One of the most important reasons for a shareholders agreement is to protect a shareholder who doesn’t have more than half of the shares in the company.
Company law provides some protection for shareholders in this position. It is the weaknesses of this protection that make a shareholders agreement so important.
Unfair Prejudice
A shareholder can apply to the court if he thinks that the company’s affairs are being conducted in a manner that is unfairly prejudicial to the interests of the members or some of them.
This would cover situations such as:
- where a company stops paying dividends and instead pays bonuses to the directors;
- the company issues new shares to some shareholders but not all of them;
- a shareholder is excluded from the management of the company;
- business is diverted to another company owned by the majority shareholders alone.
The court has very wide powers. It can stop the company doing something or order it to do an act it has omitted to do. The most usual remedy is to order the purchase of the minority shareholders shares by the other shareholders.
The problem is that any court proceedings are expensive and unpredictable. The number of cases on this section show how much discretion the individual judge has in reaching a decision or, to put it another way, how vague a remedy it is. For example the court might decide that:
- the actions of the majority are not prejudicial to the minority shareholder;
- although the actions are prejudicial they are not unfair.
Section 994 Companies Act 2006
Winding Up
The second possible remedy for an aggrieved minority shareholder is to ask the court to wind up the company. The court can do this if it considers it would be ‘just and equitable’ to do so.
There are the same difficulties with this remedy as with the unfair prejudice one in that it is expensive and the outcome uncertain.
In addition winding up the company is not likely to give the minority shareholder what he wants. The winding up of the company may mean there is some value for his shares. It is unlikely to be the full value after the costs of winding up are taken into account.
Section 122 Insolvency Act 1986
Derivative Actions
If someone injures a company normally it is the company that can claim compensation for that injury. The claim might relate to money that has been paid to someone it shouldn’t have or a contract that someone has pinched from the company. In these situations it is a normal part of the directors’ job to decide whether to make a claim for compensation.
There is a problem with this if the directors who are the people benefitting from the injury done to the company. The directors are unlikely to instruct the company to sue themselves.
In this situation a shareholder can step in and make the company sue a director (or someone else) for an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director. The shareholder is likely to be a minority shareholder and the holders of the majority of the shares would be able to appoint new directors without the need for this special procedure.
The statutory procedure set out in the Companies Act involves a review by the court of the claim before it can go ahead. The court must deny permission if a hypothetical person acting in accordance with the duty to promote the success of the company would not seek to continue the claim. A bar to derivative claims is also imposed where the matter was authorised in advance or has been ratified since it has occurred. Unless a claim cannot go ahead for one of these reasons it is still in the discretion of the court whether or not to allow it to proceed.
A similar common law procedure is still available for minority shareholders in the parent company where the subsidiary has suffered the loss.
If the claim is successful the company will be compensated but the minority shareholder won’t be affected. So in addition to all the expense and risks of litigation the minority shareholder will still be a minority shareholder with others who he knows at best do not see things the same way or more probably are not to be trusted.
Shareholders Agreements 