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MINORITY SHAREHOLDERS AND THEIR RIGHTS

Dinah Spence and James Pheasant examine what rights minority shareholders have
in company disputes – a situation that could affect both practitioners and their
clients.

Let us begin by painting a picture.

‘A Ltd’ is a SME with an annual turnover of £15–20m. It is owned and controlled by


three old friends, business partners of longstanding who decided ten years ago to
give up their day jobs and go into business together. All three are directors. They
agreed from the outset to take broadly equal amounts out of the company.

However, the shareholding is not split equally between them. One member has
58% of the issued share capital, the other two have 21% each. All three directors
play a full role in the management of A Ltd. They operate by consensus and formal
board meetings are rare.

Sounds familiar? This is how many SMEs and family companies are run. All is well
whilst the members get on with one another and are happy with the direction the
business is headed.

But what happens when clouds appear on the horizon, when the majority
shareholder sees the company as their own to do with as they like, or when they
want to eject a director who is also a shareholder? Surely, subject to having
sufficient voting power to carry an ordinary or special resolution, the majority
rules?

A minority shareholder is not entirely impotent. The Companies Acts have always
contained provisions giving a minority shareholder leverage to curb the excesses of
the majority. However, generally these provisions are little use against a majority
shareholder determined to execute their plans. In these circumstances, the minority
shareholder will need to apply to the court for protection and relief.

Derivative Claims
In many circumstances, a minority shareholder may be affected by a wrong done,
not to them personally but to the company by the majority. For example, diversion
of contracts from the company to the directors personally.

The minority shareholder faces an impossible task in attempting to force directors


into bringing an action against themselves. In certain circumstances the courts will
allow a minority shareholder to bring a claim in the company’s name.

The minority shareholder has no greater right to relief than the company would
have were it to bring an action itself. Any financial award accrues to the company
itself.
Personal Claims
All shareholders have rights that they can enforce against the company and other
shareholders whether or not a formal shareholders’ agreement has been reached.
These include objection to alteration to the Memorandum and Articles of
Association, the variation of class rights, the giving of financial assistance and the
enforcement of directors’ duties, prevention of ultra vires transactions and in
relation to certain take-over offers.

The Memorandum and Articles of Association represent a statutory agreement


between the shareholders and the company as to how the company is to be run.
The court will enforce a breach of that agreement. An otherwise proper attempt to
vary the articles can be actionable if it affects rights already in existence or the
majority has not acted in good faith.

Unfair Prejudice
The most important protection that a minority shareholder has is the right to
petition the court for an order under s459 of the Companies Act 1985. This action is
founded on an allegation that the affairs of the company are being conducted by
the majority in a manner unfairly prejudicial to the interests of members generally,
or to some part of its members (including the applicant).

The relief sought is normally an order that the other shareholders (or the company
itself) purchase the minority shareholding at fair value. An order providing for a
‘clean break’ will be preferable.

However, the court has complete discretion and, if the circumstances warrant, can
even order the minority shareholder to purchase the shares of the majority.

The court can, and will, make orders to adjust the unfair prejudice that the minority
shareholder has suffered. For example, the court may order the company to be
valued on the basis that the benefits taken by director/shareholders in breach of
fiduciary duty be repaid.

The court will also decide at what date the company should be valued and whether
there should be any discount to reflect the minority shareholding.

The court can also make an order regulating the conduct of the company’s affairs in
the future; require the company to do or refrain from any act and authorise civil
proceedings to be brought in the name of the company.

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.
‘Just and Equitable’
Winding-Up
S122(1)(g) Insolvency Act 1986 grants power to the court to wind up the company on ‘just
and equitable grounds’. The applicant must satisfy the court that there is an adequate
surplus for distribution to the members after a winding-up.

The applicant must also satisfy the court that they have ‘clean hands’ – meaning that if the
applicant can be blamed for some of the matters they complain of then the court may not
grant their application.

An application for just and equitable winding up can be used by the court as an opportunity
to look into the company’s internal affairs. Although the burden rests on the applicant to
demonstrate that the circumstances warrant intervention, the courts are willing to consider
the motivation driving a company’s actions.

The type of situations that might merit a ‘just and equitable’ winding-up include the
exclusion of a minority shareholder from management or the breakdown of confidence in
the management of the company. Or nother example might be majority shareholders 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.

But In Practice
A Ltd’s members have a falling out. The majority shareholder is advised that they have
sufficient voting power to exclude the others from management of the company under s303
of the Companies Act. They call an EGM and pass the resolution. They decide to take
advantage of pre-emption rights in the articles and makes a number of low offers reflecting
a high discount for the fact that the shareholdings are minority holdings. These are rejected.

The minority shareholders say that they have an expectation of being involved in the
management of the company; that the company was a quasi-partnership.

This means that the way that they joined together to form the company and the way that it
has been run since have given rise to an understanding that each of the shareholders would
participate in management. They say it is unfair to exclude them. They also say that this
means that their shares should be purchased by the majority without a discount.

Who is right depends very much on the facts. It is not safe to advise the majority
shareholder that a minority discount applies in every case. Nor is it safe to advise the
minority shareholder that, if trust and confidence among shareholders has broken down,
their shares should be bought at fair value.
There certainly is no such thing as a ‘no-fault divorce’ in company la

SHA mean Shareholder Agreement