50/50 SHAREHOLDER DISPUTES

When starting a business with a friend, family member or colleague, the fairest way forward often seems to be to set up a company, with each of you being a director and each of you owning 50% of the shares. However, by doing this you may be storing up trouble for the future, possibly leading to 50-50 shareholder disputes.

Shareholder Deadlock

If a difference of opinion arises between you, this arrangement can cause big problems for the business. If you have adopted the Model Articles of Association and don’t have a shareholder agreement, a disagreement means that the company is in dead lock and cannot take action until the matter is resolved. If communication breaks down completely, the company cannot act at all.

No Control Over the Business

How serious the dispute is, depends on what it’s about. If one of you wants to borrow funds to expand, whilst the other wants to trim costs to maximize current income, then that’s serious but potentially solvable without too much disruption.

Much more serious is if your fellow director/shareholder is undermining the business; stealing clients, misusing confidential information or intellectual property owned by you or the company or taking funds out of the business without consent.

No matter what the dispute is, if you can’t reach a solution, you have a big problem, as neither of you has the authority to act on behalf of the company or the power to get rid of the other.

Why Does Deadlock Happen?

When most companies are set up, the Model Articles of Association (Model Articles) are adopted as its constitution.

According to the Model Articles (Part 2, section 3) “the directors are responsible for the management of the company’s business, for which purpose they may exercise all the powers of the company”.

However, decisions can only be taken if there is a minimum of two directors present and decisions binding the company can only be passed if there is a majority or a unanimous vote in support. As it is impossible to have a majority vote if there are only two voters, the Model Articles can effectively be read as saying that both directors must agree, or else there is no agreement.

Although the Model Articles allow for one of the directors in a directors’ meeting to be appointed as the Chairman and to be granted a casting vote on any decision. It is unlikely that either of you would ever be tempted to simply concede control of their company.

The directors of a company can be overruled by the shareholders. Part 2 section 4 of the Model Articles states, “The shareholders may, by special resolution, direct the directors to take, or refrain from taking, specified action.” A special resolution though, according to s283 of the Companies Act 2006 requires 75% of the shareholders to be passed. So, in a 50/50 company the directors can never be overruled.

Also, neither of you has the power to remove the other as a director. To remove a director, according to s168 of the Companies Act 2006 requires an ordinary resolution, which needs 51% or more of shareholders to agree.

However, although not easy, there are ways to resolve the dead lock.

Can the Deadlock be Broken?

Assuming that you won’t ever be able to agree that one of you will always be the one in charge, by owning 51% of the shares or by having a the final say in directors’ meetings, by changing the company’s structure (or more accurately its constitution) you can put in place ways of resolving a 50/50 deadlock if one ever takes place.

You could divide up the responsibilities within the company. You could agree that the view of one will always prevail regarding say, marketing, whilst the other’ s view will always prevail regarding operations.

You could (and should) agree to a dispute resolution procedure. It could be agreed that if one party gives notice, an issue must be considered at mediation with a third-party present. Or you could agree to appoint an arbiter to resolve a dispute, also agreeing that the arbiter’s decision will be final.

Procedures for buying or selling shares that mean if one party wants to end the association the other must co-operate can also be put in place. At the least, you should agree to a means of valuing the company and the shares in it.

The best way to include some or all these terms in the company’s constitution is through amendments of the Articles of Association and in a shareholders agreement. For more on shareholder agreements, please read our page Understanding Shareholder Agreements.

Court Action To Resolve the Dispute

If negotiation isn’t working, there are remedies available through court proceedings.

Derivative Claims

In a 50/50 company where you are both directors, if one person starts acting unilaterally, they are doing so without the authority of the company and they become potentially personally liable for any costs or losses resulting from their actions.

A Derivative Claim allows a shareholder to initiate legal proceedings on behalf of the company to reclaim losses incurred due to harm done to the company by its directors and others responsible for its management.

Common reasons for bringing a Derivative Claim:

Breach of directors’ duties.
Misappropriation or misuse of company assets or funds.
Competing with the company by unlawful use of its confidential information.
Breaches of the company’s intellectual property rights.
Fraud, dishonesty, or unlawful behavior by directors or managers.
Negligence or mismanagement.
Failure by the board to pursue valid legal claims on the company’s behalf.
Preventing or reversing unlawful acts or contracts involving the company.
Addressing deadlock situations where wrongdoing is being shielded due to a 50/50 split.

Please read our article on Derivative Claims for more information.

Bringing an Unfair Prejudice Petition

An unfair prejudice claim is a legal remedy for shareholders who believe that the company’s affairs have been conducted in a manner that is unfairly prejudicial to their interests. Such an action is brought under Section 994 of the Companies Act 2006.

The most common remedy granted under an Unfair Prejudice Petition is an order that the petitioners shares are bought by the other side at a “fair” value. Such a value will take account of losses caused by the conduct of the other party.

Common reasons for bringing an unfair prejudice claim:

Exclusion from management of the company.
Failure to declare or pay dividends at all or in a fair manner.
Mismanagement or diversion of company assets.
Breach of directors’ duties.
Exclusion of a shareholder from access to company information.
Excessive or unjustified remuneration of directors at the expense of shareholders.
Conduct that breaches the company’s articles of association or shareholders’ agreements.
Unfair treatment in the operation or control of a quasi-partnership or family-run company, especially where informal understandings are broken.