Legal Tip 225: Dangers of investing in a Company you don’t control

Directors generally control a company as they are responsible for the day to day actions of the company, deciding what it will do, entering into contracts, deciding if and when a dividend would be paid etc.

The shareholders generally control the directors by having the power to appoint them. They don’t really have direct control over the directors, other than having the power to remove them. But shareholders generally need to vote to remove or appoint a director, and voting is usually based on a majority decision – but not always.

So, the issue with being a minority shareholder in a company is that you cannot really do much other than sit back and wait for your dividends.

But often there will be none as the company may not make a profit.

Sometimes majority shareholders can milk a company by appointing themselves or a relative into the position of director, contracting with related entities to divert profits, having lavish expenses paid for by the company etc.

Shareholders can sue the company and/or directors in certain instances, but this can get expensive.

This makes it pretty risky investing in a company which you cannot control.


Example

Homer invests in Leftporium Pty Ltd which is a company set up and controlled by the Flanders family. Ned is the director and Lefty Pty Ltd is the majority shareholder. Lefty sold 20% of its shares in Leftporium for $50,000 and Homer loaned the company $200,000 on promised returns of 10% p.a.

Suddenly Ned Flanders is seen driving a new BMW. Homer queries this and finds out it is a company car – Ned says it is a legitimate company expense and is justified.

Todd Flanders is 17 years old, but Leftporium has just employed him on a $50,000 salary to manage the shop being run by Leftporium Pty Ltd.

Homer digs further and it seems that the Leftporium Pty Ltd is renting the shop from Left Nominees Pty Ltd and the renting being paid is 23% more than the rent a similar shop is paying next door.

Looking through the expenses of the company Homer sees expenses for Uber Eats, Hotels, Taxis, even a loan to a company called Lefty Pty Ltd – which later goes into administration and never pays it back.

6 Months later Ned comes over to Homer and says the business is not doing too well and he needs Homer to lend the company more money. Homer lenders another $20,000 on the proviso that he becomes a director.

Homer gets in as director with Ned bailing out. Homer didn’t really understand why Ned was happy to get out, but he soon finds out why – the company is about to trade while insolvent and now Homer has to pay for expensive legal advice himself, as the company has no money left.

The company eventually fails after 6 months. Homer has lost his money, and he has a bad credit history as he was a director of a company that went into administration.