Under the Model articles of association, there is no statutory provision that enables any one party to force a company shareholder to sell their shares. However, if certain circumstances necessitate the removal of a shareholder, there are several potential ways to achieve the desired outcome. We discuss these below.
How to remove a shareholder or force a sale of shares
Ordinarily, a sale of shares takes place through negotiation between the shareholder and another party. The purchaser may be one of the other existing shareholders in the company, or even an external investor.
In such situations, and provided there are no restrictions on share transfers in the company’s articles of association or shareholders’ agreement, the sale can be carried out by mutual agreement using the share transfer procedure.
However, business relations and negotiations are not always plain sailing. There is no way to predict what may or may not happen throughout the life of a company, even when going into business with family or friends.
This is why it is so important to plan for all eventualities when you set up a company, ensuring carefully drafted articles and a shareholder’s agreement are in place from the start. By doing so, potential disputes and problematic situations can be avoided or more easily resolved.
Where share transfer negotiations fail, there are several potential options available for forcing the sale or removing a shareholder from a company entirely.
1. Existing provisions in the articles or shareholders’ agreement
In the first instance, check the company’s articles of association and shareholders’ agreement. One or both of these documents may contain specific provisions that would enable the company to force a sale of shares under certain circumstances.
Some companies include a compulsory transfer provision and a share buyback clause, which can be applied when specific events occur, such as:
- cessation of directorship – i.e. when a director (who also holds shares) resigns, retires, is dismissed, or is made redundant
- cessation of employment – i.e. when an employee (who holds shares as part of an employee share scheme) resigns, retires, is dismissed, or is made redundant
- the death of the shareholder
- the mental or physical incapacity of the shareholder
- shareholder bankruptcy or company insolvency
- a change of control of the company
- separation or divorce – e.g. if you chose to transfer some of your shares to a spouse or partner for tax purposes, or set up the company together
Also known as a ‘leaver provision’, a compulsory transfer provision protects the interests of the company. For example, if a director or employee who holds shares were to stop working for the business, it would make sense that they would have to sell their shares and no longer profit from the company’s success.
Under this type of provision, an exiting director or employee is usually categorised as either a ‘good leaver’ or a ‘bad leaver’. The circumstances of their departure will determine which type of leaver they are and, consequently, whether they should receive market value or nominal value for their shares.
Death of a shareholder
In the case of a shareholder who dies, their shares in the company would pass to whoever inherits them under the terms of their will, or if a will doesn’t exist, under the rules of intestacy. If there are no relevant provisions or agreements in place to provide otherwise, this could result in a relative with no understanding of the business controlling a significant percentage of the company.
Most companies would prefer to avoid this type of potentially problematic situation. The best way to do this is to incorporate specific provisions setting out the procedure that must be followed if a shareholder dies. For example, compulsory transfer to the surviving shareholders, pre-emption rights, a cross-option agreement, or a share buyback.
Drag-along rights enable majority shareholders to force minority shareholders to sell their shares if the company is to be sold. Including a drag-along clause in the articles means that the minority cannot prevent the sale of the company.
2. Alter the articles of association
If there are no appropriate provisions in the articles of association or shareholders’ agreement, it may be possible to alter the articles to include provisions that would allow for compulsory share transfers. To do so, the members would have to pass a special resolution.
To pass a special resolution, a 75% majority of shareholder votes must be in favour of the proposed course of action. However, care must be taken with such decisions, because minority shareholders could apply to the court to claim ‘unfair prejudice’.
This type of claim is generally only valid if the motive for altering the articles of association is deemed improper and not in the company’s best interests. It depends on whether a ‘reasonable person’ would consider this to be the case.
If the alterations are being introduced for the first time, as opposed to an enhancement of existing share transfer provisions to provide greater clarity and consistency within the articles, the changes are more likely to be deemed unfairly prejudicial to minority shareholders.
3. Reduce dividend payments
In situations where a former director refuses to sell their shares, the company could consider reducing shareholder dividend payments and increasing the salaries of the remaining director(s). However, this would only work if all of the existing shareholders were also directors.
Whilst this is not the most tax efficient form of director remuneration, it may be preferable to distributing future profits to someone who no longer participates in running the business.
4. Wind up the company
As a last resort, the other shareholders could wind up the company using the members’ voluntary liquidation procedure, provided that:
- they hold at least 75% of the shares, and
- the company is solvent
By doing so, the company’s assets can be transferred to a new company in which the non-participating shareholder has no shares. This is a drastic measure, but it may be the best option if all other attempts to force a company shareholder to sell their shares have failed.
Thanks for reading
There is no statutory provision that enables you to force a shareholder to sell their company shares, and there is no guarantee of being able to reach a mutual agreement through negotiation.
To avoid potentially drawn out and costly alternative routes, you should ensure that your company has suitably drafted articles of association and a shareholders’ agreement, that enables the compulsory sale of shares in certain situations.
We recommend consulting a corporate solicitor to help with the preparation of these documents, and to provide expert advice on any shareholder issues that may be affecting your company.
If you have any questions about this post, please comment below or get in touch with our company formation team.