Shareholder and Boardroom Disputes
Incidents or cases of shareholder and boardroom
disputes are now a commonplace in both public as well as private companies.
In Kenya, the causes of such disputes are varied
and will generally involve: breach or lack of trust between shareholders or directors;
dishonesty, embezzlement or misappropriation of funds and theft of company’s
assets; difference of opinion arising from failure to agree on key management
or governance issues; dispute on operational issues like disagreements relating
to operations issues like dates or agenda for meetings or even bank signatories
or their mandates; dispute related to breach of the provisions of the company’s
constitutive documents or the Companies Act; breach of provisions of a
shareholders’ agreement by one of the parties; disagreements related to
shareholders’ or directors’ rights or obligations in the company; perceived or
actual conflict interest situations, personal wrangles or feuds between the
shareholders or directors; oppression of the minority; or abuse of office,
particularly by the majority shareholder(s).
As is the case elsewhere in the world, in Kenya
many businesses are started by family members or friends. Initially, such persons do not have elaborate
governance and management structures. In addition, in such social enterprises
most of the major decisions are made informally, either collegially or by one
of the shareholders or directors. In addition, in most cases all shareholders
and directors are involved in the day-to -day affairs of the company as well as
in the making key decisions.
Inevitably, as the business thrive or years wears
on, it is common for shareholders or directors to pull in different directions
or collegiality to end, or the effective communication to break down. For instance, some shareholders may emigrate
to other places or countries or decide to leave the business and pursue
different interests, which mean that they may not been involved in the day- to-
day management of the company. In additional, these shareholders or director
may appoint a nominee or a representative who do not see eye to eye with other
shareholder or directors.
In the example given above, the remaining shareholders
or directors may start feeling that that their time and resources investments
in the business in not being rewarded adequately or sufficiently appreciated. Others may also resent the fact contribution
of others in the company is disproportionate to the benefits derived from the
company. Such feelings are a major cause of shareholders or board room
disputes.
Also, as the company become successful,
shareholders and directors may disagree on key strategic issues. Often times,
due to disparity in shareholding ratios, the main shareholders may start making
decisions without consulting the minority shareholders at all or consulting
them sufficiently. The minority shareholders may also start resenting some decisions
which they feel are not made in their best interest, especially where this
relate to change of governance structure or require additional capital
injection.
For
family companies, after a generation or two, the founders or their children
will invariably have different interests in the business. Arising from siblings
or family rivalry, it is often the case that some founders or their children
will invariably try to take over the control the business for purposes of their
succession planning or just sheer family competition. When this happens, other shareholders and
their children may lose control and get sidelined in major decisions making
concerning the business. Moreover, as is often the case, those who have control
will always get better remunerated compared to those who are sidelined or
excluded from running the family business or businesses.
In
addition, where there is no clear policy on employment of family members,
children of some founders or their children may be allowed to work in the
business while others may be fairly or unfairly denied the opportunity. In
family companies, where there is no proper corporate governance is also common
for some shareholders or directors to form different camps in order to champion
or defend their interests.
In
other cases, where a founder shareholder or director dies or get incapacitated,
the remaining shareholders or directors may also not trust his personal representative(s),
who may not have experience in the business with some confidential information
about the business. In such cases, due
to weak governance structures, the wife or children of the deceased or
incapacitated shareholder may feel neglected, sidelined or taken advantage of
by the other shareholders. Where the
probate or succession for the estate of the deceased member is contentious or
involve other shareholders as potential beneficiaries, such disputes may also
seep into the entire family business.
Regardless
to the nature of the dispute, the undersigned has extensive experience on the best
tactics, strategies and action plans to resolve various types of shareholders
and board room disputes. We normally
adopt a multidisciplinary approach which ensures that as client is able to get
commercial sound, comprehensive and actionable legal advice that takes into
account all applicable options before guiding the client in implementation of
the agreed best way forward. Our team is also comprised of various experts like
tax lawyers as well as corporate investigators and investigative accountants in
order to help the client in analyzing reports and gathering crucial evidence
that would be required in resolving the dispute fairly.
In
most cases, we usually prefer to resolve shareholders dispute through alternative
dispute resolution methods like mediation and or arbitration. This is usually the case where there the
articles of association or the shareholders’ agreement provide for such methods
or where the disputants are willing to agree on such a method in resolving
their dispute. Nevertheless, if need be,
or in deserving cases, we usually result to robust litigation in order to get
the fair outcomes for our clients.
When
a shareholder or a director has a dispute, we usually record the facts, analyse
for evidence, give our legal advice on the best way to resolve the matters and
the alternatives that are available. We then discuss the strategies with the
client and the implement the agreed proposals.
Options that are available in
resolution Shareholder or Boardroom Dispute
Some
of the ways in such a shareholders or board room dispute can be resolved
include:
(a)
Share
buyback and cancellation
The major advantage of this method is that the
acquisition cost is paid by the company. The shares of an outgoing
shareholder(s) are cancelled meaning that all the remaining shareholders receive
an increased shareholding percentage. This method requires the company to have
sufficient surplus cash to pay for the shares.
Besides
the tax issues, another big problem of a share buyback is that it must be
approved by at least 75% of shareholders.
(b)
Variation
of Rights
In
this is a creative solution whereby certain rights of are varied or withdrawn
to suit the desired outcome. For instance, one shareholder may decide to cede
control of management in consideration of retaining some income or capital
rights. This may be popular with a founder shareholder who may
be looking to step aside from management but retain some financial reward for
their work.
(c)
Splitting
of the Businesses
In
this method, the company’s businesses or business divisions are split up and
reorganized to enable the shareholders get their separate businesses. There are many options and choices all of
which dependent of the specific case at hand as well as other imperatives
including taxation.
(d)
Deferred
Payout or Kind Consideration
Where
cash flow is the problem, the consideration payable for shares can be deferred
or paid in kind. The main problems
associated with this method are:
·
Deferred payments, if not proper structured, may
trick tax obligations for the seller;
·
seller may
be looking for some security which the buyers are not willing to give;
·
The seller may insist on earnsout, which is a contractual provision stating that
the seller of a business is to obtain additional compensation in the future if
the business achieves certain financial goals (usually stated as a percentage
of gross profit or revenues)
·
The
seller has to think carefully where he is ceding or relinquishing full
control of the business as he might thereafter be unable to control business
direction.
·
Interest will usually apply for deferred payments
(e)
Independent valuation of the shares under a shareholder dispute
Where the
dispute is about the price payable for shares, parties can agree, in a separate
agreement, on the method to be used to determine the value of the shares. This usually involve involvement of a
professional valuers or a panel of valuers, methods of valuation or guidelines
thereof, involvement of company auditors and parties’ representatives, the timelines,
the payment terms of the agreed consideration and resolution of any disputes
arising from the valuation process.
Since
there are no fixed rules, the terms of appointment of a valuer or a panel of
valuers should be through considered and should inter alia include: -
·
The basis for valuation –will it be on a whole
company basis or on the basis of the minority shareholding only;
·
Whether the parties are allowed to appoint
representatives;
·
the rights of parties to access information and
seek clarifications from the management or directors;
·
The involvement of the company’s auditors and
other professional;
·
Whether it is to be assumed that the business will
continue as a going concern;
·
The value to be attributed to goodwill (if any);
·
Application of minority discount (if applicable);
·
Who will cater for the costs of the valuation;
·
Whether the valuation will be binding or how to
resolve any dispute arising therefrom.
(f)
Court action
Our
action is usually employed variously to resolve boardroom as well as
shareholders’ disputes. The types of
actions that can be initiated include:
(a)
Derivative action
Derivative Action is provided for under Part XI (sections 238-241) of
the Companies Act. These provisions are akin to those of the
Companies Act 2006 (UK) especially
sections 260-264.
A derivate action
is an exemption to the rule in Foss –v- Harbottle [1843] 2 Hare 461 that
“a
company is a separate legal personality and the company alone is the proper
Plaintiff to sue on a wrong suffered by it.”.
Under section 238
(3) of the Companies Act, a derivative action can be commencing by a member on
behalf of the company only in respect of a cause of action arising from ‘an
actual or proposed act or omission involving negligence, default, breach of
duty, breach of trust by a director of the company’
The statutory procedure of
derivative action has two stages:
a) Firstly, the applicant must apply
for leave to commence the derivative suit. The
essence of judicial approval under the Act is meant to screen out frivolous
claims. In order to get leave from the
court, the applicant needs to establish, through evidence, is a prima facie
case on any of the causes of action noted under section 238(3) of the
Companies Act without the need to show that it will succeed. Under section 239(2)
of the Act, the application for permission will be dismissed if the evidence
adduced in support “do not disclose a case” for giving of permission.
b) The second stage entails a consideration of
statutory provisions and factors which ordinarily guide judicial discretion
albeit in the realm of derivative action.
From various judicial
pronouncements, the factors that the court will consider before granting leave
to commence a derivative action include:
·
Whether the applicant
is acting in good faith;
·
Whether the
applicant has pleaded particularized
facts which plausibly reveal a cause of action against the proposed
defendants. If the pleaded cause of action is against the directors, the
pleaded facts must be sufficiently particularized to create a reasonable doubt
that the challenged actions or omissions do not deserve protection under the
business judgment rule;
·
Whether the applicant has made any efforts to bring
about the action he or she desires from the directors or from the shareholders
including sending demand letter on the board, unless where this is can be
excused;
·
Whether the applicant fairly and
adequately represents the interests of the shareholders similarly situated or
the corporation. Hence, a shareholder seeking to bring a derivative suit
in order to pursue a personal vendetta or private claim should not be granted
leave;
·
Whether the action taken by the applicant is
consistent with one a faithful director acting in adherence to the duty to
promote the success of the company would take;
·
The extent to which the action complained against –
if the complaint is one of lack of authority by the shareholders or the
company – is likely to be authorised or ratified by the company in the future;
·
Whether the cause of action
contemplated is one that the Plaintiff could bring as a direct as opposed to a
derivative action.
·
The seriousness of the alleged wrong-doing which is assessed by conducting
a cost-benefit analysis of the intended action. The court will have to satisfy
itself that the litigation will not disrupt the company business and
additionally that the cost of the intended litigation is not burden-some to the
company. The court will also assess the reputational damage, if any, the
company is likely to suffer in the event the claim fails.
·
The factor that the
derivative suit ought to be allowed if it is in best interest of the company.
This factor should be of the highest concern especially when section
s143 and 144 of the Companies Act are read into context. Both sections advocate
the duty of the director to act in a way as to promote the success of the
company for the benefit of its members.
·
Finally, the existence
of alternative remedies and the view of independent members of the company
where the court has invited such evidence pursuant to sections 239
(4) and (5) and section 241(3) of the Companies Act.
(b)
Oppressive Conduct
This is inter alia
provided for under section 780-783 of the Companies Act. In summary, these sections provide
that an action for oppressive conduct may be initiated by a member of the
company or the Honorable Attorney General where:
(a)
the conduct of the company’s affairs;
or
(b)
an actual or proposed act or omission
by or on behalf of the company,
is or has been either:
·
contrary to the interests of the
members as a whole; or
·
oppressive or unfairly prejudicial to,
or unfairly discriminatory against members generally or to a section of its members.
Some of the
well-known examples of oppressive conduct include:
(i)
denying other board members, the
opportunity to carry out their functions e.g. failing to call directors
‘meetings when required;
(ii)
refusing access to information about
the company’s affairs;
(iii)
usage of company funds for improper
purposes – for example personal expenditure;
(iv)
paying excessive remuneration to the
person having control of the company.
(v)
an unfair allocation or restrictions on
the payment of dividends to particular shareholders;
(vi)
a combination of the inability to sell
out of a private company where improper exclusion from management has occurred
and there is no reasonable offer to buy the oppressed party’s shares.
The above examples
are not exhaustive and there are numerous other situations that can be
categorized as oppressive conduct. A
single act may be sufficient to attract the court’s intervention and there is
no requirement for history of oppressive conduct. Nevertheless, it should be noted that mere
mismanagement of the company’s affairs may not be regarded as oppressive
conduct and this method not meant to be a substitute in such instances or where
there is a breakdown in parties’ relationship or where the shareholders cannot
agree on how to run their company.
Under the Companies
Act, 2015, the High Court has very wide powers to make orders it considers
appropriate if it finds there has been oppression. These include:
a)
making orders to regulate the conduct of affairs
of the company in the future;
b)
ordering the company to
refrain from doing or continuing an act complained of, or to perform an act
that the applicant has complained it has omitted to do;
c)
ordering the purchase
of shares of any members of the company by other members or the company itself
and in case of a purchase by the company itself, the reduction of the company’s
capital accordingly;
d)
requiring the company
not to make any, or any specified, alterations in its articles without the
leave of the Court;
e)
ordering the company to institute civil proceedings in the name and on behalf of the
company by such person or persons and on such terms as the Court may direct;
f)
modifying or repealing the constitution of the
company;
g)
authorising or directing the company to make any, or any specified,
alterations to its constitution, the company shall, within fourteen days after the making of the order
or such extended period as the Court may allow.
(c)
Initiating legal proceedings for breach of
directors’ duties-
Under the Company
Act, 2015 as well as in common law, directors have numerous obligations imposed
on them. The directors’ general duties include:
·
the duty to exercise their powers and
discharge their duties with reasonable care and diligence;
·
the duty to exercise their powers and
discharge their duties in good faith in the best interests of the company and
for a proper purpose;
·
the duty to not improperly use their
position to gain an advantage for themselves or someone else or cause detriment
to the company;
·
not to improperly use information
obtained as a director to gain an advantage for themselves or someone else or
cause detriment to the company.
As can be deciphered from
the above, a director who is breaching one or more of the above duties is
almost certainly likely to be engaged in conduct that is unfair to shareholders
or the company. Moreover, where such a director is a controlling director, is
most likely to cause the company’s affairs to be conducted in an oppressive
manner.
Without prejudice to
the foregoing, where there is no oppressive conduct the only option available
for the innocent parties is to wait for the other party to slip up and start
engaging in acts or omissions which may be regarded as oppressive conduct. In
such cases, the best that the innocent party can do is to keep a detailed
record of such acts or omissions, keep track of cash and so forth.
(d)
Seeking a declaration from the Court
This is meant to clarify the rights, duties or obligations
of the shareholders.
(e)
Seeking injunctive orders
This is meant to prevent the continuation of act complained
of, and can be in the nature of temporary injunction orders or permanent
mandatory injunction orders
(f)
Suit for damages or enforcement of
personal remedies
This may be applicable where the company’s constitution or a
shareholders’ agreement has or is being breached to the detriment of a member.
(g)
Winding
Up of the Company
This is the most drastic
action that can be used in resolution of a shareholders’ dispute. Part
VI of the Insolvency Act, 2015 provides for liquidation of
companies and Section 423 of Insolvency Act gives the High Court the
jurisdiction to supervise the liquidation of companies
Section 424 of Insolvency Act
provides that a court may order the liquidation of a company in a number of situations,
including where the court is of the opinion it is “just and equitable” that the
company be wound up.
Application
for liquidation of a company akin to
that for oppressive conduct can only be initiated by filing a Petition in the
High Court.
The
determination of when it is ‘just and equitable’ to wind up a company is rather
complex. In brief, the court will consider whether, in all the
circumstances, the deadlock or dispute is so serious that it is not capable of
being resolved in any way other than by bringing the company’s existence to an
end.
In Kenya,
the courts will generally not wind up a company if there is an alternative
remedy. This is also the position in UK.
Therefore, winding up is a remedy
of last resort and one which ought not to be granted if some other less drastic
form of relief is available and appropriate. The Court has set out what would
amount to a reasonable offer of an alternative remedy as follows:
(a)
The offer must be to purchase the
shares at a fair value;
(b)
If not agreed the value must be
determined by a competent expert;
(c)
The offer should include to have
the value of the shares determined by an expert;
(d)
The offer should provide for the
equality of arms between the parties; Both should have the same right of access
to information about the company which bears upon the value of the shares.
Subject to the
foregoing, the law has been employed in deadlock situations involving small
private companies where, notwithstanding their corporate structure, in truth
the relationship between the shareholders is one of mutual trust and confidence
akin to being in a partnership.
Conclusion
As
explained before, boardroom or shareholder disputes are common. Fortunately, as
explained above there are number of options that are available including
litigious and non-litigious methods. Nonetheless,
in my experience, many of these disputes are best dealt with by one or more
parties being bought out. Unfortunately, it sometimes takes legal proceedings
for the parties to come to this realisation.
Be
that as it may, with swift action and the tactical use of proceedings (or
threats of proceedings), disputes can often be resolved in a way that allows
either part ways or recalibrate their relationship productively and continue
during business together.
If
you require any help in a shareholder dispute, kindly do not hesitate to
contact the write via mainacy@gmail.com
