Shareholder disputes: what practical steps can directors take?

Shareholder disputes are not uncommon and many board members will have experienced the difficulties that arise when matters between members become litigious. 

There are practical things that can be done to try and mitigate the potential for shareholder disputes and, even when those prove impossible or unsuccessful, directors may still be able to avoid litigation or disruptive shareholder action.

In this short note, Ferbrache & Farrell LLP offers a practical checklist for board members.

1. Am I having regard to my core duties as a director?

Directors can quickly find themselves caught up in shareholder disputes. The best means of personal protection is to focus upon the fact that your duties are owed to the company for which you act and that you need to:

• Act bona fide in the bests interests of the company as a whole;
• Avoid acting for any collateral or improper purpose;
• Exercise your independent judgment;
• Avoid conflicts of interest; and
• Exercise reasonable skill and care.

These duties will hold true regardless of the size of the company, the number of shareholders, the nature of any obligations to specific shareholders or whether the company is listed.

2. Can I legislate for shareholder disputes before they arise?

Few people become involved in a company on the basis that they will end up in dispute with their fellow members. It must, however, be recognised that the potential for a breakdown in trust and confidence can occur in any company. 

A well-drafted shareholders agreement can help to legislate for the sorts of issues that arise when members end up at loggerheads. A good shareholders agreement may have regard to:

• The composition of the board and shareholders’ rights to appoint directors;
• Quorum requirements;
• The resolution of deadlock;
• Reserved matters;
• Any dividend policy; and
• Pre-emption rights and appropriate share valuation.

3. Are there signs of potential problems?

In some cases it will be entirely obvious that shareholders are in dispute and that there will be a near inevitable march towards litigation. In other situations, there may be early indicators of potential problems. These may include:

• Shareholders exercising statutory or constitutional rights for information or to call meetings;
• Subject access requests;
• Agitated members at meetings;
• Active members suddenly going quiet (possibly whilst they take legal advice);
• Efforts to organise members’ groups or claims to act as member representative;
• Allegations that dissenting board members are conflicted, acting negligently or in some way breaching their fiduciary duties. 

4. Are there any practical things the board can do? 

The intervention of independent parties can sometimes be of assistance. Where there are no formal requirements under, say, a shareholders agreement, alternative dispute resolution methods may be worthy of consideration. These could include:

• Appointing a new independent director to break any deadlock;
• Asking existing independent directors to try and broker an agreement between the factions;
• Appointing an independent arbitrator to make a binding decision; or
• Appointing a mediator to facilitate negotiations and a binding agreement.

5. Where this could end up? 

If a dispute cannot be resolved, then the matter may well end with litigation, forced share purchases, regulation of the company’s affairs by the Court and/or the company being wound up.

Shareholders may have claims that they can bring to require the company (via its directors) to act within the capacity afforded by its constitution or against one another and the company under any shareholders agreement. 

Shareholders may also have: 

• statutory claims for:
  • unfair prejudice in circumstances where an actual or proposed act (or omission) consisting of the company’s affairs would cause unfair prejudice to the interests of any member or members;
  • just and equitable winding up of the company in ‘quasi-partnership’ scenarios; or

• common law rights to bring a derivative claim in their own name on behalf of the company. Such a claim may arise where there is:
  • an alleged wrong or breach of duty by a director (most notably a fraud on the minority);
  • which is incapable of being ratified by a simple majority; and
  • where the alleged wrongdoers are in control of the company so that the company itself is effectively stopped from being the proper plaintiff.

None of these is likely to be conducive to, at the very least, the short-term success of the company.  All of them carry the potential for directors to come under significant scrutiny. 

As such, we recommend that directors:

• try to legislate for shareholder disputes before they arise;
• look for warning signs that could be indicative of future problems; and
• obtain early advice once the prospect of a dispute emerges.