How to Protect the Rights of Minority Shareholders?

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Date Created: 12 Jun 2020
Last Update: 22 Aug 2020

Traditional company law requires the company to act in the interest of its shareholders and to benefit the company as a whole. The interest of shareholders would mean all shareholders, including minority shareholders. In reality, however, the majority shareholder usually controls the board of directors and thus dictate the actions of the company. 

 

One of the most common questions in company law as a minority shareholder, is how do I protect my interests?

 

This guide provides an overview of minority shareholders' rights under the Common Law and addresses the possible legal protections and remedies available to a minority shareholder if things go wrong with the company. It is not intended to provide a detailed analysis of the law but gives general guidance on the important matters to take into account.

 

 

A. What is a Minority Shareholder?

 

A minority shareholder refers to shareholders who own less than 50% of a company’s total shares. A minority shareholder generally does not have voting control of the company and cannot single-handedly elect directors to the board of the company.

 

However, in some companies, there are no majority shareholders. The controlling shareholder may own less than 50% of the voting rights but would generally not be considered a minority shareholder.

 

B. What are "Minority Interests" or "Minority Rights"?

 

Minority interest refers to the rights that minority shareholders have due to their shares. These rights include participation in sales and certain audit rights. These rights are limited as the shares that the shareholders hold are limited. As such, these interests are also called non-controlling interests.

 

More information about minority interest can be found at Introduction to Minority Shareholder Rights Guide.

 

C. Minority Shareholder Oppression

 

A company is a collective organization, and like any collective organization, it makes decisions through its members and relies on majority rule. Any decision that the majority shareholder(s) make will be seen as reflecting the will of the company and binding on the minority.

 

While this is very efficient and democratic, such a tendency will give rise to the temptation of abuse by the majority. This may be prejudicial to minority members as it is possible for the majority shareholder to abuse their powers to the detriment of the minority members.

 

For instance, majority shareholder may appoint majority directors to direct the company to enter into business deals that will benefit the majority shareholder but not the company. This, in turn, will cause minority members to suffer loss as they are unable to stop the deal from going forward with their limited voting rights and control over the company.

 

Therefore, it is crucial that minority shareholders of the company have safeguards to protect their rights.

 

 

D. How to Protect Minority Interest in a Company?

 

Unlike majority shareholders who can exercise their rights by voting in general meetings, minority shareholders may not have sufficient votes to make a difference. Instead, minority shareholders can rely on different kinds of contractual or legal remedies to address wrongdoing by the company’s controllers.

 

1. Contractual Protections under the Shareholders Agreement

 

The Shareholders Agreement is the best form of legal protection for a minority shareholder. By incorporating certain express contractual provisions in the Shareholders Agreement, the minority shareholder can be protected by contractual rights beyond those afforded by statute and corporate law. 

 

A well-drafted Shareholders Agreement should allow the minority shareholder to: 

  • participate in management through board representation;

  • be involved in any major decisions (including a right of veto if possible);

  • be protected against its share from being improperly diluted;

  • a fair and proper distribution of profits;

  • access to information about the Company's affairs by obtaining a right of inspection;

  • protect itself and the Company against dilution by the majority shareholder;

  • exit the joint venture through tag-along and drag-along rights.

If the holding company is a shell company, one may also seek to have a parental guarantee by the ultimate parent of each party to the Shareholders' agreement.

 

For more information, please refer to the following shareholders' agreements available on DocPro:

 

Documents When to Use
Shareholders Agreement - Unequal Shareholdings

A Shareholders’ Agreement to be entered into upon completion or establishment of the Joint Venture Company with standard clauses for minority protection.

 

This agreement is drafted for 2-5 parties and can be in Neutral Form, or in favour of the Majority / Minority Shareholder.

 

For minority shareholders:

 

For 2 parties: https://docpro.com/doc366/shareholders-agreement-2-parties-minority-shareholder

 

For 3 parties: https://docpro.com/doc365/shareholders-agreement-3-parties-minority-shareholder

 

For 4 parties: https://docpro.com/doc364/shareholders-agreement-4-parties-minority-shareholder

 

For 5 parties: https://docpro.com/doc363/shareholders-agreement-5-parties-minority-shareholder

Parental Guarantee to other parties in relation to Shareholders Agreement

In relation to a Joint Venture / Shareholders Agreement, a guarantee is given by a party's parent to the other shareholders for the party's obligations. 

 

Neutral: https://docpro.com/doc411/parental-guarantee-to-other-parties-in-relation-to-shareholders-agreement-neutral

 

Drafted in favour of the guaranteed shareholders: https://docpro.com/doc412/parental-guarantee-to-other-parties-in-relation-to-shareholders-agreement-guaranteed-shareholders

 

2. Protecting the Interest of the Company as a Whole

 

Minority shareholders' interests tend to be more aligned with the interest of the Company. To protect the Company and in turn themselves from the abuse of power by any majority shareholder, the minority shareholders need to ensure that the Company’s right of claim is not blocked by the majority’s voting rights.

 

Some common solutions are:

  • Set up a committee in the Company that excludes any appointees of the majority shareholder who will be responsible for such claims

  • Ensure that the majority shareholders and their appointed directors will not be allowed to vote on or interfere with any such claim

It is also important to ensure the smooth running of the Company – to make sure that there is no funny business going on because of the majority shareholders and their directors, e.g.:

  • Ensuring that the Company maintains proper insurance, preparing and maintaining proper record-keeping and bookkeeping

  • Ensuring that businesses are conducted in accordance with all applicable laws;

  • All affiliated companies and key employees should enter into appropriate non-competition covenants, confidentiality agreements and employment contract

3. Conferring Rights on Different Classes of Shares

 

Class rights refer to rights that are given to a particular class of shares. They include rights conferred on a shareholder under the company’s articles even though they are not attached to a particular class of shares in the context of joint ventures.

 

Company law allows certain protections for the members of a class against any change in such rights. For example, certain reserved items in the Articles of Association may require the approval of all classes of shares. Minority shareholders can thus ensure that they are given certain class rights under company law for further protection.

 

4. Weighted Voting Rights

 

Another way for minority shareholders to protect their position is by having "weighted voting rights" on particular matters, where the minority’s vote will hold more weight than what their percentage of shares actually weighs. This will ensure that a minority shareholder's appointee as the director cannot be removed by the majority shareholders.

 

 

5. Articles of Associaiton

 

As mentioned above, the Articles of Association could include certain reserved items that would require the approval of the supermajority of shareholders (two-third or 75% depending on the situation). Or certain matters that would give the minority shareholder a right to veto.

 

The supermajority vote or right of veto is generally over certain major decisions by the Company, such as:

  • changes in the Company's articles of association;

  • changes in the share capital of the Company (including the grant by the Company of any share options or convertible securities);

  • any significant change in the nature of the Company's business;

  • the Company incurring capital expenditure or contract commitments in excess of pre-agreed financial limits or not specifically contemplated by an agreed budget;

  • any borrowing by the Company which would cause a pre-agreed borrowing limit to be exceeded;

  • major business acquisitions or disposals by the Company;

  • dividend distribution below an agreed minimum level;

  • appointment and dismissal of executive directors or other key personnel and directors (including approval of long-term service contracts or material variations to their remuneration or benefits);

  • material dealings by the Company with its intellectual property;

  • dealings between the Company and any of its shareholders (except, perhaps, arm's length dealings in the ordinary course of business);

  • voluntary winding-up.

Other usual protections for minority shareholders as stipulated in the Articles of Association include:

  • how many board seats each shareholder would get;

  • there would be no forum in any directors' meeting without attendance by representatives of each of the shareholders; and

  • directors should abstain from voting should any conflicts of interest arise. 

For an example of an Articles of Association for Private Company, please refer to the below:

https://docpro.com/doc1182/articles-of-association-private-company

 

6. Right to Distributions

 

The board of directors of the Company will declare dividends and the amount of each dividend distribution. A minority shareholder may wish to ensure that an agreed distribution policy is established at the outset - and, in some ventures, to ensure that profits cannot be diverted in a discriminatory manner to the majority shareholder.

 

7. Right of Inspection

 

A minority shareholder's rights to information regarding the Company's affairs is limited under Common law. Apart from the right to receive the annual audited accounts, a shareholder has no statutory right to inspect the accounting records of the company nor, as a shareholder, a right to inspect the minutes of board meetings.

 

A minority shareholder should consider seeking the rights to inspect and audit the accounting and corporate secretarial records of the company.

 

E. Remedies/Protections under the Law

 

While contractual protections are important and effective in protecting minority shareholders, minority shareholders may also want to look to the legal system and corporate law for statutory protection. In many common law countries, there are limited protections offered to minority shareholders under corporate law.

 

1. Derivative Action

 

The case of Foss v Harbottle (1843) established that when the company suffers a wrong, the proper plaintiff is the Company itself instead of the individual shareholders of the company.

However, there are situations where the company will be unable to bring an action as it is those in control (the majority shareholders) that perpetrated the wrongdoing against the company in the first place. In such situations, minority shareholders can seek remedy by bringing a derivative action.

 

The situations where a minority shareholder can bring a derivative action to court include (a) preventing a company from acting illegally or (b) when those in control of the company is abusing their power to derive a benefit or (c) invading private rights etc.

 

2. Unfair Prejudice Petition

 

In many common law jurisdictions, the main statutory remedy that company law allows minority shareholders is an unfair prejudice petition. This remedy allows the court wide discretion to grant relief if any member of the Company can show that their company’s affairs are unfair and prejudicial towards them.

 

If the court is satisfied that a petition is well-founded, it may make an order that it thinks is fit depending on the situation. These fact-specific orders can include:

  • requiring the company to refrain from or continuing to do a particular act;

  • authorising civil proceedings to be brought in the name of and on behalf of the Company;

  • regulating the conduct of the Company's affairs in the future; and

  • providing for the purchase of the shares of any member(s) of the Company by other member(s) or by the Company itself.

In most cases, the petition aims to get one party to purchase the shares of another party where the court is specifically empowered to make such an order in a private company.

 

One reason for bringing such an application is to force a sale at a better price than would otherwise be obtained - although the court will pay close attention to any terms agreed in the Articles of Association. 

 

3. Just and Equitable Winding-up

 

The other main remedy of a minority shareholder under Common law is to seek a winding-up. Company law generally gives the court the power to order that a company is wound up when the court finds it justifiable that the company should be wound up.

 

Before making its decision, the court will look at all the facts and circumstances closely to decide whether or not the petitioner had a legitimate expectation that he would participate in the management of the company.

 

This expectation does not have to be written in the constitutional documents.

 

However, if there had been efforts between parties to set out the details of their working relationship, the court will not accept that the petitioner had any other expectation given that s/he had ample opportunity to talk it out with his/her working partners.

 

The court will also not extend a helping hand to the petitioner if there are any detailed Articles of Association or Shareholders Agreement that are agreed between the parties regarding the management of the company. This again points to the importance of a well-written Shareholders Agreement to ensure there is no miscommunication and misinformation within the business partners.

 

The court also has the discretion not to make an order when the petitioner is acting unreasonably. For example, where the petitioner has been offered the chance to sell his or her shares at a fair value. So make sure that there is good and reasonable ground before you make the petition to avoid unnecessary legal costs.

 

As there are no fixed categories as to what amounts to ‘just and equitable’, it is up to the court’s discretion to decide when a just and equitable winding up is needed.

 

The more common examples where just and equitable winding up is applicable include:

  • a breakdown of trust and confidence in the partnership

  • exclusion from management

  • a management deadlock, and

  • the need for an investigation.

The main limitation of this remedy is that the only remedy that the court can provide is to order for the winding-up of the company. In some situations, this may be unnecessarily drastic and the courts will not grant a petition for just and equitable winding up if other options are still available. This is especially the case where the company is still healthy and profitable.

 

As such, winding up is usually seen as a last-resort option. Minority shareholders should only consider the option of winding up when the situation is so bad that the minority shareholder cannot use other methods to protect their interests. For example, when it is impossible for the minority shareholder to become a majority shareholder by buying out the shares of other shareholders or when the misbehaviour of the directors is so problematic that it requires a full investigation by a liquidator.

 

 

 

F. Choosing the right protection

 

While these methods are all possible methods to protect minority rights and provide remedies for minority shareholders, these methods are highly fact-sensitive and minority shareholders are reminded to carefully choose the correct method for addressing the specific problems they face.

 

This is because different remedies will only cater for different situations. If an inappropriate route is adopted, the situation will not improve. This is especially in the case of legal remedies as the court may not be willing to grant the remedy at all if it finds it inappropriate.

 

The minority shareholder may then have to bear heavy legal costs. Therefore, it is advised that minority shareholders should seek professional legal advice early to determine how they want their rights to be protected or what kind of remedy they would want to seek.

 

Please note that this is a guide on the general position of minority shareholder rights under common law. This does not constitute legal advice. As each jurisdiction may be different, you may want to speak to your local lawyer.

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