Most directors and shareholders are the same persons in SMEs, known as ‘quasi partnerships’. So what happens to the shares if a director leaves or ceases to play their part in running the business? Can you force a sale of the director’s shares?
The majority shareholders can remove a director by passing an ordinary resolution (51% majority) after giving special notice. That much is fairly straightforward. But take care, since if the director is also an employee you will need to terminate their employment. A director who has been dismissed may have a claim for unfair dismissal. The director will continue to own the shares and will continue to be entitled to their share of dividends.
Can you force a sale of the shares?
There is no automatic right for the majority shareholders to force a sale by a minority shareholder. Conversely, there is no automatic right for a minority shareholder to force the majority to buy their shareholding.
So what are the ways of removing a minority shareholder?
There are several possible ways of removing a shareholder, or forcing a sale of their shares, but care needs to be taken in each case, and a tactical approach is required.
- Check the articles of association of the company to see if they contain drag along provisions which would enable the majority of the shareholders to force the minority to sell in the event of a buyout of the company.
- Consider passing a special resolution (75% majority) to alter the articles to include provisions to force a sale of the shares, say for fair value. However, any alteration should not amount to an oppression of the minority and should not be unjust.
- Check if there is a shareholders’ agreement which contains a ‘buy-back’ clause which can be invoked if a shareholder leaves the company. This is sometimes known as a ‘bad leaver’ provision.
- Consider increasing the remuneration of the remaining directors, and reducing sums paid by way of share dividends. This may not be tax efficient, but may be preferable to paying dividends to a shareholder who no longer participates in the running of the company. But take care, since you should be able to justify this course of action.
- Once you have assessed your options, you should start negotiations with a view to reaching agreement for the purchase of the shares for fair value. You should first discuss with your accountant carrying out a valuation of the shares. A minority shareholding will often be valued at a figure below what the shares would be worth based on a percentage of the whole. Check to see if the Articles contain a formula for valuing a minority shareholding.
- Care should be taken to avoid a dispute which could end in costly litigation. A minority shareholder has the right to apply to the court claiming ‘unfair prejudice’. The court will usually order a sale of the leaving shareholder’s shares at a determined value. Company litigation is expensive and the costs would usually be paid for by the individual shareholders. However, the threat of such proceedings can be used to put pressure on the minority shareholder to reach agreement for the sale of their shareholding.
- The company could consider bringing a claim against the departing director if it can show it has suffered some loss as a result of a breach of his duties as a director. Care should be taken, however, to check that the other directors have not themselves been in breach of their duties.
- If the majority hold 75% of the shares, then you could consider the nuclear option of winding up the company. If a solvent company is wound up through a members voluntary liquidation (MVL), the company’s assets can be transferred into the name of Newco, which would not issue shares to the minority shareholder in Oldco.
Each case needs to be carefully considered on its merits. Most shareholders disputes are resolved by having the majority buy out the minority shares for fair value. A well drafted solicitor’s letter making an offer to purchase the shares on terms which would most likely be awarded by a court (adopting the principles in the leading case of O’Neill v Phillips) will put pressure on the minority shareholder to negotiate sensibly, otherwise they risk incurring substantial legal costs if they fail to do so.
To avoid these situations arising in the first place, companies should put in place suitably drafted articles of association and a shareholders’ agreement.