Shareholder Disputes

It may be necessary to engage in litigation to achieve the best outcome.  Potential actions can include:

• Unfair prejudice petition, if the company’s affairs are conducted in a manner that is unfairly prejudicial to the interest of all or some of the members of the company. Typically this will result in the shareholder that has suffered the unfair prejudice being bought out by the other shareholders, although the court has wide discretion as to the awards it can make;
• Derivative action, if wrong has been committed but the directors are unable or unwilling to pursue it themselves (e.g. because they are the perpetrators, through breach of trust or director’s duties);
• Just and equitable winding up of the company;
• Actions against directors for breach of duties.

Our dispute resolution and corporate commercial departments work hand in hand as in a majority of cases litigation leads to a negotiated settlement of sorts, via mediation or during the course of litigation.

Shareholder disputes between owners can also take the form of boardroom or partnership disputes.

If a negotiated solution can be reached then this can give flexibility to the parties to structure the transaction to suit them. Potential structures can include:

• Straightforward buyout by the continuing shareholders, with flexibility as to the timing of payment (e.g. deferred payments if the consideration is not readily available);
• Purchase of own shares by the company (out of the company’s own distributable profits before they are distributed to shareholders);
• Purchase by a new holding company (and a share for share exchange of the existing shareholders);
• Demerger, the business is split up and transferred into the names of different shareholders, so that each takes ownership and control of a different element of the business.

The added flexibility of a negotiated agreement can allow the parties to structure the transaction tax efficiently.

Minority shareholders can often have less power over the management of the company. This can lead to disputes between shareholders particularly where their relationship breaks down.

The classic litigation process for resolving shareholder disputes is the unfair prejudice petition under Section 994 of the Companies Act. This is typically brought by a minority shareholder in circumstances where the company’s affairs have been or are being conducted in a manner that is unfairly prejudicial to the interest of all or some of the members of the company.

Unfairly prejudicial conduct

For conduct to be unfairly prejudicial it must cause prejudice or harm to an interest of some or all of the members of the company and it must be unfair. Examples of unfairly prejudicial conduct are:

• Failure to pay dividends to the shareholders;
• Exclusion from management where there is a justified expectation of involvement;
• Breaches of the articles of association;
• Majority shareholders awarding themselves excessive remuneration; and
• Inequitable conduct.

The petitioner must demonstrate that they are worse off as a result of the conduct. The Court will take into account the legitimate expectations of the shareholder to define the parameters of the unfairly prejudicial conduct – for instance the rules in the articles of association or whether a “quasi-partnership” exists.  

Remedies

The Court has a very wide discretion to grant relief where unfair prejudice is found. The most common relief sought and granted is the purchase of shares which allows a “clean break” between the shareholders who can no longer work together.  Other orders that the Court can make include:

• Regulate the conduct of the company’s affairs in the future;
• Require the company to refrain from or carry out an act;
• Authorise civil proceedings to be brought in the name of the company; and
• Prohibit the company from making changes to the articles of association.

Shareholders may bring a derivative action when a wrong has been committed against the company but the directors are unable or unwilling to pursue it themselves. Under the Companies Act 2006, derivative actions give shareholders the power to challenge the acts or omissions of a director or third party when it involves negligence, default, breach of duty or breach of trust. This allows shareholders to “stand in the shoes” of the company.

Procedure

Derivative actions are restricted by the Companies Act 2006 to a very narrow set of circumstances, which is usually breach by a director of duties to the company.

The court acts as a gatekeeper to weed out weak or vexatious claims, therefore after the derivative action has been issued the shareholder must apply for the Court’s permission to continue with it.

The application may be automatically dismissed if the court considers that a person acting under the duty to promote the success of the company would not pursue the claim; or the act or omission complained of was authorised or ratified by the company. There are various other factors which are considered at this stage, including:

• Whether the shareholder is acting in good faith;
  • Whether the company has decided to pursue the claim;
  • Whether the member has a cause of action that they can pursue in their own right; and
  • The views of other shareholders who have no personal interest in the application.

Multiple derivative actions

Shareholders can pursue an action against a subsidiary of the parent company if they have shares in the parent company. This also extends to pursuing a cause of action against the subsidiary of the parent company’s subsidiary. These claims are called ‘double’ and ‘triple’ derivative claims.

Multiple derivative claims do not follow the same system as other derivative claims, however, as they are still governed by common law principles and not the Companies Act 2006.

Costs

One of the main attractions of bringing a derivative action is that the company can be ordered to indemnify the shareholder for costs where:

• the claim could have reasonably been pursued by the directors,
• the claimant’s only interest in the outcome of the claim is as their capacity as a shareholder and
• the benefit from the action will accrue to the company.

Shareholders can petition for the winding up of a company on the grounds that it would be just and equitable to do so. The authority for this is s122(1)(g) of the Insolvency Act 1986 and it is generally considered a last resort because it can be highly disruptive to ordinary trade

Who can present a petition?

The Insolvency Act sets out the categories of people who may present a petition for just and equitable winding up:

• the company;
  • the directors;
  • any creditor (including any contingent or prospective creditors); and
  • shareholders and other contributors who meet certain requirements.

In the vast majority of cases it is a minority shareholder who presents the petition due to the grounds which must apply for the petition to be successful.

The grounds

The presenter must firstly show  that they have sufficient interest in the winding up. They must demonstrate that there will be a tangible benefit i.e. that there will be a monetary surplus after the winding up. This ground will not be met if the company is insolvent and so this petition is unsuitable under those circumstances.

The court will look at each case on its own merits, however common grounds include:

• Exclusion from management- where the minority shareholder has been wrongly excluded from the management of the company;
• Mismanagement- there has been a loss of confidence on the part of the shareholder in relation to the way that the directors or managers have been managing the company, for example the directors have awarded themselves excessive remuneration whilst refusing to pay dividends to the shareholders;
• Deadlock- where decisions cannot be made due to a deadlock within the company; and
• Loss of substratum- the company can no longer pursue its original purposes, either because it has achieved them or otherwise.

Even if the Court considers that a ground has been established, it may refuse to grant the petition if there is an alternative remedy available and where the petitioners are found to be acting unreasonably in petitioning to have the company wound up instead of pursuing this alternative.

A warranty is a contractual statement. A breach of warranty can give rise to a claim for damages. In relation to warranties for the sale of shares or a business, they are statements in the contract regarding the business’ condition and financial standing. They offer some protection to the buyer who is often exposed to considerable risk when purchasing shares and assets of a business. Warranties should not be relied on in place of due diligence, but they offer additional protection and remedies in the event that the business assets or potential are not as expected.

The warranty

Warranties are usually included in the contract in a separate schedule. What the warranties will cover will depend on whether you have bought the shares or assets of the business, but they generally include many different aspects of the business, including assets, employees, accounts and tax.

Indemnities may also be used in the sale of shares or assets, but they are different to warranties. A claim for breach of warranty will only be successful if the buyer can show that it caused a reduction in the value of the business acquired. However, a breach of indemnity does not have to cause a loss of value of the business for a claim to be successful. You can recover damages for breach of indemnity to cover other costs not related to loss of value.

Warranty claim and limiting liability

A buyer may find that after they have purchased the business, its affairs are not quite what they expected. If the seller made a warranty that turns out to be untrue, the buyer can make a claim for breach of that warranty to recover damages for the loss of value of the business that has resulted from the breach.

The seller will often try to limit their potential liability under warranties by restricting the circumstances under which a claim can be made and the value of the claim. This includes:

• Knowledge. The seller will usually qualify their liability on an awareness basis. Therefore, they would not be in breach of a warranty if they were unaware of an issue or circumstance at the time of making that warranty. This is usually achieved by including the words “so far as the seller is aware” in the warranty clause.
• Financial caps. The seller can also place financial limits on claims in order to limit the extent of their liability. A minimum limit for claims will prevent the buyer bringing low-value claims and a maximum cap will limit the amount the buyer can claim in damages. The maximum cap is usually the total consideration received for the business.
• Time limits. A time limit can be placed on bringing a claim- this is usually 2 or 3 years. However, any warranties relating to tax are normally subject to longer periods as HM Revenue & Customs has 6 years from the end of a tax year to investigate.

Boardroom disputes

Disputes can arise between the directors of a company for many reasons. For example, the directors may disagree over the direction the company should be going in, there could be problems with the performance of one of the directors or removing a director from the board. Importantly, claims against directors who are acting wrongfully can only be brought by the company itself and not shareholders or other directors. However,  shareholders do have some options, such as derivative actions and a minority shareholder petition.
The articles of association will usually detail how disputes will be dealt with. alternative dispute resolution such as mediation is often used as it can prevent the dispute from escalating unnecessarily and is often more cost and time effective.

Partnership disputes

The most common disputes that arise regarding a partnership are liability and departure. Partners are financially liable for the partnership and so a third party can make a claim against both the partnership and the partners themselves. A dispute may arise about how liability is proportioned. Partnership disputes also occur when one or more of the partners want to leave the partnership. Disagreements may arise over the terms of their departure. For example, they may want to withdraw any money that they invested in the partnership, which could cause a problem for the business and the remaining partners.

The way that partnership disputes will be dealt with depends on whether there is a partnership agreement. Most partnerships will have such an agreement, however there may be some circumstances where two or more people informally enter into business together but may still be considered to be in a partnership. This may make any dispute that arises more difficult to resolve as there will be no guidance from the partnership agreement.

Companies can be dissolved or struck off the Companies Register for various reasons. When this happens it means they no longer exist in a legal capacity. However, it is possible to restore the company back on to the Register. There are two ways to restore a company- administration registration and restoration by court order.

Reasons for restoration

It may be desirable for a company to be restored for a number of reasons. The most common reasons are when:

• A company has been struck off the Register for failing to file annual returns and accounts but it continues to trade;
  • There is an unresolved claim for or against the company and in order to obtain compensation or redress it must be restored; and
  • The company had title to an asset that is of value of importance to another company.

Administration restoration

This method of restoration is where an application is made to the Treasury Solicitors and Companies House. This is often used where the reason that the company needs to be restored is that it has been struck off for not filing company documents at Companies House. It is a relatively inexpensive and fast way to restore a company.

There are certain conditions which must be met for the Registrar to restore the company:

• The company must have been carrying on business at the time it was struck off;
  • If any of the company’s property has vested in bona vacantia, the Crown representative has provided written consent to the restoration; and
  • The company has brought any outstanding statutory documents up to date and has paid any penalties that apply.

There is a fee payable to Companies House. If applicable, the company must also pay any penalty fees for the late filing of accounts at Companies House.

Court order restoration

Restoration by court order is often used when the company has been struck off by the directors voluntarily and it is not possible to use the administration method. However, it can also be used where the company has been struck off for not filing documents at Companies House, as long as it was carrying on business at the time it was struck off. In circumstances other than these, the court can restore the company if it considers it just to do so.

The appropriate Court fees apply. The penalty fees for late filing of accounts that are applicable in administration cases may also apply.

The effects of restoration

If the company is successfully restored, a notice of restoration will be published in the Gazette. The company will be deemed to have continued as though it had not been struck off or dissolved.

Sometimes it will not be enough to simply restore the company to the Register. The court has the power to make provisions to enable the company and any other persons to be put back in the position they would have been if the company had not been dissolved or struck off. In the case of administrative restorations, a separate application would have to be made to the court within 3 years from the date on which the company was restored.

Directors are in a position of responsibility and trust and must carry out the company’s business having regard to the best interests of the company and the shareholders. They must put the interests of the company over their own personal interests.

The duties

A director owes certain duties under both common law and the Companies Act 2006. The Companies Act codified many of the common law duties, however they are still relevant when interpreting and applying the statutory duties.

The seven general duties are:

• Duty to act within powers.
  • Duty to promote the success of the company.
  • Duty to exercise independent judgment.
  • Duty to exercise reasonable care, skill and diligence.
  • Duty to avoid conflicts of interest.
  • Duty not to accept benefits from third parties.
  • Duty to declare interest in proposed transaction or arrangement.

In certain circumstances, the above duties can be set aside by authorisation of the members. For example, the duty to avoid conflicts of interest can be complied with by disclosing such an interest to the directors who may then authorise and proceed with the transaction or arrangement.

A director must also perform in accordance with the fiduciary duties to act in good faith in the best interests of the company and to use their powers solely for the purpose for which they were granted. Directors must also comply with the duties to keep accounts up to date and maintain records.

Consequences of the breach

The duties are owed to the company and so only the company can enforce them. However, shareholders may be able to bring a derivative action against a director in certain circumstances.

Remedies and penalties for a breach of duties include:

• An injunction;
  • Setting aside the transaction;
  • Disqualification of the director; and
  • Damages.