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Why have a Shareholders Agreement in place?

Glassdoor legal issues | Arro Lawyers

We understand that times have been difficult for many businesses during the COVID-19 pandemic, however we also understand that many businesses have taken this time to review their internal governance and company structure with a view to ensuring their business structure is in order and ready for when the business finally comes out the other side of COVID-19.

Whilst our free Legal Health Check booklet (available on our website here: https://arrolawyers.com.au/legal-health-check/) provides some high-level guidance on matters you may wish to consider for your business, we have received several enquiries from clients regarding the need for, and use of, shareholders’ agreements.

As a result, we take this opportunity to focus on shareholders’ agreements, what they are, what they usually say and whether companies should be looking to have one in place moving forward. 

What is a Shareholders’ Agreement?

It is an essential document whenever two or more shareholders are involved in a private company. The agreement basically forms the basis of their (the shareholders) relationship. Anyone who has experienced disputes restructures, expansion or dissolution will know the importance of such an agreement and how important is it to have this agreement in writing.

The objective of the agreement is to minimise the possibilities of misunderstandings or disputes between the company members in a range of situations such as deadlock, retirement or death of a shareholder.

General contents

While there is no such thing as a standard agreement, a shareholder agreement will generally deal with, amongst other things, the following crucial information: –

  • Company structure;
  • Rights and obligations of the shareholders;
  • Financial controls;
  • Non-competition provisions;
  • Company policy;
  • Deadlock;
  • Pre-emptive rights (the right for existing shareholders to have first option to buy shares being sold by another shareholder);
  • An agreed procedure for the sale, transfer and allotment of shares;
  • Management for the Company’s business; and
  • Dispute resolution.

Involvement in Business

A shareholders’ 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. The agreement can actually set out the minimum involvement that each shareholder is to have in the business and how any remuneration is to be calculated.

Company Management

The agreement can deal with issues in relation to company management. 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?

Pre-Emption Arrangements

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 (for example, deliberately devaluing the business, total and permanent disablement, convictions or death)?
  • Must the shares being sold be offered to the remaining shareholders in proportion to their current shareholding?
  • Who will value shares?
  • At what price 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? (for example, at the same price or higher or at a price which is no less than X% of the price offered to remaining shareholders.)
  • Must the outgoing shareholder disclose who they intend to sell their shares to? Must the outside buyer be someone approved of by the remaining shareholders?

Decision Making

A shareholders’ agreement should set out which decisions require a majority consent and those that 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.

Deadlock

As one of the objectives of a shareholders 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 or shareholders to be resolved?
  • Should they 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?

Restraint of Trade

We often recommend inserting a clause in a shareholders’ agreement which prevents a shareholder from competing with the company’s business while they are still a shareholder and for a period of time after they cease to hold shares. This must be carefully dealt with because if this type of restraint clause is too wide to adequately protect the interests of the business, it can be found by a court to be unenforceable.

Confidentiality

A shareholders 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.

Termination of Agreement

Under what circumstances will a shareholders’ agreement be terminated?

This can be after a certain time frame, or it can be on 1 of the shareholders selling their shares and ‘getting-out’ of the business (i.e. that the agreement is terminated in respect of that shareholder).

Default

What happens if one of the shareholders breaches a shareholders’ agreement?

The defaulting shareholder can often be required to sell their shares to the remaining shareholders. If so, consideration should be had of the selling price, for example if it be discounted to take into account the effect the breach may have on the value of the business.

What about the Company constitution?

Whilst a company constitution governs, in part, the relationship between a company and its shareholders, a shareholders’ agreement will cover a much wider range of issues between shareholders, and in more detail.

Conclusion

In short, a shareholders agreement provides the framework for your company’s operations, development and growth and has the common objective to clarify a shareholders’ rights and obligations.

Any company and/or shareholder that relies on the subjective recollection of its principals in relation to these issues can run a significant risk of expensive litigation. A shareholder agreement will give certainty and predictability to many situations which might otherwise result in time, money and effort wasting, disputes or “management paralysis”.

We strongly recommended business advisers, including accountants and lawyers, are involved in the process of considering and drafting a shareholders’ agreement, to ensure rights and obligations are respectively protected and honoured.

If you require any further advice or assistance, then please don’t hesitate to get in touch with us.

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