What Can I Do If I Have a Dispute With My Joint Shareholder?

Tim Elliot: Hello and welcome to Lawgical from the Dubai-based law firm, HPL Yamalova & Plewka, the UAE’s first and only weekly legal podcast. I'm Tim Elliot. I’m here once again at Reef Tower in Dubai’s JLT District with the firm’s Managing Partner, Ludmila Yamalova. As ever, Ludmila, good to see you.

Ludmila Yamalova: It’s great to see you too, Tim. Thanks for being here and it is always lovely chatting with you.

Tim Elliot: In this edition of Lawgical, disputes in business, specifically shareholder disputes. Now, in your practice, Ludmila, you have advised, are currently advising, and will no doubt continue to advise clients who are looking to set up shop here in the United Arab Emirates. Now the UAE is an attractive place to do business. There is a lot of opportunities.

The current legal framework in the UAE means that overseas parties wishing to do business in this jurisdiction will generally have to enter into shareholder arrangements with a local partner. That’s to be onshore. Offshore is a different situation. But here’s the thing, put the way you structure your company to one side, people are people.  We can’t get along all of the time. Disputes arise. An ironclad legal agreement, if that’s even a thing, is the first thing you need, isn’t it?

Ludmila Yamalova: Indeed. You’re correct that if you set up onshore you need, in most cases, to have a local partner. A partner in that context means a 51% shareholder who is a UAE national. It’s not just a partner on paper or in an agreement, but in fact on your share certificates and on all your corporate documents and registered with the government authority that is licensing that particular company. A very similar concept exists in all the free zones with regards to at least the registration of the shareholder.

That is, let’s say you and I set up a company in the free zone, in that case, we do not need to have a local partner. That is the whole idea of a free zone. You and I, the two shareholders, can be 100% shareholders collectively, but our arrangement is registered with the government just like it is on the mainland. It’s just registered by a different economic entity if you will. On the mainland, it’s the Department of Economic Development or otherwise known as DED.  In the free zone, it is the particular free zone that becomes your licensing authority. This is important. I’ll explain shortly why this particular discussion is important. Our relationship as shareholders, for example, is now registered by the particular free zone authority.

This means that we receive a license and as part of that license it will show that Tim and Ludmila are 50/50 owners of the company. It will also be registered with the government, and we will also be issued a number of corporate documents as part of our company. Depending on where you are set up, some of these corporate documents are quite standard templates of the particular issuing authority, let’s say the free zone. We will have the MOAs, the memorandums of association, and articles of incorporation.

These are the typical corporate documents that are issued in connection with the opening of a company. All of these documents cumulatively will reflect you and me as the two shareholders. It’s not just a side agreement between us if you and I draft something and say, okay, Tim is 50%, Ludmila is 50%. These are actually government documents that are registered with the government and reside with the government that clearly show that you and I are registered shareholders.

Now, as part of these government documents, there will be a whole series of corporate structures that are outlined in terms of how we’re going to run our company: The voting, the meetings, the decisions, the appointments, the notices, and so on and so forth. One is the things is that we are 50/50 shareholders, so we are equal shareholders. Perhaps we will outline that to make certain decisions we can do singly, some decisions we have to have to do jointly, and so on and so forth. If you have partners with everyone 50/50, it creates a bit of a theoretical bind when you’re talking about a dispute.

Okay, if we are in a dispute, who will prevail since we are 50/50? But in a lot of relationships actually these companies are set up in different percentages. Back to you and me, but this time I am a 10% shareholder and you are the 90% shareholder. This seems much simpler, a simpler scenario in terms of disputes, at least theoretically, right.

Tim Elliot: Oh, in theory, I’m the boss in this relationship.

Ludmila Yamalova: In theory. In practice, however, that is not the case.

Tim Elliot: I saw that coming.

Ludmila Yamalova: Yes, I know the 90% obviously in most other countries it seems pretty clear, I am the majority shareholder. Therefore, I have the majority decision making authority in terms of certain decisions, including if we have a dispute. In most other jurisdictions, the same governing corporate documents that I described earlier, like MOAs and AOIs, and also shareholder resolutions and board resolutions and such, they will outline what happens in the event you and I are in a dispute.

In very simple terms, for example, it would say if we were in a dispute, we would have X number of meetings and X number of notices. We try to resolve the dispute and let’s say after all that, we are unable to resolve our dispute, therefore, you as a majority shareholder can take over my shares. Now, it’s not to say that I won’t get compensated for those shares. I will get compensated but in practical terms, you can ultimately reassign those shares to you. Now you are a 100% shareholder of the company, but you have to compensate me for the value of those 10% shares, but at least you can manage the company.

The reason this formula or this structure exists, obviously for that same reason, is that you want to continue to run the company, and often when shareholders are in a dispute the whole thing comes to a halt because when the shareholders don’t agree, often this kind of disputes become very acrimonious and very ugly and then everything becomes an issue in terms of taking money, making transfers, hiring, firing, office hours, and anything else, your dividends, and what have you. Day-to-day business issues become issues and become problems when you have shareholders fighting.

That’s why in theoretical terms, you understand, okay, well, the company should continue to run. Therefore, it makes sense and we have accounted for that in our initial governing documents. That is, in that particular case, you can take the shares and you can now run the business, but that does not deprive me of my interest in the company as of that point in time. You will still have to compensate me for the value and that is a separate process and often even the mechanisms for value my shares will be in those governing documents.

There is a process that we already ahead of time know we will follow in terms of figuring out what the value should be. Now, under that particular scenario, you can run the company on your own, and I get compensated for my 10%. That’s how it’s done in most jurisdictions, I guess, particularly in the US. In the UAE, however, it doesn’t quite work that way. On paper and legally speaking, we may have a very similar structure, still 90% and 10%. You’re the majority and our governing documents will have a process outlined for purposes of disputes and how we’re supposed to resolve them and how many notices are supposed to be given.

Ultimately, there may even be a provision, in most cases, there is a provision that you can take over the shares because you’re the majority shareholder. Legally speaking and document wise, the process is perhaps outlined, and we know that and try to avail ourselves of that, but in practical terms, that’s not possible. This is because going back to my earlier description of how our company is registered. Is it registered with the authorities? In order for you to take over my 10% shares, you basically have to go to the authority, and the authority has to reassign those shares to you. It’s not contractual. We cannot do it.

In other countries, these documents are not necessarily registered with the authorities and basically, it’s done by contract. You just go and update the contract with the government saying, hey, listen, I am a 90% shareholder and we had all this happen, so now please reassign the shares to me, and that happens. Here, the authority has to basically get my permission, my approval, that I am selling the shares or transferring the shares to you.

But in the context of a dispute, obviously, I am not going to give you that permission, so, therefore, you cannot, in practical terms, transfer the shares to yourself even though we had agreed to do that in legal terms. But you cannot do it now that we have a dispute without my approval. My approval can come either by transferring the shares or I’m selling the shares, but one way or another, you need my approval. The authorities will not process your request even if you showed them all these other governing documents until I have given you my approval.

Now, the way that the authorities look at is, listen, when you try to present the governing documents, listen, we have got a mechanism here that clearly describes what happens. This has happened and I have a proof for you that it has happened, so now transfer the shares to me. Their position is that’s not their jurisdiction to do it. They are just a governing authority. They are not a judicial authority, so they’re not the right entity for you and me just to look at and say, okay, who is right and who is wrong and how do we interpret all of these governing documents. That is the position of the authorities here.

Therefore, your only option, in this case, is to go to the court because the licensing authority will not help you. Then you go to the court, and then the court in fact here, and this is also very important, in the majority of the cases the courts will not issue the order for you to take over my shares, but rather, in most cases, the court will issue an order for us to liquidate the company and then get compensated as per the percentage of our shares. That is how it works today in practical terms and in simple terms. That is why it’s a very nuanced issue.

Whenever you have shareholders, it’s not so easy to resolve their disputes, even when you have 99% and 1% shareholders, as long as I hold any shares you will need approval from me to do anything, to change that shareholding structure. To do so, if I don’t give it to you, the only way and your only recourse is to go to the court. We have yet to see a decision where the court actually issues an order to transfer the sales. In most cases, it’s a decision to liquidate. In the meantime, you’ve got a company, you’ve got a business that perhaps is failing and is struggling because you and I cannot agree.

It presents some serious challenges to a lot of businesses, and we see this quite often. This is where the system is looking how to potentially soothe or ease these kinds of burdens, and depending on the governing authority, the licensing authority, certain free zones are starting to introduce regulations that at least have some kind of temporary measures for shareholders or for stakeholders to avail themselves while there is a dispute. Most of the time, they are quite limited options still, but the idea is that if a licensing authority, for example, can freeze certain activities of the company or one party’s ability to perhaps abuse their powers, then at least there is a chance of preserving the business. But this is still a new concept, a novel concept, and still a work in progress.

Tim Elliot: I mean, it’s often said, isn’t it, that outside of divorce courts the most bitter disputes are between shareholders and often times company shareholdings bring together very different people, very different outlooks, very different attitudes. There are a whole host of issues that can lead to disputes. You can disagree on the management, the direction of a business.

There could be personal relationship problems. It might be the distribution of dividends or the lack thereof, I suppose. The point is you can’t see where the problems might arise. Let’s get down to brass tacks, as it were. Where do you start, Ludmila, if you do have a dispute with a shareholder?

In some cases, you operate in the DMCC, the Dubai Multi Commodity Center, that’s your licensing jurisdiction if you like. I know that there you can apply to disqualify a shareholder, but you have to prove they’re no longer fit for the role based on DMCC regulations here in Dubai. Similarly, you can file with the courts to have a shareholder removed, as you’ve outlined. But how would you, under DMCC regulations, for example, prove that somebody is not fit? Where on earth do you start?

Ludmila Yamalova: Sure. This is actually a great example. The DMCC, in particular, is a great example because, as I mentioned earlier, this is obviously a challenge that has existed. A number of licensing authorities have been looking to update their rules to offer more flexibility for shareholders and business owners to resolve these kinds of disputes. The DMCC is a good example because only in January of 2020, just a month ago, they have introduced a new set of rules which now, as you rightfully said, does offer the ability to apply to the registrar of the DMCC to have the manager or an officer disqualified, not so much a shareholder disqualified, but an officer disqualified.

This is important because in most cases here, one of the shareholders is also an officer, one or the other, or both shareholders are also officers. In practical terms, it’s not the shareholders that run companies, but rather officers. The officers, in most cases, are also the shareholders. The disqualification is not of the shareholders because that’s the ownership interest. It’s not that you are asking the licensing authority to take away the right of ownership or the interest of the ownership from someone, but rather their involvement in running the business on a day-to-day basis. That’s what you are asking for.

The DMCC has now introduced that particular mechanism to apply for a company, for a shareholder, for an officer of the company to apply to the registrar to seek disqualification of that particular officer, and as you said, you have to present proof that the particular person is unfit to run the businesses. Now, the way the rules are structured, you don’t have to show that an office is unfit or is not suitable. You don’t need to bring a court judgment because obviously that would defeat the whole purpose. It’s just to show to the registrar the reasons why you believe that person is unfit to run.

That’s obviously subject to interpretation in terms of what kind of evidence you prove and what else the registrar might require for them to feel satisfied. But in general terms, it’s just an example of perhaps what you may consider abuses of process or abuses of power that you would show to the registrar. For example, let’s say, somebody, that particular officer, is terminating an employee who you know as a company is either a valuable employee or who, for example, you as the other office holder rely on quite heavily.

You know that the termination of the particular employee is not in the benefit of the company. Remember, the officer’s job is to act in the interest of the company and all of the shareholders, not just one of the shareholders, but all of the shareholders. When an office is now terminating a valuable employee, that will affect the company’s business. That obviously is an example of an abuse of power. Or, for example, when an officer is terminating an employee, let’s say an executive assistant, of the other shareholder who is also an officer in the company.

Let’s say I’m a shareholder and an officer in the company, and I’ve got my right-hand executive assistant who I have been working with and relying on for the last many years. Now the other officer, you being the other officer, you go and unilaterally try to terminate that employee, well, now you’re not acting in the interest, certainly in my interest as a shareholder, and you’re not acting arguably in the interest of the company because that particular person is valuable. If you can show that to the registrar, that obviously could constitute proof that the person is not suitable for managing the role of the company because obviously they are abusing their powers and doing things that are not in the interest of the company. That’s one.

The other one, for example, if that same officer, being you - we’ll make you the bad cop here – is that you go and you harass your employees and you mistreat them, and that also can lead to liabilities for the company. If you mistreat your employees or you terminate them arbitrarily that can lead to massive liabilities for the company, or if you start taking away documents from the company, or if you start taking loans for yourself and paying out dividends to yourself, or taking money from the company and setting up your own company. Obviously, the burden of proof is on the requesting shareholder or officeholder, but these are some of the examples.

It doesn’t need to be a conclusive court judgment, but you can show whatever evidence you may have to show to the registrar that there are things that are obviously happening today that are detrimental to the company’s interest and certainly to the interest of at least one of the shareholders. That, by the DMCC’s own regulations, renders those people unfit for that role. That’s doing it through the licensing authority.

Tim Elliot: Yes.

Ludmila Yamalova: But as you said earlier, there is also the next step. Now under the DMCC regulations, now there is a provision also allowing the shareholder to apply for disqualification of the other shareholder when there is an unfair prejudice. Then you apply to the court. Here, as per the DMCC rules, now me as a shareholder, going back to you and me as an example, I’m the good one and you’re the bad one, me as the shareholder can now apply to the local court and request the court to disqualify you as the other shareholder for your unfair prejudice that you are causing to the company overall and to me as a shareholder individually.

Just to use the DMCC as an example, there is a perfect example of how the regulations have been recently updated, again just a month ago, allowing the shareholders a different avenue to resolve or at least to moderate their disputes. In other free zones, the DIFC free zone, and the ADGM free zones, these processes are much easier to follow, but in other licensing authorities, we presume that they will follow suit soon enough, but for now, the overall process of resolving shareholder disputes is still quite challenging.

Tim Elliot: I know you can’t comment on particular ongoing cases, but can you offer any ideas of some of the kinds of disputes you’ve heard about, been involved in, the things that people do in shareholder disputes.

Ludmila Yamalova: I think that would warrant a separate podcast in itself.

Tim Elliot: It probably would.

Ludmila Yamalova: An extended edition because there are so many examples of these kinds of disputes.

Tim Elliot: Really.

Ludmila Yamalova: Perhaps this is because the UAE is very dynamic and very fast-paced business culture and so many new businesses are being set up here quite often and not just one business, multiple businesses, and a lot of the times it’s between partners who are perhaps foreigners of different countries. Somebody is here, more present than the other, and their personal circumstances change, their financial circumstances change, but they are all very eager to benefit from the UAE’s burgeoning business culture so they jump on that wagon of setting up a business and having a partnership together without perhaps having done the proper, the more expected due diligence of each other’s skills and talents, experience, and history perhaps that would have otherwise been done elsewhere.

The UAE is very unique in that situation. Historically, in the not so distant past, there was a lot of money here and a lot of people coming here with money, wanting to invest, and they were very open also to investment ideas and equally so. A lot of people here were willing to work with that money, trying to create a business. We have seen a lot of partnerships like that where one partner is investing money and the other one is supposed to be investing the sweat equity, trying to build a business, and then they sell to the investing partner or the investor the dream, and the investing partner wants to buy the dream because there are lots of great salespeople here, and then so you invest as the investing partner into this dream, and the dream ends up being not a dream at all because let’s say, you’re the investor and I’m the sweat equity partner, and I don’t know how to run a restaurant.

We have had examples like that. This is an important one because, in other jurisdictions, investors do not in most cases become shareholders. They do not necessarily become owners in the company. They are just investors. But here, in most cases, the only way for investors to protect their interests is to actually become shareholders, so in most of these kinds of financing cases, the investor becomes the actual shareholder. We’ve had cases like that.

For example, you’re an investor and I want to open a restaurant for you, and I’ll give you whatever fancy graphics and Excel spreadsheets showing you that I grow this restaurant at the pace of Google. You like the idea and you don’t really have the time to monitor me, nor be involved in this business, but you really want to invest and diversify, so you buy my sales pitch and then a year later you realize I’m just asking for more and more money, and you have not seen a single dirham of even revenue, let alone profit. That’s one example, right.

There have been a lot of examples like that where some of the owners of the companies are investors and others are supposedly investing sweat capital and equity and want to grow the business, but the business has not grown. At some point the investing partner either wants out or in most cases they want out and they want the investment back. That is one example. The other example is where families come together, families or friends, that often happens. But in particular, it is very sensitive and painful when families come together to set up businesses, be it father and son, or husband and wife, and then they have a dispute.

The dispute, especially when it is husband and wife, and there is a divorce involved, it gets very ugly. I guess by virtue of the whole idea of a divorce, a lot of these cases become very acrimonious, and then at that point the business obviously kind of falls in the line of fire. But as you know, as we all know, when you run a family business, you don’t do things in a way that a normal business would run. It would do them a lot more, kind of informally, because it’s a family, a husband and wife and their children, for example, are running the business.

There is not the same level of reporting and accounting and bookkeeping because we’re a family, and we’re living off of that until you and I now have a dispute and we’re divorcing, and all these kind of lax practices now start backfiring because you, as the divorcing husband, you want to take advantage or you want to assert leverage over your spouse. This is another example and a very painful example that we see all too often.

Tim Elliot: Final general thoughts, Ludmila. Disputes often escalate and they escalate quickly because parties don’t get advice early on about legal rights. They don’t understand the best options and/or, I guess, strategies to follow. Company memorandums and articles, tend to be pretty complex sets of documentation, often hard to understand, the reality of having to deal with that. You know where I’m going with this. With shareholder disputes in mind, the things that you’ve seen, the things that you’ve had to deal with, just your final thoughts and advice.

Ludmila Yamalova: Number (1) is just choosing your partner carefully. Number (2) just manage your expectations and know the law. Obviously, for a lawyer, it’s easy to say that, but truly know the law and know the practice because, as I mentioned earlier, the governing documents may have a very clear mechanism for us to separate, but in practice, if that mechanism does not work, you should know that. Going into partnership, you should know that. Just basically do due diligence and not just in the legalities, but also importantly in your partner.

Obviously, when you have a husband and wife, you’ve chosen a partner and you think that’s a perfect match. Then seek legal assistance and professional assistance early on, before things escalate too much. That’s very important because often these disputes escalate and become very acrimonious because parties seek assistance just too late. They have done things already that have been just so damaging that at this point most of the time things are no longer salvageable. To summarize, choose your partner carefully, do legal due diligence and practical due diligence, and seek professional advice early on and throughout.

Perhaps one other one, I’m saying this also as the business owner, is just to have professional and competent advisors and staff throughout out your business, even if it’s your family business. Have a professional accountant. Have a professional financial advisor, for example. Have a professional lawyer throughout because they will help you at least make sure that you have some basic tools and mechanisms in place of running a business that will not only help you when there is a dispute but also help you in making sure that your business continues to grow in the right direction.

Tim Elliot: Ludmila Yamalova is the Managing Partner at the legal firm, Yamalova & Plewka in Dubai. As ever, great to talk to you.

Ludmila Yamalova: Great talking to you too, Tim.  Thank you.

Tim Elliot: That’s another edition of Lawgical. Each week we cover legal issues, legal news, and much more either in a Lawgical Lite, a bite-sized podcast or in our slightly more detailed full-length Lawgical podcast just like this one.

If you have a legal question you need to be answered in a future episode, if you’d like a consultation with a qualified UAE experienced legal professional, you can click the Contact button at LYLawyers.com.

This article is a transcription of the Lawgical with LYLAW podcast episode published on 25 February 2020.

Written by:

Ludmila Yamalova | HPL Yamalova & Plewka DMCC