A brief guide to companies and some options for unhappy shareholders

07/05/2024

This article seeks to demystify some of the terminology surrounding companies and to summarise some options available to shareholders (particularly minority shareholders) in a private limited company who believe their interests are being ignored or mishandled.

Principal parties and documents

In the context of a private company limited by shares, there are three principal parties and usually one or two principal documents.

Principal parties:

The company. This is a legal entity (or a “legal person”) which is distinct from its management (the directors) and its owners (the shareholders). Because the company is a separate entity with its own legal personality, it can enter into contracts, be liable for debts and sue in its own name, meaning that the management and owners do not have to take on these responsibilities and risks in their own person.

The directors. These are the individuals who control the day-to-day affairs of the company and make decisions on its behalf. As directors they are “officers” of the company with certain prescribed legal duties, including to the shareholders. Directors who commit their time actively working in the business are usually also employed by the company, on the terms of a directors’ service contract, being paid a salary.

The shareholders (or members). These are the owners of the company. They can be directors as well, and in a small business they often are. They have typically invested in the company (financially and in other ways) and will be looking to receive a share of the profit from the company via dividends, in addition to any salary they may receive as directors. They may also be hoping that the company increases in value so that they will gain through the ultimate sale of their ownership stake or the company as a whole.

Principal documents:

The articles of association. This document can be seen as a “rule book” for the company. At incorporation, every company has a set of articles assigned to it automatically (the standard form under the Companies Act 2006 is known as the “model” articles). The articles record the practical basis on which the company will operate, including decision-making procedures for the board of directors and matters to do with shares and voting. The articles can only be amended by the shareholders by agreement (normally on a 75% vote). They are available for inspection on the public record at Companies House, which means that sensitive matters are unlikely to be included within this document.

Shareholders’ agreement. This does not come into existence automatically and not all private companies have one, although a well-written shareholders’ agreement clarifies the parties’ rights and greatly expands on the rights existing under the articles and at law. It is an agreement between the shareholders (and often the company itself) which can supplement or override the provisions of the articles. The agreement will usually contain sensitive arrangements between the shareholders for, unlike the articles, it is not available for inspection by the public. Therefore, the content of shareholders’ agreements is typically less “procedural” than that of the articles and will set out important rights and duties of the shareholders, which may have been heavily negotiated.

What if shareholders are unhappy with the way in which the company is being run?

Shareholders are likely to have various remedies open to them, including the following:

The exercise of voting power attaching to their shares, whose effect will depend on factors such as the size of a shareholder’s stake and the terms of the articles and of any shareholders’ agreement. (For instance, the shareholders holding over 50% of voting shares can remove directors, unless they are prevented from doing so by the terms of a shareholders’ agreement.)
A claim under the articles of association if there has been a breach.
A claim under the shareholders’ agreement if there is one and there has been a breach.
A claim in the name of the company (known as a derivative claim).
An unfair prejudice petition where the conduct is prejudicial to the petitioning shareholder and their shareholding.
A winding up petition sought on just and equitable grounds.

The availability and viability of all these remedies will be affected by the contractual framework that exists among the parties and in particular the terms of the articles and any shareholders’ agreement.

In the remainder of this article, we will focus on the last three.

What is a derivative claim?

If a shareholder believes that a director is acting inappropriately in their duties to the company, causing loss to the company, it is possible to apply to the court for permission to bring a claim in the name of the company against the individual director.

It should be remembered that any remedy ordered by the court will be for the immediate benefit of the company, not the shareholder per se.

Specialist legal advice should be obtained on the merits of taking this course of action but sometimes a shareholder will consider it the most cost-effective, and direct, way to force a director’s hand and return the company to its proper position.

What is an unfair prejudice petition?

Under section 994 of the Companies Act 2006, it is open to a shareholder to petition the court where it is alleged that the company’s affairs are being conducted in a manner which is unfairly prejudicial to all or some of its shareholders.

The remedy is most often used by shareholders with a minority shareholding, but it can be used in circumstances where there is held to be a “quasi partnership” (a company operating in effect as a partnership of individuals) or where there is a 50/50 shareholding.

In most cases, the aggrieved shareholder will seek a buyout of their shares at fair value, but the court can exercise a wide range of options including ordering a buyout of the other shareholders and ordering changes in the management of the company.

Common grounds for bringing an unfair prejudice petition include the following:

Misappropriation of company assets.
Mismanagement of company affairs.
Failure to pay reasonable dividends or retaining dividend payments without justification.
Improper allotment of shares.
Failure to consult with or provide information to the shareholder.

To succeed, the shareholder will need to prove both that the conduct is prejudicial (causing some harm or prejudice to their interest as a shareholder) and that it is unfair (objectively assessed against the context of a commercial relationship). The court will consider the position objectively and consider whether a hypothetical reasonable bystander would regard the conduct as satisfying these criteria.

What is just and equitable winding up?

This is a “nuclear option” which can potentially arise where relationships have broken down to such an extent that the company cannot continue operating.

In those circumstances, a shareholder (assuming they have held their shares for more than 18 months) can apply to the court to wind the whole company up but will need to show, as a prerequisite to the petition being granted, that there will be assets available for distribution to the shareholders once the company has been wound up.

Grounds that a court may consider suitable to justify a winding up may include the issues listed above in support of an unfair prejudice petition.

However, winding up is not guaranteed as it is at the court’s discretion as to whether to order it. The court may be reluctant to wind up a company which is in a good financial position, particularly if the shareholder has other options open to them and/or an offer is made to buy the shareholder’s shares for fair value.

Conclusion

Unhappy shareholders usually have a range of avenues available to them if they are concerned about how a company is being managed, with concomitant impact on the value of their shareholding or the level of their dividend income.

However, this is a complex area, and each situation is different, being affected by a wide range of legal and practical factors. As such, it is unlikely to be obvious to non-specialists how the various legal avenues we have described above compare, in the specific situation they face.

Early involvement from a specialist dispute resolution lawyer will help identify viable remedies and should ideally promote an upfront discussion between the parties before matters escalate as far as the courts. The English courts advocate parties exploring alternative means of resolution, such as mediation, and these options can be explored at any stage in the process.

If you have any questions arising from this article or have any issues you wish to discuss, whatever stage these may be at, please contact either Richard Gore ([email protected] or 07916 160387) or Claire Boucher ([email protected] or 07939 288777).

This article is not legal advice, which it may be sensible to obtain before you take any decisions or actions in the areas covered. Please do contact us if you would like an initial discussion of your situation.