Proper Balance Between Majority and Minority Shareholder.

North South University LAW 200 Assignment # 2 Prepared for: Barrister A. M. Masum Faculty of Business North South University Prepared by: ID NAME 062 528 030 M. Montasir Imran Khan Section: 02 Page | 1 “A proper balance of the rights of majority and minority shareholders is essential for the smooth functioning of the company. ”- Explain & Illustrate? 1. Introduction: The basic principal relating to the administration of the affairs of a company is that “the will of the majority is supreme”. The general rule is that the decisions of the majority shareholders in a company bind the minority. In a world that recognizes ‘simple majority rules’, minority shareholders of companies are by default vulnerable to oppression, disregard and unfair treatment by majority shareholders who are in control of the company. Majority shareholders also have certain obligations to minority shareholders in their capacity of controlling the corporation. In certain cases this minority shareholder right can be exercised directly against a shareholder, without having to go against a corporation or through the derivatives action process. In such case a proper balance of the rights of majority and minority shareholders is essential for the smooth functioning of the company. The oppression of minority or mismanagement of a company by majority therefore calls for some remedial action. 3 Today’s minority shareholders come to the corporation with varied attitudes and agendas. Although their shareholder status results from a variety of circumstances, it is important in each case to make their relationship with the corporation and the other shareholders as productive as possible. This 1 2

Ashok, S. (2009-2010). Company law (p. 246-248). India:V. K Enterprise. The right of the majority to have their way has, however, been occasionally abused and the whip of majority has The companies act, 1956 has laid down certain provisions which restrict the unbridled supremacy of the majority often produced sullen effects prejudicial to the best interests of the company and the majority shareholder 3 and confer rights on minority to apply the National Company Law Tribunal or to the Central Government in case of oppression and mismanagement. Page | 2 s best done by understanding their rights and striking the appropriate balance among all shareholders. 2. Who are the majority and minority share holders? A company can be private or public. A public company is one that offers shares, debentures and interests to the public. Owners of a company are called shareholders. Shareholders are people who have purchased interests in a company that makes them partial owners of the company. Minority shareholders are defined as owner of a company who does not have the voting control of the company by virtue of owning below 50 percent of the firm’s equity capital. Minority shareholders are shareholders who have minority stakes in a company that is controlled by a majority shareholder. The majority shareholder is the individual who owns most of a company’s shares. 5 This means he or she generally has more power than all of the other shareholders combined6. The majority shareholder is most commonly the company’s parent but may also be an individual or a group of connected shareholders. 3. Widespread mistreatment by Majority Shareholders Minority shareholders can be unfairly treated by majority shareholder or company directors. Precedence of such cases is widespread in the business world.

Although protection mechanisms existed for a long time, these laws have not effectively deterred minority prejudice and abuse. 7 4 Anonymous, (n. d. ). Minority Shareholders (paragraph-5). Retrieved March 2, 2011 from http://www. law-essays-uk. com/resources/free-essays/minority-shareholders. php 5 To be a majority shareholder, a person generally must own more that 50 percent of a company’s shares. When this is the case, the individual generally wields a substantial amount of power over the corporation. 6 Owning the much of a corporation gives an entity a huge amount of control.

The majority shareholder is often the Based on a study commissioned in April 2004 by Jardine Lloyd Thompson Pte Ltd, there were a total of 19 cases founder of the corporation. 7 of minority shareholder claims (personal and derivative) for oppression under Section 216 of the Companies Act. Page | 3 Shareholders holding minority interests in closely-held corporations are at risk of unfair or oppressive treatment8 by the majority or controlling shareholders, to an extent well beyond that of their counterparts in partnerships or in corporations whose shares are publicly traded. 9

Sometimes directors and officers of closely held corporations that have acted fraudulently or illegally mismanaged the corporation and also acted oppressively or unfairly toward one or more minority shareholders. Shareholder oppression occurs when the majority shareholders in a corporation take action that unfairly prejudices the minority. It most commonly occurs in close corporations because the lack of a public market for shares leaves minority shareholders particularly vulnerable, since minority shareholders cannot escape mistreatment by selling their stock and exiting the corporation. 0The majority shareholders may harm the economic interests of the minority by refusing to declare dividends or attempting a squeeze out. Majority may physically lock the minority out of the corporate premises and even deny the minority the right to inspect corporate records and books, making it necessary for the minority to sue every time it wants to look at them. 11An important concept in law pertaining to shareholder oppression is the “reasonable expectations” of the minority shareholder. Minority shareholders who find themselves in a situation where the majority shareholder is taking funds from the business With this division of power, it is not uncommon for minority shareholders of a closely held business to feel as though decisions are being made which favor the majority over the minority and that as minority shareholders they are being “oppressed. ” 9 Robert, C. (April 1, 2003). Shareholder rights and remedies in close corporations: Oppression, fiduciary duties, and reasonable expectations (Paragraph-1). Published by Journal of Corporation Law. Retrieved March 2, 2011 from http://www. allbusiness. com/legal/laws/1058708-1. html 10 Benjamin, M. (October 15, 2008).

A Voice-Based Framework for Evaluating Claims of Minority Shareholder Oppression in the Close Corporation. Georgetown Law Journal. 97. Meinhardt, J. M. (2001). Investor Beware: Protection of Minority Stakeholder Interests in Closely held Limited – Liability Business Organizations (p. 288). 11 Page | 4 through loans or leases and have recourse available including commencing litigation. 12 The majority shareholder does not want to invite the minority shareholder to corporate meetings and doesn’t want to disclose financial information to the minority shareholder.

He or she doesn’t want the minority shareholder to know how well or how badly things are going or know how much the majority shareholder has taken in salary and bonus. If the majority shareholder is engaged in any financial impropriety, he or she certainly doesn’t want to reveal such information. If the corporation is doing very well, the majority shareholder may feel threatened by the prospect of giving financial information to the minority shareholder. It has been said that the business judgment rule and notions of majority rule have allowed shareholder majorities to use the minority’s investment without paying for it. 3Finally, it is difficult to determine how to deal with the rights of the minority shareholder without destroying the corporation, while still respecting the rights of the majority shareholder. 14 4. Shareholder Disputes Disputes between shareholders arise for any number of reasons . The following are some common examples, generally involving issues of control, use of assets and strategy15: ? Breach of directors’ duties ? The Company’s strategy & management ? Dividend policies 12 13 14 Majority of these litigation involved breach of duties to companies or person.

Spratlin, D. J. (1990), Modern Remedies for Oppression in the Closely Held Corporation (p. 405). Grandfield, C. S. (2002), Reasonable Expectations of Minority Shareholders in Closely Held Corporations: The Morality of Small Businesses (p. 381). Anonymous,(n. d. ). Shareholder Disputes,(paragraph-2). Retrieved March 3, 2011 from http://www. darlingtons. com/site/srvbusiness/srvbusinesslitigationanddisputes/srvshareholderdisputes/ 15 Page | 5 ? Disparities between salaries ? Separate business interests ? Failure to provide financial, accounting and statutory information ?

Exclusion from meetings ? Wronged partners or quasi partners16 ? Breaches of shareholders agreements/ partnership deeds 4. 1The minority shareholders’ perspective: Minority shareholders in closely held companies face significant disadvantages. They cannot control the course of the business and are subject to the majority stakeholder’s decisions. There is often not a market to sell their shares outside of the company. This situation is ripe for abuse. While minority shareholders cannot control the business the majority ownership still owes duties to these shareholders.

If the majority interests engage in conduct such as fraud, oppression, selfdealing, profits skimming or any other act motivated by the desire to punish or coerce a minority shareholder it may result in a violation of those duties 17 . Generally speaking, a minority shareholder has little redress against the decisions of the majority. The majority shareholders seek to act in a way which is ‘unfairly prejudicial’ conduct18 to their interests. 16 The significance of the status of a ‘quasi-partnership’ is that the courts are, generally speaking, more willing to give ertain additional rights to minority shareholders in those Companies. In particular, a minority shareholder in a ‘quasi-partnership’, who have been involved in the running of the business, can often claim protection from being ousted or excluded from the ongoing management of the business (without any good reason). 17 Minority shareholders have long been at risk of oppressive conduct by majority shareholders in control of the corporation. Freeze-outs, squeeze-outs, and a host of other tactics, some legally permissible and others not, have long given majority shareholders the upper hand in any shareholder dispute. 8 Common examples of “unfairly prejudicial” conduct are: Exclusion from management in circumstances where there is a (legitimate) expectation of participation; the diversion of business to another company in which the Page | 6 4. 2The majority shareholders’ perspective: As a majority shareholder, they may be faced with a dissident shareholder or partner who refuses to co-operate in the running of the business and who hampers the decision-making process and is causing inter-personal conflict.

Therefore majority shareholder wants very much to “get rid” of the minority shareholder and they take great care to play everything by the book to avoid unnecessary claims against them. This means that they must continue to observe legislative rules are governing the management of the company in the provision of financial information and voting procedures. To an extent the concerns of a majority are the converse of those of a minority. Whilst in ordinary reasonable day to day situations statutory minority rights have ittle application, the more fundamental acts that a majority might wish to take to exert its rights, are those in which minority protection rights take effect. For majority shareholders there are probably two key issues. The first is to recognize and overcome the balance (or imbalance) of power between the directors and the shareholders and the second is how to get rid of the unwanted minority shareholder. 19 5. Growing Importance of Minority Shareholders Economic reforms have not only increased growth prospects, but they have also made markets more competitive.

This means that in order to survive companies will need to invest continuously on a large scale. Meanwhile, financial sector reforms have made it imperative for firms to rely on capital markets to a greater degree for their needs of additional capital. Simultaneously, the increasing institutionalization of the capital markets has tremendously majority shareholder holds an interest; the awarding by the majority shareholder to himself of excessive financial benefits; and Abuses of power and breaches of the company’s articles. 19 Roderick, R. 1998). Company shareholders and directors (paragraph-1). Retrieved March 3, 2011 from http://www. law-office. demon. co. uk/art%20power-1. htm Page | 7 enhanced the disciplining power of the market. Globalization of financial markets has exposed issuers, investors and intermediaries to the higher standards of disclosure and corporate governance that prevail in more developed capital markets. 20Therefore, minority shareholding is becoming more prevalent in business world. The protection of minority shareholders interests encourages investment.

If majority shareholders are permitted to use their power to further their interests at the expense of minority shareholders, then the latter will tend not to invest in that company. This lack of assurance can substantially reduce the amount of local and foreign investment. 6. Need to strike a Balance between Majority Rules and Minority Rights The need for minority shareholder protection can be gauged from the fact that better protection of minority shareholders increases access to capital by companies as more investors would be willing to invest, if adequate legal protection is afforded to their investment.

World over, investors are looking for newer areas and avenues for investing their funds with emphasis on the safety of their investments. Many studies have indicated that good governance standards have a significant positive impact on shareholder returns. Poor investor protection results in constrained or more costly access to capital. Therefore, strong and ethical corporate governance is indispensable for the development of resilient and vibrant capital markets and is an important instrument of investor confidence.

World over, global pressures are mounting on companies to observe more and more transparency in their functioning and operations and thus to be more 20 Prakash, O. P. (July 29, 2009). Minority Shareholder Rights – Necessities & Limitations. Retrieved March 4, 2011 from http://www. lawyersclubindia. com/articles/MINORITY-SHAREHOLDER-RIGHTS-NECESSITIESLIMITATIONS-1464. asp Page | 8 responsive to entities they serve. Such actions ensure that the benefits of good governance accrue to the shareholders and other stakeholders and also to the society at large.

As the legal treatment of shareholder protection finds its balance between enabling logical majority rule and safeguarding minority interests, it lands itself in a sticky situation of perpetual grey area where the laws and regulation could no longer afford straightforward legal resolution but requires judiciary intervention for even the most trivial cases21. While the need for minority shareholder protection was earlier established, this should not be taken to the extreme. In fact, excessive lawsuits by minority shareholders in the name of ‘minority protection’ can bog down the legal court system and deter investments when cases drag.

Over-protection may also lead to abuse by minority players to deliberately utilize their rights to create obstacles for company directors in running the day-to-day operation and harass management. Therefore, there is a need to maintain a balance by providing adequate avenues for redress while deterring litigious shareholders from gaming to benefit from lawsuits. Although the spirit of the law is to ensure equitable treatment of all stakeholders, the company law has always struggled in trying to balance the need to uphold majority rule and yet respect minority interests. 7. Avenues for Minority Shareholder Redress

There are essentially three avenues22 by which a minority shareholder could seek redress in respect of unfair conduct against them. 21 Anonymous, (n. d. ). Minority Shareholders (paragraph-18). Retrieved March 5, 2011 from http://www. law-essays-uk. com/resources/free-essays/minority-shareholders. php 22 Anonymous, (n. d. ). Minority Shareholders (paragraph-8). Retrieved March 5, 2011 from http://www. law-essays-uk. com/resources/free-essays/minority-shareholders. php Page | 9 Avenue 1: Companies Act It serves to provide redress for shareholders in the event of oppression, disregard, discrimination and prejudice.

This provision for minority to take legal action in court is a key informing the baseline protection for shareholders against possible abuse of majority power. In this regard, there are three possible modes of action that a minority shareholder can takes are personal, representative or derivative actions. Avenue 2: Constitutional Documents Under Companies Act, it is a mandatory requirement for every company to have a Constitution. This legal document typically encapsulates the raison d’etre of the company and regulates its structure, management and control. Most common law countries separate their onstitutional documents into two key parts, namely the Memorandum of Association (MoA) and Articles of Incorporation (AoI). Avenue 3: Shareholder Agreement A Share holder agreement is a legal contract between two or more parties to abide by specific requirements and agreed practices in order to safeguard the interests of the shareholders concerned and maximize their returns. 8. Rights of Minority shareholder: There are some rights of minority shareholder’s are given below: ? The most fundamental right of every shareholder is the right to vote their shares. 23 23

Minority shareholders have the right to vote for the election of directors and on certain extraordinary matters affecting the corporation. Page | 10 ? Shareholders have the right to expect their officers and directors to act in good faith, with due diligence and in the best interests of the corporation. 24 ? Shareholders have the right to question the action of officers, directors and majority shareholders. 25 ? Shareholders have the right to inspect certain records and to receive certain reports and other information from the corporation. ? Shareholders have the right to benefit from corporate operations. Shareholders have the right to force the dissolution of the corporation. ? Shareholders have the right to participate in distributions from the corporation upon its dissolution. ? Shareholders may further develop their relationship through the use of a Shareholders’ Agreement. 9. Recommendation: To protect the rights of all shareholders, including minorities frequently include the following provisions: ? The law must balance the need for effective decision making on corporate matters on the basis of consensus without permitting persons in control of the company. 4 Shareholders have the right to expect the officers and directors of their corporation to perform their duties in Shareholders may question the decisions of officers or directors and this can be done in the name of the accordance with established standards of conduct. 25 corporation through derivative actions. Page | 11 ? The right of all shareholders to inspect corporate books, papers and records. This right allows shareholders to protect themselves against mismanagement by or disloyalty of corporate managers or other shareholders.

The right may be limited by the corporation to allow its exercise for proper purposes and at certain times and places. ? A good solution is for minority shareholders to only buy into their company on condition that all shareholders sign a “Shareholders Agreement” containing safeguards for the minority. ? The financial information and disclosures to be provided to shareholders should not be in excessively technical format but should be simple to understand. This will enhance the credibility of the company and will help the shareholders to take an informed and conscious decision in respect of their investments. Provide the rights of minority shareholders to participate in meetings of the company. ? Apply the right to bring derivative action on behalf of a company in respect of wrong done to the company. ? Initiate class/ representative action to protect classified or minority interests. ? Company allows dissenting shareholders to demand appraisal and payment for their shares from the majority, if a shareholder vote is required for fundamental changes. ? Ensuring fair valuation of share. ? Establishing the pre-emptive rights26 26 A right of pre-emption is a right, to all intents and purposes, to require a shareholder to offer his shares for sale to ther members of the company before they are offered to an outsider. Page | 12 10. Conclusion: Every shareholder is entitled for certain rights in the company and at the same time, the rights of minority in a company should not be ignored. A company can carry out business activities smooth fully when there is a proper balance between the majority and minority shareholders. Management of the company should aware of every shareholders right and the majority should not be allowed to oppress the minority and mismanage the company’s properties.

Shareholders start agitating only when they perceive that the company is being highly mismanaged and the shareholder value is getting destroyed. A regrettable consequence of almost any shareholders dispute is damage to the company itself. Therefore, a good structure of corporate governance is that encourages balanced relationship among shareholders, executive directors and the board of directors. The highly skilled and experienced solicitors and lawyers will seek a solution which resolves the shareholders dispute. Page | 13 Bibliography 1. Ashok, S. 2009-2010). Company law (p. 246-248). India:V. K Enterprise. 2. Anonymous, (n. d. ). Minority Shareholders (para-5). Retrieved March 2, 2011 from http://www. law-essays-uk. com/resources/free-essays/minority-shareholders. php 3. Anonymous, (n. d. ). What is a Majority Shareholder? (Paragraph-3). Retrieved March 2, 2011 from http://www. wisegeek. com/what-is-a-majority-shareholder. htm 4. Majority Shareholder. (n. d. ). Retrieved March 3, 2011 from http://www. answers. com/topic/majority-shareholder#ixzz1GPM9cC6j 5. Robert, C. (April 1, 2003).

Shareholder rights and remedies in close corporations: Oppression, fiduciary duties, and reasonable expectations (Paragraph-1). Published by Journal of Corporation Law. Retrieved March 3, 2011 from http://www. allbusiness. com/legal/laws/1058708-1. html 6. Benjamin, M. (October 15, 2008). A Voice-Based Framework for Evaluating Claims of Minority Shareholder Oppression in the Close Corporation. Georgetown Law Journal. 97. 7. Meinhardt, J. M. (2001). Investor Beware: Protection of Minority Stakeholder Interests in Closely held Limited – Liability Business Organizations (p. 288). 8.

Spratlin, D. J. (1990), Modern Remedies for Oppression in the Closely Held Corporation (p. 405). 9. Grandfield, C. S. (2002), Reasonable Expectations of Minority Shareholders in Closely Held Corporations: The Morality of Small Businesses (p. 381). Page | 14 10. Anonymous,(n. d. ). Shareholder Disputes,(paragraph-2). Retrieved March 4, 2011 from http://www. darlingtons. com/site/srvbusiness/srvbusinesslitigationanddisputes/ srvshareholderdisputes/ 11. Roderick, R. (1998). Company shareholders and directors (paragraph-1). Retrieved March 4, 2011 from http://www. law-office. demon. co. k/art%20power-1. htm 12. Prakash, O. P. (July 29, 2009). Minority Shareholder Rights – Necessities & Limitations. Retrieved March 4,2011from http://www. lawyersclubindia. com/articles/MINORITY-SHAREHOLDER-RIGHTSNECESSITIES-LIMITATIONS-1464. asp 13. Anonymous, (n. d. ). Minority Shareholders (paragraph-18). Retrieved March 5, 2011 from http://www. law-essays-uk. com/resources/free-essays/minority-shareholders. php 14. Anonymous, (n. d. ). Minority Shareholders (paragraph-8). Retrieved March 5, 2011 from http://www. law-essays-uk. com/resources/free-essays/minority-shareholders. php Page | 15