Most Shareholder Agreements provide that Companies are controlled by a shareholder (or a group of shareholders) that holds a majority of the shares in the Company. These Agreements allow majority shareholders to appoint directors and control many other company activities including the day-to-day operation of the business, payment of Dividends or Dividend distribution policies, financing policies and, in most instances, the issuing of new shares.
The issuing of new shares, by definition (and operation), dilutes the value of shares in a Company. Share dilution happens when a company issues additional shares, thereby a shareholders' ownership in the company is reduced, or diluted when these new shares are issued.
For example, assume a small business has 10 shareholders and each shareholder holds 1 share. This means that each one has 10% control of the Company.
Suppose 6 of those shareholders use their majority vote and issue 6 new shares to themselves. The new share structure will comprise of 16 shares, 6 shareholders will own 2 shares and the remaining 4 shareholders will still only owe 1 share. But the 6 shareholders will each now have 12.5% (up from 10%) control of the company; whilst the other 4 will have 6.25% control (down from 10%).
The minority shareholders’ shares (or effective control) were severely diluted even though the number of share they hold have not changed.
As a result, Parliament sought to provide protection to minority shareholders from decisions of the majority by virtue of enacting section 232 of the Corporations Act.
Section 232 of the Corporations Act states:
“The Court may make an order under section 233 if:
- the conduct of a company's affairs; or
- an actual or proposed act or omission by or on behalf of a company; or
- a resolution, or a proposed resolution, of members or a class of members of a company;
- contrary to the interests of the members as a whole; or
- oppressive to, unfairly prejudicial to, or unfairly discriminatory against, a member or members whether in that capacity or in any other capacity.”
Dilution of share value is one example, but the above provision is drafted very broadly, so there is no defined limit of what constitute ‘oppressive conduct’ under the Act. Some other examples include refusal to provide access to company records, improper exclusion from participation in the management of a company, failure to call or attend meetings, misappropriation of a business opportunity or excessive salaries paid to majority shareholders.
The Court’s task is to objectively assess the conduct based on whether it would be regarded as ‘unfair in the eyes of the reasonable commercial bystander.’ Unfairness may be assumed where the decision does not provide sufficient commercial value to the company to outweigh any possible detriment to other shareholders. It may also arise where shareholders seek to exclude management or in circumstances where the relationship between directors have irretrievably broken down and are no longer functional.
The Court’s powers under section 233 are extensive and it includes orders that a Company’s constitution be modified to protect minority shareholders, orders regulating the conduct of the company’s affairs in the future, for the purchase of shares with an appropriate reduction of the company’s share capital, requiring or restraining a person from doing or not doing a specified act, appointing a receiver or that a company be wound-up.
At Frank Law we can assist shareholders exercising their rights under a Shareholder Agreement or take the appropriate to protect them from shareholder oppression. If you have further questions please contact Philip van den Heever at firstname.lastname@example.org.
This is not legal advice.