As the majority shareholder, you may query the rights of minority shareholders, especially those with 5% or less shareholding in your private company. You may have considered whether, as majority shareholder, you can force minority shareholders to sell their shares to you or to someone else. As a founder, in particular, you may be considering this in the context of an impending exit event. This article explores whether a majority shareholder can force minority shareholders to sell their shares.
General Rules for Holding Shares
Broadly, a minority shareholder holds onto shares the same way they own any other property. In general, you cannot force a minority shareholder to sell their shares. An exception is if there is express documentation in place providing for this scenario and the minority shareholder has consented.
A minority shareholder can consent to sell their shares but is entitled to receive fair market value for them. An exception is if they specifically want to gift their shares for less than fair market value.
Minority Shareholder Rights
Minority shareholders cannot direct the outcome of certain company decisions. However, they have a number of rights under the Companies Act to protect their interests. As a broad rule, company directors cannot allow the company to be run in a manner which would be unfairly prejudicial to the minority shareholder. Otherwise, they risk a minority shareholder bringing a claim against them.
In addition, certain key company decisions require shareholder approval, such as:
- adopting or altering their rights under the company constitution;
- fundamentally changing the company's nature of business; or
- entering into a major transaction worth more than half of the company's assets.
These decisions typically require approval by a special resolution of shareholders, being 75% of the shareholders. Where a minority shareholder votes against such a decision, while they cannot stop the decision proceeding, they can invoke a minority buy-out process. This is where the company is required to buy back their shares for fair market value.
Director Duties
Where the majority shareholder is also a director, they will need to comply with their directors duties. This is true when considering company decisions that may trigger minority shareholder rights. Such duties include acting in good faith and in the best interests of the company, and exercising due care, diligence and skill.
Notably, a director does not owe these duties to individual shareholders but rather to the company as a whole. Still, they can still be relevant when considering minority shareholder rights.
Avoiding Minority Shareholder Disputes
A common way to mitigate the risk of disputes with minority shareholders is to put in place a shareholders agreement. Importantly, you cannot include a provision in your shareholders agreement that overrides the requirement of 75% approval for key company decisions. However, the agreement can provide clarity for many other company processes.
The shareholders agreement will give clear rules as to the following:
- processes for making company decisions are made;
- rights of minority shareholders;
- process for how a shareholder can sell their shares (if they choose to do so); and
- other rights and responsibilities between shareholders.
Typically, the shareholders agreement will also outline that the majority of key company decisions are conducted at the board level (by company directors), rather than at the shareholder level.
If there is no shareholders agreement in place, the default rules under the Companies Act will apply.
Default Rules Under the Companies Act
Board Decisions
Shareholders, by a 50% majority, can appoint and remove directors of the company. Once the director has been appointed, the default rules in the Companies Act require the business and affairs of the company to be managed or supervised by the board. However, the default rules do not go detail what sort of decisions the board can make, and what approval thresholds are required. With no shareholders agreement, there can be an overall lack of clarity for the board. This might lead to potential disputes if certain directors make decisions without the approval of the whole board.
Selling Shares to Third Parties
Moreover, the default rules under the Companies Act allow minority shareholders to freely sell their shares to any third party. This is typically not a favourable position for the company. Indeed, a minority shareholder could sell their shares to an unknown third party who could then vote at shareholder meetings and be involved in the company's general affairs. Further, the default rules do not specify any details about conducting a share sale or the appropriate valuation method.
Accordingly, drafting a shareholders agreement will allow your company to include standard pre-emptive rights provisions. Such provisions would require that the shares are sold back to existing shareholders or bought back by the company.
Buyout Process
In situations of a potential minority shareholder dispute, it is usually preferable from the perspective of both parties to enter into some form of buyout process. Where a fallout occurs, a company usually does not want to have a shareholder involved in any shareholder meetings. Likewise, a shareholder usually does not want to stay involved with a company that is not acting in line with their interests.
To avoid any claims of prejudicial treatment, a company should look to offer fair market value in exchange for the minority shareholder's shares. Consider entering into a formal sale and purchase agreement where the shareholder agrees not to make any future claims against the company.
Key Takeaways
In New Zealand, a majority shareholder cannot force a minority shareholder to sell their shares to them. Where the majority shareholder is also a director, they must keep in mind their duties under the Companies Act and the requirement to not be unfairly prejudicial to any shareholder.
