As a shareholder of a company, it’s important to know that in certain circumstances, the law gives you the right to ‘remedies’ (legal actions you can take as a shareholder) if you are in dispute with the company and its directors, or if you think that your rights as a member are being compromised. We’ve put together this article to set out what those shareholder remedies are, when they are available and what you as a shareholder has to do to be able to use them.
- What are the main shareholder remedies?
- Just and equitable winding up
- What’s the legal basis for winding up a company?
- What will the court consider if asked to wind up a company?
- Do you have to be a shareholder to ask the court to wind up a company?
- What criteria does a winding up petition have to meet in order for the court to review it?
- What might be a barrier to the success of a winding up order being made?
- Final thoughts on the winding up process
- Unfair prejudice petitions
- Where does the right to bring an unfair prejudice petition arise in law?
- How can ‘unfair prejudice’ be defined?
- How is unfair prejudice assessed?
- Examples of unfair prejudice
- When might a petitioning shareholder not be able to make a successful petition?
- What options are available to the court when it is faced with an unfair prejudice petition?
- The derivative claim
- Shareholder remedies against directors
- Do shareholder remedies vary depending on the type of company?
- Minority shareholder remedies
- Can shareholders claim remedies for a breach of the articles of association?
What are the main shareholder remedies?
Under statutory law, there are three main remedies available to you as a shareholder of a company if you think that your rights as a member have been compromised:
- Just and equitable ‘winding up’
- Unfair prejudice petitions
- The derivative claim
These remedies are important for a member to have, particularly if you don’t hold a large number of shares in the company you’ve invested in and are in the minority when it comes to making decisions about the company as a whole.
A word of warning, however: each of the three processes relies heavily on the wide discretion of the court, and each one is complex and likely to be costly to pursue. If you’re looking to start the process of any shareholder remedy, we recommend seeking legal advice. Our experienced corporate dispute resolution solicitors are well equipped to support and guide you throughout.
Just and equitable winding up
This remedy is quite literally a show-stopper. If you believe that it would be just and equitable for a company to be put into liquidation and cease to do business (widely referred to as the ‘winding up’ of the company), you can make a petition to the English courts under the Insolvency Act 1986. If you’re considering making a petition, it’s a good idea to seek legal guidance on how to do so, as the petition process is complex and needs to be closely followed.
What’s the legal basis for winding up a company?
In England and Wales, a petition can be brought in relation to a company that has been incorporated under the Companies Act 1985 or the Companies Act 2006 and, in certain circumstances, foreign companies that carry out their business in England or Wales.
What will the court consider if asked to wind up a company?
What the court considers to be ‘just and equitable’ is not set in stone. A winding up process like this is a discretionary remedy, meaning that the court can decide how it would like to act depending on the facts and circumstances of the individual case. The most common reasons that the court will consider the winding up of a company to be just and reasonable are:
- If there is a deadlock in the decision-making of the company
- If the petitioning member (the individual asking the court to wind up the company) thinks there has been mismanagement of the company
- The petitioning member has been excluded from management decisions; or
- Where it’s impossible for a company to carry on the business for which it was established, and the only remaining reason for the company continuing to be incorporated is to get its affairs in order.
Do you have to be a shareholder to ask the court to wind up a company?
Even though petitions can be made by people that are not necessarily shareholders of the company (such as directors of the company – for themselves or on behalf of the company itself, and creditors), the fact that the grounds for the petition need to be just and equitable (and are usually connected to the strategy and management of the company) means that it is common for the person making the petition to the courts to be a shareholder of the company at the time that the petition is being made. Additionally, they are likely to be a minority shareholder.
Also, in some cases, a circumstance that qualifies for a petition for just and equitable winding up will also be unfairly prejudicial, and there is the possibility that a person could bring a petition for winding up on just and equitable grounds at the same time as an unfair prejudice petition (discussed in more detail below).
What criteria does a winding up petition have to meet in order for the court to review it?
For a petition to be eligible for court review, the number of shareholders of the company must have been reduced below two. Alternatively, at least some of the shares of the company held by the petitioning member have to have been originally either given to or held by that member (and registered in their name) for at least six months during the 18 months before the start of the winding up process. Another option is that the petitioning shareholder has ended up with the shares through the death of a former shareholder.
As well as these requirements, English case law has set out that a shareholder must have a sufficiently tangible interest in what is leftover in the company after the company has gone into liquidation. This means that it has to be likely that there will be some value left in the company for the petitioning member once the company has gone through the liquidation (including any insolvency) processes. If there is no value left, the petition will not be successful.
What might be a barrier to the success of a winding up order being made?
Another barrier to success is that if the court hearing the petition thinks that there is another route or remedy available to the petitioning person, it’s likely that the court will not make a winding up order if it thinks it is unreasonable to ask for the winding up of the company rather than trying to claim the other remedy. The seriousness of the just and equitable grounds will also be taken into account.
As this remedy has a finality to it and can have chaotic consequences, where a company is being wound up voluntarily in England and Wales, the court will not usually make a winding up order as a result of a member’s petition unless it is convinced that the voluntary winding up does not take into account the interests of the creditors or shareholders of the company being wound up.
Final thoughts on the winding up process
Ultimately, this remedy is one that relies on the opinion of the court, its interpretation of the facts and circumstances at the time of the petition and the availability of other, less potentially draconian remedies that the petitioning party may have access to – after all, the winding up of a company can have a major impact on a lot of other parties.
Unfair prejudice petitions
Where does the right to bring an unfair prejudice petition arise in law?
Sections 994 and 996 of the Companies Act 2006 gives a shareholder of a company the right to make a petition to the court if it thinks that the business of the company that it is invested in is being run in an unfairly prejudicial way against them as a shareholder. The company does not necessarily have to have carried out the act in question – the member can still make a petition to the court if the act has been recently proposed, or was proposed and then dropped. The court then has unlimited power and discretion to listen to the petition and make an order to rectify the situation, in the way it thinks is appropriate.
It’s also worth noting that it’s not just members and other shareholders that can make a petition to the court. In some circumstances, the Secretary of State can also bring a petition as well if it became aware that the actions of a company were unfairly prejudicial.
How can ‘unfair prejudice’ be defined?
So, what constitutes ‘unfair prejudice’? Ultimately, this will be down to the court to decide, but English case law has suggested that for unfair prejudice to take place, something has to have happened or not happened (either committed in the past, happening now or that might happen in the future) that relates to the way in which the company’s business and affairs are handled and that must have unfairly disadvantaged certain people. Case law suggests that what counts as ‘unfairness’ should be judged by that word’s ordinary meaning: a lack of equality or justice, which practically on a day-to-day level of management might involve not keeping promises or honouring agreements.
How is unfair prejudice assessed?
Both ‘unfairness’ and ‘prejudice’ need to be individually assessed. Case law also suggests that the prejudice that the petitioning person has suffered has to be substantial. This can either be:
- Financial (for example, in relation to how the member’s shares are valued or how dividends are paid or, in the instance of an insolvent company, if the unfairly prejudicial act means that a company’s shares no longer have value); or
- Must somehow otherwise prejudice a member’s rights (such as a right to be involved in the management or a mismanagement of the company).
To be clear, if you’re acting in the capacity of a petitioning party, you have to actually be able to show that you have lost out as a result of the unfair prejudice.
Examples of unfair prejudice
Examples of unfair prejudice include:
- Intending to reduce the decision-making power of a minority shareholder by creating more shares in the company so that the percentage of shares in the company that are held by that shareholder is less, and so they have an even smaller percentage of votes to influence the decision-making of the company.
- If there is a failure to run the company in accordance with its articles of association, or if there is a failure to comply with what has been agreed by the shareholders and the company in a shareholders’ agreement, and it has had a direct effect on the petitioning shareholder.
When might a petitioning shareholder not be able to make a successful petition?
A petitioning shareholder might not be able to make a successful petition if they hold enough shares or power in the company’s decision-making that it means that they could easily rectify the situation by voting a certain way, or otherwise doing something that would change the unfair outcome or situation.
What options are available to the court when it is faced with an unfair prejudice petition?
The court’s discretion to make any order to remedy what it considers to be the unfair prejudice in question means that it has a number of options available to it, including:
- Doing something to regulate the company’s future affairs or business
- Asking the company to do something, or to stop or refrain from doing something
- Change or stop changes to the company’s articles of association
- Allow the company to start court proceedings, or
- In some circumstances, provide for the shares of a member of the company to be sold to other members.
As you have probably guessed, this is another remedy where the petition-making process is complicated and getting it right is important, so it’s advisable to seek legal advice before starting the process. Delay in presenting the petition can mean that the court will refuse to hear it, and there may be other contractual remedies available to the petitioning party that are set out in a shareholders’ agreement (or the articles of association of the company) that might give the petitioning member a better outcome.
The derivative claim
What’s a derivative claim & who can it be brought against?
Under the Companies Act 2006, members of a company, trustees or personal representatives holding shares in the company can bring a claim against a director on behalf of that company because of something that the director did or proposed to do (or didn’t/proposed not to do) which was negligent, in default, in breach of their duties, or in breach of trust in respect of their actions and responsibilities towards the company. This is called a ‘derivative claim’. In some circumstances, a shareholder can even take over a derivative claim that was started by the company itself.
A derivative claim can also be brought against a former director of the company or a shadow director of the company (a person in accordance with whose directions or instructions the directors of a company are accustomed to act).
What’s the procedure for bringing a derivative claim?
The Companies Act 2006 sets out the two-stage procedure that members need to follow to bring a derivative claim. At the first stage, the petitioning party will need the court’s permission to progress with the claim, so the court can judge (exercising its own discretion) whether or not the claim has met all of the pre-conditions that it needs to, in order to continue along the statutory process and to be taken seriously.
When the court is deciding whether to continue with a claim, it has to consider all relevant matters (including several factors set out in the Companies Act 2006), such as:
- Whether the member is acting in good faith
- Why the company decided not to make the claim itself
- Whether the petitioning party has any other remedies available to it, and
- The views of other members of the company who are impartial or not involved.
The two pre-conditions are:
- The claim cannot be based on the subject of a director breaking their duty to promote the success of the company, and
- The act that is the subject of the derivative claim must not have been approved or authorised by the company since it happened. The court can decide to pause proceedings so that the members of a company can approve that act (provided that the act is not illegal and is in the proper scope of the company’s powers).
The court can then grant full, limited or conditional permission to carry on the claim to the second stage of the process: the court hearing of the claim.
As we’ve touched on earlier, this is a complex process and getting professional legal assistance to make and submit the claim is advised. It can be confusing when considering whether to bring a derivative claim or to make an unfair prejudice petition because a breach of a director’s duty that causes an unfair prejudice toward a shareholder can fall into both types of relief.
In fact, due to its complicated two-stage process, the statutory derivative claim is not a favoured remedy because even though it was introduced to make the claim process more flexible for minority shareholders, the wide discretion that the courts have to interpret the process means that you cannot be sure of the outcome when you start the two-stage process. Plus, there is the likelihood that you will incur significant costs with no guarantee of being indemnified by the company for them (i.e., there’s no guarantee that the company will pay the petitioning member’s costs on its behalf).
Shareholder remedies against directors
Directors only owe their duties to the company, and so shareholder remedies have to be made indirectly against directors. One way of doing this is by bringing a derivative claim on behalf of the company.
Another way is to remove the director from their position on the board of the company. Under the Companies Act 2006, shareholders can remove a director by making a decision, called an ordinary resolution, where more than 50% of the shareholders that are entitled to vote on the decision approve the decision. If this were to happen, be aware that if the director is employed by the company, their employment may continue if the term of the director’s service contract is not linked to their term as a statutory director.
In certain circumstances where the director has acted against these duties (for example, by committing fraud, persistently breaching the legislation provided for by the Companies Acts, or on conviction of an indictable offence), a court can make a disqualification order against a person to stop them becoming or remaining a director for a period of up to 15 years.
Can a company director be protected from liabilities?
It’s worth noting that there are a few ways in which a director may be protected from liabilities arising as a result of their acts as a director. The articles of association of a company will usually contain a limit of liability and/or an indemnity for directors acting on its behalf. If it appears to the court that a director is or may be liable but, considering the circumstances of the case, it looks like they acted honestly and reasonably, the court can relieve the director (either wholly or partially), from liability.
Do shareholder remedies vary depending on the type of company?
There is not much variance on the main shareholder remedies between public and private companies in England and Wales. However, a lot will depend on how the individual company has chosen to be governed. Companies can set out certain rules in their articles of association and shareholders’ agreements that will affect shareholders, such as rules that shares cannot be sold without first offering them to existing shareholders, and information sharing rules and notice period requirements for meetings.
What about classes of shares?
If a company has different sets of shares (called ‘classes of shares’), different shareholders can have different rights depending on what has been agreed between those shareholders and the company. These classes of shares will usually be set out in the company’s articles of association. In some cases, the company may give certain shares more votes than others and this again can be a remedy for shareholders (although in reality, this is likely to be a right for majority shareholders and may put minority shareholders in a worse position).
It’s more likely that private companies will have better shareholder protections, and often companies with a shareholders’ agreement will set out in detail the ways in which shareholders can veto, modify or waive certain courses of action of the company. They may also specify in more detail than the articles what consultation or information rights a shareholder has. (These are just some of the many reasons why it’s advisable to have a shareholders’ agreement in place.)
Minority shareholder remedies
As well as the statutory remedies of just and equitable winding up, unfair prejudice petitions and the derivative claim, the Companies Act 2006 gives minority shareholders certain protections as part of the general governance of the company. To what extent a minority shareholder can benefit from those protections will depend on how many shares that shareholder holds and the voting rights attached to those shares (which makes sense: if a shareholder holds 1%, it should not be able to overrule the strategy of a company where other shareholders hold 99% of the shares).
- If a minority shareholder holds at least 5%, it can: apply to court to prevent the conversion of a public company into a private company, arrange for a general meeting of shareholders, ask for a written resolution to be circulated in private companies and ask for a decision to be made at an annual general meeting of a public company.
- If a minority shareholder holds at least 10%, it can ask for a poll vote on a decision.
- If a minority shareholder holds more than 10%, it can stop a meeting being held on short notice if the company is a private company.
- If a minority shareholder holds at least 15%, it can apply to the court to cancel a variation of rights of a class of shares.
- If a minority shareholder holds more than 25%, it can stop the passing of a special resolution – this being a decision of the company’s shareholders which requires at least 75% of the votes cast by shareholders in favour of it in order to pass.
As well as the above remedies, the minority shareholder can sometimes also rely on a negotiated position in the company’s shareholders’ agreement or articles of association, where, if able, it can incorporate provisions that provide it with remedies, including:
- Reserving certain matters (such as share sales or other major decisions of the company) to be decided by the unanimous vote of the shareholders of the company, effectively giving a minority shareholder a power of veto.
- Forcing selling shareholders to make sure that they get an offer for the minority shareholder’s shares (called ‘tag along rights’).
- Have a right of first refusal to new shares being given out and share transfers.
- Acquire a right to have its representatives attend or observe the company’s board meetings.
Can shareholders claim remedies for a breach of the articles of association?
Yes, the Companies Act 2006 states that the articles of association of a company are a contract between the shareholders and the company. On this basis, a shareholder can claim against the company if their rights as a member are breached or infringed – see the section on unfair prejudice petitions. A breach of the obligations of the articles of association will also usually make the action taken void or invalid.
As mentioned earlier when highlighting the benefits of having a shareholders’ agreement in place, it’s sensible to think about putting one together because the articles of association are public documents – whereas a shareholders’ agreement is a private contract between the shareholders and the company (and so may contain more provisions that protect shareholders). A breach of these provisions may mean a shareholder might be entitled to more remedies, such as damages or an injunction.