SHAREHOLDER DISPUTES: FRAYED RELATIONSHIPS AND QUESTIONS OF CONTRIBUTION
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Fortune Law founder Shainul Kassam reports on how COVID-19 is accelerating shareholder disputes
As a lawyer to founders and entrepreneurs approximately half of my work involves shareholder disputes, and in my experience, the underlying cause of most shareholder disputes is an argument about contribution to value or more accurately the lack (or perceived lack) of it.
A shareholders’ dispute, particularly in smaller businesses sits firmly in an emotional context no matter what each party comes to the table with. One party feels hard done by. They argue that they have worked harder, put in more hours or more money or more resources. They have made greater sacrifices for the greater good. Alternatively, the other party has engineered situations or created a smoke and mirrors scenario behind which they have sought and achieved unfair financial advantage or gain. Trust is broken. Contribution to value then becomes the yardstick by which shareholders start to measure their equity.
Although shareholders or co-founders may historically have turned a blind eye to undesirable conduct balancing current expectations with future reward, the economic climate has changed beyond recognition. Parties have been forced to reassess their positions and challenge conduct with a view to parting company on the best commercial terms possible. Coupled with this is the time that has been made available to make such an assessment against a backdrop of falling revenue, the impact of company valuation and the refusal to inject further sums into a business. Finally, the courts are not as accessible and seeking legal recourse is less straightforward.
Some shareholders want to ensure a fast exit banking a higher exit valuation as swiftly as possible. Others who remain want to ensure their hard work and additional capital injection in a time of crisis does not benefit their errant partner further. If a business is doing well in the crisis, and many are, there is often a greater desire to part company and keep the lion’s share of the upside.
Parties have come to realise that the threat of litigation is not as potent as it once was, they have other commercial priorities and legal costs of enforcement are unpalatable.
Regardless of timing, the legal issues disputed largely remain the same. A shareholder who is also a director is usually alleged to be in breach of their statutory duties: either they have failed to declare their interest in a commercial transaction, made a secret profit, have declared an unlawful dividend to themselves unbeknownst to their co shareholder, they have a separate side business and haven’t come clean, they have not followed due company procedure or the allegations comprise a combination of these. There has been a breach of the articles of association of the company and/or the Companies Act 2006.
Shareholder disputes are expensive to resolve because they are fact based and as such there needs to be a careful and thorough review of the facts to understand the exact circumstances. They are also technical and require specialist knowledge of the Companies Act 2006 and either the Model Articles or bespoke articles.
Where a shareholders’ agreement has been signed, it is often the case that this has not been kept under review and does not reflect the current legal position of the parties who may have waived certain rights or adopted new contractual positions through conduct. Individuals also come with entrenched views and it often takes time and money to help them see the situation in more commercial terms.
People as we know are unpredictable. However, we are seeing, and expect to continue to see, a more pragmatic approach to shareholder disputes going forward.