Don’t Let The Shareholder/Director Conflict Ruin Your Business

A director-shareholder is an owner who also serves as a company director. It’s important to be aware of the difference between each as the business grows.

So what is the difference?

The following are the main differences between directors and shareholders.

  • Directors can be appointed by the shareholders (or elected by them depending on the articles of association) to manage the company on behalf of the shareholders.
  • They set the strategy, approve major decisions and appoint senior managers.
  • Shareholders can vote at general meetings (if one is held each year) to remove directors they feel are doing a bad job, or if they want to appoint somebody else.
  • The articles of association is a document that contains most of the rules that govern how a company is run, including who can be a director (generally anybody with an interest in the company’s success)
  • What powers directors have
  • When meetings should be held and who can attend them
  • If you’re a shareholder, getting hold of a copy of the articles is a good idea as it will tell you what rights you have and how your shares can be valued.

Conflict of interest can arise if this person uses his position to further his own interests rather than the interests of the company.

Generally, directors are fiduciaries with a duty to make decisions in the best interest of the corporation. The director must avoid even the perception that he may be acting in his own self-interest instead of for the benefit of all shareholders.

The growth in the number of companies with at least one insider on their board has led to more scrutiny by regulators and shareholders alike.

Find out more about the laws of corporate governance

Some boards have adopted governance policies that seek to minimize potential for conflict between directors and owners. These policies can prohibit, for example, dual-class stock structures that give insiders greater voting power than other shareholders or allow insider directors to cash out their holdings upon retirement or termination, while requiring other shareholders to wait until the next annual meeting to sell their shares.

Some shareholders in a company can be “sleeping” lenders providing finance, and not involved in the management at all.

A sleeping lender is just that: they’re lending money to the company and not really doing much else, apart from being a member of the company and receiving dividends.

The other type of shareholder in a company is one who is much more active in the running of the company, for example by taking on a directorship role.

Shareholders in a company are legally entitled to certain rights when they become members. Some of these rights can be very important in difficult situations when things aren’t going so well for the company and one or more shareholders may want to do something about it. For example:

Right to information: As a member, you’re legally entitled to know about key business issues such as poor performance against targets, requests for financial assistance from other members, issues with contracts and suppliers and changes to directors.

Right to vote: You have the right to vote at meetings (which will generally only happen if there’s something like an annual general meeting or extraordinary general meeting). You can exercise this right even if you’re not physically present at the meeting – your vote will be counted by someone else attending instead. 

Day to day involvement

The decisions that shareholders make tend to be more strategic and less frequent than the director’s decisions. Whereas the directors might decide on the introduction of a particular accounting software package, the members are more likely to consider issues such as the management structure of the company.

What is the law?

The law does not seek to prevent all possible conflicts of interest. Some are so remote or insignificant that they present no real risk to corporate governance. The law seeks to regulate those conflicts that might lead to actual or perceived bias, where relevant decisions are made that may be contrary to the interests of minority shareholders.

It is important for directors and shareholders to understand their respective roles clearly, so that neither takes over responsibilities belonging properly to another body. Directors’ duties include making decisions for the benefit of all shareholders, not just themselves, while shareholders are entitled to use their majority voting rights in whatever way they see fit.

Managing the conflict of interest

In most cases, the most effective way to manage a conflict between shareholders and directors is to remove the possibility of a conflict occurring. By planning in advance, the potential for a conflict can be removed before it even begins. Shareholders’ agreements and directors’ service contracts are documents that set out a company’s structure and rules, which makes them ideal for dealing with these issues.

A shareholders’ agreement can establish a range of issues that could potentially cause tension between shareholders. These usually include:

The number of shares owned by each shareholder. This allocation prevents one shareholder from becoming dominant and ensures that all shareholders have an equal say in how the business is run.

How many votes shareholdings will carry at meetings of the company. In most cases, one share equals one vote, but it is sometimes possible to purchase shares entitled to more than one vote. This allocation gives more power to those who have invested more money in the company or who represent a larger group of investors.

To protect shareholders against each other, a clause might also specify that they will not take any action against each other outside of the company. It should also state that if any action is taken against one shareholder, all other shareholders will be notified immediately so they can take appropriate measures to protect their interests.

For more on the conflict of interest between shareholders and directors see netlawman.co.uk.

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