Main Causes of Shareholder Disputes and Litigation

The root cause of the failure of 65% of start-ups is due to founder conflicts. Issues like executive misconduct, conflicts of interest, and mismanagement of resources are often the roots of shareholder disputes. A common flashpoint within these disputes is a financial reporting dispute, where disagreements arise over the accuracy, transparency, or interpretation of a company’s financial statements.

We have seen this time and again in cases like the Autonomy acquisition fiasco and the lawsuit against Elon Musk in relation to Tesla’s acquisition of SolarCity.

The foundation of effective corporate governance is preventing shareholder disputes through understanding the common causes of these disputes. However, seeking expert dispute consulting services can be crucial for resolution when prevention fails.

In this article, we will explore various cases of financial reporting disputes and five common causes of shareholder disputes, backed by real-life examples. Read on to gain a deeper understanding of these issues and take steps toward fostering effective corporate governance which may include seeking valuation advisory services to ensure fair practices.

Understanding the Roots of Shareholder Disputes and Legal Conflicts

The foundation of effective corporate governance is preventing shareholder disputes among themselves and with the company’s management. Implementing robust corporate governance practices, including regular shareholder communication and dispute consulting services, can help prevent conflicts from escalating into full-blown litigation. With this in mind, let’s explore some common causes of conflicts:

When Ethical Boundaries Are Crossed

When a company’s executives defraud their shareholders by misrepresenting facts on financial statements, committing invoice fraud, or through any other means, they may seek redress by filing lawsuits. This often leads to a financial reporting dispute, in which the accuracy and integrity of the company’s financial information are questioned. The most famous example of this would be the Enron scandal of 2001.

This was one of the most pivotal moments in the history of American corporate law regarding executive compensation.

The now-defunct American energy giant’s executives were accused of defrauding its shareholders by misrepresenting facts and numbers in their financial statements. When the dust settled, it was found that the executives were inflating Enron’s profitability in the financial statements and hiding troubled assets off Enron’s books.

Furthermore, while the company was marching steadfastly towards bankruptcy, the 200 highest-paid employees received $1.4 billion out of which only $173 million comprised base salary and other income. The rest was made up of bonuses, stock options, and restricted stock units (RSUs).

In response to claims of fraud, Enron was ordered in 2008 to pay $7.2 billion to its shareholders. 16 years later, this is still one of the biggest settlements ever.

Competing Interests in Business Relationships

Conflicts of interest arise when someone’s personal interests could potentially hinder some of their other duties. An example of this could be an executive promoting their relatives to a position of power while better candidates are available. In this case, the executive’s instinct to look out for their family is affecting their responsibility to the company.

When conflicts arise, seeking professional dispute consulting can be crucial. Experienced consultants can provide impartial mediation, help navigate complex legal issues, and propose solutions that protect the interests of all parties involved.

A real-life example of a conflict of interest leading to disputes would be when Tesla’s shareholders filed a lawsuit against Elon Musk. The allegation was that he coerced the board to acquire SolarCity to rescue his investment. SolarCity was founded by Elon Musk’s cousins and at the time of the deal, Elon Musk owned about 22% of both companies.

The deal was valued at $2.6 billion; however, shareholders sought $13 billion in damages, as it was an all-stock deal and Tesla’s share price boomed following the acquisition. 

However, the judge ruled in favor of Elon Musk noting that Tesla paid a fair price and that SolarCity was at least as valuable as what it was sold for.

Conflicts of interest may also manifest in disputes over financial disclosures. A financial reporting dispute is a common scenario where shareholders suspect that financial statements have been manipulated to benefit certain parties at the expense of others.

Ineffective Corporate Asset Management

Mismanagement of corporate assets can be in the form of making unnecessary acquisitions, utilizing funds and assets for personal use, neglecting asset management, or even overstocking inventory or raw materials, which leads to waste. Mismanagement of resources often leads to disputes among shareholders, especially when it involves discrepancies in financial records or accounting practices. A financial reporting dispute can arise when stakeholders question the accuracy or transparency of financial statements, leading to mistrust and potential litigation.

A famous example of corporate asset mismanagement leading to shareholder disputes occurred when Hewlett-Packard was sued by shareholders for $1 billion over the Autonomy acquisition. This lawsuit alleged that the management neglected even the surface-level due diligence in the $11 billion takeover.

A year after the acquisition, HP wrote down $8.8 billion of its book value because of the Autonomy acquisition. The stock market reacted by wiping off $3 billion of the company’s market capitalization in a single trading session. HP stated that $5 billion of the write-down was on account of accounting irregularities at Autonomy.

This mismanaged acquisition turned into a public dispute between the executives of the two companies. HP accused Mike Lynch, Autonomy’s co-founder, and senior executives of inflating financial results through fraudulent accounting practices. On the other hand, Lynch asserted that the fiasco resulted from HP’s efforts to cover up poor results.

Minority shareholder oppression 

This is more likely to happen in a closely held company or a family-owned business where there may not be adequate legal and regulatory protection for minority shareholders. Minority shareholders have less voting power than the majority and hence, are often in a vulnerable position. The majority of them may exploit the vulnerability of the minority by withholding dividends, limiting or blocking access to financial statements, and excluding the minority shareholder from decision-making.

Sometimes, the majority may try to force minority shareholders to accept a buyout at undervalued prices by issuing new shares to themselves. This is a form of squeeze-out tactics.

Minority shareholders should know their rights and the available remedies in disputes. Engaging in dispute consulting early on can help minority shareholders understand their options and potentially resolve issues before they escalate to litigation. If you are looking to invest in a closely held company or a family-owned business, you must negotiate a shareholder agreement that lists all your rights and includes clauses on dividend policies, buy-sell agreements, and share valuation.

Engaging a valuation advisory firm can help determine fair share prices and protect your interests. You should also familiarize yourself with state laws on minority protections and the types of remedies available.

Divergent Visions in Corporate Strategy

Shareholders and management may not always agree on the company’s direction. Sometimes, founders may want to take an aggressive risk-taking approach, like making heavy investments in production processes instead of relying on external vendors, while investors may prefer a more conservative approach.

Similarly, disputes may occur when some prefer that the company reinvest all its earnings while others may want payouts in the form of buybacks or dividends. When shareholders disagree on strategic decisions, independent valuation advisory can provide objective financial analysis to inform decision-making

A famous example, Yahoo Shareholders disagreed with the management’s refusal to sell the company to Microsoft for $45 billion in 2008. Even though the bid was at a 62% premium over Yahoo’s market value, Jerry Yang, the then-Yahoo CEO, argued that it significantly undervalued Yahoo.

Eight years later, in 2016, Yahoo’s core assets were bought by Verizon for $4.8 billion.

Eqvista – Expert valuations, reliable litigation support

Shareholder disputes typically arise out of frauds, conflicts of interest, mismanagement of corporate assets, perceived minority oppression, and disputes related to company direction. Often, these disputes escalate due to underlying issues related to financial reporting, requiring expert investigation and resolution. In these situations, early intervention with legal counsel and potential dispute consulting can be essential for achieving a favorable outcome.

High-profile cases like the Enron scandal, the Autonomy acquisition by HP, and Yahoo missing out on an attractive buyout illustrate how these issues can significantly affect shareholders.

Understanding and addressing shareholder disputes requires a proactive approach to governance and transparency. Particular attention should be given to avoiding financial reporting disputes, as these can severely damage trust among stakeholders and lead to costly legal battles. Seeking professional valuation advisory services can help founders navigate complex issues, protect their interests, and safeguard the company’s future.

In such scenarios, partnering with a trusted valuation advisory firm, such as Eqvista, can be invaluable. With a proven track record of accurate valuations for over 15,000 companies, we can offer the necessary credibility to back your case. Contact us to know more!