Litigation lawyers are seeing the same trend in the commercial sector where some majority shareholders of businesses are increasingly trying to end their relationship with long standing minority shareholders and forcibly acquire their minority stake because, as with divorce, share values are down.
In the ownership and management of limited companies, the legal rights and obligations arising out of the ownership of shares are separate from the legal rights and obligations arising out of being a director.
However, within an owner-managed business (OMB) (where the owners of the shares are often the same as the directors) there can often be a “blurring” of those rights.
A good example of this relates to decisions to appoint and remove directors from the board. The ability to choose who the directors should be can be voted on by either the directors or the shareholders. As a starting principle though, no director should expect an underlying “right” to remain permanently on the board.
The law provides a natural process whereby directors are regularly removed from and appointed to the board by proper majority vote (so long as the correct procedure is followed).
Therefore in taking a decision as a board to vote someone off (following “the rules”) you would expect that to be a lawful decision and one that cannot be challenged. However, where ownership and management are the same even a decision taken lawfully through the company’s rule book may have significant consequences.
In an OMB with common shareholders and directors (often the founders of the business) its shareholder/directors may gain additional rights and protections; beyond what the rule book says.
One such right may include the right not to be removed from the board. For example, in many businesses its owners/managers will have been in business together successfully for many years. However, for various reasons, sometimes not necessarily business related, relations can break down between the majority and those who then become the minority.
If relations cannot be reconciled or the departure of one of them cannot be agreed, then a “battle” for control often ensues. Where decisions have previously been made informally by agreement there develops a “taking of sides” where more formal “voting” takes place leading to decisions being taken that the minority don’t agree with and can often specifically prejudice the minority.
Again, a good example here will be where the majority take the decision (following the company’s rules) to remove the minority from the board and exclude him/her from management altogether.
In this example, whilst the majority have taken a decision to remove a director by following the company’s rules, such a shareholder/director is likely to have obtained additional rights and expectations beyond the company’s rules including the right to remain on the board and participate in management.
More importantly, by taking what would appear to be a lawful step, the majority actually prejudice that shareholder’s rights. In that situation, the usual remedy open to the minority shareholder/director is to have their shares purchased by the majority at fair value.
In that sense the analogy with divorce is emphasised. The courts are unlikely to force shareholder/directors together where prejudice like this can be demonstrated and so it becomes an argument about “how much” the departing shareholder should be paid for their shares following a “clean break.”
Whereas perhaps majority shareholders had previously not “grasped the nettle” with perceived under performing minority shareholders because of the significant cost of purchasing their shares when times were good, in the current climate a different attitude is developing.
A practical example could be where a reducing income stream puts pressures on the owners of a business and their respective lifestyles. Hence three director/shareholders in an OMB might want to gain control and ownership of the company for themselves to the exclusion of the fourth director/shareholder who they perceive is not making an appropriate contribution for his level of remuneration.
Due to the flat economy (and share and asset values being down generally) now might be seen as a good time for self preservation to take the initiative in removing him/her from the business. Clearly the price they will have to pay for the minority’s shares will be much lower than if the economy was strong. If the majority feel the value of the business will bounce back in the medium term, the investment in buying all the shares now for future return seems a good one.
At DWF we are being asked to advise both majority and minority shareholders about their rights and options more than ever before. This is unlikely to be a coincidence and is, in our opinion, related to the stagnant economy and low asset values. Whether steps are being taken by majority shareholders to deliberately prejudice minority shareholders in order to try and trigger a purchase of shares remains to be seen.