5 - Rights and Remedies of Shareholders

Question 1

Why might a shareholders’ agreement be needed?

Answer 1

• Directors vs. shareholders: Day-to-day management is handled by directors, with certain key decisions reserved for shareholders.
• Majority rule principle: Decisions requiring shareholder approval are passed by a majority vote. Minority shareholders often have little influence unless they align with others to form a majority.
• Minority shareholder’s position: In most cases, minority shareholders must accept decisions made by the majority.
• Existing protections: While protections/remedies are available, they can be costly and uncertain.
• Role of shareholders’ agreement: To mitigate majority rule, shareholders may opt for an agreement that defines how the company will be run and how shareholders will vote on particular issues.

Example: Shareholders may agree that unanimous consent is required for certain decisions, such as removing a director.

Question 2

What are membership rights under the Articles according to s33 CA 2006?

Answer 2

Under s33 CA 2006, the Articles of a company function as a contract between the company and its members, and also among the members themselves.

• Contractual binding: The company and its members are bound to the Articles as if there were mutual covenants to uphold these provisions.
• Enforcement under s33 CA 2006: If membership rights under the Articles are infringed, members can sue for breach under s33 CA 2006.
• Remedy: The usual remedy for a breach of s33 CA 2006 is damages.
• Membership rights: While the meaning of “membership rights” isn’t clear-cut, case law helps define these.

Complete contract: Articles are deemed a complete contract, and courts will not imply any terms for business efficacy. Non-membership rights must be protected through a separate contract, such as a shareholders’ agreement - they cannot be protected through a shareholders agreement.

Question 3

Provide examples of membership and non-membership rights.

Answer 3

Examples of membership rights:
- Right to a dividend once lawfully declared
- Right to share in surplus capital on winding up
- Right to vote at meetings
- Right to receive notice of general and annual general meetings (GMs and AGMs)

Non-membership rights: Certain rights not considered membership rights cannot be enforced under s33, as shown in Eley v Positive Government Security Life Assurance Co Ltd where the right to be appointed company solicitor was not enforceable as a membership right.

Question 4

What is the role of shareholders’ agreements?

Answer 4

Governance extension: Shareholders’ agreements extend the governance of a company beyond what the Articles can provide, adding flexibility where the law restricts what can be included in the Articles.

Key provisions: The specific provisions depend on the venture but often include rules on:
- Unanimous voting on major matters like removing a director
- Quorum requirements for general meetings (GMs)
- Dividend policy
- Allotment of new shares
- Entry and exit procedures for new and departing shareholders

Purpose: Shareholders’ agreements are common in companies with multiple owners and serve to provide certainty in governance, which might not be achieved solely through the Articles.

Question 5

How do shareholders’ agreements compare to Articles?

Answer 5

Private contract: Shareholders’ agreements are private contracts between shareholders, outlining how they will regulate company affairs.

Articles as a public contract: Articles of a company, under s33 CA 2006, are a public contract between the shareholders and the company, governing members’ rights and obligations.

Flexibility of shareholders’ agreements: Shareholders’ agreements allow for more freedom, letting shareholders agree on matters that go beyond what the Articles permit.

Privacy: Shareholders’ agreements can be kept private unless explicitly referenced in the Articles.

Binding under CA 2006: Articles must comply with CA 2006 and primarily regulate shareholders in their official capacity, whereas shareholders’ agreements give more leeway in personal rights and obligations.

Question 6

How do shareholders’ agreements protect minorities?

Answer 6

Right of action: Shareholders’ agreements provide a right of action that allows shareholders to enforce provisions directly against one another, a protection not always available under the Articles through s33 CA 2006.

Enforceability: Provisions that wouldn’t be regarded as membership rights under s33 can be enforced through a shareholders’ agreement.

Remedies for breach: Breach of a shareholders’ agreement allows the wronged party to claim damages for breach of contract or seek an injunction to prevent further breaches.

Avoiding unfair prejudice claims: A shareholders’ agreement can reduce the need for s994 petitions (unfair prejudice), although it does not prevent shareholders from filing such a petition.

Reserved matters: Certain matters, like director removal, can be reserved for unanimous consent, protecting minority shareholders from decisions that could otherwise be made by majority vote.

Question 7

What reserved matters in shareholders’ agreements protect minorities?

Answer 7

Unanimous consent: Shareholders’ agreements can specify that key decisions, such as the removal of a director, require the unanimous consent of all shareholders, including minorities.

Influence through breach of contract: Although statutory rights (e.g., under s168 CA 2006) permit majority vote removal of directors, breach of the agreement enables a minority shareholder to influence such decisions.

Example: A director removed by majority vote can still claim breach of the shareholders’ agreement if the required unanimous consent was not obtained, creating leverage for the minority shareholders to block the removal.

Question 8

How are amendments to shareholders’ agreements different from Articles?

Answer 8

Amendments to Articles: Can be made by a special resolution, which requires 75% approval from shareholders.

Amendments to shareholders’ agreements: Require the unanimous approval of all parties involved in the agreement, giving minority shareholders a veto right over any changes.

Minority protection: This veto power protects minority shareholders by preventing changes to the agreement that might negatively affect them without their consent.

Question 9

What are shareholders’ rights under CA 2006?

Answer 9

Any shareholder:
- Receive notice of a general meeting (s307)
- Appoint a proxy for attending a general meeting (s324)
- Vote at a general meeting if they hold voting shares (s284)
- Receive dividends if declared
- Obtain a copy of company accounts (s423)
- Inspect minutes and company registers (s116)
- Seek court intervention to prevent breaches of directors’ duties
- Initiate a derivative claim (s260)
- Bring a petition for unfair prejudice (s994)
- Bring a petition for just and equitable winding up (s122 Insolvency Act 1986)

5% or more:
- Require directors to call a general meeting (s303)
- Circulate written statements for general meetings (s314)
- Propose a written resolution (s292)

10% or more: Demand a poll vote (Model Articles 44)

Over 25%: Block a special resolution (s283)

Over 50%: Pass or block an ordinary resolution (s282)

75% or more: Pass a special resolution (s283)

Question 10

Provide a summary of the rights and remedies of shareholders.

(ADD TABLE FROM ADAPT NOTES)

Answer 10

Shareholder decisions are taken by majority rule ie ordinary resolutions will pass when they have the support of a simple majority and special resolutions will pass when they have the support of 75% of the shareholders. This may cause problems for minority shareholders.

The Articles act as a contract between the members (in their capacity as members) and the company.

Section 33 CA 2006 means that shareholders can sue if their membership rights are infringed. The usual remedy for breach of s 33 CA 2006 is damages.

CA 2006 does provide some statutory protection for minority shareholders, eg 5% of shareholders can request that the board call a GM under s 303 CA 2006.

Shareholders’ Agreements often provide a simpler and more effective way of protecting minority shareholders’ interests.

Question 11

What is the legal basis for removing a director by the shareholders?

Answer 11

• Under s 168(1) CA 2006, shareholders can remove a director by ordinary resolution before their term ends.
• This is the ultimate sanction shareholders hold against directors.
• The Board cannot remove a director unless specifically allowed by the articles.
• Directors who are also shareholders can vote on their own removal resolution in their capacity as shareholders.

Question 12

What is special notice, and what options are available to the board when receiving a removal resolution?

Answer 12

Special notice requires shareholders proposing a removal resolution to give the company (the board) at least 28 clear days’ notice before the GM where the resolution will be voted on (ss 312(1), 360(1) & (2) CA 2006).

When the board receives a removal resolution, it has two options:
- Option 1: Place the removal resolution on the agenda of a GM.
- Option 2: Choose not to place the resolution on the agenda of a GM.

Question 13

What happens if the board decides to place the removal resolution on the agenda of a GM?

Answer 13

The board must give shareholders notice of the removal resolution simultaneously with the GM notice (s 312(2) CA 2006).

Shareholders must be given at least 14 clear days’ notice of the removal resolution (ss 307(1), 360(1) & (2) CA 2006).

If not practical (e.g., GM notice already sent), notice of the removal resolution may be given by newspaper or other modes allowed by the Articles, at least 14 clear days before the GM (ss 312(3), 360(1) & (2) CA 2006).

Question 14

Why must the board give shareholders notice of the removal resolution even though shareholders initiated it?

Answer 14

Only some shareholders, the “unhappy shareholders”, may have proposed the removal resolution.

Other shareholders might be unaware of the proposal.

The board must notify all shareholders so they can vote on the removal resolution at the GM - this protects other, potentially minority shareholders.

Question 15

What happens if the board decides not to place the removal resolution on the agenda of a GM?

Answer 15

The board is not obliged to place the removal resolution on the agenda of a GM (Pedley v Inland Waterways Association Ltd).

If the board ignores the resolution, shareholders may be forced to compel the directors to call a GM under s 303 CA 2006.

Question 16

What power do shareholders have to require the calling of a GM - s303 request?

Answer 16

Under s 303(1) CA 2006, shareholders holding at least 5% of the voting share capital can require the board to call a GM by submitting a request.

The s 303 request must state the general nature of the business to be discussed and can include the removal resolution under s 168 CA 2006.

The power to call a GM is a general right and is not restricted to resolutions for removing a director.

Question 17

What obligations do directors have upon receiving a s 303 request?

Answer 17

Upon receiving a s 303 request, directors are obliged to call a GM:
- Within 21 days from the date of the request.
- The GM must then be held within 28 days from when the notice to convene the GM is issued (s 304(1) CA 2006).

Question 18

What happens if directors fail to comply with a s 303 request?

Answer 18

If directors fail to call a GM within the prescribed time limits, shareholders who submitted the request, or those holding more than half of the total voting rights of the requestors, can proceed to call a GM themselves (s 305 CA 2006).

The GM must be held within 3 months of the date of the original s 303 request, and must be called with no fewer than 14 clear days’ notice (s 305(3) & (4) CA 2006).

Shareholders can also recover reasonable expenses incurred in calling the GM from the company, and the company can then recoup these costs from the directors responsible for failing to act (s 305(6) CA 2006).

Question 19

What practical points should shareholders note when issuing special notice and a s 303 request?

Answer 19

It is advisable for shareholders to serve a s 303 request at the same time as serving the special notice under s 312 CA 2006.

This ensures that the matter of the director’s removal is dealt with promptly, as either:
- The board calls a GM that includes the removal resolution.
- Or shareholders themselves can call the GM under s 305 CA 2006 if the board fails to do so.

Question 20

Provide an overview of the timelines when the court does/does not cooperate with a s 303 request.

Answer 20

When the board does cooperate:
Day 1: Unhappy shareholders issue a s 303 request (assuming the special notice has already been given).
Day 22: The board must decide within 21 days whether to call a GM.
Day 50: The GM must be held within 28 days if the board calls it.

When the board does not cooperate:
Day 1: Unhappy shareholders issue a s 303 request (assuming the special notice has already been given).
Day 22: The board fails to call a GM within 21 days.
Day 23: Shareholders can proceed to call the GM, providing at least 14 clear days’ notice.
Day 38: The GM must be held within 3 months of the s 303 request.

Question 21

What rights does a director have to protest their removal?

Answer 21

Upon receipt of the removal resolution, the company must immediately send a copy to the director facing removal (s 169(1) CA 2006).

The director has the right to make written representations of a reasonable length (s 169(3) CA 2006), which should be circulated to shareholders or read at the GM (s 169(4) CA 2006).

The director is also entitled to be heard at the GM (s 169(2) CA 2006), regardless of whether they hold shares in the company.

Question 22

What is a Bushell v Faith clause, and how does it protect a director who is also a shareholder?

Answer 22

A Bushell v Faith clause grants a director who is also a shareholder enhanced voting rights in any GM where a resolution to remove them under s 168 CA 2006 is proposed.

This clause can effectively block the passage of an ordinary resolution for removal, giving the director an added layer of protection.

Such clauses are often found in smaller companies, where directors have had a pivotal role in forming the company.

Example:
In ABC Ltd, A, B, and C are directors, with the following shareholdings:
- A: 60 shares
- B: 20 shares
- C: 20 shares
To prevent A and C from removing B, the Bushell v Faith clause may grant B 4 votes per share, giving B 80 votes and making it impossible for A and C to pass the removal resolution with their combined 80 votes.

Question 23

How do shareholders’ agreements protect a director who is also a shareholder?

Answer 23

A shareholders’ agreement might include a provision requiring unanimous consent for passing resolutions that remove a director.

This protects a director who is also a shareholder by ensuring that any resolution passed by a simple majority under s 168 CA 2006 does not override the agreement.

If a resolution is passed without following the agreement, the director may bring a claim for breach of contract and potentially seek an injunction to prevent the resolution’s enforcement.

Question 24

Will the director be entitled to compensation for loss of office?

Answer 24

A director removed under s 168 CA 2006 may be entitled to compensation or damages for loss of office, depending on the terms of their service contract.

s 217 CA 2006 requires that any such compensation paid by a company to a director of its holding company must also be approved by the shareholders of that holding company.

No shareholder approval is required under s 217(4) CA 2006 if the company paying the compensation is a wholly-owned subsidiary.

Question 25

What are the procedures and additional provisions for providing compensation to directors?

Answer 25

A memorandum outlining the payment must be available to shareholders for 15 days before the resolution is passed, ending with the general meeting (s 217(3) CA 2006). Shareholder approval is also required for: - Payments in connection with the transfer of company property or undertaking, such as a share or business sale (s 218 CA 2006). - Payments related to a takeover bid involving the transfer of shares in the company or its subsidiaries (s 219 CA 2006).

Question 26

Provide a summary for when a director's appointment may be terminated by shareholders.

Answer 26

A director’s appointment may be terminated by ordinary resolution of the shareholders under s 168 CA 2006. Shareholders wishing to remove a director will need to give 28 clear days’ notice of the resolution to remove the director to the board. The board is not obliged to put the resolution on the agenda of a GM. Shareholders can serve a notice on the board under s 303 CA 2006 to require it to call a GM at which the resolution to remove a director will be heard. If the board fails to call a GM within 21 days, the shareholders may call it themselves on normal notice. Directors who are also shareholders may protect themselves by inserting Bushell v Faith clauses into the articles or entering into a shareholders’ agreement. A company may pay compensation to a director who leaves office. This will require shareholder approval under s 217 unless one of the exceptions apply.

Question 27

What is a derivative claim, and how was it established?

Answer 27

A derivative claim is where a shareholder’s right of action is derived from the company’s right of action, which the company has not exercised. It is not personal to the shareholder. Before the CA 2006, this claim existed under common law, specifically through exceptions to the rule in Foss v Harbottle: - The rule in Foss v Harbottle stated that a minority shareholder cannot sue for a wrong done to the company unless under limited exceptions. - The company, typically acting through the board or majority shareholders, is the proper claimant in such cases. The procedure for derivative claims is now set out under s 260 CA 2006

Question 28

What does Section 260 CA 2006 provide for derivative claims?

Answer 28

Section 260 CA 2006 allows shareholders to bring a derivative claim where directors breach their statutory duties. It creates a statutory right to bring claims, acting as an exception to the Foss v Harbottle rule, covering a wider range of circumstances than common law. A derivative claim must be: - Brought by a member on behalf of the company. - In respect of a cause of action vested in the company. Any remedy is granted to the company, not the shareholder bringing the claim.

Question 29

Under what circumstances can a derivative claim be brought?

Answer 29

Under s 260(3) CA 2006, a derivative claim can be brought for: Negligence, default, breach of duty, or breach of trust by a director. This includes both statutory and common law duties. A director does not need to have benefited personally for a derivative claim to proceed. Shadow directors and former directors are also included under the definition of ‘director’. The claim can address breaches of duties outlined in ss 170-177 CA 2006, such as the duty of care, skill, and diligence under s 174 CA 2006.

Question 30

Who can a derivative claim be brought against?

Answer 30

Under s 260(3) CA 2006, a claim may be brought against: The director or another person (or both). However, the cause of action must arise from the actions or omissions of a director. Third parties can only be defendants if their actions relate to a director’s breach. For example: - A third party involved in a contract breached by the director, with knowledge of the breach, can be included in the claim under common law rules of ‘knowing assistance’.

Question 31

Who is eligible to bring a derivative claim under s 260 CA 2006?

Answer 31

**A member** of the company can bring a derivative claim under s 260(4) CA 2006. The claim can be made **regardless of whether the cause of action arose before or after** the person became a member. This highlights that the cause of action is vested in the company, not the member. However, **former members** cannot bring claims, even for actions that occurred while they were members.

Question 32

What is the first stage of court approval for a derivative claim?

Answer 32

At Stage 1, the member must obtain court permission to continue the derivative claim under s 261(1) CA 2006. The member must establish a prima facie case. The court must refuse permission if: - A person acting under s 172 CA 2006 (duty to promote the company’s success) would not seek to continue the claim. If no absolute bar exists under s 263(2), the court will assess factors under s 263(3), including whether: - The member is acting in good faith. - The action would likely be ratified by the company.

Question 33

What is the second stage of court approval for a derivative claim?

Answer 33

At Stage 2, if the claim passes the first stage, the court will consider further criteria. The court will have particular regard to the views of members who have no personal interest in the matter (s 263(4) CA 2006). If successful, the claim proceeds to trial. This safeguard prevents a single member from pursuing litigation against the wishes of the general body of shareholders, deterring tactical litigation.

Question 34

Provide a summary of when a member has a right to bring a derivative claim.

Answer 34

Any member has the statutory right to bring a derivative claim under s 260 CA 2006 on behalf of the company against directors (and third parties) who have breached their duties. A derivative claim may be brought by a shareholder on behalf of the company in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company. Claims may be brought against a director and/or a third party. Any remedy granted is to the company, not to the shareholder bringing the claim. There is a two-stage process for a derivative claim under s 260 CA 2006 to avoid an abuse of this right. Derivative claims are rare in practice.

Question 35

What is unfair prejudice under s994 CA 2006?

Answer 35

Unfair prejudice allows a shareholder to bring an action on the grounds that the company is being run in a way that unfairly prejudices their interests. Examples include: - Excessive remuneration to directors - Directors dealing with associated persons = Non-payment of dividends The shareholder sues for themselves (unlike derivative actions under s260 CA 2006, where they sue on behalf of the company).

Question 36

What does s994(1) CA 2006 provide in terms of unfair prejudice?

Answer 36

A member of a company may apply to the court by petition if: a) The company’s affairs are being or have been conducted in a manner that is unfairly prejudicial to the interests of members. b) An actual or proposed act/omission of the company is or would be unfairly prejudicial. The court will assess unfair prejudice through an objective test (Re Guidezone Limited).

Question 37

What are the key principles of unfair prejudice under s994 CA 2006?

Answer 37

Unfairly prejudicial conduct developed through case law includes: Negligent or inept management: Not unfair unless it leads to serious or repeated mismanagement. Disagreements in policy: Does not justify a petition. Bad faith: Unnecessary to prove bad faith or intent. Breaches of articles: May only justify a petition if equitable considerations make strict reliance unfair. Claimant’s conduct: Relevant but not determinative. Excessive remuneration: Can be a valid claim. Legitimate expectation: Particularly in quasi-partnerships, minority shareholders may expect involvement in management.

Question 38

What are the remedies for unfair prejudice under s996 CA 2006?

Answer 38

The court can grant any order deemed fit to provide relief, such as: - Regulating the future conduct of the company’s affairs - Ordering the company to do or refrain from doing specific acts - The most common order: Purchase of the petitioner’s shares by the wrongdoer(s) Rarely, the court may order minority shareholders to buy the majority's shares.

Question 39

What are the valuation principles in an unfair prejudice claim?

Answer 39

The court aims to set a fair price and generally follows these principles: - Valuation mechanism in the articles: Used if fair; otherwise, court valuation applies. - No minority discount: Usually no discount for minority shareholding in quasi-partnerships unless the shares are viewed as investments. - Valuation date: Typically the date the court order is made. - Claimant’s conduct: Previous rejection of a reasonable offer may be relevant.

Question 40

What are the commercial points of an unfair prejudice petition under s994 CA 2006?

Answer 40

In cases of disputes over share valuation, courts encourage out-of-court settlements using third-party valuations. Petitioners objecting to settlements must provide reasons. Caution: Unfair prejudice petitions can be costly, time-consuming, and uncertain. Therefore, negotiated settlements are often preferred over petitions.

Question 41

What is a just and equitable winding-up under s122 Insolvency Act 1986?

Answer 41

- A shareholder can petition the court to wind up the company on grounds of just and equitable reasons under s122(1)(g) IA 1986. - Winding-up ends the company’s existence, making it a drastic remedy. - Courts have discretion in deciding if winding-up is just and equitable. - Overlap with s994 CA 2006 means petitions under both sections are often made simultaneously.

Question 42

Provide a summary for the scenarios where a shareholder can bring an unfair prejudice claim under s 994 CA 2006.

Answer 42

Any shareholder can bring an unfair prejudice claim under s 994 CA 2006 on the grounds that the running of the company has unfairly prejudiced them. A claim under s 994 CA 2006 is a personal action brought by the shareholder against the company. The various orders for relief are set out in s 996 CA 2006 and the most common order would be that the other shareholders or the company buy the claimant shareholders' shares from them. It is possible, but rare for a minority shareholder to apply to bring a petition to the court for the company to be wound up because it is “just and equitable” to do so.