The risks of making your shareholders/director employees of your business

By Robert Lamb, Director & Caitlyn Wessels, Graduate Law Clerk at Hillhouse Legal Partners
| 1 min. read

Key takeaways

  • If your company’s minority shareholders are also your employees, you could be facing some risks
  • Shareholders’ rights and remedies are restricted and both difficult and expensive to enforce
  • If a minority shareholder is also an employee they may bring action for unfair dismissal or adverse action
  • If employees are also shareholders, well drafted Shareholders Agreements and employment agreement(s) should be considered and implemented

Many businesses operate through a corporate structure, and it is likely that your business is run through a company with yourself and your business partners as directors and shareholders. 

Directors are responsible for the management and control of the company, and shareholders own the company in proportion with their shareholding.  Legislation including the Corporations Act 2001 (Cth) and case law govern the rights and duties of directors and shareholders.

For a small business, there are sound legal and accounting reasons for shareholders of the company to often also be employees of the company.  However, for the benefit that this provides, there is also associated risk.

The Risks

Before making your shareholders employees, careful consideration should be given to the risks surrounding minority shareholders. A shareholder that does not have control of the company or the majority of the shares can cause significant issues for the business if they become of the view that the right thing is not being done by them by the majority shareholder/s.

A minority shareholder may raise issues such as:

  • Being excluded from the involvement in company affairs;
  • Excessive or extra payment being made to a majority shareholder or an associate of a majority shareholder;
  • Opportunities being diverted to a majority shareholder or their associates;
  • Being denied access to information;
  • Being bullied at board meetings; or
  • Dividends not being paid fairly or at all. 

 The genesis of the issues is that shareholders’ rights and remedies (especially minority shareholders) are restricted and both difficult and expensive to enforce.  For example, a minority shareholder can:

  • Apply to the Court alleging the conduct of the company's affairs is contrary to the interests of the members as a whole, or oppressive to, unfairly prejudicial to, or unfairly discriminatory against them personally. In limited circumstances, they can also allege there was a fraud committed against them;
  • Apply to the Court for an injunction restraining the company from engaging in conduct that contravenes the Corporations Act; and
  • Apply to the Court for an order that the Company be wound up because it is just and equitable to do so. 

Unless the parties are able to agree to a solution internally, these remedies may have to be enforced by way of Court action.  Such Court actions are complex and require a great deal of evidence. Most importantly, they are expensive, and usually prohibitively so, for a minority shareholder.

Even if the minority shareholder is successful and the Court orders that the majority shareholders buy the minority shareholders shares, there are often long and expensive arguments as to what is the true value of the shares, with competing and expensive valuations from forensic accountants and valuers. 

Further, if the minority shareholder loses the Court case they may be liable for not only their own legal costs but the Company’s and/or the major shareholders’ legal costs.  Generally, it is a brave minority shareholder that takes such action.

Risks: Fair Work actions 

However, if a minority shareholder is also an employee, they may rightly or wrongly take advantage of the rights and remedies afforded to employees under the Fair Work Act 2009 (Cth) by bringing an action for unfair dismissal or adverse action. 

Under the Fair Work Act an employee is protected from and can take action in relation to:

Their dismissal being harsh, unjust or unreasonable;

An adverse action being taken against an employee because the employee exercised a workplace right (such as taking sick leave) or was engaged in a protected activity;

Action against the employee that was done for discriminatory reasons;

Action for breaches of Awards or the Fair Work Act. 

All of these actions are available to all employees who have been working for at least six months full time or part time, or 12 months as a casual. 

These rights can be exercised in the Fair Work Commission or the Courts usually with no consequences of paying the other party’s costs if they lose, meaning there is usually limited risk of an employee having an adverse costs order made against them.  

Where these issues intersect, is that a minority shareholder who, for example, is being bullied or feels otherwise aggrieved, might allege the issue or the action taken was related to their employment and not their shareholding. The company and the majority shareholders will then likely have to defend a Supreme Court action and a Fair Work action simultaneously.

What can you do to minimise the risks?

If it is decided to employ shareholders, we recommend that there is a well-drafted Shareholders Agreement and that employment agreement(s) are considered and implemented.

Ensure that all directors and shareholders have discussions around the risks outlined above including discussions with their professional advisors. Please contact Hillhouse Legal Partners to discuss your specific circumstances and obtain advice about the best course of action for your company, preferably prior to the company commencing business or prior to making any formal arrangements with shareholders (existing or new) and employees. We are here to help.

The information in this blog is intended only to provide a general overview and has not been prepared with a view to any particular situation or set of circumstances. It is not intended to be comprehensive nor does it constitute legal advice. While we attempt to ensure the information is current and accurate we do not guarantee its currency and accuracy. You should seek legal or other professional advice before acting or relying on any of the information in this blog as it may not be appropriate for your individual circumstances.