A shareholders’ agreement is an essential document required whenever two or more shareholders are involved in a private company. This agreement forms the basis of their relationship. Anyone who has experienced disputes restructure, expansions or dissolutions will understand the importance of such an agreement and how essential it is to have this agreement in writing.
The objective of the agreement is to minimise the possibilities of misunderstandings or dispute between the members in a range of situations such as deadlock, retirement or death of a shareholder.
This agreement can ensure smooth business transition and function if implemented at commencement. It is never too late to put one in place. Further, a Company which is already operating can have a document drafted which reflects and reinforces existing understandings and arrangements. This process can also serve to highlight areas which need attention.
Whilst the Company Constitution partially governs the relationship between the Company and the Shareholders, a Shareholders Agreement will cover a much wider range of issues between shareholders in greater detail.
A shareholder agreement will usually cover the following crucial information:
• Company structure;
• Rights and obligations of the shareholders;
• Financial controls;
• Non-competition provisions;
• Company policy;
• Pre-emptive rights (for existing shareholders to have first option to buy shares);
• An agreed procedure for the sale, transfer and allotment of shares;
• Management for the company’s business; and
• Dispute resolution.
However, there is no such thing as a standard agreement. This list is not exhaustive and many agreements will deal with a range of other topics.
An agreement should contain a provision requiring all shareholders to co-operate with each other and act in good faith to ensure that the business remains successful. This clause can actually set out the minimum involvement that each shareholder is to have in the business and how any remuneration is to be calculated.
This may include:
• What rights will shareholders have to nominate a representative director?
• In what situations can a director be removed?
• Who is to be chairman and does the chairman have a casting vote?
• How many signatures are required for the signing of cheques?
A pre-emption clause usually provides that a shareholder cannot sell their shares to an outside party without first offering them for sale to the remaining shareholders. This raises issues including:
• What restrictions will there be on the transfer of shares?
• How much notice needs to be given?
• In what circumstances is there to be a compulsory transfer of shares?
• Must the shares being sold be offered to the remaining shareholders in proportion to their current shareholding?
• Who will value shares?
• At what price (i.e. same price or higher, price which is no less than 95% of the price offered to remaining shareholders) are they to be offered to the remaining shareholders? If the remaining shareholders do not buy all of the shares, at what price can the unsold shares be offered for sale to an outside party?
• Must the outgoing shareholder disclose who they intend to sell their shares to? Must the outside buyer be someone approved by the remaining shareholders?
The agreement should set out which decisions require the majority consent, which require unanimous consent of the directors, and which decisions should be referred to a shareholders’ meeting for approval. Examples of decisions which may require unanimous consent may relate to:
• The allotment of further shares;
• A proposed change in the direction of the business;
• The winding up of any group company; and
• Purchases by a group company over a set dollar value
As one of the objectives of the agreement is to minimise the possibilities of misunderstandings or dispute between the members in a deadlock situation, the agreement should address:
• How are disputes between directors and shareholders to be resolved?
• Are they to be referred to mediation or arbitration?
• Should a shareholder be entitled to buy out another shareholder?
• Should a shareholder be forced to sell shares to another shareholder?
We recommend inserting a clause in the agreement which prevents a shareholder from competing with the business whilst they are still a shareholder and for a period of time after they cease to hold shares. This must be carefully dealt with – if this type of restraint clause is too wide to adequately protect the interests of the business, it can be found to be unenforceable by a court.
The agreement can also contain a confidentiality clause preventing shareholders from disclosing ‘trade secrets’ to outsiders. Consideration needs to be given to what type of information / know-how this clause should cover, and how long should the clause bind a shareholder after they have left the business.
Under what circumstances will the agreement be terminated? This can be after a certain time frame elapses, or it can be triggered by one of the shareholders selling out of the business, a situation known as ‘terminated in respect of that shareholder’.
What happens if one of the shareholders breaches the agreement?
• Should they be required to sell their shares to the remaining shareholders?
• Should the selling price be discounted to reflect any impact on the value of the business?
Any company and/or shareholder that relies on the subjective recollection of its principals in relation to these issues runs a significant risk of expensive litigation. This agreement will give certainty and predictability in many situations which might otherwise result in time, money and effort wasting, disputes or “management paralysis”.
In short, this agreement provides the framework for your Company’s operations, development and growth and has the common objective to clarify a shareholder’s rights and obligations. It is strongly recommended business advisers, including accountants and lawyers, are involved in the process to ensure rights and obligations are respectively protected and honoured.