Disagreements between shareholders are often unavoidable. However, when they do arise, they can raise emotive issues and a whole host of complex legal issues too.
Whatever the origin of the disagreement – be it lie in Brexit, pandemic, or slow down of the economy – shareholders’ disputes are far more common than we think – even within the fashion industry where shareholders’ disputes are often kept private. For example, the last few years has seen the shareholders’ dispute involving Ralph & Russo. Such a dispute was financial in origin with shareholder Candy Ventures, owned by Nick Candy. The shareholder disputes within Fenwick over the years have also been publicly reported.
It is also the case that it is not only financial considerations that the business is left contending with, but reputational issues too. Further the differing “hats” worn by the individuals (shareholder / employee / director / consultant) can be further complicated in family-owned fashion businesses, where there are often long-standing resentments.
What is the case is that we have seen a rise in client enquiries about how to resolve shareholder fallouts. These enquiries range from clients at the very start of a dispute, to shareholders who have already agreed outline terms to settle their differences but are now contemplating how these can work legally.
Using an illustrative example, we have set out a handy guide to working through your shareholder dispute.
A hypothetical shareholder scenario
Two 50 / 50 shareholders in a UK private company in the fashion industry (“FashionCo”) have a spectacular fallout. After months of painful negotiations, Shareholder A has agreed terms to purchase Shareholder B’s entire shareholding in FashionCo. However, Shareholder A doesn’t have their own money and picks up the phone to instruct Fox Williams as follows:
“We have managed to settle our differences.”
“FashionCo is going to buy back Shareholder B’s shares as I haven’t got any available funds.”
“FashionCo 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?”
Company law and the hurdles to overcome
The short answer to the above question is yes, but the execution is more complex.
There is the small issue of company law. Company law provides that payment for a share buy back must be made by the company in full at the date the shares are bought back. This means that deferred payments paid on days following the date of the buy back are not permitted (and advance payments are also unlikely to be acceptable). Therefore, the following must be considered:
- the structure to be put in place to allow FashionCo to use its funds over a period of time to buy back the shares without falling foul of company law; and
- the terms for the continuing, as well as the exiting shareholder, and the documentation needed to achieve this.
This can be achieved in one of two ways as follows:
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 FashionCo in exchange for deferred cash paid to Shareholder B. At the same time, NewCo will often also make an offer to Shareholder A to buy all their shares in FashionCo in exchange for being issued shares in NewCo.
There is no buy back by FashionCo (as NewCo is the purchaser making deferred payment to Shareholder B) so there is no problem under company law.
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 payable to Shareholder B, advice will be needed to establish whether 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 and Shareholder B will have little, if any, assurance that they will be paid the deferred cash payment. This is why a share charge over the capital of FashionCo will often be sought by Shareholder B in this scenario.
Also, Shareholder B will consider asking for other contractual protections such as information rights in relation to FashionCo’s affairs and / or consent matters over the operation of FashionCo going forward until all the deferred cash is paid.
Documents required
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 share buy backs by FashionCo. There will usually be one umbrella sale agreement (the “Sale Agreement”) where there is an obligation on FashionCo 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 company law as on each agreed completion date, there will be a pre-signed stock transfer form and all cash due to be paid on that tranche of shares is fully paid. The Sale Agreement will also contain key terms dealing with events of default; grace periods and default interest.
Company law sets out the procedure that must be followed to action a share buy back. Failure to comply with such procedure could render the transaction void and will constitute a statutory offence by the company and every officer in default so it’s important to get it right.
We also recommend that the shareholder seeks personal tax advice before making the buy back.
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 FashionCo to allow it to fund the future payment, 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 ensure that they don’t jeopardise any business asset disposal relief. This will typically see them wanting to remain as a director of FashionCo until the final tranche sale of shares. Thought will also need to be given to the sale percentages so that, for example, on the final sale they are not selling only 2% of FashionCo’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 frustrated in the middle of a shareholder dispute, the other side is also likely to be in the same position.
- It is often said, but usually true, that a sensible deal is one where both sides feel they have lost as they need to make material concessions to bridge the gap (usually on the valuation of the shares).
- With some creative structural thinking, it is often possible to bring disparate positions closer together by the use of deferred payment; security; tax allowances etc.
- Avoid litigation if at all possible – it is costly and very stressful!
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