An economic downturn and uncertainty around how businesses can recover from the impact of COVID-19 has created a spike in director and shareholder disputes for many businesses. Disputes can be a major distraction and it is important to forge a plan to resolve disputes quickly and cost-effectively, writes Attwood Marshall Lawyers Commercial Litigation Senior Associate, Charles Lethbridge.
Small businesses under pressure in a climate of uncertainty
In March 2020, things took a dark turn for businesses and their employees as the coronavirus pandemic permeated its way though our economy. Many businesses had to quickly change tack while others simply had to close their doors permanently.
According to the Australian Bureau of Statistics’ most recent survey of COVID-19 business impacts, more than a third of small to medium businesses were pessimistic about making it through the next three months and are finding it difficult to meet their financial commitments, as reported by businesses in August 2020.
It is not surprising that as a result of the COVID-19 pandemic, we are seeing an increase in director and shareholder disputes for many due in part to panic and loss of profits. A slowdown in the economy has left a bitter aftermath as businesses accumulate debt and try to navigate their way through the current economic challenges. Changes to government support packages, such as JobKeeper, combined with leasing and loan deferral periods coming to an end and the QLD/NSW border remaining closed will only apply more pressure to those businesses already struggling in the lead up to Christmas.
There’s a lot at stake for business owners
It is often the case for small businesses that the company directors and shareholders are the same and they each have significant financial interests in the company, with the business being a significant source of income (and in many cases the only source).
Uncertainty about what the future holds, and concern about future consumer demand, are a major focus for business owners. Without a clear path forward, it can be difficult for business partners to agree on whether they want to continue to invest in their business or cut their losses and close their business.
When starting a company, a well drafted Shareholders Agreement can outline dispute resolution processes to be undertaken by shareholders with a view to resolving disputes at an early stage. Unfortunately, many shareholders in companies fail to draft and sign a Shareholders Agreement. When relationships between shareholders sour and conflict arises, unfortunately this means the tools may not be in place to manage and resolve the conflict, as would be the case if a well drafted agreement was in place.
What disputes can arise between directors and shareholders?
Even without the added pressure and restrictions implemented by COVID-19, disputes between directors and/or shareholders invariably arise during the course of business for various reasons.
Situations that can escalate and lead to director/shareholder disputes can include:
A lack of clarity around roles
It is important that each director’s role is clearly defined to avoid blame games.
Arguments over contributions/effort
Underperformance can be a sensitive point of contention between business partners, where one side may feel they have contributed more than the other – shareholders inevitably overvalue their contribution (sweat equity).
Different opinions as to management and the direction of business
Differing opinions can have a significant impact on business partners being able to resolve matters and successfully move forward.
When it comes to disputes among business partners, often common sense is left for dead. In the heat of a dispute, shareholders can find it difficult to focus on a commercially sensible outcome. Parties engage in a blame game and inevitably overvalue their contribution (sweat equity).
Advantages of having a Shareholders Agreement
Although it is impossible to predict and guard against every type of dispute that may arise between business partners or shareholders, a well drafted agreement will usually have a dispute resolution mechanism which includes a ‘buy out’ or ‘sale’ option with an agreed path or method for valuing the business, as well as reciting the agreed initial financial inputs and what is to happen with the intellectual property of the business.
It may also govern succession issues and provide for appropriate insurance so that if a business partner dies or becomes permanently disabled, there are funds to pay out the departing partner’s share with the remaining partner/s able to continue the business.
Although certain businesses have different issues and may need specific clauses dealing with matters exclusive to that area, having an agreement can save a lot of time, emotional energy, money and legal costs.
The best approach to resolve disputes
We have found that by getting parties to communicate openly and honestly about their roles and contributions and by exploring their interests, disputes can be resolved at an early stage. We can assist our clients by generating viable options without having to resort to litigation. Resolving a dispute in this manner will ultimately save you time and money and will give both sides more control over the outcome.
What if shareholder/director disputes are unable to be resolved?
If disputes are unable to be resolved, there are various avenues available to parties through which to seek redress under the Corporations Act. These avenues include seeking a court order that a company be wound up on the “just and equitable grounds”. This is an application usually brought when relationships have irretrievably broken down, when a director is acting in his or her own interests to the detriment of the company, or where there is a deadlock.
Where minority shareholders have been oppressed by majority shareholders, they may bring a ‘derivative action’ or a shareholder oppression action under the Corporations Act.
How can Attwood Marshall Lawyers help?
When seeking to resolve a dispute between business partners, addressing the issue at an early stage is essential. This can reduce interference to business operations, or ultimately allow all parties to move on with their life. Early intervention can also reduce the cost, delay and stress associated with litigation. Getting appropriate advice from an experienced dispute resolution lawyer can assist parties to engage in open and honest discussion which is critical to resolving all matters.
Attwood Marshall Lawyers specialise in advising on breaches of shareholders’ agreements, explaining party’s obligations and assisting with deadlocks, buyouts and separations.