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Exit Strategies - How can a shareholder in a small private company leave or be made to leave?
Shareholders setting up a small private company rarely focus on how, at sometime in the future, they might get out of the company and recover their investment if the relationship between them breaks down. There is no automatic right to exit from a private company.
If the Company's Articles Association or a shareholders' agreement does not provide an exit route, the circumstances in which a sale or purchase of shares can be forced on an unwilling party are extremely limited.
Shareholders Agreements
Relations between shareholders are governed by the Company's Articles, and, if there is one, a shareholders agreement. Shareholders agreements should contain provisions about how the relationship between shareholders may come to an end and how and when shares can be transferred. Situations commonly covered are when a shareholder dies, becomes bankrupt or ceases to be a director of the Company. There may also be a requirement that a shareholder is deemed to have given notice to transfer his shares if he has breached the shareholders agreement.
Some Articles and shareholders' agreements contain put options giving each shareholder the right to require the other(s) to purchase his shares, or a call option allowing shareholders to oblige another shareholder to sell his shares, in accordance within an agreed mechanism at a valuation determined by a set formula.
Well drafted Articles and a shareholders' agreement will help to help to avoid legal proceedings when relationships break down and there is deadlock.
Unfair Prejudice Petitions
The only way in which shares may be bought or sold without agreement between the shareholders (either on a case by case basis or via the Articles or a shareholders' agreement) is by obtaining a court order to the effect that the shares be sold, in what is known as an unfiar prejudice petition.
Section 994 of the Companies Act 2006 (which replaced section 459 of the Companies Act 1985) allows any shareholder who has suffered "unfair prejudice" as a result of the behaviour of one or more other shareholders to petition the court. What amounts to "unfair prejudice" is an objective test in the context of the commercial relationship as governed by the articles of the company and any shareholders' agreement.
It is not necessary for a petitioning shareholder to show that anybody has acted in bad faith or with the intention of causing prejudice, but the conduct complained about must be prejudicially unfair to the petitioner's interests in his capacity as a shareholder.
In one case it was held there was unfair prejudice where a shareholder had complained that the other two shareholders (who were directors of the Company) had failed to call Annual General Meetings, had awarded themselves remuneration and had transferred funds out of the Company to another company which they owned. In another case, joint owners and directors each accused each other of dishonesty and acting unfairly. The judge held that where both shareholders had
acted dishonestly it wasn't possible for one of them to have been treated unfairly.
The fact that trust and confidence between the shareholders has collapsed is not enough to amount to "unfair conduct", and the courts have held that the law does not support "such a stark right of unilateral withdrawal".
The courts have held that, in a small family run business, the removal of a shareholder as a director may amount to "unfair prejudicial conduct" under section 994. This may be the case where the Company is effectively run as a partnership and all the shareholders are involved in its management. Where the Company is essentially a quasi partnership, such as a small family-run business, the court has held that a family member would have a legitimate expectation of being made a reasonable offer for his shares if he were excluded from the management of the company unfairly.
The courts can make an order unfair prejudice proceedings that the remaining shareholders buy the shares of the shareholder who has been unfairly prejudiced at a fair value. Whether the Court will make that sort of order in a particular case is difficult to predict; it depends on the Court's discretion and its interpretation of the facts. The House of Lords has held that conduct that might be fair in a purely commercial business may not be fair between family members.
If a shareholder were successful in unfair prejudice proceedings, he would normally be entitled to a pro rata value for his shares without any discount for a minority holding. The valuation of the shares will usually require expert evidence from an accountant (instructed by both parties).
The House of Lords has held that, where a reasonable pre-action offer to buy the shares at a fair market value has been made, the court should strike out any petition. So, if shareholders find themselves faced with a shareholder demanding that his shares be purchased, they should make a pre-action offer. By doing so they may prevent any proceedings being issued. The problem is often that this solution is not available to shareholders who cannot to afford to buy the shares at a fair market value. That may be a serious barrier to the resolution of the dispute.
An order for the purchase of shares is the most common order given by the courts in unfair prejudice proceedings, but the courts do have the power make other orders, for instance, regulating the future conduct of the Company's affairs or requiring that the Company refrains from doing something or requiring to Company to do something.
Where shareholders no longer want to be in a company together but there is no unfair prejudice the courts will not intervene. In the absence of adequate provisions in the articles or a shareholders' agreement, the shareholders will have to try to reach a compromise through negotiation. This is easier said than done when there is animosity between the parties.
Contact Details
If you would like further advice about any of the issues considered above please contact Paul Northwood on 01869 331753 or email him at paul.northwood@northwoodreid.com.
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This article is not intended to be, and should not be taken as being, legal advice. The law often changes and it varies from jurisdiction to jurisdiction; the information in this article is generic in nature and specific legal advice should be taken before acting on any of it.
© Northwood Reid 2008. The use, copying and dissemination of this article are subject to our