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"Breaking up is never easy, I know": Avoiding shareholder disputes before they arise

View profile for Daniel Dodman
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Two friends spot a gap in the market and develop a new product. They set up a company together owning half each, work long nights and weekends, miss significant birthdays and acquire grey hairs. But after much hard work and perseverance they get funding, take the product to market and develop a successful business.

Five years down the road, one of the friends decides that international expansion is the way forward. The other feels that he wants to take money out of the business and start something new. They meet. Temperatures rise and cross words are said. Open warfare is announced and the battlefield is the company that represents their shared labour over many years.

“Discourage litigation. Persuade your neighbours to compromise whenever you can. Point out to them how the nominal winner is often a real loser---in fees, expenses, and waste of time.” Abraham Lincoln

Before long, lawyers are involved and costs escalate for each side. The position will ultimately be decided by obtaining the best legal advice (of which more in another article) but could this have been avoided? 

Was there any way in which this dispute could have been resolved before it got to this stage? Could lawyers have assisted when the business was still in its early days to prevent this from happening? 

Knowing me, Knowing you?

The answer to both of these questions is yes. No-one goes into business with another party expecting to fall out but there is nothing wrong with acknowledging the possibility that the parties may, at some point, want to part ways. Steps can be taken at the very outset to make sure that when you’re through (really through) it’s the best you can do:

1. Shareholder Agreements: If there is one single step that can resolve disputes before they actually arise, it is a clearly drafted and comprehensive shareholder agreement. This governs the relationship between the shareholders in the company, but crucially can cover topics such as:

(a)  Duties of the shareholders: To promote the best interests and abide by the articles of the company, ahead of their own personal interests.

(b)   Restrictions on shareholders: Preventing them from being in competition with the company (therefore stopping individuals from setting up rival organisations until the shareholder dispute is resolved).

(c) Rules on shareholder control over director appointment: The company will need to be run on a day to day basis, regardless of any dispute between the key shareholders. Consideration needs to be given to how a board will run the company if parties disagree on the company’s direction. Who will have the deciding vote?

(d) Deadlock provisions: What happens if shareholder resolutions can not be passed because there is a fundamental disagreement between significant shareholders? Pre-emption and buy-back provisions can provide the terms by which one party has to sell his shares to the other to avoid the deadlock crippling a company.

(e) Mediation clauses: These can provide for an independent party to intervene and mediate between the parties before either resorts to (potentially more expensive) legal methods.

(f) Governing law/jurisdiction clauses: It is particularly important for companies that include overseas shareholders to define where they would want the dispute to be heard if it ultimately ended up in the Courts.

2. Articles of Association: These should be drafted so as not to conflict with the shareholder agreement. It’s also helpful to consider whether there are any restrictions that need to be included in what the company can do (for example, if one shareholder is insistent that a company should not be trading abroad, make sure that the Articles reflect this).

3. Lines of communication: Many (if not all) shareholder disputes in private companies start with a breakdown in communications. If there is an issue, an early discussion can sometimes resolve any misunderstanding. The process of drafting and understanding a shareholder agreement can sometimes focus minds in understanding the catastrophic affects for a company if a communication breakdown occurs.

4. Get lawyers involved early: Even if a shareholder agreement does not exist and communications have definitely broken down, there is still more that can be done to resolve the position. Early instruction of a legal team can give you solid advice as to what to do and not to do.  Sometimes, attempting to wrest control of the company without a careful strategy can actually open yourself up to further claims and make the position worse. Early legal advice can reduce overall costs in the long term.

No one expects that they will fall out with their business partners. But taking some simple steps as per the above will help to make sure that, should the worst happen, both sides can resolve the problems without a lengthy Court battle.

This guide is for general information and interest only and should not be relied upon as providing specific legal advice. If you require any further information about the issues raised in this article please contact the author or call 0207 404 0606 and ask to speak to your usual Goodman Derrick contact.