Navigating Director & Shareholder Disputes

Whether you’re a fledgling startup or a seasoned company, dealing with a shareholder or director dispute can quickly turn into a messy ordeal.

It can be difficult enough to grapple with opposing shareholder or director ideas – let alone not having a set procedure or agreement to provide guidance for when things hit the fan.

In construction companies in particular, it is common for directors to also be the major shareholders or directly connected to the major shareholders. This increases the complexities of the already complex internal disputes, though at least can limit the number of voices wanting to be heard.

In this article we discuss how to manage a shareholder dispute – ideally through a shareholders agreement – and what to do if your company doesn’t have one of these handy documents when things go wrong.

Managing shareholders disputes with a shareholders agreement

Shareholders agreements aim to set out the out the mechanisms and processes in the event of a dispute between shareholders and/or directors.

A well-drafted shareholders agreement will be beneficial because it will provide:

1. clarity to avoid confusion with rights, obligations or management roles;
2. mechanisms for the quick resolution of disputes; and
3. predictability for future foreseeable or unforeseeable conflicts or events.

To achieve these goals, a shareholders agreement will typically contain the following provisions relevant to a dispute:

• decision-making provisions – this outlines who has the power to make decisions, what decisions are to be left to majority shareholders or directors of the company, and the basis on which decisions can be made.
• a share transfer provision – this sets out the processes for transferring shares, pre-conditions to transferring shares and the valuation of the shares being transferred.
• dispute provisions – this provides procedures for the resolution of these internal disputes.

In most cases, a well-drafted shareholder agreements will set out both the clarity around decision making to avoid many disputes as well as the method for resolving the different kinds of disputes that arise without the need for litigation.

Common causes of director or shareholder disputes

Director or shareholder disputes are high-stakes disagreements that can quickly derail the productivity of your construction company. They arise when key players can’t find common ground. This might be, about the company’s direction, financial matters, or even personal dynamics. Some examples of internal disputes include:

• shareholder believes the company has been mismanaged;
• minority shareholders feel that their rights are being infringed upon;
• there are disagreements around the interpretation or enforcement of a shareholders agreement;
• during signification corporate transactions, such as mergers or acquisitions;
• shareholders may feel reporting and disclosure responsibilities are not being sufficiently met or when shareholders disagree on the interpretation or adherence of regulations and laws;
• there is a breach of contractual obligations;
• where activist shareholders have differing agendas or strategies, and which may clash with the company’s management;
• where existing disputes are exacerbated by economic downturn or financial difficulties;
• where there are disagreements over investment exit strategies; or
• where there are differing views on financial matters, strategic direction or leadership during CEO succession or key management changes.

If one of these arises and you have a shareholders agreement, the dispute resolution mechanisms should help you work through the dispute and achieve either a resolution or, at worst, a forced (but fair) exist for some or more protagonists.

But let’s consider some common disputes that may be difficult to solve without a shareholders agreement:

• director/shareholder deadlock disputes; and
• breach of director’s duties.

Director deadlock disputes

A director deadlock occurs when there is differing opinions between directors about an important decision, and the parties become equally split. For example, this may be the case in a small company managed by two director shareholders (that is, a director who is also a shareholder), each of whom own 50% of shares.

In essence, it’s like hitting a roadblock in the decision-making process because neither side can garner enough support to move forward. It can paralyse decision-making within the construction company, leading to delays in critical strategic initiatives or operational matters.

A shareholders agreement will normally have a mechanism for resolving deadlocks, such as a tiebreaker vote held by the chairperson. Without a mechanism in place, resolving the deadlock can be challenging.

Common causes of deadlocks may include:

• future direction and strategy;
• risk appetite; and
• interpersonal disputes.

Let’s explore an example:

Imagine a pandemic had just hit the world (hard to imagine, I know). Before the pandemic, Joe Bloggs Construction Pty Ltd had been contemplating expansion to capitalise on a growing economy. However, the onset of COVID-19 introduced uncertainties and challenges to the construction industry. Some board members see this as an opportune time to diversify and enter new markets, while others are more risk-averse and prefer a cautious approach.

The three directors in favour argue that the economic downturn caused by the pandemic presents a unique opportunity to acquire distressed assets and talent at a lower cost. They believe expanding into new geographic markets and taking on larger, riskier projects can position Joe Bloggs Construction as an industry leader when the economy rebounds. Advocates emphasise that some competitors may be more vulnerable during the pandemic, providing a chance for Joe Bloggs Construction to gain a competitive edge.

The three directors against argue that the uncertainties brought about by the pandemic make expansion too risky. They are concerned about potential delays, increased costs, and a shrinking pool of qualified subcontractors and skilled labour. Instead, these directors propose focusing on consolidating the company’s position in existing markets, maintaining financial stability, and minimising exposure to economic uncertainties. They point out that the company should prioritise smaller, more secure projects over large-scale ventures during a period of economic volatility.

The company board has six directors, but no shareholders agreement. The votes are three for expansion, and three against.

Joe Bloggs Construction is now deadlocked.

So what are the potential consequences of this deadlock for Joe Bloggs Construction?

1. Financial implications: The deadlock is impacting the company’s financial planning. The aggressive expansion strategy may require significant upfront investments, while the conservative approach focuses on preserving cash flow and minimising financial risks.
2. Operational challenges: The lack of a clear expansion strategy hampers operational planning. Project managers, unsure of the company’s direction, are hesitant to tender for new business opportunities, potentially leading to missed projects.
3. Employee morale and retention: The uncertainty surrounding the expansion strategy affects employee morale. Some employees may prefer the stability of a conservative approach, while others may be excited about potential growth opportunities. The lack of a decision may contribute to talent retention challenges.
4. Market perception: The company’s indecision may impact its reputation in the market. Clients and partners may be uncertain about the company’s direction and commitment to future projects, potentially leading to a loss of opportunities.

Resolving a director deadlock

Practically, a deadlock may be resolved by parties compromising in order to come to some middle ground. This may be the better option where the positions are flexible and open to movement. However, this may not be possible where there is an ‘all-or-nothing’ proposition. Some other options include:

• Buy-out – director shareholder(s) buy out the other director shareholder(s) at market price.
• Shareholder intervention – shareholders exercise their company powers (if they exist) and make decisions about the future management of the company. This, of course, involves any shareholder or group of shareholders having sufficient majority interests to do so.
• Alternative dispute resolution (ADR) – directors engage a third party to help resolve the dispute, such as a mediator or a business consultant.
• Litigation – directors or shareholders initiate court proceedings for a court to resolve the issue.

Litigation involves applying to the court under the Corporations Act 2001 (Cth) for an order that that the company’s affairs are being conducted in a way that is oppressive or contrary to the interests of the members as a whole. This is a fairly high bar to pass and may have some unintended consequences if successful, including the court:

• ordering that the company be wound up;
• ordering that the company’s existing constitution be modified or repealed;
• ordering share transfers;
• authorising a member to bring proceedings in the name of the company;
• appointing a receiver or a receiver and manager of any or all of the company’s property;
• restraining a person from engaging in specified conduct or from doing a specified act, or requiring a person to do a specified act.

Of course, litigation between directors or major shareholders is a big stick to wield and typically ruins any chance of future internal reconciliation. It will inevitably change the character of the company one way or another.

You should also consider how such an action might affect your construction licence, your current projects (and contracts) and your relationship with the company’s financiers.

Breach of directors’ duties disputes

Types of directors’ duties

Another common dispute that may be difficult to resolve without a shareholders agreement may be where a director breaches his or her duties.

Common breaches of these duties include:

• Conflict of interest (information obtained): A director proposes an idea to his or her company, which is rejected, but starts up his or her own business with the same idea.
• Conflict of interest (loyalties): A director makes a decision that is adverse to the company in order to avoid a detriment to a personal business interest.
• Personal loan repayment: A director inputs personal finances into a company to aid a business deal or financial management with the expectation to be later repaid and repays themselves just before the company falls into liquidation.
• Exercise independent judgement: A director seeks advice from another, which effectively controls their decision-making, thereby impacting independent judgement to make final decisions.

These duties will also apply to company officers and may also apply to other influential company personnel.

Is there a breach? What happens next?

If a company director is found to be in breach of his or her duties, the director may be:

• investigated (by ASIC), charged with an offence;
• considered to have contravened a civil penalty provision and may be ordered to pay a fine;
• personally liable to compensate the company or others for any loss or damage they suffered; or
• disqualified from managing a company.

Of course, this is dependent on ASIC investigating the breach (difficult to predict) or the company bringing an action in its own name against the director.

So, what happens if, in a company with two directors, one director wants to sue for damage caused to the company, and the other doesn’t?

Or what if the company, in a general meeting, ratifies the breach of duty (votes to agree the breach was okay), but a shareholder still wants to pursue the breach?

A shareholder or company officer may be able to take statutory derivation action. Where wrong is done to a company, a shareholder or officer can apply to the court for permission (leave) under the Corporations Act to commence Court proceedings in the name of the company. The court can grant leave if satisfied:

• there was inaction by the company;
• the applicant was acting in good faith;
• the action is in best interests of the company;
• there is a serious question to be tried; and
• the applicant gave notice or it was appropriate to grant leave in the absence of notice.

However, similar to applying to the courts to assist with a deadlock, applying to the courts for leave for a statutory derivative action is quite difficult and not a guaranteed option. Being an aggrieved party does not automatically entitle you to cause Court proceedings to start in the name of a company.

How to manage an internal company dispute

Unfortunately internal disputes are all too common, even in companies with a long and positive history.

A danger foreseen is half avoided, so preparing for potential disputes by putting in place a functional shareholders agreement can mitigate some of the more avoidable disputes, and provide a clear path for resolving the rest.

If you need help with setting up a shareholders agreement that suits your company’s needs, feel free to reach out.

This article was originally published here at Batch Mewing Lawyers.