You and a mate have come up with a brilliant idea that you reckon will be a great business venture. So, you set up a company — you both own 50% of the company as shareholders and are appointed as directors. You know each other well and you want to get the business up and running as soon as possible. There’s no need for a Shareholders Agreement — it’s just a formality, right?
You both share the same interests and goals now, but what happens if these change down the track? This could happen for any number of reasons — maybe you want to focus on your family, or it might even be that you feel like you’re putting in more time and effort into the business than your friend.
Shareholders Agreements are an important contract that can save your business a lot of time, effort and money. It outlines how decisions are made, what happens if you or another shareholder decides to leave the company, and dictates how disputes should be dealt with.
Find out what a Shareholders Agreement is here.
Understanding the terminology relating to shareholder disputes can be useful for working out your options.
A shareholder is an owner of a company. They are in control of the company and have the power to elect directors.
In contrast, the director of a company is in charge of managing the day-to-day affairs of the company. When it comes to small businesses, it is quite common to see one person holding both the role of shareholder and director.
- A Company Constitution lays the ground rules for how the company will operate (such as what the director’s powers and duties are, how to hold meetings and vote)
- A Shareholders Agreement is geared towards outlining the rules around the relationship between shareholders and directors, as well as how to deal with money and other company capital.
You can read about the differences between a Company Constitution and a Shareholders Agreement here.
Resolving Shareholder Disputes
So, what happens if a dispute arises between shareholders? Let’s explore what happens for 50/50 shareholders and minority shareholders.
Resolving Disputes Between 50/50 Shareholders
What happens if you and your friend don’t see eye to eye on a business matter or decision? The best outcome would be to negotiate a solution that everyone is happy with and lets you stay friends.
You may be surprised to find out that you can’t force your friend – or any other shareholder – to sell their shares just because there has been a disagreement.
If you and the other shareholder are willing to come to a compromise, negotiation is often the preferred avenue of resolving a shareholder dispute. This is because it tends to be quicker and cheaper than taking the matter to court.
The outcome of negotiation will differ according to your situation and what you and the other shareholder wants, so it is important that you consider what your best and worst case scenario is before starting negotiations.
If neither you or the other shareholder wishes to continue operating the business, there are two main options:
1. Splitting the business’ assets
2. Selling shares (this can be from one shareholder to the other, to a third party, or back to the business)
Splitting The Business’ Assets In A Shareholder Dispute
Negotiating and splitting the assets can be useful if you wish to continue using any of them in the future.
For example, if you created any intellectual property for the business, you may wish to retain it for a new business.
Selling Shares In A Shareholder Dispute
If one shareholder wishes to continue to operate the business, the other shareholder could sell their shares — either to the remaining shareholder or to a third party. A company buy-back may also be arranged.
If it looks like a sale of shares could take place, it may be useful to have the company and shares assessed independently to avoid any disagreement or argument over their value.
Where a shareholder wishes to sell their shares to a third party, it is important to make sure that they find a buyer who brings something valuable to the business. Some Constitutions may enable the remaining shareholder to refuse the transfer of shares to a proposed new shareholder, so it may be helpful to read over and review your own company’s Constitution for any relevant clauses.
The company may also buy back shares from the departing shareholder, so long as there is nothing in your company Constitution that prevents it.
According to s 257A of the Corporations Act 2001 (Cth) (‘the Act’), a company has the power to buy back shares if:
- The sale doesn’t impact the company’s ability to pay its creditors; and
- The buy-back complies with the procedures outlined in ch 2J.1 div 2 of the Act.
A company-buy back can be difficult as it involves complex processes that often depend on how many shares are being sold. Seeking professional legal help in this situation is recommended to make sure all your bases are covered.
Unfortunately, negotiation may not always work and you may be thinking about going to court. Initiating court proceedings should be treated as a last resort: not only do they cost you a lot of time and money, the court is also limited in what orders it can make, and it may result in an outcome that neither party is happy with.
In addition, the process may worsen your relationship with the other shareholder. What started as a great friendship may ultimately come to a bitter end.
Courts will not hear matters simply because you and the other shareholder have a disagreement or dispute. Rather, you will need to start proceedings according to certain criteria. Some common examples include, but are not limited to:
1. Breach of a Director’s Duty
Directors have four main duties:
- To act with due care and diligence
- To work in good faith
- Not to improperly use their position
- Not to improperly use information
You can read more here about what these duties entail and what happens if directors fail to meet them.
2. Applying to Wind Up the Company
According to s 461 of the Act, Courts may order that a solvent company be wound up if it found to be ‘just and equitable’. This will only happen in very limited circumstances, especially if there are employees that will be impacted by the order.
But what does it mean to be ‘just and equitable’?
Looking at the circumstances of the dispute, the Court will ask whether it is so serious that the only way to resolve the deadlock would be to wind up the company and bring its existence to an end. This is sometimes more relevant with small businesses and companies founded by friends because the relationship between the two shareholders is often built on mutual trust and confidence.
3. Oppressive Conduct
This will be discussed in the next section.
Resolving Minority Shareholder Disputes
If you are a minority shareholder, it is good to know about oppression and what actions could constitute oppressive conduct under part 2F.1 of the Act.
Oppression is defined in s 232 of the Act:
|The Court may make an order under section 233 if:(a) the conduct of a company’s affairs; or(b) an actual or proposed act or omission by or on behalf of a company; or(c) a resolution, or a proposed resolution, of members or a class of members of a company;|
(d) contrary to the interests of the members as a whole; or(e) oppressive to, unfairly prejudicial to, or unfairly discriminatory against, a member or members whether in that capacity or in any other capacity.
Oppressive conduct may comprise either a single act or a pattern of behaviour, as long as there is a demonstrated lack of fair dealing that oppresses the minority shareholder.
Some examples of oppressive conduct:
- Refusing the minority shareholder access to information about the company’s affairs
- The unfair allocation of, or restrictions on, the payment of dividends
- Using company funds for improper purposes
- Denying other directors the ability to carry out their own functions and duties
It is important to note that oppression can’t be used as a tactic to further your own interests and isn’t applicable in circumstances where there is a disagreement on how to operate the company or a breakdown in the shareholders’ relationship.
Talk To A Lawyer
Preventing shareholders disputes is generally much more effective and cheaper than finding a cure!
If you’d like to chat more about making sure your business has dispute resolution processes set up and ready to go, we have a friendly team of expert lawyers who are ready to help.
You may also want to check that your other legal documents – such as your Company Constitution or Shareholders Agreement – are up to scratch. It’s important that these are drafted properly to save you and your business unnecessary headaches if a shareholder dispute does arise.
If you’re not sure about what legal stuff you’ll need to do when starting a company, get in touch with us! You can reach us at 1800 730 617 or firstname.lastname@example.org for a free, no-obligations chat.
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