Minority shareholder rights and protections
Sun 8 October 2023
Minority shareholder rights
The reality is that unless you protect your interests as a minority shareholder, under English law, you will have few protections. Even where you may be able to take legal action, typically claiming unfair prejudice, you will probably find that the damage to your interests has been done, you will need deep pockets and strong nerves to litigate. By far the best approach is to consider protecting your shareholder rights at the time you invest.
What general protections are there for minority shareholders?
Under current English law, not much. If you don’t have a comprehensive shareholder agreement with enhanced protections and the company’s articles of association are standard, the position, generally speaking is :-
- Right to Information - Shareholders have the right to access certain company information, including financial statements, annual reports, and minutes of general meetings.
- Right to Vote - Minority shareholders typically have the right to vote at general meetings of the company. This includes voting on key decisions such as the appointment of directors or significant corporate transactions.
- Pre-emption rights – perhaps the most valuable right for minority shareholders who do not have other enhanced protection. Pre-emption means that where new shares are issued by the company the existing shareholders have a right to subscribe so as to maintain their existing shareholding percentage.
- Right to Dividends - Shareholders have the right to receive dividends when they are declared by the company (but the majority shareholders may decide that dividends should not be declared), provided the company has distributable profits.
- Right to Inspect Books and Records - Shareholders have the right to inspect the company's books and records, subject to certain limitations.
- Blocking rights - your ability to block actions of the majority shareholder(s) is that if you have 5% or more you can request general meeting, if you have 15% or more you can try to block the company from issuing new classes of shares at court. If you have 25% or more shares, either yourself or together with other minority shareholders, you can block special resolutions. Special resolutions are generally needed to change the company’s articles of association, to remove directors or to buy back shares.
So, if you have invested into a company where the majority shareholder is a director and you are not, you don’t have enhanced protections in a shareholder agreement and the company has standard articles, you are very vulnerable. The directors have day to day control of the business, and this means you will have very little ability to stop the majority shareholder/director doing exactly what they want, potentially to your disadvantage. Any blocking rights you may have, as detailed above, are likely to be of little use to you,
What are the biggest risks for minority shareholders?
Without a shareholder agreement and/or amended articles of association, situations that can and do arise regularly with private UK limited companies include :-
- Directors only act in their own interests - this may include paying themselves very significant salaries rather than declare dividends, to divert business to other businesses they have an interest in and to generally manipulate the company in their capacity as shareholder/directors
- Lack of information – without regular and meaningful information, a minority shareholder will not know what’s really going on in the company.
- Value of shares – there can be situations where minority shareholders do not get fair value for their shares, especially if they are employee shareholders (see below).
- A disposal of the company or assets of the company - in a way which only benefits the majority shareholder.
- Financial manipulation – for example, excessive or unusual borrowing and/or entering into contracts which are onerous and/or benefit the majority shareholder in some manner.
Specific risks for employee shareholders?
Bad leaver provisions in employment contracts and where the employee is a minority shareholder and/or an employee who has share options which have not yet vested can be very unfair on employee shareholders. Specifically : -
- Unfair Triggering Events - The triggering events that lead to bad leaver status, such as resignation, termination, or performance-related issues, may be influenced by subjective judgments. Minority employees may be unfairly targeted or treated in these situations.
- Valuation of shares - bad leaver provisions often result in employees forfeiting equity or bonus entitlements. Minority employees may lose a significant portion of their compensation or share ownership, impacting their financial stability and future prospects.
Ways to protect yourself as minority shareholder
The starting point is that you should seek to address the issue of suitable protections at the time you become involved with the company. Do not take things on trust or at face value and think about what could go wrong and your potential position on exit.
Agreeing to deal with issues later rarely works to a minority shareholders’ advantage. If the majority shareholder is not prepared to consider your concerns this ought to be a serious red flags for you, whether you are investing a significant sum or are on a promise of future benefit without cash investment.
The usual ways to protect yourself will be via a shareholder agreement and/or enhanced protections in the company’s articles of association. For employee shareholders the employment contract and terms of any share scheme plan are also extremely important.
In terms of specifics :-
- Veto rights - on key decisions, like changes to the company's capital structure, borrowings, contracts, or the appointment of directors.
- Board Representation – if you have a fairly significant minority shareholding or there are other minority shareholders who agree with you, push for a place on the board of directors.
- Enhanced rights to information – proper and regular availability of information about financial health and performance.
- Dividends – steps to prevent directors rewarding themselves and deliberately not paying dividends. A clear policy on payment of dividends and prevention of profit reducing tactics.
- Valuation of shares on exit - known as tag along rights but also favourable terms and fair good leaver/bad leaver provisions, potentially also a formula to fairly value your shares on a buyout.
- Dispute Resolution mechanism - a fair process which means you are not left only with very difficult unfair prejudice or derivative claims and which potentially also include arbitration or mediation.