Two friends became business partners
Let’s assume two long-term friends start a business together. They incorporate a private company limited by shares at Companies House with Model Articles.
Both friends:
- are shareholders (also called, members of the company)
- hold 50% shareholding interest in the company
- and are directors of the company
As a start-up business between friends, the commercial development of the company is at the forefront of their minds, and the communication and decision-making process between them is informal. They believed that a Shareholders’ Agreement was not required.
The friends fall out
Years later, the business is a success, the company is thriving with healthy profits in the millions year by year. The friends, however, are no longer friends. They have different views as to the direction of the company, its investment and dividend policy. Their respective positions become increasingly entrenched to the point that one does not trust the other one anymore, and allegations and counter-allegations of mismanagement and even misappropriation of company’s money are raised. The problem is that the company has become deadlocked, both at the shareholders’ level as well as at the level of the board of directors. No majority decision can be reached. The company is paralysed.[1]
Neither the Model Articles nor the provisions of the Companies Act 2006 (“CA 2006”) offer any resolution for such deadlock save for a petition by a member of the company under section 994 CA 2006, which may result in a court order for the purchase of the shares of any members of the company by the other member or by the company itself. This, however, is only possible if the court finds that the company’s affairs have been conducted in a manner that is unfairly prejudicial to the interest of members generally or of some part of its members (including at least the member issuing the petition itself). These kinds of proceedings are extremely time consuming and costly, and often detrimental to the business interest of the company.
A Shareholders' Agreement was all that was needed
How could the friends have avoided or at least better managed the disputes between them? They could and should have agreed the terms of their business relationship in writing by way of a Shareholders’ Agreement.
The existence and the terms of a Shareholders’ Agreement are confidential between the shareholders. The Shareholders’ Agreement does not need to be sent to Companies House. In contrast to the Articles of the company, the Shareholders’ Agreement is not a public document.
The confidentiality of the Shareholders’ Agreement renders this document to be the perfect vehicle for the shareholders to set out (among others) all matters in relation to the business of the company, the composition, quorum and majority of the board of the directors, and the quorum and majority of the members’ meetings. In addition, the Shareholders’ Agreement often include provisions on
- Dividend policy, and
- Deadlock and resolution.
Shareholders' Agreement: Dividend Policy example
“Subject to the requirements of the CA 2006, and unless the parties agree otherwise in relation to any particular Financial Year, the company shall distribute by way of dividend at least [NUMBER]% of the profit of the company in relation to each Financial Year but after making all necessary, reasonable and prudent provisions and reserves for taxation.”
Shareholders' Agreement: Deadlock and Resolution example
“There is a deadlock if a resolution is proposed and one of the following applies:
- at a properly convened meeting of Shareholders or of the Board there is no quorum at the meeting and no quorum at the meeting when it is reconvened following an adjournment, provided that the meeting, or adjourned meeting, is not inquorate because the person who proposed the resolution does not attend; or
- on a directors’ resolution, all Eligible X Directors or all Eligible Y Directors vote against or abstain from voting on the resolution (unless one of their number proposed the resolution); or
- on a shareholders’ resolution, all the Shareholders of the X Shares or all the Shareholders of the Y Shares vote against or abstain from voting on the resolution (unless one of their number proposed the resolution).
Either JV Party may within [20] Business Days of the meeting at which the deadlock arises or within [20] Business Days of the date of the resolution in respect of which the deadlock arises (as the case may be) serve notice on the other JV Party and the company (Deadlock Notice):
- stating that in its opinion a deadlock has occurred; and
- identifying the matter giving rise to the deadlock.
The JVC shall within [10] Business Days of receipt of the Deadlock Notice refer the matter in writing to the Resolution Panel (Resolution Request) enclosing a copy of the Deadlock Notice.
The Resolution Panel is required to prepare a written decision and give notice (including a copy) of the decision to the parties within a maximum of [three] months of the matter being referred to the Resolution Panel.
The Resolution Panel shall be made up of the [DETAILS OF EXECUTIVES POSITIONS OF EACH JV PARTY TO BE APPOINTED TO THE PANEL] and shall agree with such members the terms of their appointment.”
A Shareholders' Agreement could have lead to a workable solution
Had the friends, in my case above, entered such Shareholders’ Agreement, chances are they would have avoided or at least managed their differences and most likely come to a workable solution.
If you are in any doubt about the legal situation of your company, you as shareholder and/or director of the company, please seek legal advice. I specialise in Corporate Law. I can provide advice, drafting and review of your Shareholders’ Agreement in order to avoid and/or mitigate identified risks, so that you can concentrate on the business instead of worrying about legal disputes with your fellow shareholder(s).
[1] This case is based on a few instructions of mine from shareholders, which came to me in this, similar or even worse situation.
