Do you know exactly what rights and protections minority shareholders enjoy? The answer to this question is something that every entrepreneur should understand because minority shareholders have the power to cause irreparable damage to your business if relationships break down.
While the complexities of company law might seem like a distant technicality, understanding the rights of shareholders is an important tool to help business owners avoid conflicts entirely, or better manage them if they do arise.
Proactive and careful management of the power balance at incorporation, or upon taking investment into the business, will help avoid or minimise the risk and impact of disputes in the future.
Shareholder rights: where do they come from and what do they cover?
Shareholder rights are usually derived from four sources – the Companies Act 2006, the company’s articles, the terms of the issue of shares and through shareholder agreements.
In general, ordinary shares give shareholders a right to influence the conduct of the company by attending general meetings and voting, a right to a dividend if one is declared and a right to the return of capital and to share in any surplus assets if the company is wound up.
The percentage of the issued share capital that is held by a shareholder can make a difference. For example, usually shareholders holding:
- at least 5% of the share capital can require the circulation of a written resolution (i.e. a vote taken in writing rather than at a general meeting of the shareholders), the calling of a general meeting and the circulation of a statement relating to a matter which is to be the subject of a vote;
- 10% or more can require an audit of the business (where it would otherwise be exempt); and
- 25% or more can block a special resolution (i.e. a vote on an issue that requires 75% of votes to be in favour of it in order to be passed).
Other rights also exist or can be attached to shares through the adoption of additional or replacement rights in the company's articles (including preferential rights). It is worth considering the rights when issuing further shares.
Although shareholder rights might seem technical, its important not to underestimate how they could be used to cause significant disruption to your business.
Entrepreneurs are often surprised to find just how extensive minority shareholder rights are. They include the right to:
- enforce compliance with the company's articles and to remedy an abuse by directors of their fiduciary powers;
- present a petition to the courts claiming that the company's business is being conducted in a manner that is unfairly prejudicial to member(s);
- bring a claim against a third party (which can include a director of the company) on behalf of the company; and
- present a petition for the winding up of the company on 'just and equitable grounds'.
The range of conduct that can be regulated is diverse and can span everything from breaches of the company's articles and/or shareholder agreements, illegal conduct and misuse of the company's funds to payment of excessive remuneration and other activities.
What legal protections do majority shareholders have?
If the majority of shareholders make a decision in good faith then they are protected by both common law and statutory provisions. English law generally recognises the principle of 'majority rule' in companies so courts tend not to interfere with decisions made by the majority of members in good faith.
What are the consequences when things go wrong?
Courts have a wide discretion in exercising their powers and determining the form of relief to grant. There is no concept of a 'no fault divorce' in English law when it comes to shareholder claims. This means there must be an element of unfairness for the claim to succeed and so how parties conduct themselves in a dispute can be pivotal. The court can impose sanctions as it sees fit such as ordering the majority purchase of the minority's shareholding (on whatever basis the court deems just) or vice versa, ordering the payment of equitable compensation or even regulating the conduct of the company's affairs or granting injunctions to prevent certain actions.
In short
If you can obtain appropriate legal advice at an early stage you can mitigate the risks of potential future problems, for example by ensuring articles of association and shareholder agreements are suitably tailored and structured.
This is important because further down the track, shareholders will be constrained by the agreements that they enter into (for example the shareholder agreement or the company's articles).
Similarly, if disputes do arise, obtaining appropriate legal advice can help businesses navigate these, from the initial stages all the way through to achieving resolution whether through a consensual negotiated process or via recourse to the courts.
Katie Philipson