While all entrepreneurs accept that hard decisions need to be made from time to time and things will not always go your way, it is important to have trust between shareholders. While the coronavirus pandemic has been characterised by the public pulling together, the tough economic situation is stretching some business relationships to their limit.
One common reason for a dispute between shareholders is when one or more believe that their interests are being unfairly prejudiced by the actions of the rest.
‘Where entrepreneurs have money tied up and they feel the business is not going in the right direction, or there is an information vacuum, then they might need to consider their options,’ says Phil Moir, a Dispute Resolution solicitor with Richard Reed.
‘One option will be to seek an exit from a business, where the director can show that its affairs are being conducted in a manner which causes ‘unfair prejudice’ to him or her. This will allow them to sell their shares, free up their capital and allow the remaining shareholders to take the business in the direction they want.
Unfair prejudice defined
The courts have defined ‘unfair prejudice’ as an objective test where a company’s affairs are being, or have been, conducted in a manner which is unfairly prejudicial to the interests of members generally or to some parts of its members or that an actual or proposed act or omission of the company is or would be prejudicial.
Typically, a director can claim unfair prejudice in two sets of circumstances:
- the company is conducting its affairs in an unfairly prejudicial manner; or
- an act of the company (or an omission to act) would amount to unfair prejudice.
The test for what is unfair prejudice is whether a reasonable bystander observing the consequences of their conduct would regard it as having unfairly prejudiced the petitioning shareholder’s interests.
Examples of conduct that could amount to unfair prejudice include where:
- a company has agreed a transaction in which it is conflicted, for example where it has entered into a contract with another company where some shareholders also have an interest;
- a shareholder has been excluded from the management of the business; or
- directors are paid excessive renumeration when compared to dividends paid to shareholders.
Prudent business owners will have a share purchase agreement in place, setting out the terms between shareholders in exchange for their invested capital. This should be consulted in the first instance to see what it says about disputes, and your solicitor will be able to advise you about this.
It is important to seek advice at an early stage where an unfair prejudice claim is contemplated. If a claim is brought it could prove stressful whilst continuing to have to work with others in a small business where there are existing close personal relationships. Provision will also need to be made for a budget for bringing a case.
Obtaining a valuation
Before you can negotiate about the value of your shareholding, an accountant will need to value the business and your share in it. They will look at the assets and its future value as a going concern, as well as forming a view on whether there should be a discount for non-controlling shares.
Most shareholders will wish to avoid the expense and distress of going to court, which may cause further damage to strained relationships. Our dispute resolution experts can help you to explore alternative routes to resolving your differences, such as via mediation.
This will involve putting forward a valuation of your share in the business and will give the other shareholders a chance to propose an acceptable compromise. Its success will hinge on whether the other shareholders are able to buy you out.
If your fellow shareholders cannot, or do not wish to, buy you out and you still wish to avoid litigation, you may want to look around to see if you can find someone else who would be willing to buy out your share in whole or in part. If so, you may need to take a realistic view on price.
Companies Court petition
If all else fails and you have no other option than to head to court, then your solicitor will need to send a formal letter before action to the other shareholders. Any responses to this will need to be analysed.
If this does not elicit a satisfactory solution, your solicitor will need to issue a petition in the Companies Court claiming unfair prejudice on your behalf.
Your solicitor will pay the court fee, attend a court to issue the petition and the Companies Court will set a return date for the first hearing. They will serve this petition on the other relevant shareholders for you.
At the first hearing a judge will usually make orders in relation to points of defence, points of reply and witness statements. The judge may also order a costs and case management conference to deal with the approval of costs budgets and other steps necessary to bring the case on for a final hearing.
The Companies Act provides five broad ranges of remedy in an unfair prejudice petition. These include:
- regulating the conduct of a company’s affairs in the future;
- requiring it to refrain from doing something;
- authorising civil proceedings to be brought in the company’s name;
- requiring a company not to make any alterations to its Articles of Association without court permission; or
- providing for the purchase of any shares of any shareholder member of the company by any other shareholder member.
At a final hearing, a judge will have to rule on whether your unfair prejudice claim is made out or not. If so, the judge will make an order as to the terms of a share buy- out and costs. Your solicitor can advise you on your options where a share buyout is not wanted or not ordered.
If a business is going through a rough patch because trading conditions are poor, then a business may need to seek advice from an insolvency practitioner as to available options. The unfair prejudice remedy is available only where one member believes the company’s affairs in a solvent company are being conducted in a manner unfairly prejudicial to him.
In summary, it is a good idea to consider making a claim of unfair prejudice when a shareholder has money tied up in a business, but does not believe that business is being run in the optimal manner, where the shareholder is getting the cold shoulder from the others and calculates that better returns could be made elsewhere.