The importance of Shareholders’ Agreements
Shareholders’ Agreement – Definition
A Shareholders’ Agreement sets out the rights and obligations of shareholders of a company, and commonly covers matters governing the management and structure, initial and continued funding, administration, and business activities of the company. A Shareholders’ Agreement is a helpful document in setting up a business, or in acquisitions of partial interests in businesses, because it provides a mechanism for setting out the principles upon which the shareholders intend to run the business and deal with unforeseen circumstances and contingencies.
A Shareholders’ Agreement is distinct from the company’s constitution. Without a Shareholders’ Agreement, the company would be controlled solely by the exercise of shareholding or directorship rights through its constitution, which are generally insufficient to govern and control the business activities, as opposed to administration of the Company as a legal entity. The potential for disputes between the shareholders or other events to detrimentally affect the performance of the company is increased where there are no mechanisms in place to govern potential business activities and management of the company.
When is a Shareholders’ Agreement used?
Shareholders’ Agreements are commonly used in two scenarios:
- A joint venture between two or more persons, where the parties to the venture agree to set up a joint venture company or partnership. The Shareholders’ Agreement (commonly called a “Joint Venture Agreement” in this circumstance) provides a supervening set of rights and obligations, independent of the joint venture company’s constitution (if a joint venture company is used). The Shareholders’ Agreement sets out those rights and obligations (and any other details) that are inappropriate for inclusion in the constitution, or that the parties wish to remain confidential.
- A Company with several or numerous shareholders. The Shareholders’ Agreement sets out the shareholders’ rights and obligations in relation to the company, and is essential to govern the management of the company, and to protect the interests of all the shareholders in the event of changing circumstances.
What is covered by a Shareholders’ Agreement?
Such an Agreement commonly includes, among others, policies governing the following matters:
- The company structure: Includes composition of the capital of the company, and its internal rules relating to share allotment and transfer.
- The appointment of directors: Includes the power of each shareholder to appoint a director or directors, and the authority of such directors when making decisions. May also cover situations where additional directors are appointed in the event of additional shares in the company being issued to third parties.
- Management of the company: Covers the appointment of the company management (e.g. director, managing director), and requirements on the company management to prepare financial and management reports for the shareholders (e.g. monthly financial statements to be prepared in accordance with generally accepted accounting principles applicable at the time).
- Shareholding restrictions and the transfer of shares: This may include a provision that, if one shareholder dies or wishes to sell its shares in the company, the other shareholder has the first option, on certain terms, to purchase the shares. Other provisions may include prohibitions on transfers of shares or interests in shares except in certain circumstances, the procedure for the transfer of shares and the procedure for calculating a fair value for the shares.
- Adding new parties to the Shareholders’ Agreement, and additional shareholders.
- Restrictions on the activities of the company (e.g. “major activities” involving substantial amounts, or affecting the nature or structure of the company) unless such activities have the unanimous approval of the directors of the company.
- Dividends, and the provision of additional funding by the shareholders: Includes the methods and the proportions in which the shareholders will provide funds to maintain the company, the amount of the profits to be allocated as dividends each year, and a procedure for resolving disputes that arise in respect of these matters.
- The rights of shareholders and directors: Includes shareholders’ access to records, and any variations or additions to the statutory powers, rights and duties of shareholders and directors.
- Dispute Resolution: For example, a provision dealing with the resolution of disputes involving matters which could lead to substantial injury to the company as a going concern, and which seem incapable of satisfactory long-term resolution by mediation or negotiation.
- Non-competition provisions i.e. preventing either shareholder from setting up a business in competition to the company within a prescribed time period and geographical distance from the company.
- Confidentiality: Includes provisions relating to the exposure of company documents, both during the period of the Shareholder Agreement and following the termination of the Agreement.
What are the benefits of a Shareholders’ Agreement?
It is not a legal requirement for a company to have a Shareholders’ Agreement. So what are the benefits of having an Agreement?
- Avoiding disputes because the parties have already agreed what should happen in certain circumstances – i.e. how to deal with deadlock in the event of equal shareholdings
- To regulate the internal management of the company
- It can be designed to protect minority shareholders
- It can place restrictive covenants on shareholders who leave the company
- It can restrict to whom a shareholder can transfer shares
- A Shareholders’ Agreement is a contract between all of the shareholders of a company. Once in place it can only be amended with the agreement of all of the shareholders, whereas the company’s Articles of Association can be altered by a 75% majority; this means that the Shareholders’ Agreement is a better protection for minority shareholders.
- The Shareholders’ Agreement is not a public document registered at Companies House in the same way that the company’s Memorandum and Articles of Association are, so internal company management can be kept private with a Shareholders’ Agreement.
A Shareholders’ Agreement is particularly useful in situations where a company has no majority shareholding, because of the correspondingly high potential for the company to be adversely affected by disagreements between shareholders. The Shareholders’ Agreement could specify the management structure of the company, and provide a dispute resolution mechanism for resolving disagreements between shareholders.