Minority Shareholders: How safe is their position?

Minority shareholders in a private limited company, by the nature of their holding, face a number of risks to the stability of their positions and their ability to make material decisions. However, the recent case of Staray Capital Ltd v Cha [2017] UKPC 43 has brought to light just how precarious a minority shareholder’s position can be.

What happened?
Mr Chen and Mr Cha established a company together with Mr Chen holding 80% of the company’s shares and Mr Cha holding 20%, with each appointed as a director.

The relationship between the two later deteriorated and Mr Chen claimed that Mr Cha had made a number of misrepresentations in the course of acquiring his shares. As majority shareholder, Mr Chen removed Mr Cha as a director and passed a special resolution to amend the company’s Articles of Association. The amendment inserted a provision which allowed the company to redeem a shareholder’s shares if that shareholder had made material misrepresentations when he acquired them. Mr Chen then purported to serve a notice on Mr Cha under the new mechanism to redeem his shares and thus also removing him as a shareholder of the company.

Previous cases have stated that the power of a special majority (75%) of shareholders to amend the articles and bind the minority will only be valid if it is “exercised in good faith in the interests of the company” (Sidebottom v Kershaw Leese and Co Ltd [1920] 1 Ch 154) or “bona fide for the benefit of the company as a whole” (Allen v Good Reefs of West Africa Ltd [1900] 1 Ch 656).

Mr Cha challenged the shareholder resolution to amend the Articles, arguing that it was invalid as it had been directed solely at him and not passed in good faith in the interests of the company. He also challenged the subsequent notice to redeem his shares.

The court’s decision
The court found that the amendment to the Articles was valid. Although the amendment was aimed at forcing Mr Cha out as part of a “clean-up” of the company, the court stated that Mr Chen had acted in a manner which he believed was beneficial to the company and this view was not so oppressive or extravagant that no reasonable person could hold it.

Although the amendments to the Articles were held to be valid, the court found in favour of Mr Cha in respect of the subsequent redemption notice. It was decided that none of the alleged misrepresentations were material and on that basis, the redemption notice was invalid and Mr Cha was not required to surrender his shares.

Practical implications
This case demonstrates that, provided a majority shareholder can evidence that an amendment to the company’s constitution is for the benefit of the company and for a genuine purpose, it may be possible to introduce compulsory acquisition powers which are prejudicial to the minority shareholder’s interests, without obtaining their consent. The majority shareholder must, however, be acting in good faith when making such an amendment.

For minority shareholders, this should serve as a reminder of the importance of having their rights entrenched in a separate shareholder’s agreement. Such an agreement could include a clause which prevents the company’s Articles of Association from being amended without their consent.

How can we help?
We provide advice to individual shareholders and companies in respect of the rights and obligations of the members of the company. We are also able to assist in drafting a shareholder’s agreement to clearly regulate the relationship between shareholders and provide for minority shareholder protection. For specialist advice on the potential implications of your company’s current constitutional documents, contact the experienced company and commercial solicitors at Herrington Carmichael as early as possible.

Please contact our corporate team.

Melissa Deutrom
Legal Director, Corporate
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This reflects the law and market position at the date of publication and is written as a general guide. It does not contain definitive legal advice, which should be sought in relation to a specific matter.

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