Shareholder Disputes: Avoiding Expense and Deadlock in Management
Our Commercial Litigation Specialists Look at a Recent Case
In this article, our commercial litigation solicitors look at a recent case decision by The Privy Council (‘PC’) that illustrates the massive complications and costs incurred when the relationship breaks down between company Shareholders. The case concerned a company, ‘OSL; Limited’, a shipping company registered in the British Virgin Islands (‘BVI’). Shareholder disputes is an area of specialism for our team, and we comment on this case and suggest using alternative dispute resolution as a way of avoiding/reducing the expense and time consumed in such disputes.
The Details of this shareholder dispute – where winding-up can result if shareholders are too busy with fighting each other
Court proceedings began in 2015 and were only decided by the PC in London in October 2020. In Chu v Lau  UKPC 24 (Mr Chu and Mr Lau were the two equal shareholders and sole directors of OSL) the PC agreed with the original BVI Trial Judge that:
- There was an irretrievable deadlock and breakdown in relations between the 2 parties, Mr Chu and Mr Lau (‘C and L’), which breakdown was ongoing;
- The breakdown was on-going, both at the time the proceedings had been commenced, and at the date of Trial; plus
- Whilst both parties had some responsibility for the breakdown of their relationship, the blame primarily lay with C.
As a result of this shareholder dispute, the company was wound-up and the Court appointed Joint Liquidators over OSL Limited. The PC decided that it was reasonable L had not pursued an alternative remedy, such as sale of his shares, instead of Liquidation.
The PC gave important clarification for situations where there is deadlock in management (i.e. equal Shareholders cannot agree) and where a Winding-Up Petition is issued. It should also be noted that many of the arguments could also be applied in relation to Unfair Prejudice Winding-Up Petitions.
The key lesson is that a Shareholder dispute, will be very expensive and generates uncertainty for all concerned. That can trigger insolvency of the company if Shareholders are too busy fighting with each other to concentrate upon the business.
Winding up can Happen if the Court Considers it to be Just and Equitable
If a winding up petition is issued, a Court has a wide discretion about whether it makes a winding up order to appoint Liquidators. However, the BVI legislation says that this can happen if the Court is of the opinion that it is just and equitable.
Accordingly, the PC said that that must refer to the Court assessing the facts as at the time of Trial, in addition to the facts that existed when the Petition was first issued. In Chu v Lau, the Trial Judge decided there was a deadlock/breakdown at the time the Application was filed.
Matters arising thereafter only caused the situation to deteriorate.
The Conduct of the Petitioner is Important
In Chu v Lau, C argued that L was partly responsible for breakdown in the relationship between the parties. It was suggested that L therefore had ‘unclean hands’.
The PC rejected that argument. The PC confirmed that a winding up order would only be refused if the Petitioner’s behaviour is the ‘sole’ cause of the deadlock. That probably reflects a practical approach in such cases, where it is likely that both sides will have complaints and grievances.
Functional Deadlock is a Key Determinant of Winding up in Shareholder Disputes
The Court in Chu v Lau decided that two related (but distinct situations) might lead to winding-up on a just and equitable ground:
- Where Shareholder are unable to co-operate, which means the company stops functioning at either Board/Shareholder level. The Court referred to this as ‘functional deadlock. A company could be wound-up on those grounds in any event.
- As an alternative, a company can be wound-up where there is an irretrievable breakdown in the relation of trust and confidence between Shareholders. However, this limb will only justify winding-up where the company is a ‘quasi-partnership’ e. subject to equitable considerations due to the nature of relationship between 2 Shareholders.
The second limb can arise, even if the dispute does not directly relate to the management/affairs of the subject company. This is because the Court can consider whether there has been a breakdown in the wider relationship of mutual trust and confidence between Shareholders.
Manifestly, there might be an overlap between the above limbs. They might co-exist and justify winding-up.
Alternative Remedy. Transfer of Shares?
The constitution of the company might require one of the Shareholders to transfer Shares to the other. This is often a remedy applied in case of unfair prejudice petitions. In Chu v Lau there was no such requirement, where the Court did not think the lack of restrictions upon Share sale would prevent a finding of functional deadlock and a Winding-Up Order.
This was because:
- If no third party would pay a fair value for the shares; then
- Whilst a sale might be theoretically available;
- It cannot be regarded as a realistic alternative.
- If it was not a realistic alternative, then it would not be reasonable to expect that route to be pursued.
Alternative Dispute Resolution
The experience of our dispute resolution solicitors is that these types of Shareholder dispute can generate considerable heat (and massive legal cost) but not much light.
We have found that various techniques of Alternative Dispute Resolution, specifically including third party Mediation but also Early Neutral Evaluation in front of a Judge, can save significant amounts of time and money.
As Chu v Lau illustrates, 5 years of uncertainty in a multi-million pound, multi-jurisdictional dispute is not a sensible use of time or resources or of a company’s assets.
Talk to our Commercial Litigation Team’s Dispute Resolution Specialists
If you or a client is involved in a shareholder dispute, we suggest you contact our team of dispute resolution specialists for an initial discussion of your case. We have significant experience at Director level, of dealing with and settling such disputes early on. Over the years, our team has acted for many shareholders across a diverse range of industries and professions. It has recovered many millions of pounds for directors and shareholders who find themselves in conflict and in need of guidance.
We also have considerable experience of preparing and pursuing cases to final hearing, when necessary.
Contact us or call us on 0121 200 7040. The initial discussion is free.