Disputes between shareholders: why are they so messy and expensive?

Owning shares in a small, private company is like having a legal interest in a marriage.  The parties come together with the best of commercial intentions, seeing an opportunity for profitable business that is greater than the opportunity if they operate separately.  Their shareholders’ agreement should be like a matrimonial pre-nup, addressing what will happen if the relationship goes sour.  If the parties are inexperienced, or let their hearts rule their heads, the agreement may skirt over the possibility of a future break-up.  Oh, these terms are far too dry and theoretical, cries the client.  We need to focus on the positive aspects of the relationship, not the negative!

As long as the parties have a good relationship, they are unlikely to care what the contract says.  Once they start fighting with one another, they start looking at the contract terms.  At this point, the wise solution may be to recognise that there is no point in the parties trying to work together any more, and to seek an amicable divorce.  But they may have too much invested in the company to simply walk away.

The terms of shareholders’ agreements give plenty of opportunities for the parties to prick one another with sharp needles, hurting but rarely causing permanent damage.  On a few (thankfully rare) occasions, we have had clients who have pored over every clause of the agreement, seeking ways to get their way, or get their revenge.  We have been bombarded with questions from such clients on the finer points of company law.  Can I call a meeting and vote to expel the other party from the Board?  Can I appoint another director, to outvote the other party?  Is this resolution valid, when the other party has a conflict of interest that he hasn’t declared?  Can I …?  Can I …?  Can he …?

Sometimes, these strategies work, because one party or the other is careless about company procedures.    More often, they just create aggravation.   For the lawyer, answering detailed questions about company law can be a thankless task, as it is easy to make a mistake in this area, so considerable care is required.  By the time you have worked out the answer to one hypothetical question, the client has thought of another.  And anyway, the client doesn’t really care about the legal answer, they just want you to find a way of gaining a legal advantage over the other party.  Doing this via the medium of company law procedures is usually misguided.  Of course, you tell the client this, and keep a good file note.  But parties who find themselves caught up in a shareholder dispute don’t always listen to wise counsel.

In summary, shareholder disputes can be very messy and can waste money on legal fees.  Parties should be cautious about getting locked into a business relationship with other shareholders, and clear-eyed about how they will extricate themselves if it goes wrong.  This will involve spending time on getting the terms of the shareholders’ agreement right.  But good contract terms are not a complete answer.   Sometimes, during negotiations, your instincts may tell you that this party is not right for you, in which case it may be best to avoid closing the deal.  If necessary, jilt them at the altar!  If you do consummate the transaction, the agreement should probably be thought of as a shield against the other party in a dispute, and not as an aggressive weapon.

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