Article originally posted on LinkedIn.
Disputes among company shareholders are not just common, they should be seen as almost inevitable. This is not to take a negative view of human nature but merely to state the facts. Management and strategy questions can be difficult. People often disagree on fundamental business choices. Work and personal life change. Office pressures and financial challenges take their toll. Meantime, corporate structures can remain rigid and procedures unclear.
So, it is highly likely that the interests of shareholders – even between close friends and original founding partners of a modest-sized venture – will diverge. What to do then?
Shareholder Agreements. At Sajen legal, we urge you to seek legal advice well before you find yourself in this situation. Prevention is always the best medicine, and we cannot emphasise this point strongly enough. Any investment in resources and time (including legal fees) at this stage will save you significant effort and money compared to the later expense and strain of a contentious negotiation or risky litigation.
This is because the underlying problem is often not the matter of dispute itself but rather the absence of corporate mechanisms for working out a solution in a procedural and amicable manner. Well-drafted company constitutions should make allowance for all eventualities, and a thoughtful and comprehensive shareholders agreement can help guide parties through their differences by enshrining agreed pathways, even in the case of sharp disagreement.
If these provisions do not exist within existing company material, it will be difficult to put them in place once a dispute emerges. So it is best to have experienced legal support to review your governing documents while relations are positive and things are going well. Fix the roof while the sun is shining.
Causes of Dispute. If differences among shareholders have already reached an impasse, it is important to understand the various avenues available to resolve the matter – as well as their cost implications, in money, time and stress. All of these are critical factors, and should be carefully considered with your lawyers to help you make a clear-headed decision.
Every company is different, and every dispute distinct. There are, however, some classic causes for disagreement among shareholding partners:
- Capital v Sweat Investment. Many ventures are launched with one partner providing the seed capital and one investing ‘sweat equity’. Over time, as the business stabilises and grows, the financially investing partner may wish to see a healthy return, while the working partner may come to feel that it is his time and effort that has really established the company and that he, therefore, deserves greater compensation or a controlling say over corporate affairs.
- Investment v. Disbursement. Disparities in interests among shareholders can be driven by life events: children, an illness, a divorce, aging. Such factors can impact strategic preferences. One partner may wish to distribute funds to the shareholders – for example, to deal with a life emergency or life change – while another with a longer time horizon may be keen to invest for growth.
- Retirement or Departure. Even where relations have remained positive, a dispute can arise in the absence of good financial and corporate planning. If one partner wishes to depart the venture but no provisions have been made to buy him out, then he may see no other option but to dismantle the company, even if the other partner strongly wishes to continue successful operations.
- Trust Breakdown. Too frequently disputes among shareholders arise from a breakdown in relations. One partner may feel he is working harder and more effectively than the other. The parties may suspect that they are no longer working towards a common goal, or are even purposefully working against each other. Questions of transparency and the reliability of financial and other corporate information can become matters of sharp dispute.
The type and severity of the disagreement will guide you in determining how best to reach a settlement. Whatever the situation, the benefits, costs and risks must be assessed carefully – based on a detailed review of the underlying legal position.
Pathways to Resolution. Drawing on our substantial experience, at Sajen legal we always seek to achieve cordial and early settlements where possible, while retaining the capacity and expertise to engage in hard-nosed negotiation and ultimately in litigation should more aggressive approaches be required. It must be remembered that the further any dispute escalates, the more the cost of the effort will eat into existing assets. The key question is which pathway offers the most cost-effective means to achieve the most optimal solution possible.
The main pathways are as follows:
- Negotiated Settlement. It is generally preferred to achieve a negotiated settlement. The drawbacks are that, if the dispute is complex or bitter, it can take a long time and compromise will be required. As a result, the parties may feel disappointed not to have the final satisfaction of achieving a real ‘victory’, one over the other. There is also likely to be a lower financial return than initially hoped. But if both sides can commit to a process of negotiations, a resolution will be achieved more quickly and at far less cost than by going to court – and with significantly less risk.
- Court Proceedings. Shareholder disputes can be taken to court under the provisions of the Corporations Act. Typically, this will mean one party accusing the other of breaching director’s duties and of engaging in ‘oppressive conduct’. In the case of alleged fraud, mismanagement or self-dealing, a party may bring a statutory derivate action – that is, a claim brought on behalf of the corporation on the basis that directors have failed to exercise their duty for the benefit of all shareholders. Remedies sought can include injunctions, specific personal remedies or, in extremis, the winding up of the company.
The venue for any litigation is determined by the scale, complexity and location of the company and its operations. Sajen legal brings extensive experience in court proceedings before State and Federal courts.
In many cases, the ultimate and inevitable solution is a buy-out. But sometimes it may take either litigation or the threat of court proceedings for both parties to reach this understanding. Of course, any threats of litigation should not be made recklessly, so the interrelationship between these two pathways must be considered and managed carefully.
Breach of Duty & Oppression. A hostile dispute may arise when one party makes significant claims against another for breach of duty or oppression. Under the Corporations Act and common law, company officers are required to undertake their roles with reasonable care and due diligence. They must act in good faith and in the best interests of the company and for a proper purpose. And they must not use their position for unfair advantage or to the detriment of the company, including improperly utilizing information gained as a company director.
Oppression can be a single act or a pattern of behaviour in which an officer of the company acts against the interests of the members (shareholders) as a whole or in ways that are unfair or discriminatory against a member or group of members. Examples can include:
- making excessive compensations payments to the controlling director;
- using funds for personal expenditure or other improper purposes;
- withholding or reducing dividend payments;
- restricting or refusing access to financial or other corporate information;
- impeding the ability of other directors to carry out their duties such as by failing to hold required directors’ meetings;
- taking improper steps to obstruct or prevent a member from selling their shares.
Where legal advisors may determine, or a court may conclude, that such duties have been breached, there arises a potential finding of oppression, which can strengthen a negotiating posture or significantly determine the finding of a court.
Potential Remedies. Before embarking on any approach, it is important to have a realistic idea of what might be possible to achieve through a dispute. The Corporations Act itself provides limited options for resolving shareholder disputes. At Sajen legal we take special care to talk over the likelihood of any and all potential outcomes and scenarios so that clients feel fully informed before embarking on any specific pathway.
In sharp disputes, one party may feel the other has so defaulted on their responsibilities, performed so badly or selfishly, or worked so clearly against the interests of the company, that their objective and they believe the obvious solution, is to kick the other partner out of the company. Sadly, this situation arises too frequently from 50:50 partnerships between founding partners and old friends.
In reality, it is not straightforward to force one party to sell up and leave just because of a disagreement – unless this is specifically provided for in an existing shareholders agreement. Equally, once a dispute gains momentum, it is likely that there will be competing claims of breach of duty or oppression, such as obstructing access to company financials.
What, then, are the possible outcomes?
In effect, the solutions available through either process are the same, with the difference that in a court proceeding a judge will hear evidence and impose a solution which may not be to the satisfaction of either party, whereas in a negotiated process any decisions are reached through dialogue.
With this in mind, there are four main potential outcomes of a shareholder dispute:
- Directions, either by agreement or by court order, governing the conduct of company affairs. This could include, for example, transparency of information, level of commitment and effort, or disbursement of payments to shareholders. It could also result in a revision of the company’s constitution.
- The sale of shares by one shareholder to another, either at a negotiated price or at a price determined by the court. In most cases, the parties will not be able to agree on a price, so an independent external evaluation will often be obtained. Other approaches include agreeing to a process of sealed bids. It is also possible, in some cases, to agree on the sale to a third party. A corporate buy-back, which is governed by specific regulations, is also a possible option to remove a shareholder.
- Splitting the company. In some cases, it can be pragmatic to agree to a division of assets through a negotiated sale of a business contract, or a court may impose this. A business may have evolved into different components which different partners wish to pursue. Or one partner may have a higher claim to the initial intellectual property, while the other may wish to dispose of assets he has contributed to building through his efforts.
- A decision to wind up the company. Courts hesitate to wind up companies which are solvent, as this could have the effect of depriving workers of their livelihoods because the directors cannot resolve their differences. Nevertheless, the law provides for this in cases where it is ‘just and equitable’ to do so, such as an irretrievable breakdown of trust between the shareholders such that in reality there is no other option.
How We Can Help. At Sajen legal, we believe that the best kind of legal advice should be good business advice. Options such as our Accord relationship can ensure that we support you and your partners over time so that the risk of shareholder disputes is reduced. The most profitable situation for all parties is usually to maintain a healthy, stable and profitable company with minimal internal discord. A good first step is to review your company’s constitution and review or put in place an updated shareholder agreement.
If matters have gone beyond this point, then you definitely need legal advice as soon as possible. The team at Sajen legal bring extensive experience in both amicable and hostile negotiated processes and incorporate litigation at all levels. Where it may come to a court proceeding, it is vital to have a robust and experienced team hard at work on your behalf, while always open to settlement opportunities that may arise.
No one likes a shareholder dispute. The experienced team at Sajen legal works hard to provide our clients will the full support and information they need to manage a difficult situation with clarity and confidence. The ultimate goal is to achieve the best solution for our clients in the most cost-effective and efficient way possible.