James Thackray, a senior associate at law firm Pannone, looks at the options for those who hold a controlling stake.
They were once perfect partnerships born from the shared vision and goals of a handful of ambitious entrepreneurs.
But in these tough economic times when founding friendships are being forgotten, cash-strapped minority shareholders are resorting to allegations of bullying and increasingly using the law as a powerful weapon to enforce payouts.
Shareholder disputes, which involve parties claiming they are being ‘unfairly prejudiced’ by the behaviour of others, are among the most expensive to defend, and those facing claims need to ensure they act quickly as failure to negotiate can be a costly mistake.
Minority shareholders utilising the Companies Act
As a business grows and fledgling enterprises evolve in to limited companies, former partners can easily find themselves as minority shareholders. And when they decide the day has come to cash in their chips and exit the business, many find that the majority shareholders are not in a position to pay or willing to pay them out.
In the absence of a formal shareholders agreement, minority shareholders in limited companies have no legal entitlement to force their fellow shareholders to buy out their stake once the business relationship has soured. However, cash-strapped minorities are increasingly utilising the Companies Act in an attempt to recoup their investment.
For those seeking an exit it is possible to bring a claim under section 994 of the Companies Act 2006 by alleging their minority shareholding has been ‘unfairly prejudiced’ by the behaviour of the majority.
Common allegations which can be classed as unfairly prejudicial behaviour include majority shareholders awarding themselves excessive financial benefits, excluding minorities from management decisions, not providing financial information, unfair division of corporate assets or opportunities and failure to declare dividends.
Such allegations are, according to minority shareholders, tantamount to bullying and can be potent weapons to force majority shareholders into action.
With money now in short supply for many, we are seeing increasing numbers of claims and enquiries, particularly from shareholders in smaller limited companies where the business was founded as a partnership.
And even in cases where there can be little criticism of the conduct of the majority, with the assistance of professional advisers, a case of unfair prejudice can easily be constructed as small and medium-sized companies do not always comply with all aspects of company law.
If, for example, the majority failed to formally declare dividend payments in accordance with procedure or file accounts on time, then the minority would have a claim.
The problem is exacerbated by the fact that minority shareholders tend to throw everything into the ring, and because small firms often fail to keep adequate records and board minutes, it is sometimes difficult to rebut the claims.
In addition, while numerous allegations can be made, it only takes one proven incident for a judge to rule in their favour. An order that the minority will be bought out at a fair price would usually follow. And if the majority lose, they will also have to foot the minority’s legal bill.
Stay cool when dealing with an unfair prejudice claim
If you find yourself at the end of an unfair prejudice claim, it is imperative you seek advice as early as possible, and there is certainly no room for rancour or bloody mindedness.
Claims of this nature, where you could be defending a number of separate allegations of unfair prejudice, can be extremely expensive to bring to trial. And while it may rankle, it is often wise to consider a settlement at an early stage and invite the minority shareholder to the negotiating table.
Obviously prevention is better than cure, and if you believe that a potential bust-up is on the cards, it is essential you comply with the Companies Act 2006 to the letter in terms of filing accounts and accurately recording board meetings.
Also, even if the company is run informally, agreements between shareholders on certain points must be documented in writing, and if there are issues relating to a minority shareholder’s performance, then it must recorded as it could be useful evidence in due course.
Unfortunately as the UK economy still lingers in the doldrums, claims from minority shareholders, who are desperate to crystallise their investments, may only increase further. So it is imperative that you follow procedures and be prepared to negotiate, or you risk a very large legal bill which could have a devastating impact on your business.