Can I Force a Shareholder of a Company to Sell their Shares?

No specific statutory provision under the model articles can force shareholders to sell their company shares. However, certain circumstances may result in the removal of the shareholder.

Forcing a shareholder out of the company can be tricky, but you can achieve this in several ways. This blog discusses how to force a company's shareholders to sell their shares and what happens when they refuse to sell them.

How do you Force a Shareholder to Sell their Shares

In most cases, the sale of shares happens through the negotiation between a shareholder and a buyer. The buyer may be an external investor or another shareholder within the company.

If the shareholders' agreement or company's articles of association provide no restriction on the transfer of shares, the transfer or sale of shares may occur by mutual agreement through a share transfer procedure.

However, in company relations and negotiations, things may turn wrong. Additionally, you may not predict what may happen in your company in the future, even when partnering with your closest allies.

Planning for even the unexpected is essential when setting up your business. You can do this by drafting the shareholders' agreements and articles of association from the company's beginning. This will help solve potential disputes and other problematic situations in the company.

In case the share transfer negotiation fails, you may use other options, such as removing or forcing the share sale to remove the shareholder from the business.

Provisions in Shareholders' Agreement or Articles of Association

You need to look into the company's shareholders agreement and articles of association. These documents may have existing provisions that may enable the business to force a shareholder to sell their shares under specific circumstances.

Some companies include compulsory transfer clauses or share buyback provisions that they can employ whenever certain circumstances occur, such as:

1. Death of a shareholder
2. Cessation of directorship: this is when a director who owns shares retires, resigns, or is dismissed from the company
3. Cessation of employment: when an employee owning shares retires, resigns, or is dismissed from the company
4. Physical or mental incapacity of a shareholder
5. Business change of control
6. Company insolvency or shareholder bankruptcy
7. Divorce or separation

Compulsory transfer clauses, or leaver provisions, protect your business's interest. This means if an employee or director who owns shares in the company stops working, they must sell their shares, and they will no longer profit from business success.

This provision classifies departing directors or employees typically as either good or bad leavers based on the circumstances of their exit. This classification determines whether they should be compensated with market or nominal value for their shares.

Examples of good and bad leavers

Good Leavers

1. Redundancy
2. Death or critical physical or mental condition that results in a shareholder not working
3. Ill health or death of employee, child, or spouse
4. Retirement as a result of an individual retirement age
5. Unfair dismissal by the business
6. Failure to meet performance goals due to reason beyond control
7. If an individual voluntarily resigns for justified reasons, such as investors or founders recognising their significant contributions to the company's success, this could be a good leaver scenario.

Bad Leavers

These are individuals who damage the business or cause losses, such as:

1. Fraud
2. Failure to meet performance goals due to poor performance
3. Termination because of severe misconduct
4. Voluntary resignation, even if investors and founders don't want the employee to leave
5. Disqualification as a director
6. Bankruptcy
7. Leaving before the agreed milestone
8. Breach of the shareholders' agreement

Shareholders' or share scheme agreements may include provisions granting the board of directors the authority to exercise discretion in determining whether a departing individual should be a good or a bad leaver, as it can sometimes be challenging to make this distinction definitively.

Death of a Shareholder

When a shareholder dies, their business shares will pass to an individual who inherits them based on their will or intestacy rules when there's no will. Without any pertinent provisions or agreements dictating otherwise, this case could lead to a situation where an individual lacking business knowledge has significant control over a portion of the company.

Many companies prefer to prevent this problematic scenario by incorporating provisions of procedures to follow in case a shareholder dies—for instance, compulsory transfer to available shareholders, cross-option agreement, pre-emption rights, or share buyback.

Drag along Clause

Drag-along rights allow majority shareholders to compel minority shareholders to sell their shares when the company is being sold. Incorporating a drag-along provision in the articles ensures that the minority shareholders cannot obstruct the company's sale.

Change the Articles of Association

If your company shareholder's agreement or articles of association have no appropriate provisions allowing compulsory share transfer, you may alter it. However, the company member must pass this special resolution.

To enact a special resolution, a 75% majority of shareholder votes must support the proposed action. However, you must be cautious when making such decisions, as minority shareholders can petition the court, alleging unfair prejudice.

The petition is only valid if the motive of changing the articles of association is improper and not in the business's best interests. The determination hinges on whether a reasonable individual perceives this as accurate.

Suppose the modifications are new rather than improving the existing transfer provisions to make them clearer and more consistent within the articles. In that case, the alterations are more likely to be considered unfairly biased against minority shareholders.

Reduce Dividend Payments

If a former director refuses to sell the company shares after exiting, the business may consider reducing its shareholder dividend payments and increasing the salaries of existing directors. This may only work when all current directors are shareholders.

Although the method it is not the most tax-efficient way to compensate directors, it might be better than giving future profits to someone no longer running the business.

Wind up the Business

As a final option, the remaining shareholders could opt to dissolve the company through the members' voluntary liquidation process, given that:

• They own at least 75% of the company shares
• The business is solvent

In this way, the company's assets can be moved to a new company where the shareholder who is not participating does not hold any shares. Though it's a serious step, it might be the most suitable choice if all previous efforts to compel the shareholder to sell their shares have been unsuccessful.

How are Shares Valued Upon Shareholders' Exit?

As you can understand, determining the value of shares upon exit can lead to disagreements. Therefore, investing time upfront to contemplate different scenarios and seeking sound legal counsel is essential.

Good leavers are paid market price once they return their shares to the company. The company may permit good leavers to retain the vested shares, as they symbolise their past contributions.

In contrast, bad leavers must typically surrender their shares back to the company at a nominal value, such as £1 per share.

Sometimes, the share price offered may be at a discount market value discount based on the circumstances as a way of penalty.

You may have talked about how to figure out the market value. One way is to base it on the share price from the last investment round. You could ask your auditor or accountant to help with the valuation for employee share schemes.

How a Share Transfer Works

The company articles describe how shares are transferred back to the company. The business may repurchase the shares by transferring them to a pool of shares they can offer to other employees, or existing shares may buy them. This may need negotiation.

A company acquiring leavers' shares is advantageous because:

1. Executives are motivated to remain with the company until their shares are completely vested
2. Leavers' shares will be available to new shareholders instead of issuing new shares and diluting other shareholders
3. It's not advisable to have an ex-employee who left holding shares and benefit from the business growth

If a founder departs early as a good leaver in a company acquisition scenario, its vesting schedule could be sped up to allow its shares to vest sooner. Because it's not their fault, they should receive the originally planned rewards upon the company's sale and the agreed-upon earn-out.

When an individual leaves, they must be paid for their shares. Existing shareholders must look for money and pay for the leavers' shares. You should consider this in advance, perhaps arranging for payments to be spread out over time to prevent cash-flow problems. This could discourage someone from leaving, as they won't receive immediate payment for their shares.

Final Thought

No statute allows you to force a shareholder to sell their business shares, and there's no assurance of reaching a mutual agreement through negotiation.

To avoid getting into expensive alternative options, ensure your company has drafted shareholders agreements and articles of association provisions allowing compulsory share sale in specific scenarios.

You can consult a corporate attorney to help draft these documents and share expert advice on shareholder issues that may affect your business. If you have any questions about forcing a shareholder of a company to sell their Shares, don’t hesitate to contact us here, and we’ll do everything we can to help.