This month we focus on some of the rights held by minority shareholders of a company incorporated in the UK, and how they can impact on the influence wielded by majority shareholders.
Where to find these rights?
Minority rights have two key sources: statute (principally the Companies Act 2006 for companies incorporated in the UK) and contract. Many of the statutory rights outlined below are mandatory, i.e. cannot be disapplied. By contrast, contractual rights are freely negotiated, and typically enshrined in a shareholders’ agreement and/or the company’s articles of association. Now that you know where to look, what are these rights and how can they affect you?
1. The mighty 25%+
Shareholders in this category may hold little more than a quarter of the company’s shares, but statute grants them the power to block some of the most important decisions a company might wish to make. This is because the Companies Act 2006 requires a 75% shareholder vote to (among other things):
- amend the company’s articles of association;
- disapply statutory pre-emption rights on a new share issue; and
- approve the redemption or purchase of a company’s own shares out of capital.
It is likely that any significant structural change (such as a pre-sale corporate reorganisation) will require one or more of these actions so, from a majority shareholder’s perspective, it is critical to have this in mind when agreeing the extent and terms of any minority interest.
2. From 15% to 5%
Even majority shareholders with 85% of the company’s share capital is not necessarily home and dry. For example:
- 15% – Right to object to variation of class rights: If a company’s articles of association are amended so as to change the rights attaching to a particular class of share, shareholders representing at least 15% of that particular share class can apply to the court to have the variation cancelled on the basis that the change unfairly prejudices them. This right exists even though the requisite majority (75%) of the shareholders of the relevant class of shares may previously have approved the variation.
- 10% – Audits: Shareholders representing not less than 10% of the nominal issued share capital of a company have a right to request that the company’s accounts undergo a full company audit. This applies even if the company is otherwise exempt from a full audit. This right may be invoked to investigate legitimate concerns about a business’ finances, but also has considerable tactical value to apply pressure on senior management and other shareholders, as this would require the company to incur additional expense, and consume considerable management time.
- 5% – Convening General Meetings: 5% shareholders have the power to call a general (shareholder) meeting of the company, and table one or more resolutions of their choosing. The directors are obliged to set a date for the general meeting within 21 days, and hold the meeting within a further 28 days. Failure to comply with this gives the minority shareholders a right to circumvent the board of directors and convene a meeting themselves.
Similarly, minority shareholders can influence how quickly a general meeting can be held. As a general rule, members of a private company must be given 14 days’ notice of a general meeting. This notice period can be shortened with the approval of at least 90% of the company’s shareholders. However, the company’s articles of association can raise this threshold up to 95%, providing a 5%+ minority with a powerful blocking right in the event that an urgent meeting is required.
3. 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.
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.
Both prejudice and unfairness must be evidenced. A member may, for example, be able to demonstrate this where an act or omission has resulted in a disproportionate significant decrease in the economic value of their shareholding, or a company has procured the allotment of shares with the purpose of diluting a minority shareholder’s interest.
If successful, the court has a wide range of powers 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.
Statutory Derivative Claim
Where a company’s directors have been negligent, have breached their fiduciary duties to the company or committed a breach of trust, a shareholder can initiate what is known as a derivative claim. This is a claim brought by the shareholder on the company’s behalf, in respect of a cause of action that the company would ordinarily have against one of its directors, a third party, or both.
Such derivative claims can only be pursued if certain criteria are fulfilled, and the court has wide discretion to examine the merits of the claim and to determine whether a derivative claim is appropriate in the circumstances. In practice this makes them notoriously difficult to pursue.
4. Contractual rights
Statutory rights are only half (or, often, less than half) of the story – shareholders typically enhance or vary statutory provisions within the articles of association, and in a bespoke shareholders’ agreement. The most common minority rights to watch out for are:
- Tag-Along Rights: enabling minority shareholders to force other selling shareholders to procure an offer for their shares (on the same or substantially the same terms). They are converse to the usual drag-along rights that allow majority shareholders to force a sale by the minority. Note that a minority shareholder also has a statutory right to have its shares purchased where, following a takeover bid, at least 90% of the company’s shares have been purchased, known as a ‘sell-out’ right (the converse of the statutory ‘squeeze’ out where a 90%+ shareholder can force the minority to sell).
- Pre-emption rights: these rights of first refusal typically apply to new share issues and share transfers.
- Director/observer rights: the shareholders’ agreement and/or articles of association may permit a minority shareholder to appoint someone to represent it at meetings of the board of directors, either as a director (with voting rights, but also all responsibilities that attach to directorship) or as an observer (with rights to attend meetings, but no voting rights).
- Minority consent rights: these rights, typically drafted into a shareholders’ agreement, can grant a minority shareholder a ‘veto’ over specified actions of the company. The matters subject to any such ‘veto’ typically go to the existence and value of the minority’s shareholding, e.g. no winding up of the company without minority shareholder consent, but can be as wide or narrow as the shareholders agree.
- Information rights: a minority shareholder may have very limited (or no) involvement in the management of the business, so a right to monthly, quarterly or annual updates/information packs may be enshrined in the company’s constitutional documents in order to help the shareholder monitor the performance of its investment.
5. The nuclear option
If there has been a fundamental and irreparable breakdown in the relationship between the shareholders and the company’s directors, any shareholder who has held their shares for at least 6 out of the last 18 months may apply to the court to seek a winding up of the company. The court will decide whether it would be just and equitable to do so. As a general rule, the court will only make an order to wind up the company where the applicant shareholders have no other remedies available.
Is this brief too brief? Do you need any help with your upcoming M&A process? Expert legal advice is on hand from MJ Hudson’s M&A and corporate law team.