Podcast S3E2 | Corporate & Commercial: Shareholder Disputes

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Podcast S3E2 | Corporate & Commercial: Shareholder Disputes

Podcast S3E2 | Corporate & Commercial: Shareholder Disputes 1920 700 Christopher Hooley
Reading Time: 15 minutes

Christopher Hooley and Jonathan Gray discuss shareholder agreements and eventual disputes. They give a holistic perspective on the topic – which spans from Corporate & Commercial to Dispute Resolution in how to strategize and implement necessary contractual protections in case disputes will arise. They highlight practical ways to settle such disagreements – including mediation and arbitration which might be used as alternative ways to resolve conflicts amongst shareholders.


02:49 Breach of contract
03:48 Diverging interests
05:19 Contractual rights
09:09 Early stages of a dispute
13:32 Settling a dispute
16:27 Option deeds
19:05 Arbitration of disputes
23:36 Final considerations


Welcome to Series 3 of The HIP Talks podcast: a series of discussions on legal issues hosted by Hugill & Ip Solicitors. The firm provides high quality legal services with integrity, professionalism and respect for its clients and the community. An outstanding team of lawyers who have achieved exceptional results and recognition in the areas of Dispute Resolution – Corporate & Commercial – Private Client – Family – Employment & Business Immigration and Data Privacy.

Chris Hooley  00:29
Good morning, everybody. I’m joined today for our HIP talk by Jonathan Gray, a partner in Hugill & Ip’s Dispute Resolution group. Morning, Jonathan.

Jonathan Gray  00:38
Morning, Chris.

Chris Hooley  00:39
Jonathan and I will be discussing shareholder agreements and shareholder disputes and how they interact and especially, we will try to identify commercial issues, related clauses and what is essential to be included in any shareholder agreement. In its respect, we’re concentrating on private companies, not on those listed on any regulated exchange. Why? Well, slightly different rules apply to listed companies and shareholder activism, and the requirements that a regulator can each play influential roles in those respects.

Jonathan Gray  01:10
So, Chris, if a corporate client comes to you with a potential business idea, what would your first advice be?

Chris Hooley  01:16
Well, Jonathan, depending on the relevant circumstances, and we need here to actually sort of drill down with the client and understand what his needs are. But I would suggest that every client puts in place a structured shareholder agreement, and that this agreement has specific clauses to cover practical matters, such as the adoption and implementation of a considered business plan and budget, the composition and makeup of the board of directors, matters that might require super majorities, whether that be by way of shareholder or directors, and all matters relating to transfers of shares, including preemption rights, drag along tagalong rights, what happens if there’s a default, and sometimes put and call options that might be the actual solution to that. And then, of course, there’s the dispute resolution process itself. And finally, the exit strategy: in other words, how do I sell my equity in the company, at what price and to whom. Of course, it’s very difficult at the beginning of the life of a company to think and agree upon every possible exit strategy, but assuming that the company is successful, then the client owner probably won’t just want to be rewarded by way of salary and dividend, and as an exit strategy is hugely important. Additionally, the absence of any capital gains tax in Hong Kong makes the sale of an equity in the company prima facie a non-taxable event and therefore, very good for that owner, majority shareholder.

Jonathan Gray  02:44
I see. And what would those exit situations be?

Chris Hooley  02:49
Well, it could be a breach of contract by another shareholder, in other words, a default situation, there could be a deadlock in operational management. Or there could just be a situation where a competitor, or a larger entity comes along and wants to buy out a particular shareholder. And that person being bought out would typically be the largest shareholder. In most cases, it’s essential to have an agreed methodology in advance for each situation. And sometimes that might include having tagalong and drag along rights in the shareholder agreement so that other minority shareholders can be bought out, at the same time, at the same price along the same terms and conditions as the majority shareholder. Having said that, of course, Jonathan, there’s no magic formula or definitive wording to prevent disputes from actually happening. But Jonathan, perhaps we should actually get into the areas where we would commonly see disputes, perhaps you could run through various of those.

Jonathan Gray  03:48
Sure, Chris. Well, the most common would include, say disputes where the interests of the local shareholder diverged from those of the international shareholder. For example, where the local shareholder considers that they’re being excluded from the business, or maybe that excessive costs are being attributed to the company. Or perhaps where an international shareholder considers that its partner is obstructing the smooth running of the business. Disputes can also arise from changes in share ownership in a company, for example, where a new shareholder has acquired existing shares, but considers that the company’s financial position is not as warranted, or where there’s been an issue of new shares and circumstances which might breach preemption rights or dilute existing shareholders ownership. Disputes sometimes arise between shareholders with different visions for the business. For example, where a private equity investor is looking for more short term value added solutions leading to an exit. Whereas another shareholder, maybe the founder of the business has a longer term vision for the company’s future and say other operational or other disputes, which might lead to deadlock at board or shareholder level, or to the triggering of exit clauses, the operation of which itself is disputed.

Chris Hooley  05:10
So Jonathan, do you feel that a shareholder agreement with properly structured clauses could at least reduce the risk of full blown litigation?

Jonathan Gray  05:19
Absolutely. A well drafted shareholders agreement should provide a procedural framework to regulate and govern the company’s internal management. And it should, among other things, protect the rights of minority shareholders, provide a mechanism for the quick resolution of deadlocks, regulate the rights of entry or exit of shareholders in the company and provide for methods of valuation of the fair value of the shares of the company.

Chris Hooley  05:47
I suppose it’s also worth mentioning that a shareholders agreement has the additional advantage of not being available for inspection by the general public and like the company’s Articles of Association, which can be very quickly and simply obtained by a search at the Hong Kong companies registry. So possibly sensitive details regarding the role of the parties in the in the company’s management, their rights and obligations can be confidentially contained in a shareholder agreement.

Jonathan Gray  06:16
Indeed, I know, Chris, that in many cases, clients come to you for advice at the beginning of a dispute, or perhaps where dispute looks likely to escalate. But before it gets to litigation, what do you typically tell your client at this stage?

Chris Hooley  06:32
What I think is most important, Jonathan, remember that there is no one size fits all solution, but if a dispute does appear likely, or is, is actually starting out, there are typically a number of actions that should be taken by a shareholder to properly protect his position. I think first, it’s imperative to identify what contractual documents actually exist. And so what contractual rights – typically those in a shareholders agreement or in the memorandum, or articles of association – may already have been breached, or might be in danger of being breached, particularly those at operational board and shareholder level.

Jonathan Gray  07:10
Those are obviously a documentary breaches, but what about other practical problems?

Chris Hooley  07:15
Well, that is really in respect of operational aspects. And it’s often the case that when a dispute arises, the person who’s being held out as being the general manager, is used by one party to push through various actions without reference, either to the board or to the shareholders and sometimes that would be in breach of relevant contractual documents. At board level board meetings might be called resolutions put forward in a manner, which is not consistent with corporate documents. And of course, at shareholder level, it’s imperative to identify any reserved matters, which are to be dressed only at shareholder level, and which might need to be passed with a super majority of votes or by way of unanimous vote. So, it’s very, very important to ensure that no such matters are tabled at management or board level.

Jonathan Gray  08:07
And what about the company’s corporate records?

Chris Hooley  08:09
Well, clearly, it is imperative to review the company’s statutory records to ensure that relevant parties are as they are shown, and that individuals have been properly appointed, especially the directors, the corporate status of the company needs to be considered, therefore at a very, very early stage. That is because in practice when relations are amicable companies are often not run strictly in accordance with their M&A and laws. For instance, directors are sometimes not properly appointed, but they have been treated as being de facto directors for some time, board meetings are often not convened or not conducted in accordance with relevant corporate documents and as a result, when a dispute begins, appointments or corporate actions with shareholders are considered being made, can then come under greater scrutiny. And what shareholders consider to be in the true position of company can quickly start to unravel as I think you’ve seen very recently, yourself.

Jonathan Gray  09:09
Indeed, yes, I think that’s right. The main reason for obviously, for addressing such issues at an early stage of a potential dispute, as well as any corporate requirements is really an order to avoid losing significant leverage if the dispute becomes more serious. So, for example, any corporate action, if not taken in accordance with the company’s articles should be ratified. Any directors appointments should be formalized. The company’s auditor may need to be appointed or the accounts approved in a short period of time, or maybe certain employees visas need to be renewed and this should be done. If possible, any escalation of a dispute should be avoided until issues like these have been resolved. Otherwise, it will be difficult for the shareholders to continue to run the business and one shareholder may try to use these issues as leverage to obtain an unfair advantage in a future discussion. The flip side, of course, is that if the other shareholder requires any of the actions to be taken, consideration should be given to opposing such action in order to maintain leverage if, of course, it’s to your advantage. So, Chris, what then if the dispute persists?

Chris Hooley  10:25
I think it’s important and you and I discuss this quite regularly on practical basis with clients, but it’s important to have a strategy, the answer to the dispute. And that’s where we at Hugill & Ip ensure that our commercial practice groups do work closely. And that’s with commercial working with dispute to consider what the key objectives of the relevant shareholders are likely to be. And so whether they can be realistically achieved, and I do use that word realistically, because clients at this stage need to know what is or is not in the realms of fantasy. Also, what concessions might a shareholder be prepared to make in order to reach a compromise and avoid the the cost and time of an escalating dispute?

Jonathan Gray  11:12
Yes, I think as you rightly say, it is a good idea. And I would say at a very early stage to involve litigators with experience of shareholder disputes so that they can be involved in the process. And the agreed upon strategy can and should reflect, among other things, various potential outcomes, including the possibility of court proceedings, whether it’s plaintiff or defendant.

Chris Hooley  11:36
Absolutely, one good reason to set objectives and an appropriate strategy is that they can then be clear indicator of actions going forward otherwise, apparently minor actions taken or communications exchanged between parties in the early stages of dispute can become significant later on, or they can undermine the ability of the parties to achieve the desired objectives.

Jonathan Gray  12:00
What exactly do you mean here?

Chris Hooley  12:02
Well, practically, this means that if there is an ongoing dispute, then the board representatives need to be fully aware of all operational aspects of the business in order to be informed of any significant actions which management may be taking. Any action taken by management or by the general manager that I mentioned earlier should be scrutinized in order to assess whether it is consistent with the company’s budget and business plan, authority matrix and its articles of association. And it’s also important to understand both the stated and real purpose of certain actions. For instance, if a board or a shareholders meeting is called, it’s important to review the agenda, and the information that’s attached carefully, in order to be clear about the purpose of the meeting and in order to decide whether to insist on certain items being added to the agenda, not added to the agenda, to require clarity about whether any disputed issues will be discussed, and whether of course, to attend the approval vote down any of these proposals. For example, it is possible the disputed item is not expressly mentioned on an agenda, but is then raised under an ember general heading. If the board representatives are present, then bearing in mind the quorum requirements, this could lead to a vote on an issue unless a proper objection is raised at the relevant time. So Jonathan, a situation where we have a potential dispute, but we also have a very profitable business, I still want my company to keep on running.

Jonathan Gray  13:32
Well, Chris, in that situation, it’s worth bearing in mind that settlement of a shareholder dispute is invariably the most desirable commercial outcome, given both the time and cost involved in formal proceedings, and of course, the uncertainty of their outcome.

Chris Hooley  13:48
So formal or indeed informal discussions to explore a potential settlement should always be considered, yeah?

Jonathan Gray  13:54
Absolutely. Exploring settlement, whether by way of without prejudice discussions, or mediation is always something that should be looked at and considered early on in any dispute. Some shareholders agreements, in fact provide for the parties to go through some form of ADR before they commence proceedings. Is this something you would consider when preparing shareholders agreement?

Chris Hooley  14:16
Yes, definitely every structured shareholder agreement should include a dispute escalation mechanism, under which informal negotiations or some form of what you mentioned, ADR — alternative dispute resolution, must be attempted before the actual dispute is formally referred to arbitration or court litigation. Even in the absence of such provisions, it’s always helpful to explore the situation. If this process involves discussions between senior management, this practically means engaging with the representatives of the other shareholders who are authorized to make significant decisions on their behalf. At each stage of the dispute resolution mechanism there is a trigger for the next level of process to be commenced. It is important that the shareholders precisely follow any such dispute resolution mechanism, as might be set out in relevant contractual documentation, so that in the event that a dispute needs to be resolved formally, all the requisite contractual steps have been taken, and an appropriate paper trail is already in place. For example, notice provision should be complied with and time period and deadlines need to be actually maintained and adhered to. Failure to do so might mean expensive jurisdictional challenges and a formal dispute forum, or can even mean that the resulting judgment or award could be set aside. Now you previously had mentioned as a potential ADR element mediation. So do you think that mediation is a good tool to solve shareholder disputes?

Jonathan Gray  15:53
Yes, I do, provided of course, there’s a genuine will on both sides to try to resolve matters. A mediator obviously guides the parties rather than issuing a decision and provides objectivity and experience in brokering commercial agreements. The process even helps where no settlement results from the mediation as it forces the parties to identify, often for the first time, what they’re really looking for, and also what compromises they might be happy with, as well as the weaknesses, legal or otherwise in their position.

Chris Hooley  16:27
Yes, sometimes disputes may actually not be capable of resolution, but an agreement could be reached that a shareholder will exit by selling his shares, usually for some representing the fair market value of those shares. The inclusion of a mechanism in the shareholder documentation for determining the value of such as often helps to facilitate this type of solution.

Jonathan Gray  16:49
Now, you mentioned option deeds, perhaps you can explain how those work?

Chris Hooley  16:53
Well, typically, you’d have an agreed form of option deed which would be attached as an agreed form and part of the shareholder agreement. There are two kinds of option a put and a call. I either put by selling my shares to you or there’s a call for you to sell your shares to me. The problem is that for an option to properly work, there needs to be an agreed time in which to exercise the option and an agreed price or formula for the exercise. So for instance, if there is an agreed deadlock, and one party agrees to buy out the other, the buyout price might be based on the NAV net asset value of the company. If the option is exercised when there has been a default by one party, then the price payable may be a substantial discount to the actual NAV which would be shown from the last set of audited accounts of the company.

Jonathan Gray  17:45
In disputes which are purely between shareholders, where there’s no allegation of insolvency, and thus no issues regarding interests of general creditors, and no allegations requiring full investigation in the public interest, the court also actively encourages parties to engage in mediation, and that can be cause sanctions in the event of an unreasonable refusal or failure to attempt mediation.

Chris Hooley  18:10
It is worth noting here that some parties view mediation with a degree of skepticism, but a good mediator can obviously bring about a resolution to any dispute and indeed, if the mediator does identify points that are in agreement between the parties, then it shows what is not agreed, and therefore what may need a court ruling to agree upon. And there’s also of course, the overriding issue of timing and also of the costs in any dispute situation.

Jonathan Gray  18:43
Yes, as already pointed out, litigating shareholders disputes tends to involve significant legal costs. The disputes can also drag on for a long time being extremely disruptive to a company’s business, whereas mediation where successful, can resolve disputes in a cost effective, and certainly more expeditious and user friendly manner.

Chris Hooley  19:05
We’ve talked about mediation, but might arbitration be a preferred forum, especially if there are international parties, and the Hong Kong International Arbitration Centre is the stated contractual agreed forum?

Jonathan Gray  19:22
In some cases, yes, and not just the HKIAC, but any well recognized, well regarded arbitral institute and of course, assuming that there is a valid arbitration clause in place, and if so, that the dispute itself is arbitrable. There are of course various rights and obligations associated with membership of a company that exist independently of any shareholders agreement, meaning that there can be various types of disputes between shareholders on questions on which their shareholders agreement may make no provision, and which may not be said to have arisen out of the shareholders agreement. Where applicable, arbitration simply provides a procedure for resolving disputes by way of a private process, usually under the auspices and rules of a recognized arbitral institute, such as the HKAIC, (the) Singapore International Arbitration Centre, or the ICC, rather than through the national courts.

Chris Hooley  20:21
So could we actually say that the specific advantages of arbitration are that the process is actually confidential – whereas, of course, anything that’s litigated in the High Court is open to the public – that there’s more flexibility in that and parties can by agreement – to a degree – tailor their arbitration process to suit their needs, and that an enforcement of an arbitral award under the New York Convention may be easier than having to enforce a judgment in another jurisdiction.

Jonathan Gray  20:54
Yes, I mean, I would caution here that the arbitration process is usually confidential, but not absolutely confidential. But privacy is one reason, and enforcement in particular, maybe an advantage.

Chris Hooley  21:10
Unfortunately, you and I know that certain people just like to litigate or arbitrate because that’s in their nature, and they have the money to do so.

Jonathan Gray  21:18
Yes, it seems that some people do like to litigate. And very often we do see litigation as a means of applying pressure on the other side. However, the courts often alive to this and it’s worth bearing in mind that the court takes a dim view of parties using proceedings or making certain applications within proceedings, simply in order to apply pressure, or to oppress the other side. If the court views such proceedings or applications as unmeritorious, the court may well hold them to be an abusive process.

Chris Hooley  21:53
Jonathan, you and I have a number of ongoing client matters where there are actually shareholders disputes and for two recent ones in particular, I know that there’s actually no formal contractual shareholder agreement in place – only standard articles of association. So, could I put it to you that those disputes might have been prevented if a structured shareholder agreement had actually been in place?

Jonathan Gray  22:22
Well, in one of the cases, I think that the answer would probably be yes. This case concerns a relatively common situation in Hong Kong, namely, a family company set up by the first generation. Now, there’s a divergence of opinion among the second and third generations, who are fighting primarily about how the company is being managed, whether certain real property assets owned by the company should be sold for redevelopment and exiting or cashing out by some of the shareholders. I think that had there been a well drafted shareholders agreement in place here, many of the issues in dispute would not have arisen, and the remaining issues might well have been easier to resolve without resorting in this case, to full blown litigation involving multiple sets of proceedings.

Chris Hooley  23:10
That was the first case what about the other case, the second case?

Jonathan Gray  23:13
That case is less clear. I suspect that the issues in that case would have arisen even had there been a shareholders agreement in existence. I think the point to understand here is that having a well drafted shareholders agreement is not going to guarantee that there won’t be any disputes. But certainly, it may significantly reduce the likelihood of there being any.

Chris Hooley  23:36
So could we just conclude this discussion, Jonathan, by trying to agree on a few key points?

Jonathan Gray  23:43

Chris Hooley  23:44
So that the agreement between us is that there must be if possible, a written detailed shareholder agreement, which is actually fundamental to any company having an organized and peaceful business life. However, to get to that actual situation, the solicitor instructed needs to have a detailed discussion with the client to fully understand the relevant business needs to understand practical situations that comes in, so you need to actually have a detailed due diligence discussion with the client at a very early stage.

Jonathan Gray  24:18
I believe so. And if I’ve correctly picked up on what you’ve been saying, the situations here might then entail the use of an option deed to resolve the practical situation.

Chris Hooley  24:29
Yes, certainly, the use of a properly drafted option deed can resolve many situations, not only where there is a default, and the non-defaulting party is forcing the defaulting party to sell the shares, probably at an agreed discounted price, but also where there’s deadlock in management, and one party wants to buy out all the other party’s equity interest. So, Jonathan, I think that just about concludes everything for today. So, thank you very much indeed for all your time and your very wise sage input on this matter.

Jonathan Gray  24:58
Well, thank you, Chris and thank you too for your input on the Corporate & Commercial side of things.

Tune in and listen to more episodes of The HIP Talks podcast by checking the insights section at our website at www.hugillandip.com and our channels on Apple PodcastsSpotifyGoogle Podcasts and Stitcher. They are also available on Hugill & Ip’s YouTube channel. You can send comments and feedback to our email address hello@hugillandip.com. If you found the hip talks interesting, please share them with friends, family and business associates.

This podcast is for informational purposes only. Its contents do not constitute legal or professional advice.

Christopher Hooley

Chris advises on a wide range of corporate commercial, corporate finance, mergers and acquisition, information technology matters, from strategising on tech driven start ups to drafting documentation required for complex cross border transactions.

All articles by : Christopher Hooley
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