Founder Series: Navigating Shareholder Disputes in the UK

Orrick's Founder Series offers monthly top tips for UK startups on key considerations at each stage of their lifecycle, from incorporating a company through to possible exit strategies. The Series is written by members of our market-leading London Technology Companies Group (TCG), with contributions from other specialists. Our Band 1 ranked London TCG team closed over 200 growth financings and tech M&A deals totalling $3bn in 2023 and has dominated the European venture capital tech market for 33 quarters in a row (PitchBook, Q1 2024). View previous series instalments here.

As a founder of a startup, it’s important to maintain harmonious relationships with (and between) your shareholders as it can help ensure the smooth operation and growth of your business. 

Despite best efforts, however, disputes can still arise and pose significant challenges to your startup's stability. Understanding what these disputes entail and how best to avoid or, if necessary, address them can protect your company from costly legal battles and disruptions.

1. Unfair Prejudice Petitions. Shareholder disputes typically arise when disagreements exist among shareholders or between shareholders and directors. These disputes can stem from a variety of issues, including differences in strategic vision, perceived unfairness in the distribution of profits or concerns about the conduct of directors.  They are also a tool that a minority member on the cap table might use to try to extract value at a critical moment in your startup's journey (e.g., during fund raising).

One of the most common legal actions taken by shareholders in respect of such disputes is an unfair prejudice petition, available to shareholders under section 994 of the Companies Act 2006. It allows shareholders to seek relief where they believe their interests have been unfairly prejudiced by the actions of the company's management or other shareholders. This could include actions such as:

• Appointing directors without the consent of a shareholder (especially if it was previously agreed that such consent would be required).
• Failing to consult with or provide information to a shareholder despite an agreement to do so. 
• Excluding a shareholder from management decisions if participation was part of the shareholders' agreement.
• Issuing shares to dilute a shareholder’s interest.
• Misappropriating company funds and/or breaches of fiduciary duties by the directors.
• Failing to pay dividends, especially when the payment of a certain level of dividend formed part of the basis on which someone became a shareholder.

The most common order courts make in successful petitions is for the shares of the petitioning shareholder to be bought by other shareholders of the company, or (in rare cases) the company itself.

2. What To Do If a Shareholder Submits (or Threatens to Submit) an Unfair Prejudice Petition. If a shareholder submits an unfair prejudice petition against your company, it is crucial to act promptly and effectively.

• Seek Legal Advice: It is important to understand the implications of the petition and develop a strategy for responding with advice from an experienced legal team acting for the right parties. It may be necessary to secure separate representation for the company and the majority shareholders.
• Review the Allegations: Collect and preserve documents and evidence related to the claim(s). Collate documents that demonstrate the company's actions were fair and in the best interest of all shareholders.
• Engage in Dialogue: Subject to legal advice, prioritise seeking to resolve the dispute through an open dialogue with the shareholder(s) in question. This can often be more cost-effective and less damaging to the company’s reputation than going to court.

3. How to Avoid Shareholder Disputes. Shareholder disputes can be time-consuming, resource-intensive, and can lead to negative publicity that can affect relationships with stakeholders. Here are various ways to mitigate the risk of such a dispute arising in the first place:

• Know Your Documents: Ensuring you understand the company's articles of association and the shareholders' agreement will help ensure that the company's actions are in compliance with these documents. Non-compliance can, in some instances, be viewed as unfairly prejudicial conduct.
• Know Your Duties: Ensuring you understand the directors' duties under the Companies Act 2006 will help you avoid breaching these duties. We set out what these director's duties are and how to avoid breaching them in the eleventh instalment of the Founder Series (Top Tips on Complying with Directors Duties Under English Law) here.
• Maintain a Clear and Comprehensive Shareholders’ Agreement: Ensuring you have a robust, well-drafted shareholders' agreement can prevent many disputes. This document should outline the rights and obligations of shareholders, procedures for resolving disputes and mechanisms for decision-making. This includes making sure you clearly define the roles and responsibilities of directors and shareholders. This can help prevent conflicts arising from overlaps or ambiguities in duties.
• Emphasise Transparent Communication: Regular and transparent communication with shareholders about the company's performance, strategies and significant decisions can build trust and mitigate misunderstandings. Hold regular board and shareholder meetings to ensure everyone is informed and has a chance to voice concerns. Accurate and timely financial reporting is also essential. Avoid excluding any shareholder from management decisions without a justified cause as this might be seen as inequitable conduct.
• Avoid Personal Disputes: Personal disputes between shareholders or between shareholders and directors should be kept separate from the affairs of the company.
• Dispute Resolution Mechanism: Make sure the company has a robust and fair dispute resolution mechanism. This will provide a clear pathway for resolving disagreements. It may also help to prevent such issues escalating to the point where legal action might be considered. 

While shareholder disputes and unfair prejudice petitions can pose significant challenges for startups, proactive measures and a thorough understanding of the issues can help mitigate risks. By fostering transparent communication, having clear agreements, and knowing how to respond to legal challenges, you can protect your company and maintain a positive relationship with your shareholders.

Shareholder disputes are incredibly fact sensitive and legal advice should be obtained from the outset. Orrick's Dispute Resolution team advise on all aspects of shareholder disputes, including unfair prejudice petitions. If you would like further advice on the issues above, or general UK disputes advice, please contact Mark Beeley, Simon Willis or Harriet Gibson.