Commercial skill and artistic flair are often strange bedfellows. A situation where the shareholder/managing director of a successful fashion brand wants to go in one direction whilst the shareholder/design director has other ideas is a regular occurrence. Existing tension between the two shareholder directors is often exacerbated by the belief – or lack of it – that further investment is needed.
With apologies to Jack Nicholson, something’s gotta give. This usually occurs when the managing director seeks investment and agrees that a third party invests money and receives 20% of the company. In the absence of legal advice there is not an agreement between the shareholders in place or bespoke articles of association. The designer feels affronted and disagrees with price at which the shares will be sold.
So what are the lessons to be learnt?
1. “In life, problems are solutions waiting for answers”
A very old cliché but often very true.
In a couple of transactions this year, there were problematic obstacles which could have prevented a potential exit strategy. For example, there was a concern about whether transferring assets out of the deadlocked brand company could be subsequently attacked as a transaction at undervalue. This is where an insolvency official has the right to review recent dubious transactions. After reviewing the assets of the company it was soon apparent that a transfer of the assets was not actually needed, as key customers/suppliers were more than happy to enter into new contracts with a newco rather than having their existing contracts transferred over.
2. Big Characters = Big Challenges
People often get very entrenched in shareholder disputes. Typical examples of these are when directors fall out with other directors or when shareholders no longer trust the board and the direction in which they are taking the company. Often the chief protagonists were initially friends, as well as business colleagues before, so the breakdown of the relationship impacts on several levels.
"Each story has two sides" and "principles are expensive things" are also truisms very relevant in shareholder disputes. Even if a client has a very strong legal position, it is often a case of being pragmatic and looking for common ground and trying to repair a relationship too. Sometimes even an apology will go a very long way to solving a dispute.
3. Carrot and Stick
Often a party can be wearing three hats (employee, shareholder and director) particularly if working for a close knit fashion brand. With a bit of creative thinking, an unhappy shareholder can be encouraged towards a settlement if pressure is applied in the right areas. A bunch of carrots could include:
- a favourable tax rate (if entrepreneurs’ relief applies, tax should only be charged at 10% on a share sale);
- a possible tax free payment in compensation for loss of office;
- a relaxation of restrictive covenantsnon-compete obligations; and
- an agreed reference and press release (if required).
The sticks are often the reverse of the above with, for example, the threat of removal as a director/employee putting at risk entrepreneurs’ relief. If the company is in financial difficulties, unsurprisingly the threat of bringing in an administrator can have a galvanising impact. Time limiting or otherwise reducing the offer can sometimes also be an effective tactic.
4. Mediation but get the right mediator
If there is a shareholder’s agreement in place, there is often a dispute resolution clause requiring the parties to sit down to try and thrash out a resolution. Often there is an additional obligation to appoint a mediator to assist with the process. Mediators can work wonders in bringing parties together who were polar opposites at the start of the mediation.
On the flip side, there can be mediators who add no discernible value and waste valuable time struggling to understand entrenched positions. It is important that the professional advisors identify the right mediator for the particular set of circumstances and characters in question.
5. Use trusted intermediaries
Sometimes the deadlock can become so toxic that there is no ability to negotiate directly between the parties. In such circumstances, it can be effective for each side to appoint a trusted intermediary who is fully briefed and have a mandate to negotiate an exit from the company without all the emotional baggage also taking part in negotiations.
6. Read the small print
It is important that all the parties review the wording and understand key provisions in shareholders’ agreements and bespoke articles of association such as what consents are required to remove a director; deadlock resolution clauses; what are the quorum provisions for shareholder and director meetings; has the chairman got a casting vote etc.
7. Legal costs can take centre stage
Parties who have been previously arguing over the commercial running of the company can suddenly find another agenda added to their settlement discussions: who pays legal costs (particularly if particulars of claim have been filed)!
Costs can escalate rapidly and there are often legal considerations involved if the deadlocked company is asked to pay the same. Parties should take care that the legal costs do not overtake the value of any potential settlement. Settlement at an early stage obviously reduces this exposure.
8. Check the articles/insurance policy
Sometimes the dispute in question can arise as a result of the actions of a director (as opposed to actions taken by an employee or by a shareholder pursuant to his rights under a shareholders’ agreement). Often towards the end of the articles of association, there are indemnity provisions allowing the director to be indemnified by the company for his action. It may also be that the company has taken out a D&O insurance protection and a costs contribution is available under that policy.
9. Future proof your actions
Sometimes directors will commit to writing proposals that arguably are not in the best interests of their company's creditors or other shareholders. Often there is a misunderstanding that because communication is with the company’s lawyers, such emails will be deemed privileged and not be disclosed. This is not always the case. For example, if the company subsequently goes into insolvency, its appointed administrator/liquidator could legitimately request access to such emails as they are standing in the shoes of the company. Even if a proposal was not implemented, it could provide ammunition if the official is looking at the actions of the board in a wrongful trading, transaction at undervalue, or breach of duty case.
10. Find a way to settle
In post mortems after a deadlock has been settled, clients often express the wish that they wished they had found a way to settle the case at an earlier stage. It follows that getting the parties together (even if it does involve at first separate conference rooms), is always key. Thinking about the future, the wider impact on the brand (particularly if the brand is linked to a key person involved in the dispute) should be at the forefront of minds in such discussions. If a brand is damaged, any investment in the company housing such brand will also be damaged.
Having creative and proactive professional advisors looking to identify middle ground is also essential. They can help and hopefully assist in the early stages of a likely dispute before things escalate.