Forcing Out a Business Partner: Proceed with Caution

Often, businesses are started between friends. They strike gold on a great idea - so they incorporate a private company, appoint themselves as directors and shareholders, and off they go. Cash flow is generally tight at the beginning, so the parties decide not to incur the expense of having a lawyer prepare a Shareholders Deed. It also seems unnecessary to have a long contract drawn up when they are friends, and they trust each other. Instead, they get going without one and put in the work to build the business from the ground up. Some businesses don’t make it, but others become very valuable.

The Importance of a Shareholders Deed

Some shareholders in private companies work together for the entirety of a business’ lifespan without issues. Others aren’t so lucky, and the relationship sours. Unfortunately, it is more common than you think. Relationships naturally change and evolve over time outside of a business setting and once inside the pressure cooker of operating a business – friends are more likely to fall out. Conflict can stem from a difference in opinion on critical business decisions, or perhaps one friend no longer ‘pulls their weight’ like they used to (whilst still taking the same share of the profits). Even more sinister are the friends who begin to act inappropriately, and in a betrayal of trust, they steal from the business bank account or act in a way that damages the reputation of the business.

Unfortunately, these situations are not far-fetched, and we regularly see shareholder disputes of this nature in practice. Clients who find themselves in such a situation are often shocked to discover that it is usually not possible to unilaterally force a shareholder (even a misbehaving one) to sell their shares in the company and exit the business unless there is a provision to this effect in the Shareholders Deed or a Court order. Therefore, it is critically important to have a Shareholders Deed put in place from the outset, so that the parties have a legally binding ‘rule-book’ with provisions to minimise the risk of disputes which derail the business and end up in Court.

However, there are ways to resolve a dispute without a Shareholders Deed.

Negotiating a Business Separation

Shareholder disputes are most commonly resolved by negotiation between the parties. However, the length of this process can vary significantly. The parties are rarely aligned on the key terms of the business separation (particularly, the value of the business and the conditions of exit) and lots of back and forth is generally required.
There are a few different resolutions that can be negotiated to achieve a business separation, including:

1. one shareholder buys the other’s shares;
2. the company buys one shareholder’s shares via a share buy-back, to effectively cancel the exiting shareholder’s shares and leave the remaining shareholder as sole owner;
3. selling the business, or the exiting shareholder’s shares, to a third party; or
4. winding up the company.

The parties will also need to consider a long list of ancillary items (such as releases of personal guarantees and restraints of trade). Once an agreement is reached, a Settlement Deed should be prepared to formalise the agreement between the parties and to give it legal effect.

Litigation (Court)

If the parties fail to agree on an exit, then litigation may be an option. Whilst it is not possible for a shareholder to force another shareholder to sell their shares, it is possible for a Court to compel a shareholder to sell.

However, a shareholder can only apply to the Court for an order in limited circumstances, usually, if a director has breached their directors’ duties or oppressed a shareholder within the meaning of the Corporations Act 2001 (Cth). It is usually insufficient if the parties are merely in disagreement with one another about routine business matters.

Directors Duties

There are several legal duties that are imposed on a person when they are appointed as a director of a Company. These duties are known as ‘directors’ duties’ and are set out in both common law and the Corporations Act. If a person breaches these duties, they may be liable for penalties, be required to pay compensation, be disqualified as a director, or even be convicted of a crime. In short, these duties carry serious consequences. Some examples include a duty to act in good faith in the interest of the company and a duty to act for proper purposes and not to abuse a corporate opportunity.  

Shareholder Oppression

Shareholder oppression is conduct by a shareholder that is unfairly prejudicial to, or contrary to the interests of, the other shareholder(s). It must be conduct that is greater than mere mismanagement or differing views in how the business should be run. Similarly to directors duties, there is no exhaustive list of conduct that will constitute oppressive conduct. However, past cases have pointed to some examples of conduct that is likely to be considered oppressive.

The court has discretion over the orders they can choose to make in an oppression proceeding. Section 233 of the Corporations Act 2001 (Cth) provides a list of possible orders, including:

1. that the Company be wound up;
2. a shareholder buys the other out (either by using Company funds in a buy-back and by using funds out of the shareholder’s own pocket); or
3. the Business is sold to a third-party purchaser.

There is no guarantee that the court will agree to make the order that the shareholder bringing the proceeding has requested.

Resolving a Business Partner Dispute

Business partner disputes should be handled with care. Failing to take strategic steps at the right time can result in irreversible mistakes, particularly given the complex legal landscape governing relationships between business partners. Conversely, a carefully developed and methodically executed strategy plan will likely result in a better outcome.

Please click here and fill in the contact form to start a conversation with our team about a business partner dispute.

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This article in no way constitutes legal advice. It is general in nature and is the opinion of the author only. You should seek legal advice tailored to your individual circumstances before acting on anything related to this article.