Shareholder disputes can be costly in money, time and stress. They are, perhaps, a feature of the sometimes raucous business of enforcing shareholders' will on boards. This article, from a law firm, digs into the weeds of the topic and provides actionable ideas.

The following article, examining shareholder disputes and how they can be managed, comes from Edward Starling, partner in the insolvency and restructuring team at law firm Wedlake Bell. The editors are pleased to share these views; the customary disclaimers apply. Email tom.burroughes@wealthbriefing.com and amanda.cheesley@clearviewpublishing.com if you wish to respond.

You wouldn't start a playing a sport without everyone knowing what the rules are, so why do it with a business in which you are going to invest blood, sweat and tears?

Why shareholder disputes arise
Disputes between shareholders of a private company are not unusual and arise over a wide range of issues, from disagreement as to the approach or management of the business, to personalities, a souring of a friendship, the conduct of shareholders or directors, or overall company direction.

Often, minority shareholders feel that their rights are not being observed or are being diluted, that there is a lack of consultation/provision of information or that directors are taking large sums out of the company in circumstances where dividends are not being paid. If not de-escalated at an early stage, disputes often become toxic and all-encompassing and may lead to claims of unfair prejudice or breach of duty. 

Where the business is run by family members or close friends, the same emotions that were the creative source of the business can become the fuel for disputes that may escalate, potentially disrupting the underlying business, destroying value and irretrievably damaging personal relationships. Care is needed to navigate these sensitive issues with minimum disruption to the business.

Litigation should be avoidable in most cases – but taking proactive steps at an early stage in the company's life is crucial, including clearly setting out expectations for appropriate conduct and establishing a legal framework within which shareholders, directors and employees should operate. 

What does this look like in practice?
The company should have carefully drafted articles of association: these are a fundamental, public constitutional contract regulating the internal affairs of, and prescribing regulations for, the company. There are models that can be adopted for private companies, but these have significant limitations for closely-held companies and every company should consider whether the model articles, or some of them, should be amended to fit the business and the relationship matrix.

Whilst not compulsory like articles of association, it would be prudent to put a confidential shareholders' agreement in place between the shareholders of the business at the outset to ensure that potentially contentious issues are considered in advance, key matters are defined and boundaries understood. Early engagement can also flush out fundamental divergences in approach and may then help shape how the business and underlying relationships develop.  

Whilst the precise terms will differ depending on the objectives, needs and priorities of the parties involved, a shareholders' agreement should cover important issues such as how the company should be managed and key decisions made, shareholders' rights and liabilities, the distribution of profits and losses, exit and sale provisions and the governance of the company including voting rights and the conduct of shareholder meetings. 

Whilst the aim of these measures is to set the ground rules, they can also help avoid costly disputes down the line, and should include a mechanism for the resolution of disputes such as arbitration (a confidential process involving an independent third party that is often favoured in family or family office settings).   

Employment contracts and directors' service agreements should also be put in place to provide clarity in respect of individual employee and directors' job titles, what each role entails and their scope. This will provide a reference point by which the management team can distinguish individual roles and responsibilities, and ensure that employees and directors are performing these appropriately, but also gives clarity if lines are blurred by shareholders having prior relationships. Vitally, these documents evidence duties of fidelity and confidentiality and contain non-disclosure provisions.

For one media client, we successfully managed a buy-out by boxing a shareholder in using a suite of documents and wider leverage regarding director and shareholder conduct. 

Should these principles apply to loans made by shareholders, directors or third parties to the company?
Shareholder finance is vital for any startup business and the above principles should be applied to any loan that an individual shareholder, director or third party is proposing to make to the company. 

Whilst family members and close friends will often trust that the loan will be taken in good faith and that terms agreed informally will be adhered to, there may be instances where circumstances change or third parties become involved with a different agenda or approach. It is, therefore, important that the lending party considers taking security from the company for any loan to protect against any risk, give extra control and to assist in addressing any subsequent disputes between stakeholders. 

How can you approach formalities with family and friends?
It is often the case that proactive measures such as those above are not taken in a family business context because of concerns over how to approach family or friends with formal documentation. The worry is that they will become defensive and perceive it as showing a lack of trust in the relationship or their commitment to the business. The best way to approach this sensitively is to:

-- choose an appropriate time and place for the discussion;
-- explain that a distinction needs to be drawn between personal relationships and the management and ownership of the business to avoid the relationships being affected by inevitable business pressures; 
-- explain that the documents reflect pre-existing conduct and standards of good behaviour and are there not just to protect the shareholders but also the business and founders and their families; and
-- Make clear that agreeing the rules and regulations of the business and how to manage its internal affairs is a collaborative process – involve the other key parties to the business in the preparation of documents and the instruction of solicitors to assist in drafting (which also helps bring an element of objectivity and emotional detachment to the process).

What happens if a shareholder dispute arises?
If a shareholders' agreement is in place, then it should provide a mechanism for the resolution of disputes which the parties can follow and should narrow the issues that can be the subject of legitimate dispute. However, either way, pragmatic and early intervention is crucial to understanding what the parties want to achieve and to prevent positions from being entrenched. 

These situations can be even more emotional in the context of a family business, so there needs to be detachment and objectivity in the decision-making where possible. If resolution is not possible internally, it can sometimes be facilitated through third parties such as solicitors, mediators, arbitrators or even mutually respected unconnected family members or third parties, who can help steer the situation away from a formal public court dispute.

Fail to plan, plan to fail
There is an extra cost to putting some of these measure in place and these issues often arise at an early stage where the business is in its infancy and has low (if any) revenue streams. But implementing some rules as early as possible can save time, money – and relationships. After all, an airline would not decide to forgo emergency exit plans on the basis that it will "probably never happen."