11 March 2021

A salutory tale of the need for shareholder protection

John was 63 and James was 42. Together they ran a successful software development business producing software for a niche sector. Both had distinct roles in the business. John was a software developer and James had significant contacts in the industry and therefore drove sales.

John and James were equal shareholders and the sole directors. They had run the business together for 20 years and it had become relatively successful, generating profits for the two shareholders in the region of £300,000.

One day James died suddenly in a car crash. He had a wife and two children under the age of 10. His wife and John had fallen out a number of years previously and did not talk to each other.

A few weeks after James’ funeral John contacted us, as James’s widow was demanding money from the business and John did not know what to do.

John and James had never had a shareholder agreement prepared, they didn’t think that it was needed as they could never foresee a situation where, between themselves, they could not resolve any differences that they may have.

John told us that since James’s death, the pipeline of sales had ended, as James was the only person in the business with the contacts and knowledge to push the sales. John had found a new salesman, but he had to headhunt a senior person from a competitor, at considerable cost. The salary was a large additional burden, which significantly reduced the profits.

John and James had always paid themselves by dividends and neither took a salary.

John did not think that it was fair that he was working long hours in the business, but he had to pay himself and James’s widow the same amount.

John could not face the thought of having to run the business with James’s widow. He had offered to buy James’s shares, but his widow wanted far more for them than John felt that they were worth, given that the business had lost one of its major assets.

They had reached a stalemate.

John wanted to force James’s widow to sell her shares, but we had to advise him that in the absence of any shareholders agreement, there was no easy way for him to force James’s widow to sell the shares and that the only real option was to negotiate a settlement.

However, if John and James had put a shareholder agreement in place, this could have included a provision which set out what would happen in the event of one shareholder dying.

It could have provided that the surviving shareholder would have an option to purchase the deceased shareholder’s shares and provision as to how the price is to be determined. It could also have provided for life insurance to be put in place so that the surviving shareholder could have a lump sum with which they could purchase the deceased shareholder’s shares.

The shareholdings could also have been structured so that each shareholder had a different class of share, with provisions in the shareholder agreement allowing for equal dividends to be paid on each class, unless one shareholder should die or cease to work full time, in which case the dividends paid on those shares could then reduce.

These practical steps would have meant that John and James’s widow would have known what they could and couldn’t do and the scope for dispute would have been narrowed. It would have given John an avenue for resolving the issues, which ultimately would have protected the business.

This is not an isolated situation. So for more information on Shareholders Protection insurance, and how it might protect you and your business, please do not hesitate in contacting Stacey Gibson on 01270 758057 or contact us.

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