Vol 5 (2008) - Issue 2

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The Use of Insolvency Procedures to Remove Minority Shareholders

This article will focus on the use of English insolvency procedures by majority shareholders to remove minority shareholders. The aim will be to highlight some
of the possibilities of insolvency procedures, besides dealing with the company’s insolvency, and to consider the advantages which insolvency procedures have over other mechanisms for getting rid of minority shareholders.

There is a wide variety of reasons why a majority shareholder may wish to remove a minority shareholder. The simplest, particularly in small private companies, is that the majority has simply fallen out with the minority, and each side is no longer willing to have any involvement with the other. Other reasons involve the potential tax advantages if a company is subsumed within a wholly owned group, the opportunity to reconsolidate widely dispersed shares (often done to save the costs of circularising hundreds of tiny shareholders), the need to take full control of a company, and to smooth the path to a takeover. There are many other possible situations, but there is no need to attempt an exhaustive summary in this article: for majorities and their advisers, I think it is a case of 'you know one when you see one'.

Non-insolvency procedures

Before turning to insolvency procedures, a little should be said about the possible non-insolvency routes for eliminating minority shareholders. The simplest is probably to use the statutory squeeze-out provisions in sections 974-991 of the Companies Act 2006 (perhaps more familiar as sections 428-430F of the Companies Act 1985). These sections allow a bidder to acquire compulsorily the shares of a dissenting minority where 90% of the shareholders by value and by voting rights have accepted the takeover offer.

Where the statutory regime can be complied with, it provides a relatively neat and efficient means of mopping up and squeezing out minority shareholders. Although there is a possibility of a court challenge under s. 986, this is fairly remote if the bid is conducted properly: see Fiske Nominees Ltd v Dwyka Diamonds Ltd [2002] 2 BCLC 123. The main limitation of this procedure is that it only works where there is a takeover offer by a bona fide third party: shares held by the offeror and the offeror's associates are not included when calculating whether the 90% threshold has been reached. Even without this statutory protection, the common law prevented majorities setting up a newco to make an offer in order to utilise the statutory squeeze-out provisions: see Re Bugle Press Ltd [1961] Ch 270. This procedure will not work, therefore, when the majority want to stay put.

An excellent alternative to using insolvency procedures is to use a court-approved Scheme of Arrangement under section 425 of the Companies Act
1985. Schemes have become increasingly popular in recent years, particularly to effect takeovers. It is easy to see why: the threshold is 75%, not 90% as with the statutory squeeze-out regime; there is no final commitment until the Scheme is sanctioned by the Court; and the requirement of the Court's sanction should
help to prevent a completely botched 'DIY' job with subsequent litigation brought by aggrieved minorities. These points are as relevant in a non-takeover context. Schemes are a controlled process under which minority shareholders can be deliberately and securely disposed of. On the other hand, Schemes are time-consuming and expensive, so they are only suitable for substantial companies where there is little urgency. They give objecting shareholders express opportunities to voice their dissent publicly, both in court and at the Scheme meeting, which could be embarrassing to the majority.

A further option is to use squeeze-out rights in a company's articles (if they are there already), or to insert new ones. If a company has squeeze-out rights in its articles from incorporation, it is clear that these can be used to eliminate a minority shareholding: Borland's Trustee v Steel Brothers & Co Ltd [1901] 1 Ch 279. Many small companies have compulsory transfer provisions in their articles, compelling the members to transfer their shares in the event that they leave the company's employment, for example.

More difficult is the question whether the articles of the company can be amended to include compulsory transfer provisions. The starting point is the test in Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656, that alterations to a company's articles must be 'bona fide for the benefit of the company as a whole'.