Introduction
Disagreements between shareholders in a commercial organisation are often unavoidable. When they do arise, they often come with (a) an outpouring of emotions and (b) a whole host of complex legal issues.
The differing “hats” worn by the various protagonists (shareholder/ employee/ director/ consultant) can be further complicated in family companies, where you can often add long standing simmering resentments into the mix.
Following the conclusion of the various lockdowns, we have seen an upturn in client enquiries about how to resolve shareholder fallouts. These can be at the start of a dispute but just as often we are receiving enquiries from shareholders who have agreed outline terms to settle their differences but are now trying how to work out as to how these can work legally.
Using an illustrative example, we provide a handy guide to solving your shareholder dispute.
The scenario
Two 50/50 Shareholders in a UK private company (“TradeCo”) have a spectacular fallout. After months and months of painful negotiations, Shareholder A has agreed terms to purchase Shareholder B’s entire shareholding in TradeCo. However, Shareholder A has none of its own money and picks up the phone to instruct you as follows:
- “We have managed to settle our differences”
- “TradeCo is going to buy back Shareholder B’s shares as I haven’t got any available funds”
- “TradeCo also doesn’t have sufficient cash flow to purchase them all on day one, so we’ve agreed a three-year payment plan”
- “Can you draw up the documentation to make all this happen?”
The hurdles to overcome
The short answer to the question above is yes, but the execution is more complex.
There is the slight issue of the Companies Act 2006 (the “Companies Act”). The Companies Act provides that payment for a buy back must be made by the company in full at completion. This means that deferred consideration for a buy back is not permitted (and advance payments are also unlikely to be acceptable). Therefore:
- Structures need to be put in place to allow for the commercial intent (i.e. TradeCo’s funds being used over a period of time to buy back the shares) without falling foul of the Companies Act.
- Considerations for the continuing, as well as the exiting shareholder, and what documentation should be used must be ascertained.
This could be achieved in one of two ways:
Structure 1 – use of a NewCo
- In the simplest of terms, a NewCo is established by Shareholder A. NewCo makes an offer to buy all of Shareholder B’s shares in TradeCo in exchange for deferred cash consideration. At the same time, NewCo will often also make an offer to Shareholder A to buy their shares in TradeCo in exchange for the issuance of shares in NewCo.
- There is no Buyback by TradeCo (as NewCo is the purchaser paying deferred consideration to Shareholder B) so there is no problem under the Companies Act.
Pre-closing structure:
Post-close structure:
Considerations for Shareholder A
The main issue here is tax. Clearance should be sought from HMRC to ensure, amongst other things, that no capital gains tax is payable by Shareholder A.
Advice will also need to be sought on stamp duty. Although this will be payable (albeit at 0.5%) on the cash consideration payable to Shareholder B, advice will be needed to ascertain if stamp duty can be avoided on the share for share exchange involving Shareholder A.
Considerations for Shareholder B
Here, all the shares are being transferred on day 1. As such Shareholder B will have little, if any, protection that they will be paid the deferred consideration. This is why a share charge over the capital of TradeCo is often sought by Shareholder B in this scenario.
Also, Shareholder B will consider asking for other contractual protections such as information rights and or consent matters over the operation of TradeCo going forward until all the deferred consideration is paid.
Required documents
As well as the Share Sale/Exchange Agreement and any security document relating to the share charge, there will also be the need for a settlement agreement which will include clauses such as:
- Waiver of all Rights by all the parties.
- Restrictive covenants from Shareholder B.
- Assignment of any intellectual property rights by Shareholder B.
- Agreed position on confidentiality / announcements / references.
Structure 2 – buy back in tranches
In this structure, there are a series of subsequent buy backs by TradeCo. There will usually be one umbrella sale agreement (the “Sale Agreement”) where there is an obligation on TradeCo to purchase and on Shareholder B to sell their shares over an agreed period of time. This is considered future, rather than deferred, consideration.
The price, sale dates and number of shares in each tranche are all agreed in advance. There is no issue with deferred consideration and the Companies Act as on each agreed completion date, there will be a pre-signed stock transfer form and all consideration applicable to that tranche of shares is fully paid. The Sale Agreement will also contain key terms to deal with events of default; grace periods and default interest.
Considerations for Shareholder A
This will see Shareholder B continuing as a co-shareholder and usually as a director for some time until the final tranche of shares is bought back, so there is no clean break.
Shareholder A will want a clear mandate to run TradeCo to allow it to fund the future consideration, they will also want a clear understanding of Shareholder B’s role (or lack thereof!) going forward.
Considerations for Shareholder B
Pretty much the same as with a Newco structure. However, in addition, they will need to be careful to make sure that they don’t jeopardise any business asset relief. This will typically see them wanting to remain as a director of TradeCo until the final tranche sale of shares. There will also need to be consideration given to the sale percentages so that, for example, on the final sale they are not selling only 2% of TradeCo’s capital (which is lower than the disposal percentage required to qualify for the tax relief).
Required documents
These would be very similar to Structure 1, except that there will be a series of future stock transfer forms needed with stamp duty payable on each buy back.
Practical lessons to bear in mind
- If you are feeling exhausted and frustrated in the middle of a shareholder dispute, the other side are also likely to be in the same position.
- Its often said but usually true that a sensible deal is where both sides feel they have lost as they need to make material concessions to bridge the gap (usually on valuation).
- With some creative structural thinking, it is often possible to bring disparate positions closer together by the use of deferred consideration; security; tax allowances etc.
- Avoid litigation if at all possible!
Contact us
Fox Williams has extensive experience in handling shareholder disputes and is aware of the tensions/acrimony which can arise in such circumstances.
If you have any questions about these issues in relation to your own organisation, please contact a member of the team or speak with your usual Fox Williams contact.
Authors
Follow us online
