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Law of unintended consequences: Arbitration clauses in shareholder disputes

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United Kingdom

Fieldfisher arbitration specialists Donna Goldsworthy, Nicola Sewell and Kirstie Imber discuss how poorly drafted arbitration clauses in shareholder disputes can lead to undesirable results.

In some cases, shareholders will seek to resolve a dispute through arbitration but will still need to go through the English courts to obtain specific remedies.

Where a contractual remedy is sought, arbitration clauses will provide recourse in claims against other shareholders. However, arbitral clauses do not provide a full answer where statutory remedies are sought, particularly in unfair prejudice claims.

Failure to address this in the shareholders’ agreement is likely to lead to unnecessary costs for further proceedings through the courts.

Shareholders should therefore ensure their options for resolving disputes are carefully considered at the drafting stage.

Shareholders agreements

Shareholders’ agreements are commonly used to define the rights and obligations of shareholders, and to provide for the management and financing of the company.

A well-drafted shareholders’ agreement not only regulates the relationship between shareholders, but can also include provisions setting out ways for disputes to be addressed should things go wrong.

Shareholder disputes can range from disagreements over the company’s strategy to a breach of the company’s articles.

Unfair prejudice claims

Shareholders are provided with some protection under statute, in particular s994 Companies Act 2006.

Section 994 allows a shareholder to petition the court for relief (such as a buy-out order whereby the majority shareholders buy out the minority shareholder at a ‘fair price’) on the grounds that the company’s affairs are being, or have been, conducted in a manner that causes unfair prejudice to the interests of shareholders generally or some part of its shareholders (i.e., the petitioning shareholder).

Other protections include petitioning for ‘just and equitable winding-up’ under s122(1)(g) of the Insolvency Act 1986, or a derivative action under ss260-264 Companies Act 2006.

Arbitration and shareholder disputes

Shareholders often select arbitration clauses for potential disputes because of the advantage that proceedings are private.

Other advantages include flexibility (in relation to language and location), confidentiality (of the process and any award) and a degree of control over the process and who the arbitrators will be.

However, shareholder disputes can be complex, and careful consideration is required at the drafting stage; especially where minority shareholder disputes are concerned, as the remedies an arbitral tribunal can award may not be sufficient.

A common misconception is that arbitration offers a ‘one-stop-shop’ for resolving disputes. But in the context of shareholder disputes – particularly minority shareholder disputes – there can be practical difficulties.

While unfair prejudice claims can be arbitrated and determined by an arbitral tribunal (as confirmed by the Court of Appeal in Fulham Football Club (1987) Ltd v Richards), the tribunal does not have the power to grant all of the available remedies under s994 Companies Act 2006, most notably a buy-out order (which is the remedy most often sought).

The practical reality is that parties may end up increasing time and costs as a result of arbitrating the dispute, and then going to court to seek an order for a buy-out.

A solution to this may be a hybrid dispute resolution clause – with arbitration for some types of dispute and litigation for others.

If a party is based overseas (particularly, since Brexit, in Europe) a dispute resolution clause using the judicial process should be approached with caution, as in many cases only an exclusive jurisdiction clause will result in a recognised judgment in the country of enforcement.

Companies’ court judges are experienced and well-equipped to determine shareholder disputes, particularly unfair prejudice claims where there is scope for coming up with ‘creative’ remedies (judges having the ability to order any remedy they think fit for giving relief).

Lastly, an arbitration clause can cause further difficulties and costs if it is not carefully drafted. Wide wording encompassing ‘all disputes’ between the shareholders would be likely to include unfair prejudice claims, but wording referring to disputes ‘relating to or arising from the shareholders’ agreement’ may not (given unfair prejudice is unlikely to relate solely to a breach of the shareholders’ agreement).

The shareholders could unwittingly incur significant costs in arguing about the interpretation of the clause before the claim can even begin.

Drafting tips – Dispute resolution clauses

­Consider what shareholder disputes could arise from the parties’ relationship and what methods of dispute resolution may be the most appropriate.

­Never include a standard, boilerplate clause without further thought – ensure that the clause is drafted carefully and will ensure all relevant types of dispute between the parties are arbitrable (if that is intended) as well as making it clear who is bound by the clause.

­When considering whether to use an arbitration clause:

  • Check whether the arbitrator has specific powers for interim remedies, and if there will be a mechanism for consolidation in multi-party actions;
  • Note that the arbitrator may have power to grant specific performance or an injunction, but it may not have power to unwind transactions;
  • Remember that an arbitral panel cannot: remedy invalid resolutions; remedy non-compliance with the Companies Act 2006; or require a company to pass a new resolution;
  • Consider the implications of Brexit and where the parties (and company) are located and whether a hybrid clause may help (or hinder);
  • Bear in mind that arbitration has many advantages but cannot provide all remedies. Shareholders need to balance considerations such as confidentiality against these limitations.

Donna Goldsworthy is a partner, Nicola Sewell is a director, and Kirstie Imber is a solicitor, all in Fieldfisher’s dispute resolution team.

A copy of this article was first published by Litigation Funding.
 

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