Is this happening to you?

Majority, you’re not giving me any information on the financials or affairs of the company. I’m in the dark!  

Introduction

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.[1]

The following are the most common complaints made by minority shareholders[2]:

  1. The majority are paying themselves excessive remuneration;
  2. Little or no participation in profits;
  3. The majority are diverting corporate opportunity / are operating a competing business;
  4. Exclusion from management;
  5. No involvement in important decisions;
  6. Limited access to information about the company’s affairs;
  7. Inability to prevent dilution of their equity stake;
  8. No freedom to transfer shares;
  9. No market for their shares;
  10. Bad management by the majority.

The following is a consideration of the sixth of these complaints with recommendations on how a shareholders agreement could assist to prevent it.                                                                                                                

Shareholders Agreement – What is it?                                                                                                        

Shareholders agreements are a fundamental tool to help a company’s shareholders to 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”[3].

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 – the rules.

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[4].

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, or the company by a resolution passed at a general meeting, may authorise a shareholder to inspect the books of the company[5].

Therefore, a minority shareholder (against a majority shareholder controlling the board) is unlikely to be able access to the books of the company.

Lack of access to company information is one of the most common complaints in shareholder disputes.[3] It often causes suspicion and mistrust between shareholders[4] so it is quite serious.

Protection

A shareholder requiring access to the books and records to ensure the company is being managed properly, and complying with the law, should incorporate such provisions in a shareholders agreement, also specifying required timing.

The extent of disclosure is also important to consider. What will the shareholder be entitled to? Reports or the actual books of the company if necessary, including copies of invoices and banks statements. A shareholder (depending on the number of other minority shareholders) should also be mindful of the company perspective. That is, any disclosure of company books or other information cause confidential and sensitive information being accessible to disgruntled shareholders with bad intention.[6]

With that in mind, the shareholders agreement can incorporate the following provisions to protect the minority[7]:

  1. Access: a direct right to have financial reports and access the books of the company, setting out the timing and specific documents required (in first instance);
  2. Nominee Director Release: where the shareholder has the right to appoint a director to the board, a provision that the nominated director may provide the appointing shareholder all information regarding the company without breaching their duty of confidence;

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 as a result of any of these complaints, please call Joe Kafrouni to discuss how we can help.

Author

Joe Kafrouni, Legal Practitioner Director, Kafrouni Lawyers

Disclaimer

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.

References

[1] Lipton, Phillip; Herzberg, Abe; Welsh, Michelle, Understanding Company Law (Law Book Co, 17th ed, 2014 ), 629

[2] Cadman, John, Shareholders’ Agreements (Sweet & Maxwell Limited, 4th ed, 2004), 190

[3] 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

[4] Section 140 Corporations Act 2001

[3] Cadman, John, Shareholders’ Agreements (Sweet & Maxwell Limited, 4th ed, 2004), 190

[4] John H Farrar and Laurence J Boulle. Minority Shareholder Remedies: Shifting Disputer Resolution Paradigms – [2001] BondLRev 13; (2001) 13(2) Bond Law Review Article 3

[5] This is a Replaceable Rule – s 254W(2) Corporations Act 2001

[6] Lipton, Phillip; Herzberg, Abe; Welsh, Michelle, Understanding Company Law (Law Book Co, 17th ed, 2014 ), 658

[7] Cadman, John, Shareholders’ Agreements (Sweet & Maxwell Limited, 4th ed, 2004), 194