Shareholder Agreement - Reserved Matters & Veto Rights

If a limited company has two or more shareholders, their relationship can be regulated using a shareholders' agreement and/or specifically tailored articles of association. If not, their rights and obligations will be governed by the provisions of the Companies Act 2006 and the default constitutional rules that are prescribed thereunder.

For companies incorporated on or after 1 October 2009, the default constitutional rules are known as the "Model Articles". Before that date, companies often adopted standard form articles which incorporate the constitutional rules known as "Table A".

These default document will contain rules in relation to certain fundamental matters, such as the issue of new shares, the administrative procedures surrounding shareholder decisions and board meetings. However they are "one size fits all" arrangements and will rarely be suitable.

The dynamic between two equal shareholders, shareholders who represent a majority and a minority shareholding, shareholders who comprise both founders and investors and shareholders who are spouses can be dramatically different.

Standard constitutional documents are also ineffective at regulating specific commercial issues such as shareholder vetoes on operational matters, preferences on income and/or capital and mandatory transfers (e.g. from a shareholder who ceases to contribute to the business).

Our corporate solicitors are very experienced in advising shareholders on the alternatives available and helping guide them through the process. This will often include drafting a bespoke shareholder agreement and articles of association, as well as restructuring the share capital and discussing the benefit of insurance-backed cross options upon the death of a shareholder.

To help you decide whether or not a Shareholder Agreements and / or tailored Articles is right for you, please find some more details below.

Shareholder agreement

A shareholders' agreement comprises a contract between the shareholders which, in broad terms creates definitive, personal, contractual rights in relation to the commercial arrangements between the shareholders. A shareholders agreement will commonly provide for the following:

• Reserved Matters – whilst directors are empowered (and duty bound) to make day to day decisions regarding the business, shareholders have very limited rights to control operational decisions. The inclusion of reserved matters (or veto rights) means that the shareholders and the company can agree that certain actions will not be taken without the consent of the shareholders (or an agreed proportion of their number). Common reserved matters include:
  • significant capital expenditure;
  • employing staff with salaries in excess of an agreed amount;
  • amending the articles; and
  • paying a dividend.

As a general rule, directors must be careful about entering into agreements that "fetter their discretion" in operating the business but this can be resolved through careful drafting.

• Rights of Appointment – whilst there are mechanisms under the Companies Act 2006 that empower shareholders who hold a majority of the shares to remove board members, the shareholders agreement can give a shareholder (often an investor or substantial minority shareholder) the right to appoint and/or be appointed as a director.
• Transfer Restrictions – these can range from absolute restrictions to tie-in provisions for a certain period before which a shareholder can sell. They can also be accompanied by pre-emption rights that give the other shareholders the option of acquiring the departing shareholder's shares before he can sell to a third party.
• Dividend policy – these can include the rights of shareholders to dividend payments from the company's distributable reserves (often expressed as a percentage) in each financial year and any priority for the repayment of shareholder loans before dividends are paid.
• Restrictive Covenants – for example, the shareholders could be restricted from competing against the company or poaching its staff whilst a shareholder and for a period after he ceases to be a shareholder.
• Deadlock – these provisions deal with what happens if shareholders cannot agree on issues affecting them either because the board is at odds with shareholders who are blocking a reserved matter or because equal shareholders disagree on a course of action. There are a number of options available here depending on the circumstances and shareholder dynamic.

What if there is no shareholder agreement in place?

If an issue arises between the shareholders and there is no shareholders agreement or bespoke articles of association in place dealing with the issue, the options can be very limited. Often, the remedies available are drastic (resulting in the company being wound up) or the shareholders engaging in lengthy and expensive litigation, using the blunter tools provided by the legislation to prosecute their claims.

While a shareholders' agreement cannot prevent every dispute, they can be a very useful in avoiding and managing such difficulties. Notably, they force the shareholders to consider, negotiate and commit to objectives and methods of resolution ahead of time, often meaning that the dispute does not arise. They are also invaluable if shareholders have different goals. This can be the case if a company has founders, investors and strategic shareholders.

Articles of Association

The articles of association are usually tailored to complement the terms of the shareholders agreement. They must contain certain provisions relating to the internal regulation of the company but, in broad terms, the company has some freedom in relation to content. When appropriate and permissible, the articles will often seek to rebut or enhance the standard member rights / obligations provided under the legislation.

As a general rule, the articles are categorised as a form of contract between the shareholders, but the terms must relate to their status as "members", which restricts what can be included. Furthermore, the remedies differ to regular contracts and not all of the shareholders need to consent to an amendment. Critically, unlike a shareholders' agreement, articles are not a private document and must be filed at Companies House.

For these, and a number of other reasons, it's very important that the arrangements agreed between the shareholders are included in the correct document and that there are clear provisions on which terms take priority. It can be difficult to successfully achieve this without taking professional advice.

The sorts of issues that might commonly be addressed in a company’s Articles are:

• Share rights – the rights "attaching" to shares (notably, voting, income and capital) and the details of any different share classes.
• Shareholder and director meeting – how meetings of directors and shareholders are convened and held, including how many must attend in order for the meeting to be quorate, the notice requirements and appointment of proxies.
• Director appointments and removals – how the directors will be appointed and removed, including any requirement for them to retire by rotation, along with the maximum and minimum number of directors required.
• Income and capital rights – how dividends will be declared and distributed and, if economic preferences have been agreed, how capital will be distributed to share classes on a winding up (or share proceeds dealt with on a sale of the company).
• Tag and drag provisions – the ability to force minority shareholders to sell their shares to a third party if a majority has agreed to sell the company (drag-along) and for a minority shareholder to insist on participating in such sale (tag-along).
• Anti-dilution rights – restrictions on the issue of new shares, which could dilute existing shareholders’ interests, including pre-emptive rights to subscribe for the new shares.

How can we help

Our corporate team are highly experienced in advising on and preparing both shareholder agreements and articles of association. Please contact any member of the team for more information.