In business agreements, the possibility of conflicts between directors and shareholders in partnerships always exists. Businesses in their early stages such as startups, or in growth or expansion phases, are especially affected by this trend. These companies usually have relatively short cash runways, making them less equipped to handle balance sheet stressors.

In the event of a shareholder dispute, including those involving breaches of fiduciary duty, a key strategy is to thoroughly comprehend your position, legal rights, and the potential outcomes specific to your disputes. Engaging solicitors specialised in shareholder disputes becomes crucial for effective resolution while prioritising the company’s interests.

Engaging legal representation is often necessary in shareholder disputes, but legal fees can accumulate quickly, especially if the dispute involves complex issues, or proceeds over an extended period.

Given that partnership and shareholder disputes can incur significant costs, it is essential to be informed about funding and insurance options to ensure a cost-effective approach to dispute resolution. At Annecto Legal, we can assist clients in finding funding and insurance coverage to provide peace of mind.

Ways to mitigate and manage shareholder risks

Establish clear communication from the beginning. Consistently provide updates to all shareholders concerning the company’s financial requirements and offer clear summaries of the various alternatives being assessed and pursued for obtaining financing. It is especially crucial to prevent any inference of concealing material facts from shareholders, as such actions could potentially extend the limitation period for claims.

Thorough record-keeping in relation to decision making and careful examination of articles and essential documents, such as shareholders’ agreements. This involves scrutinising all necessary consents and approvals for proposed changes to articles or agreements.

This also includes assessing the potential impact of any proposed investments or alterations to shareholder rights on each class of existing shareholders. This may entail providing participation rights beyond the minimum requirements to mitigate the risk of complaints.

Deliberate attention should be given to conflicts of interest, ensuring they are openly acknowledged and documented. Specific concerns may arise, especially when the board is predominantly composed of majority shareholders or their representatives.

It is advisable to disclose the financial interests of all directors and assess how they could potentially gain from the proposed transactions. If feasible, the board should consider forming a sub-committee of directors without a financial stake in the company to oversee the process.

Evaluate whether further legal counsel is necessary, such as regarding directors’ obligations, and explore whether advice on insolvency is needed. Alternative dispute resolution should also be discussed.

Explore the use of mitigating the costs of shareholder disputes through the use of legal funding and insurance. Alternative funding methods and insurance coverage can help to keep legal costs to a minimum while pursuing litigation.

Types of shareholder disputes

Shareholder disputes can arise at any point during the course of business for a range of reasons. Some of the main types of shareholder disputes we see include:

• Partnership disputes – Disputes can arise within any partnership due to disagreements on the apportionment of the partnership, when one partner wants to leave the partnership, or during an equitable winding down process. All of these situations have potential to give rise to issues and complications for the business and remaining partners.
• 50/50 shareholder deadlocks– Disputes often arise in situations where no written shareholders’ agreement has ever been drawn. When there are no minority and majority shareholders, disagreements can arise when minority shareholders are required to make key business decisions and no shareholder has the majority vote.
• Unfair prejudice claims– In situations where shareholders believe the company’s affairs have been conducted in a manner that is unfair and could impact the interests of the shareholders, an unfair prejudice petition can be brought by majority shareholders under Part 30 of the Companies Act 2006. Through Court proceedings, an Order can be sought which allows an affected shareholder to effectively be “bought out” by the company or other shareholders.
• Funding disagreements– Disputes regarding funding of a business are extremely common, especially when there has been no clear agreement made as to how the business will be funded beyond initial contributions from shareholders.
• Breaches of fiduciary duties – Conflict may arise from a director’s breach of duties and these breaches may ultimately result in derivative actions such as fraud or misfeasance claims.

Funding a shareholder dispute

If a shareholder dispute does arise, it can lead to high levels of legal costs. Fortunately, there are funding and insurance options available to assist when conducting litigation in a cost effective manner. These methods include:

Third party funding 

One funding method that is commonly used for shareholder disputes is third party funding. Third party funding acts as a form of non-recourse financing for litigation. Third party litigation providers take on the financial risk of litigation so that clients can pursue a claim without having to worry about the legal fees associated with it.

In return for taking the risk, the litigation funder will typically seek a share of the proceeds in the region of a fifth to a third of any damages recovered. This means that you keep up to 80% of the reward, having taken none of the risk. If the claim is unsuccessful, the funder will lose their investment. 

Damages based agreement 

A damages based agreement (DBA), also known as a contingency fee agreement, is a type of arrangement made between a client and a solicitor in which the solicitor agrees to fund their case and share the risk of litigation. In return, the solicitor will be paid a percentage sum of the damages recovered as long as the client’s case is successful.

DBAs provide that, instead of being paid on a conventional hourly rate, the solicitor’s legal fees are only payable in the event that the case is successful. Therefore, these types of agreements allow clients the opportunity to pursue a case without having to worry about the solicitors’ fees associated with it. In some circumstances, however, fees for Counsel and other disbursements may still be payable by the client. 

ATE insurance

After the event (ATE) legal expenses insurance is taken out after the event that has led to a dispute has taken place, to protect you in the case of your claim being unsuccessful. ATE insurance can protect you from paying your opponent’s legal costs should your claim not be successful.

However, ATE insurance is not free, and it is important to remember that if your case is successful, you may have to use some of your reward to pay the cost of the insurance premium, which will be included in the terms and conditions.

The use of third-party litigation funding, CFAs and ATE insurance can sound complicated, but they are simply risk management tools and when used correctly, they can make all the difference to a partnership or shareholder dispute case.

How Annecto Legal can assist with shareholder disputes

In shareholder dispute cases, getting the right advice early without spending an excessive amount on legal fees is the best way to save money and protect your position.

Annecto Legal helps clients realise the value of their shareholder disputes. We work closely with litigation funders, insurers and lawyers that seek alternatives to the traditional hourly rate funding model.

Get in touch with an expert member of our team to find out which litigation cover is the right litigation funding option for you to reduce your commercial litigation costs.