Opinion

A guide to minority shareholders' rights

15th August 2019

A guide to minority shareholders' rights

It is not uncommon for shareholders in a company to fall out with either the board of directors or each other.

Here Adam Johnson, an Associate in the Dispute Resolution team at Higgs & Sons, looks at the legal tools available to minority shareholders – who don’t have the voting power to prevent or reverse perceived wrongdoing - to seek proper redress.

 

Articles of Association and/or Shareholders’ Agreement

The Companies Act 2006 confers various basic rights upon shareholders of companies incorporated in England & Wales. The breadth and force of those rights is dictated by the proportion of the shares in the company held by the shareholder in question. 

For example, a shareholder with more than 75% of the shares in the company can pass any resolution placed before the members for consideration.  By contrast, a shareholder owning just over 5% of the shares can do little more than require the board to call a general meeting.

However, it is open to the parties to agree to bolster and/or vary the basic rights conferred by the Companies Act. This is often achieved by negotiating bespoke Articles of Association and/or a detailed Shareholders’ Agreement. Such agreements might confer the following rights on all shareholders:

  • A right to access information regarding the company (such as management accounts)
  • A right to have sight of and approve the company’s annual business plan
  • Enhanced rights to prevent dilution of existing shareholdings through the issue of additional shares to new or current shareholders
  • A power to veto certain proposed actions of the company (such as the sale of certain assets, expenditure over a certain level, termination of material contracts, etc.)

It is highly recommended that the shareholders in any company with more than one member consider entering into such agreements. While the investors in a company often see no scope for falling out at the start of their relationship, it is often too late to change the Articles or impose a Shareholder’s Agreement once the grounds for discord arise.

 

Unfair Prejudice Petition (Section 994 of the Companies Act 2006)

Even with meticulously documented agreements, relationships can turn sour. One of the more powerful weapons available to an aggrieved shareholder is to issue a petition against fellow shareholders and usually also the company pursuant to section 994 of the Companies Act 2006. The benefit of establishing unfair prejudice is that this course of action is particularly effective where the shareholder’s aim is to sell their shares at a fair share value (and can sometimes even be used as a means of taking control of the company from the majority) and no discount is applied for the fact the shareholding is a minority state.

An unfair prejudice petition may be brought on the basis that:

  • the company’s affairs have been conducted in a manner which is unfairly prejudicial to the interests of the shareholder; or
  • an actual or proposed act (or omission) of the company is or would be so prejudicial

In practical terms, the most common complaints forming the subject matter of an unfair prejudice petition include:

  • Directors paying themselves excessive salaries
  • The company failing to declare dividends
  • Breaches of directors’ duties
  • Breaches of the Articles of Association and/or Shareholders’ Agreement
  • General mismanagement of the company
  • Excluding a shareholder from management

The most frequent remedy granted by a Court if it accepts that the petitioning shareholder has been unfairly prejudiced is to order that their shares be purchased by the wrongdoers at fair market value.  However, the Court may make any order it sees fit to remedy the wrongdoing, including:

  • Regulating the future conduct of the business
  • Requiring the company to take a step or refrain from a particular act
  • Less commonly, requiring the wrongdoers to sell their shares to the petitioning shareholder

 

Derivative Claims (Part 11 of the Companies Act 2006)

While it is a particularly complex procedure, a member may seek to bring a derivative claim in circumstances in which the Board (or a particular director) is responsible for an act or omission involving:

  • negligence;
  • breach of the Articles or a Shareholders’ Agreement;
  • breach of directors’ duties; and/or
  • breach of fiduciary duties

Subject to the Court granting permission for the claim to proceed, the shareholder bringing the claim steps into the shoes of the Company. The Company then brings a claim against its own directors.

Part of the attraction of a derivative claim is that the shareholder bringing the claim may be granted an indemnity in respect of all costs incurred in pursuing the action. Even more attractive is that the indemnity is likely to be ordered against the directors in their personal capacity, so the pursuit of the litigation may not have a detrimental effect on the company’s finances.

 

Winding up on the just and equitable ground (Section 122(1)(g) of the Insolvency Act 1986)

In certain limited circumstances, a minority shareholder can wind up the company on the grounds that it is just and equitable to do so. This is very much the nuclear weapon in a minority shareholder’s arsenal and it is a course of action that is rarely available in practice.

In order to have standing to bring the winding up petition, the shareholder would need to demonstrate that the company had historically been operated as a ‘quasi-partnership’ (i.e. there was a close and trusting relationship between the shareholders and an understanding that they would be entitled to participate in running the business).

The shareholder would also need to be able to show that:

  • there is deadlock between the shareholders (such that no shareholder resolutions can be passed);
  • the original purpose of the company has been achieved or may no longer be pursued;
  • the company has been mismanaged; and/or
  • the petitioning shareholder has been excluded from management

In conclusion, Adam said: “There are a wide range of tools available to a wronged minority shareholder.  The issues are often complex and early strategic advice is key to getting matters off on the right foot.

“A well-advised shareholder will invest in the negotiation of detailed and comprehensive Articles of Association and Shareholder Agreements’ at the outset of their involvement with the company.”

 

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