How to resolve Shareholder Disputes and Director Disputes?

Shareholder Disputes and Director Disputes can arise in any business and frequently do.

While the disruption caused by Shareholder Disputes and Director Disputes can be stressful and costly for the people involved, it is the impact on profit and cash flow and destruction of business value that is often the most serious consequence.

To avoid such disruption, and maintain business and share value, all Shareholders and Directors should have some understanding of the circumstances in which Shareholder Disputes and Director Disputes commonly arise and how they can be resolved.

It is important to recognise that not every dispute between Shareholders or Directors has legal consequences. To have legal consequences, there must be a breach of a legal obligation by a shareholder or director.

Why you need a Shareholders’ Agreement

Shareholders’ Agreements are highly recommended whenever a company has 2 or more shareholders as they will typically set out a regime for resolution of disputes and/or the steps and terms governing a shareholder’s exit.

When negotiating a Shareholders’ Agreement parties must apply their minds to matters relating the management, control, operation and financing of a company. Importantly, the consideration of these matters at the outset of an enterprise can greatly assist with planning and reduce the risk of a dispute arising in relation to such matters at a later date.

Please see our article on “When and Why You Need a Shareholders’ Agreement; and What Should it Cover” for more information about Shareholders’ Agreements.

Even when a Shareholders’ Agreement is in place, however, parties often require legal assistance and sometimes Court intervention to resolve a Shareholder or Director related dispute.

The rights and obligations of Directors and Shareholders?

Directors and shareholders are the individuals that stand behind a company. Being a director or shareholder comes with certain rights and obligations. Failing to understand these rights and obligations can lead to inadvertently breaching an obligation or having your rights infringed upon by another director, shareholder or a third party.

Directors’ Duties and Rights

Directors are the people who manage a company’s affairs. All companies must have at least one director.

In some circumstances, executives and other people who control the way a company operates (also known as shadow directors or de facto directors), can also be considered as directors of a company and be subject to certain duties or obligations.

Directors also have certain rights. These rights include the right to be participate in board meetings and make decisions, the right to remain appointed until validly removed and the right to access certain documents.

[2] ASIC v Mitchell (No 2) [2020] FCA 1098

Shareholders’ Duties and Rights

Shareholders are the owners of a company. Technically, shareholders own the shares in the company and do not otherwise have any direct right to the property of the company. Shareholders can be individuals or other companies.

Being a director does not automatically make you a shareholder. Similarly, being a shareholder does not make you a director or automatically give you the right to be involved in the day-to-day management of a company.

The specific duties and rights that a shareholder has can be impacted by the company structure, constitution and any Shareholders’ Agreement in place. However, shareholders will commonly have the right to attend shareholders meetings, vote on key issues, sell their shares, receive company reports and share in the company’s profits.

Shareholders’ duties will usually arise from a Shareholders’ Agreement and will often include not competing with the company, not soliciting customers or clients of the company and an obligation to keep information about the company confidential.

Common Shareholder Disputes and Director Disputes and When They Arise

In this article when we discuss Shareholder Disputes and Director Disputes we are referring to:

• a dispute between 2 or more shareholders;
• a dispute between 2 or more directors; and/or
• a dispute between a shareholder and a director of a company.

These disputes can arise in a wide variety of circumstances. However, there are some common circumstances or ‘friction points’ that cause disputes, including,

• a business downturn or external financial pressure,
• the company becoming involved in a dispute with a third party,
• the issue or proposed issue of shares in the company,
• a party wanting to exit the company,
• a party becoming involved in a similar or competing business to that of the company,
• personal issues of a shareholder or director; and
• a potential sale of the business.

Directors and Shareholders should be aware of these circumstances so that they can anticipate when an issue may arise and take steps to prevent it becoming a dispute.

What to do if you think a Director Dispute or Shareholder Dispute is likely

If you think that an issue is likely to become a dispute you should take steps immediately to ensure that your position is as strong as possible.

The first step that should be taken is information gathering. If you are a director of a company you may have access to most of the information that you will need. However, it is a good idea to get together copies of the relevant information in case your access to company documents is removed in the future.

The next step that should be taken is to obtain or arrange legal advice. Having an experienced Solicitor engaged and briefed on the background of the matter will ensure that you are able to take action quickly if it becomes necessary.

How Shareholder Disputes and Director Disputes can be resolved

The best way to avoid shareholder disputes is to have a strong Shareholders’ Agreement that deals with the way that a company will be run. Please see our article here about preparing Shareholders’ Agreements. A good Shareholders Agreement will normally have a mandatory dispute resolution process set out in it.

When seeking to resolve a Shareholder Dispute or Director Dispute, we adopt a client-focused approach that aims to achieve the client’s goals with minimal disruption to the business.

Critical to this approach is first determining what the client wants to achieve. It may sound simple, but often it can be overlooked when considering the legal issues. Once we understand what the client wants, we can move on considering the strategies available to achieve that goal.

In seeking to achieve our client’s goal, we focus on creating leverage for our client and protecting the assets of the company. For example, a sensible first step is often to lock down the company bank accounts to prevent any funds of the company being taken. This both creates leverage and protects the assets of the company.

Finally, we consider what strategies should be used (and in what order) to achieve the client’s goal. For example, there are number of ways to resolve a Shareholder Dispute or Director Dispute, including negotiation, using the Courts to obtain orders, and/or resignation by a director or a buy-out/sale of shares. Each of these options can be used separately or together and the order in which they are used can change depending on the individual circumstances of the case. These options are discussed in more detail below.

Court Options

A company can claim against a director or former director for a breach of directors’ duties. However, this will generally require a majority of the shareholders of a company to agree to do this.

If the majority of shareholders do not agree to bring a claim against a director, the shareholders can apply to the Court for leave (or permission) to do so – this is called a derivative action.

The classic situation where the derivative action is used is when a minority shareholder wants to force a company to take action against its director/majority shareholder. There are specific requirements that must be satisfied in order to do this and specialist legal advice should be sought in advance.

A shareholder can also apply to the Court for orders when a company is being managed in a way that is oppressive, unfair or discriminatory against a shareholder – known as an oppressive conduct case. Some examples of circumstances that may give rise to oppressive conduct include:

• a CEO and majority shareholder paying themselves a large salary resulting in no profit available to be paid as a dividend;
• one of the directors and shareholders of the company diverting business to a new company controlled exclusively by him;
• issuing additional shares to the exclusion of a party (ie. a share dilution);
• improper exclusion from management;
• denying access to information.

There is a great deal of flexibility in the orders the Court can make in an oppressive conduct case, including orders:

• that the company be wound up;
• for the purchase of any shares in the company;
• for the company to institute legal proceedings;
• appointing a receiver or a receiver and manager;
• restraining or requiring a person from engaging in specified conduct or from doing a specified act or requiring a person to do a specified act.

While there is a broad discretion afforded to the Court, generally the Court will seek to make the least intrusive remedy (for example, a Court will not ordinarily wind up an otherwise profitable company due to a dispute between its shareholders).

If a company is otherwise profitable, a Court will commonly order that one party buy another party’s shares in the company. The value of the shares is then either agreed or sent to a valuer to be determined. In this case, the basis of the valuation and point in time at which the shares are to be valued will be important considerations. For example, it would ordinarily be appropriate to value the shares in the company as if the oppressive conduct complained of had never occurred.

If a company is not profitable or will not continue to trade, a Court will often order that the company be wound up. In this case a liquidator will realise the company’s assets, pay its creditors and pay any balance to the shareholders.

Conclusion

If not resolved promptly, Shareholder Disputes and Director Disputes can be distracting, time consuming, financially damaging and expensive.

Unresolved disputes take the attention of key decision makers away from the core business of the company and can lead to complex litigation that is often devastating to share equity.

Ultimately, acting quickly and decisively at an early stage of a dispute can lessen the impact and cost of the overall dispute and allow focus to remain on the core business.

If you are reading this and wondering if you need advice about an issue or dispute, you probably do, and you should seek legal advice as soon as possible.