Taking the cream from the fat cats – minority shareholder super powers

It’s common for a group of friends to get together in business, and like a new relationship everything is rosy and no one is thinking about things going wrong or breaking down. For example, a good friend may ask you to chip in a few thousand pounds in return for a 25% interest in her new venture, or you might start a business up from scratch, with a number of long standing friends each contributing a share to get the business off the ground.

Alternatively, you might be given a few shares in your employer’s company as part of a director package or simply decide to invest in a new and exciting tech start up hoping for a rainbow return in a few years time. Or you may be the owner/founder of a successful business where you have handed over a significant chunk of your shares to private equity in return for springboard investment and support.

Where your share in a company is less than 50% you will be a minority shareholder.   Your ability to control the operations of the company (and protect your investment) can be limited. So what do you do when you see friends or fat cat owners taking the company in the wrong direction and flushing your investment down the drain?

A disgruntled minority shareholder does not have to sit back and do nothing. It potentially has a number of powerful weapons available in its arsenal.

The starting point will be to look at the rights given to you within the company’s articles of association. You may also have had the foresight to insist upon a shareholder agreement which gives you some additional protection . Certain duties are also automatically imposed upon directors by statute. But what other options are available?

The concept of unfair prejudice is flexible and can be a powerful tool for a minority shareholder. The complaint must be about the conduct of the company’s affairs, particularly where there has been a breach of the articles of association or shareholders agreement or an abuse of power. Other examples include the misapplication of funds or property and the diversion of business to another business in which the majority shareholder holds an interest. In some instances, it may also be ‘unfairly prejudicial’ if there has been a failure to pay dividends or where there has been excessive director remuneration.

The conduct complained of must be unfair and must prejudice the interest of the shareholder. The court has a wide discretion when deciding the most appropriate remedy but in most cases an order is made that the majority purchase the minority’s shares at a fair value determined by the court (which usually means a market value enhanced to take account of the unfair conduct which has taken place).

Although relatively rare a further remedy is a derivative claim.   In an unfair prejudice the petitioner usually seeks personal relief. However, in a derivative claim the shareholder brings or continues a claim on behalf of the company in relation to a breach of duty by a director. The claim is brought for the benefit of the company. It is often used where the majority wrongfully stops the company from making the claim itself. The shareholder does not have to show that a director has benefited personally from the breach of duty. It is also not necessary to show that the directors who did wrong are in control a majority of the shares.   As the claim is brought for the benefit of the company it is the company which is entitled to any remedy obtained. In these claims the court must give permission for the claim to continue to trial.

The nuclear option for a minority shareholder is to make an application to wind up the company on the basis that it is just and equitable to do so. Such an order will not be made if there is a fairer alternative remedy available which would allow the company to continue, and obviously you may not wish to wind up the business if it is still making a profit. However the threat of wind up can be a powerful negotiating position to take in certain circumstances.

These three options are often very powerful tools in small to medium sized companies with a relatively small number of shareholders. Often the minority shareholder will also be a director. There is usually more than one option available and the best one will usually depend upon what the shareholder wants to achieve. For example, does she want a clean break, a change in direction of the company or simply to ensure that her voice is being heard in future. As a rule of thumb an unfair prejudice petition will often be most suited when there has been a breakdown in the relationship. Where there has been damage to the company itself a derivative action may be more appropriate. In some cases it may be better to pursue both an unfair prejudice petition and a derivative action at the same time. With specialist legal advice often a solution can be reached quickly outside of the formal court processes saving time and money.