Sometimes shareholders can find themselves bound together as more than just the owners of shares, becoming 'quasi-partners'. Andrew Cromby explains.
English law recognizes many different types of entities; individuals, companies, and LLPs being just three of the most common. It also recognises various kinds of relationships between those in business. One of those is, of course, the relationship of “partnership”.
Unlike a company or an individual, a partnership has no separate legal personality – rather it is a relationship between individuals who own the business and where they owe each other strong duties of good faith.
Unlike partnerships, which are owned by individuals directly, companies are owned through shareholdings. Generally, shareholders don’t owe each other duties as a consequence of owning their shares, although they can and often do agree matters between themselves in bespoke shareholders' agreements.
However, there are times when the shareholders in a company can find themselves bound together as more than just the owners of shares, becoming “quasi-partners”.
What is a “quasi-partnership”?
A quasi-partnership may arise when two or more individuals decide to establish or develop a business together, using a corporate vehicle – typically a limited company.
This doesn’t happen in every case, but it can happen when the individuals developing the business share risk and reward, jointly managing their business. It’s a feature of this relationship that they act in a way which is consistent with them owing each other a duty of trust.
This occurs more often than might be expected. Small family businesses, friends founding a commercial dynasty together and long-term business associates operating though corporate vehicles are all capable of being deemed to be quasi-partnerships.
If the arrangement is such that it amounts to a quasi-partnership, what are the consequences?
One of the main consequences is that the court will grant to a minority shareholder in a quasi-partnership additional protection from being “unfairly prejudiced” by the majority shareholder(s).
In particular, if a minority shareholder is ousted from the business (or, equally, removed from control) it may be possible for him to bring a claim in accordance with section 994 of the Companies Act 2006.
If successful such a claim results in the shares of the minority shareholder being purchased by the majority (or sometimes the company) – but without any discount being given in relation to the price of the shares, to reflect the fact that they represent a minority (non-controlling) shareholding.
Instead, they are valued pro-rata to the total value of the company’s shares, increasing their purchase price substantially.
Quasi-partnerships are nothing new. The concept was first developed in the case of Ebrahimi v Westbourne Galleries 1973 AC 360, a decision of the House of Lords, which has now been replaced by the Supreme Court as the highest domestic English court.
The leading case in this area is currently O'Neill v Phillips 1999 BCC 600HL, which concerns an employee being given shares in a business by the owner and the battles that ensued to control the division of profits and the running of the business.
It’s a lesson in what can go wrong when business partners don’t have a proper agreement in place regarding the ownership and running of a business.
So, where shareholders fall out with each other and one or more are excluded, deprived of profits or otherwise treated in a prejudicial manner, the minority can rely on their quasi-partnership to permit them to fight back.
Disputes in relation to quasi-partnerships are notoriously complex and (even for litigation) acrimonious. When it comes to litigation, prevention is always better than cure.
A well-drafted shareholders’ agreement will significantly reduce (or even extinguish) the possibility of a quasi-partnership claim. The best time to put such an agreement in place is before your start your new business but, in reality, this is often overlooked.
If litigation can’t be avoided, it is important to act quickly and not to delay bringing a claim, failing which a party’s position can be damaged.
This is a specialist area of law and acting swiftly in response to abusive practices by the majority shareholders can be helpful. Claimants may seek damages but also, exceptionally, injunctions where the need to act quickly is essential.
Most cases advanced by minority shareholders settle – fairly typically at a mediation at which the parties can present their respective positions with the involvement of a neutral mediator. The involvement of a third party can assist in defusing what may otherwise have scope to be a confrontational meeting where little can be achieved because of the strength of feeling involved.
Whether you need a pre-emptive shareholders’ agreement, assistance with a claim or guidance on resolving matters, our corporate and litigation teams will be happy to assist.
Learn more about the services offered by our partnership and LLP solicitors.