This article is the second in our Corporate Disputes series, and deals with some of the key issues to be addressed when a dispute has arisen between a company's shareholders.
There can be any number of reasons why disputes arise between shareholders in the Middle East. The most common include:
- Disputes within onshore companies, where the interests of the "local" shareholder diverge from those of the "international" shareholder (for example, where the "local" shareholder considers that they are being excluded from the business or that excessive costs are being attributed to the company, or where an "international" shareholder considers that its partner is obstructing the smooth running of the business);
- Disputes arising 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 has been an issue of new shares in circumstances which may breach pre-emption rights or dilute existing shareholders' ownership);
- Disputes between shareholders with different visions for the business (for example, where a private equity investor is looking for more short term "value add" solutions leading to an exit, whereas another shareholder - often the founder of the business - has a longer term vision for the company's future); and
- Operational or other disputes which lead to deadlock at board or shareholder level, or to the triggering of exit clauses, the operation of which is itself disputed.
Protecting your position at the start of a dispute.
If a dispute arises (or looks likely to escalate), there are some immediate actions which should be taken by a shareholder:
- You should review your existing contractual rights under the relevant corporate documents (typically a shareholders' agreement and the memorandum and articles of the company (MoA)) in order to identify provisions which a party may have breached, or be in danger of breaching, at operational, board and shareholder levels. For example:
- It is often the case, when a dispute arises, that the "General Manager" position (which is a common position in the region but not elsewhere) is used to push through actions without reference to the board or shareholders, sometimes in breach of relevant documents;
- At board level, board meetings may be being called, or resolutions put forward, in a manner which is not consistent with the corporate documents; and
- At shareholder level, certain matters (usually designated "Reserved Matters") will be required to be addressed only at shareholder level and can often only be passed with a super-majority, or unanimous, vote. It is important to ensure that no such matters are tabled at management or board level.
You should consider the corporate status of the company at an early stage. That is because, in practice, when relations are amicable, companies are often not run strictly in accordance with their MoA/relevant laws. For example, directors are sometimes not properly appointed but have been treated as de facto directors for some time, and board meetings are often not convened or conducted in accordance with the relevant corporate documents. As a result, when a dispute begins, appointments or corporate actions which shareholders have considered to have been made can come under greater scrutiny, and what shareholders consider to have been the true position of the company can quickly start to unravel.
It is important to address any such issues, as well as any corporate requirements, at an early stage of a potential dispute in order to avoid losing significant leverage if the dispute becomes more serious.
- any corporate action (if not taken in accordance with the company's articles) should be ratified;
- any directors' appointments should be formalised;
- if the trade license needs to be renewed shortly, this should be expedited;
- the company's auditor may need to be appointed, or the accounts approved, in a short period of time; and
- if certain employees' visas need to be renewed, this should be arranged.
If possible, any escalation of a dispute should be avoided until issues like the above are resolved. Otherwise, it will be difficult for the shareholders to continue to run the business - and one shareholder may use these issues as leverage to obtain an unfair advantage in any future discussions.
The flip-side of the above, of course, is that, if the other shareholder requires any of the above actions to be taken, consideration should be given to opposing such action in order to maintain leverage.
What to do if the dispute persists
It is very important to formulate an overall strategy at the outset of a shareholder dispute: the respective shareholders should consider what their key objectives are, and how they can realistically be achieved. Consideration should also be given to what concessions a shareholder would be prepared to make, in order to reach a compromise and avoid escalation of the dispute.
One good reason to set objectives and an appropriate strategy is that they can then inform all actions going forward. Otherwise, apparently minor actions taken, or communications exchanged between the shareholders or their lawyers, in the early stages of any dispute can become significant later on, or can undermine your ability to achieve your objectives.
When a dispute is persisting, focusing on the ongoing corporate actions of the company becomes even more important. For example:
- Your board representatives need to keep close to the business, in order to inform you of any significant actions which management may be taking;
- Any action which may be being taken by management or the General Manager should be scrutinised, in order to assess whether it is consistent with the company's business plan, authority matrix and the MoA;
- It is important to understand both the stated, and real, purpose of certain actions. For example, if a board or shareholder meeting is called, it is important to review the agenda and information packs 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;
- Whether to require clarity about whether any disputed issues will be discussed; or
- Whether to attend at all.
For example, it is possible that a disputed issue is not expressly mentioned on the agenda but is then raised under another general heading. If your board representatives are present, then (bearing in mind any quorum requirements), this may lead to a vote on the issue unless objections are raised at the relevant time.
Settlement of a shareholder dispute is invariably the most desirable outcome, given both the time and cost involved in formal proceedings, and the uncertainty of their outcome. This is particularly the case if the company whose shareholders are in dispute is incorporated in an onshore jurisdiction in the Middle East, as remedies such as orders requiring a shareholder to transfer its shares and exit the company are not generally available in the local courts (and will not be enforced even if ordered by an arbitral tribunal).
Informal dispute resolution
Often, shareholder agreements set out an escalation mechanism under which informal negotiations, or some form of ADR, are required before any dispute can be formally referred to arbitration or litigation. Even in the absence of such provisions, it is always helpful to explore this option first. If this process involves discussions between senior management, this means engaging with representatives of the other shareholder(s) who are authorised to make significant decisions on their behalf.
Although not yet common in the Middle East, mediation can facilitate commercial settlement in the event that the shareholders themselves are unable to resolve their differences. A mediator guides the parties, rather than issuing a decision, and provides objectivity and experience in brokering commercial agreements. The process often helps, even where no settlement results from the mediation. It forces the parties to identify (often for the first time) what they are really looking for and what compromises they might be happy with, as well as the weaknesses (legal or otherwise) in their position.
Sometimes, disputes may not be capable of resolution, but an agreement can be reached that a shareholder will exit, usually for a sum representing the fair market value of their shares. The inclusion of a mechanism in the shareholder documentation for determining the value of shares often helps to facilitate this type of solution.
At each stage of the dispute resolution mechanism, there is a trigger for the next level of the process to be commenced. It is important that the shareholders precisely follow any dispute resolution mechanisms set out in the relevant contractual documentation, so that in the event a dispute needs to be resolved formally, all requisite steps have been taken and an appropriate paper trail is in place. For example, notice provisions should be complied with and time periods/deadlines within any tiered clause should be fully adhered to. Failure to do so can mean expensive jurisdictional challenges in a formal dispute forum, or can even mean that the resulting judgment or award is set aside.
In our next article, we will look at the formal dispute resolution options available to shareholders who have been unable to resolve their dispute amicably.