Company law

At Emso & Co Solicitors, our specialist Corporate Lawyers take the time to understand clients' commercial objectives so that they can provide practical, targeted advice to businesses.

A Brief Summary of the Corporate Law Services we provide includes:

• Sales and purchases of companies and businesses
• Joint ventures
• Company’s purchase of own shares
• Shareholders’ agreements and articles of association
• Directors' duties and corporate governance
• Shareholders’ issues and disputes
• Setting up companies, LLPs, businesses and partnerships, and constitutions
• Restorations to the Register of Companies
• Striking offs and Dissolutions
• Partnerships and LLPs
• Share Scheme and Employee Incentives

We can, among others, assist with:

Services for SMEs

• We recognise that compliance issues can be bewildering, especially for small, young or growing companies.
• For start-up companies, we can offer guidance and insight whether you are a sole trader, partnership, limited liability partnership of limited company. We can assist with incorporation and drafting key documents.
• We can attend Board meetings, prepare minutes, prepare Board packs and advise on Company law and procedure and ensure that relevant Companies House notices are correctly filed.

Employee Share Schemes: EMI Schemes & Company Share Option Plans

Some businesses have a policy of allowing its employees to take out company shares. The arrangement is a way of providing benefits for employees, which may include executive directors but not normally non-executive directors.

It can take the form of shares, interests in shares, share options or anything else where there is an advantage to be gained from having shares.

A company may wish to establish an employee share scheme for its employees for a number of reasons. These may include acting as an incentive for the employee to stay with the company, to reward employees for their workplace performance or to allow employees to obtain and sell their shares in a tax-efficient way over a period of time.

In short, shares can be used to attract potential employees and then as an incentive for motivation and retention.

• Save As You Earn (SAYE scheme)
• Enterprise Management Incentives (EMI scheme)
• Company Share Option Plan (CSOP scheme)
• Non-Tax Favoured Share Option Plan

Shareholders Agreement Lawyers & Shareholder Disputes
Where there are several shareholders in a new or existing company, none with a controlling interest, it may be appropriate to have a shareholders’ agreement.

Alternatively, where one shareholder effectively controls the company by reason of having a majority shareholding, the minority shareholders should consider protecting their interests by way of a shareholders’ agreement.

A shareholders’ agreement regulates the relationship of the shareholders with each other and agreed aspects of the affairs of and their dealings with the company.

Our expert Corporate Solicitors can help with all aspects of a shareholder’s agreement, from drafting the agreement to advising on disputes.

Key Issues for Shareholders' when Starting a New Business

Introduction

This Guide is intended to highlight some of the key matters that need to be considered by shareholders on the establishment of a new Company.

It may be helpful at the outset to mention the distinction implicit in company law between “management decisions” and “ownership decisions”.

The Articles of Association will invariably provide that the business of the Company is to be managed by the Directors.

Accordingly day to day management decisions will be decided upon by the Directors who will make decisions on the basis of a majority vote. In the event of deadlock the Articles frequently provide that the Chairman shall have a second or casting vote.

Accordingly, the Board by majority vote can decide to take on or dismiss employees (including terminating the contracts of employment of Executive Directors), decide to acquire or dispose of premises and to enter into commitments of a capital or income nature.

Ownership decisions on the other hand are made by the shareholders in general meeting. One of the key powers of the shareholders is the power to appoint and remove Directors (although the Board usually have the ability to fill casual vacancies). Other matters reserved to the decision of the shareholders include increasing and authorising the issue of additional share capital, approving each year’s audited accounts and any recommendation by the Directors as to payments of dividend, changing the constitution of the Company and decisions to wind-up the Company. Some of these matters require approval by a 51% majority of shareholders who attend and vote, others require a 75% majority.

Minority Protection

In view of the company law position noted in the introduction it is sometimes considered appropriate by shareholders to enter in to voting agreements. These may provide for a different majority (or perhaps unanimity) in relation to certain (or perhaps all) management or ownership decisions. Such agreements may blur the distinction between management issues and ownership issues. Whether an agreement to vary the operation of general company law on these matters should be entered into will need to be carefully considered by the promoters of the new Company in conjunction with their professional advisers.

There is a danger that an over elaborate voting agreement may lead to an undesirable deadlock. Attached to this memorandum are two annexures which list some of the key ownership and management issues which may be the subject of a shareholders agreement.

Each Company will be different and there will rarely be an “off the peg” solution. However, it is worthwhile making the following general observations:

(a) An institution investing in a new Company (perhaps in the context of a management buy-out or buy-in) will frequently be in a minority shareholder. Invariably they will seek for themselves undertakings from the other shareholders that certain ownership or management decisions (as listed in the annexures) will not be made without their written consent (or perhaps the consent of a Special Director appointment by them at a relevant Board Meeting). If the institution holds a strategic or “Balancing” shareholding the other shareholders may well be content to rely upon the decision of such institution to resolve any disputes between them. Indeed, an institution will be unlikely to agree to enter into a voting agreement to support other minority shareholders.
They might also be wary of voting agreements between other minority shareholders which for example, entrench a particular shareholder on the Board. Accordingly, the points made below will often only be relevant in the context of a Company without institutional shareholders.

(b) A deadlock structure can be devised for a “partnership” Company (even if shareholders do not hold shares equally) whereby shares are designated as “A” and “B” ordinary shares. Each class of shares has the right to appoint (say) two Directors (“A” Directors and “B” Directors). The Chairman’s casting vote is excluded and it is stipulated that no meetings of the Board or General Meeting are quorate unless an “A” Director and “B” Director and “A” Shareholder and “B” Shareholder as appropriate are present. Similarly, no resolutions (or perhaps resolutions on certain key issues) are to be validly passed without the affirmative vote of “A” and “B” Directors or shareholders as appropriate.
The structure can be adopted for companies with three or more shareholders by creating “C” and/or “D” ordinary shares.

(c) A voting agreement can be entered into whereby certain shareholders will vote to ensure that they each have a nominated Director on the Board. Having the right to a Director on the Board (and accordingly access to confidential information) can be a powerful right.

(d) Voting agreement can be entered into whereby certain key (or all) ownership and/or management issues require the written approval of all or a specified majority of shareholders.

Unfair Prejudice

Provision exists under Section 994 Companies Act 2006 for minority shareholders to apply to the Court if the affairs of the Company are being conducted in a manner unfairly prejudicial to the interests of its members generally or some part of its members.

Such an action might be considered if the Directors are running the Company without regard to their fiduciary duties, or if, in a “quasi-partnership” Company, a director/shareholder’s employment contract is terminated. If such conduct is proved the Court has a wide discretion as to the orders it may make.

These include orders as to the conduction of the Company’s affairs.

Frequently, however, the order is that the majority shareholders must purchase the shares of the minority shareholder at fair value.

Frequently, particularly where the share capital is broadly held (or where perhaps an institutional shareholder holds the balance of power or a strategic stake), shareholders will dispense with any voting agreement of the type mentioned above and instead let matters rest on the basis of the general Companies Act protection under Section 994. Otherwise, an over elaborate structure may be created in which effective decision taking becomes impossible. If this view is adopted then the points noted below regarding service agreements, dividend policy and transfers of shares can be put in place to provide an element of minority protection.

Service Agreement

It was noted above that decisions on whether or not to terminate a contract of employment will generally be matters for the Board of Directors. However, a director/shareholder can secure certain protection if he is given fixed term service agreement.

The advantage of a fixed term service agreement is that if an employee is summarily dismissed in breach of his service agreement he will have a claim for damages for wrongful dismissal and/or unfair dismissal against the Company.

Essentially, the damages he can claim will be based on the salary and benefits to which he is entitled multiplied by the number of years unexpired on the service agreement. It should be noted, however, that the employee is under a duty to mitigate his loss. Accordingly, to the extent that the employing Company can demonstrate that another job could have been obtained within a reasonable period at the same or high remuneration the claim for damages will be reduced.

Nonetheless, as the starting point for compensation discussions is the salary and benefits for the unexpired period of the service agreement the existence of a long term service agreement can provide the executive with a good degree of comfort.

(It should be noted that an agreement for a fixed term in excess of five years will not be effective unless approved by shareholders in general meeting. This provision was introduced to prevent Directors introducing protection for themselves without shareholders’ sanction.)

Dividend Policy

Unless the Articles of Association otherwise provide the Directors normally fix and pay interim dividends. So far as final dividends are concerned the amount in question must be recommended by the Directors and approved by the shareholders.

Accordingly, a minority shareholder might himself licked into a private Company with little or no return being made by way of a dividend.

Recent case law suggests that failure to pay a reasonable dividend can form the basis of a claim for unfair prejudice by an aggrieved minority shareholder (see paragraph 3 above).

However, there will always be difficult questions of how much cash is required for the working capital purposes of the Company. Accordingly, a dividend policy may provide added protection for the minority shareholder. This might be fixed as a percentage of the after tax profits.

A device sometimes incorporated in Articles (particularly for the benefit of institutional shareholders) is a stipulation that, if profits are available for distribution, dividends become payable whether or not declared by the Directors. This is linked to calls rights giving shares a fixed percentage profit. Provided distributable profits are available the minority shareholder is not then in a position where the Directors or the majority shareholders will not approve a reasonable dividend. If he is not paid in accordance with the Articles he can sue for the dividend payments in question which become a debt due to him from the Company.

Transfers Of Shares

The Articles of the Company should always firstly be considered particularly as to whether they contain or should contain pre-emption provisions which give existing shareholders the right of first refusal before shares can be transferred to a third party.

The transfer provisions in the Articles of Association may be reinforced for the benefit of minority shareholders by put options in favour of an outgoing shareholder. It may be that such a put option will only be acceptable on the occasion of the death of a shareholder where an insurance policy will provide the case to make the purchase of shares from personal representatives.

In addition, a “buy-out” clause may be included in the Articles. This would be to the effect that the majority shareholders cannot transfer their shares to a third party unless the third party has made an offer to acquire their shares at the same (or perhaps a minimum) price...

Restrictive Covenants

The Shareholders Agreement may be a suitable document in which to include restrictions on outgoing shareholders as to non-competition. Relevant restrictions may fall into four areas:

• The use of confidential information
• Non-competition for a specified period in relation to a particular business
• Non solicitation of customers or suppliers
• Non-solicitation of employees

Restrictions of this type are prima facie unenforceable unless the party seeking to uphold them can show that they are reasonable as between the parties involved. The Court will look to the duration of the restriction, its scope and geographical limit in determining whether or not the restrictions are reasonable.

If written service agreements are to be entered into restrictions can be frequently be included in the service agreement and dispensed with the Shareholders Agreement.

Annexure 1

List of possible “ownership matters” requiring prior written consent of a specified percentage of shareholders

(1) modification to the rights attached to any of the shares of the Company or of any subsidiary or the consolidation, subdivision or conversion of any of the shares of the Company or any subsidiary

(2) the creation, allotment or issue of any class of shares or of any instrument convertible into shares by the Company or any subsidiary.

(3) any change or amendment to the Memorandum and Articles of Association of the Company or any subsidiary.

(4) any material alteration (including cessation) to the nature of the business or presently proposed nature of the business of the Company and its subsidiaries.

(5) the disposal of any interest in the capital or instruments convertible into capital of any subsidiary;

(6) the acquisition or formation of any subsidiary by the Company or any subsidiary.

(7) the purchase by the Company of any subsidiary of any of their own shares.

(8) The grant of any option by the Company or any subsidiary over the whole or any part of its capital.

(9) The passing of any resolution to put the Company or any subsidiary into liquidation.

Annexure 2

List of possible “management issues” requiring specified approval.

(1) The adoption of or any material amendment to an annual business plan of the Company or any subsidiary shall include (inter alia) annual budgets and a statement of business objectives (“the Annual Plan”)]

(2) Except and to the extent that the following are specifically authorised in the Annual Plan:

(a) capital expenditure on any item in excess of £###

(b) any revenue commitment in excess of £### per annum

(c) any contract representing more than [15] per cent of the turnover as [projected in the relevant annual budget of the Annual Plan

(d) the acquisition or disposal of any freehold or leasehold property or parts thereof or the granting or surrendering of a lease in respect thereof by the Company or any subsidiary

(e) the acquisition or disposal of assets by the Company or any subsidiary (other than in the ordinary course of business) where the item to be disposed of is a capital item the net book value of which exceeds [1-] per cent of the net assets of the acquirer or disposer

(f) any borrowing by the Company or any subsidiary (including debt factoring) (other than normal trade credit) any alteration in the terms of such borrowing and the creation of any charges on any Company’s or any subsidiaries’’ assets

(g) any loan or advance by the Company or any subsidiary (other than an advance against expenses) exceeding £[ ] in aggregate to any one person or company (other than in the ordinary course of business) or the granting of any guarantee or indemnity of the obligation of any person, firm or company by the Company or any subsidiary (other than that of a subsidiary where such obligation is in the ordinary course of that subsidiary’s business);

(h) the disposal by the Company or any subsidiary of any patent, trademark, copy right, registered design or other know-how or intellectual property whether absolutely or by way of licence or otherwise; and

(i) any review of the Company or any subsidiary’s insurance cover.

(3) The remuneration drawings and benefits in kind of all Directors, consultants and key employees of the Company and any subsidiary and their service contracts (if any) or contracts for services (if any) (as appropriate) or any amendment to them.

(4) Any transaction, arrangement or agreement with or for the benefit of any Director of the Company or any subsidiary or any person “connected” with any such Director.

(5) The formation or acquisition by the Company or any subsidiary of any associated company or any other investment in another company or investment in a partnership, consortium or joint venture and any disposal of all or any part of such investment.

(6) Any political or charitable contribution by the Company or any subsidiary.

(7) The appointment or the termination of the appointment of any Director to the Board of Directors of the Company and the appointment of a committee of the Board or of the Board of Directors of any subsidiary.

(8) The approval of the annual consolidated accounts of the Company or any subsidiary.

(9) The appointment of the auditors to the Company and any subsidiary.

(10) The payment of any dividend.

(11) Any change to the accounting reference date of the Company.

(12) Any change to the accounting policies of the company.

(13) Any other matter out of the ordinary course of business of the Company and its subsidiary.

(14) Specify any others

Removal of Directors: Removing a Director from a Company
Make Sure You Get It Right !

The principal role of a director (or “manager”) is to manage a company in such a way as to maximise the benefits to its shareholders (or “owners”), whilst ensuring that the company complies with all applicable laws and regulations. In many companies, regardless of size, directors are often both the owners and managers, hence the common term, “owner managed businesses”.

Therefore, it is a serious matter of concern for a company if a director is underperforming or if he or she is at odds with the strategies which the majority of the company’s management have adopted. In such circumstances, there may be no alternative option for the company other than to seek the removal of such a director.

How do you remove a director from a company?

In many companies, the power to remove a director from office is granted to the board of directors or to a majority of the shareholders under the company’s articles of association. For these companies, removing a director will require the board or a majority of the shareholders to serve written notice on the director in question.

For companies that do not have such powers enshrined in their articles of association, the Companies Act 2006 provides a statutory procedure to allow the shareholders agreement to remove a director by passing an ordinary resolution (i.e. anything over 50%) at a general meeting of the company.

In both cases, such removal is subject to any rights and protections the director may have under any contract of employment or service agreement, so it must never be assumed that it will be without cost to the company, particularly if during the removal, any such contract is breached.

The Statutory Procedure

What is the statutory procedure for removing a director from a company?

The procedure for removing a director by ordinary resolution is set out in sections 168 and 169 of the Companies Act 2006.

A shareholder wishing to propose a resolution to remove a director must give special notice of his intention to the company. On receipt of this special notice, the board of directors must call a general meeting of the shareholders of the company to consider the proposed resolution. This general meeting must take place no earlier than 28 days from the date the company received the special notice.

Notice of the general meeting is then sent to all shareholders and to the director in question. This director may make written representations in response to the proposal to remove him and, if practicable, the company must circulate these representations to the shareholders prior to the meeting.

At the meeting itself, the director facing removal is entitled to speak in respect of the resolution and to have any written representations he has made read to the meeting. The resolution to remove the director is passed by a simple majority (i.e. anything over 50%) of those shareholders who are entitled to vote, voting in favour.

The Articles Of Association

The statutory procedure can be used to remove a director even if the company’s articles of association contain a provision which purports to exclude the relevant sections of the Companies Act 2006 from applying to the company. Such a provision is deemed to be an unlawful fetter on the company’s statutory powers and is unenforceable against the company.

The statutory procedure can, however, be defeated by a provision in the articles of association granting a particular shareholder or group of shareholders enhanced voting rights on a resolution to remove certain directors.

For example, where a shareholder in a company is given the right to appoint a director (often themselves), the articles of association may provide that such a shareholder may exercise ten votes for every share he or she holds on a resolution to remove him or her from office. This is a common protection for investors and in joint venture companies.

The Director’s Employment Status

As touched upon above, one area that must be considered and handled very carefully is the director’s employment status with the company.

Can a Director be removed if they are also an employee of the company?

Yes. The procedure under the Companies Act 2006 applies notwithstanding any agreement between the company and the director, so if the director is also an employee of the company, the fact that he or she has a service agreement with the company will not prevent him or her from being removed as a director.

However, depending on the particular circumstances, a court may find that removing the director from office amounted to constructive dismissal, thus opening the door to the former director bringing a claim for wrongful and/or unfair dismissal against the company.

How Do You Remove A Director Who Is Also A Shareholder? Unfair Prejudice Claims.

A further potential difficulty arises if the director is also a shareholder in the company.

Section 994 of the Companies Act 2006 allows a shareholder to petition the court on the grounds that the affairs of the company are being or have been conducted in a manner which is unfairly prejudicial to its shareholders or some part of them. This is commonly referred to as an “unfair prejudice” claim. The question of what amounts to unfair prejudice has been the subject of much deliberation by the courts over the years and the concept has been applied in a variety of scenarios.

These have included the situation where a director has been removed from office in a company which the court has deemed to be a “quasi-partnership”.

A quasi-partnership, as the name suggests, is a company which was intended to be operated as a partnership between the shareholders and in which it was reasonable for each shareholder to expect to remain involved in the management of the company. A large number of owner managed businesses could be considered quasi partnerships.

If the court accepts that a company is a quasi-partnership then it may also decide that any director removed from office, and thus excluded from the management of the company, has been the victim of unfairly prejudicial treatment in their capacity as a shareholder.

In such circumstances, the court has wide powers and could, for example, order that the director be reinstated or, more likely, that the shares held by the deposed director are purchased by the other shareholders at market value.

Conclusion

The statutory procedure set out in the Companies Act 2006 is an important tool for a company in dealing with an unfit or dissident director. However, any company seeking to make use of the procedure must ensure that it obtains proper legal advice, both to ensure that the procedure is properly complied with and that it avoids the potential pitfalls discussed above.

Why have a Shareholders' Agreement?

People starting a business often ask whether they should have a Shareholders' Agreement. Below, we consider some of the main issues.

What Percentage Of Ownership Should I Retain?

One of the first questions for anyone setting up or running their own business is whether to invite someone else to join them in their business as a shareholder.

This decision needs careful consideration and should not be taken lightly. Shared ownership, particularly of a family business or an owner-managed business, will complicate relationships. Before taking this step the implications need to be carefully thought through, these include remuneration, dividend policy, rules on departure etc.

The new shareholder could be an employee and becoming a shareholder may improve their motivation and help grow the business. On the other hand the prospective shareholder may bring vital investment capital to the company.

An institutional investor, such as a private equity investor, will almost definitely require a Shareholders’ Agreement giving the them additional rights to those generally enjoyed by a minority shareholder. It will also carefully structure its investment, for example, via loans which may be secured or convertible into ordinary (sometimes called equity) share capital. It may also decide to invest in preference share capital. In addition the ordinary shares it acquires will often be of a different class to those held by the management, and those shares will generally carry special rights.

This page is concerned principally with the issues facing companies which do not have institutional investors. However, many of the points raised will be relevant to owner-managers considering taking in institutional investment capital and for business angels looking to make an investment, perhaps for the first time.

Reading this page will show you there are many aspects which could be covered by a Shareholders’ Agreement, or outside one. As this page conclude “provided the budget allows it, the services of an experienced corporate lawyer may be money well spent”.

This page should highlight the main issues and choices, and explain some of the terms the lawyer will use. They should help you decide whether you need a Shareholders' Agreement at all, and if not what aspects you should still cover.

As The Controlling Shareholder Will I Need The Protection Of A Shareholders’ Agreement?

If you hold more than 50% of the voting shares you will be considered a controlling shareholder. A Shareholders’ Agreement is rarely a protection a controlling shareholder will need.

A controlling shareholder has a fundamental power in relation to a company: which is the power to hire and fire the Directors of the company. Since it is the Directors who are responsible for the management of the business this gives the person (or persons) who hold 50.1% of the votes the ability to control the company. So if, in the opinion of the 50.1% controlling shareholders, the Directors are not performing, the Director(s) concerned can be removed.

The removal of a Director may not be without risks: employment claims may arise and there may occasionally be shareholder claims (eg in a quasi-partnership company) which to do so would be unfairly prejudicial. However, the ability to appoint and remove Directors is a very powerful right and responsibility.

If I Have Less Than 50.1% Of The Votes Do I Need A Shareholders’ Agreement?
The answer to this question is 'perhaps'.

The reason for wanting a Shareholders’ Agreement will generally be to assert veto rights: so that contrary to the general law the powers of the Board to run the business (or the shareholders to exercise their own power – see below) are curtailed.

This may be fine in legal theory but the commercial context of the business of the Company must first be understood.

A business that will need new funding may be crucially dependent on a minority investor regardless of the percentage of ordinary shares initially held. An astute investor may also have loaned money (rather than just invested share capital) and that loan may have become repayable with the result that the investor is in a very strong position commercially: he could require the winding-up of the company so that his loan can be repaid. The business may also be critically dependent on the business knowledge and skills and client relationships of a single Director. The exercise of a legal right to dismiss such a person may in practice be impossible without causing irreparable harm to the business.

The shareholders (and their advisers) must first understand these commercial and economic realities before deciding whether a Shareholders’ Agreement is needed.

The shareholders (and their advisers) must first understand these commercial and economic realities before deciding whether a Shareholders’ Agreement is needed.

What About 50/50 Partnerships?

A complex area can be the business which is to be jointly owned 50/50 by two shareholders.
There may be sound commercial reasons (see previous section) which dictate that it would be “better” for one of the partners to have a controlling interest. This could be achieved by the holding of one extra share or by that person’s appointment of an extra Director to represent his interests, or to be appointed as Chairman of the Board. A chairman has generally had a second (or casting) vote in the event of equal votes on any issue. For companies incorporated after 1 October 2007 this is no longer permitted.

Where 50/50 ownership is commercially right then a “deadlock structure” may achieve rough justice. This subject is covered more fully below.

Does The Board Have Absolute Power?

No it doesn't and the following points need to be remembered:

1 Changing the Constitution
The constitution of a company comprises its Memorandum of Association (effectively the charter which describes what the company can do) and its Articles of Association (this is the rule book for the company’s internal affairs and decision making).
A change in the constitution will generally need the support of shareholders who hold 75% of the voting share capital; this is the percentage of the votes needed to pass a special resolution.

2 Issuing of New Shares
Before new shares are issued the authorised share capital of the company may need to be increased and the Board will also need authority to issue the shares (Section 80 Companies Act 1985).
Under the general law (Section 89 Companies Act 1985) new shares must first be offered for 21 days to the existing shareholders pro rata to their shareholdings (a so called rights issue). This general requirement can be waived for any particular proposed share issue by the passing by shareholders of a special resolution: for a special resolution to be passed those holding 75% of the votes cast must generally vote in its favour.
It is common for the Articles of Association of a private company to exclude this general requirement and a minority shareholder may want to remove the exclusion.

3 Winding-up the Company
A resolution to wind-up the company will need the support of shareholders who hold 75% of the voting share capital; this is needed to pass an extraordinary resolution.

4 Buy-back of Shares
A company is allowed to buy-back its shares but needs the authority of a special resolution (75% shareholder support).

In Practice What Does All This Mean?
The key point to remember is that those who hold more than 25% of the votes can block the passing of a special resolution or an extraordinary resolution to wind-up the company.
Remember it is a holding of more than 25% (i.e. 25.1% plus) that is needed. Other Important Percentage Shareholdings
There are several but one in particular should be remembered when issuing shares. There are procedures in the Companies Acts which allow a person who acquires 90% of the ordinary share capital to acquire compulsorily the other 10%. So a 10.1% shareholding gives the power to block a takeover and buyers almost inevitably want to acquire 100% of the company’s shares. There are in fact other procedures (but these require a Court Order), under which someone who acquires 75% shareholder support can acquire all the shares.

What else do I need to know about company law if I am a minority or majority shareholder?
Two other key provisions of company law should be remembered by all shareholders:

1 Secret Profits1 Secret Profits
Directors have very strict fiduciary duties and if they make a secret profit (e.g. by diverting a contract or business to themselves) they can be made to hand over that profit.

2 Unfair Prejudice (Section 994 Companies Act 2006)
The general law provides protection for a minority shareholder against the majority shareholders acting in an unfair manner.

Conduct covered might include:

• Paying excessive Directors’ remuneration
• Not paying dividends if the financial performance would justify it.
• Issuing shares for the purpose of diluting a minority shareholder’s interest.
• Terminating a Director’s employment in a quasi-partnership company.
• Buying or selling assets from or to the Directors at an overvalue/undervalue.
• Failing to follow the constitution.

These are just examples of conduct of which the minority may complain.
The Court has very wide powers in relation to cases of unfair prejudice but the most usual is an order for the shares of the outgoing shareholder to be bought at fair value. Injunctions to restrain unlawful conduct may also be available.
The existence of these remedies can act as a powerful weapon for the minority shareholder albeit generally only for those with the financial resources to assert their legal rights.

If I am a controlling shareholder, what does all this mean?

If a founder allows someone to obtain a 10.1% shareholding he may be blocked from selling the company: a buyer may not be interested in less than a 100% acquisition.

The existence of the unfair prejudice protection also means that the majority shareholder must be careful not to act unfairly: if he does the minority shareholder may end up with the right to require that his shares be bought at fair value as determined by an independent accountant. This may be much more than the majority shareholder wants or is able to afford.

What protection should a majority shareholder seek?

There are two key protections that should be considered:

1 A buy-back right so that for example the shares held by an employee-shareholder who leaves employment can be bought back.

The buy-back price could even be less than market value for an “early leaver” or a “bad leaver”.

The valuer could also be the Auditors who may (it is often thought) be more likely to opt for a low valuation so as not to upset the majority shareholder. Ethical guidelines (introduced in April 2005) means that the Auditors may have to refuse to act but this is only likely to be applied to larger companies.

Remember a buy-back right is a call option in favour of the majority shareholder: he does not have to buy if he does not like the valuation. This is very different to a put option which effectively is the remedy for a minority shareholder judged by a Court to have been unfairly prejudiced. With a put option the majority shareholder must buy: an unfortunate position to be in particularly if the valuation is not to the buyer’s liking or he does not have the cash.

2 A Drag Along Right

A provision can be inserted in the Articles under which the sale of a specified percentage (often 75% but sometimes 50.1%) can trigger the compulsory acquisition of the minority shares at the same price per share.

It is recommended that a drag along provision is included in the Articles even if the controlling shareholder holds 90% or more of the equity. This is because the compulsory purchase procedures in the Companies Acts are cumbersome and can be expensive to operate.

If I Hold 75% Of The Votes I Can Insert A Drag Along Provision If And When I Choose To Sell? Why Should I Consider Now?

Any change to the Articles by special resolution must be exercised in the best interests of the company as a whole. Case law has established that a change to the Articles, to insert a compulsory acquisition provision, may be challenged in the Courts under this rule.

After all buying someone out against his wishes runs counter to the general rules on ownership: the owner decides when he sells. Indeed the Companies Act procedures include the right for the minority to apply to the Court to stop the procedure. It is best, therefore, to insert such provisions in the Articles before the minority shareholder acquires his shares.

What Is A Tag Along Right?

A tag along right is the right of a minority shareholder to block the sale of a 50.1% interest unless a like offer has first been made for the 49.9% interest.

Generally, a majority shareholder will be happy to concede the inclusion of a tag along right perhaps as a quid pro quo to the drag along.

Care must be taken though in the framing of the tag along right. From the majority shareholder’s perspective it should be the right to insist only on a like for like offer. So the minority should not be able to insist on cash if the majority offer is one in shares and if the offer is of deferred consideration (or an earn out) the tag should be similarly limited.

What Does This Mean In Relation To Pre-Emption Provisions On Transfer?

Private company Articles will frequently include rights of first refusal on share transfers in favour of existing shareholders.

Where such rights are included they should exclude transfers made under either drag along or tag along provisions.

Is There Anything Else I Should Known About Pre-Emption Rights On Share Transfers?

First of all they do not have to be included. The Articles can either allow free transferability (those of a company whose shares are publicly traded must allow this) or give the Directors a veto on transfers to persons of whom they do not approve.

Secondly, where they are included certain “permitted transfers” may be allowed outside those pre-emption provisions. In addition to drag and tag along transfers “permitted transfers” may include those to family members or perhaps, in the case of founders, transfers between founders.

Where family transfers are permitted but buy-back rights are included in relation to the shares of leavers, the Articles will generally apply the buy-back to the family-held shares too.

What about valuations on share transfers?

There are two alternatives. Either the seller is allowed to specify his price or the seller must agree the price with the Board failing which a valuer will be engaged.

In the case of buy-backs (or compulsory transfers) there is really no alternative to using a valuer in the event the price cannot be agreed with the Board.

Historically the Articles have generally provided for an Auditors’ valuation although the well-advised minority shareholder has tried to secure valuation by an independent accountant. Except for Small and Medium-Sized Enterprises (i.e. those that qualify to file abbreviated accounts at Companies House) an April 2005 ethical guideline means that Auditors will generally not be able to undertake such valuations.

What are Russian Roulette clauses (or Put/Call Articles)?

This is a mechanism sometimes included in the Articles of a company owned 50/50 to act as a deadlock breaker. They work on the basis that if there is a deadlock (e.g. evidenced by the failure to pass a resolution at two consecutive Board Meetings) the deadlock breaker can be triggered.

Either party can offer to sell his shares at a price specified by him and, if the second party does not agree to buy, he must sell at the same price.

Such provisions may sound fair and may produce a rough form of justice for two corporations with equal buying power. However, where one party is (or becomes) impecunious the provision may allow the financially stronger to buy the shares of the weaker at a considerable undervalue if he cannot raise the funds to buy.

Do We Need A Shareholders’ Agreement?

This page has so far described provisions which are frequently included in the Articles of Association.
The Articles represent a contract between the shareholders. It can be changed by a 75% vote of those shareholders but subject to well-established rights designed to protect the minority from being unfairly treated.
Frequently those general legal provisions will be sufficient to provide a base level of protection.

Is There Any Extra Protection We Might Want To Include?

One method of protecting an employed-minority shareholder is to give him an employment contract with a minimum notice period.

Sometimes a Shareholders’ Agreement may also include a dividend policy. This may provide some protection against the failure of the Board to pay interim dividends or recommend final dividends to the shareholders.

Other protections can include:

• A right to appoint a Director to the Board (or an observer to attend Board Meetings).
• A right to information (e.g. monthly management accounts).
• A list of items which whilst generally within the power of the Board (or shareholders viz 75% of vote) are to be decided upon by a specified majority of the shareholders.
• Terminating a Director’s employment in a quasi-partnership company.
• Buying or selling assets from or to the Directors at an overvalue/undervalue.
• Failing to follow the constitution.

Beware of the tyranny of the minority

For the inexperienced an easy trap awaits; namely the inclusion of a long list of veto items. Whilst such protections may be appropriate for an institutional investor making a large capital investment it will often be imprudent to give similar power to an individual who is not a professional investor.