The shareholders agreements can be used to restrict among others the activities of the company, the rights of shareholders and directors, non-competitive provisions, confidentiality, and Dispute Resolutions. Shareholder disputes as in the case of Carla are covered by Section 459 Companies Act 1985 in which it states that if a dispute arises between shareholders, the most important legal principle is considering the small print of the Company’s Articles of Association, the next most important legal principle for any shareholder is to understand Section 459 of the Companies Act 1985. The most relevant part of the provision states as follows:-
“A member of a company may apply to the court… for an order under this Part on the ground that the company’s affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of its members generally or of some part of its members…” [emphasis added; a “member” is simply a shareholder] “
The section is, in itself, worded in a very legalistic manner and many lawyers find it difficult to understand, so what chance does the layman have?
What the section seeks to do is protect minority shareholders (those with a 50% shareholding or less) in circumstances where the majority shareholders seek to act in a way which is “unfairly prejudicial” to their interests. So the provision protects minority shareholders from “unfairly prejudicial” conduct, but what is that?
It would be impossible to accurately reduce to only a few words the many legal authorities on precisely what conduct is classed as “unfairly prejudicial”, but in very general terms it means that minority shareholders have a right to complain to the court if the majority shareholder(s) run the Company in a manner that damages their position and the worth of their shareholding, often done deliberately and often by misapplying or misusing Company assets. But the complaint cannot be vague or trivial (e.g. “they’re managing the business badly”) and must stand up to some objective analysis. Examples of “unfairly prejudicial” conduct might be using company assets or money for the personal benefit of a shareholder or the majority shareholder(s) paying themselves far more than people in their position could objectively justify. In the eyes of law many small companies are regarded “quasi partnerships” - in other words, they are, in effect, small partnerships of a limited number of individuals which, although operating as a limited company, are in practical terms run as if they were a partnership between those individuals at the helm. Commonly, the business was originally run as a partnership and later incorporated as a limited Company.
The significance of the status of a “quasi-partnership” is that the courts are, generally speaking, more willing to give certain additional rights to minority shareholders in those Companies. In particular, a minority shareholder in a “quasi-partnership”, who has been involved in the running of the business, can often claim protection from being ousted or excluded from the ongoing management of the business (without any good reason), and Ann & Brenda have no good reason although they may argue that they deserve the pay rise as they have done more work, Carla hasn’t been able to contribute due to her ill health.
As a result of this if Carla makes a complaint alleging that she as a minority shareholder has been “unfairly prejudiced” a law suit can be brought against the other shareholders in their personal capacity. Where “unfair prejudice” can be established, the Companies Act provides that the court “may make such order as it thinks fit”. Although this means the court has very wide powers to make almost any order, by far the most common order made by the court is an order that one or more of the shareholders should purchase the shareholding of the other shareholder(s). Normally, the court will order the majority shareholders must purchase the shareholding of the minority shareholder(s) at a “fair value and the most appropriate individual to decide upon the value of any given shareholding will be a suitably experienced and qualified accountant.
There are essentially two different ways to value a company (and therefore a shareholding in that company).
It is normally a matter for the valuer to decide which of these bases is the most appropriate in any given circumstances. Certain companies may well strongly favour a net asset based valuation (such as property investment companies) and other companies will more obviously lean towards an earning based valuation (for example, an internet based retailer with little or no assets).
The possibility of the value of any minority shareholding being discounted for the very fact that it is only a minority shareholding is very slim. The question of a discount does not arise where the shareholding to be valued is a majority shareholding.
In most cases where a minority shareholder wishes to voluntarily sell his shareholding in a company, a discount will be applied to reflect the fact that the shareholding does not represent a majority (and therefore does not enable the owner to control the company). However, where a minority shareholder is in effect being “forced” to sell his/her shares or is left with no alternative but to force the majority shareholder to purchase his/her shares (as in the case of Carla), it may well be inappropriate for any valuation to “punish” the minority shareholder by applying a discount. Most commonly, this situation will arise during the course of a dispute between shareholders in a small limited company. Where a minority shareholder is forced to resort to legal proceedings against a majority shareholder he or she will normally seek an order of the court that the shareholding should be bought at a full value, namely without any discount being applied for the fact that it is a minority shareholding.
In the shareholder dispute scenario, valuing a company or a shareholding may also be complicated by the misconduct or wrongdoings of others. For example, a company director might have entered into a contract which involves substantial and excessive payments to themselves (Ann & Brenda have given themselves 20% pay rises) or a member of his family (Hump Haulage Ltd). That contract may be disadvantageous to the company and devalues the company itself. In the circumstances of a dispute between shareholders, the court has the power to order that a valuation should take place on the hypothetical basis that such a contract had never been entered into - in effect, making a “compensating adjustment” for the wrong doing in question.
On the face of it, majority shareholders who control the Company (and its finances) have a massive advantage in any fight with the other shareholders in that they can pay their legal fees using Company funds. Even with a great legal case, a minority shareholder (who has often been booted out of employment by the Company) has only limited funds and is no match for the funds at the disposal of the Company.
However, in most genuine shareholder disputes, the courts will not allow Company money to fund what is essentially a personal battle. The Company does not exist to serve the majority shareholders and spend its funds on their personal legal fees so the courts will be willing to prevent any attempt to use Company funds in the battle, by granting an injunction if necessary.
The most important thing Carla must do is secure the Company assets and protect them from the other shareholders. This may mean double checking (or even changing) the Company bank mandate. Checks should also be carried out to make sure that Company monies haven’t been paid out to lawyers to fund the battle ahead.
Access to fundamental documents or information may also be important. It is not uncommon for documents and files to mysteriously “go missing” and these may be the very documents needed to prove the case of one or other shareholder. Securing vital documentation may need to be considered in conjunction with regulating arrangements for access to Company premises.
It may be difficult to take one or more of the above steps without holding a controlling majority shareholding. The real power to do many of these things lies with those who are able to control the Board of Directors and securing control of the Board will normally be of vital practical importance.
Typically, at the outset of many shareholder disputes, there will be a short period of confusion about which exact rules govern the particular Company in question and there may be factual arguments about what has actually gone on in the Company’s past. Many of the answers to these matters will be found in the Company’s Articles of Association and the statutory books and records of the Company, which should always be checked immediately.
Every private limited company in England & Wales has its own “Articles of Association” and “Memorandum of Association”. These are often referred to as “Articles” or “Memorandum”. Together they form the constitution of the company and as discussed earlier regulate the powers of the company and the rights of its shareholders (although a separate document to “a shareholders agreement).
Ann & Brenda between them own the majority vote with 66.66%; they may therefore via an ordinary resolution pass some of the following amendments:
- An item of routine business where Ca 1985 requires approval of the matter by members.
- Exercising authority to alter (but not reduce) the authorised share capital
- Payment of a final dividend (CA1985, s320)
- Removal of a director or auditor (CA 1985, s303 (2)
- The appointment of a director or auditor (CA 1985, s391A)
In my opinion the only relief to Carla is under the Companies Act 1985 section 459 which allows any member of a company to petition the court for relief where the affairs of the company are being or have been conducted in a manner which is unfairly prejudicial to the interests of its members. This was introduced in 1980 to replace a provision which provided relief only when oppression could be shown.
As in Carla‘s situation the most common problem is where two or more people set up a company and all members become directors, Ann & Brenda may be legally entitled to remove you from the board but this would be seen as unfairly prejudicial conduct. In this case Carla has a genuine expectation to be involved in the management as much as her ill health allows, a number of cases involving similar issues include re: Elgindata Ltd (1991) re: Saul D. Harrison Plc (1995) in re: Sam Wellor (1989) and finally Ebrahimi v Westbourne Galleries (1972), this would also include the issue of shares to directors on advantageous terms; which Ann & Brenda are threatening to do.
In practice, the strict rights and entitlements that come with the ownership of shares in a Limited Company are seldom fully exploited or utilised by shareholders. This is largely because shareholders are generally unaware of the rights that they have simply by virtue of being a shareholder. Similarly, most Company Directors would be alarmed at the strict obligations that they have as regards the Company’s shareholders.
It may seem an obvious statement but the greater the shareholding of an individual, the greater are his/her rights and the greater is his/her power within the Company. This is so not only because the larger the shareholding the more likely it is to represent a controlling interest, but also because the Companies Act affords greater rights and power to an individual as the size of his/her shareholding increases. For example, a shareholder owning 5% of a company has the right to have an item placed on the Agenda for discussion at the Annual General Meeting and, once the shareholder’s ownership reaches 10% of the company, he/she has the right to actually call a General Meeting of shareholders, to this effect it would be possible for Carla to call one, however, it would be of no use, this is because in the majority of Limited Companies, a shareholding in excess of 50% of the issued share capital will be enough to control the company, dictate the makeup of the Board of Directors and to be able to do most of the acts necessary to run the company in its everyday business.
It is possible for those owning less than 50% of a company to protect themselves from being at the mercy of those holding over 50% of the shares in the company and this is one reason why shareholders should give serious consideration to agreeing a shareholders agreement or adopting professionally drafted Articles of Association.
A further difficulty sometimes faced in seeking to sell a minority shareholding is that the Articles of Association for many companies will also contain provisions enabling the Board of Directors to refuse to “register” (in broad terms to recognise or ratify) a transfer of shares on specific grounds or, in some circumstances, on whatever grounds they choose and without giving any particular reason.
In conclusion it must be remembered that while s.459 provides an extensive remedial jurisdiction, the costs involved in actually bringing the case to court is very high, it is therefore recommended that you try and resolve the problems amicably, although if negotiations are unsuccessful then as a minority Carla does have the right to commence legal action under s.459 of unfair prejudice this would mainly be for the 20% pay rises Ann & Brenda have awarded themselves even though the company has not declared any dividends, this is even though as a shareholder she cannot expect a dividend, but seeing there are only 3 directors and 2 have had pay rises is unfair.
Carla could also complain about the issuing of new shares to directors on advantageous terms, as this is what they plan to do if Carla refuses.
This was the scenario in Re Sam Wellor (1989) in which it was held that shareholders whose only income was from dividends could be regarded as unfairly prejudiced under s.459 by low dividend payments.
This is unless, of course, Ann, Brenda & Carla have a shareholders agreement, in which case Carla’s argument becomes a lot stronger, especially as Carla has the right to request copies of the annual report & company accounts which could then be used as evidence, however, this would only be successful if Carla can acquire a court order, otherwise she may be left with no other option but to sell & move on, this would mainly be due to s9 Companies Act 1985, which allows you to freely change companies’ articles subject to certain restrictions via a special resolution. A special resolution only requires 75% of the members to vote in favour of change.
