Problems that arise without a properly prepared shareholders agreement

The following story highlights the sorts of scenarios that we see where clients come to us asking for advice on how to resolve problems with their fellow shareholders in circumstances where a properly prepared shareholders agreement would have resolved the majority of their problems for them.

We often find that companies are set up when times are good and everyone is enthusiastic and in agreement with each other. Often, by the time we are contacted the owners’ relationship has deteriorated and the company and shareholders are suffering as a result.

A recent matter is a typical example. Three colleagues set up a company with equal shareholdings, and their business enjoyed plenty of initial success with them as the directors and shareholders. The company grew steadily until one of the director shareholders fell out with the others, after which the relationship between the three of them became difficult. Ultimately he handed in his notice, resigned and walked away from the company he had helped to create.

The company had been set up using the standard model articles which meant that the remaining director shareholders had no power to compel him into selling his shares upon his resignation.This meant that the shareholder who had left had walked away with a ⅓ shareholding.As a result he could block any special resolutions the company proposed to pass and as the company only had one class of shares, he was entitled to ⅓ of any dividends which were declared.

Despite losing one of its founding shareholders, the company continued to grow, but the remaining shareholders were in a difficult position. As their former colleague still held his shares, not only had he retained his right to receive a share of the profits of a company in which he was no longer involved but he would also benefit from the increased value of the company if it was ever sold. As a result, the remaining directors had decided not to declare dividends for several years, which badly affected their own incomes.

No common ground could be found between the parties, due to the circumstances under which the former director had left, and the parties were worlds apart on their valuations of the former director’s shares.

After numerous attempts to negotiate a deal, an audacious proposal to restructure the company and a threat of unfair prejudice court proceedings, some 24 months later the parties came to the realisation that it would be best for everyone concerned to enter into negations for the former director to sell his shares.

After a further 6 months of negotiations we finalised the purchase of the former director’s shares for a price only marginally higher than our clients had originally envisaged paying. As the shareholders’ positions were so entrenched, the fees for resolving this matter – which included the fees for obtaining an opinion from Counsel on the merits of the threatened litigation – were understandably high. By the end, it had cost the parties in excess of £60,000 to resolve their issues.

Although we could not have prevented the circumstances leading to the initial disagreement between the shareholders, there are safeguards that could have been placed into a shareholders agreement which would have helped resolved these issues quickly and efficiently. One such safeguard is to link a director’s shareholding to his continued involvement in the company.Provisions can be prepared so that if a director resigns and leaves the company, they must offer their shares for sale to the remaining shareholders.A shareholders agreement would also contain a mechanism for how any shares which are to be sold are valued.

We will always advise you to consider a shareholders agreement when you instruct us. After all, no matter how close you are to your colleagues, and how unlikely a problem may seem at the moment, disputes can arise from any number of issues, and in these cases an agreement with a clear road map to resolving the dispute can save everyone stress, time, and money. With the potential costs of shareholder disputes running high and with the associated disruption to the business, can you afford to not have one?

For individual advice about shareholders agreements, please contact Mark Watson on 01603 703087 or email mark.watson@ashtonslegal.co.uk . Alternatively, please complete one of our enquiry forms.