Majority shareholders may dilute minority shareholders to gain greater control of a company. Generally, the issuing of new shares makes each share of a company worth less – diluting the minority. Without a shareholders agreement, this oppression may occur. This article breaks down the law on this topic.
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How is diluting shareholders done?
Majority shareholders can create new shares in the company for them to control. This dilutes all the current shares. However, as the majority have issued themselves additional shares, they have greater control of the company. Doing so will dilute the minority shareholders votes and earning capabilities.
Due to the shareholders having a direct impact on the Board of Directors, the majority have the power to force the issue of new shares.
Why would this be done?
Two predominant reasons emerge as to why a majority shareholder might attempt to dilute the minority.
Buying the shares at below true value
As the value of the minority’s shares diminish, it’s common for the majority to buy the shares at below their original value. If the shares weren’t diluted, they would still be worth more. Thus, the majority would’ve had to pay more.
Special resolutions within a company require a minimum of 75% of the votes cast by members with voting rights. For example, changing constitutions, changing the company name/type, or winding up a company require the 75% of votes.
The majority shareholders may dilute the minority’s shares, to ensure they reach the 75% threshold required.
Is it legal?
The Corporations Act 2001 (Cth) allows the court to take action against a company or shareholders that conduct oppressive or unfair action against other shareholders. Companies in Australia have been punished for issuing shares for the purpose of diluting the minority.
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The punishments can be significant. They include:
- That the court can decide the purchase price of the shares.
- An injunction preventing the dilution.
- Winding up of the company.
Looking after your members is an important part of belonging to a company. Therefore, it is important to treat all shareholders as equal. Bullying or oppressing minority shareholders will lead to significant issues for both the company, and the majority shareholders.
In conclusion, diluting minority shareholders is an oppressive action, making it illegal. A company and their majority shareholders face significant punishments for the purposeful dilution of the minority’s shares. For issues or further enquiries on this topic, a commercial litigation lawyer may be able to assist.