How To Avoid And Resolve Shareholder Disputes

How To Avoid And Resolve Shareholder Disputes

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In our previous discussion we explored the importance of establishing a foundation to any equity sharing relationship. In this follow-up we look at specific provisions of the shareholders’ agreement and other methods to avoid and resolve disputes.

Crucial Provisions

Capital Contribution. Clearly state how much each shareholder has contributed, whether the capital is applied as equity or shareholders’ loan and terms of repayment, if any.

Also, determine how to apply and repay future shareholders’ loans, and any arrangements when raising capital in the future from shareholders and third parties. In some instances shareholders’ will be required to contribute monies, security, or sureties.

Related: Understanding Shareholder Agreements

Minority and Majority Shareholder Perspectives

Minority shareholders look for protection in quorums to start meetings, vote at meetings and pass resolutions, and the right to appoint directors on the board.

This ensures complete and autonomous representation of shareholders and reduces the risk of ambushing or bullying tactics by majority shareholders. Minority shareholders also look for protection on disposal of shares in the Tag Along principle – if a majority is selling, the minority has the right to join the deal.

Similarly, majority shareholders look for protection in adequate board representations and quorums. Critical to majority shareholders is pro rata participation of all shareholders and that the majority is not required to carry the burden of financial or administrative support or pro rata dilution if the business issues new shares.

Similar to the minority, the majority is protected during disposal of shares in the Drag Along principle — if a third party wishes to buy all the shares of the business and the majority wishes to sell, the minority is forced to sell.

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Disposal of Shares

Disposal of shares includes sale to a third party, disposal on death or incapacity, or retirement as an exit strategy. Shareholders often dread the introduction of heirs and beneficiaries to a deceased estate for multiple reasons, including the lack of ability to strategically influence the business.

Mechanisms in managing disposal of shares for the Shareholders’ Agreement may include pre-emptive rights or first option rights to remaining shareholders for voluntary and involuntary sale; or introducing a succession plan for retirement; or establishing a call/put option to the business on retirement dates.

Related: How To BootStrap Your Business With Funding From Your Shareholders

Resolve Shareholder Disputes

Shareholders’ Agreement. The Companies Act and Memorandum of Incorporation adequately cover the basic terms of engagement including powers, duties and related limitations. It is not a requirement of law to execute a Shareholders’ Agreement, however, it is recommended.

Negotiation and Mediation

The first step in resolving a dispute is for parties to commit to avoiding approaching the courts. To this end, the Shareholders’ Agreement should clearly state that all parties will negotiate, and if required appoint an appropriate independent third party, such as an expert in the field of the dispute, to mediate the negotiation.

The Companies Tribunal

This tribunal is established in terms of the Companies Act and is a voluntary resolution of disputes as an alternate to formal arbitration or litigation. Its mandates adjudicate any matter regulated by the Companies Act.

Formal Arbitration

If the negotiation and mediation is unsuccessful the parties can approach an arbitration body, such as the Arbitration Foundation of South Africa, or submit a complaint to the Companies and Intellectual Property Commission.

The point of arbitration is to offer an alternate to resolving disputes in court. The rules and costs of this route must be considered.

Related: How To Fund Your Business By Taking On New Shareholders

Litigation

The Shareholders’ Agreement must allow for any party to approach the courts if alternate resolution is unsuccessful or if a matter is considered pressing, such as an application for an urgent interdict.

As with arbitration, shareholders must consider the cost implications of this remedy.

A shareholder cannot be dismissed nor resign voluntarily or involuntarily. The only way a shareholder may exit the business is if she sells, donates or bequeaths her shares to a third party, the remaining shareholders or the company; alternatively if the company liquidates.

It is critical that two important aspects of preventing or resolving shareholders’ disputes are implemented at the outset of a start-up business: Ensure that this is the right match for you and your business, and be absolutely certain about when and how to exit if the arrangement doesn’t work.

Monisha Prem
Monisha is a corporate advisor, admitted attorney at M. Prem Inc, and author with over 14 years deal-making experience. Monisha litigated for several years before joining an investment banking firm specialising in mergers and acquisitions. Monisha has owned and operated several businesses, is passionate about business development, commercial and corporate law.