What is a Shareholders Agreement?
A Shareholders Agreement is a contract entered into by the shareholders of a Company. It regulates the relationship between the shareholders and governs the management of the Company. It can outline shareholders’ rights and obligations which therefore provides protection for each Shareholder, whether a minority or majority Shareholder.
Although a Shareholders Agreement is not a legal obligation of a Company, its value should not be underestimated. It is often omitted with the view of saving time and money, however the lack of certainty created by not having a Shareholders Agreement in place can often lead to disputes amongst the Shareholders which can be costly to deal with. When Shareholders disagree, the effect on the business/Company can often be detrimental and time consuming.
It is important to seek the right legal advice at an early stage to safeguard your position and if possible, prevent matters from escalating unnecessarily while exploring whether a resolution might be reached without recourse to litigation.
Some if the benefits of a well drafted Shareholders Agreement from the outset are outlined below:
Despite everyone’s best intentions, day to day running of the Company can lead to business disputes between Shareholders and Directors. Disputes can be time consuming and costly for the Company. A Shareholders Agreement is an inexpensive way to minimise any potential for disputes as it provides a framework and procedure for dispute resolution by outlining how certain decisions are to be made. This prevents the use of Shareholders relying on draconian measures as a way to settle disputes and ensures that everyone’s attention and focus is on promoting the success and development of the Company.
Governs the management of the Company
The Board of Directors usually govern the day to day running of the Company and therefore, despite common misconceptions, Shareholders have very limited rights in decision making. If drafted correctly a Shareholders Agreement can hold the Directors accountable for certain actions and compel the Directors to seek the Shareholders’ consent in advance of key decisions such as amendments to governing documents. large expenditure by the Company or borrowing by the Company. This is extremely important in circumstances where Directors are not Shareholders.
Minority Shareholder Protection
A Shareholders Agreement can provide protection for minority Shareholders by reserving certain decisions for the unanimous consent of all the Shareholders, for example varying the Articles of Association or the objects of the Company. This will give the minority Shareholders the right to veto and prevent majority Shareholders from forcing issues that are not in the minority Shareholders’ best interests. In addition, a Shareholders Agreement can also contain “tag-along” provisions. This allows a minority Shareholder to “tag along” in a share sale situation where the majority Shareholders attempt to sell their shares to a third-party buyer. A “tag along” clause gives minority Shareholders the right to receive the same price, terms and conditions as the majority Shareholders that are selling their shares.
Majority Shareholder Protection
A Shareholders Agreement often includes a “drag along” provision to go alongside the “tag along” provision mentioned above. A drag along provision enables majority Shareholders to force minority Shareholders to join in the sale of a Company on the same terms so they do not prevent the deal from going ahead.
During the life of the Company it can be expected that Shareholders and Directors will not see agree on all matters. The inability to reach a consensus on key matters will result in a deadlock which may bring the Company’s business to a standstill. A Shareholders Agreement can mitigate this risk by containing a deadlock provision to facilitate a quick resolution which can include mechanics for the parties to buy each other out. It is very difficult to deal with the resolution of any deadlock through Articles of Association, and a Shareholders Agreement is therefore advisable.
In the absence of relevant pre-emption provisions in a Shareholders Agreement or the Articles of Association, shares may be freely transferrable. This enables a Shareholder to sell or transfer their shares to a completely unknown person or even a competitor. A Shareholders Agreement can provide a mechanism to provide that if one Shareholder wishes to transfer/sell their shares, the remaining Shareholders have the “right of pre-emption” over those shares. If they do not take up that offer then the Shareholders Agreement would contain a clause requiring the recipient of those shares to enter into a “Deed of Adherence” whereby he/she would be bound by the terms of the Shareholders Agreement. This provides comfort to the other Shareholders as it ensures the new Shareholder has to act in accordance with the provisions of the existing Shareholders Agreement.
There are many other matters to include such as exist provisions for Shareholders, Dividend payment etc. It is instrumental that a Shareholders Agreement is drafted with adequate legal advice to reflect the intentions of the Company Shareholders and Directors.