Protection of Rights of Minority Shareholders

Meaning of ‘Minority Shareholder’:

Minority shareholders are the equity holders of a firm who does not enjoy the voting power of the firm by the virtue of his or her below 50% ownership of the firm’s equity capital.

Fiduciary Duty Owed by Majority Shareholders: The majority shareholders owe a fiduciary duty to the minority shareholders. This means that majority shareholders must deal with minority shareholders with candor, honesty, good faith, loyalty, and fairness. Minority shareholders have the right to expect company officers and directors to act in the company’s best interests and in compliance with the shareholders agreement.
Ways that majority shareholders can breach this fiduciary duty

i. form other companies to compete directly with the corporation,

ii. Pay themselves high salaries, or

iii. Sell stock of the company on terms favorable only to themselves

♦ STATUTORY CLAIMS:

Shareholders may also be entitled to bring a claim for unfair prejudice, or a statutory derivative claim, purely by virtue of being a shareholder, and irrespective of the size of their stake.

♦ Meaning of Unfair Prejudice:

Where the affairs of a company are being conducted in a manner that is unfairly prejudicial to a shareholder’s interests, or an actual or proposed act or omission of the company would be prejudicial, any shareholder can apply to court for relief.
If both prejudice and unfairness is evidenced, the court has a wide range of powers with respect protection of interest of the minority shareholders which include:

• regulating the conduct of the company’s affairs in the future
• requiring the company to refrain from an act, or to carry out an act that it has omitted to do (including ordering the company to amend its constitutional documents)
• prohibiting changes to the company’s articles of association; or
• requiring shareholders (or the company) to purchase the shares of other shareholders.

Ways to Protect the interest of minority Shareholders:

Many provisions of Companies Act, 2013 deals with the situations where minority shareholders rights have been protected and the same can be divided into various major heads. The ways to protect the rights of minority shareholders are discussed below.

1. Use of winding up action to protect minority shareholder:

This is obviously the most serious route and so very strict guidance applies. A minority shareholder can petition the court to wind up the company if it is “just and equitable” to do this. It is generally unlikely this will be in the interests of any shareholder for various reasons, including the time it will take, the cost implications for the process and that the company debts require repayment as soon as the process begins. The shareholder has to show that there is a tangible benefit to the winding up order and that there is no other alternative.

2. Protecting minority shareholders under crowd funding

• Drafting new articles and a shareholders’ agreement for a business wishing to attract a number of small minority investors via crowd funding.
• Placing limits on the running of the business via veto rights on salaries paid to the team and restricted use of dividends.
• Review of the intellectual property created by the founders to make sure that all rights were transferred to the company.

3. Resolving dispute over payment of dividends to minority shareholder

• Where the majority shareholder thought they could force the minority shareholders to sell their shares by not paying a dividend. Minority shareholders may complain about the lack of dividends and if the company have sufficient distributable reserves to pay a dividend.
• Because the majority shareholder controls the board of directors, and the resolution to pay dividend were not being proposed. So, we can use the power of minority shareholder combined to call a shareholders meeting to approve that a dividend be paid.

4. Review of Shareholder agreement for a minority shareholder:

• Review of the articles and shareholders’ agreement before a shareholder invested to acquire a 10% stake. We can make suggestions to lessen the risks attaching to the shareholding. Risk reduction included securing protections via the use of the right to veto key decisions such as review of regular management accounts, substantial expenditure, sale or winding up of the business.

5. Protecting minority shareholders under crowd funding:

• Drafting new articles and a shareholders’ agreement for a business wishing to attract a number of small minority investors via crowd funding.
• Enhancing the rights for investors whilst complying with the EIS legislation which prevents a preference being given to investors. Building in control via rights to appoint directors and voting rights. Placing limits on the running of the business via veto rights on salaries paid to the team and restricted use of dividends.
• Review of the intellectual property created by the founders to make sure that all rights were transferred to the company. Drafting irrevocable deeds of assignment to transfer the intellectual property.

6. Protection against dilution of shares of a minority shareholder:

Unless the articles of association of a company have dis-applied a shareholder’s right of first refusal (also known as a pre-emption right), any new shares that are being issued must first be offered to the existing shareholders in such proportions as to preserve their percentage shareholding in a company. This is to ensure that their investment is not diluted without first having the opportunity to invest further in a company to maintain their current shareholding.

♦ COURT ACTION

Can the Court Always Intervene?

A minority shareholder cannot ask the court to interfere with a decision made by the majority of the shareholders – this would be regarded as a decision of the company.

However, where the act has occurred through “negligence, default, breach of duty or breach of trust by a director of the company” then the minority shareholder can sometimes make the company take action against that director. These are known as “derivative actions” and are incredibly complicated scenarios where a shareholder with any level of holding requests the court to intervene either to:

• prevent an action of the directors that they feel is harmful; and
• make a claim against the directors for loss that the company has suffered due to their actions.