The Importance of being an earnest shareholder

Jan 30, 2020

…The Importance of being an earnest shareholder- as Gwendolyn would say, a sensational read. 

The word ‘earnest’ means an action showing, or resulting from, sincere and intense conviction. 

Shareholders are some of the wealthiest and most scrutinised people in society, yet they are not always the best protected. So how do shareholders become more earnest when performing their shareholder responsibilities? Well… the truth is rarely pure and never simple.

What is a shareholders’ agreement? 

A ‘shareholders’ agreement’ is a confidential contract between all or some of the shareholders of a company. The contract is typically drafted to document the relationship between the parties (specifically their rights and obligations), the future management of the company, how the company is owned and what protections the owners can expect.

Whilst Algernon could never be induced to part with Bunbury on bad terms, regrettably, many shareholders part ways in the fashion of Jack and his imaginary brother. A shareholders’ agreement is instrumental in reducing awkward conversations and potential clashes when this happens, as leaver provisions will be clearly documented.

Key clauses that can be included

The real benefit to a shareholders’ agreement, and the reason business owners put a special emphasis on them, is the flexibility of the document. Whilst this is not an exhaustive list of the potential provisions that can be included, here are a number of useful clauses that are available:

Approval for specific matters by some or all shareholders, e.g. instigating legal proceedings or entering into key contracts.
– A clause dealing with how profits should be paid to the shareholders by virtue of dividends – dividend policy.
– Documenting the process to what should happen if a shareholder wishes to sell their holding, e.g. should the company have the first right to buy back the shares or the other shareholders? Should third parties be allowed to purchase the shares? There are many issues for the shareholders to consider here particularly around the ability for a shareholder to sell to a third party and what controls should be included for this to be acceptable.
– A ‘drag’ right, giving a right to usually the majority shareholders providing an ability for the majority shareholders to require the remaining minority shareholders to sell their shares, on the same terms as those who have the right to exercise the drag right.
– A ‘tag’ right, giving minority shareholders the right to require the third party purchaser to also purchase their shares on the same terms as the majority shareholder(s) where a transaction is being considered.
– What should happen if there is a deadlock in a shareholder vote for and against a particular matter.
Restrictive covenants, e.g. restricting outgoing shareholders from competing with the company or poaching client clients / suppliers and / or employees.
Shareholder funding provisions, to set out the process for to be followed where surplus funds are required for the company (including for example debt and equity funding).

When should I consider putting a shareholders’ agreement in place?

Regrettably, in such corporate matters, sincerity and not style is the vital thing. 

The short answer is – as soon as possible. We advise clients to consider putting a shareholders’ agreement in place from the inception of their company. What we often see is that a shareholders’ agreement was considered with the intention to put an agreement in place. However, it is often not entered into and then sorely missed where circumstances change.

Benefits to having a shareholders’ agreement.

As listed above, shareholders can agree to include any number of clauses to fully customise the agreement to their needs. In addition, shareholders’ agreements can give protection to business owners whilst clarifying the ground rules.

Some of the key issues we often see come to fruition, where no shareholders’ agreement is in place, include where a shareholder:

– Wishes to transfer their shareholding, but no clear process has been agreed in advance.
– Dies.
– Becomes seriously ill or incapacitated.
– Has a significant disagreement with the other shareholders.

Having an agreement which clearly lays out what is to happen in these events will crush any gravest doubts that may be caused by these (non-exhaustive) scenarios / examples.

Could I not just amend the company’s articles of association?

The articles of association set out the rules and regulations for how the company should be run. Whereas a shareholders’ agreement provides for a separate contractual remedy for a breach of the terms set out in the shareholders’ agreement (on a private and not public basis). Also, certain provisions set out in the shareholders’ agreement do not necessarily need to be included in the Articles which are shown on the public Companies House register.

Among other potential pitfalls, when relying solely on the articles, is that articles can be amended with a 75% majority of shareholders. An amendment to a shareholders’ agreement must be agreed by all shareholders party to the agreement. This provides greater protection to minority shareholders.

Please feel free to contact our team to discuss having a legal review of your articles and your shareholders’ agreement or to discuss having a new shareholders’ agreement prepared – we call a spade a spade and always prefer stories with a happy ending.

How can we help?

We advise companies, company directors and shareholders on their corporate rights and responsibilities. For strategic advice and representation, contact the expert company law solicitors at Herrington Carmichael as early as possible. 

Please contact Melissa Deutrom on 0118 977 4045.

This reflects the law at the date of publication and is written as a general guide. It does not contain definitive legal advice, which should be sought as appropriate in relation to a particular matter. 

 

 

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