When there are two or more shareholders in a limited company, in the absence of an express agreement between them, they must rely on the company’s Articles of Association to regulate their relationship with each other and with the company. However, while the Articles of Association will govern such fundamental matters as the issue of new shares, the administrative procedures surrounding shareholder decisions and board meetings, they are unlikely to influence the day-to-day running of the business, or many of the issues that shareholders care about. For example, companies generally have no provision for what happens if a shareholder wishes to leave the company, or if some of the shareholders wish to remove or buy out others.
Shareholder agreement provisions
This is where a shareholders agreement comes in. A shareholders agreement is a contract between the shareholders (and, usually, the company as well) which governs the relationship between the shareholders and places some degree of control over the day to day business of the company. A shareholders agreement will commonly provide for the following:
- restrictions on shareholders selling their shares. Without such restrictions, a shareholder can freely sell his shares, which might result in the remaining shareholders being in business with someone they do not know or approve of;
- the ability to force certain shareholders to sell their shares to the others. This can be useful if there is a shareholder who is not “pulling his weight”, commits some wrongdoing, or in the event of the death or bankruptcy of a shareholder;
- determination of the correct price to be paid for shares should a shareholder wish (or be forced) to leave the company;
- restrictions on the issue of new shares, which could change the proportions in which shareholders own the company, or bring in new shareholders, thus diluting the existing shareholders’ interest in the company;
- rights of shareholders to nominate a director of the company;
- restrictions on the way the company does business, for example in the spending of large sums or committing to big contracts, or employing staff on excessive salaries. These are not matters in which shareholders in would otherwise have any significant say ;
- restrictions on what shareholders may do outside the company. For example, shareholders might be restricted from competing against the company or poaching its staff. These restrictions may also apply for limited periods after someone ceases to be a shareholder, thus providing the company and other shareholders with some protection against competition from former shareholders;
- what happens if the shareholders simply cannot agree on issues affecting them and the company. There will often be provisions in a shareholders agreement for breaking deadlocks.
What if there is no shareholder agreement in place?
If there is no shareholders agreement in place, for as long as shareholders agree with the way the company’s affairs are managed and are happy with the relationships between themselves and the company, then no problems are likely to occur. However, when these matters break down, there is little in the general law than can be of much help – often the solution is drastic and results in the company ceasing to exist, or the shareholders engaging in lengthy and expensive legal battles. While a shareholders agreement cannot prevent every dispute, they can be a very useful tool in avoiding and managing such difficulties. They are also invaluable where investors in a business wish to have an exit plan which the other shareholders agree in advance. It is therefore essential that shareholders reach a formal agreement between themselves at an early stage in their relationship, highlighting and dealing with any potential problems in advance. Too often people embark on business together believing that they are in agreement on all important issues and thinking that they do not need any formal contracts in place, only to regret it when disagreements arise.
A note of caution on shareholder agreements
Some of the matters which shareholders may feel govern the way they deal with each other and with the company, such as how and when they may transfer their shares, are better dealt with in the company’s Articles of Association. This is because a shareholders agreement is a contract between the shareholders and as such any action taken in breach of it may lead to a right to claim damages, but will usually not affect the legal validity of the act complained of. For example, a transfer of shares in breach of a shareholders agreement will usually be a perfectly valid and legal transfer, even if the other shareholders have a claim for breach of contract. The claim is only worth anything to the other shareholders if they have suffered any loss, as the normal remedy for a breach of contract is to be awarded compensation for losses caused by that breach.
However, if the relevant matters are in the company’s Articles of Association, then the rights of the aggrieved shareholders are stronger, because a company cannot act outside the provisions of its Articles. Therefore, for example, a transfer of shares which is not permitted by the company’s Articles will often be legally invalid. It can thus be very helpful when entering into a shareholders agreement to review and, if necessary, amend the company’s Articles of Association.
For more on Articles of Association, click here.
How can we help?
We are very experienced in advising on and preparing shareholders agreements. We can also advise on the initial setting up of the business and on the other legal issues that arise in running a business, such as property and employment matters and all kinds of commercial agreements. If you have any questions or are looking for information on shareholders agreements or any other business law matter, please contact Charmaine Dudman.