Directors’ Duties and Shareholder Disputes
This Article considers some of the issues that arise in connection with directors’ duties and shareholder disputes, in particular, the role and relevance of breaches of directors’ duties in the context of minority shareholder protection.
In the case of family run businesses and smaller companies, quite often, the directors will be substantial shareholders of the company. There may however, be shareholders (usually minority) who are not directors (or who are being excluded as such) and are not involved in the day to day running of the company.
Typically, shareholder disputes involve claims made by a non-director minority shareholder, about the conduct of directors who are either individually or collectively in the majority.
The disputes in which Charles Russell Speechlys are instructed can range from disagreements about how the company should be operated and managed, to claims involving serious allegations of dishonesty and misappropriation of company monies/assets. More often than not, the claim is made on the basis that the conduct constitutes a breach of the majority directors’ duties.
Directors’ duties are now codified in the Companies Act 2006. The general duties are:
- To act within powers
- To promote the success of the company
- To exercise independent judgment
- Exercise reasonable care, skill and diligence
- To avoid conflicts of interest
- Not to accept benefits from third parties
- To declare an interest in a proposed transaction
A director is in the position of a fiduciary in relation to the company. This means that he owes the company a duty of good faith and is in a position of trust and confidence.
De Facto and Shadow Directors
A recent Act has confirmed that the general duties (as above) apply to a shadow director of a company “where and to the extent that they are capable of so applying”. De facto and shadow directors therefore must be extremely careful to avoid a breach of duty.
Minority Shareholder Protection
The law gives protection to minority shareholders through various means and mechanisms, of which four are the most important:
- The Shareholders’ Agreement
- Derivative proceedings
- Section 994 of the Companies Act 2006
- Just and equitable winding up of the company
1 The Shareholders’ Agreement
The first port of call for any disgruntled shareholder is the Shareholders’ Agreement. This will be enforced like any other contract. It will usually confer additional rights over and above what is provided for in the company’s Articles of Association but, it cannot be varied or modified by the majority without the agreement of all parties to it. A well drafted Agreement should make provision for how any breaches of duty by a shareholder or a director impact on the relationship between the shareholders and what remedies might be available. Most commonly, this would involve a right to terminate the Agreement and/or require the majority shareholders to purchase his or her shares in the event of a breach of duty by a director. Invariably, such breaches would have to be of a fundamental nature and many agreements usually require notice requesting the breach to be remedied before any action can be taken in relation to such breach. An innocent party must tread extremely carefully when considering whether to trigger a termination or buy our clause for minor or trivial breaches to avoid being in breach of the Shareholders’ Agreement themselves.
2 Derivative proceedings
It is a fundamental principle of company law that, generally speaking, where a wrong has been done to a company, only the company can sue for any damage caused. A shareholder cannot seek to recover losses suffered by the company, even if the value of the shareholder's shares is reduced as a result. There are however some exceptions to this rule, permitting the minority to bring a derivative claim on behalf of the company in cases of equitable fraud or where the majority wrongdoers were in control of the company. A derivative claim does however have its limitations, in that any damages or compensation recovered vests in the company. The minority shareholder will not therefore benefit directly from the proceedings. The benefit is limited to the increase of the value of the shareholding, as a result of the monies being recovered by the company and thus the increase in the company’s value. A derivative claim may not therefore provide a long term solution to any deep seated dispute between the majority and minority.
3 Section 944 Companies Act 2006
This is the most common relief relied upon by a minority shareholder. There are two key elements that such a claim requires:
- the conduct must be prejudicial
- the conduct must be unfair
Generally, the conduct being complained of is a diminution in value of the shareholding as a result of the conduct.
4 Just and Equitable winding up
This is the nuclear option where no other remedy is available and other avenues have been exhausted. The Court may wind the company up, if it is "just and equitable" to do so.
The above is a summary of the most important and commonly used remedies available to a disgruntled minority shareholder. Each of the mechanisms can be tailored to suit the specific circumstances complained of.
This article was written by Claudine Morgan, for more information please contact Claudine on 01242 246325 or Claudine.firstname.lastname@example.org
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