Imagine you and your friend come up with a new business idea. You go online and set up a company, owning 50% of the company each, as shareholders, both appointed as directors and away you go. There are only two of you, so you do not see the need for a shareholders’ agreement. You are friends, right? But what options do you have for resolving a shareholder dispute between friends? What happens when your and your friend’s common interests, goals, or hours on the business diverge, and things turn sour? What if you or your friend can no longer contribute to the business, but do not want to let it go? Behold – the deadlock.
The best option for resolving such disputes is to have a shareholders’ agreement with a clear dispute resolution process. However, not all 50/50 shareholders have such an agreement. This article outlines your options for resolving a shareholder dispute between friends.
1. Disputes Between 50/50 Shareholders
Many scenarios can lead to a dispute between two shareholders. For example:
- one may want to receive dividends from the business, and the other to reinvest the money to grow the business;
- they each have different expectations for how to operate the business; or
- one shareholder does not contribute, leading to resentment.
Without a shareholders agreement to set out what should happen when the parties reach a deadlock, two friends in business together can find themselves in a difficult situation. They may each want to give the other ‘the boot’, or one may want to sell the business and its assets, while the other wants to keep it running. Often, shareholders are surprised to learn that they cannot force the other person to sell their shares simply because they disagree.
Where there is a deadlock between the parties, there are often competing claims of breach of director duties and oppression. For example, the first director may claim that the second breached their duties, while the second director may claim they were prevented from accessing critical information.
2. Resolving Shareholder Disputes in Court
Shareholders may think that the provisions of the Corporations Act (Act) will provide them with a solution. This is true in part. The court can make orders to resolve a shareholders’ dispute. Some of these orders include:
- that the company be wound up;
- that one shareholder is to purchase the other’s shares at a price determined by the court; and
- directions regulating the conduct of the company’s affairs.
However, these may not be the solutions that the parties necessarily want. Furthermore, court proceedings under the Act are inevitably time-consuming, expensive and bitter. It can also have a damaging effect on your relationship with your friend in the future.
A shareholder can also apply to the court to wind up the company because it is ‘just and equitable’ to do so. Where there has been a breakdown in the relationship of the parties, this may provide a ‘just and equitable’ basis to wind up the company. However, courts are reluctant to wind up a solvent company. In reality, this is not something that shareholders should rely on.
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3. Resolving Shareholder Disputes by Negotiation
The more common pathway to resolving a shareholders’ dispute is the parties entering into negotiations and agreeing on a solution.
A negotiation is a form of alternative dispute resolution, typically involving the shareholders’ meeting to:
- explain their positions; and
- come to a compromise.
Parties can attempt to negotiate on their own, with the assistance of lawyers, or in a more formal mediation process, with an experienced mediator to guide the process. This can be a lengthy process. Neither may feel like they ‘win’ or have achieved the initial outcome they wanted. However, if the parties are both willing and prepared to make a compromise, they can resolve the dispute through negotiation faster and at a lower cost than through court proceedings. It is important to consider whether you would like to maintain your relationship with your friend outside the company. If so, negotiating an outcome amicably could be an ideal option for you.
So, what are the options for resolving shareholder disputes through negotiation?
Sell or Split the Business
The shareholders may agree that neither party will continue to run the business. They will sell the business to a third party in this case. Or they may agree to split the assets of the business, and negotiate which assets each will retain.
This can be advantageous, for example, where one party has created some or all of the intellectual property for the business and wishes to continue using it, in the same or a new business. A well-drafted sale of business contract will set out what each shareholder will receive.
Negotiate a Share Sale
One party may keep their shares and continue to run the business. The other party may opt to sell their shares. In most cases this will be to the other shareholder, giving them full control of the business. However, the departing shareholder may also sell their shares to another (third party) person.
If one shareholder proposes to sell to a third party, it is, of course, important to find someone that can bring value to the business. If the remaining shareholder does not agree with the proposed new shareholder, the company constitution may allow them to refuse the transfer of shares.
In most cases, the parties will disagree on the value of the company and the shares. Therefore, it is a good idea to have the company and shares independently valued. This will provide a firmer basis for negotiation.
If you reach an agreement with your friend, it is a good idea to enter into a deed of settlement. A deed of settlement will formalise the terms of your agreement and set out the obligations of each party. A deed of settlement can then be used to enforce an agreement if either of the parties does not perform their obligations.
Where the relationship between the parties has deteriorated too far that neither can agree to sell to the other no matter what price is offered, the parties may consider submitting a ‘sealed envelope bid’ to each other or to an independent third party. This will have the higher bid buying out the other party, in a ‘Russian Roulette’ style deal.
Company Buy-Back of Shares
Alternatively, shareholders may negotiate to sell their shares to the company. A buy-back of one shareholder’s shares is called a ‘selective buy-back’.
Section 257 of the Corporations Act enables a company to buy back its shares. However, a company can only buy back its shares if the purchase:
- does not materially affect the company’s ability to pay its creditors; and
- complies with the procedures in Chapter 2J.1 Division 2 of the Act.
A company buy-back is a technical process with different rules according to how many shares are being sold. Therefore, having legal guidance is almost always necessary.
Want to sell your business? A share sale may be beneficial compared to an asset sale. Download our free Guide to Share Sales today.
Key Takeaways
If you and a friend have started a company together, you may find yourselves in a difficult position if the business relationship deteriorates. Even if that seems doubtful now, you need to consider what you each may want in five or more years’ time.
The Corporations Act has limited options for resolving shareholder disputes, especially for resolving a shareholder dispute with friends. Going to court is also expensive and time-consuming. In the absence of a shareholders agreement, you and your friend may find yourselves in lengthy negotiations over what each has contributed, what each is entitled to and the value of the business.
You can avoid these problems by having a well-drafted shareholders agreement that includes a clear dispute resolution process. Most shareholders’ agreements contain a dispute resolution clause that outlines the procedure for resolving a shareholders dispute. Some of them may require pursuing a form of alternative dispute resolution before considering court. Others may require one party to sell their shares to the other party. If you require further assistance with resolving shareholder disputes, call LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.
If you can negotiate an outcome with your friend, it is always a good idea to formalise the agreement in a deed of settlement to outline both of your obligations and to enforce the agreement if need be.
Frequently Asked Questions
As the name suggests, a shareholder dispute is where two or more shareholders in the same party are in disagreement about their rights and obligations.
The law has several backstop outcomes that can force certain parties to sell their shares or buy out an aggrieved shareholder. However, these may not be the most commercially sensible solutions in practice. Arriving at a negotiated settlement is almost always the superior option, especially where friends are involved.
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