Chloe Cottle, Associate, HCR Law and Matthew Gillett, Solicitor, HCR Law
Many private companies give shares to key employees and directors — whether to reward loyalty, attract talent or align interests with business success. This works well while the relationship is positive. But when someone leaves on bad terms, they take their shares with them.
A disgruntled former colleague who remains a shareholder can use that position to cause real problems for your business, sometimes for years.
Can you force the sale of an ex-director or employee’s shares?
Shares held by a leaver can’t be compulsorily acquired unless the articles of association and/or a shareholders’ agreement provide for it. This remains the position even where a company has adopted Model Articles for private companies.
Without a contractual or constitutional compulsory transfer mechanism, you may be left with unwanted shareholders who can’t be forced to sell.
If the shareholder consents to sell, options include transfers to existing shareholders, a company purchase of its own shares (a buy-back) or a sale to third parties.
The risk of an unwilling shareholder
Even a very small shareholding gives someone legal rights that can be used to disrupt your business. These include the right to attend and vote at general meetings, receive accounts and reports and access certain company records.
The most powerful weapon, however, is the right to bring a court claim alleging that the company’s affairs have been conducted in a way that is unfairly prejudicial to the shareholder.
In smaller, closely held companies — where relationships between shareholders resemble a partnership — the courts have been willing to protect shareholders who are squeezed out without a fair deal. If a departing shareholder isn’t offered a reasonable price for their shares, they may have a strong claim. Defending such a claim is expensive and time-consuming.
Practical steps when dealing with an exiting director/employee-shareholder
1. Secure property and information: act quickly to recover laptops, phones and documents, and cut off access to email and IT systems. This is particularly important if the director or employee is leaving on hostile terms, you believe confidential information may have been taken or if they have strong customer relationships. Be proactive by ensuring employment contracts include detailed confidentiality obligations, provisions requiring the return of property and documents on termination and the ability to deduct the value of unreturned items from final salary payments. Restrictive covenants preventing an employee from contacting clients or other employees, or from competing against the business for a certain period of time, can also be valuable if drafted correctly. Urgent court orders and other legal remedies may be available in these scenarios.
2. Check your documents and act promptly: review the company’s articles and, if available, the shareholders’ agreement. Identify whether a compulsory transfer has been triggered and follow the procedure without delay. Consider the circumstances of the employee’s exit alongside their employment contract to assess whether their actions may warrant summary dismissal. This may affect whether they’re considered a ‘good’ or ‘bad leaver’ in any documentation relating to their shares. Bad leaver provisions can be hugely beneficial at this point.
3. Get the valuation underway: if the shares need to be independently valued, instruct a valuer early. Common disputes include whether to apply a minority discount and which valuation date to use — ideally your shareholders’ agreement will already answer these questions.
4. Remove the director if appropriate: if the departing individual is still formally a director, shareholders can vote to remove them. There’s a statutory procedure that must be followed carefully, including giving the individual proper notice and an opportunity to be heard. Removal as a director doesn’t automatically terminate employment. If the individual is also an employee, separate steps will be required to end their employment in line with their contract and to minimise the risk of claims for constructive or unfair dismissal.
What if the documents don’t help?
Where an ex-director or employee-shareholder is unwilling to sell their shares and there’s no mechanism for a compulsory transfer, resolving the dispute can become far more complicated.
In these situations, the parties often attempt to negotiate a buyout or other commercial solution. Options may include:
1. Agree a share transfer on exit: where the departure involves a negotiated exit, the company should seek to include an obligation on the departing shareholder to transfer their shares as a term of the settlement. The settlement agreement can specify the price (or valuation mechanism), the timetable for completion and the mechanics of transfer, bringing certainty for both sides. In practice, coupling the share transfer with any termination payment or enhanced benefits gives the company meaningful commercial leverage. Failing to address the shareholding at this stage is a common and costly oversight; once the employment relationship has ended and the settlement has been signed, the company loses its strongest negotiating position. Be aware of the legal requirements needed to ensure an employment-related settlement is binding and seek legal advice if necessary.
2. Amend the articles: with sufficient shareholder approval, it may be possible to amend the company’s articles to introduce compulsory transfer provisions. This usually requires a special resolution (75% majority), which can be difficult if the departing shareholder has a sizeable interest. However, targeting a minority shareholder in a way that isn’t for the benefit of the company as a whole risks an unfair prejudice petition, particularly if the amendment is used to force an exit without offering a fair price.
3. Consider mediation: the courts expect parties to engage seriously with alternative dispute resolution. Mediation should be explored before litigation, as refusing without good reason can lead to cost penalties. In practice, well-timed mediation often resolves matters quickly and at far less expense than going to court.
4. Winding up as a last resort: in complex quasi-partnership disputes where no viable exit is available, a petition for just and equitable winding up may be an option.
Conclusion
If your company has shareholders who are also employees or directors, you should have clear documentation in place dealing with what happens when they leave.
A well-drafted shareholders’ agreement provides the best protection. If a dispute has already arisen, acting promptly, following the correct procedures and engaging constructively with settlement proposals will give you the best chance of avoiding prolonged and costly litigation.
