It wasn’t that long ago that former Scottish First Minister, Alex Salmond, who lost his seat in the 2017 General Election, was being pushed toward the chairmanship of Johnston Press by Custos, a major shareholder that was unhappy with the performance of the board.
While the move didn’t pay off for Custos, it begs a question – if a majority shareholder can make such a move, what can minority shareholders do if they feel unhappy with the direction of the company?
Speak to any lawyer and minority shareholder rights is an issue that crops up frequently. Surprisingly, the law does afford minority shareholders specific protections that increase in line with the number of shares held. The result is that a minority shareholder may be able to wield influence within a company, even though they may own few of the company’s shares.
The first place to look for succour, says John Deane, a partner at Gannons Solicitors, is the company’s articles or a shareholders’ agreement. This is because, as Deane notes, “there is no limit on the extent of enhancement over and above the Companies Act that may be put in place. It is all a matter of knowing what rights you will need and what you can agree.”
Typically, the problem for many firms is that they adopt standard articles and agreements without consideration for the future and the problems that it may bring. That means that the remedies available are limited to whatever the Companies Act 2006 grant.
Paul Taylor, a partner in the corporate department of law firm Fox Williams, says that where a shareholder owns just one share in a company, they still have some basic privileges. They are entitled to inspect the constitutional documents of the company and are entitled to a copy of the company’s annual accounts. They are also allowed to attend, and be heard at, shareholders’ meetings.
However, these rights need backup through being written into company documents. Says Deane: “Often minorities suspect the business is not being managed properly but lack evidence to prove as much. Controlling shareholders and directors will often refuse to voluntarily disclose evidence. In practice, one of the most important provisions to include for a minority shareholder is the right to access financial records.”
But apart from information rights, Taylor says that a shareholder can trigger two potentially significant processes: “A shareholder can, in certain circumstances, seek a ‘winding up’ (liquidation) of the company on the grounds that it is ‘just and equitable’ to do so. Circumstances where courts have ordered such an outcome include the board’s failure to pay reasonable dividends, and a lack of confidence in the company’s management.” He adds, however, that a high threshold has to be met for the court to order this, and it is fairly rare for it to be granted.
Deane too has witnessed the threshold coming into play when it comes to winding up. However, he’s found that the courts have helpfully outlined the principles through rulings. Example cases have involved a deadlock that was not contemplated by the shareholders – this is often the case in a firm with two equal shareholders as ordinary resolutions cannot be passed and the shareholders are often the two directors of the firm and also employees; justifiable loss of confidence in management arising from serious company mismanagement on behalf of the directors – for example fraud or excessive director remuneration; and exclusion from management or failure to provide information where an agreement renders such conduct inequitable.
Another tool a shareholder can employ is the right to apply to a court on the basis that the conduct of the company’s affairs amounts to “unfair prejudice” to the shareholder. Here Taylor says courts have “given relief in a variety of circumstances, including the firm’s failure to consult with shareholders or to provide information, and mismanagement by the directors of the company’s business and internal affairs.”
It’s interesting, as Deane explains, that for both prejudice and unfairness claims the courts have not provided any definitions: “The courts assess unfairness on an understanding of the commercial relationship from an objective point of a view, it is determined on a case by case basis to ascertain whether any minority shareholders rights have been interfered with.”
He adds that if prejudicial and unfair conduct is proven, courts have a wide range of discretionary powers. They can order the purchase or sale of the petitioner’s shares at a price determined by the court; can regulate the company’s affairs in the future; require the company to undertake an act or omit from taking action on a specific matter complained of; or authorise proceedings to be commenced under the derivative claim route (that is, claims against directors instead of the company).
It is important to remember that bringing an unfair prejudice claim can be costly and time consuming, and therefore they are not frequent in practice. Nonetheless, it is a process open to all shareholders, regardless of how many shares they own in the company.
Shares make prizes
Moving fractionally up the shareholding scale, owning just 5% of the company’s shares gives a shareholder further rights, such as the right to request that a resolution be proposed at a shareholders’ meeting (although the shareholder must pay the company’s reasonable expenses of giving notice of such a resolution).
Further the shareholder can request that a general meeting takes place and can ask the company to circulate to shareholders a statement relating to a matter referred to in a proposed resolution to be put to shareholders at a general meeting. Also, a shareholder owning 5% of the company’s shares can prevent the deemed re-appointment of the company’s auditor.
And on owning 10% of the company’s shares the law grants a shareholder the ability to block the holding of a general meeting of shareholders on short notice, resulting in 14 clear days’ notice being required to be given before the meeting can take place.
The right to object
But what of higher levels of ownership? 15% of the company’s shares gives a shareholder the right to object to a variation of the class rights of the shares he holds (such as the voting, dividends and rights to the company’s assets upon a liquidation event), by requesting that the court cancels the variation.
Taylor says that 25% plus one share gets a minority shareholder to a significant milestone – “a special resolution cannot be passed without their consent because a clear 75% is needed.
“The importance of this cannot be overstated as special resolutions are required to implement key changes in the company’s business.” He says that while more minor matters need only be passed by an ordinary resolution, special resolutions are required to, among other matters, alter a company’s articles of association, change its name, re-register a private company as a public company (and vice versa), and to put the company into voluntary liquidation.
Special resolutions are also needed to enable certain specific changes to the company’s share capital, such as disapplying pre-emption rights, reducing its share capital (although this is also subject to the confirmation by the court), and redeeming or purchasing the company’s own shares out of its capital.
Of course, any shareholder owning the majority of a company’s shares will be in control of the company. The problem for the 50% shareholder turns on the interaction of simple maths and the law because, as Taylor explains, “ordinary resolutions are required for the company to implement a multitude of matters, including (amongst others) the appointment of a director (although this will be dependent on the terms of the company’s articles of association), the removal of a director, and the ratification of past acts of directors. But to pass an ordinary resolution, a majority of shareholders must vote in favour of it (that is, 50% plus one voting share). Therefore, an ordinary resolution cannot be passed if a shareholder holds exactly 50% of the company’s shares.”
And remember, as with the 25% plus one shareholder, even owning the majority of the company’s shares, does not grant absolute control as that requires a shareholder to have more than 75% of the shares to pass special resolutions.
Bring me solutions
As Deane knows from experience, minority shareholders need to plan ahead at the outset of the business relationship so that they “are given powers of veto” that can be used to block actions unless all, including the minority, consents.
Other terms should specify direct access to financial reports with sight of internal management accounts; protecting against the dilution of shareholdings where only wealthy investors can afford to buy new shares; protecting against transfer of shares to a third party or family member; and most importantly, the writing into the shareholders agreement of a dispute resolution process.
So, it appears that even shareholders with a small proportion of a company’s shares are afforded specific rights. This is obviously to the benefit of minority shareholders, as such provisions act as their shield, protecting them against more powerful shareholders. But this can cut both ways. If a company has a disgruntled activist minority shareholder, the protections become their sword – for instance by constantly requisitioning general meetings and proposing potentially unhelpful shareholder resolutions, such minority shareholders can make life difficult for the company, and by implication, its larger shareholders.