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Falling out with your co-founders or directors how do you get back on track?

Written by Karen Holden on Wednesday, 08 June 2022. Posted in Commercial law, Legal

Running a company, especially where there are many different people involved, can often lead to differences of opinion and unfortunately some of these may escalate into full blown disputes.

Falling out with your co-founders or directors how do you get back on track?

Falling out with your co-founders or directors how do you get back on track?

Running a company, especially where there are many different people involved, can often lead to differences of opinion and unfortunately some of these may escalate into full blown disputes. Whilst debates and differing opinions may have a positive impact on the business, a full-blown dispute typically results in missed opportunities, delayed operations, financial loss, and relationship breakdowns, some may even lead to the company having to close.

We herein explore shareholder & director disputes, but there of course other disputes you may experience during your business, including those with customers, suppliers, employees, landlords and many more. It is important to have robust terms & conditions to govern the resolution of these disputes and more, so we advise you to take advice early to try and mitigate your risks and protect your position.  

Shareholder disputes are not uncommon, the key to minimising the impact and harm that this may cause is to understand: (1) how a company makes decisions; and (2) how disputes could be effectively resolved in case an agreement cannot be reached.  

There are several reasons why disputes may arise with a shareholder, such as disagreement on the direction of the company maybe new investment or a sale, feeling you have been unfairly prejudiced, or the unsatisfactory performance of directors or directors breach of their duties. 

How a company makes decisions  

The articles of association (the Articles) are created upon the formation of a company. It is a written document setting out the rules by which the company is run, such as the authorities of directors and shareholders to make decisions. The Articles also provide provisions for how directors can vote and how shareholders pass resolutions. 

Many new companies adopt the default Model Articles, to minimise time and costs at the early stage. These contain basic provisions on management and administration of a company in accordance with the Companies Act 2006 (CA 2006) whilst these are not tailored to the needs of a specific business or the relationship dynamics between certain shareholders, it is something which is not typically changed for some time. 

It is important to carefully read your articles. Directors are required to act in accordance with the Articles and deviation from this may result in shareholder action being taken for breaching fiduciary duties. It is therefore very important therefore that these are correct and suitable for your business, and you understand what you are required to do. If a dispute arises these will be used as a default framework to govern action 

Shareholders’ agreement  

This is a simply a contact governing the relationship between shareholders. Not all businesses secure one, but this is a fundamental tool to help with disputes amongst other things. In particular this is a really good platform which to in particular this is a really good platform in which to manage expectations and build upon the business. 

The shareholders’ agreement often contains provisions addressing a wide range of issues. For instance, it can provide a ‘default position’ when shareholders cannot reach an agreement on certain matters (e.g., deadlock provision/casting votes). It can vary the requirements for resolutions, such as making certain decisions needing all shareholders approval or some only a majority vote (e.g., reserved matters). It can address issues when a shareholder wishes to leave for example

The provisions can also be drafted to ensure the protection of existing shareholders and the company’s business (e.g., restrictions on transfers of shares, tag along and drag along rights regarding investment and sales, and restrictive covenants so preventing co-founders setting up in competition). Further, the shareholders’ agreement can stipulate consequences for breach of contract and methods to resolve disputes between the parties (e.g., mediation and arbitration).  

Unlike the Articles, the shareholders’ agreement is typically a private document so terms are all negotiable, and it is not generally required to be filed at Companies House, meaning its content can largely be kept confidential between the parties. 

Deadlock 

A deadlock is where a resolution cannot be passed because it does not receive enough votes from those entitled to vote on it. A simple example of a deadlock is where a company has only two shareholders, each holds 50% of the shares, and they disagree, and a decision cannot be passed. A deadlock can also occur when a minority shareholder blocks a resolution from being passed or the majority shareholder influences a decision to exclude the minority shareholder’s rights. 

Certain deadlocks, and especially those where the parties are embroiled in a dispute, can prevent the company from functioning properly and may leave the company with limited options other than petitioning the Court for dissolution. This is a very serious situation for a company and requires specific advice and support to try and navigate. 

It is therefore very important, especially if you are a company where the shareholding is 50/50 to have a suitable shareholders agreement that deals specifically with how you will resolve any deadlock. This may be one party buying the other party out or someone having a casting vote in some circumstances. Specific advice from an experienced corporate lawyer should be taken to try and put in place effective safeguards early in the relationship and if a deadlock does arise it is advisable to take advice as early as possible to try and mitigate the impact on the business and potential consequences. 

We have had clients where one shareholder wished to sell, and the other did not. There was no shareholders agreement, the other could not afford to buy the other one out so sadly a distracting dispute lost the sale and caused the company to shut down. This is the worst-case scenario

How to resolve disagreements between shareholders and directors  

Effective documentation, such as workable shareholders agreements and directors’ services agreement should be in place at an early stage to try and set expectations between the parties and how disputes are to be resolved.  

What if the dispute is with the directors though? Well, if a shareholder is unhappy with actions taken by directors, and such actions are taken in accordance with directors’ powers and duties, steps can be taken to try and amend the powers given to directors. In such cases, a special resolution may be required which would require 75% or the shareholders to agree.

 In certain cases, if directors fail to perform an act, there are mechanisms that allow shareholders to perform such act themselves (e.g., calling a general meeting) and steps can be taken by shareholders to remove a director, but this is a complex process which requires special notice and there may be employment law ramifications.   Again, robust agreements are  important such as a directors service level agreement which fits in with the articles . This is all also subject to any specific contractual agreements contained in the shareholders agreement. As such not only do you need strong contracts, but they all need to be read in conjunction with each other and cross refer. 

If a director is in breach of the Articles or their duties, there are several potential legal avenues. For example, if in breach of the Articles, the director’s actions may be restrained, and they may also be liable to third parties.

The company may be able to bring a civil action against the director or even try to request that the director is disqualified as they are unfit to be concerned in the management of a company. A director in breach of their fiduciary duties may also be forced to account for profits to the company, subjected to an injunction or liable for damages if a claim is successfully brought.   

Further, the director may be the subject of a derivative claim or an unfair prejudicial petition by shareholders. A derivative claim is a claim by a shareholder on behalf of the company in relation to a breach of duty by a director. The shareholders would stand in the shoes of the company and be able to bring the claim directly against the Director. In addition, a minority shareholder can bring a petition if they think they have been 'unfairly prejudiced as a result of a decision. These are however complex areas which would require specific guidance and advice before steps are taken to try and bring proceedings. 

Prevention is better than cure 

We have unfortunately seen several different disputes between shareholders, directors, and the company.  Thinking ahead it is therefore imperative that the shareholders have properly drafted and suitable agreements in place that work for them, the articles and directors service agreements cross refer accurately, and they all clearly set out expectations and roles and responsibilities. The agreements should also document how disputes are dealt with promptly, effectively and with minimal negative impacts on the running of the company.  Draft document sets out everybody’s expectations, everybody’s voting rights, it’s a good platform on which to run the company and build relationships and discussing these terms and conditions while starting the business enables you to concentrate and running the business aware that everything has been affectively agreed and documented

It is the case that in many circumstances prevention is better than cure.

About the Author

Karen Holden

Karen Holden

Karen Holden is an award-winning solicitor, media commentator and founder of A City Law Firm. She was one of 100 women invited into the Freedom of the City last year, an accolade previously bestowed upon Florence Nightingale and Margaret Thatcher. Karen specialises in advising businesses about scaling-up, starting up, investments, Brexit, Covid-19 and everything in between.

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