Shareholder Disputes - How to Avoid Them Blog

How to Avoid a Shareholder Dispute

Imagine the scene. You have known Billy for ages. You both spot a gap in the market and over a chat you decide to team up and go into business together.

You might set up a Partnership or a Limited Company each owning half the business. Imagine that you plump for a Limited Company (however, the problems faced apply equally to Partnerships).

You both work really hard and the business is successful after a couple of years. You then decide it's appropriate to promote one of your key workers to director level and reward her with some shares. You think having 3 director shareholders is the correct way forward. Billy disagrees. Billy instead wants to inject more capital into the business and develop a new product offering. You disagree as the business is now starting to earn decent money and you wish to consolidate for a couple of years.

Unfortunately, you did not enter into a Shareholders Agreement when you set up the business because:

1. You had known each other for ages.

2. You both got on really well and therefore trusted each other.

3. It was an exciting time and you both wanted what was best for your business.

4. When you started out funds were tight and you felt that you couldn't afford it.

5. You always meant to, but never got around to it.

5. Or perhaps you did not know that such a thing as a Shareholder Agreement existed.

6. Nothing could go wrong – could it?

You start to argue about the way forward and then you realise that recently you have been working Saturdays and Billy has not! Billy suddenly realises that you have started leaving the office early and playing golf during work time. You then realise that Billy took more holiday than you last year. And so, it goes on!

The relationship starts to fracture and eventually your successful business is impacted badly. You feel that you need some legal advice, yet the costs start to mount and the business begins to suffer as you simply no longer trust each other anymore.

The situation can get even more fragile where one or more shareholders have minor shareholdings and struggle to get their voices heard. Regrettably, relying just on the standard corporation documents of a company will not help you in any of the above scenarios. The question therefore begs - was there any way in which this dispute could have been resolved (or even prevented) before it got to this stage?

Early Prevention

Yes – you could have both prevented this from happening and/or arrived at an early resolution as to the way forward by having a shareholder agreement in place. Clearly, no-one goes into business with someone expecting to fall out but there is nothing wrong with preparing for that possibility and acknowledging that it may happen one day. You can take steps at the very outset to make sure that there are agreed processes for finding solutions and if you do need to go your separate ways from one another – how to do it.

1. Shareholder Agreements

The singularly most important document in anyone’s business is a Shareholder Agreement (or a Partnership Agreement, if you have a partnership). This is a private document and is not filed at Companies House. A clearly drafted document makes clear how the relationship between shareholders works and governs obligations and expectations. It can cover items such as your duties to the business, restrictions on what you can do with your shares (e.g. not to sell them to a competitor), rules on new director appointments, deciding votes mechanism if you can’t agree on something, how to prevent any deadlock from crippling the company, mediation clauses, and jurisdiction (very important if you have shareholders outside of England and Wales). Other matters such as exit mechanisms, hours of work, holiday, sickness, remuneration, etc can also be prescribed.

The simple act of drafting such a document will really make you consider what could feasibly go wrong.

2. Articles of Association

You can have these drafted specifically so as not to conflict with your Shareholder Agreement. It’s also helpful to consider whether there are any restrictions that need to be included in what the company can do (for example, if one shareholder is insistent that a company should not be trading abroad, make sure that the Articles reflect this).

3. Communication

A great deal of shareholder disputes in private companies begin with a breakdown in communications. Keep talking to each other! Have working lunches or the odd dinner together and keep a written note of meetings for future reference. You may decide not to hold official board meetings because you are small in number, but decisions should still be recorded in writing somehow.

If there is an issue, an early discussion can sometimes resolve any misunderstanding. The process of drafting and understanding a Shareholder Agreement should focus minds on understanding the potentially catastrophic effects for a company if a communication breakdown occurs.

4. Policies

It is healthy and good governance to have a professionally written set of Policies that set out your business’s appetite and procedure in certain areas. This may include the correct way to hire and fire, data protection, IT security, or the purchase of certain assets and risk appetite generally. The very fact that you will be discussing and agreeing on these areas at the outset will make you think where issues may lie going forward.

5. Service Contracts

The likelihood is that even though you are a director of the Company, you will eventually become one of its employees. Employees should have written contracts of employment and that is exactly what a Service Contract is. A Service Contract will reflect your senior position in the Company and contain clauses that reflect that, together with your expected contribution. It is always best to have these matters recorded in black and white, to avoid confusion or dispute.

If you choose to engage a Non-Executive Director, the same should follow.

Conclusion

No one expects that they will fall out with their business partners. But taking some simple steps highlighted above will help to make sure that, should the worst happen, both sides can resolve the problems without the need for additional legal costs. After all, if is more cost-effective to put in place the correct measures from the start, rather than fix the problems after they arise.

Everyday Legal offers a range of professionally written templates for all your business needs. And if there's anything we don't offer that you need you can take advantage of our tailor-made services. Whichever services you need, you will save significant sums versus those you will pay on your typical high street.

John Davies

18th November 2020

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