When two people decide to set up a company and are investing
equally in terms of
time, money and effort, they frequently do so by each holding 50%
of the shares in that company and both being directors. There
are many such quasi-partnership companies in existence.
However, the equal shareholding structure does have the obvious
drawback that in the event of a dispute between the two
shareholders, the company will be unable to operate due to
deadlock. The key to unlocking the deadlock is a properly
drafted shareholders' agreement, which typically contains a
so-called "texas shootout" clause which provides that the fastest
on the draw, or in this case, the fastest to serve a notice, gets
to buy the other out of their shares.
But how can the deadlock be overcome in companies whose
shareholders do not have a shareholders' agreement? There are
a number of potential actions a shareholder could bring, depending
on the reasons for the deadlock and the actions of the other
shareholder/director.
A shareholder/director could bring a personal
claim against another shareholder/director for breach of
the company's articles of association, for example, if that
shareholder/director was taking actions in the company's name
without reference to the first shareholder/director and had failed
to call meetings or comply with any other provisions of the
articles of association.
It may also be possible to file an unfair
prejudice petition against the other director/shareholder
under Part 30 of the Companies Act 2006. Usually considered
to be the remedy of a minority shareholder, an unfair prejudice
action can also be relevant in the case of an equal shareholder
where there is deadlock if the actions of the other
director/shareholder are unfairly prejudicial to the shareholder's
interests. Types of action which has been held by the courts
to be unfairly prejudicial include misapplication of company funds
for the personal benefit of the director controlling the company,
payment of excessive remuneration, misuse of company funds to pay
for legal fees in relation to a dispute between shareholders,
exclusion from management of the company, and acting in breach of
fiduciary duties or in breach of director's statutory duties.
The Court has wide powers to grant whatever relief it considers
fit, but commonly the relief sought is a buy out order for the
petitioning shareholder's shares to be purchased by the defendant
director/shareholder at a price fixed by the court or determined by
an independent valuer, on bases set by the court.
If the other party has acted in breach of his statutory or
fiduciary duties as a director or acted negligently and that has
caused loss to the company thereby affecting the value of the
shareholding in the company, a shareholder can bring a
statutory derivative claim on behalf of the
company. This applies even if the director has not benefitted
personally from his actions or default. Since the claim is
brought on behalf of the company, any damages awarded are for the
benefit of the company and therefore the shareholder bringing the
claim does not directly benefit, other than by virtue of the
increased value in their shareholding. Such a claim could not
resolve the deadlock, because the shareholder bringing the claim
will still remain a shareholder even if successful, but it may be
important to reinstate the value of the company as it was prior to
the breach or negligence of the other director before taking
another action to realise the value of the shareholding.
The Court may authorise a derivative claim on behalf of the
company in the course of proceedings for unfair prejudice if it
believes that the petition alleging unfairly prejudicial conduct is
well founded. There have been few cases in which the court
has done so to date, but the remedy is available in meritorious
cases.
An example of a director acting in breach of fiduciary duties
which may be relevant in the context of deadlock is if one director
set up another company and diverted the company's contracts and
opportunities to the new company in order that he could benefit to
the exclusion of the other shareholder in the deadlocked company
and basically run the deadlocked company into the ground until it
has no value. This would be in breach of his duty
to avoid a conflict of interests and in breach of the duty to
promote the success of the company. The Court could order all
profits made by the new company to be paid back into the deadlocked
company.
Finally, if the deadlock cannot be resolved by using one of the
above methods, a petition may be issued for the winding up of the
company on just and equitable grounds under section 122 of the
Insolvency Act 1986. Deadlock is the most common reason for
winding up on just and equitable grounds. However, the court
will not order the winding up of the company lightly as it means
the death of what may otherwise be a perfectly healthy
company. It will only be wound up as a last resort and the
parties will have to show that they have made every effort to
resolve the deadlock through negotiation before filing a
petition. Winding up is not usually in the interests of
either party to the dispute, since it is likely to result in a
lower return for the shares than by sale of the company or one
party buying out the other's shares. However, if all other
efforts have failed, just and equitable winding up does at least
allow a shareholder to release their investment from the company
and a complete parting of the ways with their
co-shareholder/director.
As the saying goes, prevention is always better than cure, and a
lock is easier to open with a key, so if you are a shareholder in a
company and you do not have a shareholder's agreement, now may be
the time to put that right. If you are already in a dispute
and do not have a shareholder's agreement, there are at least some
statutory safety nets to protect your investment.