The Companies Act, 2008 (“Companies Act”) (utilised in conjunction with some careful and commercially savvy legal drafting) offers a range of protections aimed at combatting the risks alluded to above. These mechanisms (which should be seen as tools in a commercial lawyer’s toolkit) must be considered upfront. This article highlights some of the most effective tools and the manner in which they could be employed to the benefit of a company’s minority shareholders.
1. Reserved Matters and Veto Rights
One of the most common ways to protect minority shareholders is to identify specific “reserved matters” requiring not only an ordinary resolution, but a super-majority or even unanimous consent. Examples include:
- the issue of new shares (to prevent dilution);
- the sale of the business or major assets;
- changes to the company’s Memorandum of Incorporation (“MOI”); and
- related-party transactions.
By building these consent thresholds into the MOI or shareholders’ agreement, minority shareholders secure a meaningful voice in decisions that fundamentally affect their investment.
2. Pre-emptive Rights on New Issues and Share Transfers
The Companies Act recognises pre-emptive rights by default (section 39). These rights are however capable of being limited or waived in the MOI. Minority shareholders should therefore insist on retaining or even strengthening these rights:
- upon an issue of shares: first option to subscribe for new shares before outsiders; and
- upon a transfer of shares: right of first refusal before existing shareholders sell to third parties.
These provisions guard against dilution and unwanted business partners entering the company’s shareholding with the minority shareholders.
3. Tag-Along Rights
Whilst majority shareholders may secure “drag-along” rights (compelling minorities to sell if a majority sale occurs), minority shareholders should balance this with tag-along rights.
Tag-along entitlements provide that in instances where, controlling shareholders sell their stake, minority shareholders are entitled to require the purchaser to acquire the minority shareholders’ stake on the same terms so as to ensure that such minorities are not left stranded with an unwanted new majority shareholder.
4. Information and Access Rights
The Companies Act provides shareholders with statutory entitlements relating to access to records (section 26). The ambit of information to which they are entitled is however often insufficient, and practical protection requires further reaching entitlements. Minority shareholders should attempt to negotiate access to:
- quarterly management accounts;
- auditors and financial statements; and
- observer rights at board level.
5. Remedies for Oppression and Unfair Prejudice
Section 163 of the Companies Act creates a remedy in favour of minority shareholders in instances where the company or its controllers act in a manner that is “oppressive” or “unfairly prejudicial” to the applicable shareholder.
Whilst section 163 provides for powerful remedies, the litigation required to be embarked upon to invoke these remedies is often costly and faces uncertain outcomes. A properly drafted agreement remains the first line of defence in relation to undesired conduct undertaken by the company and its controllers.
6. Exit Mechanisms
It is imperative that minority shareholders negotiate clear exit options, allowing them to realize their investment. These may include:
- put options (forcing the majority or company to purchase their shares);
- forced purchase provisions triggered by deadlock; and
- agreed valuation methodologies (in order to avoid costly disputes later).
Conclusion
Minority shareholder protection should not be aimed at obstructing company management or eroding majority rule. It should rather endeavour to strike a fair balance by ensuring that investors who take the risk of backing a business venture (but who do not control it) are treated with dignity and fairness, whilst providing for them to exit their investment on reasonable commercial terms at the appropriate juncture.
