Shareholder Rights - Shareholder Disputes

Shareholder Disputes

Section 459 Companies Act 1985

If a dispute arises between shareholders, after considering the small print of the Company’s Articles of Association, probably the next most important legal principle for any shareholder to understand is 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.

“Quasi-Partnerships”

Many small companies are regarded by the law as “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).

Court Orders protecting shareholders

Any complaint alleging a minority shareholder has been “unfairly prejudiced” is a law suit 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” [see the“Valuing your shareholding” section].

Funding the fight

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.

Practicalities

In practice, the first thing to do in most shareholder disputes is to 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 (see “Company Structure”) 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. [see the “Rights of a Shareholder” section for details of what statutory books and records should be kept by every company]