Wilfred Wu, Principal, Specialist Advisory Services, BDO, suggests some simple and practical ways to mitigate or resolve shareholder disputes

Disputes are an unavoidable fact of human life. People will often disagree with one another because of different opinions or perceptions. While some ideologues may argue that disputes help to generate fresh ideas, in most cases they destroy harmony, create tension and ultimately cause relationships to break down. That is a tragic but realistic description of where disputes can lead if no remedial measures are taken quickly to resolve them.

A company is only a legal person that is owned by its shareholders. It cannot get into a dispute with itself, but its shareholders can dispute between themselves. Nowadays, shareholder disputes often end up in a courtroom, where the litigants have to take the witness stand, give evidence and reveal a company’s ‘confidential’ matters to the public. That can lead to personal humiliation and the failure of a business, neither of which is a desirable outcome. Once a dispute materialises, the best course of action is to manage it sensibly. This article aims to provide some observations about the factors surrounding shareholder disputes, as well as some simple and practical ways to mitigate or resolve them.

Causes of disputes

If we are to analyse and identify the causes of shareholder disputes, we need to have some insights about human nature. From ancient times to the present day, people having been fighting over wealth, power and passion. While wealth and power are the most obvious causes of disputes, passion should not be overlooked. When a spouse jointly owns a family’s assets, that ownership is often served by the establishment of a corporate entity. And disputes between husbands and wives about company matters can become very heated if their relationship turns sour. You may regard them as a kind of matrimonial disagreement. But, in a legal sense, the possible remedy under ancillary relief during matrimonial proceedings is limited. So most aspects of such a dispute will need to be resolved under the company law regime.

Going one level deeper, wealth, power and passion are just the outer shell of the causes of disputes. People are unhappy if their wealth and power seem to be jeopardised. At the heart of such perceptions is the idea of fairness – the antithesis of inequity and the embodiment of equality. It goes without saying that everyone longs for equality. If a shareholder perceives some form of inequity in any matter, the first and most important element of a dispute is already present. The clock has started ticking.

The most common type of shareholder dispute is triggered by a disparity in profit distributions. In essence, that does not refer to actual dividends declared to shareholders. Those are governed by the shareholder structure. Instead, a practical example of such a disparity would be if the pre-distribution profits were skewed towards the benefit of one group of shareholders, by way of management compensation such as salaries or other remuneration packages. Such arrangements might be seen by the ‘disadvantaged’ parties as mechanisms to syphon off significant portions of the economic benefits a company has generated, instead of fairly distributing them to all its shareholders. Another common complaint is when the management camp of shareholders gains unequal benefits by setting up relatedparty transactions and not trading at arm’s length prices. Overpaying related suppliers and undercharging related customers will definitely affect a company’s results, as its partners in the transaction will benefit from the price differentials.

Other than monetary issues, management authority is also a common cause of disputes. Unsurprisingly, such power is seen as an important component in an organisation. A shareholder who also plays a role in the company’s daily management may choose to deny other shareholders access to information or fail to give meaningful responses to their questions. That is usually construed as a hostile act. The ‘victims’ of such behaviour may perceive it to be a disparity of power and seek ways to eliminate it. Power disparity can also come about as the result of who occupies certain key positions in the company. Finance and marketing are usually regarded as core functions that possess important information. If one group of shareholders (or its allies) occupies crucial roles in those departments for lengthy periods of time, it could easily create friction with other shareholders.

Types of disputes

It is also worth noting the most common types of shareholder disputes. Although disputes between business partners are seen to be the most widespread, those between family members can sometimes turn out to be the fiercest. Of course, that includes disputes between shareholders who are married to each other. Disputes between business partners are normally the result of disagreements about strategy, although they can also arise from different interpretations of a shareholders’ agreement. Strategy disagreements can be about the direction a business is taking, the use of funds, expansion in the market, etc. Frankly speaking, such issues are likely to be profit-driven rather than emotional. Shareholder agreement disputes generally materialise as the result of a critical incident that has caused the parties to refer to the contractual agreements they previously entered into. They are primarily disputes about legal terminology.

But disputes between family members are a different kettle of fish. They are less formal or legal, and more relational and emotional. Beside disputes between married couples, disputes about inheritances are common. Wrangles over the next generation’s succession after a senior family member who has been a company’s figurehead retires can cause enormous problems. When you read about various court cases, it is often easy to identify instances where different members of the family have totally opposite management and business styles. Like their familial relationship, their shareholder status is not a matter of choice. They cannot cooperate effectively with each other when significant issues arise; instead, matters become more and more heated. Finding a practical way to resolve their differences under such circumstances is often difficult.

Disputes in action

Besides theoretical analysis and general observations, one must not overlook the practical side of the coin. Disputes can be logically divided into three categories: (i) one-on-one; (ii) one-to-many; and (iii) many-to-many. Their meanings can easily be deduced from their names. One-on-one disputes are the simplest type, but unfortunately they are often the toughest to deal with. They usually have intense emotional undercurrents. If two parties have equal equity and equal representation on a company board, it can result in complete deadlock.

One-to-many disputes normally occur when a minority shareholder raises a complaint that they are being oppressed and that their equity interest is being jeopardised. The complainant generally demands monetary compensation or wants the majority shareholder to buy out their equity.

Many-to-many disputes may involve complex shareholding structures and unusual circumstances that lead to a major dispute. They can be extremely complicated. Nevertheless, the fact that a number of parties are involved may mean there is actually more room for negotiation than in the other two types of disputes.

Consequences of shareholder disputes

Some may consider a courtroom to be the most appropriate place to resolve disputes. While that may be true in a legal sense, in practical terms, legal proceedings can bring about undesirable and unpleasant consequences. The parties involved should always bear in mind that legal proceedings not only consume money and time, they also entail stress and psychological discomfort. They require a lot of documentary evidence and/ or witness testimony. That will definitely disturb the operations of the business concerned, and it may undermine its efficiency and morale. The firm’s financial performance is likely to be seriously affected too.

Another obvious side effect of dispute proceedings on a company is the loss of its trading partners’ confidence. That is obvious and understandable. Customers will worry whether the company will be able to deliver the products they have ordered. Vendors will be concerned about whether the company can pay their invoices. It is unwise to assume that business disputes and friction are private and confidential issues between the parties concerned, and that outsiders will remain unaware of them. In reality, every staff member in the company has the potential to communicate these matters to other people. Experience shows that few customers and suppliers will be willing to continue trading on the existing terms once they find out there is a dispute within their trading partner. Most likely, business will decline, sometimes to the extent where there will be serious doubts about a company’s continued viability.

Suggestions and remedies

As your family doctor will always tell you: prevention is better than cure. To a certain extent, that also applies to managing shareholder relationships. While it is true to say that no shareholder agreement can be perfect, having one is better than having none. In-depth discussion and participation are the keys to making a shareholder agreement a good reflection of the shareholders’ intentions. A good shareholder agreement should be tailor-made and not standardised, like a tenancy agreement provided by a property agent. It need not be written in Shakespearean English, but it should take into consideration and deal with all the potential scenarios that the shareholders might face. It should at least cover management authority, representation, responsibility, remuneration and commission, as well as competition clauses, dividend policies, fundraising rules and equity disposal procedures. If a company is formed for a specific purpose, the unique circumstances surrounding the cooperative partnership should be properly and unambiguously addressed in the agreement. A well-written shareholder agreement can help to reduce the likelihood of shareholder disputes.

Of course, we must accept that disputes can still occur, despite every reasonable precaution. The disputing parties should try to remain calm if that happens. Rational and sensible behaviour is a crucial factor in mitigating the fallout it might cause. Forceful attitudes and responses just pour oil on the flames, and they do not help matters. A cooling-down period is definitely a useful way to identify and seek common ground for negotiation. Aside from their dispute, the shareholders involved have common interests. Disputes are painful in the short term, but shareholders would be unwise to prolong the agony, which can eventually cause them serious financial damage.

Disputing parties should also seek proper legal advice at the first sign of trouble. That is not for the purpose of launching hostile actions against their partners. Instead it is a form of self-protection and a precautionary measure. Some actions taken during the daily management of a business may have prejudicial repercussions if legal proceedings later become inevitable. These can often be avoided with legal advice. Conversely, if a shareholder considers himself or herself to be unfairly treated, he or she may need to substantiate this allegation with adequate evidence. Proper legal advice can also place you on a firmer and more advantageous foundation during negotiations. Nevertheless, you should bear in mind that it might not be a good idea to let your opponents know that you are consulting a lawyer too early in the game. Doing so may have an adverse effect, and a legal confrontation should be regarded only as a last resort.

My final piece of advice is to separate your emotions from the subject of a shareholders’ dispute. That may not be easy, but it is usually the best way to resolve a dispute. One must recognise that the law is different from morality. Shareholder disputes have their roots in company issues, and they are primarily legal matters. Morality is morality, and it cannot replace the law when dealing with corporate disagreements. If something is immoral, that does not necessarily make it illegal. Putting your faith in your emotions and moral justice can ultimately turn out to be an expensive way of dealing with a shareholder dispute, and it can cause a lot of regret. The best way to handle a dispute is always to seek the best possible outcome. Then put it behind you and look to the future with confidence and a smile.

Wilfred Wu, Principal,

Specialist Advisory Services, BDO