COMMON REASONS FOR A DISPUTE
Common reasons for a dispute in a company/partnership
- The age difference between shareholders/partners create differing requirements from the company; older – cash out, younger – cash in and growth of the business.
- There are only two directors/partners and they are each a 50% shareholder. Once the relationship declines there is only stagnation in the company as no agreement can be reached and no decisions can be taken.
- One director/partner is completing considerably more work, is being paid less or conversely feels their contribution to the business is undervalued. It may have been that at the start of the relationship one party felt they were responsible for establishing/financing the business and the other party’s role was purely operational.
- Work/profit is being diverted away from the business for the benefit of one of the directors/partners.
- One director/partner is being paid a disproportionately large salary/drawing or any such payment increases.
- Exclusion from information about the business or being excluded from an important meeting.
Most of these examples are based on the individual’s perspective. It is rare that there is actually theft of property or a deliberate attempt by one party to obtain more than their fair share of the value of the business. Each side will believe they are right and justified in their action/inaction.
The correct way to deal with this, in all cases of a potential dispute, is to raise the issues with your fellow shareholders/partners as soon as possible. Unfortunately, this often does not happen and the problem festers and increases the ill will as a result, by the time you speak to a solicitor or an accountant the relationship may be irrecoverable.
Successful businesses that continue for a long period of time often review the performance of the directors/partners and adapt their contributions. This can only be achieved in a company where there are trust and goodwill between the owners/directors.
COMMON ROUTES TO RESOLUTION
Common routes for resolving a shareholder’s dispute
Once the dispute has taken hold it is very unlikely you are going to resolve matters with a clearing of the air meeting and go back to normal. The staff are often aware of the tensions at this stage and the dispute may be starting to damage the business. The business may already have a natural leader if there are only two directors/shareholders.
There is now invariably one outcome, and although we always advise this from the outset, it often takes time (typically 6/8 months) for a client to realise this. There are really only two things now to agree; which shareholder is leaving and what sum they will receive for their shares.
The question as to who is leaving is often an easy question to answer but without a shareholders agreement one party cannot force another to sell their shares and you must (unless there is a genuine minority prejudice action under S.994 Companies Act 2006) agree the sale process.
There is also the issue when it is agreed who is leaving, of what sum is paid for the shares. The proposed seller may demand a settlement sum that is too high and a buyer may only be prepared to pay a sum that is too low.
COMMON ROUTES TO RESOLUTION – INFORMAL
Talk to your fellow shareholders/partners
Talk to your fellow shareholders/partners
The most important aspect of avoiding or resolving a dispute is communicating with your fellow business owners. Once in the dispute, both sides need to acknowledge that a compromise of their positions will be necessary to achieve a resolution. A settlement achieved at an early stage will be cheaper than a dispute that becomes protracted and involves a legal process. Be flexible, creative and most of all realistic in order to achieve a resolution.
This is the middle ground position from letters passing between solicitors and legal proceedings being commenced. It generally involves both parties, and their solicitors, attending an agreed venue/meeting place with a trained mediator shuttling between the parties in their separate rooms. Mediations are very good at moving, often over a full day, both parties’ perception of a realistic settlement. Even if an agreement is not reached it will expand each party’s view of their position and inform their settlement position.
COMMON ROUTES TO RESOLUTION – FORMAL
The formal process is purely a legal process. Often it can be progressed via an employment tribunal claim (to prove the director and employee has justifiable grounds to claim against the company for breach of their employment right. This is often a cheaper route to show a company that a disenfranchised shareholder has a good claim to wind the company up on just and equitable grounds. Alternatively and most commonly through the formal process taken by a shareholder starts with a S994.CA 2006 claim.
S.994 Companies Act 2006
The cornerstone of the legislation is the right for a minority shareholder (one holding 50% or less of the voting rights) to apply to the courts against the majority shareholder(s) and the company for an order requiring the majority shareholder(s) to buy the minority shareholder’s shares. The court also has the power to wind the company up, though this is generally considered to be the last resort.
The court must be satisfied that:-
- the company’s affairs have been conducted,
- in a manner that has prejudiced,
- the minority shareholders interests as a member of the company.
The key elements are that the minority shareholders rights in the company have been prejudiced and unfairly so. What clients often do not realise is that even a total breakdown in the relationship of the individual directors/shareholders is not, in itself, grounds for a successful S.994 application.
The court will, if there is unfair prejudice found, most commonly order that the minority shareholders share be valued and purchased by the other shareholders or, the company be wound up
EACH PARTIES PERSPECTIVE
The Majority’s & Minority’s perspective of a dispute
As set out above the opinions of why a shareholder or partner is in the “right” and has the moral high ground is an emotionally driven stance and not a stance based on reason;
You have control of the company/partnership but you do not want any profit from your labour to go to the dissident shareholder. The dissident’s continued presence will, over time, be a constant thorn in your side and it will influence your decision-making process. You will need to deal with the disenfranchised individual at some point.
Unless the dissident has a shareholding of 10% or less in the company you cannot force them to sell their shares.
Unless you can prove (with a S.994 CA 2006 claim) your rights have been unfairly prejudiced you cannot force the majority to buy your shares. For a quasi partnership, you have a greater ability to windup up the company if the purpose that bought you together has come to an end.
Under the Partnership Act of 1890 (if no partnership agreement exists) the partnership will be deemed to be dissolved upon one partner leaving the partnership. This will trigger a valuation of the assets of the business.
If the partnership is a limited liability partnership (LLP) you can apply to the court in a similar way to that which applies to a company. However, if a partnership agreement is in place it is likely to override the minority rights and dictate how such a situation is dealt with.
As the name suggests this concept came from an understanding that many companies are run as a partnership would be. The company is the legal construct but a small company with two directors and shareholders is, obviously, very different in practice from a large listed company. The small company is personal to its directors. They may be directors, employees and shareholders but in reality, they have often set the company up themselves and part of their expectation is to work within the company. They see the company as “theirs”, not as their employer as they are their own boss.
This concept, like partnership law, introduces “good faith” and “mutual confidence” and affects not only the valuation basis of the shares but also the possibility that an action lies in the breach of the quasi partnership.
There is not a clear set of rules or tests that define a quasi partnership and partnership law is not applied if one is found to exist, the courts have said the term is just a convenient “shorthand” to describe the concept. As you may be able to anticipate if the court looked at your situation and found that there:-
- was a personal relationship between the shareholders before and during the formation of the company;
- was an expectation by the shareholders to be allowed to work within the company; and
- was an understanding that the shares would not be transferred out of the current ownership,
you may then be able to establish a quasi partnership exists
LEGAL AGREEMENTS TO AVOID A DISPUTE
The purpose of negotiating these agreements is for all directors and shareholders to properly understand their roles and duties within the new enterprise. Often assumptions made by each individual, about the others, are wrong and the process of entering into new contracts assists all parties to understand their fellow shareholders’ expectations.
The reality of this agreement is that they are only ever referred to and used in earnest if there is a form of dispute or to avoid a dispute.
Many clients see these agreements as superfluous at the start of a business as they have absolute certainty of the businesses success and the strength of their relationship. Many also see such agreement as an unnecessary expense – though in the event of a dispute arising they are invariably ‘money well spent’.
This defines your role and duties as an employee. It can be used to ensure that, amongst all directors, all areas of responsibility of the business are dealt with. It defines also your holiday entitlement and your pay/benefits.
If you resign as an employee it should entitle the remaining directors to remove you from the board of the company.
The shareholders’ agreement addresses several matters that are not dealt with by statute or common law. The key areas are:-
1. Being able to work in the company/ ceasing to work in the company
It is often a basic requirement for each owner that they should be allowed to work in the company for so long as they hold shares. For this reason, it is often stipulated they can continue to be a director of the company for so long as they hold shares. Conversely, if they leave the company’s employment, by consent or if they are dismissed the other shareholders or company have a right to buy the departing shareholders shares.
If there is an even number of directors then in the event of an even number of votes for and against a decision then how are decisions made. A dispute mechanism enables the directors to reach decisions and if it is used regularly to allow the shareholders, who regularly disagree with the decisions, to sell their shares to the other shareholders.
3. Directors or shareholder making decisions
If not all shareholders are directors or if the directors hold differing percentages of shares certain decisions can fall to the shareholders to be made on a vote passed by the majority of shareholders.
4. Agreeing on a business plan
A requirement to agree on an annual plan by the directors and shareholders stimulates debate about the direction of the company and the shareholders’ requirements.
If only some shareholders provide financing should it be by a loan or an increased shareholding?
VALUATION OF BUSINESS
Minority shareholders normally have a discount applied to the value of their shares to take into account their lack of control of the company. This is the reason it is important for a minority shareholder to establish a quasi partnership if possible.
An expert, an accountant, will be appointed, in most cases, by the court to value the company and then the value of the minority shareholders shares.
It is possible (and always advisable) to suggest in writing that the minority shareholder requires their shares to be valued and purchased to try and limit the time and their costs involved in obtaining the court order to value the shares. This can also be suggested by the majority shareholder to forestall an application to the court against them. You can appreciate this is an example of the courts reiterating the view that the dispute should be resolved as quickly as possible.
One of the key issues is the date on which the company is to be valued to ensure the actions the minority shareholder is complaining of do not have a negative value on the value of their shares.
Once the expert has valued the company and determined the minority shareholders value the court can order the shares to be sold and if the majority do not purchase the shares the company will be wound up.