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

Boardroom and shareholder disputes can arise for many reasons. For example,

• 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
• concern over whether the board is meeting its legal responsibilities

They can also arise because directors are stopping money getting 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 boardroom and shareholder disputes in your articles of association or a shareholders' agreement in advance can save you a great deal of time, money and aggravation. Many SME and start-up companies are governed by the default model articles of association. These provide the chairman of the board a casting vote in the event of a deadlock at board level, but do not contain any further provisions to resolve disputes which might occur between directors or shareholders. For this reason, it is often advisable to consider entering into a separate shareholders’ agreement.

Even if you don't have a shareholder's 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 shareholder's agreements often 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 them 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.

If a boardroom or shareholder dispute arises, take early advice

Boardroom or shareholder 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.

As a first step, it is important that you understand the provisions of your company’s articles of association. Many start-up and SME companies are governed by a default company constitution, known as the model articles of association (or ‘model articles’). 

If your company has a shareholders’ agreement, you should also ensure you fully understand the terms contained.

If in any doubt about the meaning of any terms, you may need to instruct a new solicitor who has not acted for the company previously.

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

A shareholder or director who works in the business may also be an employee, even if there is no written contract of employment. Therefore, they 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.

In particular, if you are seeking to remove a director from their position, you must account for their rights as an employee and there is a very specific procedure that must be followed. 

In a boardroom or shareholder dispute 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 chairperson having a casting vote if there is a tie. This is the case for many SME and start-up companies, who use the default model articles of association. The majority on the board can therefore force through any decision that is made at board level (provided they turn up to board meetings). If your company does not use the model articles, you should ensure you understand who controls how board decisions are to be made.

If your company has a shareholders’ agreement, this can often state 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. For example, there is a duty to act in the best interests of the company.

If you breach your responsibilities as a director, you could be made personally liable to pay over any profit you have made to the company, and to 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 where there is, or might be, any other sort of direct or indirect conflict between your personal interests and those of the company). You would need the approval of the shareholders or of the independent directors on the board (ie those directors who are neither directly nor indirectly involved) to authorise this.
• 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, if you don't declare to the board any direct or indirect personal interest you have in a proposed contract or other dealings your company intends to have with a third party.

3. Are you in control of shareholders' meetings?

Even if you control the board, you will be vulnerable unless you also have control of shareholders' voting rights. Some matters can't be decided by the directors but have to be referred to the shareholders for a decision. Different shareholder decisions (called 'resolutions') require different majorities - having a simple majority of the votes on a shareholders' resolution isn't always enough to ensure it will be passed.

If you can cast more than 75% of the votes on a shareholders' resolution, you can always force through any decision. 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 (a 'special resolution') and which a simple majority (an 'ordinary resolution') depends on the Companies Act, your articles of association and any shareholders' agreement. 

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?

Some private companies are set up with provisions in the articles and/or a shareholders' agreement restricting the way that shares can be sold. You should check the provisions of your shareholders’ agreement and articles for any such restrictions.

The default model articles of association, used by many SMEs and start-ups, require any share transfer to be approved by the directors. In practice, it is unusual for the directors to reject a proposed share transfer, as the right to refuse must be exercised in good faith and in the best interests of the company. The directors cannot allow their personal opinions or interests to affect any decision.

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 if 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 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. In addition, if your company becomes insolvent as a result of a prolonged or unresolved dispute, your conduct as a director will be reviewable by any administrator or liquidator. 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 their interests. These are personal actions, not actions brought by the company. You can't stop a shareholder bringing one against you simply because you control the board and/or shareholder voting rights.

Actions like this 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 them.

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.

If there is a threat of any such unfair prejudice claim, you should always take advice on your specific circumstances.

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 ask that the company be wound up at the same time as they petition for unfair prejudice (see above), citing the same facts in support of each claim.

As with any unfair prejudice claim, you should seek advice if any such action is being threatened.

What can you do to protect yourself in a boardroom or shareholder dispute?

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 out the aggrieved shareholder at a fair price
• the company buys back the aggrieved shareholder's shares 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 them out, it can help to demonstrate that you have not have acted 'unfairly' and that 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.