Shareholder Disputes within Owner Managed Businesses

Shareholder disputes can be damaging for any business. Management time can get diverted away from growing the business. Key senior employees may become demotivated and leave. It may become harder to secure future investment or a sale. Ultimately, if the dispute heads towards legal proceedings then substantial legal costs can accrue.

These problems can be exacerbated if the business is controlled in whole or in part by family members. This is especially the case if some or all of the family interests are held through family trusts. Alliances based on family connections rather than the commercial needs of the business can complicate the resolution of conflicts. The death or serious illness of a key family member involved in the business can create succession problems.

If the dispute escalates into litigation then legal claims are likely to focus on two main areas. The removal of an individual as an employee or a director may give rise to unfair or wrongful dismissal claims but it is also possible that minority shareholders within a company may bring a petition for unfair prejudice. In certain circumstances, minority shareholders can seek relief from the Companies Court – normally an order that the majority buy out the minority at a fair price. Sometimes the court orders the share price to be adjusted to reflect past grievances.

Clearly, if possible, early negotiation is a better solution than full-scale legal proceedings to trial. There are a number of key considerations that may help the warring shareholders find such a solution: –

1. Dispute resolution mechanism in a shareholders’ agreement. A shareholders’ agreement, if one exists, may have a dispute / deadlock resolution mechanism that prescribes a solution. The remaining comments below assume this is not the case.
2. An early valuation. If a negotiated solution is going to be based on one side buying out the other, it may be difficult to make progress until an up-to-date share valuation has been obtained and any differences in valuation approach between the two sides have been clarified. Such a valuation may also help clarify whether there are likely to be problems funding a purchase.
3. Mediation. If negotiations prove difficult, it can sometimes be useful to bring in a professional mediator.
4. Take early legal advice. This will allow proper guidance to be given about documentation and record-keeping. This could be crucial either for avoiding a dispute completely by structuring a commercial solution or alternatively allowing the best possible case to be presented in court.
5. Family trusts. If there are family trusts with an interest in the business, early advice should be sought over the implications of this especially if minors are involved.
6. An early offer to purchase the minority shares at fair value. The courts encourage the early resolution of unfair prejudice proceedings. Sometimes, if an early offer is made to buy out the petitioner/minority shareholder at a price to be determined by an independent valuer then this can be used to stay or strike out the petition. Even an offer to purchase the shares for a specific price may provide some professional cost protection/jeopardy and thus indirectly apply pressure towards a settlement.
7. Remaining shareholders funding the purchase of the minority shares. The remaining majority shareholders may have the means to purchase personally the minority shareholder’s shares although this may become a less viable option the bigger the minority shareholding and thus sale value. Unless the purchase price can be agreed to be paid in instalments –  in which case the minority shareholder may want security from the purchaser for any deferred payments and/or contractual “step back in” remedies if any of those deferred payments are not made. Commercial warranties may be sought from the minority shareholder, particularly in relation to any conduct issues that may have provoked the dispute, as well as a compromise agreement waiving all employment related claims albeit that the purchaser should consider whether this is a case of perfection being the enemy of the good.
8. Company funding the purchase of the minority shares. If the remaining shareholders are unable or unwilling to fund the buy out, the settlement may be structured as a company buyback of shares. For the minority shareholder’s shares to be effectively purchased, a Companies Act process must be observed strictly. This includes ensuring that the purchase price is backed by sufficient distributable profits and that price is paid in cash and in full on completion which may be cash-flow challenging for the company. Advance tax clearance is recommended to confirm the most favourable tax treatment. The above warranty/compromise agreement protections from the minority shareholder will also apply.
9. Alternative settlement structures. If the Companies Act buyback conditions cannot be complied with, alternative buyout structures can be considered including the company buying the minority shares in instalments or creating a new holding company to purchase all of the shares in the company for shares or, in the case of the outgoing minority shareholder, cash.
10. Early advice. As ever, early advice is essential. If you have any questions about the contents of this article or how to resolve shareholder disputes please contact us by emailing [email protected] or [email protected].