Minority Shareholders and Their Rights
Dinah Spence and James Pheasant examine what rights minority shareholders have in company disputes a situation that could affect both practitioners and their clients.
Let us begin by painting a picture.
A Ltd is a SME with an annual turnover of £1520m. It is owned and controlled by three old friends, business partners of longstanding who decided ten years ago to give up their day jobs and go into business together. All three are directors. They agreed from the outset to take broadly equal amounts out of the company.
However, the shareholding is not split equally between them. One member has 58% of the issued share capital, the other two have 21% each. All three directors play a full role in the management of A Ltd. They operate by consensus and formal board meetings are rare.
Sounds familiar? This is how many SMEs and family companies are run. All is well whilst the members get on with one another and are happy with the direction the business is headed.
But what happens when clouds appear on the horizon, when the majority shareholder sees the company as their own to do with as they like, or when they want to eject a director who is also a shareholder? Surely, subject to having sufficient voting power to carry an ordinary or special resolution, the majority rules?
A minority shareholder is not entirely impotent. The Companies Acts have always contained provisions giving a minority shareholder leverage to curb the excesses of the majority. However, generally these provisions are little use against a majority shareholder determined to execute their plans. In these circumstances, the minority shareholder will need to apply to the court for protection and relief.
In many circumstances, a minority shareholder may be affected by a wrong done, not to them personally but to the company by the majority. For example, diversion of contracts from the company to the directors personally.
The minority shareholder faces an impossible task in attempting to force directors into bringing an action against themselves. In certain circumstances the courts will allow a minority shareholder to bring a claim in the companys name.
The minority shareholder has no greater right to relief than the company would have were it to bring an action itself. Any financial award accrues to the company itself.
All shareholders have rights that they can enforce against the company and other shareholders whether or not a formal shareholders agreement has been reached. These include objection to alteration to the Memorandum and Articles of Association, the variation of class rights, the giving of financial assistance and the enforcement of directors duties, prevention of ultra vires transactions and in relation to certain take-over offers.
The Memorandum and Articles of Association represent a statutory agreement between the shareholders and the company as to how the company is to be run. The court will enforce a breach of that agreement. An otherwise proper attempt to vary the articles can be actionable if it affects rights already in existence or the majority has not acted in good faith.
The most important protection that a minority shareholder has is the right to petition the court for an order under s459 of the Companies Act 1985. This action is founded on an allegation that the affairs of the company are being conducted by the majority in a manner unfairly prejudicial to the interests of members generally, or to some part of its members (including the applicant).
The relief sought is normally an order that the other shareholders (or the company itself) purchase the minority shareholding at fair value. An order providing for a clean break will be preferable.
However, the court has complete discretion and, if the circumstances warrant, can even order the minority shareholder to purchase the shares of the majority.
The court can, and will, make orders to adjust the unfair prejudice that the minority shareholder has suffered. For example, the court may order the company to be valued on the basis that the benefits taken by director/shareholders in breach of fiduciary duty be repaid.
The court will also decide at what date the company should be valued and whether there should be any discount to reflect the minority shareholding.
The court can also make an order regulating the conduct of the companys affairs in the future; require the company to do or refrain from any act and authorise civil proceedings to be brought in the name of the company.
Just and Equitable
S122(1)(g) Insolvency Act 1986 grants power to the court to wind up the company on just and equitable grounds. The applicant must satisfy the court that there is an adequate surplus for distribution to the members after a winding-up.
The applicant must also satisfy the court that they have clean hands meaning that if the applicant can be blamed for some of the matters they complain of then the court may not grant their application.
An application for just and equitable winding up can be used by the court as an opportunity to look into the companys internal affairs. Although the burden rests on the applicant to demonstrate that the circumstances warrant intervention, the courts are willing to consider the motivation driving a companys actions.
The type of situations that might merit a just and equitable winding-up include the exclusion of a minority shareholder from management or the breakdown of confidence in the management of the company.
A Ltds members have a falling out. The majority shareholder is advised that they have sufficient voting power to exclude the others from management of the company under s303 of the Companies Act. They call an EGM and pass the resolution. They decide to take advantage of pre-emption rights in the articles and makes a number of low offers reflecting a high discount for the fact that the shareholdings are minority holdings. These are rejected.
The minority shareholders say that they have an expectation of being involved in the management of the company; that the company was a quasi-partnership.
This means that the way that they joined together to form the company and the way that it has been run since have given rise to an understanding that each of the shareholders would participate in management. They say it is unfair to exclude them. They also say that this means that their shares should be purchased by the majority without a discount.
Who is right depends very much on the facts. It is not safe to advise the majority shareholder that a minority discount applies in every case. Nor is it safe to advise the minority shareholder that, if trust and confidence among shareholders has broken down, their shares should be bought at fair value.
There certainly is no such thing as a no-fault divorce in company law.
Dinah Spence is a Partner and James Pheasant a Trainee Solicitor in the Commercial Dispute Resolution Group at Charles Russell. For further details, telephone 020 7203 5170 or e-mail firstname.lastname@example.org.