Buying Out Minority Shareholders under the Companies Act 1985

If you own a minority interest in a company, the end may be nigh. Large numbers of people are becoming aware of their rights as minority shareholders and there’s an increasing number of challenges to the procedural and legal rules that underpin the system. As shares change hands, potential buyers are carefully considering what protections minority shareholders need.

In this post we'll discuss how buying out minority shareholders can give companies more powers. We'll address some of the misconceptions around what is actually available under law to protect minorities, and conclude by looking at how things might change in future with new legislation on its way.

The Myth of the "Independent":

One of the greatest myths regarding minority shareholder law is that a company with no investors, who takes no share capital, and has no share register, is automatically 'independent'. This is an incorrect interpretation of the Companies Act 1985.

The Act was amended in 1995 to create a new category, "no investor" company. Any company that could be formed without any registration or share capital was classed as 'no investor' and entitled to special advantages under certain circumstances. The 1991 Regulations set out some specific features of these companies which are designed to protect minority shareholders should they need it. However, the Act and Regulations still require that a company must have either a share capital or shareholders to be classified as an "investor" company under the Companies Act.

The 1995 Act also contains provisions which allow those who have 'invested' in a company (e.g. bought shares) to protect their rights by buying out those who previously had an interest in the company but do not now.

The 1991 Regulations run alongside the 1995 Act and some of the provisions (particularly around no investor companies) will only apply to companies which were formed before January 1, 1991. There are provisions which protect those with minority interests no matter what date their company was formed. It is therefore essential to read the entire section of the Regulations and consider its effect.

For example, in order that a company is not classified as 'no investor' under the Act, at least one of three conditions must be satisfied:

The advantage of a no investor company is that it can avoid being designated as a public company (i.e. an unlimited company / public limited company) and thereby avoid some of the requirements that would otherwise apply – but only if these conditions are met! Also, once that status has been lost for any reason (e.g. an investment being made) it cannot be regained.

If you have no shareholder or share capital and are not prepared to comply with the conditions above, you will still have a duty of disclosure to all your 'interested parties' – especially if the value of their investment changes, or if new shareholders are added (see below and section 688 of the Companies Act 1985). However, there is no requirement for accounting records or an audit.

1A 'Interested party' can be a current employee, management consultant, creditor or anyone else who may gain from knowledge of a company's finances (e.g. share price etc.). This can include individuals as well as companies.

Cross-Director Deals

A company cannot purchase its own shares. However, the Act does allow a director to buy shares independently of their company and in so doing represent his or her own interests. This is known as a 'cross-director' deal. A cross-director deal can be structured so that it benefits the director personally or it can be structured in such a way that it benefits another company with which the director is associated (e.g. as shareholder, employee or consultant). In this case, the share purchase must be made with that other company's money and not from corporate funds (e.g. cash raised on credit cards).

The company in which the director is a director will have to be treated as an 'interested party' and so be notified of the cross-director deal. If no 'interested party' has been identified and also confirms that it does not object to the deal, then the purchase can go ahead. If there are multiple cross-directors involved and there are concerns about the amount of money involved etc., the company responsible for making those decisions should be contacted first.

You will have to comply with all financial reporting rules (e.g. keeping accounts) under Companies Act requirements even though you are not required by law to issue any statements to your shareholders or investors – or indeed any financial information at all.

Transfer of Control

The Companies Act 1985 contains provisions to protect a company's independence and its ability to conduct business by restricting the transfer of control. Essentially this means that if you want to sell a large stake to an external party, you need to seek approval from the directors first. If they believe that the transaction would adversely affect the company's future prospects, share price or its ability to raise funds in the future, then they may refuse your request for approval. In such a case you will need to consider whether the transaction is truly in the best interests of the company and its shareholders – i.e. whether it would be beneficial for all concerned, or would result in your company being bought out by another party.

Companies can also be 'dissociated' from other companies if the ultimate objective is to take a company private and ultimately to sell it (or part of it) on to another party. This may occur when the founder(s) leave, or when the management buy out their peers with shares (and then try to pursue an IPO). The full reasons for refusing an application to acquire shares are set out in the Act and Regulations but can be summarised in four ways:

(1) There is a belief that the financial position of the company is not as good as it had been thought to be. An example might be giving misleading accounts to inflate share prices, thereby increasing the value of a private sale.

(2) There is a belief that information held by the company would adversely affect its future prospects. Such information may include proposed changes in ownership or management (or both), pending litigation etc. For example, if you are planning on changing your current legal status (e.g. from an LLP to a company) you would need to inform your shareholders and receive their approval first.

(3) There is a belief that the transaction does not represent good value for money for the company as a whole. An example might be where your business has been struggling, but you have only informed your fellow directors of this but not the shareholders.

(4) The sale results in part or all of the company's assets passing into the control of a single body. This is known as 'de-facto' privatisation and may apply whether or not there are other interested parties who wish to buy in at that time.

Conclusion

It sounds complicated, but if you are an individual making a decision about whether to become a shareholder in a company then there is only one key question to ask yourself: What is the likelihood of your investment being successful? If you think that it is very likely then proceed. If you have mixed feelings, you may wish to talk it over with a qualified solicitor or qualified accountant.

You should also be aware of the new rules for companies which are 'no investor' – i.e. those companies which are not public limited companies or public companies (see above). If your company wants to be classified as 'no investor', then you must comply with all disclosure and accounting rules under Companies Act 1985 requirements.