different majorities – having a simple majority of the votes at a shareholders’ meeting isn’t always enough to control it.

If you can cast more than 75% of the votes at a shareholders’ meeting, you can always force through any decision (called a ‘resolution’) at shareholder meetings. If you can cast more than 50% of the votes at a shareholders meeting, you can force through some resolutions, but not all.

Which resolutions require a 75% majority, and which a simple majority, depends on the Companies Act, your constitution and any shareholders’ agreement. Take advice on your specific circumstances.

One resolution that can always be passed by majority vote at shareholders’ meetings is a resolution to remove a director from office. This power is enshrined in the Companies Act, though the director has the right of appeal. The threat of removal can sometimes stop a minority shareholder who is on the board from taking things further. Take advice before acting – the procedure is complicated and lengthy; and you will often have to pay compensation for unfair dismissal.

4. Are there any restrictions on the way that shareholders can sell their shares? Many private companies are set up with provisions in the Articles and/or a shareholders’ agreement restricting the way that shares can be sold.

What happens if you get it wrong?

Minority shareholders can make a procedural nuisance of themselves. They may allege that you have not acted properly as Director. More importantly, shareholders have significant remedies if they have been ‘unfairly prejudiced’, or it is ‘just and equitable’ that the company be wound up.

Getting embroiled in any of these sorts of action is both time-consuming and expensive. If there is a threat of any such action always take advice on your specific circumstances, in order to try and avoid it.

Actions against you as Director

If you haven’t acted properly as a director, you may still be safe. It is the company that has been wronged if you breach your duties, so it is the board that decides whether to take action against you. Obviously you will not do this if you control the board!

However, it is now possible for someone else to apply to the court for permission to bring an action on behalf of the company — what lawyers call a ‘derivative’ action. It is dangerous to assume that you will get away with improper conduct and it can put you in a position of weakness later on.

‘Unfairly prejudicing’ a shareholder

The biggest danger is that any shareholder can take you to court on grounds that the company’s affairs have been conducted in a manner which is ‘unfairly prejudicial’ to his interests. These are personal actions, not actions brought by the company, so you can’t stop a shareholder bringing one against you simply because you control the board and/or shareholder meetings. They consume time and money, and are a major distraction from the business. You can’t use the company’s money to fund your defence - if you try, the other side may take out an injunction to stop you.

If an unfair prejudice claim against you succeeds, the court can grant any remedy it thinks is fair. For example, it can order you to buy the aggrieved shareholders’ shares at a fair price, or order you to sell your shares to him.

In private companies, ‘unfair prejudice’ actions are often based on a failure to fulfil the ‘legitimate expectations’ of the aggrieved shareholder about what the company was set up to do, and how it would be run. For example, if it was agreed (formally or informally) that:

• the company would carry on a particular business
• all would be entitled to an equal say in how the company is managed
• the directors would be fair when deciding on the salaries to be paid, the amounts to be kept in the company to fund growth, and the dividends to be paid out

and you act contrary to these legitimate expectations, the court may intervene.

Shareholder’s powers to wind the company up

The court has a general power to wind a company up, on a shareholder’s application, if it is ‘just and equitable’ to do so. Like an unfair prejudice action, you can’t stop this action being brought even if you control the board and/or shareholders’ meetings. An aggrieved shareholder will usually also ask that the company be wound up at the same time as he petitions for unfair prejudice (see above), citing the same facts in support of each claim.

What can you do to protect yourself?

1. Understand what is important to the other party and why the dispute has arisen. Put yourself in their shoes and try to understand what they want to achieve rather than looking just at the legal rights and wrongs. Are there any practical steps which could be taken which might solve the current problems? It can be helpful to speak to a professional adviser.

2. In the first instance, aim to negotiate, rather than rely on your strict legal rights. It is almost always quicker and cheaper to negotiate a solution (if necessary using your strict legal rights as bargaining counters) rather than end up in court. Ideally, reach a solution that implements practical changes which enable the aggrieved shareholder to stay in the company. If that is impossible, common options are:

• the other shareholders have to buy him out at a fair price
• the company buys his shares back at a fair price

3. Make a reasonable offer to the aggrieved shareholder. The courts are keen to encourage settlement in shareholder disputes. If you have made a reasonable offer to the ‘aggrieved shareholder’ to buy him out, you will not have acted ‘unfairly’ and it will not be ‘just and equitable’ to wind the company up. The courts have set out guidelines for such an offer. It is therefore vital to take advice on the terms of any offer you make.

If you submit to mediation or alternative dispute resolution, you are also unlikely to have acted ‘unfairly’.

4. Always take advice early to save cost and time.

For further information on resolving boardroom disputes, see Shareholder and boardroom disputes: 20 FAQs.