Is this happening to you?

Majority, I can’t sell my shares. You won’t buy them at a reasonable price and I can’t sell them anywhere else. I’m locked in!

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 ninth 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”[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 provides that the directors of a proprietary company may refuse to register a transfer of shares in the company for any reason [5] and that a person transferring shares remains the holder of the shares until the transfer is registered and the name of the person to whom they are being transferred is entered in the register of members in respect of the shares [6].

There is no real market for shares in private companies. Even if there was no restriction on transfer to an outsider, any transfer will often be at a substantial discount because the transferee will suffer the same problems of being a minority shareholder; it’s not usually an attractive proposition for a buyer.[7]

Protection

The shareholders agreement can incorporate the following provisions to protect the minority:

  • Call option: agreement where the minority shareholder can call on the majority to acquire (or the company to redeem it) their share on pre-determined terms.
  • Tag along right: provision giving a minority shareholder the right to force a substantial shareholder to allow them to participate in a sale to a buyer.
  • Drag along right: provision giving a substantial shareholder (or group of shareholders acting together) the right to force all of the shareholders to participate in sale of the company to a buyer (in the expectation that the majority shareholders are likely to structure a sale with the confidence in knowing they can sell 100% of the shares).

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.

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] S 140 Corporations Act 2001

[5 ] S 1072G Corporations Act

[6] S 1072F Corporations Act

[7] Cadman, John, Shareholders’ Agreements (Sweet & Maxwell Limited, 4th ed, 2004), 200

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