The Passive Shareholder and the Disengaged Family Member

The passive shareholder is one of the most common sources of family business disputes. Specifically, this is the family member who owns shares in the business but does not work in it. Often, they have inherited their shareholding. Alternatively, they may have left the business years ago to pursue another career. Either way, they have a continuing financial interest but no day-to-day involvement. As a result, they sit in a position that the working family members often find difficult to manage. Importantly, the passive shareholder is not the cause of family business disputes. Rather, the way the family handles the passive shareholder is what determines whether a dispute develops.

This page explains who the passive shareholder is, why they so often trigger family business disputes, and what the family and the passive shareholder can do to manage the relationship before it breaks down.

Who the passive shareholder is

In short, a passive shareholder is a family member who holds shares in the family business but is not employed in it and is not involved in management. Specifically, they may have inherited shares from a parent. They may have been given shares as part of an early succession plan. Alternatively, they may have worked in the business once but left. As a result, they remain a part-owner of the business without any operational role in it.

Importantly, the passive shareholder is not necessarily disengaged from the family. Often, they remain close to the working family members socially. By contrast, when the disengagement is from the business specifically, it can be invisible until something brings the underlying issues to the surface.

For the wider context, see the three circles model, which explains why the passive shareholder is structurally different from the working family members.

Why the passive shareholder is structurally vulnerable

Importantly, the passive shareholder occupies a structurally vulnerable position in a family business. Specifically, they own a stake in a business they do not run. As a result, they depend on the working family members for everything that affects the value of their shares. For example, they depend on dividends being paid. Likewise, they depend on the business being run profitably. They depend on accounts being honest. They depend on related-party transactions being fair.

Crucially, the passive shareholder has very limited ability to verify any of this independently. Specifically, they have no day-to-day visibility into the business. They rely on what they are told. As a result, the relationship between the passive shareholder and the working family members is built on trust. When that trust is intact, the passive shareholder is content. By contrast, when the trust is shaken, the passive shareholder typically has no choice but to take formal steps.

The three classic passive shareholder grievances

Importantly, the disputes that the passive shareholder typically raises fall into three patterns. Specifically, these are dividends, information and value.

Dividends

First, the passive shareholder commonly raises concerns about dividends. Specifically, they may complain that dividends are too low. By contrast, they may complain that dividends have stopped being paid altogether. As a result, the passive shareholder feels they are being denied the return they expected from their shareholding.

Crucially, the dispute about dividends is rarely just about the figures. Typically, it is about the imbalance between what the working family members are taking out of the business in salary and benefits compared with what the passive shareholder is receiving in dividends. As a result, the dividend complaint is often the surface presentation of a deeper concern about fairness. For more on this, see the have and have-not pattern.

Information

Second, the passive shareholder commonly raises concerns about information. Specifically, they may request management accounts. They may ask for breakdowns of director remuneration. They may request schedules of related-party transactions. Often, the requests are framed politely. Crucially, the underlying message is that the passive shareholder no longer trusts what they are being told.

Importantly, the legal position on information is more favourable to the passive shareholder than the working family members often assume. Specifically, statutory accounts must be filed and made available. Likewise, where the company is a quasi-partnership, the shareholders’ legitimate expectations may include access to additional information. As a result, refusing reasonable information requests reliably accelerates the dispute. For more on this, see unfair prejudice petitions in family business disputes.

Value

Third, the passive shareholder commonly raises concerns about the value of their shares. Specifically, they may want to exit the business at full value. Alternatively, they may want to challenge transactions that they believe have damaged the value of their stake. As a result, the dispute becomes about price as much as about principle.

Crucially, the legal framework around share valuation in family businesses is complex. Specifically, whether a minority discount applies depends on whether the company is a quasi-partnership and on the conduct of the parties. For more on this, see family business valuation in a dispute.

The disengaged family member

Importantly, a particular type of passive shareholder deserves its own treatment. Specifically, this is the disengaged family member. The disengaged family member is not just someone who does not work in the business. Rather, they are someone who has actively stepped away from the family’s affairs. Often, they live far away. They rarely attend family gatherings. They may not see the working family members from one year to the next.

Crucially, the disengaged family member is in some ways the most difficult passive shareholder to manage. Specifically, they have no current social relationship with the working family members. As a result, the goodwill that might smooth over a disagreement in a more engaged family is absent. By contrast, when the disengaged family member re-engages, often triggered by a life event, the working family members have no relationship capital to draw on. As a result, the dispute that follows tends to be more transactional and more legalistic than disputes between siblings who still see each other regularly.

Why the working family members often misjudge the passive shareholder

Importantly, the working family members often make a particular set of mistakes in how they treat the passive shareholder. Specifically, the most common are these.

• First, they treat the passive shareholder as if they have no legitimate stake. By contrast, the passive shareholder is a part-owner of the business with all the rights that brings.
• Second, they pay themselves generously and pay dividends meagrely. As a result, they extract value through the routes that benefit them and starve the passive shareholder of the only route that benefits them. Crucially, this is one of the classic patterns that gives rise to unfair prejudice petitions.
• Third, they resist information requests. Often, they do this on the basis that the information is none of the passive shareholder’s business. Importantly, this is usually legally and practically wrong.
• Fourth, they treat the passive shareholder’s questions as personal attacks. Typically, this hardens the relationship beyond what the original question warranted.
• Finally, they delay decisions. Specifically, they hope that the passive shareholder will lose interest or go away. Crucially, this almost never works. Instead, the delay gives the passive shareholder time to take advice and harden their position.

What the passive shareholder is entitled to

Importantly, the legal rights of the passive shareholder are often stronger than the working family members assume. Specifically, the passive shareholder is entitled to the following as a minimum.

For one thing, they are entitled to receive notice of and attend general meetings. Likewise, they are entitled to vote their shares. They are entitled to receive a copy of the company’s annual accounts. Importantly, they are entitled to dividends on the same terms as other holders of the same class of shares. Where the company is a quasi-partnership, they may also be entitled to legitimate expectations such as participation in management or access to additional information.

Crucially, where the passive shareholder is being denied these rights, or where the working family members are conducting the affairs of the company in a way that is unfairly prejudicial to the passive shareholder’s interests, the passive shareholder has a potential unfair prejudice claim. For the legal detail, see unfair prejudice petitions and quasi-partnership in family companies.

What the working family members should do

Importantly, the working family members can take steps that significantly reduce the risk of a passive shareholder dispute. Specifically, the following are most useful.

Maintain transparency proactively

First, the working family members should share information with the passive shareholder before being asked. For example, sending the management accounts each quarter. Sharing a summary of major decisions. Explaining significant transactions. Crucially, proactive transparency is the single most effective protection against a passive shareholder dispute. As a result, the working family members should treat transparency as a routine investment rather than as a concession to be made under pressure.

Establish a fair dividend policy

Second, the working family members should agree a clear dividend policy with the passive shareholder. Specifically, the policy should set out how much of the profits will be paid as dividends, on what timetable, and on what basis the policy may change. Importantly, the policy does not need to commit the company to high dividends. By contrast, it needs to be predictable and to balance the interests of working and non-working shareholders. For more on this, see shareholders’ agreements for family businesses.

Document the remuneration of working family members

Third, the working family members should document and explain their own remuneration. Specifically, they should be able to show that their salaries are at market rates for the roles they perform. Likewise, they should be able to show that their benefits and expenses are reasonable. Importantly, the documentation does not need to be exhaustive. By contrast, it needs to be sufficient to demonstrate that the working family members are not extracting value at the passive shareholder’s expense.

Offer an exit route

Fourth, the working family members should think carefully about whether to offer the passive shareholder an exit route. Specifically, some passive shareholders genuinely want to remain part-owners. By contrast, others would prefer to sell their shares at a fair price and move on. As a result, a structured exit can be a far better outcome than a continuing relationship that is heading for dispute. For more on this, see settling a family business dispute.

Use mediation if the relationship has broken down

Finally, where the relationship with the passive shareholder has reached the point of dispute, mediation is almost always a better forum than litigation. Specifically, mediation allows the parties to address both the legal issues and the wider family dynamics in a confidential setting. For more on this, see why mediation is usually the right starting point.

What the passive shareholder should do

By contrast, the passive shareholder can also take steps to reduce the risk that the relationship will break down. Specifically, the following are most useful.

• First, stay engaged. Importantly, the passive shareholder who attends general meetings, reads the accounts and asks reasonable questions throughout is far less vulnerable than the one who only re-engages when something has gone wrong.
• Second, build a relationship with the working family members that is not just about the business. Crucially, the social and family relationship is often what carries the parties through the difficult conversations.
• Third, make information requests reasonable and proportionate. Specifically, asking for what is genuinely needed rather than for everything is far more likely to be agreed to. Importantly, the goal is to verify the position, not to demonstrate suspicion.
• Fourth, take advice before raising serious concerns. Specifically, advice from an experienced barrister or mediator can help the passive shareholder identify what their actual rights are and what the most effective approach would be. Importantly, early advice from a direct access barrister does not commit you to a dispute.
• Finally, consider whether an exit at a fair price would be a better outcome than continued involvement. Crucially, this is a personal decision rather than a legal one. By contrast, the legal options exist whether the passive shareholder wants to stay or wants to leave.

The particular issues with multi-generational passive shareholdings

Importantly, passive shareholdings often become more complicated with each generation. Specifically, the founder may have given equal shares to all children. The next generation may then have given equal shares to all grandchildren. As a result, by the third generation, the family business may have a wide pool of passive shareholders, most of whom have never met each other and have only a distant connection to the business.

Crucially, multi-generational passive shareholdings carry particular risks. Specifically, the working family members are running a business with a long list of part-owners they barely know. Meanwhile, the passive shareholders are part-owners of a business they have no operational connection to. As a result, the conditions for dispute are unusually favourable.

Importantly, families that anticipate this often introduce mechanisms to manage the situation. For example, share buyback rights, family trusts, or family councils that include passive shareholders. For more on these structures, see family constitutions and family forums and shareholders’ agreements.

Frequently asked questions

What is a passive shareholder in a family business?

In short, a passive shareholder is a family member who owns shares in the family business but does not work in it and is not involved in management. Specifically, they may have inherited their shares, been given them as part of an early succession plan, or worked in the business previously and left. As a result, they have a continuing financial interest in the business but no operational role.

What rights does a passive shareholder have?

Typically, a passive shareholder has the same legal rights as any other shareholder of the same class. Specifically, they are entitled to receive notice of and attend general meetings, vote their shares, receive the company’s annual accounts, and receive dividends on the same terms as other shareholders. Where the company is a quasi-partnership, they may also have legitimate expectations of participation in management or access to additional information.

Can a passive shareholder force the company to pay dividends?

Generally, no, not directly. Specifically, the decision to declare dividends is a matter for the directors. However, where dividends are being kept artificially low while the working family members extract value through high salaries and benefits, the passive shareholder may have an unfair prejudice claim. As a result, the practical position is more favourable to the passive shareholder than the strict legal position alone might suggest. For more on this, see unfair prejudice petitions.

Can a passive shareholder be required to sell their shares?

It depends. Specifically, the answer turns on the company’s articles of association and any shareholders’ agreement. Importantly, some agreements include compulsory transfer provisions in certain circumstances. By contrast, in the absence of such provisions, a passive shareholder generally cannot be forced to sell. As a result, the working family members who want to buy out a passive shareholder usually need to negotiate. For more on this, see shareholders’ agreements for family businesses.

What is the best way to handle a passive shareholder dispute?

In practice, the best approach is usually mediation. Specifically, mediation allows the parties to address both the legal issues and the underlying family dynamics in a confidential setting. By contrast, litigation tends to harden positions and damage the wider family relationship. Importantly, the parties to a passive shareholder dispute usually have a continuing connection that will outlast the dispute. As a result, mediation is almost always preferable to court. For more on this, see why mediation is usually the right starting point.

Further reading on this site

• Family Business Disputes (main page)
• The Three Circles Model
• The Common Causes of Family Business Disputes
• Early Warning Signs of a Family Business Dispute
• The Have and Have-Not Pattern
• Unfair Prejudice Petitions
• Quasi-Partnership in Family Companies
• Shareholders’ Agreements
• Family Business Valuation
• Why Mediation Is Usually the Right Starting Point
• Settling a Family Business Dispute
• Family Constitutions and Family Forums

Get advice on your situation

If you are a passive shareholder concerned about how the family business is being run, or if you are a working family member dealing with a passive shareholder dispute, early specialist advice is one of the most valuable investments you can make. Specifically, I act as a direct access barrister, commercial mediator and mediation advocate in family business disputes throughout England and Wales.

Call 020 4538 0246, use the contact form, or book a call directly. In addition, my book Winning in Family Business Disputes (forthcoming) covers the passive shareholder dynamic in detail, alongside my published works on shareholder disputes and commercial mediation. Organisations like Family Business United also publish useful guidance for family business owners.

Important disclaimer: This page is provided for general information purposes only and does not constitute legal advice. The content may not be legally accurate for your situation or at all. You must not rely on anything on this page in respect of your legal rights. Before taking or refraining from taking any legal action, you should seek advice from a qualified lawyer. I disclaim any and all liability for any loss, damage or expense howsoever caused by reliance on the contents of this page. If you would like advice on your specific situation, contact me here.