This article was published by Fashion Rider in conjunction with Seth Lovis & Co Solicitors. Beavis Morgan is the preferred finance partner to Fashion Rider, the fashion industry’s premium membership site.
The birth of a new business
An idea, its creative development, then a practical analysis of its commercial viability. The new business is born. Exciting times.
Very quickly an idea can turn into a small business proposition, which can grow so quickly that its owners wonder whether they are in control of it, or it of them. The individual realises they can’t do this alone so look to bring on board others with expertise in finance, personnel, creative and business development, and employees to get the work done. The individual soon has fellow directors and employees, some who may have shares in the new company.
But the company’s directors can have different ideas as to what is best for the business and where it should go. They can push and pull the company in different and conflicting directions which can lead to disagreements arising.
Examples of shareholder and director disputes
Disputes of all types can arise between shareholders and directors.
These may be about:
– the direction and development of the company;
– a conflict of interest (for instance, where one director has other business interests);
– director performance;
– the terms of the director’s service contract;
– the amount of money being paid to or taken by a director / the lack of funds available to shareholders.
In many small businesses, shareholders will often also be the company’s directors. It may also have other shareholders, usually minority shareholders, who are not directors and not involved in the day-to-day running of the business but have some “ownership” through their shareholding in the company.
Shareholder disputes usually involve a minority shareholder bringing a claim that the majority shareholders have acted in a way that unfairly prejudices their position as minority shareholder.
Every director owes duties to the company which are governed by the Companies Act.
What are a director’s duties?
A director’s duties are set out in the Companies Act 2006. The duties include:
– to act within the powers given to the director (section 171);
– to promote the success of the company (section 172);
– to exercise independent judgement (section 173);
– to exercise reasonable care, skill and diligence (section 174);
– to try to avoid conflicts of interests (section 175);
– not accept benefits from third parties (section 176); and
– to declare any interest in a proposed transaction (section 177).
It is not uncommon for directors to reach a disagreement, and when that happens, the directors will need to refer to the articles of association for the company and/or any shareholders agreement to see how to resolve such disputes. In the absence of a shareholders’ agreement, it can be difficult to clarify a shareholder and directors’ rights and obligations.
A situation may also arise where the directors reach a deadlock because they are of equal standing (i.e. 50:50 director shareholders) but are unable to agree a decision on behalf of the company. Neither director then has the majority needed to pass a company resolution and so advice on alternative options including exiting the company or litigation should be sought.
How can shareholders protect themselves from miscreant directors?
If a director of a company is in breach of his or her duties, it is for the company itself to bring an action against that director. It is possible, however, for a director and shareholder of the company to bring the same action through a derivative claim in place of the company itself.
Alternatively, a shareholder can commence an unfair prejudice action against the company in respect of actual or proposed acts or omissions by the company in a manner that is unfairly prejudicial to his or her interests as a shareholder, for example, a director breaching his or her duties or the mismanagement of the company which results in serious financial loss.
In order to prevent these situations from arising, we recommend that directors and shareholders protect themselves by agreeing the terms of the Articles of Association for the company and separately enter into a shareholders’ agreement.
1. Shareholders’ agreement
A shareholders’ agreement is an agreement between the shareholders of the company and the company itself and will normally give the shareholders more rights than those set out in the company’s Articles of Association.
2. Derivative proceedings
As only the company and not an individual shareholder can bring action against an errant director, a shareholder may look to bring what is known as a derivative claim against the company. The allegations must be against those in control of the company.
3. Companies Act 2006
Where directors have acted so as to prejudice minority shareholders, those shareholders may bring a claim for unfair prejudice against the company under the Companies Act 2006. The claim may often be that the directors’ actions have led to a reduction in the value of their minority shareholdings.
The shareholders must demonstrate that the conduct of the majority was both prejudicial and unfair.
4. Just and equitable winding up of the company
In circumstances where there is no other remedy available to a minority shareholder, it may, in certain circumstances, ask the court to wind the company up and the court may do so if it is “just and equitable” to do so.
Avoid disputes – stay in control
As a director, you may well be in control of board meetings but are you in control of shareholders’ meetings? If not, you could lose votes on crucial issues and therefore lose control of the direction of the company.
If you meet the requirements of the Articles of Association and/ or shareholder agreement, then you may be able to force through a decision (known as a resolution).
Note that a vote for the removal of a director from office will be passed by majority vote at shareholders’ meetings so a threat of removal from office of an errant director may be enough to get him or her to toe the line or step down.
How to respond to shareholder claims or disputes
– Consider the complaint objectively. Have you “unfairly prejudiced” their interests or acted contrary to your duties as a director;
– Try to resolve the issues amicably as such disputes can be disruptive, destructive and costly.
– Take legal advice early on.
About Beavis Morgan
As specialist business advisers to the fashion and retail sectors, and through our association with Fashion Rider, we work with businesses to identify their unique requirements. We then design and implement a system that will provide all the information needed to run and grow a business, through real-time information on actual performance, within a cost effective and efficient framework. We can help your new business identify the areas and aspects of control and management that should be incorporated into a shareholders’ agreement. We recommend that such agreements are drawn up at the outset of a new business, when the parties are not in a conflict situation and when there are no disputes.
We are here to guide you through each stage of the business lifecycle, whilst navigating the challenges and advising on making the right decisions both now and for the future – for you, your family and your businesses.
Note: Our specialists to the Professionals Sector regular contributors to Barrister Magazine and the Barrister Lifestyle Blog, providing expert commentary on topical issues relevant to barristers and the legal profession as a whole.