In Technology Corporate Management a story is told of a small domestic company that was started in 1987 as somewhat of a quasi-partnership between two founding shareholders and friends. Over time, the company became increasingly successful and gained additional shareholders. In 2007 the relationship between the two founding shareholders irretrievably broke down for a number of reasons, and one of the founding shareholders decided that the only solution was to exit the company.

The disgruntled shareholder did not have an exit mechanism available in terms of the shareholders’ agreement, was unable to dispose of his shares, and was effectively locked-in. These circumstances are not uncommon. The essence of a private company is that its shares are not freely transferable; something that is often forgotten in the heady early days of a business relationship. This lack of liquidity can be extremely frustrating, particularly where former friends have fallen out.

To dispose of shares in a private company requires that either a fellow shareholder, a third party or the company itself acquires them: there must be a buyer as well as a seller. This is equally true in the listed environment of course, but the fact that public exchanges bring together a multitude of buyers and sellers means that the chances of being (anonymously) matched are very good. Any third party buyer in a private company must of course be willing to enter into the same illiquid shareholding and a much more intimate relationship than that between shareholders in a public company.

Finding a third party purchaser might be no easy task, and if no such purchaser can be found and neither the company nor the remaining shareholders are willing to acquire the departing shareholder’s equity at an agreed price, the unhappy shareholder will remain locked-in. No doubt becoming unhappier as a result.

Claim for unfair prejudice

In Technology Corporate Management, the disgruntled shareholder eventually applied to court with a claim for unfair prejudice against the company in terms of section 252 of the Companies Act 61 of 1973 (the section that is the predecessor to section 163 of our current Companies Act 71 of 2008). In terms of section 252, a shareholder is afforded a broad menu of possible remedies if they are subjected to conduct that is “unfairly prejudicial, unjust or inequitable”.

Among the many and varied complaints that the disgruntled shareholder brought before the courts, was a claim that he was unfairly prejudiced by the mere fact of being locked-in by virtue of being unable to dispose of his shares. The SCA determined that, although it may always be prejudicial that a minority shareholder who wishes to exit a company becomes locked-in, the mere fact that they are locked-in does not mean that there has been conduct which is unfairly prejudicial. The court also remarked that there is no obligation on the other shareholders to make an offer to purchase the shares of any shareholder merely because that shareholder no longer wishes to continue with the relationship (although interestingly, the court noted that a reasonable offer may cure an otherwise prejudicial position).

The court has thus affirmed that there is no unilateral right to exit an unwanted shareholding.

How to manage such scenarios

So how do we cater for uncertain future scenarios where the happily ever after does not come to pass? A shareholders’ agreement and memorandum of incorporation of a company might provide for various options to facilitate or force an exit, but it is difficult to legislate for an unknown and unknowable future upfront, and even more difficult to compel a commercial solution years in advance. Creative solutions such as auction clauses, which allow one shareholder to set a price and the other shareholders to decide whether to buy or sell at that price, can seem pleasingly clever, but often simply create an unpleasant quick-draw stand-off. And the problem remains that any seller always needs a buyer able to pay the price, however that is determined.

It is clear that expecting a court to resolve a commercial problem is not the answer. There are good arguments that the best way to manage these scenarios is perhaps not to provide for them at all. The natural (rather than forced) stand-off that results might well compel everyone to eventually behave like adults and find a commercial solution.