The importance of a Shareholders’ Agreement- Can a majority shareholder force out a minority shareholder by amending company articles?

Posted on May 25, 2018

Minority shareholders may find themselves in the precarious position of being forced out of a company against their will. This can happen during disputes between a minority and majority shareholder, and in a recent case, it was ruled that a majority shareholder’s decision to amend the articles of association to create a mechanism designed to oust a minority shareholder was valid. Here’s what happened, and some information about what you can do if you find yourself in a similar position.

The Case – Can a minority shareholder be forced out by a majority shareholder?

Staray Capital Limited v Cha [2017] UKPC 43 concerned two shareholders, one Mr Chen who owned 80% of the shares, and Mr Cha who owned 20%. The shareholders’ relationship broke down over time, where eventually Mr Chen amended the company’s articles of association in order to create a mechanism intended to redeem the minority shareholder’s shares in situations where the shareholder had made false representations in the course of acquiring them.

Mr Chen acknowledged that the mechanism was designed to force Mr Cha out of the company, which Mr Cha argued was in bad faith and not for the benefit of the company.

The Judicial Committee of the Privy Council held:

the amendment of articles will be valid providing that it was made in good faith for the benefit of the company;
it is the decision of the shareholders whether or not an action taken is in the interest of the company, unless no reasonable person would agree; and
even if an amendment made was solely targeted at removing an individual shareholder, it does not necessarily invalidate that amendment.

Despite the amendment in this case being valid, the court found that the accusations of misrepresentations made on the part of Mr Cha were material, and therefore the redemption notice, not the mechanism itself, was found to be invalid.

Previous cases have stated that the power of a special majority of shareholders (i.e. those holding 75% or more of the voting rights) to bind the articles and bind the minority will only be valid if it is “exercised in good faith in the interests of the company” or “bona fide for the benefit of the company as a whole”. Although the Staray case concerned the actions of shareholders of a BVI company, the substantive legislative provisions in the British Virgin Islands are consistent with the Companies Act 2006.

The Staray case suggests that if a genuine purpose for making amendments to a company’s articles can be identified, which could reasonably be said to be for the benefit of the company, it might be possible to introduce compulsory acquisition powers, such as drag along rights or compulsory redemption rights, which are potentially prejudicial to the interests of minority shareholders, without the consent of such shareholders.

The Importance of a Shareholders’ Agreement

This case stresses the importance of Shareholders’ Agreements in any company that has two or more shareholders.

A minority shareholder can find themselves in the precarious position of having significant changes made in the company against their will, providing that the majority shareholder holds 75% or more of the voting rights attaching to the issued shares. The ramifications of this can be very serious, as demonstrated above, however, the presence of a Shareholders’ Agreement can go a significant way towards ensuring smooth running of the company.

Many shareholders agreements contain “tag along” and “drag along” rights, which can protect both minority and majority shareholders’ interests in various circumstances.

A drag along provision enables the majority shareholder(s) to force the minority shareholder(s) to sell their shares to a third party purchaser who makes an offer to acquire all of the issued shares in the target company. This has obvious benefits for the majority shareholder(s), because they don’t need to worry about the minority shareholder(s) being able to block their exit from the company.

Tag along rights are also known as “piggy back” rights. They are common provisions in joint venture or private equity agreements, which enable certain shareholders (usually minority shareholders) to force other shareholders who wish to sell their shares to procure an offer for the shares benefitting from the rights. The tag along rights act as protection for the minority holders in case the majority chooses not to exercise its drag along rights.

The existence of a Shareholders’ Agreement can act as a deterrent against shareholder disputes, but when disputes do occur, they often provide a means of resolving that dispute without recourse to litigation. For example, they often contain provisions to unlock any deadlock that occurs, whether at board or shareholder level, through (for example) the appointment of an expert to resolve the deadlock. More draconian methods to resolve a deadlock situation include a so-called “Russian Roulette” clause, whereby one party offers either to buy the shares of the other party or to sell its own shares to the other party (but not both) at a specified price. The party in receipt of the offer can either accept the offer or reverse the offer at the same price. This works in the context of a 50:50 deadlock joint venture company where both parties are of broadly equal financial standing.

Shareholders’ Agreements often contain a schedule of so called “major matters” or “reserved matters”, which require a certain number of the persons or those shareholders holding a certain percentage of the shares to vote in favour of, before the matter in question can be implemented. Fundamental decisions about the business can fall into a separate category, which require a unanimous vote. Shareholders’ Agreements typically also contain restrictive covenants so that the shareholders cannot, for example, set up in competition whilst they are a shareholder and for an agreed period after they cease to hold their shares. They also deal with the company’s dividend policy and how the company will be financed. Unlike at company’s articles of association, Shareholders’ Agreements do not need to be filed at Companies House, and therefore allow the shareholders to keep matters that they would prefer to remain private out of the public eye.

Contact

If you need guidance on any of the issues mentioned above, or if you need advice or assistance with a shareholder issue, you should contact one of our experts at the earliest possible time. You can get in touch with Keith Kennedy on 0161 785 3500.

Please note that the information and opinions contained in this article are not intended to be comprehensive, nor to provide legal advice. No responsibility for its accuracy or correctness is assumed by Pearson Solicitors and Financial Advisers Ltd or any of its members or employees. Professional legal advice should be obtained before taking, or refraining from taking, any action as a result of this article.

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