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In a company with more than one shareholder, there is typically a shareholder who has a minority share in the company. Notably, a company with two shareholders with an equal stake in the company would not have a minority shareholder. Minority shareholders are afforded certain rights and protections under company law. This article will provide an overview of these rights and explain their importance.
What Are Minority Shareholders?
A company’s shareholders collectively decide important decisions for the company by voting on resolutions at shareholder meetings. Each shareholder’s power in the company correlates with the power of the voting rights attached to the shares. Not all shareholders necessarily have voting rights if there is more than one class of shares.
Technically, you are a minority shareholder if you have less than 50% of voting rights in a company. Hence, any one shareholder with more than 50% of voting rights has broad powers to appoint and remove directors and approve shareholder measures that only require more than 50% of the votes.
However, shareholders with less than 26% of the voting rights are the most vulnerable.
In practice, shareholders with more than 25% of the shares can block special resolutions. Special resolutions require the approval of shareholders holding 75% or more of the shares to make fundamental changes to the company. Therefore, if a shareholder has more than 25% of the votes, they can defeat significant proposals.
Where are Minority Shareholder Protections?
Most of the rules that govern a company are in your company’s articles of association. Companies have broad powers to decide how the company will function through the votes of directors and shareholders. However, certain laws restrict the power of your company, its directors, and the majority shareholders from undermining certain rights of minority shareholders. So, no matter what your company’s articles say, these rights remain.
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How Can Minority Shareholders Protect Their Rights?
Shareholders and directors are legally distinct and hence, have different rights and obligations. In most cases, the interests of shareholders and directors broadly align — they all want to maximise the company’s profit. However, this is not always the case.
Minority shareholders have three main options to protect their rights, all involving the court. These are:
- claims of unfairly prejudicial conduct;
- petitions for the winding up of the company; and
- derivative claims.
To help explain how each method works, we will use the following example and see how it applies to each option.
An Example
Say you own 80% of your company’s shares (and hold 80% of all available votes). You are also a director. Likewise, the four other directors receive the remaining 20% of the shares, giving them 5% each. Using your shareholding powers, you decide to remove all directors. You propose a new resolution to authorise the company to pay you an unreasonable director’s salary. As the shareholder, you approve this.
The minority shareholders are clearly prejudiced since you receive an unreasonable salary. This money could be reinvested in the company or paid out as a dividend. They cannot take action at the shareholder level to remove you as a director because you can block any resolution they put forward. Additionally, you also ratified the unlawful resolution.
What Options Do the Minority Shareholders Have to Protect Themselves?
Unfair Prejudice
The law recognises the right of all shareholders not to be unfairly prejudiced by other shareholders. However, where a shareholder feels they have been treated unfairly as a shareholder, they can petition the court. The court will ask if the conduct is objectively unfair and prejudicial by asking if the conduct breaches an agreement between shareholders as to the running of the company.
Notably, shareholders cannot ask the court to consider conduct that might prejudice them in a capacity other than a shareholder. For instance, removing the other shareholders from the board of directors might be unfair. However, that conduct would not necessarily affect their rights as a shareholder. Although, where a shareholder is also a director, particularly for a smaller company, this action may occur in a wider context that is unfairly prejudicial to the individual as a shareholder.
In addition to authorising unreasonable salaries, other conduct that can amount to unfair prejudice includes:
- not issuing dividends;
- directors exercising their powers improperly; and
- not permitting minority shareholders from participating in the management where the company is formed on the basis that all the shareholders will share in the management of the company.
That said, such conduct does not necessarily mean it is unfairly prejudicial. It is a question for a judge to decide. If the court is satisfied that the conduct is unfairly prejudicial, it has wide powers to make the situation right. For example, the courts can rectify the situation through orders requiring the conduct to cease or requiring the other shareholders to buy out the aggrieved shareholder.
Winding Up the Company
All shareholders have the right to ask the court to wind up a company, which is the equivalent of putting a company down for good. The effect is that the Court will sell the company’s assets to pay off any creditors, with the remaining proceeds distributed to the shareholders.
To put it lightly, this is the nuclear option. A court will only grant such a petition where it is the just and equitable thing to do. In most cases, especially where the company is not in any financial distress, the court will deny the motion on the grounds there are other options available. Therefore, in practice, aggrieved shareholders will ask the court to recognise unfair prejudice before seeking a winding-up order.
Derivative Claims
In the above examples, the minority shareholders are bringing an action against the company itself. Minority shareholders do this due to the Foss v Harbottle Rule which states that a company is its own legal person and its directors act on its behalf.
However, in limited cases, a minority shareholder(s) can bring an action on behalf of the company in a derivative claim. That is, the shareholder makes an application to the court in the company’s name. To do this, the shareholder must prove that there has been a breach of the company’s rights. Derivative claims are not suitable for vindicating personal rights as a shareholder.
In the above example, a derivative claim may be feasible on the basis you are exercising your directors’ duties with malfeasance (misappropriating its assets) and therefore harming the company. However, if you just removed all shareholders as directors without cause but exercised your directors’ duties competently, the law may recognise the legitimacy of a derivative claim.
How Do Shareholder Agreements Protect Minority Shareholders?
This article has only examined how shareholders can protect their interests under company law, which seeks to protect them as shareholders (and not in any other capacity). These shareholder rights cannot be overruled by the company’s constitutions. If there are provisions in the company’s articles, the law will refuse to recognise them.
But suppose you and the other shareholders agree to abide by an additional set of terms and conditions as agreed between you in your individual capacity. The law that governs companies and their shareholders will not have the authority to comment on this agreement. Instead, contract law will govern here. Such agreements are called shareholder agreements. They are purely private agreements.
In practice, no shareholder would agree to enter into a shareholder agreement that binds them in a private capacity to rights they enjoy as a shareholder under company law. But on the other hand, minority shareholders often use shareholder agreements to improve their position. For instance, you might have a term that states no director can be removed without unanimous consent. If this is in place in our example, you would breach the shareholder agreement. Hence, the shareholders would be entitled to sue you in your private capacity.
Key Takeaways
Absent checks against a majority of shareholders can act in such a way that is unfair to one or more minority shareholders. However, the law grants certain protections to minority shareholders that enable them to seek help if they think they are not being treated fairly. These are all causes of action that the aggrieved shareholder must pursue in court and include:
- claims of unfair and prejudicial conduct;
- a petition seeking an order to wind up a company; and
- derivative claims brought on behalf of the company.
The company’s constitution cannot overrule the right of shareholders to bring these claims. Additionally, a well-drafted shareholder agreement can provide additional protection, but only under the contract and not through any rights arising by virtue as a shareholder.
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Frequently Asked Questions
At the most fundamental level, minority shareholders have a right not to be treated unfairly and with prejudice. Minority shareholders can enforce these rights in a court by presenting a petition asking a judge to recognise the conduct. If this is recognised, the court has the power to issue an order against the conduct, damages, or an order for the other shareholders to purchase the aggrieved shareholders’ shares.
The former is brought by the shareholder in the shareholders’ name, whereas the latter is brought by a shareholder on behalf of the company.
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