Is this happening to you?
“Majority, you’re paying yourselves excessive salaries and fees and it’s affecting what I can be paid and my dividends!”
Proprietary companies are often controlled by a single shareholder or a group. The majority’s nominated directors will control the board and therefore the activities of the company. If the majority (whether as shareholders or with their nominated directors) run the company in their own interests, the detriment to the minority can be serious. The minority shareholders have limited options because they cannot vote the directors out, in a general meeting, without the majority’s support. Getting out is difficult because they cannot force the majority to buy them out. As it’s not a listed company, they are also likely to find it hard to find a buyer of their minority stake. They are locked in with no control of their investment. It’s a difficult position to be in.
The following are the most common complaints made by minority shareholders:
- The majority are paying themselves excessive remuneration;
- Little or no participation in profits;
- The majority are diverting corporate opportunity / are operating a competing business;
- Exclusion from management;
- No involvement in important decisions;
- Limited access to information about the company’s affairs;
- Inability to prevent dilution of their equity stake;
- No freedom to transfer shares;
- No market for their shares;
- Bad management by the majority.
The following is a consideration of the first of these complaints, with recommendations on how a shareholders agreement will assist to prevent it.
Shareholders Agreement – What is it?
Shareholders agreements are a fundamental tool to help a company’s shareholders establish expectations and manage their risk. They are particularly useful to establish rights for minority shareholders and arguably, its primary purpose is “to eliminate the tyranny of the majority”.
Starting Point – The Company’s Constitution
To properly appreciate how to address a risk in shareholders agreement, you first need to understand what the legal position would be without a shareholders agreement. To do so, the first point of call is the company’s constitution. This is because the company’s constitution contains provisions relating to the day-to-day internal management and proceedings of the company.
Legally, a company’s constitution has effect as a contract:
- between the company and each shareholder; and
- between the company and each director and company secretary; and
- between a shareholder and each other shareholder;
under which each person agrees to observe and perform the constitution and rules so far as they apply to that person.
Every company’s constitution will be different, depending on who originally helped the company founders establish the company. Typically, however, the constitution will provide that the directors of a company are to be paid the remuneration that the company determines by resolution.
Therefore, the majority controlling the company are capable of determining their remuneration and pay remuneration deliberately compromising dividend available for distribution to all shareholders.
With that in mind, the shareholders agreement can incorporate the following provisions to protect the minority:
- Veto Right: a veto right where remuneration decisions concerning shareholders (including any nominated directors or related workers). This is usually achieved by requiring unanimity or concurrence of a higher percentage of voting units for shareholder or director action.
- Fixed Apportionment (%): a provision that any sums to be paid to remunerate the shareholders (including their nominated directors and related workers) are to be apportioned between the majority and minority (pursuant to their employment / service contracts) in accordance with a stated percentage. Therefore, if the majority pay themselves excessively, they will also have to pay the minority proportionately.
- Fixed Amount: if capable of being determined, fix the remuneration to be paid to an exact amount and how it is to be reviewed or a standard (say a reputable industry guide on market wages). This may also be done (or coupled) with employment or service agreements with the shareholders where remuneration, and increases to it, are fixed unless agreed unanimously.
Shareholder Disputes Rights and Remedies
This post is not a consideration of the legal duties and remedies that may prohibit the conduct or the remedies available when such conduct occurs. If you have, or anticipate, a dispute between shareholder in your company, please call Joe Kafrouni to discuss how we can help.
Joe Kafrouni, Legal Practitioner Director, Kafrouni Lawyers
The information provided by Kafrouni Lawyers is intended to provide general information and is not legal advice or a substitute for it. Business people should always consult their own legal advisors to discuss their particular circumstances. Kafrouni Lawyers makes no warranties or representations regarding the information and exclude any liability which may arise as a result of the use of this information. This information is the copyright of Kafrouni Lawyers.
Liability limited by a scheme approved under professional standards legislation.
 Lipton, Phillip; Herzberg, Abe; Welsh, Michelle, Understanding Company Law (Law Book Co, 17th ed, 2014 ), 629
 Cadman, John, Shareholders’ Agreements (Sweet & Maxwell Limited, 4th ed, 2004), 190
 Duffy, Michael J. (2008) “Shareholders Agreements and Shareholders’ Remedies Contract Versus Statute?” Bond Law Review: Vol. 20: Iss. 2, Article 1 at 5 citing A Elson, ‘Shareholders Agreements: A Shield for Minority Shareholders of Close Corporations’ (1967) 22 Business Lawyer 449
 Section 140 Corporations Act 2001
 This is a Replaceable Rule – s 202A Corporations Act 2001
 F Hodge O’Neil. Giving Shareholders Power To Veto Corporate Decisions: Use Of Special Charter And By-Law Provisions, p 451: http://scholarship.law.duke.edu/cgi/viewcontent.cgi?article=2572&context=lcp
 Cadman, John, Shareholders’ Agreements (Sweet & Maxwell Limited, 4th ed, 2004), 193