When a shareholder who is also a director faces bankruptcy proceedings, it can create significant uncertainty and risk for the business and its stakeholders.
The remaining shareholder(s) must act swiftly to safeguard their interests and ensure the company’s stability.
In this article, we explore the key risks faced by the remaining shareholder(s), how to mitigate those risks, and potential solutions in such situations.
Consequences of a Shareholder-Director Facing Bankruptcy
Loss of Directorship
If a shareholder-director is declared bankrupt, they will be automatically disqualified from acting as a company director of a limited company or as a partner of a limited liability partnership under the Company Directors Disqualification Act 1986.
The remaining shareholder(s) must consider how to redistribute the bankrupt director’s responsibilities to ensure business continuity. This may include appointing a new director, adjusting decision-making processes, or seeking legal advice on the best course of action.
If the bankrupt director refuses to step down voluntarily, the company may need to formally remove them under the Companies Act 2006, typically requiring a resolution passed by shareholders. The shareholders’ agreement (if any) and articles of association should be reviewed to determine the exact procedures for director removal in such circumstances.
Operational and Reputational Risks
The loss of a director can significantly disrupt business operations, particularly if they played a key role in decision-making or the day-to-day running of the business. Their absence may create leadership gaps, cause uncertainty within the team, slow down key projects, or result in an imbalance of skills within the remaining management team.
Furthermore, the association with a bankrupt shareholder can negatively impact the company’s reputation. Clients, investors, and suppliers may perceive the company as financially unstable, leading to a loss of business opportunities, difficulty securing credit, or increased scrutiny from regulators.
If the bankrupt shareholder had a public-facing role, the reputational damage may be even more pronounced, requiring a strategic and immediate response, such as proactive communication with stakeholders, rebranding efforts, or legal steps to distance the company from the affected individual.
Shares Becoming Property of the Trustee in Bankruptcy
The bankrupt shareholder’s shares will likely vest in the trustee in bankruptcy, who may seek to sell them to realise value for creditors. This could result in an external party acquiring a stake in the company, potentially disrupting the business.
If the company’s articles of association or shareholders’ agreement contain pre-emption rights, the remaining shareholder(s) may have the first opportunity to purchase the shares before they are sold to a third party. However, if no such protections exist, the trustee may sell the shares to the highest bidder, which could lead to an unwanted third party gaining influence over the company.
This could pose significant operational and strategic risks, particularly if the new shareholder does not align with the existing business vision or seeks to interfere with decision-making.
In some cases, the remaining shareholder(s) may need to negotiate with the trustee or seek legal remedies to limit potential disruption. It may also be possible to challenge the sale on the grounds of unfair prejudice if the new shareholder’s involvement is detrimental to the company’s interests.
How Can the Remaining Shareholder(s) Protect Their Interests?
1. Review the Shareholders’ Agreement
A well-drafted shareholders’ agreement can provide mechanisms for dealing with insolvency. Key clauses may include:
- Compulsory transfer provisions – allowing the company or remaining shareholder(s) to buy out the affected shareholder’s shares.
- Good leaver/bad leaver provisions – determining how shares are valued and transferred in adverse circumstances.
2. Check the Articles of Association
The company’s articles of association may include provisions for the removal of a director and rules governing share transfers in the event of a shareholder’s bankruptcy.
3. Negotiate a Share Buyout
If no automatic transfer provisions exist, the remaining shareholder(s) may negotiate the purchase of the bankrupt shareholder’s shares to maintain control. Seeking expert legal advice is recommended.
4. Apply for a Court Order
If the affected shareholder’s continued involvement damages the business, the remaining shareholder(s) may seek relief under the Companies Act 2006, potentially applying for an unfair prejudice petition or pursuing a just and equitable winding-up of the company.
For further information on legal action, please see our article: “Shareholder Disputes: Navigating Breakdowns in Trust and Confidence.”
5. Protect the Business from Reputational Damage
Proactive communication with clients, suppliers, and employees can help reassure stakeholders and mitigate reputational harm. If necessary, a rebranding or distancing strategy may be required.
When a Shareholder-Director Faces Bankruptcy: Frequently Asked Questions (FAQs)
Can I remove a shareholder-director who is facing bankruptcy?
A bankrupt director will be automatically disqualified, and it is an offence for them to continue acting as a director. However, their shares will remain under the control of the trustee in bankruptcy. While the company can remove them from their directorial position under the Companies Act 2006, their status as a shareholder is a separate matter.
If the shareholders’ agreement or articles of association contain provisions for compulsory share transfers in the event of bankruptcy, the remaining shareholder may have the right to buy out the bankrupt shareholder’s interest. Otherwise, the trustee in bankruptcy will control the shares and may sell them to an external third party. It is essential to review company documents, including any existing shareholder’s agreement and the articles of association, to determine the available options for maintaining control of the business.
What happens to the bankrupt shareholder’s shares?
Their shares will be controlled by the trustee in bankruptcy, who may sell them. The remaining shareholder(s) should check if pre-emption rights apply to prevent an unwanted third party from acquiring the shares.
How can I prevent these risks in the future?
Ensuring a robust shareholders’ agreement is in place, with provisions for dealing with insolvency and forced buyouts, is the best way to protect your interests.
Key provisions to consider include:
- Pre-emption rights – giving existing shareholders the first option to buy shares before they are sold externally.
- Automatic transfer clauses – requiring a bankrupt shareholder to transfer their shares to the company or other shareholders.
- Drag-along and tag-along rights – ensuring smooth exit strategies in case of share transfers.
- Director disqualification consequences – setting out steps for removing a director who is no longer eligible to serve.
Regularly reviewing and updating the shareholders’ agreement, especially when new shareholders join or the business structure changes, will help mitigate risks and provide clarity in difficult situations.
Shareholder – Director Bankruptcy Solicitors: Contact Us
If your fellow shareholder-director is facing bankruptcy, early action is crucial to protect your interests and the company’s future. Prevention, in the form of a comprehensive shareholders’ agreement, is strongly recommended.
Reviewing key company documents, negotiating a buyout, and seeking early legal advice can help you minimise potential negative impacts and ensure business stability.
For more information on your rights and the steps you can take to safeguard your position, or to discuss any specific concerns, please contact Commercial Litigation Associate Katinka Beamish via email at k.beamish@rfblegal.co.uk or by phone on 0207 467 5768.
Katinka Beamish
Associate Solicitor
