Introduction
When business partners, friends or family members set up or buy a company together through which they intend to implement their business plan, they rarely admit that the initial enthusiasm and harmony may fade over time or that circumstances may change to such an extent that it becomes unbearable for any of the shareholders to remain in the joint business.
If all shareholders agree on the termination of the common intention, the termination of their participation in the company, or even the dissolution of the company, is in principle a legal formality. Complications arise when only one partner wants to leave but the others do not agree. In extreme cases, a stalemate may arise – the company is dysfunctional, but none of the shareholders can leave without the cooperation of the others.
In this article, we will look at how to prevent such conflicts, how to set clear rules when founding a company and how to deal with situations where an agreement between shareholders is no longer possible.
Specific arrangements between the shareholders
When founding a company, it is advisable to think about how the shareholders should be settled in the most likely situations, i.e. in a situation where:
- the joint venture will be successful as expected (or even more) and an investor will be interested in the company;
- on the other hand, the company will not be successful / will fail to find further funding;
- there is a fundamental dispute between the shareholders about the future operation of the company or the shareholders are unable (unwilling) to take decisions at the general meeting and the company is threatened with paralysis;
- any of the shareholders will be interested in transferring their share to a third party who is not a shareholder;
- the death or dissolution of a shareholder;
- a competitor of the company becomes the controlling person of the shareholder-legal entity.
In the situations described above, a split between the shareholders can most often occur, as each of them may have a different idea of how to resolve it. In practice, a combination of special contractual arrangements between the shareholders is used to resolve the above or other situations. The most typical arrangements include:
- limitation of the transferability of the share, whereby the share may be transferred to a shareholder or a third party only with the consent of the general meeting or, alternatively, the statutory or controlling body of the company. Although such a provision protects the other shareholders from one of them transferring their shares to a competitor, such a provision may, on the contrary, lead to the preservation of the shareholder structure in the event of inactivity of the general meeting (or other competent body). For this reason, as with all other mechanisms, it is necessary to set up this mechanism appropriately, including in the relationship between the shareholders to each other;
- pre-emption right to the share, which obliges the transferring shareholder to offer to buy his share to the other shareholders. The other shareholders can thus decide whether to increase their shareholding in the event of the exit of one of the shareholders;
- drag-along right, under which the transferring shareholder can legally force the sale of the shares of all other shareholders, most often in the event that an investor interested in the company is prepared to pay the price set by the shareholders for the (entire) company. This is a relatively strong legal institute, therefore in practice the conditions under which the drag-along right can be used are established between the shareholders, e.g. negotiation of a minimum purchase price offered by the investor, possibly confirmed by an expert opinion, etc.;
- tag-along right, under which minority shareholders are usually able to force the majority shareholder to buy the shares of minority shareholders together with the majority shareholder’s shares. This right offers minority shareholders the possibility to exit together with the majority shareholder and thus not be forced to remain in the company with the new majority shareholder (investor);
- call option, which allows an eligible shareholder to force the purchase of another shareholder’s share(s). This is a purely contractual institution, therefore the terms and conditions for exercising a call option can be tailored to the company in question. For example, a call option may be granted to the majority shareholder, who will be entitled to force the purchase of another shareholder’s share (call) if the agreed conditions are met (e.g. expiry of a certain period of time, achievement of a certain economic milestone, etc.);
- put option is the opposite of a call option, where a shareholder can “force” its share on another shareholder. Together with a call option, it is most often used to resolve deadlock situations. Of course, the conditions for exercising the option, the amount of the purchase price (or the method of calculating it) and other parameters of the sale must be set appropriately;
- contractual penalties as a sanction for breach of key provisions. The negotiation of contractual penalties contributes to the motivation of the obligated shareholders to comply with the agreed rules.
Under a tag-along, drag-along right or both types of option arrangement, the shareholders must negotiate the exact terms for exercising the option. These terms may also include confidential information (e.g. the amount of the purchase price at which all shareholders are prepared to sell the company). For this reason, such arrangements are generally not reflected in the company’s main document, the memorandum of association, but are negotiated in a separate confidential document called the Shareholders’ Agreement, which is not filed in the publicly accessible collection of documents of the commercial register.
In the framework of the shareholders’ agreement, it is advisable to further negotiate the rules for (i) decision-making at the general meeting (e.g. quorum, in which matters a simple majority is sufficient, when a higher majority of votes or a unanimous decision of the general meeting is required), (ii) the management of conflicts of interest and the prohibition of competition between shareholders, as well as the rules for (iii) information sharing, communication and reporting. Full transparency also contributes to the prevention of potential disputes, in particular by ensuring that disputed matters can be identified early.
From the minority shareholder’s point of view, it is essential, and the minority shareholder should always insist on this, that his protection is contractually ensured against the majority shareholder, who is entitled to force through his votes the majority of the fundamental decisions at the general meeting. The majority shareholder would thus be free to fill the positions of managing directors with his representatives and, in the case of a limited liability company, would not have to vote for the payment of the profits made in the long term, thereby “starving” the minority shareholder. The minority shareholder can be assured of the so-called blocking right in these cases, usually by setting the necessary voting majority for key decisions of the general meeting in the company’s constituent document (so that it is impossible to do without the minority shareholder’s votes) and related arrangements in the shareholders’ agreement (e.g. the right of the minority shareholder to nominate “his” executive officer, rules for profit distribution, etc.).
Common mistakes and dispute prevention
Our experience clearly confirms that the most common mistake that shareholders make when setting up a joint venture is underestimating the potential development. Riding a wave of positive expectations, they do not admit the possibility of failure or break-up and more or less ignore these scenarios.
They feel no need to take these precautionary measures right from the start, because they believe that “we know each other” or “we can arrange everything as we go along”. But these assumptions are the biggest trap. Once the interests of the shareholders start to diverge, the lack of rules can escalate the situation. Moreover, it is not advisable to simply copy a shareholders’ agreement from the internet – to avoid future disagreements, it is essential that it is “tailored” to the specific shareholders and their company from the outset. It is therefore worth investing time and resources in prevention while relations between the shareholders are good.
Dispute resolution by termination of a shareholder’s participation in the company
Despite all efforts at prevention, sometimes disputes between shareholders develop to such an extent that further cooperation is no longer possible. These situations can be resolved primarily through the negotiated mechanisms described in above. If the shareholders do not agree on these rules, there is no choice but to settle or to use the options provided by law for terminating the shareholder’s participation in the company.
Termination of participation can occur in several ways:
- transfer of share – the condition for the transfer of a share to a third party is that the transferability of the share is not limited in the memorandum of association or the necessary majority of the shareholders agrees to the transfer. In the case of transfer of a share to an existing shareholder, the consent of the general meeting is not required by law and, unless the memorandum of association provides otherwise, the share is transferable without restriction;
- shareholders’ agreement on termination of the shareholder’s participation – the least conflict solution, when all shareholders agree on the shareholder’s departure and settlement of its share;
- withdrawal of a shareholder, if this is permitted by law or the memorandum of association – a shareholder is entitled to withdraw from the company, for example, in the event of a change in the predominant nature of the company’s business to which he or she has not agreed;
- exclusion of a shareholder by the court – the last resort, where the company itself asks the court to expel a shareholder if the shareholder commits a particularly serious breach of duty. In practice, it is quite disputable which conduct of a shareholder can be considered particularly serious;
- cancellation of a shareholder’s participation by the court – a shareholder who wishes to leave the company may file a petition for cancellation of its participation if the shareholder cannot be fairly required to remain in the company (e.g. because of insurmountable disagreements between the shareholders, if the company cannot carry out its business for this reason).
The disadvantage of the non-consensual statutory regime for options (iv) and (v) above is usually the lengthy court proceedings, the outcome of which is difficult to predict given the complexity of the situation and the often specific relationships. In addition, in most cases, many years of litigation would lead to paralysis of the company or a substantial reduction in its value. Options (i) to (ii) require the agreement of all shareholders. In the case of option (iii), there are three legal situations in which a shareholder can withdraw, unless other situations are contractually agreed.
The application of the statutory exit options is not tied to the size of the share, i.e., if the statutory conditions are met, both minority and majority shareholders can use these institutes. However, the majority shareholder usually has more available (de facto) options for proceeding (e.g., he controls the decision-making of the general meeting and can declare the transfer of his share to a third party, for which the consent of the general meeting is required under the statutory regime), while the minority shareholder is often in a much more difficult position. It is for the minority shareholder that a court action may be the only way to get out of the company.
In the event of a shareholder’s exit other than by transfer of its share in variant (i) (i.e. without a legal successor), the shareholder is entitled to a settlement share. The settlement share shall be determined as at the date of the termination of the shareholder’s participation in the company, from the value of the shareholders’ equity as determined from the interim, regular or irregular financial statements drawn up at the date of the termination of the shareholder’s participation. If the fair value of the company’s assets differs materially from their valuation in the accounts, the fair value of the assets less the amount of debts recognised in the relevant financial statements shall be used to determine the settlement percentage. The objective is to ensure that the settlement share of the exiting shareholder corresponds to the fair value of the company’s assets less debts. Of course, of the value of the company thus determined, only the portion corresponding to the share of the exiting shareholder is due to the exiting shareholder.
If an existing shareholder argues that the fair value of the company’s assets does not correspond to the book value, it will be necessary to have an expert’s report prepared in the event of a dispute to establish the amount of the settlement share.
A completely different situation arises when the majority shareholder tries to completely “displace” the minority. This procedure is allowed by law only in the case of joint-stock companies, through the so-called squeeze-out institute. Under this procedure, the major shareholder (holding at least 90 % of the shares) may request a forced transfer of the shares of the remaining minority shareholders for a reasonable consideration. Here again, the value is determined by an expert, but the minority shareholders can also defend themselves against the amount of the consideration by bringing an action.
In limited liability companies, there is no similar mechanism – the majority shareholder does not have the right to “displace” the minority. Therefore, unless an agreement is reached, it cannot force the minority shareholder to transfer the share. All the more important are the preventive arrangements negotiated in the framework of the shareholders’ agreement (e.g. drag-along rights or call options), which can serve as foreseeable tools for dealing with such situations.
On the other hand, the minority has in practice very limited possibilities to force the majority to buy its share. The law does not directly provide for such an institute – again, this is why contractual put options or well-established mechanisms for resolving deadlock situations, which may result in the “break-up” of the shareholders on the basis of a pre-agreed procedure, become important.
It is clear from the above that the sooner shareholders prepare for even less optimistic scenarios, the less they will be exposed to unpredictable judicial intervention.
Dispute resolution through company transformation
Another option to resolve fundamental disagreements between shareholders is to convert the company under the Transformation Act. This route makes sense especially where the shareholders do not want to leave their business completely, but at the same time are no longer able to work together within the same company.
In particular, the division of the company, which can take several forms, is a possibility:
- demerger – the company being demerged is dissolved and its assets are transferred to two or more new or existing companies;
- spin-off – the company being split up is retained but part of its assets are transferred to one or more new or existing companies.
Such a division can allow the shareholders to each continue with their “own” business without having to deal with the complexities of share transfers or exiting the company that we have described above.
It should be stressed that the division of the company is not decided by the court, but by the general meeting of the company – therefore, either the required majority of the shareholders will have to agree on this solution (the Transformation Act stipulates in most cases the requirement of a three-quarters majority of the shareholders present) or it is necessary to prepare for a situation when the majority shareholder himself will push through the conversion. However, in any event, any shareholder who loses a share in the company being divided as a result of the conversion must be adequately compensated in the form of a new share in the successor company, where, in principle, the equivalent value of the original share and the new share should be maintained.
In the context of the conversion, it is also necessary to assess the tax consequences, in particular in relation to the possibility of breaking the “tax test”. Therefore, it is imperative to engage a tax advisor when planning the conversion to avoid unexpected tax consequences and to ensure that the demerger serves its purpose – i.e., to allow the shareholders to share fairly without distorting the value of their shares or putting them at a tax disadvantage in subsequent transactions.
Conclusion
Disputes between shareholders can easily jeopardise the running of a company – its reputation, its value and its very existence. No contract, no matter how good, can completely prevent disputes from arising. However, the appropriate preventive contractual set-up of functional mechanisms is a prerequisite for dealing with those cases where one of the partners decides to leave the company against the will of the others, or for resolving deadlock situations.
For this reason, it is more than advisable for the shareholders not to underestimate these extreme situations when establishing a new company and to prepare for their solution by concluding a shareholders’ agreement at an early stage of their joint business. Otherwise, it is very difficult to unilaterally get out of the company, and without an agreement between the shareholders, it is necessary to prepare for potentially protracted litigation.
In the event that the exit rules could not be set appropriately at the beginning of the joint venture and the relations between the shareholders have escalated, the minority shareholder may nevertheless improve its bargaining position by consistently exercising its legal rights (in particular by exercising its right to information, explanation and, in the extreme case, the judicially enforceable right to terminate the shareholder’s participation, as we have mentioned above). Thus, even in these cases, the minority shareholder’s bargaining potential can be increased and an acceptable compromise solution to the situation can be sought.
Mgr. Martin Heinzel, partner – heinzel@plegal.cz
Mgr. Nikola Tomíčková, junior lawyer – tomickova@plegal.cz
7. 8. 2025