October 9, 2020
In most SMEs, the directors and shareholders are the same people. What happens to shareholders if one director leaves or ceases to play their part in running the business? Can you force the departing director to sell their shares?
Generally, a majority of shareholders can remove a company director by passing an ordinary resolution after giving special notice. This is straightforward, but care should be taken to check the articles of association of the company and the shareholder agreement, which may include a contractual right to be on the board.
You should also consider whether the director is an employee. If this is the case, their employment will also need to be terminated and a director who has been dismissed may have a claim for unfair dismissal if they have been employed for over 2 years. The director will however continue to own the shares and be entitled to their portion of any dividends declared.
There is no automatic right that allows one party to force another party to sell their shares. However, there are possible routes to gaining the outcome you desire, (but the appropriate care needs to be taken in each case!)
Your first port of call should be to review the articles of association and any shareholders’ agreement, to see whether there are any ‘leaver provisions’ which enables the company or the remaining shareholders’ to back the shares of the departing director either at fair value or issue price. These clauses are sometimes referred to as ‘good’ and ‘bad’ leaver provisions.
If there are no leaver provisions, then you should check to see whether there is a ‘drag along’ clause which would enable the majority of the shareholders’ to force the sale of the minority shareholder in the event of a buyout of the company.
Well-drafted articles of association can be a valuable asset when needing to remove a difficult minority shareholder and you would be well advised to put these in place sooner rather than later.
If there are no leaver provisions in the articles of association and or shareholders’ agreement, then consideration can be given (if the remaining shareholders’ hold 75% of the shares in the company) to update the articles of association to include the leaver provisions referred to at point 1 above. However, care should be taken that any alteration would not amount to an oppression on the minority and no alteration should be unjust, as the company could receive an unwanted unfair prejudice claim from the minority shareholder.
One option could be to increase the salary of the remaining directors and reducing the sums paid by way of dividends. This may not be tax efficient or a long term solution, but may be preferable to paying dividends to a shareholder who is no longer involved in running the company (unless they are willing to sign a dividend waiver).
You could negotiate with the departing director with a view to reaching an agreement for the purchase of the shares. If things have turned sour, then it would be advisable to seek a valuation of the company, so you both have an idea of what ‘fair value’ would be for them.
As a last resort and if the remaining shareholders’ hold 75% of the shares, then you can consider the nuclear option of winding up the company. If a company which is solvent is wound up through a members voluntary liquidation, the company’s assets can be transferred into the name of a new company, which would not issue shares to the departing shareholder. Although this would be a lengthy procedure, it will be effective if there is no other option.