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Resolving shareholder disputes in family businesses

If a minority shareholder feels that the actions of the majority shareholders are unfairly prejudicial on their position, then that minority shareholder may then bring a petition under s. 994 of the Companies Act 2006 (“s.994”).

There are many different types of company and so the remedies that are available to the court under a s.994 are very wide, but as a general proposition the most likely order is that the majority shareholders are ordered to buy the minority shareholders shares. This is particularly the case in a “quasi partnership”. In essence a quasi-partnership is a company that exhibits all of the characteristics of a traditional partnership. There are no firm rules but useful indicators (according to Embrahimi v Westbourne Galleries Limited [1973] AC 360) are:-

  • an association formed or continued on the basis of a personal relationship of mutual confidence;
  • an agreement, or understanding, that all (or some) of the shareholders shall participate in the conduct of the business; and
  • restrictions on the transfers of shares.

Family businesses will often exhibit the characteristics of a quasi-partnership. This is because there is likely to be a relationship of confidence between family members and those individuals are also likely to be participating in a formal way in the running of the business.

Disputes involving family or friends can be very significant and once the issue has crystallised, there is often no way back. It would be impractical to force people that were once close to be in business with each other if their relationship is irretrievably broken down. This means that the minority shareholder exiting the business and the sum that they are paid for their shares will often be the key issue to be resolved between the parties. Importantly, if a company is deemed as a quasi-partnership it will usually impact on the valuation of the petitioning shareholders shares. Usually a minority shareholding in a private company will be valued on a discounted basis. This is because it is recognised that the market for such an interest is extremely limited. In essence, no one wants a shareholding in a private company that does not afford them some control. However, in a quasi-partnership the minority shareholders shares will be valued on an undiscounted basis (i.e their full proportionate value). Given that the discount can be anything up to 50% of the proportionate value, the difference might be substantial.

Disputes of this nature can have high costs, both in terms of the financial costs of retaining lawyers and the emotional costs it imposes on the parties to them. Therefore, early settlement is a sensible strategy to adopt if faced with an unfair prejudice petition.

There is a mechanism to make an offer that has some significant teeth which encourages a settlement. This is known as an O’Neill v Philips offer (named after the case in which the elements of such an offer were clarified) The key characteristics of such an offer are:-

  • The offer must be to purchase the shares at a fair value and without a discount for them being a minority holding;
  • If the valuation cannot be agreed then it should be determined by a competent expert;
  • The expert should act as an expert and not as an arbitrator;
  • All parties should have access to the same information, and should have an equal right to raise issues with and put questions to the expert;
  • The offer ought to be made on an open (as opposed to without prejudice) basis so that it can be referred to the court.

If a compliant O’Neill v Philips offer is made then it has a potentially dramatic effect. If the petitioning minority shareholder issues an unfair prejudice petition after such an offer has been made then it is likely to be struck out as an abuse of process. This is because the offer gives the petitioner the best remedy that they could hope to achieve if they did issue a petition and therefore the legal proceedings would be pointless.

There are some practical considerations to factor in before making an O’Neill v Philips offer:-

  • What are the merits of the claim and what are your prospects of resisting it?
  • If the prospects of defending the petition are good, what is the likely outcome in practical terms; you could win the litigation but end up handcuffed to a director/shareholder/family member that you cannot get on with. That won’t be good for you or for your company.
  • Can you or the company afford to honour the offer? If the company is buying back its own shares it can only do so from distributable reserves and if those are insufficient then it must not participate in the offer.

It is certainly the case that an early settlement, either via an O’Neill v Philips offer, mediation or negotiation is better than the potentially destructive impact that litigation would have on the company, its business and on your family.

If you are facing this situation then we would be happy to assist.

Peter Brewer is a partner in the commercial litigation team of national law firm Clarke Willmott LLP. He can be contacted on peter.brewer@clarkewillmott.com and on 07799 347 840.

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