Minority Shareholders: know your rights!

The governing rule of the decision-making process in a company limited by shares is the principle of majority rule. The day-to-day decisions are made by the directors, with certain ‘bigger picture’ decisions reserved for the shareholders to consider and, if thought fit, approve. Therefore, based on this principle, there is often little that a minority shareholder can do to influence the decisions of the company, and in practice they must simply accept the decisions taken by the majority group.

The best way to get your voice heard, as a minority shareholder, is to enter into a shareholders’ agreement. This is a negotiable contract between the shareholders of a company (and sometimes the company itself) which has the power to minimise the effect of the principle of majority rule by requiring unanimous consent of all shareholders for decisions in relation to certain matters, or at least a higher threshold.

However, whilst in practice entering into a shareholders’ agreement is the safest and most effective solution to empower the minority group, is not the only solution available to them.

The rights of the minority shareholders may vary depending on certain amendments to the articles of association and on the percentage of shares (and associated voting rights) they hold in the capital of the company. For example, shareholders holding at least 5% of voting shares have the right to call a general meeting or to require the circulation of a written resolution; shareholders holding at least 10% of voting shares have the right to demand a poll vote; shareholders holding more than 25% of voting shares have the power to prevent the passing of a special resolution (a resolution of shareholders which requires the approval of no less than 75%).

Some rights and remedies available to minority shareholders come directly from the Companies Act 2006 (the “Act”), others have been developed through case law. Although in practice these remedies are not frequently used or enforced, largely due to their potentially being costly and time consuming, their existence and their theoretical enforceability can be used as a bargaining tool which might help persuade the company or the majority shareholders to change their conduct towards the minority group.

In summary, these rights and remedies are:

• Enforce your membership rights under s.33 of the Act.

The articles of association of a company regulate the relationship between the shareholders and between shareholders and the company. S. 33(1), which reads: “the provisions of a company's constitution bind the company and its members to the same extent as if there were covenants on the part of the company and of each member to observe those provisions” gives the shareholders the opportunity to sue the company or other shareholders if their membership rights are infringed. As the articles of association of a company are a contract between its shareholders, the usual remedy for breach of contract is damages.

Examples of membership rights are:

• • Rights to dividends;
  • Right to be provided with copies of constitutional documents;
  • Rights to vote; or
  • Rights to receive notice of shareholder meetings.

However, there does not exist an exact definition of “membership rights” and therefore recourse here is very limited as those rights which are not classified under “membership rights” cannot be enforced under s. 33 of the Act – once again, entering into a shareholders’ agreement is the best solution to protect them.

• Derivative claims under s.260 of the Act

S.260 of the Act represents an exception to the general rule that where a wrong is committed against a company, the proper claimant is the company itself – not the single shareholder, on his behalf.

This principle has the effect of precluding the minority shareholders not only from complaining of actions approved by the majority of members, but also from bringing a claim for a wrong committed, whether by directors or by third parties, against a company of which they are members, when the company (acting by its directors) is refusing to take action.

However, over the years the court has recognised the need to allow minority shareholders to bring an action in their own name on behalf of the company where certain types of wrong are committed by a company’s directors. This necessity has since been codified in s.260 of the Act, which provides an express right to the single members of the company to apply to the court to bring a claim in certain circumstances. This type of claim is called a “derivative claim”.

As suggested by the wording of s.260(3) of the Act, “a derivative claim […] may be brought only in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company” and this “may be against the director or another person (or both).”

Interestingly, the section also clarifies that “it is immaterial whether the cause of action arose before or after the person seeking to bring or continue the derivative claim became a member of the company”. This means that a shareholder may bring a claim for wrongs which occurred before they became a member of the company, but a former member cannot bring a claim on behalf of the company once their membership has ceased. This principle underlines the fact that the cause of action is vested in the company. However, the court has great discretion in allowing a shareholder to continue such a claim and this discretion is based on multiple factors, such as the general principle of majority rule, whether the claim promotes the success of the company or whether the claim is brought in good faith. 

• Unfair prejudice under s.994 of the Act

Unlike s.260 discussed above, where the member sues on behalf of the company, a claim under s.994 of the Act is brought on behalf of the member and it is vested in the member himself.

The claim under s.994 is based on an objective test: a shareholder of the company, who applies to the court by petition for an order, needs to demonstrate that “the company's affairs are being or have been conducted in a manner that is unfairly prejudicial to the interests of members generally or of some part of its members (including at least himself), or that an actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial.”

The meaning of unfair prejudice has been developed through the years in the court rooms and is based on specific principles which give guidelines to establish when a conduct is to be classified as unfairly prejudicial, which means that the success of the petition is strongly linked to court’s discretion.

Strongly connected to s.994 of the Act is s.122 of the Insolvency Act 1986, pursuant to which a shareholder can apply to the court to get the company wound up on the grounds that it is just and equitable to do so. However, this petition is also based on court’s opinion.  This means that the court has great discretion in deciding whether conduct is classifiable as unfairly prejudicial or whether it is just and equitable that a company is wound up; as such, in practice, a settlement agreement is the preferred option for the prejudiced or petitioner member.

What does this mean for you or your business?

Clearly, the remedies available to the minority shareholders are not ideal as they are costly, time consuming and with uncertain results. However, knowing them, including their limits, can help you, as a minority shareholder, to consider your negotiating position and what provisions might be desirable and/or necessary to include in a shareholders’ agreement. This will enable you to act promptly and adequately to protect your interests and the interests of your company.

What do you need to be doing now?

Therefore, whether you are a shareholder or a company director, it is important to understand the rights, duties and limits (along with court’s powers) afforded to minority shareholders and to promptly seek legal advice for your protection and the protection of your company.

These notes have been prepared for the purpose of articles only. They should not be regarded as a substitute for taking legal advice.