Founder disputes often create unique circumstances and issues that present real challenges for business leaders. Ivor Adair, partner at Fox & Partners, explores how they may be addressed
Many start-up companies suffer from conflict at the top. Often founders will be shareholders, owe duties as directors and be employed by the company giving rise to an array of obligations. Executives brought into the business to pursue an agenda for growth may be offered a minority shareholding, enter into a contract of employment and be appointed a statutory director. Conflict can also occur with these individuals, possibly prompted by external investors with a different agenda, with disruptive consequences for the business.
Unfair departure
Founders will often have close relationships and common understandings as to the day-to-day management of the company. However, issues borne out of control or not sharing information can easily escalate and result in complaints of exclusion from management affairs or improper conduct, particularly where the business is under stress. There can also be disputes where a new investor has lost confidence in a minority shareholder’s performance. The disruptive effects of the pandemic continue to provoke disputes of this nature.
Often founders will be shareholders, owe duties as directors and be employed by the company giving rise to an array of obligations”
It is common for an executive with a stake in the business to be dismissed, seemly out of the blue, with little or no process. Often a term in the contract is relied upon to make a payment in lieu of notice to bring the relationship to an immediate end, with a view to relying on post-termination covenants designed to protect business interests.
At the same time the founder may be offered a settlement agreement and compensation. This is hardly fair play and may give rise to unfair dismissal claims or allegations of repudiatory breach of contract resulting in the avoidance of restrictive covenants protecting legitimate interests of the business, such as customer connections and protecting the stability of the workforce. All of this carries significant financial, commercial and reputational risk. Whether it is nonetheless a commercially attractive course of action, will depend on the circumstances.
Forced disposal of shares
The effects of dismissal for the founder will usually extend beyond a right to remuneration. Documentation, such as a shareholder’s agreement, may provide that being given notice means they are forced to sell their shareholding to existing shareholders, as per a valuation, or for a nominal amount, often because they are not regarded by the contract as a “good leaver”.
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A founder may be frustrated by the limitations of an ordinary unfair dismissal claim which is subject to a cap preventing substantial losses being claimed in the employment tribunal.
A founder may also be suspicious they have been forced out so that the majority shareholders can buy their shares on the cheap. It is not uncommon for founders, together with their advisers to dig deep for potential legal remedies in such circumstances, particularly if the amount a stake is significant.
Key potential remedies
Companies ought to be mindful of the risks of an unfair prejudice action by the minority shareholder, on the basis of an argument that shares have been expropriated at an artificially low price by forcing a founder out unfairly. Moreover, if there is an express duty of good faith in a shareholder’s agreement, such a cause of action may be even more compelling (and will certainly give rise to ambiguity and open the door to a claim).
The disruptive effects of the pandemic continue to provoke disputes”
Following recent case law (Unwin v. Bond [2020]) an express good faith obligation in a shareholders’ agreement resulted in a successful claim against Bond (the majority shareholder) even where dismissal was not motivated by an ulterior motive (to expropriate shares) and he acted in compliance with his statutory duties under the Companies Act 2006 to promote the best interests of the company. In not dealing fairly and openly with Unwin (the minority shareholder) when his employment was terminated, and not having regard to his interests, there was a breach of an express duty of good faith in a shareholders’ agreement.
It follows that the tactic of springing a dismissal on a founder with a view to entering into a deal is likely to be more risky where there are express duties of good faith between shareholders. A failure to conduct any proper investigation into performance concerns, consider remedial action and consider the decision from the minority (founder) shareholder’s viewpoint may not be a risk not worth taking. From the perspective of the other founders and investors in the business, a bit of fair play could go a long way to reduce the risk of a costly dispute in the courts. A departing founder may find their arguments neutralised by judicious use of process and letting them have their say.
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The content of this article is not legal advice and is not intended to provide more than general commentary on the subject matter. Specialist employment law advice should always be sought about your specific circumstances
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