Family Values and Company Disputes

A family falling out is always a sensitive matter. Not only is there the divisive effect across family lines, but your siblings, parents, cousins or what have you always know how to hurt you most – and they remember your childhood nickname!

So what leads families in business to fall out so bitterly that lawyers get involved and how can you avoid it?

A typical family company started small, maybe a kitchen table effort, and grew as good ideas and hard work paid off. This usually means there was no formal setting out of expectations – how the company would work on a day-to-day basis, what control looks like, indeed who would be in charge. Often the company is divided on a 50/50 basis with scant regard paid to the formalities of record books, share certificates or dividend versus salary policy. What could possibly go wrong?

“A shareholder agreement? Waste of time and money – we’re family, right?”

A shareholder agreement setting out expectations such as who can be a director, what happens if one shareholder wants to sell their shares and the other does not, what is “fair value”, and how to calculate it, and how the profits of the company can be paid out, is often very helpful when family ties no longer bind warring factions together.

What happens if one of the shareholder/directors needs to take time off sick? Initially, most compassionate companies continue paying the sick person as if they were still there, on the understanding they will return shortly. But what if the sick leave stretched to months and then years and the “illness” was something that the remaining director thought was merely “rampaging lazyitis”.

Should the remaining director continue to pay the sick director’s salary? What about dividends distributing the company profits – does the shareholder who is no longer working in the business still “deserve” a share of the profits?

Well, if there is no exit provision in a valid shareholder agreement, and the sick shareholder/director had always received dividends up to the point they went off sick, and there was no change in their shareholding or the company’s fortunes, and dividends are still being paid to the other shareholders, then they should continue to be paid – otherwise the remaining shareholder risks a claim under s994 of the Companies Act 2006 (the Act) for unfair prejudice. A payment on account of dividends: well that is another story altogether!

“Books and records? What a faff, I never bother with those”

S113 of the Act provides every company must keep a register of members, which is open to inspection by those members and the public (s116). It must be kept up to date and accurate. This means that those people who think they are shareholders (and actually are) should have their names entered on the register (often just a book in small companies) and should have a share certificate to brandish about when things get heated.

What if you don’t have a share certificate though? If you believe you are a shareholder, the formalities of share ownership have been overlooked and your pleas for a certificate are falling on deaf ears, you could apply to the Court for rectification, an Order to formalise your holding, perhaps with damages if the lack of a formal shareholding has caused you a loss (s125 Companies Act 2006).

The directors and the Company are also obliged to keep accurate accounting records for up to three years in the case of a small private company (six years for a plc.), with entries showing the financial health of the company and day-to-day entries showing each transaction (s386 Companies Act 2006). Directors are allowed to inspect these books and records in order to carry out their duties properly[1] and the Court will usually enforce this right to inspect. However, shareholders have no automatic right to see the accounting records.

“That’s it – you’re fired!”

So your fellow director/shareholder has really done it this time, you are furious and in the spirit of Sir Alan you point the finger of doom and utter the immortal words “you’re fired!” Then what?

There is a decent chance they grab their coat and leave taking you at your word and then press the nuclear button. The next thing you know is that not only has a claim landed on your desk for unfair dismissal but also an allegation that they have been excluded from management and their interests have been unfairly prejudiced under s994 of the Act.

Then the digging starts…

What if they find out that you, who have spent years controlling the purse strings, have, for years, surreptitiously been paying your grocery bill (perhaps at Fortnum & Mason) on the company credit card? It’s racked up to a hefty sum, but salaries don’t stretch that far…

What about if you had secretly split the dividend 30/70 rather than 50/50 and manipulated the company accounts to cover it up? Maybe the company bought you a Lamborghini to discreetly drive around in at the weekend whilst your fellow director/shareholder’s company car is still the second-hand family run-around complete with dog hair, dodgy exhaust and a baby on board sticker?

Well there is a “get out of jail free” card… you will have to buy your disgruntled fellow shareholder out.

He Did WHAT?

Perhaps the boot is on the other foot. You are the one that stormed out and discovered just how shabbily your family member had been treating you. What rights do you have? Ultimately, if you can show that you have been unfairly treated within the context of s994 of the Companies Act you can either buy out the other shareholder or have your own shares purchased for fair value, which is either determined by the Court after a lengthy battle or an independent valuation by an expert accountant.

“I’m a shareholder – get me out of here!”

So what is “unfair prejudice” and why is it relevant to my small family business?

There are four elements of a claim for unfair prejudice under s994 of the Act. The petitioner (the person complaining) is usually a minority (50% or less) shareholder and must establish:

1. The conduct complained of must consist of the conduct of the company’s affairs or an “act or omission of the Company”; and
2. His interests as a shareholder[2] must have been
3. Prejudiced
4. Unfairly.

This is quite a complicated test and there are reams of cases that discuss the nuances in fine legal language, however for example, if in your small family business you had:

1. Excluded your fellow shareholder from management;
2. Been paying dividends unequally and secretly covering it up;
3. Siphoning money out of the company without telling your fellow shareholders and (4) refusing to pay some shareholders dividends whilst continuing to pay your own you would quite probably be facing a claim with some merit.

Oh and the claim would be against the majority shareholder personally and the company cannot pay your legal fees!

Now what?

The “get out of jail not so free” card

Let us assume you have treated your minority shareholder appallingly and they had a valid claim. You could fight it and spend the best part of two years dealing with increasingly expensive lawyers or you could play the get out of jail free card and make what is called an “O’Neill v Phillips” offer[3]. This means you counteract your unfair conduct by offering to buy the petitioner out at a demonstrably fair value plus the costs that he has incurred to that point. If you do so, it is then an abuse of process for the petitioner to continue with the claim because you have offered your disgruntled shareholder all they could expect to achieve at trial.

What does this actually mean?

(1) The offer must be to buy the shares at fair value – that is without a discount because it is a minority holding.

(2) The value, if not agreed, should be determined by a competent expert as an expert (rather than an arbitrator).

(3) The offer should provide for equality of arms, each party has the same right of access to information and both the right to make submissions (either oral or in writing).

(4) You need to deal with the petitioner’s costs.

Ultimately, the unfairness is not always made up of the breakdown in the relationship (and the conduct complained of) but the failure to make a suitable offer at the right time.

Resolving commercial and family business disputes

Sarah Jackson, Senior Solicitor at IBB Solicitors, specialist in Companies Act litigation.

If your business is facing the challenge of a commercial dispute or litigation, IBB Solicitors can help. Call our experienced solicitors today on 01895 207954. Alternatively please email commercialdisputes@ibblaw.co.uk or complete our online form.

[1] Conway v Petronius [1978] 1 WLR 72; Oxford Legal Group Ltd v Sibbasbridge Services Plc [2008] 2 B.C.L.C 381

[2] This is the time for brandishing the share certificate – in order to be a “member” you must be registered on the register of members as a shareholder (or have an instrument of transfer – see Sedgefield Steeplechase Ltd, Re [2001] B.C.C 899 and McCarthy Surfacing Ltd, Re [2006] EWHC 832 (Ch) – it makes no difference if you have applied unsuccessfully to the company for registration)

[3] O’Neill v Phillips [1999] 2 All ER 961