Disputes between shareholders in small companies can arise for any number of reasons. Small companies are often run as ‘quasi-partnerships’, that is each shareholder has an active role in the business which the company operates. A dispute could arise between shareholders simply because of an irreconcilable difference of opinion as to the day-to-day management or strategic direction of the business.
Disputes can also arise where the shareholders may not be active participants in the company’s business. For example, a minority shareholder may wish to sell its shares but its fellow shareholders may be unwilling to buy out that shareholder.
There are many other factual circumstances which can give rise to shareholder disputes.
This article will provide an overview of the different means by which companies are regulated, which in turn affects how shareholder disputes can be resolved, with a focus on how having a robust shareholders’ agreement can help prevent shareholder disputes from occurring.
The Act and constitutions
The internal management of companies, the conduct of directors, and the rights of shareholders, are regulated chiefly by the provisions of the Corporations Act 2001 (Cth) (the Act), and the constitution of the company (or ‘replaceable rules’, found in the Act, which apply to proprietary companies unless replaced or modified by a company’s constitution).[1] Relations between shareholders and the general conduct of the company can also be regulated by agreement between the shareholders.[2]
The Act does not provide any specific mechanism for resolving disputes between shareholders. It does however contain provisions which allow a shareholder to apply to an appropriate court for relief if there has been oppressive conduct towards a shareholder, or if it is ‘just and equitable’ to wind up the company. Those remedies will be discussed in more detail later in this article.
Many companies are purchased ‘off-the-shelf’, meaning that the prospective shareholders seeking to incorporate a new company engage an agent which specialises in company registrations to make the application to the Australian Securities and Investment Commission (ASIC) on behalf of the prospective shareholders. The agent can also supply a ‘standard’ constitution to the new company.
Such standard constitutions often contain rights of pre-emption, that is, remaining shareholders have a right to purchase the shares of an exiting shareholder before the exiting shareholder is permitted to offer its shares for sale to a non-shareholder. However, they rarely (if ever) contain mechanisms for resolving disputes between shareholders.
Shareholders’ agreements
Shareholders’ agreements are a useful means of implementing alternative dispute resolution procedures should a dispute arise. Having a detailed shareholders’ agreement may also prevent disputes from occurring because they can clearly set out the rights and responsibilities of the shareholders, thereby avoiding ambiguity which can lead to dispute.
Alternative dispute resolution mechanisms include procedures designed to resolve deadlocks, and mediation and arbitration clauses.
Having a mechanism which deals with deadlocks is essential in companies where there is an even number of directors.
‘Tag along’ and ‘drag along’ clauses can also ensure protection for minority shareholders in the case of tag along clauses, and protect majority shareholders ability to sell their shares if they receive an offer for all of the issued share capital to be bought out.
Relief from oppression
A shareholder can apply to an appropriate court for relief under section 232 of the Act, which deals with conduct that is oppressive or unfairly prejudicial to a shareholder.
The law concerning oppression is complex and beyond the scope of this article. It is sufficient for the purpose of this article to note that oppressive conduct has been described as “conduct that is so unfair that reasonable directors who consider the matter would not have thought the conduct or decision fair.”[3]
Oppression can include conduct such as deliberate devaluing of the company’s shares; refusal to pay dividends; and exclusion of shareholders/directors from participating in management of the company.
Winding up on just and equitable grounds
A Court may order that a company be wound up under section 461(1)(k) of the Act, because it is just and equitable to do so.
A winding up order on just and equitable grounds may be made on the basis of conduct that could be termed oppressive. Alternatively, a Court may order that a company be wound up because its activities are far beyond the purpose for which the company was originally incorporated.
Conclusion
A successful application for relief under sections 232 or 461(1)(k) of the Act can have substantial consequences for a shareholder and the company if the applicant for relief is successful. In addition, litigation under those sections is typically expensive.
The risk of litigation can be reduced by having a robust shareholders’ agreement in place which provides detail and clarity as to the rights and responsibilities of the shareholders, and which provides alternative dispute resolution mechanisms.
For further information contact Daniel Fleming on d.fleming@pigott.com.au.
This article is not legal advice and may not be relied upon as legal advice. It is intended only to provide a general overview of some aspects of the law relating to trade marks and business names. You should seek legal advice specific to your own circumstances for any trade mark, business name or related matters.
[1] Replaceable rules do not apply to proprietary companies with a sole director who is also the sole shareholder: section 135 of the Act.
[2] The constitution of a company has effect as a contract between the company and each of its shareholders, the company and its directors and secretary, and as between each shareholder: section 140 of the Act.
[3] Catalano v Managing Australia Destinations Pty Ltd [2014] FCAFC 55.