The legal process to resolve a shareholder dispute depends on whether you are the shareholder taking action or whether the action is being taken against you as another shareholder, a director or against the company itself. A company is its own legal entity with its own legal personality. The company is separate from its directors and shareholders.
Here we have outlined some of the steps involved in resolving such disputes.
When a dispute arises
Shareholder disputes arise for various reasons, such as:
- Misappropriation of assets such as ongoing unauthorised withdrawals
- Dilution of shares
- A refusal by the company’s directors’ to pay reasonable dividends or disagreement over the company’s dividend policy and how profits should be distributed
- Mismanagement of the company by its directors
- Breach of directors’ duties which can be fiduciary duties and non-fiduciary duties which require the directors to act not out of self-interest, but in the best interests of the company and to a certain standard of skill and care
- Failure by the directors to provide information to shareholders or inadequate information disclosure, which does not allows shareholders to make informed decision due to relevant information having been withheld or misrepresented
- Shareholder deadlock or stalemate where there is no decisive vote on the company’s direction or strategy and there are divergent business views
- Relationship breakdowns for family businesses
- Minority shareholders feeling overlooked through perceived unfair treatment
- Conflicts of interest between the personal interests of the directors in a transaction or decision and the interests of the company
- Actions or omissions that could tarnish the company’s reputation
- Majority shareholders misusing their authority against minority interests
- Breaches of the shareholders’ agreement or articles of association
Having a clear shareholders’ agreement in place is likely to save time and money by mitigating the risk of disputes arising. It can help to resolve disputes faster and more cost-effectively if they do arise.
The Legal Path for Resolving Shareholder Disputes and Pre-litigation Considerations
Understanding Company Documentation
The first step in resolving shareholder disputes is to thoroughly review the relevant company documents. These include any shareholders' agreement, articles of association and any other legal contracts that might be in place. These documents often specify the procedures for decision-making and dispute resolution within the company. They may also outline the rights and responsibilities of both majority and minority shareholders. It is strongly advisable to obtain legal advice at an early stage.
Exploring Alternative Dispute Resolution (ADR) Methods
Before resorting to legal proceedings, you should consider alternative dispute resolution methods such as mediation or negotiation. These methods can often resolve disputes more amicably, without the need to go to court. Mediation involves the appointment of a neutral third party mediator who facilitates communication between the parties with the aim of enabling them to find a mutually acceptable settlement. Negotiation can be conducted either directly between the parties or by the parties with the assistance of their lawyers.
Legal Proceedings and Types of Remedy
If alternative dispute resolution methods fail, court intervention may be necessary. Depending on the nature of the dispute, this could involve making an Unfair Prejudice Petition under section 994 of the Companies Act 2006, bringing a Derivative Claim or, as a last resort, making a Winding Up petition which results in the company ceasing to exist. These types of legal process could result in the court ordering a company to take or not take a certain action, such as purchase shares from a shareholder. Legal proceedings can be complex and time-consuming, so it's essential to seek legal advice before going down this path.
In all cases, it's crucial to remember that every shareholder dispute is unique. The most appropriate course of action will depend on the circumstances of each case, the specific provisions in the company documentation and whether you are bringing the action against another shareholder or the company itself or are defending a petition or claim.
Consideration of Minority and Majority Shareholders’ Rights and Responsibilities
Under Section 994 of the Companies Act 2006, minority shareholders may petition the court if they believe that the company's affairs are being conducted in a manner unfairly prejudicial to their interests. Directors of a company have a responsibility to act in the best interests of the company and consider the interests of all shareholders in accordance with section 172 of the Companies Act 2006.
Unfair Prejudice Petition: under Section 994 of the Companies Act 2006, this provision protects the interest of minority shareholders.
Minority Shareholders' Rights: as well as having legal recourse by filing an unfair prejudice petition, minority shareholders holding 5% or more of the voting rights of a company can also call a general meeting.
Derivative Claims: shareholders, including minority shareholders, can bring a claim against a director for breach of duty, negligence, default or breach of trust under Section 260 of the Companies Act 2006. This allows shareholders to hold directors accountable for their actions.
Just and Equitable Winding Up Petition: a shareholder can petition the court to wind up the company on just and equitable grounds. This is typically used as a last resort when there is a deadlock in the management of the company or the majority shareholders have acted in their own interests to the detriment of the shareholder filing the petition.
Directors' Fiduciary Duties: directors have a duty to act within their powers, promote the success of the company, exercise independent judgment, exercise reasonable care, skill and diligence, avoid conflicts of interest, not accept benefits from third parties and declare any interest in proposed transactions or arrangements.
The Company's Constitutional Documents
Both a shareholders' agreement and the company’s articles of association are crucial documents in the formation and governance of a company as well as its success. They serve different purposes, however, and have different characteristics.
A shareholders' agreement is a private contract between the shareholders of a company. It sets out the rights, responsibilities, liabilities and protections for each shareholder. An effective shareholders’ agreement should be drafted to cover areas such as voting rights, decision making processes such as procedures for selling shares, dividend policies including dividend distributions, dispute resolution mechanisms and more.
The agreement is flexible and can be tailored to meet the specific needs of the company and its shareholders. It is not publicly available and can include confidentiality provisions. A shareholders’ agreement should be regularly reviewed and updated to keep it compliant, relevant and useful. If kept up to date, a clear shareholders’ agreement will clarify rights, obligations and the company’s dispute resolution procedure.
Articles of Association
In contrast, the articles of association are available in the public domain as a public document that sets out the rules for running the company. They cover areas such as the appointment and removal of directors, conduct of board and general meetings, voting rights of shareholders and allotment and issue of shares.
The articles of association must comply with the Companies Act 2006 and are registered with Companies House, which is how they are made accessible to the public. Any amendments to the articles require a special resolution, which requires approval from at least 75% of the company’s shareholders.
What if there is no Shareholders’ Agreement?
It is not compulsory to have a shareholders’ agreement and not every company will have one, especially smaller companies. Where no shareholders’ agreement exists, there will be fewer rules governing how to operate the company and what to do if things go wrong. The directors and shareholders will instead be guided by the provisions of the company’s articles of association, the Companies Act 2006 and case law, meaning rules created through court judgments.
Can the company’s own funds be used to pay legal fees in a shareholders’ dispute?
No, it is a well-established principle that a company’s funds must not be used to pay legal fees and costs incurred in a dispute between its shareholders. As always, however, the answer for each case depends on its own specific facts and there have been attempts in recent years to create exceptions to this general rule.