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COVID-19 – the catalyst for removal of the minority shareholder…?

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What we have all been seeing during the pandemic is businesses making redundancies in order to try and survive the harsh economic downturn directly caused by COVID-19. However, what you might not have been aware of is majority shareholders using that unwelcome side effect of the virus to exit minority shareholders from companies. 

This blog explains what this means for the minority shareholder and what minority shareholders can do to protect themselves.

It is not immediately apparent why a redundancy process should lead to the removal of a minority shareholder because redundancy affects an individual in their capacity as an employee and not as a shareholder. However, what can happen, and has in fact been happening during lockdown, is that redundancy is being used as the catalyst to effect removal. Termination of employment by way of redundancy can by itself trigger compulsory share transfer provisions in articles of association and shareholders agreements or lead to automatic removal as a statutory director which then triggers those provisions.

In ‘normal’ times, it is usually quite difficult to justify and effect the lawful redundancy of a shareholder, and thereby legitimately trigger compulsory transfer provisions, because if the redundancy process is carried out for an improper purpose i.e. simply to exit a shareholder, then the majority shareholders are likely to face a claim for unfair prejudice from the minority shareholder.  However, we are not currently living in ‘normal’ times and in the current economic climate the business case for redundancy against a minority shareholder employed in the business is easier to justify and more difficult to challenge.

What does this mean for minority shareholders?

If you are a minority shareholder in such a scenario then, in addition to losing your income as a result of redundancy, your capital investment may also be at risk from redundancy - you could be facing:

  1. the enforced removal from the business in all roles as a consequence of the exercise of compulsory transfer provisions;
  2. the forced sale of your shares, which is more likely to result in you being left in a worse financial position than if you had been able to keep hold of your shares or negotiate a sale in more favourable economic conditions because share values, on the whole, have fallen due the economic effect of Covid-19; and
  3. loss of Business Asset Disposal Relief (or Entrepreneurs’ Relief as it was more lately known as up until the last budget) which will mean a greater exposure to Capital Gains Tax.

What can be done to protect a minority shareholder?

There is, however, sometimes scope to prevent majority shareholders from exiting a minority shareholder from the business or at the very least ensuring that when shares are valued that no minority shareholder discount is applied notwithstanding any contrary valuation assumptions prescribed in the articles of association.  This can happen if a minority shareholder can establish that there is a quasi-partnership, and that the equitable principles which flow from establishing such a relationship should be engaged to displace any exercise of strict legal provisions.

What do you need to show to establish that there is a quasi-partnership? 

There is no exhaustive list of factors but generally speaking the courts will be looking for a minority shareholder to produce evidence of the following:

If you are in a position where you are concerned that majority shareholders are looking to exit you from the business by using redundancy as the means to achieving that end or you are being forced out of a business and at the same time being asked to accept a sum for your shares which you believe is not a fair price, or pursuant to a valuation which you feel is unfair, then please get in touch and we can advise you on the next steps you can take.

Disclaimer: Anything posted on this blog is for general information only and is not intended to provide legal advice on any general or specific matter. Please refer to our terms and conditions for further information. Please contact the author of the blog if you would like to discuss the issues raised.