Responding to misappropriation allegations: what shareholders can do

Seeking or Responding to Interim Measures

The first step when you either suspect a shareholder of misappropriation or fraudulent activity, or when other shareholders bring such allegations against you, is to consider suitable interim measures to preserve the status quo and the evidence.

It may also be helpful to bring in a third party to try to diffuse the situation, if the allegations are misguided, or to open the lines of communications towards a potential resolution. Even in situations of misappropriation, all shareholders may prefer to cooperate towards a settlement to avoid legal proceedings (see our article, How to Handle Shareholder Disputes: Common Causes and Solutions, about exit strategies).

• Preserving the Status Quo

If everyone involved is not cooperating or preliminary informal efforts otherwise stall, it may be in everyone’s interest to take steps to preserve the status quo on interim terms to give everyone time to take or respond to more formal steps.

In the context of alleged shareholder misappropriation of funds, preserving the status quo on interim terms means taking steps to ensure that the company continues operating in the ordinary course of business, while putting limits or boundaries on the activities that relate to the alleged misappropriation to protect the company. Interim measures might involve one or more of the following, among a host of other potential steps:

• temporarily restricting access to bank accounts, accounting staff, customers or suppliers;
• temporarily restricting access to some company facilities or computer files;
• providing customers, suppliers or the bank with new directions for paying invoices or taking orders;
• freezing certain bank accounts, and
• conducting an audit of the company’s financials.

This allows all sides to gather evidence, prepare claims and responses, and perhaps engage in discussions towards potential resolution. Any such steps should be carried out in a transparent manner with ongoing reports to all concerned, and usually including the shareholders alleged to have engaged in wrongdoing.

It would be ideal to reach these interim terms to preserve the status quo with the consent of all parties through communications, usually with the help of lawyers representing each side. If a preliminary agreement for interim terms to preserve the status quo cannot be reached, parties should try to confirm a list of measures that they agree to and narrow down the remaining items that are in disagreement. Perhaps informal settlement discussions or a formal mediation can help bridge the gap to formalize the terms of the status quo.

If amicable steps do not result in an agreement, parties may need to resort to the court or arbitration for an application to impose interim terms to preserve the status quo.

Gathering Evidence

Once interim measures are put in place to preserve the operations of the company, each side to the dispute should consider taking the following steps simultaneously:

• formulate the claims or defences against the other shareholders, and
• obtain all evidence that is relevant to the claim or defence of each side – this can involve collecting invoices, sales reports, bank statements, etc.

The evidence should support the claim and defence. If on behalf of the shareholder making the allegations, the evidence should demonstrate the following:

• full scope of the alleged misappropriation, financial or operational irregularity;
• how long the alleged activity had been going on;
• identification of the parties involved in these transactions, including shareholders, employees and outsiders, and
• how much money is involved or what other impact this had on the company.

For the defending shareholder, the evidence will support their case to the extent that it can outright refute the allegations or show the following:

• business explanation for the alleged activities, such as implicit approval or knowledge of the attacking shareholder;
• limited scope and impact of the alleged irregularity;
• conduct by the attacking shareholder that has resulted in prejudice or unfairness to the shareholder who is accused of wrongdoing;
• ulterior motives of the attacking shareholder, or
• wrongdoing by the attacking shareholder.

If those in control of relevant records are not forthcoming in producing them to the other side, or if there are legitimate reasons why they should not be released, lawyers for all sides should try to find a common ground on document disclosure and procedure for exchanging documents. It may be necessary to bring an application in court or in the arbitration proceeding to obtain a production order, or respond to such an application, and to set a timetable for the exchange of documents.

It may also be necessary to approach third parties who hold relevant records, such as banks, customers, or suppliers, for production of relevant documents. The consent of all parties may be required to obtain third party records. If consent of all parties cannot be obtained, it may be necessary to seek an order from a judge or arbitrator (depending on whether the overall dispute has to be adjudicated in court or arbitration).

It will usually benefit all sides to the dispute to keep the lines of communications open between all shareholders, perhaps through lawyers, to establish the legal procedures and the steps in how the dispute will be adjudicated. This can include steps on how the parties will engage in settlement discussions, which can be either informal or through mediation.

Pursuing the Overall Dispute Towards Adjudication or Settlement

Having all the evidence in place will help both sides prepare for the hearing of the case either in court (which will normally culminate in a trial) or an arbitration hearing, depending on the legal proceeding involved.

Most commercial disputes get resolved by way of negotiated settlement or mediation at some point in the course of the legal proceeding. This can happen early in the dispute or later on in the case, after all the evidence is obtained and each side has an opportunity to assess the strengths and weaknesses of its case with its lawyers.

In the course of advancing or defending a shareholder claim of this nature, there may be a dispute about the fair market value of each shareholder’s interest in the company. It may be necessary to obtain an evaluation of the company. All sides to the dispute can mutually agree on hiring one business valuator to conduct an evaluation, or each side can retain its own business valuator to prepare a valuation report.

If the two reports reach different valuations, as they often do, it will be up to the parties to bridge the gap and reach a negotiated resolution on the valuation. In the event of a trial or arbitration hearing, the judge or arbitrator will decide which valuator’s opinion to accept based on the quality of the appraisal report and the testimony of the appraiser at the hearing.

If the shareholders cannot reach a settlement to the dispute, the parties will need to start preparing for the trial or arbitration. At the conclusion of the trial or hearing of the arbitration, the judge or arbitrator will have the power to order any of the following remedies, depending on the circumstances and what is sought by each party:

• damages to compensate the aggrieved shareholders or company;
• sale of a shareholder’s shares, or
• wind-down and sale of company assets (in exceptional circumstances).

Conclusion

Navigating accusations of financial impropriety among shareholders is a delicate and multifaceted process that may demand complex legal considerations. Whichever side you are on in a complex shareholder’s dispute, it is important to obtain legal advice from an experienced lawyer, before taking any steps. It may be critical to take interim measures to safeguard the company’s assets and maintain operational stability (the status quo) while the parties investigate and pursue their dispute.

All parties to the shareholder dispute should meticulously gather evidence to substantiate their claims or defences, and, if necessary, consider obtaining interim court or arbitration orders for documentary production or forensic accounting analysis.

An overall resolution to a shareholder dispute may involve payment of damages, shareholder buyouts, or asset sales.

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The information contained in this article is provided for informational purposes only and does not constitute legal advice. Readers should not act on this information without seeking professional legal advice from a lawyer experienced in this area. The content in this article may not reflect the most current legal developments, and the application of law can vary in different provinces and territories. As such, the information in this article is not guaranteed to be complete, correct, or up to date. The author and the publisher of this article disclaim all liability for any actions taken or not taken based on any or all of the contents of this site.

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