A shareholder dispute is a disagreement between the owners of a company that the normal way of making decisions can’t settle. It might be 2 equal shareholders who can’t agree on anything, a minority shareholder shut out of a business they helped build, or a co-founder who has left but still holds a third of the shares. Many shareholder disputes end with one side buying the other out, so the main questions are who buys, at what price and how that price is worked out.
I’ve started and run over 30 businesses and invested in more than 100, so I’ve held shares as a founder and as an investor.
Why Shareholder Disputes Start
Whether a disagreement turns into a dispute usually depends on whether the articles of association and the shareholders’ agreement say what happens when it does. The articles are the company’s rulebook, filed at Companies House. The shareholders’ agreement is a private contract between the owners that sits alongside them.
Things that commonly start a shareholder dispute include:
- one shareholder doing most of the work while the shares stay split equally, which is why sweat equity needs agreeing properly at the start
- a shareholder who is also a director being removed from the board and shut out of decisions
- profits taken out as directors’ salaries instead of dividends, so shareholders who don’t work in the business get nothing
- new shares issued in a way that cuts one shareholder’s percentage
- a co-founder leaving while keeping all their shares
- disagreement over selling the business, raising money or taking on debt
- a personal relationship between the owners breaking down, such as a marriage or a friendship
Several of these come down to a missing clause. A co-founder who leaves with every share is the result of having no vesting schedule and leaver terms. A share issue that dilutes one owner is often a question of whether existing shareholders’ pre-emption rights were respected or properly disapplied.
Deadlock and What the Shareholders’ Agreement Says
Shareholder deadlock is when the company can’t make a decision because the votes are split evenly and neither side will move. It’s most common in 50/50 companies, where the 2 shareholders are often also the only 2 directors.
At board level, the model articles for private companies give the chair a casting vote when votes are tied. In a company with 2 directors that hands one of them control, so many 50/50 companies remove the casting vote from their articles. Without it, and without a deadlock clause, a tied board can’t approve accounts, sign contracts above its authority or agree a strategy.
A well-drafted shareholders’ agreement deals with deadlock in stages. It usually sets out what counts as a deadlock, a period for the shareholders to talk, then mediation, and finally a mechanism that ends it by one side buying the other out. The common mechanisms compare like this:
| Mechanism | How it works | What it suits |
|---|---|---|
| Russian roulette | One shareholder names a price per share. The other must either buy at that price or sell at it. | Equal owners with similar access to money |
| Texas shoot-out | Each shareholder puts in a sealed bid for the other’s shares. The higher bidder buys. | Equal owners who each want to keep the business |
| Put and call options | One side can force the other to buy (put) or sell (call), at a price set by a formula or an expert | Unequal holdings, or a planned exit for one owner |
| Expert determination of fair value | An independent accountant values the shares and one side buys at that value | Owners who want a neutral price instead of a bidding contest |
| Winding up | The company is closed and its assets shared out | A last resort when nobody wants to buy |
Russian roulette and Texas shoot-out clauses favour whichever shareholder can raise the money fastest. A shareholder who can’t fund a purchase may have to sell at the other side’s price, which is why some agreements pair them with an expert valuation as a floor.
Minority Shareholder Rights and Unfair Prejudice
A shareholder with more than 50% of the votes can pass ordinary resolutions, including a resolution under section 168 of the Companies Act 2006 to remove a director. A special resolution needs 75%, so a shareholder with more than 25% can block changes to the articles. A shareholder with 5% or more can require the directors to call a general meeting.
The main protection for a minority shareholder is an unfair prejudice petition. Under section 994 of the Companies Act, a member can ask the court for an order if the company’s affairs are being run in a way that is unfairly prejudicial to their interests as a shareholder. The conduct doesn’t have to be unlawful. It has to be unfair to them as a member of the company.
Claims are often brought in smaller companies run like a partnership, where the owners started out on the understanding that each would be involved in running the business. In that kind of company, things like these have supported unfair prejudice claims:
- removing a shareholder from the board and excluding them from management
- paying the majority high salaries or bonuses while holding back dividends
- issuing shares to dilute one shareholder without a proper business reason
- moving business or assets to another company the majority controls
Under section 996, the court can make whatever order it thinks fit. That includes regulating how the company is run in future, stopping a particular act and ordering the purchase of the petitioner’s shares by the other shareholders or by the company. The share purchase order is the one petitioners usually ask for, because it gives them a clean exit.
A derivative claim under section 260 is a separate route. It lets a shareholder sue a director on the company’s behalf for a wrong done to the company. A petition to wind up the company on just and equitable grounds, under section 122(1)(g) of the Insolvency Act 1986, closes a solvent company down. Courts treat winding up as a last resort, and they may refuse it where a fair buy-out offer has been made.
Buy-Out and Valuation Routes
Whether it comes from a deadlock clause, a settlement or a court order, a buy-out means one shareholder buys the other’s shares, or the company buys them back. The price depends on what the whole company is worth, whether a discount applies to a minority stake and the date the valuation is taken on.
The company’s value comes from the same methods investors use for startup valuation and for established businesses: a multiple of profits, a discounted cash flow, the value of the assets or comparable sales.
A minority discount reflects that a small stake carries no control, so a buyer would pay less for it than its straight share of the company. In unfair prejudice cases involving companies run like a partnership, courts have often valued the shares as a straight proportion of the company’s value, with no minority discount. A shareholders’ agreement can settle the question in advance.
Say the company is valued at £3m and the shareholder leaving holds 40%:
| Basis | Calculation | Price for the 40% |
|---|---|---|
| Straight proportion | 40% × £3m | £1.2m |
| With a 30% minority discount | £1.2m × 70% | £840,000 |
| Difference | £1.2m − £840,000 | £360,000 |
The discount alone moves the price by £360,000. Agreeing the valuation basis in the shareholders’ agreement, before anyone falls out, takes most of that argument away.
The valuation date matters when the company’s value is moving. A court picks the date that is fair in the circumstances, such as the date of the petition or the date of the order.
How the buyer funds the purchase is the next question. Things like these are used:
- the buyer’s own money
- payment in instalments, secured on the shares being bought
- the company buying back its own shares, which in a UK company has to be paid for out of distributable profits or a fresh issue of shares, with some exceptions
- a new investor buying the departing shareholder’s stake
- borrowing, which for UK companies Funding Guru arranges
Whichever route is used, the result goes on the cap table so it’s clear who owns what once the shares change hands.
Mediation vs Litigation
Mediation is a confidential, voluntary meeting where an independent mediator helps the shareholders reach a deal. The mediator doesn’t decide anything, and nothing is binding until the parties sign a settlement.
Litigation is an unfair prejudice petition or another claim that goes through the courts. It involves exchanging documents, witness statements and expert valuation evidence, then a trial. In England and Wales the losing side usually pays a large part of the winner’s legal costs as well as its own. Courts expect the parties to have tried to settle and can order them to take part in mediation or another settlement process, and a party who unreasonably refuses can be penalised on costs.
| Point | Mediation | Litigation |
|---|---|---|
| Who decides | The shareholders | The judge |
| Public or private | Private and confidential | Court hearings and judgments are usually public |
| Outcome | Whatever the parties agree | An order under section 996, a winding up or a dismissal |
| Effect on the business | Usually less disruption | Directors’ time and management attention go into the case |
Protecting the Business During a Dispute
A business can keep trading through a shareholder dispute if the people running it keep to the rules. Things that help include:
- holding proper board meetings and recording decisions in minutes
- keeping the bank mandate and payment approvals as they were, or agreeing changes in writing
- paying salaries, dividends and expenses on the same basis as before the dispute
- keeping statutory filings, accounts and confirmation statements up to date
- agreeing what customers, staff and lenders will be told
Changing directors’ pay, moving assets or issuing new shares in the middle of a dispute can itself become part of an unfair prejudice claim.
Australia, Canada, Singapore and the US have their own versions of the protection a minority shareholder gets under section 994, usually called an oppression remedy, and the UAE’s company law has its own rules on disputes between partners. The ideas are similar, but the tests, the courts and the remedies differ, so the company’s own jurisdiction decides which apply.
FAQs
What is an unfair prejudice petition?
An unfair prejudice petition is a claim under section 994 of the Companies Act 2006 by a shareholder who says the company is being run in a way that unfairly harms their interests as a member. If the court agrees, it can make any order it thinks fit, including an order that the other shareholders or the company buy the petitioner’s shares.
What happens when 50/50 shareholders can’t agree?
When 50/50 shareholders can’t agree, the company is in deadlock and the shareholders’ agreement decides what happens next. A deadlock clause usually leads to mediation and then a buy-out mechanism. Without one, the options are a negotiated buy-out, an unfair prejudice petition or, as a last resort, winding up.
Can a majority shareholder force out a minority shareholder?
A majority shareholder can’t force a minority shareholder to sell their shares unless the articles or the shareholders’ agreement allow it, for example through drag-along or compulsory transfer clauses. A majority can remove a minority shareholder as a director by ordinary resolution, but in a company run like a partnership that removal can support an unfair prejudice claim.
How is a shareholder’s stake valued in a buy-out?
A shareholder’s stake is valued by working out what the whole company is worth, taking their percentage of it and deciding whether to apply a discount for a minority stake. The shareholders’ agreement often sets the method, such as a valuation by an independent accountant. Where a court orders the purchase, it decides the method, the date and whether a discount applies.
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This explains how shareholder disputes generally work in the UK. It isn’t legal advice, and a solicitor should advise on any dispute before action is taken.
