How to resolve shareholder disputes

When you and your shareholders first launch your company, the idea of a dispute developing seems unimaginable. However, as your business grows you might not agree with your fellow shareholders, leading to a dispute. 

You may as a shareholder also raise claims against the directors or the company itself. 

This article considers all manner of shareholder disputes, whether against the company, its directors, or other shareholders (for example, a claim made under a shareholders’ agreement).

A shareholder dispute might be over the direction and management of the company; the level of its profits, and any dividends which flow to shareholders; a particular transaction that some shareholders considered unattractive to the company; distrust and feelings of ill will between shareholders; or a host of other reasons. 

Shareholders fall out for various reasons including:

• The shareholders are also directors, and there are unresolvable conflicts at the shareholder and board levels
• The shareholders are conspiring to outvote the minority shareholders at meetings
• The majority shareholders are also directors of the company and ratify (i.e. sign or give formal consent to) any decision of the directors
• The shareholders have stakes in competitors or are underinvesting in the company
• Allegations of misconduct or dishonesty concerning the shareholders

Shareholder disputes can be resolved in several ways and can arise in respect of public and private limited companies. It’s advisable that you speak with an expert business lawyer who can suggest the right way to approach your type of dispute.

In this article, we discuss the mechanisms for resolving shareholder disputes, issues for shareholders to be aware of in certain scenarios (e.g. IPOs, mergers, and acquisitions), and tips for resolving shareholder disputes.

Mechanisms for resolving shareholder disputes

Rule in Foss v Harbottle

The rule in “Foss v. Harbottle” is a key rule to be aware of in this context. This rule provides that where a third party wrongs a company, the company itself is the proper claimant, not its shareholders. 

If company A enters into a contract with party B and B breaches the agreement, company A can sue B, not a company shareholder.

Derivative claim

A derivative claim is a claim that shareholders can bring against the directors of the company. This can be for breach of their duties (such as to promote the company's success) or negligence, among other things.

Unfair prejudice petition

Another form of shareholder dispute is an unfair prejudice petition under Section 994 of the Companies Act 2006. This is a court application known as a “petition”; the petition is pleaded on the basis the affairs of the company are being conducted in a manner that is both unfair and prejudicial. 

Prejudice can include where shares are issued to dilute the interests of minority shareholders. 

Other examples of unfair prejudice might include:

• Exclusion of minority shareholders from relevant decisions
• The issuance of shares without observing pre-emption rights (this would arise where the shares have not been offered to the existing shareholders before being presented to new potential shareholders)
• Directors not paying reasonable dividends
• Directors approving excessive remuneration for themselves

The court can make an order to purchase the petitioner’s shares at fair value.

Just and equitable winding-up

Shareholders can also seek to wind up a company when it’s just and equitable under s122(1)(g) of the Insolvency Act 1986. A petition is presented to the court. The grounds for a petition commonly include mismanagement, exclusion from management, or a deadlock between the company's key decision makers.

Claim under a shareholders’ agreement

Shareholders’ agreements prescribe and govern the relationship between the shareholders. It’s the first port of call for shareholders to examine their rights and remedies in relation to other shareholders in the company.

Articles of Association and Memorandum of Association

A company’s constitutional documents, available on Companies House, can open doors for litigation by shareholders against one another, the directors, or the company itself.

Personal remedy

A shareholder might have a personal remedy against the company, such as an injunction, order for specific performance, or a claim for damages. 

A personal remedy for a shareholder might arise for various reasons, including as an employee (when there is unfair or wrongful dismissal), or because a deal between the shareholder and the company has fallen apart.

Removal of directors

Where a shareholder leaves a company, they may also resign as a director and as an employee (if they’re also considered an employee). 

The Companies Act 2006 regulates the resignation or termination of directors. If the director is an employee, then employment law will govern their departure. 

A disciplinary meeting is needed if the departure is due to misconduct. This can result in an employment settlement alongside the purchase of their shares.
Shareholders can also remove directors by ordinary resolution. The rules around this are quite detailed and include the circulation of a special notice at least 28 days before the meeting to consider the ordinary resolution taking place. The director is also given notice. Various other rules are in place for a director to be removed by ordinary resolution.

Share buy-back or share transfer

Shares can be repurchased from shareholders by the company, and those shares are then cancelled. This is a highly regulated activity to ensure that creditors are protected. 

Where the share buyback eats into the company’s share capital, further safeguards are put in place to protect the company’s creditors. The company must produce a Statement of Solvency and, for example, issue a notice in the London Gazette, and either in a national newspaper or serve notice on all of its creditors. 

Another option is for other shareholders, directors, or third parties to buy the shares of disaffected shareholders using a share transfer (which is affected by a stock transfer form).

Issues for shareholders to be aware of in the following scenarios

Mergers and acquisitions

Acquisitions of one company by another company are achieved by way of a purchase of shares. When this occurs, the acquiring company becomes a shareholder in the target company. 

Breaches of warranties, for example, in the share purchase agreement as to the economic performance of the target company are a common source of shareholder claims (by acquiring companies). 

A merger typically involves combining two companies to create a new company. The shareholder structure might mirror the equity/value of the two companies, resulting in a 40/60 split in terms of shareholder ownership, for example. 

Mergers can result in disputes between shareholders regarding the direction and management of the new company or in respect of the deal documentation.

IPOs

When a company offers its shares to the market by flotation on the stock exchange, these are valued to the public through the prospectus. 

The prospectus includes financials allowing investors, including large institutions such as pension funds and insurance companies, to assess the company's value. 

Where the valuation is subpar, investors (who are now shareholders) might bring claims against the company and/or the advisors (e.g. investment banks, law firms, and accountants) regarding the IPO.

Holding companies

The shareholder may be a holding company, so the real claimants (who have suffered a personal loss) are the individuals who hold shares in the holding company. 

The options for a holding company might be the same as an individual who owns shares in the company, including a derivative claim, a claim under the shareholders’ agreement, an unfair prejudice petition, etc. Further action will be taken at the behest of the holding company's shareholders.

Quasi-partnerships

Some shareholders are considered quasi-partnerships of their companies. 

Quasi-partnerships can emerge where the shareholders are family members or otherwise closely tied. 

Unfair prejudice can arise in quasi-partnerships where a shareholder takes steps contrary to discussions with other shareholders, even though such actions are not prohibited by the company’s constitutional documents or the shareholders’ agreement.

Tips for resolving shareholder disputes

As per the above, shareholder disputes can arise with other shareholders, the directors, or the company itself. Shareholders might also have concerns regarding third parties such as auditors; such concerns are best raised with the directors who can raise them directly with the relevant third party.

Shareholders have a variety of tools at their disposal to resolve disputes which are simmering or have risen with other shareholders. The first question is to consider the nature of the disagreement and how it arose. 

Has another shareholder behaved dishonestly (ie, fraudulently) or does the disagreement pertain to the proposed direction of the company? Is the dispute better thought of as a dispute with the directors concerning the day-to-day management of the company or a dispute with another shareholder? 

If it is a dispute with the directors, is it because the company has underperformed? If it is a dispute with the other shareholders, does it relate to their investment in the company or, for example, their long-term views as to the direction of the company? Is it perhaps a commercial dispute with a third party of the company (such as a contractual counterparty) that should be brought to the attention of the company’s directors? 

Try to crystallise the issues and the dispute in your mind and summarise the crux of the dispute in writing.

Once the nature of the dispute has crystallised in your mind, and on the page, drafting a chronology of the facts and issues relating to the dispute will assist you in resolving the dispute with the shareholder (and/or the directors if they seem to be at fault). 

A second step would be to review the company’s constitutional documents (the Articles of Association and Memorandum of Understanding) and the shareholders’ agreement (if one is in place).

You must identify any clauses which the problematic shareholder might have breached or which clarify the duties on the shareholders and which can be summarised to the troublesome shareholder.

If the problematic behaviour by other shareholders or directors continues, you can consider raising the matter at an annual general meeting or an extraordinary general meeting. Circulate a memo in advance of the meeting concerning your issues for discussion with the other shareholders. Try to speak with the other shareholders or the directors before escalating the matter by taking legal action.

If the problem continues, you might wish to consider a letter before claim (or a more causal letter before a letter before claim) which outlines the below:

• The nature of the dispute to the other party (eg other shareholders, the company, or the directors)
• The breaches of duty by the other party
• The mechanism for resolving the action (whether a derivative claim, an unfair prejudice petition, a just and equitable winding-up petition, a claim under the shareholders’ agreement, or one of the other mechanisms outlined in this article above)
• The remedy sought (eg damages, purchase of one’s shares, costs, interest, etc)
• The timeline for a response

Generally, an initial letter before a claim is recommended to show that you’re keen to settle the matter amicably. A letter before a claim should follow the guidance in the Practice Direction – Pre-Action Conduct and Protocols. 

Our firm and I are happy to advise on such a letter, or the steps leading up to one, or guide on your initial forays into initiating discussions with other stakeholders in respect of a corporate crisis or possible dispute.

About the author

Roderick Farningham is an experienced commercial and financial disputes lawyer at LawBite. LawBite can provide expert legal advice for shareholder management, whether drafting a shareholder agreement, providing an easy-to-use shareholder management solution, or providing advice on potential disputes or conflicts between shareholders.