November 12, 2020
In most SME’s, the directors and shareholders are the same individuals. Sometimes the relationships between them break down or one of the individuals may be unable or unwilling to continue to participate in running the business or is just not pulling their weight.
What are the options for the parties who want to take control of the company and continue with the business?
An ordinary resolution (i.e. where the holders of 50% +1 of the issues shares are in favour) can be passed to remove a director, provided the appropriate notice has been given. This is a relatively straight forward procedure. However, it should be noted that the director, once removed, may be entitled to bring a claim for compensation for loss of office as a director.
Consequential termination of an employment contract?
Where the individual is also an employee of the company, removal from the board won’t automatically terminate their employment and the company will need to formally dismiss them as an employee as well. If there is no actual dismissal by the company, the individual may treat their removal as a director as amounting to constructive dismissal. Whether actually or constructively dismissed, a claim for unfair dismissal could arise.
Can a shareholder be forced to sell his/her shares?
Even if removed as a director and terminated as an employee, the individual will continue to own their shares. Removal as a director/employee does not act as a trigger to compel the individual to sell their shares, nor does it create an obligation on the remaining participant(s) to acquire them, although they are likely to want to do so because the individual who has been removed will still be entitled to:
- receive dividends and any other distributions (without providing any contribution towards the effort required to generate profits or any other gains in value); and
- receive notice of, attend and vote at shareholders’ meetings (and therefore, if so inclined, could seek to continue to influence certain aspects of the running of the business).
Therefore, it is, at the very least, highly desirable for the remaining participant(s) in the company to acquire the shareholding of the person who has left/been removed. However, this can sometimes be easier said than done.
There are several possible ways in which a shareholder could be forced to sell their shares but, whichever method is adopted, it is important to have a carefully planned strategy:
- The articles of association of the company might already contain provisions that allow the remaining shareholders to force the one exiting to sell their shares;
- If a shareholders’ agreement has been put in place, it may contain provisions that can be invoked to compel a sale of shares; or
- If neither of the above is of assistance, if there is a majority of 75% or more in favour (i.e. capable of passing a special resolution), the articles of association can be altered to include provisions that allow a forced sale of shares and determine the value at which they are to be acquired.
Alternatives options that could be pursued, that do not involve a sale of shares, include:
- Increasing the remuneration of the directors who are continuing to run the business, and reducing the distribution of profits by way of dividends. This may be problematic though, in terms of how the additional remuneration will be taxed but it would avoid paying dividends to a shareholder who is no longer involved in the management of the business; or
- A majority holding at least 75% of the shares, passing a special resolution to wind up the company and, provided the company is not insolvent, for the assets to be transferred to a new company in which shares are not issued to the minority shareholder. This is something of a “nuclear” option and carries with it risks for all the directors in that a liquidator will have to investigate their past activities and may be compelled to bring claims against them on behalf of the old company and any creditors.
With any of the options outlined above, where the outgoing individual is a minority shareholder, there is a risk that the action taken amounts to oppression. It is important, therefore, to ensure that the action taken is not unjust. If a dispute were to arise it could result in costly legal proceedings for what is called “unfair prejudice”. More often than not, the outcome of court action would be an order compelling the departing shareholder to sell their shares at a value determined by the court.
Therefore, the prudent course of action is to carefully assess what options are available and, before taking formal action against the exiting shareholder of the kind suggested above, seek to agree on the terms on which their shares are to be acquired including how they are to be valued. A carefully drafted letter, that offers to purchase the shares on the terms that the court is likely to impose if it were to become involved would be a desirable step to take at an early stage.
Accountancy advice will be key, particularly around the issue of whether a minority shareholding should be discounted compared with the percentage of the whole company that the shareholding represents. If a discount is appropriate, what should it be (the company’s articles of association may already contain a valuation method for a minority shareholding)?
If the reasons for wanting to remove an individual from the company include actions they have taken that have caused losses to the company, that can (and perhaps ought to) be factored into any negotiation and the ultimate agreement as to what will be paid for the departing shareholder’s shares. It is worth noting that, if other directors who are to continue have themselves breached their duties to the company, the departing shareholder is likely to raise their own allegations within the negotiation and expect them to be a factor in the terms that are ultimately agreed.
The best approach to adopt is to have suitable, tailored articles of association (not just the standard model articles) and a bespoke shareholders’ agreement in place from the outset. However, with or without taking those measures, if relationships become soured, there can still be a very difficult situation that needs a great deal of care in order to try to avoid action being taken that sparks into expensive litigation and is likely to cause damage to the company in the process.
We are able to assist in resolving difficult situations between directors and/or shareholders and if you wish to discuss any issue of this kind, please get in touch with Andrew Farrell and his team.