A shareholder’s agreement that wasn’t fit for purpose

Shareholder disputes don’t come from nothing . It is often a failure to invest time and money at the outset to plan properly and get everybody’s expectations clear.

The 3 shareholders cum directors had invested in a food manufacturing business that needed a lot of investment, both financial and in managerial time to keep it competitive. The business had a long and illustrious past in its market but had become tired and jaded, although a bright future potentially awaited.

Two of the three were sleeping partners and the other was working daily for a salary.

The agreement made was that large sums would be “invested” by the sleeping partners – both experienced and hitherto successful in their respective businesses, none of which were remotely related to food.

Once the “investment” monies had been repaid to the sleeping partners dividends could be paid to all three of them. In reality the investment was a short term loan, a clear failure to understand what investing is all about.

Trouble started early on as there was no proper accounting function, the software only being used to record credit sales.

Given that the significant investment required was being treated like a short term loan instead of what it actually was – investment over the long term – there was always pressure to pull money out, which was putting the manager under pressure to produce cash quickly all the time.

However, the business continued to haemorrage cash and instead of money being repaid it was repeatedly being pumped in.

The sleeping partners continued to supply cash without asking too many questions as to why there was apparently no profits, and why they were always putting their hands in their pockets.

In essence they were constantly buying capital items but the monies from the sales the new machinery generated, was being pulled out leaving little of no working capital. The lack of bookkeeping meant that the capital items were often treated as expenditure which meant that the business was always posting losses.

Things came to a head when the sleeping partners demanded a proper reckoning – but it was too little too late.

The agreements between the parties were vague and arguably the directors were failing in their duty to direct, undermining their argument that they were being kept in the dark.

The working partner wanted to buy out the two sleeping partners and then everything kicked off.

An independent arbitrator contacted us to assist in understanding the business background and determining what might constitute a fair outcome for the sleeping partners to be bought out by the working partner.

This situation was avoidable, a classic case of vague agreements that left too much open to interpretation as each party might see fit. The fundamentals of the status of the monies put in by the sleeping partners was so vague that each side saw it differently – the sleeping partners as a loan and the working partner as an investment.

The only thing they got right was a clause to appoint an independent arbitrator in the event of a dispute

This is a common problem, as those putting in the money are always keen to get repaid especially when the working partner is drawing a salary and has usually put in far less, if anything, than the sleeping partners.

Involving an accountant with a good working knowledge of partnership finances and a pre-mortem approach involving a solicitor or a mediator would have been money well spent.

Leave a comment