One positive (in the loosest sense) of the COVID-19 pandemic and associated lockdowns was a more conciliatory approach taken by parties to shareholder disputes. This may have been because of the significant initial backlogs experienced at the courts (which, simply, were not equipped to work remotely) rather than any actual softening of attitude. As we emerge into the post-pandemic commercial landscape with new and possibly turbulent challenges ahead (from war in Ukraine to the cost of living crisis), it remains to be seen whether the soft approach will continue or whether there will be a return to aggressive and hostile shareholder litigation.
Shareholders v directors
Shareholder disputes are essentially internal business disputes, usually between shareholders and directors.
The potential for conflict is ever apparent: the directors are “running the show”, with the shareholders in the background as the business owners. Often, in smaller SMEs, individuals are simultaneously shareholders and directors, and disputes can quickly become acrimonious and acute. It is common for individuals to confuse their roles and to forget, as directors, the fiduciary duties they owe to the company which include duties to promote the success of the company, to act within powers, to exercise reasonable care, skill and diligence, and to avoid conflicts of interest. Also, directors manage the company at the will of the shareholders. They are not omnipotent; shareholders have the ability, through the company’s articles of association and company legislation, to oversee, challenge and possibly remove directors.
Common causes of shareholder disputes are:
- Perceived company mismanagement such as making poor decisions about business ventures, investment or financial borrowing;
- Lack of transparency and exclusion, where the directors do not keep the shareholders informed about the management of the company and decisions taken;
- Breach of director duties such as misappropriation of company monies, or directing the company to enter into a transaction in which the director has a personal interest;
- Deadlock, where no management decision can be made because the articles require majority voting which cannot be achieved where there are an equal number of votes on each side of an issue.
Available shareholder actions
Each shareholder dispute is unique and much will depend on the composition of the company and the content of its articles of association.
Possible shareholder legal/formal actions are:
- Call a general meeting and propose a resolution – shareholders equating to holding 5% or more can require a general meeting to be held at which a resolution can be voted on (and passed if voted by more than 50%);
- Require an audit where the company may otherwise be exempt – shareholders equating to holding 10% or more can require an audit of the company’s accounts;
- Unfair prejudice petition – a shareholder can petition the court for relief where the affairs of the company are being, or have been conducted in a manner that it unfairly prejudicial to the interests of shareholders, or an actual or proposed act or omission of the company is or would be so prejudicial. The most common outcome is for the court to order the buyout of the petitioning shareholder’s shares;
- A derivative claim – a shareholder can seek permission of the court to bring a claim in the company’s name against a director for negligence or breach of duty. If permitted by the court, this could result in the company recouping monies from the defendant director, but the cost benefit of such a claim would need to outweigh any irrecoverable costs incurred in pursuing the litigation. And, the defendant director could retain their role in the company; or
- Just and equitable winding up – a shareholder can petition the court to wind up the company on just and equitable grounds. If ordered by the court, the business will be liquidated bringing it to an end.
These remedies, (other than 1 and 2) are usually very costly and time-consuming and may result in an unwanted outcome. Shareholders should always weigh up the cost/benefit versus the risk of pursuing litigation through formal court proceedings.
It is always worth exploring alternatives to litigation as shown during the pandemic. Indeed, it may be incumbent on a shareholder to explore Alternative Dispute Resolution (“ADR”), particularly if a Shareholders Agreement provides for mandatory ADR where a dispute arises. ADR can be much more effective than court proceedings both in saving cost but also in resolving a dispute in a more practical way.
ADR options include:
- Early neutral evaluation – the parties appoint an independent and impartial evaluator to give the parties an assessment of the merits of their case – it may also include an estimate of likely outcomes and suggestions for resolution. This can then be used to aid negotiation.
- Mediation – an independent third-party mediator is appointed to foster a discussion of the issues and to try to broker a settlement. A mediation can be expensive and there is no certainty a settlement will be achieved on the day.
- Arbitration – the parties agree to submit the dispute to arbitration and enter into a binding arbitration agreement which sets out the procedure and rules for the process. The parties agree to be bound by the decision of the arbitration. A disadvantage of this process is that it can be as expensive as formal court proceedings.
- Med-arb – this is where mediation is combined with arbitration. If the mediation fails, the parties agree the mediator becomes an arbitrator and issues a final and binding award on the dispute. A downside with this option is that it may stifle genuine discussions during the mediation.