July 2020 Issue
Shareholder disputes arise in both good and bad economic times. While such disputes have risen steadily since the 2008 financial crisis, the emergence of coronavirus (COVID-19) is expected to lead to a significant uptick in disagreements within the ranks of the many companies struggling to rebuild in the face of a global economic downturn. Amid COVID-19 and in a post-pandemic environment, the growth and evolution of shareholder disputes will remain a key feature of the corporate landscape in the years ahead.
FW: To what extent are you seeing an increase in the number of shareholder disputes in today’s business world?
Williams: We have seen a steady rise in shareholder disputes since the onset of the 2008 financial crisis and are already seeing signs of a further uptick in the trend brought on by coronavirus (COVID-19). This is highly likely to continue in the post-pandemic world. These involve both public and privately held companies across a wide variety of industries, including in the financial sector, as well as in the oil, gas and construction sectors.
Bédard: Shareholder disputes and corporate disagreements constitute a steady stream of international disputes – they are perhaps the most frequent type of disputes handled by arbitration counsel at large corporate firms. Shareholder disputes arise both in good and bad economic times. But challenging financial situations probably bring additional sources of tension inside corporate organisations. Typical drivers of shareholder disputes are a lacklustre economy, disappointing financial results and major corporate reorganisation. The global COVID-19 pandemic may generate a surge in shareholder disputes, as a difficult business climate intersects with individual corporate struggles to manage unprecedented circumstances. As a result, companies may face claims arising from COVID-19, navigate onerous contracts or otherwise adjust their operations accordingly. The COVID-19 outbreak has seen some early shareholder suits regarding alleged company ‘misstatements’ related to COVID-19. Rapid drops in stock price give rise to many result-oriented shareholder lawsuits.
Maples: Businesspeople and investors have long participated in commercial activity and enjoyed the fruits of ownership by becoming shareholders. Naturally, those relationships and activities have spawned a long and varied history of shareholder disputes. Today, we continue to see shareholder disputes of all kinds. These range from disagreements between shareholders in private companies, where the equity can be tightly held, to large public company disputes, where the shareholder base is broad and constantly changing. We are seeing growth in the area, driven by distressed business conditions, third-party litigation funding and by the increasing use of modern securities laws and group litigation mechanisms. On the public company side, this growth is concomitant with a rise in shareholder activism more generally.
Elliott: We are expecting an uptick in shareholder disputes for businesses struggling to rebuild in the face of the global economic downturn where the very survival of a business is at stake. Shareholders will be likely to suffer falls in share value in this climate and will be looking to explore litigation as a means of recouping losses. This of itself does not provide shareholders with straightforward claims because loss in value is regarded as a loss suffered by the company itself with no direct right of action by shareholders. So, attention may focus on the board’s actions or on external advisers.
“A dispute in a privately-owned business, where the equity is split between only a few shareholders, whose involvement in the company may be decades-old, can be an intensely personal affair.”
FW: Based on your experience, could you provide an overview of some of the common sources of shareholder disputes?
Bédard: In privately-held companies with shareholders from different jurisdictions, disputes are often resolved through international arbitration. Cross-border M&A transactions may give rise to disputes both pre- and post-closing, including demands for purchase price adjustments, claims under indemnification rights or representations and warranties, and disputes over shareholder relations, such as rights of exit and buyout. Heated controversies often involve forced closings of transactions, resort to courts versus arbitration, fraud claims in arbitration, arbitral disputes over buyout clauses, put and call options and pre-emption rights, as well as the assessment of damages and valuation issues. Disagreements regarding company strategy crop up often, as do suits surrounding transparency issues and company difficulties that are widely publicised and transformed into litigation targets.
Maples: The causes of shareholder disputes are multifarious. And although certain types of shareholding structures and companies can lend themselves to certain kinds of disputes, some causes can be found across the board. Perhaps most common are cases driven by financial distress. Poor performance and outlook can put enormous pressure on relationships between shareholders and other stakeholders, and among shareholders themselves, sometimes leading to legal conflict. Allied to that are disputes driven by the emergence of a scandal of some kind, most often fraud. Even where no shareholder is directly implicated in such matters, they can result in a breakdown in relations between shareholders which, in turn, leads to disputes. In a public company context, a crisis of this kind may lead investors and third-party funders to consider possible group shareholder claims.
Elliott: Disputes can be between shareholders themselves or boardroom disputes. Claims by shareholders in private companies often stem from a belief that a company is being improperly run by its directors. Shareholders can resort to legal action if they believe that the affairs of the company are being conducted in a way that is unfairly prejudicial to the shareholders generally, or a specific group of shareholders. Mismanagement, misuse or even misappropriation of company assets by directors or attempts by the board to dilute a minority shareholder’s interests by allotting further shares in the company can trigger this type of shareholder action. Disputes of this nature can also arise from failure to pay dividends, or the payment of excessive remuneration to directors. Failing to hold annual general meetings, providing insufficient information to shareholders, and neglecting to obtain shareholder approval for required transactions, such as loans to directors, are governance-related issues that can be a source of disputes, particularly if shareholders feel deliberately marginalised. In private companies often the arrangements between shareholders are contained in a shareholders’ agreement and breaches of that agreement will be a trigger for disputes.
Williams: In the financial sector, numerous high profile shareholder actions have emerged from scandal, for example London Inter-bank Offered Rate (LIBOR) manipulation, false and misleading financial statements and vehicle emissions reporting. Political factors have also had an impact on ventures, leading to issues between shareholders. In the oil & gas and construction sectors, low oil prices have made the reality of joint ventures radically different to what was envisaged when agreements were first signed. This has led to gamesmanship, often acrimonious, in the day-to-day management of joint venture companies, with shareholder parties looking to exit or renegotiate ventures that had only made commercial sense when oil prices were higher.
FW: How would you characterise the differences between shareholder disputes that occur between closely held businesses as opposed to public companies?
Williams: Shareholder disputes involving public companies can be large scale and high profile given the nature of the businesses involved and the wide variety of shareholders, ranging from institutional investors, including pension funds, to numerous individuals with smaller holdings. With the stakes often high, reputation management is critical, alongside courtroom manoeuvres. Political and government involvement is also highly likely. Nothing epitomises this more that the numerous shareholder class actions that have emerged on both sides of the Atlantic from the manipulation of LIBOR, some involving banks that were wholly or partly state-owned since 2008/9. That is not to say disputes among privately held businesses are any less shielded from the public eye. In the autumn of 2010, when the former and incoming shareholders of privately held Liverpool FC battled in the English and US courts over ownership of the football club, the media scrutiny was intense and had a significant impact on the management of the business. Executive and non-executive directors were caught in the middle when seeking to exercise their management functions in the execution of the sale process in the best interest of the club. Of course, most shareholder disputes involving closely held businesses do not generate wider intention. Nevertheless, feelings on both sides can be just as intense, particularly where high-net-worth individuals and family businesses are involved.
Elliott: For public companies, securities litigation has been growing. The Financial Services and Markets Act 2000 (FSMA) provides a regime for shareholders that have suffered losses as a result of misleading or inaccurate information in listing particulars or prospectuses to bring claims. In certain circumstances, claims can also be brought where an investor has relied on untrue or misleading statements in formal company announcements, such as annual reports. Typically, claims are brought by large groups of shareholders and English courts have mechanisms to case manage such actions. A court can make a group litigation order which enables individual shareholders to pool resources and join in a ‘class action’. Litigation funding sources are widely available to support these claimant groups. FSMA claims do not apply to private companies, but where shareholders are misled, claims for misrepresentation can be available. In private companies, disputes between shareholders often centre on the shareholders’ agreement. There are particular difficulties where there is a deadlock between shareholders which the agreement has not catered for, or if there is no agreement at all.
Maples: A dispute in a privately-owned business, where the equity is split between only a few shareholders, whose involvement in the company may be decades-old, can be an intensely personal affair. And that is only to be expected. In such a case, the lives of its shareholders are often intimately bound up with that of the company, both historically – taking into account each member’s financial or operational contribution to the business – and in the future, as their equity in the company may represent their principal asset. Moreover, shareholder agreements entered many years previously may no longer reflect the business today, or the changing needs and ambitions of one or more of its shareholders. Public company shareholder disputes are fewer in number but can involve many more interested parties, making coordination and the formulation of strategy more challenging, but no less interesting. The pressure of conducting such disputes under the media spotlight adds to that challenge.
Bédard: Shareholder disputes in closely held businesses are often about the interpretation of the shareholders’ agreement or company bylaws. By contrast, shareholder disputes in public companies often involve claims by shareholders against the company, which are based on securities laws and alleged wrongful corporate disclosures. Numerous disputes in both privately held and publicly traded companies involve the relevant corporate law on shareholder rights as well as the fiduciary duties of directors and majority shareholders.
“Companies should consider mechanisms for open and ongoing dialogue with shareholders to contain and defuse unrest. Starting early with this, as soon as trouble appears over the horizon, is vital.”
FW: Are you seeing an increase in cases involving minority shareholders considering a group or class action? What advice can you offer to companies facing such circumstances?
Elliott: The current economic climate is likely to focus shareholder attention on litigation. One example of an action under FSMA is a brewing shareholder claim against Watchstone Group PLC, formerly known as Quindell. Shareholders allege that the company’s market announcements about its financial standing were misleading, and that they suffered losses as the true state of the company emerged and the share price collapsed. The growth of shareholder activism and the statutory regime underlines the importance for companies in implementing tight controls and compliance processes, and strong corporate governance regimes. Shareholders may well deploy strategies short of litigation in a bid to pre-empt potential mismanagement. Examples of this can include requisitioning general meetings and forging alliances to try to influence the decisions to be made at such meetings. Companies should consider mechanisms for open and ongoing dialogue with shareholders to contain and defuse unrest. Starting early with this, as soon as trouble appears over the horizon, is vital. Picking off the ‘ringleaders’ can be a tactic to deploy. The strategies will vary depending on whether you are dealing with a handful of shareholders in a private company or a substantial group in a public company.
Maples: There is no doubt that group or class action cases are on the rise. Although examples of such cases reaching a mature stage in the litigation process remain few in number, and acknowledging that it is still relatively early days in this area, the direction of travel is clear. Not only does English law provide effective remedies for shareholders in a public company context, the emergence of third-party funders and of conflict free or, perhaps more accurately, conflict ‘light’, litigation practices provide claimants with the financial backing and legal representation to advance their claims. Any company in such circumstances should, first and foremost, not fall into the trap of underestimating the threat it faces. Its lawyers must advise the company both on the substantive merits of the threatened claim and on the complex procedural elements involved in any action of this kind. Coordination with other advisers, including an experienced litigation public relations firm, will also be key.
Williams: In times of falling markets – as was the case during and in the aftermath of the 2008 financial crisis and, more recently, with the onset of COVID-19 and the significant slowing down of world markets – the issue for minority shareholders is distinguishing inevitable losses caused by external market factors from unacceptably poor management performance or worse, unlawful conduct – in either case, driven by majority shareholders with de facto control over the business. In these situations, access to information and documents is difficult and transparency from management illusory. Companies facing such circumstances are well reminded that the duties of management are to represent the best interests of the company, not one group of shareholders over another. Fairness to and transparency with minority shareholders is paramount in this regard. Appropriate document and record keeping of decision-making processes and the rationales for decisions both tabled and taken is best practice. Giving all shareholders a platform to share questions and concerns in a meaningful and documented way with genuine responses is also recommended.
FW: Could you highlight any recent, high-profile shareholder dispute cases that have caught your attention? What insights can we draw from these scenarios?
Maples: In November 2019, the High Court dismissed a claim brought by a group of Lloyds shareholders against Lloyds and five of its former directors relating to its acquisition of HBOS in 2008. Investors alleged that the directors negligently recommended to Lloyds shareholders that they should vote in favour of the acquisition of its rival, HBOS, and that they failed to provide shareholders with sufficient information to make an informed decision on how to exercise that vote or made negligent misstatements about the merits of the acquisition. Mr Justice Norris dismissed the claims. His views on the claimants’ damages claim are of particular interest. He did not consider they had suffered any loss as a result of any overpayment for HBOS because any such loss would generally rest with Lloyds and not with its shareholders.
Williams: The shareholder class action against Tesco for misleading and dishonest statements in the company’s financial reporting is set down for trial in the High Court in London in 2020. The claim is being made under the FSMA. An interesting and highly relevant aspect of the case is Tesco’s unsuccessful attempt, in late 2019, to have the case thrown out on the basis that the investors’ shares were held in “dematerialised” chains. Such a term describes a common ownership structure, whereby institutional investors, including pension funds, beneficially own shares in public companies, albeit legal ownership vests with a securities depository, such as the Certificateless Registry for Electronic Share Transfer (CREST). The High Court held that this was insufficient to disqualify the investors from suing as qualifying holders of security interests under FSMA. The decision has wide-reaching consequences because it clarifies, for the very many institutional investors whose shares are held via securities depositories, that they are able to sue public companies for breaches of FSMA, such as misleading and dishonest statements issued to the market which have been relied upon by investors when making investment decisions.
Elliott: A widely publicised recent shareholder dispute is the action brought by shareholders of Lloyds concerning its reverse takeover of HBOS during the 2008 financial crisis. Shareholders alleged that the company’s directors should not have recommended the takeover to the shareholders and that a circular should have provided more information, especially concerning funding which had been provided to HBOS. Shareholders claimed that directors were personally liable for the loss in value of their shares. Directors have personal responsibility for the recommendations they make to shareholders, with such recommendations tested against the standard of reasonableness. Here, the court concluded that the directors had passed that test. This case demonstrates that although mechanisms exist for disappointed shareholders to bring claims against directors, the outcome of such action will be very fact specific.
“Deadlock provisions are often relied upon to trigger a resolution arising from the sheer pressure and consequences of a lack of resolution on the business. But resorting to arbitration may nevertheless be necessary.”
FW: How important is it for parties to have recourse to a clear dispute resolution response from the outset? What, in your experience, are the most popular alternative dispute resolution (ADR) methods for shareholder disputes?
Elliott: Formal resolution of disputes can be pursued through arbitration or litigation, but the latter is the default position if the parties have not chosen arbitration as the mechanism for resolving disagreements. Shareholders in private companies who want to keep their disputes private, should be building arbitration provisions into their agreements: litigation is public, arbitration is not. Where the dispute is not central to the running of the business and there is hope of maintaining a commercial relationship, mediation is a useful tool to resolve issues. A mediator is a neutral facilitator, who can depersonalise the problems and can explore, with each side, ways of ironing out ructions.
Williams: Having clear governing law and dispute resolution provisions in companies’ constitutional documents, including any separate shareholder or joint venture agreements, is essential to ensuring shareholder disputes are managed and resolved efficiently and effectively, with minimal negative impact on the business of the company. With this in mind, tiered dispute resolution clauses that involve a series of steps are common, such as without prejudice meetings with senior management and shareholders in the first instance to seek to agree mutually acceptable commercial outcomes, followed by more formal dispute resolution processes. Mediation, ad hoc or administered by an institution, as ever remains a prevalent adjunct to litigation or arbitration. For shareholder disputes involving contentious technical points, as is often the case in the oil and gas industry and in infrastructure and construction projects, expert determination is popular, whereby a suitably qualified individual gives a final and binding view on a critical issue that underlies parties’ commercial dispute. When drafting, it is important for parties to consider whether such steps are to be mandatory or optional and, if mandatory, to ensure that one party is not prejudiced where its opposite number is not averse to using dilatory tactics.
Bédard: In international shareholder agreements, considerations that govern the choice of dispute resolution are similar to other international transactions. The overarching concern is the enforcement of the award – an arbitration award will benefit from a well-established path to enforcement under the New York Convention – and confidentiality also remains at the top of the list of factors that differentiate it from litigation. Arbitration clauses in corporate charters and bylaws remain controversial in the US.
Maples: As obvious as it may sound, it is crucial that any agreement governing relations between shareholders has a clear and considered dispute resolution mechanism. Without one, the case may well be blighted with an ancillary debate concerning how, and by whom, the matter must be resolved. Considerations of confidentiality and commercial sensitivity dictate that shareholder disputes often benefit from alternative dispute resolution (ADR) mechanisms, particularly mediation. We find that even the most bitterly fought shareholder dispute can be resolved with the help of constructive lawyers and an experienced mediator, even if settlement is often elusive on the day of mediation itself and takes further negotiation to conclude. Absent settlement, arbitration too may be suitable, allowing the parties to obtain a final and binding determination of their differences, away from the public eye.
FW: What particular challenges and legal considerations do shareholder disputes typically generate? What steps might be taken to overcome them?
Williams: The issue shareholder claimants face, particularly minority shareholders, is proper standing to bring claims against majority shareholders or the company itself. Minority shareholder protections are usually de minimis in standard form company constitutional documents, notwithstanding basic protections under statutes such as the Companies Act 2006. If minority shareholders want to enhance their protections and their recourse to specific dispute resolution procedures, these need to be contractually agreed in the form shareholder or joint venture agreements.
Bédard: Challenges depend on the type of company and the nature of the dispute. In cross-border M&A transactions and resulting shareholder disputes, parties face significant challenges when their dispute arises in the context of an ongoing relationship, where somehow business must continue. Contracts vary in their acceptance of arbitration as a dispute resolution mechanism when it comes to mixed legal and business matters. Deadlock provisions are often relied upon to trigger a resolution arising from the sheer pressure and consequences of a lack of resolution on the business. But resorting to arbitration may nevertheless be necessary.
Maples: There are, of course, certain specific remedies and causes of action which are relevant to particular types of shareholder dispute – an unfair prejudice petition, for example. Other factors attendant in many shareholder disputes present their own challenges. Perhaps the most fundamental is the destructive effect that conflict between a company’s owners can have on the functioning and survival of its business. A commercial dispute with a supplier or service provider can be distracting enough, but where shareholders are at loggerheads, those within the business can feel an existential threat. If the business is to thrive, and shareholder interests to be preserved, such a dispute must be resolved as swiftly and sensitively as possible.
Elliott: Shareholder disputes involving smaller companies, particularly where shareholders are also involved in the management of the business and disputing parties have previously had a long and close working relationship, can be particularly acrimonious. There may be the appetite to take an aggressive or obstructive strategy in approaching the dispute. Again, introducing a neutral third party, such as a mediator, can often take the heat out of the situation. Exploring practical, non-financial solutions for parts of the dispute can isolate and focus minds on ‘deal-breaking’ issues. Putting a shareholder agreement in place from the outset can make the difference between being able to achieve a resolution, perhaps with one side buying the other out, and destroying the business if parties resort to hard fought litigation as their only solution.
“The issue shareholder claimants face, particularly minority shareholders, is proper standing to bring claims against majority shareholders or the company itself.”
FW: Looking ahead, how do you expect shareholder disputes to evolve? What particular trends and developments do you expect to see in this area?
Maples: It seems unavoidable that the current extraordinary circumstances faced by business globally will lead to an increase in financial distress for many companies. This, in turn, will lead to tension between shareholders. Some may need to exit the business sooner than expected, to free up capital for other purposes. Others may simply be reluctant or unable to provide further investment when called upon to do so by their fellow shareholders. Certainly, pressure on dividends looks set to continue, so potentially leading to discord between shareholders and boards. Against this backdrop, one must also consider the apparently unstoppable wave of third-party funding, providing potential claimants with the means to seek redress when otherwise they might not have been able to do so. All in all, we expect the growth and evolution of shareholder disputes to remain a key feature of the litigation landscape in the coming years.
Elliott: Shareholder disputes may be more prevalent when the economy and businesses are struggling, and the outlook is uncertain. The current slowdown is likely to trigger an increase in shareholder actions. As further shareholder class actions are determined by courts, the body of case law will develop, giving claimants more certainty about likely outcomes and how to target their action. Access to litigation funding and insurance for adverse costs liability has broadened the opportunities for disgruntled shareholders to bring their disputes to the courts.
Williams: In times of economic turmoil and downturns in international markets, as is currently being seen, we expect shareholder disputes to increase where businesses continue to underperform and fail. Finding funds, however, to pursue or defend litigation will also be a challenge in these circumstances. One trend in particular we expect to see is the third-party funding of claims and even of very robust defences. We expect that the sources of third-party litigation funding will continue to be the established litigation funders with the expertise to select the right opportunities, but also more mainstream venture capital and private equity funds looking for new investment opportunities in an otherwise bear market.
Ben Williams is a partner in King & Spalding’s trial practice and global disputes group. He has experience, including as advocate, resolving complex commercial disputes through litigation, arbitration and alternative dispute resolution (ADR). He also handles disputes in the courts and arbitration centres across Europe and the Middle East, acting for clients in a range of sectors, including international energy companies and financial institutions. He can be contacted on +971 (4) 377 9946 or by email: bwilliams@kslaw.com.
Geraldine Elliott, who leads RPC’s commercial litigation group, has over 25 years’ experience resolving disputes for clients. Advising clients in the financial and professional services, retail, media, industrial and manufacturing sectors, Ms Elliott’s expertise covers a range of contractual disputes with particular focus on warranty claims and other post-M&A issues, shareholder and joint venture disputes, and asset and financial recovery. She can be contacted on +44 (0)20 3060 6435 or by email: geraldine.elliott@rpc.co.uk.
Trained in both civil and common law, Julie Bédard is experienced in conflict of laws and represents clients in connection with litigation and arbitration proceedings throughout the world, raising disputes on governing law, jurisdiction, the enforcement of arbitration agreements, extraterritorial discovery and international judgment enforcement. Ms Bédard regularly advises clients on protecting their global investments under international treaties and provides strategic advice on drafting dispute resolution clauses in international commercial contracts. She can be contacted on +1 (212) 735 3236 or by email: julie.bedard@skadden.com.
Jamie Maples is a partner in Weil’s dispute resolution practice in London and a member of the international arbitration and trade group. He has successfully represented clients in some of the most complex and high-profile commercial disputes in recent years. His notable cases include acting for Littlewoods in its £1.25bn claim against HMRC, including before the Supreme Court. He can be contacted on +44 (0)20 7903 1179 or by email: jamie.maples@weil.com.
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