Shareholders have a financial interest in protecting the value of their investment in a company. As such, conflicts can arise when shareholders disagree about what is good for the business or their personal interests. These disputes can be detrimental to a company, resulting in disruptions in operations, legal expenses and other damages. This is why businesses must do their best to prevent shareholder disputes. Shareholders have certain protections under most state laws, but as with partnerships and limited liability companies, the business’s ownership agreement governs much of the rights and remedies of the parties. While shareholder disputes may be impossible to avoid in some instances, they can be minimized with good legal advice.
What Are Common Causes of Shareholder Disputes?
Disputes can arise for a wide variety of reasons. Often, they result from a shareholder’s objection to the operation or management of the business. There may also be conflicts arising from the actions of a sole or group of shareholders, which can adversely affect other shareholders.
Breach of the Shareholder Agreement or Bylaws
The shareholder agreement outlines and defines the distribution and nature of the shares in a company, including identifying the different types of shares and the rights provided to the holder of each type. Disputes may arise when a shareholder breaches one of the terms of the agreement, such as selling shares in violation of the relevant terms.
The company’s bylaws specify how the corporation’s internal affairs are governed. For example, it sets forth how directors will be appointed, when shareholders will meet, and how finances will be managed and reported. The failure of a shareholder or the company to follow the rules and regulations in the bylaws is a frequent source of conflict.
Breach of Fiduciary Duty
A fiduciary duty is an obligation that one person act in the best interests of another person or an entity. Where a fiduciary duty exists, there is a heightened duty of care and significant liability can result if the duty is breached. Officers and directors owe fiduciary duties to shareholders and the company. However, shareholders do not owe fiduciary duties to one another, except in the case of closely held corporations. Examples of a breach of fiduciary duty include misappropriating company assets, insider trading, usurping a corporate opportunity for oneself, and failure to disclose a conflict of interest.
Compensation or Contribution Discrepancies
Where shareholders are also employees, conflicts may arise if there are differences in how they are compensated and there is no reasonable justification for the discrepancies.
Discrepancies in Treatment of Majority vs Minority Shareholders
Minority shareholders are at a disadvantage because they lack the votes to ensure their voices are heard. As a result, most states give minority shareholders some protection against oppressive treatment by majority shareholders. This varies from state to state however and certain states, like Delaware, are considered “majority shareholder friendly.”
Misappropriation of Company Assets
If a shareholder misappropriates company assets, he or she may still be subject to liability even if no fiduciary duty is owed. Misappropriation can come in many different forms, including skimming cash before funds are officially recorded on the company’s books, using company credit cards for personal use, abusing expense reimbursement and overstating hours worked.
Disagreement over Company’s Direction
Shareholders have a financial stake in the success of the company and may disagree with decisions made by those running the corporation when they feel it may damage the value of the business. A wide variety of actions may precipitate conflict, including the board’s or management’s decision to continue or discontinue product lines, move into new markets, relocate facilities or make capital investments.
How Can Shareholder Disputes Be Resolved?
The first step in resolving a shareholder dispute is to understand the terms in the shareholder agreement and other relevant controlling documents. Often, there are provisions to aid in conflict resolution, such as the following:
- Removal of a director. Where permitted by the parties’ legal agreements, a conflict with a director may be resolved by voting out the director.
- Appointment of a new director or advisor. The board may be permitted to bring a new disinterested voice into discussions to assist the parties in coming to an agreement.
- Alternative dispute resolution. Both mediation and arbitration rely on neutral third parties to help resolve disputes without resort to litigation.
- Buyout (or Buy/Sell). This allows the company, shareholders, or a third party to buy out the interests of shareholders involved in the dispute.
- Shareholder resolution. A shareholder can propose a resolution to try to settle the conflict through discussions or a vote of the shareholders.
What Are the Most Effective Ways to Prevent Shareholder Disputes?
The best way to prevent shareholder disputes is to address potential problem areas in advance in the shareholder agreement and other relevant legal documents (e.g., employment agreements, articles of association, bylaws, etc.). A well-drafted agreement can save the company significant time and money by avoiding disputes or minimizing the cost of resolving those that do arise.
The agreement should include detailed provisions regarding the following:
- Shareholder rights and responsibilities, including minority shareholder provisions
- Fiduciary duties of officers, directors, and executives
- Transfers of shares
- Disclosure obligations
- Corporate formalities (shareholder meetings, corporate records, etc.)
- Buyout (or Buy/Sell)
- Dispute resolution
Conflicts cannot always be avoided, but by taking proactive steps, companies can minimize the damage to the business. Experienced legal counsel can guide companies as to the most effective way to prevent or solve disputes while still protecting shareholder rights.
Romano Law offers services relating to shareholder disputes in New York, Los Angeles, Miami and San Diego.
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